Social Security and You: A 2-Tier Social Security System
In last week's column, I provided a very brief overview of the Australian Social Security system. (I got interested in the topic after my wife and I visited the Land Down Under and got to talking to some retirees there.)
Their Social Security program, which first started in 1907 (compared with 1935 in the U.S.), is a two-tier system. They have a traditional old-age pension that is funded out of general tax revenues, as opposed to a dedicated payroll tax as we (and many other countries) have. It pays a rather modest retirement benefit that caps out at about $1,200 per month (in American dollars). And those benefits are means-tested. They are gradually reduced depending on how much other income you have and the value of your assets, including your home. So many middle class and richer Australians don't qualify for any of these traditional Social Security benefits.
But there is a second tier to their system that works kind of like an individual retirement account. It is called the Superannuation Guarantee. It is funded by a tax on employers, and employees are strongly advised to contribute to the fund. Upon retirement, participants, especially those who have funneled lots of money into the fund, draw a decent amount of income out of it.
Many times over the years, some people in the United States have suggested that we should move toward a two-tier Social Security system in this country. In the past, their proposals have generally fallen under the moniker of "privatization." You don't hear that term much anymore because for many people, the idea of privatizing Social Security means entrusting our nation's bedrock social insurance system to some monkeys with a dartboard. (Sorry, I meant to say to Wall Street brokers.)
But these reform ideas really are not privatization schemes in the traditional sense of the term. Instead, they are proposals that would set up a two-tier Social Security system in this country, not quite the same as the Australian system, but with some similar characteristics. And as you might guess, both major political parties had their own take on what the system should look like.
Almost every plan I've ever seen backed by a leading Republican politician is what is commonly known as a "carve-out" plan. It is called that because it gets its funding by carving out a chunk of the current Social Security system. For example, 6.2% of a worker's salary is deducted for Social Security taxes. A carve-out plan might specify that 4.2% continue to be used to fund Social Security, while 2% would be turned back over to taxpayers for them to invest on their own.
On paper, it may sound great. You get to keep a chunk of your payroll tax to use as you want. And of course it is hoped you will invest that money and not buy a new car or boat! (A better version of these plans mandates that the payroll tax portion you keep must be invested in one or more of several managed, IRA-type accounts.)
But the often unexplained downside to these plans is that huge reductions would be necessary in future Social Security benefits. It's just simple math. If you are going to carve out about one-third of the Social Security payroll tax to fund a worker's private IRA account, then obviously future Social Security benefits for that worker are going to have to be cut by at least one-third, or be means-tested, as in Australia.
And here is the bigger problem with carve-out plans. It's not just future benefits for current workers that would have to be cut. Benefits to current retirees would also have to be radically reduced. Remember: Our Social Security program, like every major social insurance system in the world, is funded on a "pay-as-you-go" basis -- meaning the money deducted from today's workers' paychecks is used to fund benefits to current retirees. So, if you cut the amount of money going into the system by a third, then the money coming out of the system must also be reduced by the same amount. In other words, you must eventually cut benefits to all current retirees by about 30%.
Of course, that is politically (and morally) unacceptable. Many past carve-out plans promised not to reduce benefits to current retirees. But the only way to accomplish that is to take money out of the general funds of the Treasury to make up the Social Security payroll tax deficit in order to pay all promised future Social Security benefits. And we are not talking millions, or even billions, of dollars. We are talking many trillions of dollars.
In other words, the transition costs of a carve-out, two-tier Social Security system are simply too high. Either the political and moral costs are too high to cut future Social Security benefits or the economic costs are too high to dramatically increase the deficit to avoid future benefit reductions.
But there is an alternative two-tier plan. It is usually referred to as an "add-on" plan, and has usually been endorsed by Democrats.
This type of plan would require workers to contribute an extra amount to fund any private account investments they set up. So, 6.2% of a worker's salary would still be deducted to finance Social Security benefits. But in addition, that worker would be required to chip in an extra percentage point or two of salary to fund a managed investment account. In other words, instead of carving anything out of the current Social Security system, this type of plan gets its funding by adding to the system.
Of course, the downside to an add-on plan is that more out-of-paycheck deductions would be required from workers to fund their retirement portfolio. But the advantage to the plan is its greater rewards. Most add-on proposals I've seen are modeled on the highly successful Thrift Savings Plan, an add-on IRA that has been available to federal government workers for years and has given many of them the kind of financial security in retirement not usually associated with middle-class civil servants.
An add-on privatization plan is usually not favored by Republicans because it reeks of a tax increase, even though the increase would be funneled into private investment accounts. Frankly, I'm pretty sure the two sides will never agree on a two-tier system. So, if you're young and like the idea, start looking for jobs in Sydney or Melbourne!
If you have a Social Security question, Tom Margenau has the answer. Contact him at email@example.com. To find out more about Tom Margenau and to read past columns and see features from other Creators Syndicate writers and cartoonists, visit the Creators Syndicate website at www.creators.com.