Who Wants to Retire a Millionaire?

[music]

0:00:05 Paul Matzko: The premise of the long-​running TV game show, Who Wants to Be a Millionaire, is that if the person in the hot seat just answers a series of trivia questions, they can walk away with $1 million. Now, it’s hard to do, most competitors fail, but the allure is that $1 million feels like an impossibly large sum of money to most Americans, something they’ll never themselves have unless they, well, win a game show or win the lottery. But what if I told you you could very easily be a millionaire when you retire if we fixed our broken social security system? Sounds impossible, right? Well, that’s the subject to today’s episode of Building Tomorrow, a podcast where we talk about a future that can be freer, happier, and more prosperous than today, if we choose to make it so.

0:00:51 Paul Matzko: But before we indulge in that hopeful future, we need to deal with our messed-​up present. Most Americans struggle in retirement. The overwhelming majority of retirees live off fixed incomes that are a fraction of their incomes when they were working, and most of that comes from social security benefits. They are lucky to get a dollar back for every dollar they put into the system while working. And even that meager level of income is approaching a precipice, since social security is fast approaching the point when it will need to cut benefits in order to stay solvent. To discuss just how bad the current situation is, I’ve invited Michael Tanner, the Senior Scholar here at the Cato Institute, to join me. Welcome to the show, Michael.

0:01:31 Michael Tanner: Thank you, it’s a pleasure to be with you.

0:01:33 Paul Matzko: Now, our audience skews younger and I’m not sure that most 20-​somethings spend all that much time contemplating social security beyond the kind of vague feeling of annoyance when they see the deduction from their paycheck. So in very basic terms, how is social security supposed to work?

0:01:50 Michael Tanner: Well, social security is a transfer payment from people who are working to people who are retired. One of the important things to remember is that when you pay your social security taxes, none of that money is put away for your retirement, it’s not invested in anything, it simply goes right out the door to pay for basically, grandma, essentially you’re paying for their retirement. And then the hope is that when you get to be retirement age, the next generation of grandkids along in there will come in and pay for your social security taxes. In many ways, it does work a lot like a pyramid scheme, where as long as you have more and more people coming into the system and paying in, you can continue to pay benefits to the people at the top of the pyramid.

0:02:31 Paul Matzko: And that’s very different from how I think a lot of Americans think of it. They do tend to think of it as something of more of like a, there’s a literal account, you put money in, and then the government gives you back when you retire, but that’s not the case.

0:02:44 Michael Tanner: It’s not only not the case, but the courts have said that you’re not entitled to any benefits based on having paid in. The courts, in two cases, Helvering v. Davis, which is a 1937 case, and then a case around 1960 called Nestor v. Flemming, basically, the courts said, “Look, you pay your social security taxes, that’s just a tax.” It’s just like any other tax that you pay, income taxes, whatever. And social security benefits are government payment like farm price supports or something, and they’re not actually linked. You don’t get a certain level of benefits based on how much you paid in; you get it based on some formula that Congress has created and Congress is free to change that formula, or reduce your benefits, take benefits away at any time that they choose to do so.

0:03:28 Paul Matzko: Yeah, I suppose the only thing keeping them from doing that is, well, if they tinkered too much, there’d be a bit of a political uprising, right?

0:03:35 Michael Tanner: Well, but they have done in it the past. In fact, when I started working, they told me that I could retire at age 65 and collect my full social security benefits. And then we had the Greenspan Commission came along in 1982, and they said, “Oops, too bad, we kinda lied to you. Now, you’re gonna work ’til age 67 before you get benefits.” And already, we continue to hear rumblings that, well, they wanna raise the retirement age, or change the COLA formulas, or just somehow tinker with benefits that are gonna make them less. And we have to. Quite simply put, you cannot pay the level of promised benefits to young people with the level of taxes that are being paid today.

0:04:14 Paul Matzko: Mm. Now, whenever social security pops up in the press, it’s usually has to do with the Social Security Trust Fund, and when that’s supposed to run out of money. What is this trust fund, what’s the concern about it, in particular, running out of money?

0:04:29 Michael Tanner: Yeah, a lot of people misunderstand what the trust fund is. The trust fund is not an actual asset; it is more an accounting measure of how much the federal government owes the social security system. When you consider the… Between about 1990 and about 2010 or so, give or take, social security ran a slight surplus. For most social security’s history, it didn’t. It simply, money came in, money went out to pay benefits, that’s the way it worked. But for a few years, social security built up to a surplus, that is, it brought in more money in taxes than it was spending on benefits. Now, that money has to go somewhere. The government can’t put it in a cigar box and bury it out behind the treasury building; they have to do something with it. And what they do is they tend to buy government bond, and this is a special-​issue bond, it’s not tradable, you can’t go out and buy it yourself, but the government can buy it. And once they buy this bond, the money used to buy it is general revenue of the federal government. It’s just like when you buy a savings bond, after you bought it, the money you used to pay for it goes into the general coffers of the federal government. And it’s spent on whatever the federal government spends money on, whether that’s building roads and bridges or invading Middle Eastern nations, that’s where it goes. And what remains behind is this bond, which actually sits in a vault in West Virginia, so.

