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The Greediest Generation

Stephen W. Stanton

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Social Security is falling off a cliff, taking baby boomers down with it. There are two ways to avoid a hard landing: We can deploy a financial parachute, or we can soften the impact by landing on our children.

Social Security is a pay-as-you-go system. Simply put, benefits are paid from current tax receipts as soon as they are collected. Today, there are 3.4 working taxpayers for every Social Security beneficiary. According to the Social Security Administration's own estimates, that ratio should drop to 2.1 per retiree by the year 2030, perhaps even lower. No matter how hard politicians try to spin it, the math is immutable. There will be fewer workers to "pay", and more retirees to "go".

To illustrate, the current Social Security tax rate is 12.4% of most wages. The pool of money potentially available to each current retiree, then, is 12.4% of the average wages of 3.4 workers. Simple multiplication reveals that a typical Social Security recipient could potentially receive benefits equivalent to 43% of an average taxpayer's income. Holding the tax rate to its current level, retirees in 2030 would make far less on a relative basis. A tax of 12.4% on 2.1 workers could only provide 26% of an average wage to seniors, a 38% decrease from the current benefit pool. To bring retirees back up to today's standards, the Social Security tax rate would need to be over 20%, an increase of 62% over the current rate.

The bottom line is that under the current pay-as-you-go system, benefits would decline, or taxes would increase dramatically, or both. Since taking away retirement benefits from seniors is politically unfeasible (though the 1983 plan to "save" Social Security was a dramatic exception), it seems probable that increasing taxes is the path that we will follow.

Who would pay these taxes? Our kids. Generations X and Y will be in their peak earnings years as they are hit with higher payroll taxes. Their children, too will already be in the workforce, shouldering the burden imposed by grandparents that lacked the foresight to anticipate such an obvious fate. This would make today's workforce the greediest in history, spending the earliest years as a burden to parents who endured the Depression, WWII, and 70's stagflation, while spending our golden years as an unprecedented burden to our sons and granddaughters.

But we do not have to crush future taxpayers. There is a better way for a softer landing, an alternative that is better for our children, better for the economy, and much better for retirees of today and for years to come. The answer is the "P" word. Privatization offers workers a way to fund their own retirement. With real assets under their own names, retirees are protected from benefit cuts, regardless of future demographics.

Critics of privatization point to the recent stock market declines to scare voters into opposing privatization. And the market has indeed declined considerably in the past two years. However, this fact makes the critics' scare mongering no less preposterous. Even at September's lows, the lowest monthly closing level in five years, the S&P 500 was roughly twice its level of ten years ago, for an annual return of 6.9%. Going back to September 1990, the annual return jumps to 8.5%. Even going back all the way to September of 1960, the S&P 500 has returned 6.7% annually.

This is a critical point, since private Social Security accounts would never be intended for short-term investors. Workers contribute a portion of each paycheck from their very first days in the workforce continuing throughout their careers. A typical worker would build up assets for forty years, from age 25 to 65. Upon retirement, assets would be drawn down slowly, for perhaps thirty years or more. With an individual account active for the better part of a century, short-term fluctuations are meaningless, only long-term trends matter.

When temporary market downturns do occur, workers can benefit through "dollar cost averaging," buying additional shares at a discount. Seniors would not be especially sensitive to market declines if they rely on investment income to fund their benefits instead of capital gains. They should invest in high quality assets yielding reliable dividends and interest payments, so that no stock must be sold in a downturn to fund retirement benefits.

Those who oppose private accounts ostensibly favor the current system. As illustrated earlier, there are only two ways to preserve the current system: higher taxes or lower benefits. To put it another way, adherents of the current system force us to choose between sticking it to senior citizens and sticking it to our children.

Some in favor of the current system suggest that Social Security's "Trust Fund" offers an escape from this economic reality. They believe we can simply draw down the trust fund to pay retirement benefits. One problem: There is no trust fund. That money was already spent. All that is left is a stack of IOU's from another department of the federal government. The government would have to find some way to pay those IOU's, and there are no easy ways to do that. Picture a two-income family with no money in the bank. The wife cannot pay bills with IOU's from her husband. She needs real money. Similarly, as baby boomers retire, Social Security benefits will soon exceed Social Security taxes. Regardless of how many IOU's there are in the trust fund, benefits can only be paid through some combination of increasing deficits, raising taxes, or cutting spending on programs, such as national defense and education.

The critics of Social Security privatization, most of whom are Democrats, can run on fear, or they can run on facts. But not both. They can't fool everybody for too much longer. Pretty soon, our children will grow up.

Stephen w. Stanton works in finance in New York City.

This article originally appeared on Tech Central Station. Reprinted with permission.

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