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For Social Security, the Greatest Risk is the Status Quo

5 min readBy: Scott Hodge

I want to say first how delighted I am to be the new executive director at the TaxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. Foundation. Under my direction, the Tax Foundation will continue to monitor tax policy at all levels of government, disseminate relevant tax data and publish cogent, unbiased policy analyses. These are the activities that we engage in to advance a principled approach to tax policy.

When I say “principled approach to tax policy,” I am referring to the Tax Foundation’s principles of taxation. The first of those is that a good tax system requires informed taxpayers who understand what is being taxed. Several principles follow from this one: that the tax system should be as simple as possible, that it should be as stable as possible, and that changes should never be retroactive.

The purpose of the tax system is to raise needed revenue, not to micromanage the economy with subsidies and penalties. Therefore, taxes should be broadly based, and the rates should be moderate. We should aim for neutrality, favoring neither consumption nor investment.

The U.S. tax system must be competitive with those of other industrialized nations. Therefore, our tax system should not impede the free and fair flow of goods, services and capital by penalizing imports, exports, U.S. investment abroad or foreign investment here.

Since we have been pursuing this non-partisan, principled approach to tax policy for many decades, reporters have learned what a valuable resource we are. They call everyday, sometimes for interviews but often just to fact-check their stories or to get a basic understanding of a particular tax issue as background for a story. The appearance in a newspaper of the words “Source: Tax Foundation” underneath a chart or table has always been our most frequent citation in the press, and while we actively seek to play a greater role in providing policy analysis, we are always glad to simply provide objective data that we have culled from hundreds of governmental and private sources.

We often provide information and educational opportunities directly to lawmakers and their staffs. The next couple months will be exciting politically, and as the election nears, the Tax Foundation will produce a variety of economic analyses examining the major fiscal policy initiatives put forth by the presidential candidates.

I hope to use this space as my predecessor, J.D. Foster, did–to offer some insight on the issues of the day. In the space I have left, I’d like to touch briefly on the issue of Social Security reform.

In discussions of Social Security privatization, commentators often refer to future economic downturns as events that will wipe out the retirement savings of people who have invested in the stock market. While there is always risk in the stock market, these critics fail to mention how devastating economic downturns are to the current Social Security system–a system already heading toward bankruptcy.

As most Americans now know, Social Security will begin spending more on benefits than it collects in taxes in just fifteen years, and will continue to run cash deficits as far as the eye can see. According to Social Security actuaries, under moderate economic conditions, these cumulative cash deficits will total $21.6 trillion by 2075–six times the current national debt.

If nothing is done to reduce liabilities, the government will have to raise payroll taxA payroll tax is a tax paid on the wages and salaries of employees to finance social insurance programs like Social Security, Medicare, and unemployment insurance. Payroll taxes are social insurance taxes that comprise 24.8 percent of combined federal, state, and local government revenue, the second largest source of that combined tax revenue. es by 36 percent (to 16.8 percent from 12.4 percent), or borrow more than $11 trillion just to keep the system afloat until 2037, when the trust fund is expected to run out of IOUs. If politicians decide not to hike taxes or increase the national debt, they will have to cut Social Security benefits by at least 26 percent to make the system’s costs match its revenues.

But that’s the good news. The bad news is that an economic downturn would make these figures look rosy. Under what Social Security actuaries call the “High-Cost” scenario (where economic growth slows by 30 percent while inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. rises by one-third and unemployment rises 18 percent), the system will begin running cash deficits by 2010 and the trust fund will run out of IOUs by 2025. Through 2075, the system would face a total cash shortfall of $29.5 trillion.

To cover these shortfalls, the government would eventually have to double the payroll tax or boost income taxes by nearly 30 percent. Otherwise, Social Security benefits would have to be cut in half.

While some may say the nation can “grow” its way out of the problem, Social Security’s actuaries estimate that even under more robust economic assumptions, the system faces a total cash shortfall of $7.6 trillion–twice today’s national debt.

These sobering statistics are inescapably linked to Social Security’s basic design: It is a defined benefit, pay-as-you-go program reliant on a shrinking pool of workers to pay for an expanding population of beneficiaries. The only way to reduce these unaffordable liabilities is to do what countries as diverse as Chile and the Czech Republic have done–gradually replace defined benefit social insurance systems with defined contribution systems. This allows workers to invest a portion of their payroll taxes in personal accounts that they own and control.

Ironically, the Reagan administration made identical reforms to the old Civil Service Retirement System, which faced financial collapse in the early 1980s. Federal employees can now invest in their version of a 401(k)–called the Thrift Savings Plan–whose stock fund has delivered an 18.18 percent compounded rate of return over the past ten years.

Allowing ordinary workers the similar option of investing a portion of their payroll taxes in Personal Retirement Accounts is not a quick fix for what ails the Social Security system. But given time, such reform will relieve the government and taxpayers of a tremendous financial burden.