0:05:48 Paul Matzko: Literally… Oh, wow. [chuckle]

0:05:48 Michael Tanner: Literally sitting right next to confederate war bonds, it’s out there. But when the government then has to pay back social security benefits, this year, for example, they ran about a $65 billion shortfall, they go out to this vault, they take out $65 billion of bonds and they go back to the federal government, they say, “Pay us.” Well, where’s the government gonna get that money? It’s going to have to borrow it, or raise taxes, or find it some place else, but it’s not actual money that the federal government has sitting around.

0:06:23 Paul Matzko: So, we have this… It’s funny how the Social Security Administration will use language, like a trust fund. It’s language that you think you’re familiar with what that is, but it’s not. Yeah.

0:06:33 Michael Tanner: Yeah, it’s an asset for the social security system and a liability for the federal government. It’s much like, if you took an IOU and moved it from one pocket to the other, you’re not any richer.

0:06:43 Paul Matzko: Right, right, right. [chuckle] You just label your pockets differently. One pocket’s SSA, one pocket’s federal government.

0:06:48 Michael Tanner: But it’s all money in, money out.

0:06:50 Paul Matzko: When is that supposed to run out?

0:06:53 Michael Tanner: Right. We’re tapping it now, and it will eventually be completely exhausted around 2035, according to the last trustee’s report that I saw. So, we’ve got… Having this trust fund shouldn’t be much comfort to young people. If you’re 30 years old right now, well, the trust fund’s not gonna help you. [chuckle]

0:07:16 Paul Matzko: Yeah, I remember back, this is before the financial crisis, which accelerated the timeline, if you will, the first time I ever looked up anything regards to social security, I saw that the estimate at the time was at some point in the late 2040s or something, that it was supposed to run out again, before the financial crisis. But I remember it was notable, because it was the year I would have hit retirement age. This was never… We’ve advanced the timeline, but it’s never been of any real relief to millennials.

0:07:45 Michael Tanner: And once the trust fund runs out, by law, social security must cut benefits back to what’s coming in through taxes at that point. And it’s about a 25% reduction that would have to take place.

0:07:58 Paul Matzko: So I mean, this… For people who are on a fixed income, losing a quarter of their expected income is devastating.

0:08:05 Michael Tanner: Yeah, absolutely. Consider the poorest 20% of Americans in retirement that depend on social security for about 80% of their retirement income.

0:08:16 Paul Matzko: So, we’re staring at a crisis. It’s in slow motion right now, but everyone can see this coming. I know there were attempts to fix this like 20 years ago, late ’90s, early aughts, I think both the Clinton administration made noises in that direction, especially the George W. Bush administration was interested in privatization at some point. Why didn’t that happen? Some sort of reform, to put this on a better… Secure financial footing.

0:08:43 Michael Tanner: Sure. Basically, it’s something that was very difficult to do politically, ran into political headwinds that had nothing to do with social security and made it even worse. Bill Clinton had a very big interest in reforming social security. He had the Save Social Security First Tour, went all around the country, including a number of Cato people who he had speak. Jose Pinera and others from Cato spoke at Clinton events. He actually had, at one point, a secret task force at the Treasury Department looking into how to make a partial privatization of social security work. And then Monica Lewinsky happened, and suddenly, he had to shore up votes in the Senate, on his left flank. He had to keep Ted Kennedy and those folks happy, so he abandoned the program. Now, George W. Bush picked it up. He was prepared to run with it. He created a task force headed by Pat Moynihan to look into this, and their first report on this was due to come out in December of 2011. [chuckle]

0:09:42 Paul Matzko: Hmm. Something happened that fall, was it?

[laughter]

0:09:44 Michael Tanner: Yeah, I thinks so, or… I’m sorry, what was it? 2001.

0:09:47 Paul Matzko: 2001, yeah.

0:09:48 Michael Tanner: 2001, not 2011.

0:09:49 Paul Matzko: 9/11, the terrorist attacks, and no one’s talking about…

0:09:51 Michael Tanner: And it all goes down the tubes. Second term, he picks it up again. He starts a tour around the country to do this. And you had the Iraq war collapsing, you had Hurricane Katrina, and Bush’s little credibility was was kinda shot, and it all died.

0:10:06 Paul Matzko: So, how much harder will it be? Imagine, the earlier you catch this, the easier… Or not… “Easy” is not the right word, but the less harsh the transition. It’s easier to deal with the earlier you catch it, so how much harder is it gonna be 20 years on now?

0:10:21 Michael Tanner: Yeah, if you wait until you actually have hit that point at which sociality’s gotta cut benefits by 25%, it’s gonna be tough no matter what you do. You’re gonna either have to cut benefits by that much, or you’re gonna have to have a huge tax increase overnight. You can’t sort of phase anything in. So that’s part one. Part two is that debt that social security faces, which right now is about $42 trillion in unfunded liabilities, that gets worse by several hundred billion dollars every year. So the longer you wait, the more you’re gonna have to make up.

0:10:53 Paul Matzko: Okay, so, let’s roll back a second to… We haven’t yet advanced to the Eschaton, we aren’t at the end times yet. Things are kind of rolling along, people are getting more or less 100% of their expected benefit. Let’s put this in financial terms. If I were to retire today and started collecting whatever my calculated benefit was, what was the return on all of that money I gave to the federal government for my entire working career?

