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Social Security reform

By Ryan Petersen
web posted September 22, 2014

"Populations are aging. Without large changes in retirement ages, there must be a trend of rising taxes and/or declining annual benefits (relative to earnings). More funding can reduce this trend, although politically plausible levels of funding do not reverse its direction. Increased funding can finance part of benefits out of the excess of the rate of return over the rate of growth times the level of funds. This helps to lower future taxes for any level of benefits (or vice versa). But funds must come from somewhere - from currently raising taxes, cutting benefits or finding some other source of revenue (which would have an alternative use). So the purpose of more funding is to increase the burden on current generations in order to lower the burden on future generations. This is similar to a decision to raise taxes or cut spending in order to decrease the public debt. (Provided, of course, that the cut in spending is not a cut in public investment.) Economists see advantages in smoothing tax rates and foresee large tax increases in the future and so generally favor more funding, although there is considerable disagreement on how much." -- Peter Diamond (2000), "Social Security Reform, With a Focus on Sweden"

The United States' population is aging. We are living longer. As a result, we have more elders in our society. By the year 2050, as many as 1 in 5 Americans could be elderly. Now, in 2014, we have to take a serious look at how effective Social Security will be 10, 20, or even 30 years from now. The original purpose behind Social Security was to be an investment account for working citizens, earning a W-2, to pull from when they retired, but Social Security has now become a tax on citizens and the funds that are collected are being misappropriated. Because of this, the United States' government roughly spends $814 billion on Social Security every year; that's 24% of our yearly government budget! But how much do citizens actually pay for Social Security? The average employed W-2 United States citizen is required by law to pay 6.2% of their income to Social Security and self-employed citizens, which includes my father, are required to pay nearly 12.4% of their income to this tax every year; 6-12% of American citizens' income that can't be used to pay their utilities or rent. My father is required to pay 13.3% of his income as an "Unemployment Tax", which is 10.4% Social Security and 2.9% Medicare, but because my father isn't employed as a W-2 worker, he can't access any of these funds that he pays into the Social Security Administration during the years that he isn't a W-2 worker. Now, this doesn't affect just my father, this affects roughly 14.4 million self-employed Americans. Self-employment was the type of work that this country was founded on but America is now seeming to punish people financially who choose that line of work. Even though America wants to be the foremost country in the world with all of their operations and systems, they might want to look at how other countries seem to help their retirees financially so maybe the U.S. could fix our broken system. With this said, let's first look at the different systems used by the United States and Sweden, for example, look at how these systems are funded, and lastly, look at how we can stabilize Social Security in the United States of America.

There are two different kinds of systems that can be used for Social Security. The first is a defined benefit (DB) system that bases your annualized benefit that you receive on your history of earnings. You are allowed to choose a lump sum instead of an annualized benefit under this system. The problem with this system is it is based on earnings that are subject to taxes; it's not based on taxes paid. The second system that can be used is a defined contribution (DC) system. The DC system mandates that you contribute to Social Security and that all the money be collected into individual accounts based on actual taxes paid. The difference between a DB and DC system is that a DB system focusses on your history of earnings, and a DC system focusses on your taxes paid. Sweden uses a strict DC system and it has worked out fairly well for them. They have also incorporated a guaranteed minimum system that makes sure that every citizen receives a minimum amount of funds based on gender and age. If you make past a certain amount of money, then you are subject to a small payroll tax on the money that you contributed because it is assumed that if you make that much money, then you won't have a necessity for all the money. In the end, though, the system is able to work itself out and the government is able to monetarily contribute very little to the system. The United States, on the other hand, works on a variation of a DC system. It does mandate that you contribute to Social Security and your money is put into your own individual account. You will have your own specific account for Social Security that records how much you contribute and your share is based on when you start receiving money and the mortality rate for your gender and age. Choosing the DC system is costing the American government $814 billion every year, meanwhile Sweden isn't having this problem. We need to maybe adopt Sweden's version of their Social Security system, but how do we do this? Let's look at how Social Security is funded in these two systems.

The method of funding for each system is remarkably different. The Swedish DC system is funded by direct contribution from the citizens. The money is put into an account for the citizens and the money is to be used by the citizens, not the government. The citizens can also contribute to other investment accounts such as a 401(k) if they choose. The Swedish government, however, doesn't handle the money that is contributed, versus the United States' government does. In the United States, W-2 employed citizens are required to contribute to Social Security, but they do have the option to invest in a 401(k) investment plan also, but they must contribute to Social Security no matter what they invest in. When W-2 employed citizens contribute to Social Security, their money is earmarked to their account waiting for it to be pulled later on in life. How much you receive is based on how much you contributed, your age when you start drawing money, your gender, and your mortality rate. In other words, you can start drawing money at the age of 65, but if you delay drawing money up to the age of 71, your monthly check amount increases because you are getting older and closer to death. Because of political corruptness, though, the American government has been getting their hands on the Social Security money in order to pay their other debts and fix their budget deficits so that now, the Social Security fund will dry up by the year 2033.

In order to stabilize Social Security, we need to restore Social Security to what it used to be so that it truly reads "social security." Social Security was meant to be a retirement account for people to put their money into so that they did not have to think of where to invest their money. The government has now changed it to a mandatory tax, and in turn uses the money to fix their budget problems. This is not what the money is meant for. Social Security is meant to help citizens; not jeopardize their future. To stabilize Social Security, the United States government needs to look elsewhere for help, such as Sweden's Social Security system. Social Security accounts need to be invested into annuities like Sweden does with their money. The Social Security returns after retirement should be based on how much the annuity currently holds and then annualized according to current mortality rates like Sweden. Social Security also needs to be untouched by the government like Sweden. If the United States' government follows these rules, then we will see outstanding success with Social Security and smiles on its citizens.

In closing, Social Security is not what it used to be. Because of political corruptness, the United States' government has almost destroyed Social Security and at its current pace could bankrupt millions of participating American citizens, but, if we act fast, we have a chance of being able to fix it and make it better than before. If the United States' government can stop misusing Social Security funds and invest their citizens' Social Security accounts into annuities, the American citizens can be more assured that their money will be well invested and they will be less worried about their retirement years. ESR

This is Ryan Petersen's first contribution to Enter Stage Right. © 2014 Ryan Petersen







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