NCPA - National Center for Policy Analysis


November 16, 2004

Adopting personal retirement accounts would save Social Security and in so doing make the tax code more efficient, says economist Laurence Kotlikoff. He says the President Bush's plan and the concerns of Democrats can be reconciled with a three-part plan he calls the Personal Security System (PSS):

  • PSS would replace the regressive Social Security's payroll tax with a federal retail sales tax.
  • It would eliminate any further Social Security benefit accrual, paying only the benefits now owed current retirees and current workers.
  • PSS would establish an individual account system.

Replacing the payroll tax with a national sales tax would expand the tax base as well as encourage investment, says Kotlikoff. Currently, the payroll taxes only tax wages up to $87,900; a sales tax effectively taxes all wages and all wealth.

The existing Social Security system, which is currently 40 percent underfunded, would be replaced with a more modern alternative:

  • Contributions by workers formerly made to Social Security would be split evenly between spouses and invested in individual accounts; the government would provide matching contributions for low earners.
  • All account balances would be invested in a single market-weighted index fund; a government guarantee would insure that workers gain from the government investment in the market.
  • At retirement, personal account balances would be gradually sold off and converted to inflation-indexed pensions.
  • The Social Security Administration would handle all the investment and pension conversions; Wall Street would play no role and collects no fees.

While the contributions to PSS would be compulsory, the accounts would be private property, says Kotlikoff. Workers could reduce their non-PSS saving if they are already saving enough on their own.

Source: Laurence Kotlikoff, "How to Fix Taxes and Social Security," Washington Post, November 7, 2004.


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