0:11:21 Michael Tanner: Generally, it’s an average around 2.5%, a little bit less than that. Now, that’s positive, but if you stuck that money in a savings account, you do about as well. So, it’s not a big shakes, but you are still learning some sort of positive interest on it if you were to retire today. Now, someone who retired 10, 20 years ago, they made out. They got back everything they paid in, with interest, and a whole heck of a lot more besides. To go back to my pyramid scheme analogy, the first investor always does really well.

[laughter]

0:11:52 Paul Matzko: Yeah, right.

0:11:52 Michael Tanner: Pyramid scheme. It’s the people at the bottom, when the thing starts falling apart, that lose their shirt.

0:11:56 Paul Matzko: And of course, when we talk about average return, we don’t mean, again, there’s not a pool of money that’s been invested and is accruing dividends and capital gains, et cetera. That just means you’re getting more out than you put in, but someone else is paying for that, right?

0:12:12 Michael Tanner: Well, that’s right, yeah. Return on your investment is kind of a misnomer ’cause there is no investment. But if you just look at your taxes and what you’re getting back, you’re still getting back more than you paid in if you retire today. Young people can’t necessarily look forward to that. There’s some estimates that says they’ll get about a 1% return, but the reality is for an awful lot of ‘em, they will get a negative return. That is, they’ll actually die before they get back what they paid in, let alone anything on top of that.

0:12:41 Paul Matzko: So, in which case, at 0% effective return, it’s like you made a 40- or 50-​year loan to the federal government and you didn’t even get back your principal.

0:12:51 Michael Tanner: Yeah, that’s right. Let alone them paying interest on it. They just take your money and make use of it.

0:12:57 Paul Matzko: That’s pretty bad. Now, I’ve heard one defense of keeping social security fundamentally as it currently is, is that even when the trust fund runs out of money, benefits, which only have to be slashed like 75% or 80%, depending on the estimate, but that can be covered by… That shortfall can be covered by taxes. Now, that’s a very blithe answer, “I will just cover it somehow with taxpayer money.” How much money are we talking about here? So let’s say, we hit 2035, we’re having the cut benefits, 75%, but there’s political pressure for the government to make up the difference by raising taxes. How much are we talking there?

0:13:39 Michael Tanner: And that year alone, you’d be talking somewhere around $600 billion to $800 billion in that year alone. Let’s say overall, the unfunded liabilities in social security and to get [0:13:48] ____ present value terms are about $42 trillion, $43 trillion, which is real money even by Washington standards. What you’d have to do is roughly the equivalent, you could find different taxes to do it, but roughly the equivalent of a 50% increase in the payroll tax. So, you’d have to hike the payroll tax on this current 12.5%, for social security, it’s 15% when you throw in Medicare, but you’d have to raise that to about, oh, 18%, 19% or find the equivalent in other taxes.

0:14:25 Paul Matzko: Right, and then of course, that comes on with negative knock-​on effects, like you tax people more, that’s less income, less they’re spending, less they’re investing. Functionally, it has… It will be an economic drag.

0:14:36 Michael Tanner: Sure. And unless you remember we’ve already raised social security taxes repeatedly over history, we’re up about 800% in real terms since social security is created. When social security started, it was a 1% tax on the employee, 1% on the employer, and it was capped at $60 maximum.

0:14:53 Paul Matzko: Oh, wow. So we’ve gone from 2%, effectively, to 12.4%?

0:14:57 Michael Tanner: Right. It’s actually the highest tax that the average American family pays, about 70%-80% of Americans pay more in social security taxes than they do in federal income tax.

0:15:07 Paul Matzko: Wow, really? So I guess some of that’s disguised ’cause by making half of it… Half of it, you see on your paycheck; half of it, the employer pays, but in reality, that’s foregone…

0:15:18 Michael Tanner: Right. Almost anybody, almost all economists assume that the worker pays the full freight on that, even though you could say that they only pay 6.2% and when the employer pays 6.2%, they pay all 12.4%

0:15:31 Paul Matzko: Michael paints a pretty dire picture of the present and future of social security, but those problems are not actually new; some of them are foreseeable from the moment social security legislation was enacted in the 1930s. To talk about why, Peter Van Doren, The Editor of Cato’s Journal of Regulation, joins me in the studio now. Thanks for coming to the show, Peter.

0:15:51 Peter Van Doren: Thanks for having me.

0:15:52 Paul Matzko: Okay. So, we’ve talked with Michael Tanner about the uncertain future, if we can be very generous, the uncertain future of the social security system. But some of those flaws that we’re grappling with today, and they’re going to worse over the next couple of decades, were kind of baked into the system from the start, which was the 1930s. So what were some of those design flaws, if you will?

