According to most Washington observers, debate on how best to reform or restructure the Social Security system will soon begin. No doubt it will be a lively discussion, for the mythology and lack of understanding of how the system works is very pervasive. Hopefully, one result will be a better understanding of the program by lawmakers and the public.
As I understand the major proposal, the objective is to produce a better return on the deposits of future retirees. At the outset, it should be noted that this is a specious assumption and the reason can be found on the bottom of many Coke bottles: “No DepositNo Return.” There is no deposit, or fund, standing to the credit of any individual at the present time and therefore there is also no “return.” The often maligned trust funds, which do earn interest, are simply a mechanism to balance the inflow of revenue and outflow of benefits in years when they do not match. Changing the system to create individual accounts is a major shift in both economics and philosophy.
Because such a proposal is a dramatic change, the debate needs to address important and difficult questions. In many respects, questions are more important than answers. If you ask the wrong question, even if it is answered correctly, you are still on the wrong track. In that spirit, I would like to lift up a few questions that should be asked and hopefully the answers will be forthcoming.
When you move from a plan that has no vested individual accounts to one that provides them, there is a cost. It is somewhat analogous to a person converting a term life insurance policy to whole life. Costs for converting the Social Security system, creating individual accounts with some of the revenue, range from $1 trillion to $2 trillion, by some estimates. Therefore, the big question to be answered iswho pays for this?
Will taxes be raised for participants with special accountsmuch like converting from term to permanent insurance? If taxes remain the same, will participants trade part of their survivor and disability benefits for better retirement benefits? If neither of these options are acceptable, then that leaves the general fund footing the bill. Where will that money come from?
In the event individual accounts within Social Security become a reality, then equally vexing questions arise in regard to their management. Accounting and administrative costs associated with millions of small accounts would likely absorb much of the gain that might be achieved. Therefore, it is most likely these accounts would be pooled much like a 401(k). And how would that work?