Posted at 4:45 pm on Monday, July 27, 2009, in Politics, and tagged economics, social security, taxes.
The title of this post is not as accurate as it probably could be, but “Eliminating Social Security and Implementing a New, Improved Federal Retirement System” doesn’t have the same ring to it. I’m pretty sure it wouldn’t fit on one line, and that’s the type of stuff that eats away at me.
Current (and presumably future) efforts to “fix” Social Security are mostly, if not entirely, empty gestures, because none of them do anything substantive to change the dynamics of the actual problem (that taxes in will be far less than payments out), and merely serve as band-aids, temporary band-aids at that, similar to Congress enacting one-year fixes to the Alternative Minimum Tax, year after year. A one-year “fix” is not a fix. It is a stop-gap measure.
And to fix Social Security means a complete overhaul.
Step 1: Eliminate Social Security.
This is the costliest of items, because the system cannot be simply eliminated, and must be phased out. And the transition cost is huge (in the trillions). The reason to eliminate the program is clear: the mathematical formula to pay for the benefits promised (today’s workers pay for today’s retirees) is broken, and will not ever be fixed in such an insurance-based-only system (unless benefits are drastically reduced, and in such a case, the Social Security program as we know it becomes seemingly worthless). The reason for the hefty cost to switch is also clear: all of the system’s obligations must be paid in full. I will make no exceptions.
So what would a phase-out look like? First, no new members. Anyone who is joining the workforce will have no idea what Social Security is (and they’ll thank us for it). Second, a mandatory buy-out of all members under the age of thirty or all members with less than ten years of work history. The buy-out would come by way of tax deductions or tax credits or lump sum payments (or a combination). These details need to be ironed out. Third, an optional buy-out with members under forty or with less than twenty years of work history. The enticement alone should whittle down close to a half of workers in this category, and to keep the transition costs as low as possible, the more people that opt out of the system at this preliminary phase, the better. Lastly, full payment of obligations promised to everyone else, to the last penny. (The survivor and disability payments may need to be revisited however, to make the phaseout work that much easier, that is, without bankrupting the nation.)
Step 2: Establish Federal Retirement System.
Also known as FedRets. Okay, that nickname will probably not stick; I wouldn’t want it to. I’m not sure what to call it exactly. The Federal Retirement System (FRS) will consist of tax-deferred investment accounts. Now, don’t shake your head. (This is a 401k system.) The investments will be partially insured by the federal government. That is the big difference. (Ok, you are at least sitting again. Let’s move forward. Take a breath.)
This is how it works. An investment portfolio will exist for each of the twelve federal banks: Boston, New York, Philadelphia, Richmond, Atlanta, Cleveland, Chicago, Minneapolis, Dallas, St. Louis, Kansas City and San Francisco.1 Each portfolio will consist of a series of target-year funds in five-year increments matched for estimated retirement dates for workers (say, Philadelphia 2040 and Atlanta 2065), as well as a (conservative) bond fund and (higher-risk) stock fund.2 In all, there will be dozens of funds to choose from. Individuals will not be limited in any way to invest in the individual funds (except for the stock funds capped at 20 percent), e.g., a Seattle worker’s FRS portfolio can consist of 50% Cleveland 2050, 40% Atlanta 2050, and 10% Chicago Bond. (The default choice, if none is chosen upon start of employment, would be your expected retirement year in the governing federal bank in the locality under which you live.) The FRS will not be employer-based. Employers will simply be required to incorporate the FRS into their accounting procedures. The FRS would remain if workers switch jobs. (There would be no roll-overs or lost 401k accounts. Your investment options would always remain consistent.)