0:16:16 Peter Van Doren: Well, I wanna differ with that just a bit and try to differentiate what tax rates and benefit schedules were in the original 1935 act, and then what amendments occurred between the years 1939 and 1950 which altered the structure. So, right of center commentary now often argues that social security was flawed “from the start.” And there needs to be a bit of a corrective on that, which is the… The original social security law in 1935 had a tax and an increasing tax rate schedule from 1935 through 1950, put in the law, which said, “we’re not gonna have any beneficiaries to start, but as we increase the number, we’re gonna raise taxes gradually, and we wanna pre-​fund this a bit,” so that the projections were in 1935, that by 1980, they’d have a $45 billion reserve at the end of 1980. But, again, that didn’t sound much…

0:17:39 Paul Matzko: At the time, it sounds like a whole lot of money.

0:17:42 Michael Tanner: So, the original law said the tax rate on earnings would be 2% in 1935, increasing to 3% in 1940, increasing to 5% in 1946, and increasing to 6% in 1949. And there were… Roosevelt wanted to build a reserve, in effect, a government system in which the… Not truly pay-​as-​you-​go, either, it’s some sort of kind of hybrid system, and Roosevelt did not want general revenues to be used. Again, the story you’re telling, which is this sort of a fiscal contract, if you will, that Roosevelt had envisioned which is kind of a partial pay-​as-​you-​go system but also kind of a partial pre-​funded system, that that contract to find a political solution that kind of was down in the middle of the left versus right version notions of proper dealing with retirement that…

0:18:49 Paul Matzko: In theory, it would have been a little more sustainable with this, where you would kinda…

0:18:52 Peter Van Doren: Oh, very much, very much so.

0:18:54 Paul Matzko: Pot of money, and you would have used the earnings and interests from that to fund a good chunk of social security payouts. That’s the original vision in 1935, but we don’t do that. Why? What changed?

0:19:05 Peter Van Doren: Well, The 1939 amendments started us down the road very quickly to what we know today, which is where… Pay-​as-​you-​go and we don’t have much go to…

[laughter]

0:19:20 Paul Matzko: Lots of paying, not much going. Yes.

0:19:22 Peter Van Doren: Right. So, the Senator Arthur Vandenberg, Republican of Michigan, opposed the reserve, and on the Democratic side, there was strong pressure from the left to have more benefits, survivor benefits and dependent and survivor benefits, which were not part of the original ’35 act. So the original ’35 act was just retirement.

0:19:45 Paul Matzko: For people who worked and contributed themselves.

0:19:48 Peter Van Doren: And who then retired, but not of survivor benefits… If a worker dies early, that was not part of the… Giving children benefits was not part of the original ’35 act. And survivor benefits for a spouse who did not work but where the main earner worked, that was not part of the original ’35 act. So in 1939, you had a classic bargain in which the left got more benefits… They got survivor benefits and…

0:20:19 Paul Matzko: Spousal benefits and…

0:20:22 Peter Van Doren: Added, and the tax rate business interests and those fearful of a government reserve which would then be used for other things, they got a tax freeze. So all the scheduled tax rate increases from 1940, the first one was to go from 2% to 3% in 1940, well, the ’39 amendments froze that, and then through 1949, eight consecutive bills froze the tax rates at 2%, and we added beneficiary. So right from ’39 through ’50, we went… We were already well down the road of, not a hybrid system that was halfway between pay-​as-​you-​go and total reserved system to a system in which we were just dishing out stuff and not taxing. I mean, just like now. We…

0:21:15 Paul Matzko: Right.

0:21:16 Peter Van Doren: All we can agree on is spending on stuff and not having taxes. And that just seems to be an American equilibrium that has been around. I think our listeners will be surprised that Roosevelt had a little more physical rectitude then he’s often portrayed by Arth…

0:21:34 Paul Matzko: On the right, he’s supposed to be this tax-​and-​spend bad guy who… Yeah.

0:21:38 Peter Van Doren: In fact, he was… He had his priorities and he wanted redistribution, but he… There was more fiscal rectitude in him then he’s often given credit for.

0:21:50 Paul Matzko: So by the time people start getting payments, it’s pay-​as-​you-​go. I mean, it’s giving checks to the folks who hadn’t contributed to the tax system.

0:22:00 Peter Van Doren: Well, ironically… World War II, because of full employment, generated enormous… So the surpluses actually grew during World War II despite the tax raise. Had the tax rates that had been in the original ’35 act been in place in World War II and employment had been the same and wages had been the same and everyone paid in at those tax rates, the surplus would have been much greater than had been anticipated. Not $47 billion, it would have been gigantic, and we would be in much better shape now than we are.

0:22:41 Paul Matzko: I mean, I suppose they were confronting a really tough problem, which is that they both want a sustainable social security retirement system, you know, that workers today contribute to and then pull money off when they retire, but they also have a problem. It’s 1935, we’re in the middle of The Great Depression, you have a whole generation of retirees who are… Whose wealth has been wiped out and are now retired and in dire poverty. So, those are two things which aren’t… Those are two separate kind of distinct issues.

0:23:14 Peter Van Doren: Correct. We could have had… We didn’t need… I mean, you didn’t need a perpetual social security system to solve the one-​time wealth loss problem.

0:23:23 Paul Matzko: We could’ve just transferred tax then transferred a bunch of wealth to those retirees in the middle of The Great Depression.

