We Can Fix Social Security, but Don’t Hold Your Breath

Insights From the Publisher: Social Security needs desperate reform. A funded account model, similar to a 401(k) or IRA, offers an attractive solution.

By Damon Elder, publisher and editor-in-chief, The DI Wire

The Social Security program is a cornerstone of retirement for millions of Americans, but it has faced significant challenges to its long-term economic sustainability for years. These challenges pop-up every few decades as the system teeters on insolvency due to the fundamentally unsound economic foundation upon which it was built – namely that it is an unfunded system that relies upon receipts from today’s workers to pay yesterday’s workers.

As a program of the federal government, this structure is completely legal; attempt such a structure as a private citizen and you will likely find yourself a guest of the Federal Bureau of Prisons for operating a Ponzi scheme.

The system requires fundamental reform, and the urgency grows each day as the retirement aspect of Social Security has been in deficit for several years, and the trust fund that keeps the system solvent is expected to run dry in the next decade. The longer we wait to address Social Security’s looming insolvency, the harder a pill it will be to swallow. The best long-term solution would be to fundamentally reform the flawed structure of the system and transform Social Security into a funded system that could become an engine of wealth creation for all Americans.

The primary flaw that has plagued Social Security since its inception is its Ponzi-like pay-as-you-go structure. This means that current workers’ payroll taxes directly fund benefits for current retirees. In order for this system to function properly, it requires a large number of workers to fund it. In the early days of Social Security, the worker-to-retiree ratio was 159:1. By the 1970s, that ratio had declined to less than 4:1, and today it’s less than 3:1. This means much less revenue to fund retirees’ benefits and, according to the Social Security Administration’s 2024 OASDI Trustees Report, the combined Old-Age and Survivors Insurance, or OASI, and Disability Insurance trust funds are projected to be depleted by 2033, after which the system will only be able to pay out about 79% of promised benefits. And the payout percentage will decline to just 69% by 2098.

Another issue is the low rate of return that Social Security provides. The system essentially acts as a giant intergenerational transfer of wealth with little to no real investment growth. Pair this with the common and persistent misperceptions Americans have about how they will pay for long-term care costs when they’re older, and the looming crisis is clear. Past research from The Associated Press-NORC Center for Public Affairs Research finds that half of Americans expect to rely heavily on government programs such as Social Security (and Medicare). But Medicare doesn’t cover long-term care and those beneficiaries expecting to lean on Social Security will have inadequate retirement income for housing and the like, not to mention their healthcare and long-term care needs.

According to U.S. News & World Report, the average monthly benefit for retirees in 2024 is $1,907 per month, while the maximum benefit is $4,873 per month. Compare this with a 25-year-old who makes $75,000 a year and sets 12.4% of her income into a tax-deferred trust. It’s just like Social Security, but instead this trust is managed by her, similar to a 401(k). Assuming a consistent 3% annual income growth and a 6% return on a conservative portfolio of stocks and bonds, her trust fund is projected to surpass $3.5 million by the time she reaches age 70, as calculated by the Foundation for Economic Research.

A funded account model, where individuals’ contributions are invested in regulated assets, offers several possible compelling advantages:

• Higher Returns: As just stated, investing in a diversified portfolio of assets has the potential to yield much higher returns than the current Social Security system. This could significantly enhance retirement savings for future generations.
• Increased Ownership: Participants would have more control over their retirement accounts, giving them the flexibility to make investment choices aligned with their risk tolerance and financial goals.
• Portability: Accounts would be portable, allowing individuals to carry their savings from one job to another or into self-employment.
• Enhanced National Savings: By channeling a portion of payroll taxes into investments, the funded account model could boost national savings and economic growth. According to the National Bureau for Economic Research, shifting to a funded model would be equivalent to a permanent increase in real income of approximately 5% of GDP.

Transitioning to a funded account model would not be without challenges. Transition costs, potential market volatility, and the need for ongoing regulation and oversight are important considerations. Overall, the process would require careful planning and consideration, and it might involve the following steps:

1. Phased Transition: Gradually divert a portion of payroll taxes, possibly 1% to 3%, into individual accounts, starting with younger workers who have more time to benefit from compound growth.
2. Public Education: Launch a comprehensive public education campaign to help individuals understand the new system and make informed investment decisions.
3. Investment Choices: Offer a variety of investment options, ranging from conservative to aggressive, to cater to different risk profiles.
4. Regulation and Oversight: Establish a robust regulatory framework to ensure the safety and security of invested funds, similar to requirements for IRAs and 401(k)s.
5. Guaranteed Minimum Benefit: Provide a guaranteed minimum benefit to ensure a basic level of retirement income for all, especially those who may have lower investment returns.

Of course, this proposed solution is almost certainly just pie-in-the-sky dreaming from an unreformed idealist and unrepentant capitalist. The last significant effort to “fix” Social Security occurred during the Reagan administration, chaired by Alan Greenspan, no less. And even under the leadership of those champions of capitalism, the fix was to simply reduce benefits and increase taxes – the same short-sighted solution that has been applied in the past to resolve Social Security’s periodic fiscal crises. All these solutions have done is kick the can down the road to future generations and destroy wealth (rather than create more).

Social Security reform of some fashion is coming, and soon. The trust fund that pays Social Security’s retirement benefits has flipped in recent years from multi-billion-dollar annual surpluses (which flowed into the federal treasury and masked the true size of our annual deficits) to multi-billion-dollar annual deficits ($70.4 billion in 2023) that must be made up from funds from the U.S. Treasury (contributing to our ballooning federal deficits and debt). Each year this deficit will grow.

What is the likely solution to our current Social Security crisis? The payroll tax rate may rise. After all, at the inception of the program, the payroll tax was 2% but has grown with each “reform” to the current rate of 12.4%. An effort to directly raise taxes yet again on all working Americans would likely meet stiff resistance from many quarters, however.

More likely is that the cap on income that is subject to the payroll tax (currently $168,600) will rise dramatically. Many people cheer this idea; make the rich pay “their fair share” is always a popular campaign theme. But Social Security was never intended to be a welfare program supported by one class of Americans for the benefit of a different class of Americans; every American who participated was supposed to benefit from the program (however meager the return on their investment may be).

Another likely “solution” will be to indirectly reduce benefits by increasing the eligibility age. This is another time-honored reform that has been employed in the past. Full eligibility for Social Security retirement benefits had historically been set at age 65. The Greenspan Commission in 1982 introduced a gradual increase to age 67. The next reform will likely increase this to age 70 or older.

The best solution to our current Social Security crisis is to fix the system: transform it into a funded system of personal accounts that would fuel massive wealth creation for all Americans and create a sustainable national retirement system. Unfortunately, the odds of Congress embracing a market solution is unlikely. The actual reform will almost certainly be a combination of higher taxes and reduced benefits.

We can blame the politicians for this likely scenario, but we should really blame ourselves. We get the government we deserve.

Damon Elder is the publisher and editor-in-chief of The DI Wire, as well as president of Spotlight Marketing Communications. He has worked in the alternative investments industry for nearly 20 years. He was previously a congressional aide and political consultant before finding honest work in the private sector. Agree or disagree? Share your views with him at damon@thediwire.com. Thoughtful replies may be published in The DI Wire.

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