Neither Candidate Has an Ideal Plan for Social Security

Neither candidate has a perfect plan for Social Security.  Al Gore's ignores the problem and does nothing to solve the fact that current Social Security taxes will not cover the baby boomers when they retire.  His plan to pay down the debt, then pay for Social Security from the interest savings is a back-door maneuver to use funds from general revenues (in other words, money that comes from sources other than Social Security taxes) to pay for benefits.

George W. Bush’s plan to use part of the surplus we now enjoy from Social Security taxes would allow us to use the time between now and 2015, when Social Security starts running a deficit, to get a better return on the money paid into the system than is now the case.  In the long-run, this is probably the better of the two plans, though the period between 2025 and 2045 (when many of the boomers will be gone) could be dicey.

There is a third option, with some trade-offs that might, just might, make it possible to get something done.  Here it is:

1) Take Social Security “off budget”.  In other words, do not include Social Security surpluses or deficits in the total federal budget calculation.  This would clarify the actual budget picture and prevent politicians on both sides of the aisle from hiding the true picture of our financial situation from the American people.

2) Go through with Mr. Bush’s tax cut plan, but only in exchange for elimination of the income cap that will stop Social Security taxes at $80,000 in 2001.  Effectively, the wealthy would get a much smaller net tax cut, while company matching would help make up the difference in revenue.

3) Allow people the option to invest 2% of their Social Security taxes in approved investments.  While many shudder at the thought of government regulation, perhaps there could be some type of minimum certification for mutual funds or other risk-spreading investments that would make them eligible for Social Security investing.  The goal would be to set a standard (i.e. average return, volatility rating, fund size, etc.), then let fund managers strive to hit the standard, if they so choose.  This would minimize some risk, while still keeping the government out of direct approval of specific stocks or funds.

4) Cap the 2% private investment to the first $80,000 of income.  This would happen today under Mr. Bush’s proposal anyway, but with the elimination of the $80,000  cap everything paid on incomes over $80,000 would go into the Social Security trust fund.  This would extend the solvency of the fund for basic benefits.  A little actuarial work can determine the correct investment caps.

The primary goal of this plan is to assure that Social Security can stand on its own.  If it is unable to do that, we face a world of hurt under any scenario.  Yes, guaranteed benefits may need to be reduced and means-testing may be necessary, but if we can develop a generation of investors with significant personal nest eggs, those realities will not be as painful.

The argument has been made that the stock market is too volatile, too risky.  Yet since the inception of Social Security the Dow Jones Industrial average has generated a 7.3% average annual return.  The S&P 500 has done even better, sporting better than an 11% return annually.  For a worker making $40,000 a year, his investment in a fund tracking the Dow would be worth $250,000 after 45 years of earnings.  A dual income couple making $80,000 would have built a nest egg of nearly $500,000.  Portfolios of this size provide a great deal of security for seniors.

It must also be remembered, that if the stock market were to stagnate for years, it would be a reflection on the economy as a whole.  Traditional Social Security funding would not be able to support the system under such circumstances either.

At some point, we will have to move from a pay as you go system.  Given our current surpluses, now appears to the our best opportunity to do that.  Mr. Gore’s plan is really no plan at all.  His so-called “lockbox” is an illusion (the Atlanta Journal-Constitution, which endorsed him, calls it fraud.)  Mr. Bush’s plan, which is bold and worth pursuing, can be made to work with some actuarial work.  But the time to act is now.

Why and How a Flat Tax Might Work

There are three reasons we should consider a flat tax:

1) It is simple - How much time have you spent filling out your Social Security returns? None. Why? Because it is a simple flat tax.

2) It doesn't require significant collection efforts. Sales taxes require a fair amount of paperwork by the collector (i.e. retailer) to report and remit. Plus, depending on what is exempted, it could be very complicated and prone to abuse and fraud.

3) It can be as fair or progressive as we want it to be. Consider these two scenarios.

A 10% tax on everything over $25,000:
A person making $25,000 or less would pay no tax
A person making $50,000 would pay $2,500 (10% of $25,000) or 5% of their total pay.
A person making $100,000 would pay $7,500 or 7.5%
A person making $1,000,000 would pay $97,500 or 9.75%

A 20% tax on everything over $50,000:
A person making $50,000 or less pays nothing.
A person making $100,000 pays $10,000 or 10%
A person making $1,000,000 pays $190,000 or 19%

As you can see, we can set the rate and the exempted amount wherever we would want to get the effective rate desired for various income levels. In example 2 above, the person making $1,000,000 makes ten times the person making $100,000, but pays 19 times more in taxes. Still, he pays no more on each incremental dollar than anyone else. It achieves both progressivity and fairness.