Social Security or Personal Financial Security?
by Fred E. Foldvary, Senior Editor
Social Security reform is now hot. The president is proposing shifting some of the Social Security taxes to private accounts. But there is much confusion about the two aspects to reforming Social Security.
The first problem with social security is that it is out of balance. There is at present a surplus because of the large baby-boom population still working. They will be retiring and getting social security payments in ten years. The projections depend on the growth of wages and on expected retirement ages, but around 2020, Social Security will start paying out more than it takes in, depleting its treasury-bond trust fund. Around 2040, the trust fund will be depleted, and Social Security will have a deficit.
The deficit can be dealt with in several ways. 1) The federal government can finance it. 2) SS benefits can be cut. 3) SS taxes can be increased. 4) Massive immigration of young workers can increase the revenues. 5) The entire SS system is privatized, the transition financed by a national tax on land values.
Politically, the most likely way the system is put in balance will be a combination of the first three, the rate of increase in future benefits reduced by using the increase in consumer prices instead of wages as the index. A bad way to decrease benefits would be to tax social security income even more than it is now. Workers' wages are already taxed, and SS is supposed to be wages returned to workers at retirement, so taxing SS income is deeply unjust.
The second problem with Social Security is that it reduces savings and provides less retirement income than private accounts. To compare Social Security with a fully private account, consider a 20 year old man born in 1950 who will work for 45 years at $40,000 per year, with a real net return on investments of 4 percent. (The numbers assume zero inflation; with inflation, the numbers would just be higher, but the relative amounts would be the same.) The Social Security calculator says he would get $13,500 per year starting at age 65. (Enter 1/1/1950 for the date of birth, $40,000 for income, 1/2015 for the retirement date, and use today's dollars.) The monthly benefit is $1149, for an annual income of $13,788.
Now let's calculate putting 12 percent of the wage into a private account (I am taking out the portion of SS that pays for medicare). This includes the employee and employer portion of social security. With an income of $40,000 per year, the monthly investment is $400. Assume a modest tax-free real rate of return on investment of 4% (with inflation subtracted out). On retirement, the investment would have grown to $605,800, which would be put into an immediate annuity. (To calculate the amount, go to savings calculator and enter zero for the initial amount, 400 for monthly savings, 4 for interest rate, and 45 for term of investment.)
Now go to the annuity calculator. Use California for the state, 65 for the age, male for the gender, and ignore the spouse settings. Enter $605,800 for the dollar amount. The result is a single lifetime income (with no beneficiaries) of $3870 per month, or $46,440 per year. The ratio of private to SS income is 46440/13788, or 3.4 times higher! The annuity income is a bit less for women, since they live longer, but still much greater than social security.
The numbers are clear. Private accounts would be much better for a worker just starting his career. Private accounts are also better for the economy, since they increase the amount of savings and investment, and therefore increase the growth of the economy.
The problem is the transition, since folks already in the system would still be drawing out money, with no new money coming in. The president's proposal for a partial privatization would borrow the money, adding to the federal deficit.
But the transition could be financed by a national tax on land value, paid by the states in proportion to their population. This constitutional method of public finance was used several times by the federal government in the first decades after independence. The War of 1812 was financed by such a direct tax. The SS spends about $500 billion per year. The total amount of land value in the U.S. is at least $10 trillion (not counting the rental value of oil, minerals, the radio spectrum, and other natural resources).
A national land value tax of $500 billion would be economically feasible. The first effect would be a dramatic reduction of real estate prices, as taxing most of the rent would greatly deflate land prices. But unlike taxes on wages and capital, the effect of a land-value tax on the economy would be positive, since it would put idle land to full use. A taxed investor will invest less, and a taxed worker will work less, but taxed land will produce more, not less, because the idle land pays the same tax as a plot put to its best productive use. A more productive economy will then raise land rents, while the money that formerly went into SS and land purchases would now be invested in more capital goods, better worker skills, and improved technology. The US economy would surpass China in growth, further raising wages and rent.
Those who recently bought land would rightly point out that they how have to pay a tax on their deflated land value while also having to pay their old mortgage. Those who recently sold land would gain at the expense of current owners. The economic hardship by some landowners and the associated political opposition could be overcome by having the federal government sell special land-tax bonds. The bond revenue would be used to compensate landowners for the loss of land value. The bonds would be perpetual, without a maturity date, and the interest income would be tax-free. Their face value would be adjusted annually for price inflation, but the interest rate on the face value would gradually diminish to zero over 40 years. There would be a market for the bonds, and bondholders could sell the bonds at any time.
After the transition to private accounts is complete and social security is abolished, its insurance aspects either privatized or shifted to other programs, the land-value tax would be used to buy back the bonds. With a rapidly growing economy, increasing rent, and diminishing interest payment, the bonds would gradually have a reduced market price and would eventually all be redeemed by the government, and then the land-value tax would replace the federal income tax.
President Bush stated that he is open to all ideas for reforming Social Security. So I hereby propose the use of a national land-value tax to finance shifting to private accounts. But I don't expect the President or Congress to support this plan, or even discuss it. No major newspaper will even bring it up. They will refuse to discuss it because it is politically infeasible, and it is politically infeasible because there is no public support, because the major media will refuse to mention it. Nevertheless, let the record should show that it was proposed, and could have solved the problem while boosting the economy.
There is hope, though. If you think this is a good idea, write a letter to your local newspaper. Discuss it with your friends. The Social Security problem would be just the right opportunity for a shift not only to private retirement accounts but also to eventually shift federal taxation from income to land value. Social Security is a lemon. Let's make lemonade!
-- Fred Foldvary
Copyright 2005 by Fred E. Foldvary. All rights reserved. No part of this material may be reproduced or transmitted in any form or by any means, electronic or mechanical, which includes but is not limited to facsimile transmission, photocopying, recording, rekeying, or using any information storage or retrieval system, without giving full credit to Fred Foldvary and The Progress Report.
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