0:23:28 Peter Van Doren: And we could have borrowed to do so. Bill Niskanen, the late chairman of the Cato Institute, always said that government borrowing should be reserved for public goods issues and shocks that occur to a nation where the cost of those shocks should be borne across generations rather than within. And thus, one could say… He always thought borrowing for World War II was rational, and that successive generations ought to pay for that, the benefits of that public sector effort. And similarly, even though we now know that misguided federal reserve policy was a main and important contributor to the depression, right, we were in a deflationary era that wasn’t understood at the time and that generated unemployment and things like that, the… So even though government policy was responsible for in part what happened, then the redistribution to that generation that suffered wealth losses because of the stock market crash and things like that, we could have, in effect, made them whole and not then created a system that went on and on and on. But that’s… In fact, because we did not do that, you and I’ve talked off-​mic about how one generation got more than they put in into that system, and then subsequently, somewhere, sometime, somebody has to save both for their own retirement and redistribute backwards to that… For that one-​time wealth gain that occurred which has not yet been really paid for.

0:25:16 Paul Matzko: It’s been kinda like a generational hot potato. Someone has to pay for that wealth transfer.

0:25:18 Peter Van Doren: Everyone’s been passing it down on vets, and I’m doing it to you.

0:25:18 Paul Matzko: Yeah. Thanks, Peter. I really appreciate that. But yeah, I mean, in a sense, you know, boomers are… I mean, it wasn’t boomers who were responsible, though, to be clear…

0:25:18 Peter Van Doren: No.

0:25:18 Paul Matzko: It was the silent generation or the greatest… What do you wanna call them.

0:25:18 Peter Van Doren: Yes.

0:25:18 Paul Matzko: They were the initial ones who… I mean, they would’ve had to foot the bill if they had paid for it upfront.

0:25:18 Peter Van Doren: Correct.

0:25:18 Paul Matzko: And even paying for their parents’ retirement, essentially, in the 1930s.

0:25:18 Peter Van Doren: My grandfather benefited and my father needed to pay for it. And so far, nobody…

0:25:18 Paul Matzko: Yeah. And then you and you’re like, “Oh.” The boomers are like, “No, we’re not paying for this.” You know, and plus there’s lots of us retiring. So, sorry, millennials, and Gen X-​ers and whatever, yeah.

[music]

0:26:00 Paul Matzko: Hope is not lost, as bad as it looks right now. I also asked Michael Tanner about how we can fix social security to make it not only more sustainable but just better, period. Okay, so, we’ve got this big growing problem, it’s not going away any time soon and we’re heading towards the cliff. How would you right now… What’s the best way to fix this mess? What’s your preferred reform package?

0:26:26 Michael Tanner: Well, this one is not rocket science. This is fairly basic choices you’ve got to make. You have more money going out than you have coming in.

[chuckle]

0:26:36 Michael Tanner: If you go to your bank account, you realize you’re spending more than you’re taking in wages, you’ve realized you got a problem. So you got three options, basically. Number one is you can reduce the amount going out. We can cut social security benefits, and there’s a lot of people talking on the table about how to do that. We can raise the retirement age again, we can change COLA formulas, there’s something called wage price indexing which is way too complicated for this discussion, but something that I actually like. There’s things you can do to reduce the pay-​out. Or you can bring in more money. We just talked about, you could raise that payroll tax by 50%, you can bring in more money there. The third option is to make better use of the money that you actually have in the system. After it comes in, instead of simply sending it out for payments, you could actually invest it in something that earns a rate of return, the stock bonds [0:27:24] ____ and so on. And that’s what we talk about when we talk about individual accounts: The idea that younger workers should be able to take a portion of what they’re paying in social security taxes and actually invest that in something real, and that would form part of the basis for their retirement rather than waiting for the next generation to pay them.

0:27:42 Paul Matzko: It’s actually… It feels like a better way of… A better language or better way of describing this. Oftentimes the term, I’ve even used it in this conversation, this term “privatization,” which is a bit of a bug-​a-​boo word for many folks, but if you just say what this is is you’re paying into a system that you control, it’s still your money, it’s an individual account, you just can’t access it until you retire, well, yes, sure, it’s privatization, but you’re just giving people what they’ve contributed.

0:28:12 Michael Tanner: Right, privatization in the sense that it’s invested in private assets, but it’s still basically a government system, it’s a mandatory saving system. The option to what you could invest in would be limited and regulated. And we wanna do that because you have a moral hazard, is you people don’t say they can fall back on the welfare system and so on, so you want to have some requirement that they save for their retirement.

0:28:37 Paul Matzko: So we’re talking about… How would you sell this to someone who’s a bit skeptical? They say, “Look, social security has its problems, [0:28:43] ____,” yes, yes, and I get why you should raise taxes or lower benefits, that makes sense, that’s commonsensical, but this change, like individual accounts, seems a bit radical. So how do you sell someone like that on why individual accounts will actually benefit retirees far more than our current system?

0:29:04 Michael Tanner: Well, there’s lots of reasons you can explain why people should make that choice, particularly younger people. If you’re nearing retirement, you’d probably wanna stay in the current system. Simply because, look, equity markets and so on, there are volatile. If you got five years to retirement, you don’t wanna take a chance on the market hitting a bad patch and going down. But if you’re 25, you’re talking about the next 40 years, and we’ve never been had a 15-​year period in US history in which we would lost money in the markets. And if you had a diversified portfolio with bonds and stocks and so on, they are really remarkably safe, and they probably should be in there. You could earn a much higher rate of return, you can have a… It becomes part of your estates or it becomes inheritable, which is something that the current social security system is not. It is fair to working women, it is fair to minorities.

0:29:54 Michael Tanner: There’s a lot of reasons why you can do this, but ultimately, why not give people a choice? If you are congenitally a socialist or something and you just don’t trust private markets, if you’re Bernie Sanders’ kid or something, I don’t know, why not… You can stay in the current social security system and take your chances. Now, you probably have to pay more taxes or get fewer benefits, but do it. On the other hand, if you are skeptical of social security being there when you retire, like most young people are, you should be given the choice of taking your money and putting it into individual account. It’s really part of your money, we probably wouldn’t take the whole thing, but let’s just start and take some of it.

0:30:34 Paul Matzko: You can do a grand trade-​off. They can have their public option for Medicare buy-​in if we give private option…

0:30:42 Michael Tanner: There you go, that’s only fair.

0:30:43 Paul Matzko: For retirement.

0:30:45 Michael Tanner: All for choice?

0:30:46 Paul Matzko: Yeah, right? Right, it seems fair. Let’s say we did this, and I don’t know how this would look, some kind of gradual… A grade-​aided option to buy into individual accounts or something.

0:31:00 Peter Van Doren: Yeah, we put together a plan at Cato that basically allowed you to take… We sort of bought into this fiction that is an employee, an employee, half, and we said, take your half, take the employer or employee half, and you can put that into a personal account if you choose to. And the employer half will stay in the current system and does a number of things in terms of disability and it also helps pay the transition to get to the new system, but basically, we would simply let you take half your so payroll tax and invest it.

0:31:28 Paul Matzko: So, that way, it’s not all at once, it kind of decreases the… It makes it easier for someone, I think, to imagine this being possible. We’ve rolled this system out, everyone in a sense now is… I suppose every working person in America is now a capitalist in literal sense, they all own capital, they own stock, they’re in index funds and bonds and mutual funds. What are some of the spill-​over effects from this scheme?

0:31:54 Michael Tanner: Well, first of all, it vastly would increase the amount of savings in the economy, which provides a big economic boost. Right now, social security is essentially a drag on the economy because of this debt that’s sitting out there. We transformed that over time into an actual capital surplus. Marty Feldstein used to talk about trends of trillions of dollars in potential economic growth, permanent increase in GDP, as a result of this. It would lessen inequality, because it would actually give low-​income people a chance to get in on investment the same way that wealthy people can. The guy running the corner store would be able to put money in the market the same way Warren Buffett does. And over time, that would decrease inequality. So we’d have a number of spill-​offs in that way, but it would also, as you mentioned, give workers more a stake in the economy. In some ways, this is the socialist dream come true ’cause the workers would become owners of the means of production, is that basically every worker in America would have part ownership of the economy. And that has a lot of positive implications for how we treat the economy and how people feel connected with the economy. Right now, they feel the elites own everything, they’re left out. This would go a long way towards giving them a feeling of being part of it.

0:33:20 Paul Matzko: It reminds me of Cory Booker’s baby bonds plan.

0:33:24 Michael Tanner: Actually, yeah, there’s something similar to that. The difference is basically the baby bonds are simply borrowed money. This is money we’re already paying right now. But the idea of giving people a stake in the economy is something that’s important.

0:33:38 Paul Matzko: And as a means of decreasing inequality, racial inequality, in his particular case, is what is interesting.

0:33:43 Michael Tanner: Well, we should remember that the social secure system really does penalize African-​Americans.

0:33:47 Paul Matzko: How so?

0:33:48 Michael Tanner: Because what you get from social security benefits depends to a large degree in how long you live. If you live to be 100, you get a lot of security checks, and if you die at 67, you’re kind of out of luck. But African-​Americans at every age and every income level have shorter life expectancies than whites, a lot of reasons, the history of racism in the society and so on, are responsible for that, but it’s true. And that means that an awful lot of African-​Americans get fewer social security benefits over the long run. About a third of African-​American men pay social security taxes but die without ever collecting a cent in benefits.

0:34:23 Paul Matzko: Wow. So, it functionally acts as a wealth transfer from African-​American workers to white retirees, in a sense.

0:34:33 Michael Tanner: Yeah, actually, social security transfers money from the poor to the rich, from men to women, and from blacks to whites. So basically, poor black men work to support rich white women.

0:34:42 Paul Matzko: [chuckle] It’s pretty regressive. Yeah, yeah. Okay, so, let’s see here. So, let’s say we make our transition, whether it’s the Cato plan, we’d take the 6.2% that you see from your paycheck, still there is going to be… No matter what you do, there’s gonna be a transition cost, because someone has to pay twice, they have to pay for current retirees and they’re paying for their own future in retirement as well. How much money are we talking about here? How do we pay for that burden?

0:35:13 Michael Tanner: We’re talking about an awful lot of money. I don’t have the most current estimates. It depends on the plan, depends on how much you’re taking out. But it’s tens of trillions of dollars over a 30 or 40 years period. And the problem is that once you’ve run up your credit cards, unfortunately, there’s no way out. For God’s sakes, stop charging. Every day we go on in the current system, we would simply make it worse, but you can’t get out from under it. We basically… For young people, we’ve screwed ‘em. They’re going to pay twice. Now, calling it transition cost is a little bit misleading because it is less than they would pay if we kept the current system going. In many ways, is if you owed me 100 bucks and you were supposed to pay me next month, and I said, “Look, if you give me 50 bucks today, we’ll call it even.” You wouldn’t say, “Oh, my God, I just incurred a $50 transition cost!”

[laughter]

0:36:02 Michael Tanner: No, you’re 50 bucks better off. Now, if you don’t have 50 bucks today, you got a problem. And the federal government doesn’t have $50 right now, so it’s gonna be painful whatever we do. It’s just gonna be less painful if we move to the system of personal accounts than if we keep the current system going.

0:36:19 Paul Matzko: And less painful the sooner we get to it.

0:36:21 Michael Tanner: Absolutely.

0:36:22 Paul Matzko: Sooner we stop charging the charge cards. Now, I’ve seen survey results that suggest that half of millennials and Gen X-​ers don’t expect there to be any social security benefits when they retire, period, which is a bit hyperbolic. Though we do want people to be awake to the fact that social security is on an unsustainable trajectory. So how do we as people who favor reform for the system, how do we harness that kind of skeptical energy, the fuel support for reform?

0:36:51 Michael Tanner: Yeah, I think what we need to do is talk to young people about what it’s actually going to mean to them. And frankly, people discount far into the future. “Oh, well, social security might not be there. That’s 50 years from now or 40 years from now. What do I care? There’s so many more immediate issues in terms of my life.” Young people tend to not vote on it, even though they say that they basically want this sort of thing. And I think we need to make ‘em understand that they’re worried about their student debt, their social security debt is many times bigger than what they face in social security debt. And they’re ultimately gonna have to pay it, one way or another, in higher taxes or lower economic growth.

[music]

0:37:35 Paul Matzko: Now, maybe you’re listening to what Michael Tanner and myself are saying here and you think, “Wow, that sounds great. But how realistic is it? Has this ever really been tried before?” You know what? There is a place where it is. There is a country where we can get a peek into the future, our possible future. That place is the land down under. So I called Simon Cowan who is the Research Director at the Center for Independent Studies, a libertarian think tank in Australia. He’s also the author of a recent paper on the subject titled “Millennials and the Super: The case for voluntary superannuation.” Welcome to the show, Simon.

0:38:11 Simon Cowan: Thanks for having me.

0:38:11 Paul Matzko: Now, can you describe in really kind of simple lay-​terms for mostly American audience, what does the retirement savings system in Australia look like for the kind of typical middle-​class worker?

0:38:11 Simon Cowan: Yeah, sure thing. So, there’s a couple of different pillars, they’re called here, the elements of the system. There’s a means-​tested publicly-​funded age pension that’s available for people who are over the age of 66 and no longer able to work. There are voluntary savings that people have accumulated over the course of their working life. There’s the family home, so, where people tend to live, is one of our pillars, and then the last one is our compulsory superannuation system, where workers have 10% of their wages deducted and sent off to a superannuation fund to manage for them in their retirement. And those sort of elements all work more or less together. Obviously, with a system that size, it’s difficult to get them to work, but basically, we sort of end up relying on that combination of assets.

0:39:28 Paul Matzko: Now, the first two that you mentioned seemed very similar to… They kind of have American analogues, like the defined benefit system is somewhat reminiscent of social security here in the US, although social security is not means-​tested, right? Like everyone contributes and everyone pretty much gets something out of social security, whereas it sounds like in Australia, it is means-​tested, it’s only for those who make a small amount in retirement. The other one reminds me of a like 401Ks, like tax-​advantaged savings but it’s that superannuation setup that that I don’t think we really have a good corollary for that in the United States. Maybe, can you drill down in on that a little bit more? What is superannuation? What does it mean? What does even that term mean? How is it different from those other systems?

0:40:20 Simon Cowan: Yeah, absolutely. So superannuation actually came out of our industrial relations system. Australia had a pretty significant problem with wages and prices spiraling out of control in the ’70s and the early ’80s, and in those days, our left-​wing labor government basically negotiated a settlement with the unions that said, “In exchange for delaying or reducing your claims for further wage rises,” a lot of wages were set centrally by our industrial relations system at that time, “in exchange for reducing some of those wages and allowing us to get inflation in particular under control, we will compel bosses to direct some of that increase into a long-​term savings account.” So, a superannuation account is a savings account held with either a retail fund, so like think of a bank or a financial institution, or it’s managed by an industry body, so, which is typically made up of worker representatives and employer representatives, or they’re managed by individuals. And there’s 600,000 self-​managed super funds in Australia.

0:41:39 Simon Cowan: And these accounts that you pay into over the course of your working life, there’s a compulsory deduction from wages that comes out of your salary before you receive it that goes to those funds. You can also make voluntary contributions on top of that. That money is kept in these funds, it’s invested in these funds, until you reach retirement age, at which point you can access that money and use it to sort of fund your retirement in addition to the age pension. And obviously, like 401Ks and other options elsewhere, there are tax advantages involved in contributing money to superannuation.

