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Retirement Planning > Social Security > Social Security Funding

Larry Kotlikoff Would Tell Biden to Scrap Social Security, Start New System

By Ginger Szala

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What You Need to Know

  • We asked economist Larry Kotlikoff what advice he'd give the Biden administration.
  • One idea: Replace Social Security with a system of government-managed investment accounts.
  • The tax system is unfair to both poor and wealthy Americans, he says.

Economist and retirement expert Larry Kotlikoff isn’t optimistic about the United States’ fiscal direction, and it seems like he wants to change everything: the tax system, Social Security, health care, education. He even wants to change government accounting to a fiscal gap system akin to the European Union.

This is what he explained when we asked: What would you tell the Biden administration to do if you could?

“The first thing [people] need to understand is our fiscal policy, and that includes understanding the sustainability and its work, saving and investment disincentives,” he tells ThinkAdvisor. “The big picture [is] this country is probably in the worst long-term fiscal shape [of] any country in the world because we have so many obligations off the books.”

That’s a rough start, but really it’s the increasing U.S. debt, Social Security and the health care system that worry him.

“We’ve had a massive increase in the official debt … and if you look at Social Security’s unfunded liability equation, that’s $53 trillion — that was from last year’s Trustees Report,” says Kotlikoff, who has been a consultant to multiple Cabinet departments and has written several books on Social Security.

“If you put into one balance sheet all the projected outlays valued to present, and compare that with the present value of all the receipts, and then add in the liability side, the net debt of the country … you have a fiscal gap that’s roughly eight years of GDP,” he says. “No one’s looking at [the] long-term picture and what bills we’re leaving for future generations.”

Here’s how he would change Social Security and the tax system.

Retiring Social Security

“I would retire the existing Social Security system the way corporate America has retired, since the mid-1980s, the defined benefit pension plans. You freeze the existing system, start a new system at the margin and pay off accrued liabilities … pay what you owe under the existing system,” he says.

To do that, he recommends freezing accounts of those, for example, currently at age 40. When these workers retire, they would get Social Security benefits based on their earnings up to age 40.

He would maintain the payroll tax — “we need the revenue” — but recommends that people put 10% of their pay into a personal retirement account. The government would make matching contributions on behalf of the poor, he says.

These accounts would be government-invested “by a computer in a global index fund of stocks, bonds and real estate investment trusts” of major markets.

Everyone would get the same rate of return, “so the government would guarantee your return on contributions,” providing a floor for retirement. However, each person could augment their account accordingly with added contributions. Kotlikoff says Wall Street wouldn’t “get a penny” in managing these accounts.

“Investing in the global markets over a 40-year span pretty much ensures a positive average return,” he says. Then, between age 57 and 67, the person’s account would be gradually sold off at market prices and invested in inflation-indexed government bonds. After five years, that age group would start getting annuities paid from those government bonds. Those with twice as big an account would get twice the benefits.

Spouses and ex-spouses would also be protected, he says, but the point would be a retirement system that is risk-free to future generations.

“Each generation is on its own tub, so to speak,” he says. “That’s what it means to be fully funded, not requiring some other generation to bail it out.”

Some might say this idea is a bigger burden to those in their 30s and younger, who will not only have payroll taxes but also put in a 10% contribution, and still won’t have the security system of their parents and grandparents. He agrees, but “they also are not going to get hit with a fiscal system that’s going to fall apart, and horrendously high taxes.”

Taxes

To improve the welfare of people struggling right now, the government “should be taxing older, rich people like me rather than leave the bill for our grandchildren,” he says.

His answer is fiscal gap accounting, or the difference between the present value of all the government’s projected financial obligations, including future expenditures, including servicing outstanding official federal debt, and the present value of all projected future tax and other receipts, including income accruing from the government’s current ownership of financial assets.

Indeed, marginal tax brackets need to be revised, he says, as about a quarter of the lowest quintile of Americans — the poorest — face a total 70% marginal tax rate, which “is a heartbreaking statistic.”

This figure accounts for all taxes paid, as well as losses of benefits if they exceed income thresholds, such as losing access to Obamacare subsidies or even food stamps, Kotlikoff says.

Nor are the wealthy immune. Biden’s plan to impose a 12.4% payroll tax on earnings above $400,000 would push some highly paid workers to a 70% marginal tax rate, he says.

That, he says, could dissuade them from making that much money, or spur them to use tax avoidance tactics or even leave the country.

What about the Trump-era cuts in corporate and capital gains tax rates? They weren’t “exactly what the economic doctor ordered, but it did lower the effects of [the] marginal tax rate of investing in the U.S. dramatically compared to where it was before,” he says.

What about President Joe Biden’s proposal  to increase the corporate tax rate to 27%?

“I would recommend that they expand expensing at the same time they raise the rates,” he says. “What that does is [get] more revenue from old investments, but it allows new investments to be more favorably treated in the sense that if you invest money, you get a bigger write-off right now, which offsets the higher future tax on your profits from the investment.”

Ginger Szala

@gingerszalaink

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