Tuesday, September 2, 2008


I am frustrated by the refusal of Sens. John McCain and Barack Obama to adequately confront Social Security’s looming fiscal crunch. The United States faces a demography-driven crisis of entitlement spending.

Medicare is in the worst shape, but Social Security alone has $15.8 trillion in unfunded liabilities. The natural temptation is to do nothing, but the longer we wait, the bigger will be the shortfall and the more difficult it will be to reform the system.

Unfortunately, we can’t get by hoping to save a little money elsewhere. The national debt is $9.5 trillion and next year’s deficit will run a half trillion dollars.

Social Security was sold as social insurance, but benefits are neither legally guaranteed nor set aside in income-earning accounts. The “trust fund” is pure fiction, a public relations cover for a “pay-as-you-go” system.

The nation’s roughly 80 million Baby-Boomers have begun to retire and Social Security will be out of money in 2017. The “trust fund” is empty. Earlier this year, Moody’s Investors Services announced that it was considering downgrading federal bonds because of the coming entitlements tsunami.

Even if there is money to pay Social Security’s promised benefits, recipients would receive far less than they could earn in a private system. Nor would they own the principal, like any normal investment.

The “rate of return” (ROR), counting Social Security taxes as an investment, has been steadily falling. According to the Social Security Administration, five years ago, most low-to medium-income beneficiaries, other than one-earner couples, were receiving less than 2 percent, while most higher earners were below 1 percent or even negative. Other estimates for a steady-state return from Social Security in the future tend towards 1 to 1.5 percent.

In contrast, average annual returns have been stable over time - roughly 7 percent for stocks, 4 percent for bonds, and 5.5 percent for a mixed portfolio. Private investments yield a better return than Social Security even when including notorious downturns, such as in 1987 and 1929.

Mr. Obama proposes raising taxes, which may or may not find favor with Mr. McCain, who can’t make up his mind. But huge tax increases would be necessary to close the funding gap, and would discourage business investment, job creation and economic growth.

Moreover, tax hikes would target the wrong people. Current beneficiaries are receiving benefits based on paying lower taxes in the past. Future beneficiaries would be forced to pay more even though they already are slated to receive a lower ROR.

Some analysts propose allowing government to invest in the stock market. However, giving government trillions of dollars to invest in private companies would create an enormous opportunity for abuse.

True reform of Social Security requires shifting control of retirement decisions to workers and their families, moving from a government pay-as-you-go system to an individualized system of private accounts. In the long-term, this would expand freedom of choice, increase retiree returns and reduce government expenditures.

Private accounts would not be a jump into the unknown. In 1981, Chile switched from a pay-as-you-go system to private investment accounts. A score of other countries across Asia, Europe, and Latin America have followed Chile’s lead.

The principal fiscal challenge arising from private accounts would be the so-called transition cost, which is financing Social Security benefits for current beneficiaries while current workers are shifting tax payments into private accounts. There is no escaping this budget pain.

However, under my proposed reform - with a quick shift to private accounts and phasing new workers out of Social Security entirely - costs peak early and begin to diminish, in contrast to the present system, in which the red ink explodes and never ends.

Benefit cuts are undesirable, but trimming payments is more fair than hiking taxes, which would only exacerbate the system’s existing infirmities. First, we should adjust wage indexation, which increases benefits faster than inflation. Second, we should raise the retirement age, since life expectancy has increased by 18 years since 1935.Third, we should consider other benefit adjustments, such as fixing the consumer price index, which overstates the impact of inflation.

Other spending cuts - in corporate welfare, nonessential domestic programs, and military outlays for defending everyone but the U.S. - also will be necessary. If these reductions are insufficient to fully fund the transition, it might be necessary to consider short-term borrowing. Though not desirable, these obligations would be more than counterbalanced by eliminating today’s massive unfunded liabilities as a result of moving to a self-funded system.

We can argue about the details of any reform package, but we must act, and we must act soon. The American people deserve to have a retirement system that will provide for them, not bankrupt them.

Bob Barr, a former member of Congress from Georgia, is the Libertarian Party’s nominee for president.

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