Insider Darwin Abrahamson

The Social Security Act enacted in 1935 was supposed to provide a government guarantee against poverty. From the beginning, the worst myth about Social Security was that there was a trust fund being filled with money from years of Federal Income Contribution Act (FICA) payments. The myth gave Americans a false sense of security. A large number of our older generation made no other plans for their retirement funding.

And, the trend continues today with young workers saving less than 5 percent. According to Stanford University Professor of Economics Douglas B. Bernheim, "...today's workers are saving just one-third of what they'll need in retirement."

In the beginning a surplus of Social Security funds did build up. However, our government transferred the money to pay for other government projects. Most Americans were unaware of this transfer of funds because government accounting created the illusion of a trust fund. By the year 2012, this mythical retirement trust fund will be filled with $2.33 trillion in IOUs, according to Congressman Nick Smith, Chairman of the Budget Committee Task Force on Social Security.

PAY-AS-YOU-GO RETIREMENT PLAN Whatever the government's original intent was when Social Security was adopted, the system quickly changed to a pay-as-you-go system in which current workers support current retirees. In 1950, when 17 workers supported one retiree, that system worked well. Today, however, there are only three workers supporting one retiree. Add in the fact that people are living longer and collecting more benefits than the system was designed to pay, and one can quickly understand the reason we are facing a catastrophe today.

According to a statement from the Congressional Budget Office, May 1996: "Financing the growth of entitlements such as Social Security...could put an end to the upward trend in living standards that the nation has long enjoyed."

WHAT WORKERS MUST ASK  The question is not whether we need Social Security reform: The question today is: "What reform should we adopt?" Many proponents of reform are proposing bills before Congress. Chief among them is Congressman Smith's Social Security Solvency Act. Smith's proposal has been scored by the Social Security Administration as making the system solvent through the next 75 years.

The Solvency Act is headed in the right direction; however, it does not go far enough. Under the Act, workers would be allowed to initially put between 1.81 percent and 2.8 percent of their FICA taxes into an IRA-like personal retirement savings account (PRSA) with a proposed gradual increase to 10 percent as PRSAs gradually replace today's government-run system. The big flaw in the program--workers would not reach the 10 percent contribution rate for 75 years. At that pace, it is of small comfort to ThirdAgers.

TWELVE MANDATED CONTRIBUTIONS A better proposal was offered by Representative Mark Sanford (R-South Carolina). The Social Security Thrift Investment Plan (SSTIP), Rep. Sanford's proposal, would mandate that all covered individuals must contribute 6 percent of their income, with a matching 6 percent employer contribution for a total contribution of 12 percent to a SSTIP. Self-employed individuals would contribute the entire 12 percent. Under the plan 8 percent would go to the individual's SSTIP account with the remaining 4 percent going to the government to help pay for benefits due under the current Social Security system.

The proposal falls short, by dictating how the SSTIP funds must be invested. Under the proposal, the funds must be invested in a low-to-moderate risk mutual fund-type account until enough money is accumulated to pay for an annuity that would provide the equivalent of a 1966 minimum wage income level.

CURRENT PROPOSALS COME UP SHORT OF CHILE'S SYSTEM Despite all of the proposals being presented by our well-intended Congressmen, a better solution is the seemingly drastic action Chile seized upon in 1981. Karl Borden, a Professor of Financial Economics at the University of Nebraska, writes in his paper, "Dismantling the Pyramid: The Why and How of Privatizing Social Security" that "Only private pensions with individual property rights to accumulate fund balances can create a secure pension system. Chile...provides evidence of such a system's effectiveness."

Chile's solution was to give the system back to the workers. Under the Chilean system, 10 percent of every worker's paycheck is deposited into an individual savings account managed by a private fund of the worker's choosing.

Today the Chilean system manages assets of over $19.22 billion, giving Chile a savings rate approaching that of some Asian countries. One wonderful side effect of the Chilean system: It has all but eliminated the possibility that "free-spending" politicians will dip into the workers' retirement plans.

MORE INFORMATION ON RETIREMENT SAVINGS  The CATO Institute has a terrific Cato Social Security Calculator that illustrates the difference between saving for retirement through our present Social Security System or adopting a system whereby the workers invest and manage their own retirement savings.

For more information, see the congressional testimony of Michael Tanner, Director of Health and Welfare Studies at the Cato Institute, concerning Cato's Project on Social Security Privatization.

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