With declining birth rates and an aging population, Social Security’s fiscal position is worsening by the year. Per the latest OASDI Trustee’s Report, Social Security will have completely drained its “trust fund” by 2033, and if nothing is done to shore it up, it will only pay 79 percent of scheduled benefits after that date.
Rather than enacting sensible reforms to avert this looming fiscal trainwreck, Congress is actually making it worse, recently enacting a Social Security Fairness Act that boosted Social Security benefits for retirees covered by other institutional pensions. The bill is projected to increase federal spending by around $20 billion per year over the next decade. Clearly Social Security is a fiscal ratchet, capable only of overspending and accelerating its pace toward bankruptcy.
Social Security is a classic instance of interest group politics, with its concentrated benefits for current or near-future retirees, and dispersed costs onto the entire taxpaying public. Old people have proven their ability to flex their political muscle to stymie sensible reforms. Case in point: President Obama in 2012 proposed a slight alteration in Social Security’s annual inflation adjustment (COLA) calculation. This small shift would have saved the program several billion per year with no noticeable reductions in the average benefit checks. Nonetheless, the American Association of Retired Persons mobilized a brutally effective campaign to kill even this most modest reform. Congress got the message loud and clear: mess with entitlement benefits at the risk of your political life.
We won’t fix Social Security by trimming benefits or raising the retirement age. That leaves raising taxes, but the problem with raising taxes is that OASDI payroll tax is the only tax in America that is explicitly regressive — it applies to the first dollar of income, but it drops to zero for income above the “taxable maximum,” $176,100 for 2025. Increasing payroll taxes thus triggers political outrage from the entire working public. Though not as strong an interest group as old people, there are substantially more of us, and we will feel the financial hit directly and know where to direct our political angst. Some have proposed simply eliminating the taxable maximum altogether. While this would certainly help, but. according to a study by the Peter G. Peterson Foundation, eliminating the taxable maximum would only close 53 percent of Social Security’s funding gap.
So do we just shrug and wait for the fiscal implosion? Or is there a fix that doesn’t mobilize hordes of pitchfork- and torch-wielding elderly folks and taxpayers to march on DC? I’d like to propose a win-win Social Security fix that requires zero changes to benefits, taxes, or the retirement age — and therefore has a better chance than Lloyd Christmas had with Mary Swanson. May I present a Social Security buyout.
Pension buyouts allow a company to shore up an underfunded retirement plan. In a typical buyout, the company with excessive retirement obligations will offer its retirees several options, including a lump-sum payment, or switching to an annuity contract guaranteed by a reputable finance company. Retirees will take the buyout if they think they’ll be better off either self-managing the retirement assets or moving to a safer third-party alternative. The company gets the unfunded liabilities off its books, positioning it for financial recovery. A pension buyout is voluntary — it will not be offered nor accepted unless it clearly leaves both retirees and the company better off. Many companies have improved their finances with pension buyouts in recent years — e.g. GM and Ford bought out tens of thousands of retirees to slash liabilities in the wake of the financial crisis and recession of 2008-9.
My proposal is inspired by the kind of win-win dealmaking present in corporate pension buyouts. In my plan, the buyout-taker forgoes all future Social Security benefits, taking a chunk of underfunded long-term liabilities off Social Security’s books. In return, he gets a gradual reduction of the employee’s share of the payroll tax. Specifically, the payroll tax will drop by 0.53 percentage points per year for 10 years. Buyout takers are required to invest each year’s tax savings to help fund their own retirement, possibly by way of purchasing an annuity designed to replace Social Security benefits.
If this doesn’t seem like a great deal to you, you probably aren’t aware of just how bad a deal Social Security is, especially for workers in the upper half of the income distribution. Social Security, a “pay as you go” system, does not invest workers’ contributions like a genuine pension plan would. Social Security instead simply hands over taxes collected from today’s workers directly to today’s retirees. This lack of investment is the fatal flaw of Social Security. A Ponzi scheme works as long as there are more payers than recipients, but when the demographic tide turns, it becomes a ticking time bomb. This is why the total rate of return on Social Security contributions averages in the 1 percent-2 percent range for everyone, and goes into negative territory for younger, higher-income workers, who don’t see as large a percentage of their peak earnings replaced by SS benefits. This compares terribly to the long-run, inflation-adjusted rate of return on bonds (4 percent-5 percent) and a broad-market stock portfolio (7 percent). Investing just part of those Social Security taxes for 20, 30, or 40 years lets the worker come out ahead, even after SS benefits are zeroed out.
My proposal works well for people ages 45 and under earning above median income. Both the opting-out worker and the Social Security system see significant gains in the present value of the tax/benefit stream. However, as my plan takes some near-term revenue out of Social Security in order to wipe out long-term liabilities, there will be a cash flow drag for the first 15 years or so. There is no such thing as a free lunch, but the plan does offer a clear win for both workers and the Social Security program. To those who would fret about degrading the program’s near-term cash flows I offer this analogy: if you had $100,000 in credit card debt, but could get it to zero in five years by simply paying an extra $200 per month, you’d take that deal.
The American People have soured on Social Security and are ready for change. According to a 2023 Gallup survey, “Thirty-seven percent of nonretirees between the ages of 30 and 49 believe they will get Social Security benefits, while 61 percent do not.” They know that Social Security doesn’t work, and they must save and invest for themselves, and they are ready for an alternative that works. For those who aren’t ready, willing, or able to opt out, nothing has to change; “if you like your Social Security, you can keep your Social Security.” Just let those of us who want to )and are in a strong position to take responsibility for ourselves out of an insolvent, unsustainable system. If we do it right, we can save Social Security for those who truly need it and improve the long-term fiscal health of the US government.
Find the complete policy paper here:
My conversation with finance podcast Bob Murphy on the InFi podcast: