Government July 1998

Nine Misconceptions About Social Security

To take a voguish example: Privatize Social Security? Any money saved would be eaten up in Wall Street transaction costs, including million-dollar salaries

4. Future generations will experience declining living standards because of the government debt and the burden created by Social Security.

Projections indicate that workers' real wages will increase by approximately one percent a year. If Social Security benefits are left unchanged, in order to meet the fund's obligations it will be necessary to raise the Social Security tax by 0.1 percent a year (0.05 percent on the employer and 0.05 percent on the employee) for thirty-six years, beginning in 2010. This will be a total tax increase of 3.6 percent, approximately the same as the increase in Social Security taxes from 1977 to 1990.

Even with this schedule of tax increases, real wages after Social Security taxes are deducted will continue to rise. By 2046, when the tax increases are fully phased in, the average wage after Social Security taxes will be more than 45 percent higher than at present. As noted earlier, this is based on pessimistic projections about wage growth.

5. By 2030 federal spending on entitlement programs for the elderly will consume all the revenue collected by the government.

By far the greatest part of the projected increases in federal spending on entitlement programs for the elderly is attributable to a projected explosion in national health-care costs, both public and private. According to projections from the Health Care Financing Administration, average health-care spending for a family of four in 2030 will be more than 80 percent of the median family's before-tax income. If such an explosion in health-care costs actually occurred, the economy would be destroyed even if we eliminated entitlement programs altogether. If health-care costs in the public and private sectors are brought under control, the problems posed by demographic trends will be quite manageable.

It is very deceptive to combine other spending categories with health care; projected health-care costs by themselves will consume most of the budget. For example, projected federal spending on education, highways, and health care combined should be more than 80 percent of federal revenues in 2030; defense spending plus projected health-care spending should come close to 70 percent of federal revenues.

6. If Social Security were privatized, it would lead to a higher national saving rate and more growth.

By itself, privatizing Social Security would not create a penny of additional savings. All the privatization plans call for the government to continue to pay Social Security benefits to current recipients and those about to retire; therefore spending would be exactly the same after privatization as it was before privatization. Yet the government would no longer be collecting Social Security taxes. Each dollar an individual put into a private retirement account rather than paying it to the government in Social Security taxes would still be a dollar the government must borrow. Individuals would be saving more, but the government would have reduced its saving (increased its borrowing) by exactly the same amount. Most of the privatization schemes being put forward call for additional taxes and additional borrowing to finance a transition while benefits were being paid out under the old system. Any additions to national savings attributable to these plans would stem entirely from the tax increase. This tax increase would have the identical effect on national savings if it were not linked to privatizing Social Security. In other words, raising taxes is one way to increase national savings, and if we are willing to raise taxes, we need not privatize Social Security.

The fact that individuals might put their savings in the stock market or in other private assets, whereas the Social Security Trust Fund buys government bonds, doesn't affect the level of saving at all. If it did, the government could increase the level of saving in the economy by borrowing money and then investing it in the stock market, or by borrowing money and giving it to individuals with the requirement that they invest it in the stock market. If either step could increase the level of saving in the economy, the government should take it independent of any changes in the Social Security system.

In fact, all else being equal, if individuals invested the money they would otherwise pay out in Social Security taxes, less saving would result, because a large portion of this money would be siphoned off by the financial industry. Currently stock brokers, insurance companies, and other financial institutions charge their customers an average of more than one percent a year on the value of the money they hold. Thus if $1,000 is invested through a brokerage firm for forty years, the investor will have been charged in excess of $400 in fees on the original investment, plus an additional one percent a year on all gains. These fees are a big cost from the standpoint of the individual investor, and a complete waste from the standpoint of the economy as a whole. Meanwhile, the operating expenses of the Social Security system are less than $8.00 for every $1,000 paid out to beneficiaries.

It is easy to see why costs in the private financial sector are so much higher. The private sector pays hundreds of thousands of insurance agents and brokers to solicit business. It also incurs enormous costs in television, radio, newspaper, and magazine advertising. In addition, many executives and brokers in the financial industry receive huge salaries. Million-dollar salaries are not uncommon, and some executives earn salaries in the tens of millions. Privatization would add these expenses, which are currently absent from the Social Security system.

Presented by

Dean Baker is the author of Getting Prices Right: The Battle Over the Consumer Price Index (1997).

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