Higher Taxes And Lower Benefits Will Only Make Social Security Worse

Last summer, Congressional Budget Office scored 30 potential solutions for Social Security for the effectiveness of each in dealing with the financial imbalances in the system. Every solution was either a tax increase or a benefit cut. More recently, the President’s Financial Commission on Fiscal Responsibility outlined yet more solutions which consisted of benefit cuts and tax increases. It is a frightening statement on how little our leaders understand the problem.

The solvency of the Trust Fund is not the primary problem in Social Security. The question of solvency is the unavoidable outcome of a deeper problem within the system, return on contribution(“ROC”). It is terrible, particularly for younger workers. If so raising taxes and cutting benefits will only make the core problem worse and the whole system less stable because while these solutions will make the Trust Fund last longer, it also discourages people from participating.

Social Security is unfortunately a pay-as-you-go system for which the Trust Fund provides very little economic support. According to the Social Security Administration, the OASI Trust earned only 118 billion dollars in 2009 while distributing 564 billion dollars in payments . Moreover, the role of the Trust Fund in providing for Social Security benefits is likely to drop going forward . So the solutions in Washington largely provide 15% of the solution and put the rest of the system at risk.

The problem is return on contribution. When the ROC drops, so does the willingness of people and business to participate. They either evade or avoid the system. In a recent study, it was estimated that two trillion dollars of the economy is underground hiding from the tax man . The hidden economy costs Social Security as much as 250 billion dollars last year. The larger problem is that the ROC encourages business to allocate labor earnings away from wages into benefits which are not subject to FICA tax. Data from the Labor Department shows that wages are only 70% of employee compensation. The remaining wages are paid in benefits which are not subject to FICA taxes.

How bad are the returns in Social Security today? Last summer, the government provided a periodic moneys-worth study of the Social Security system, which compares a dollar of contribution with the present value of future benefits. A moneys-worth ratio of 1 means that you are getting back exactly what you put into the system. In the report, the government predicts that some workers will get back as little as .50 cents on the dollar . The report paints, however, a rosy picture of the real returns from the system by using assumptions which artificially inflate the ROC. The report assumes that all workers given a choice would invest the money as poorly as the Trust Fund does. Social Security for younger workers isn’t terribly different than spending quarters to buy dimes.

Washington’s solution to this problem is to get younger workers to spend quarters to buy nickels.