Individuals would be required to invest ten percent of their income (pre-tax, no less, no more) into the FRS, up to $25k per year, with that value indexed for inflation. An additional ten percent (up to $25k, also indexed) can be separately invested in a 401k, IRA, etc. Defined benefit plans or pensions would also be treated separately (on top of the FRS), but every American will be required to partake in the FRS. The investment funds would be managed by brokerage houses under fixed contracts. New York, for example, could be run by Goldman Sachs, and San Francisco by Charles Schwab. The managers would change over time.3 For example, a worker in San Francisco would create an account with Schwab and be able to purchase whatever funds were available from any of the regions, fully administered and controlled by the worker, similar to a 401k. If Schwab’s contract with San Francisco was not renewed, and Vanguard resumed control, the worker would have the option to transfer the account to Vanguard or remain with Schwab, which is where they may also have an IRA and college savings plan. The fund managers would be responsible for the investments (with oversight by the Federal Reserve), and individuals would have limitless freedom to move their account. Employers would facilitate the account set-up with an investment firm (most likely coinciding with their 401k administrator).
The federal government would protect and insure retiree assets. The guaranteed rate of return for individuals would be on the order of 4 to 6 percent. Fortunately, the government would only need to insure benefit payments (i.e., retirement income) in down periods, not the entire investment portfolio nationwide continuously. A 1 percent tax on incomes over $250k, with no limit (and indexed for inflation), should provide this buffered form of insurance.
Even if individuals saved and invested ten percent of their income every year, their retirement could still be in jeopardy (not including market fluctuation, which would be covered by the aforementioned insurance), by way of disability, long life, etc.4 This is the insurance portion of today’s Social Security (which goes above and beyond what was expected when first enacted in the wake of the Great Depression), a welfare type of program, however it may be necessary. That being said, individuals should not be able to plunder their retirement accounts and then be covered by such welfare. A minimum and maximum deduction may need to be included as part of the FRS (with the numbers indexed for inflation). This should not disallow individuals from purchasing a boat if they can afford it, but likewise, it shouldn’t allow individuals to purchase a boat if they cannot. The FRS would complement other savings vehicles with lesser restrictions (401k, IRA, etc.), so those that can should still be able to. The FRS is meant to stabilize retirement for every individual. The welfare aspect of the FRS would be covered with a progressive tax on those making over $250k (indexed for inflation): 1% up to $1m, 2% up to $2.5m, 3% up to $5m, and 4% as the top rate, with no limit on income. (All of those figures would, of course, be indexed.) These tax monies would, in essence, be a rainy day fund for the nation’s retirees.
The benefits of a retirement program that I have just described sells itself. It allows individuals to save and invest up 20 percent of their income tax-deferred: ten percent would be mandatory as part of the FRS; the second ten percent would be optional and outside of the FRS (and pensions, presumably less-costly than now, would be on top of that, as applicable). Retirement age would be set at 65 (why not, it’s not the government’s money), and indexed based on life expectancy. There would be minimum (and maximum) deductions from the FRS, starting at retirement, but all assets are owned, and may be transferred upon death. Unlike Social Security, where individuals are paying into a system they may never use and others are barely paying in and reaping huge rewards, the FRS will allow those to fully own their investments. Investors would be covered in lean years (with the insurance tax, providing for a minimum return), and a welfare aspect is covered with a secondary tax on the wealthy.
The idea of ten percent of the nation’s income being invested continuously back into the economy is akin to a monthly stimulus bill the world cannot fathom on its own. The FRS eliminates the nation’s costliest expenditure (Social Security coupled with Medicare) and removes it from the balance book altogether. The FRS is a social program (at heart, at least) and a capitalistic approach (with the associated benefits). It is a win-win. It is the Federal Retirement System. It is my child. I now release it for the world to see, and it will make a name of itself if it is indeed worthy.5Notes
- You know, the cities stamped on the dollar bills we use everyday. ↩
- Ownership of stock funds will be limited to 20 percent of an individual’s portfolio at any time. ↩
- There would clearly be a lot of competition to run these individual funds, with companies sacrificing higher expense ratios for the gross fees of such large accounts. ↩
- Health costs would not be a concern following the implementation of my universal health care plan. ↩
- I’ll hold my breath, but you should release yours. ↩