0:42:20 Paul Matzko: Hmm. And each person has some degree of control over which funds that money goes into? Like index funds, mutual funds, that kind of thing, or… How much consumer control is there over that money?

0:42:35 Simon Cowan: So, that’s a good question, and it depends to a certain extent on what industry you’re in, what sort of job you’ve got. So, the basic idea is that everyone should be able to choose what super fund they have, and you can decide to put it in an industry fund or into a retail fund. Within certain restrictions, you can manage that money yourself. You can’t draw money out of that, but you can have some degree of control over where it goes. The industry funds, the sort of union-​dominated super funds, really, they do have a slightly higher degree of control in some industries because the industrial relations system will mandate a particular industry fund for a particular person working in that industry, and those workers tend to have slightly less choice than others.

0:43:25 Paul Matzko: Mm. It is interesting, too, that labor union role in the history of superannuation, I mean, I have a hard time imagining, in the United States context, labor unions backing this kind of partial privatization of the retirement system. In fact, they’ve… Previous efforts to do so have been kind of strenuously blocked or argued against by American labor unions. So, what was the reasoning for labor unions? Why were they in support of this as an alternative, of superannuation as an alternative, to the old age pension program?

0:44:04 Simon Cowan: It’s a really good question, and I think partly it’s a function of that particular time. The Australian economy had been performing relatively poorly. The government was engineering a fall in real wages over that period of time as a way of combating what was fairly dire economic circumstances. So, we had a situation where some more radical reforms were on the table simply because we were genuinely concerned about the direction of the country. One thing that we have seen with unions, whether or not they had the foresight to see this in advance, the private sector coverage of unions in Australia has declined enormously to the point now where it’s something like only 10% of private sector workers are a member of a union. We still have quite a strong union coverage in the public sector, but outside the public sector, unions have all but disappeared in Australia. And so, one way that they can ensure their financial viability and one way that they can sort of make money without having a lot of members or a lot of fees is that they actually can get management fees from the superannuation system, and given that the size of our super system, you know, it’s $3 trillion which is well and truly more than 150% of Australia’s GDP…

0:45:33 Paul Matzko: Wow!

0:45:33 Simon Cowan: The size of that system generates a reasonable income for the participants in it. So, the unions, whatever their original thoughts are on super, they’ve certainly become quite dependent on the system for their financial stability.

0:45:47 Paul Matzko: I’m struck by that number. 100, what, 130-​plus percent of Australia’s annual GDP in the superannuation system, whereas in the US, our Social Security Trust Fund is just under about 14% of US annual GDP. So it’s proportionately 10 times less. How did you get from there to here? So, these laws are passed in the early ’90s. My understanding was that the contribution rate kind of has been gradually going up. And has there been pushback against the rising amount of money in the superannuation scheme and the rising contribution rate?

0:46:37 Simon Cowan: Yeah. So, you’re right, the original super system was set up as 3% of wages. It rose to 9% over the course of the next 15 years. There wasn’t a huge amount of pushback in relation to that increase because that period of time happened to be an exceptionally high period of economic growth in Australia. We saw quite a significant economic boom in the early 2000s and then even again towards just after their global financial crisis, there was quite strong income growth in that time, so people perhaps didn’t notice the increase in super as much. And obviously, the system is now 25 years old, so we’re now starting to get a degree of maturity in the system.

0:47:26 Simon Cowan: You can imagine that that this system, having built up over 25 years, we’re now starting to see people who are coming into retirement with enough money in their super system balance to be able to influence their retirement. And part of that… I think a significant part of that really comes from the fact that superannuation is compulsory. And so, for younger workers in particular, workers in their 20s and 30s, so superannuation is something they’re going to receive in 30 or 40 years, they’re not as focused on the competitive aspects of super. They’re not as focused on the returns. They’re not as focused on costs. They’re not as open to moving to get a better deal from their super. And so there’s a great deal of inertia in the system that allows people to charge fees that are higher than reasonable or higher than necessary.

0:48:20 Paul Matzko: Mm. That makes sense. One of the analyses I saw actually came from Vanguard, which is an investment firm that operates across the globe. But they estimated that average retiree earnings in Australia… And this is half an estimate. But they estimate that it will nearly double from 1992 to 2029 to about $50,000 a year in income from superannuation funds. Does that line up with your own estimates? What does… How has retirement changed in terms of how much revenue your typical retiree is going to be bringing in 10 years from now versus when this plan was first put in place?

0:49:07 Simon Cowan: Yeah, absolutely. I think we’re already starting to see an increase in people who are self-​sufficient in retirement. That increase, while it’s not as large as we’d hoped for, it’s… Those numbers of people are growing. Especially early in retirement, we’re finding more people who were not eligible for the age pension until they start to get older, and we’re seeing of that generation of people who are coming into retirement in the next 10 or 15 years, the balance in their superannuation accounts is expected to be somewhere in the vicinity of $300,000-$500,000, which is a sum of money that can go a reasonably long way in retirement, especially when it’s supplemented with an income from the pension. So, I think there’s no question that amongst retirees who own their own home and have some money in the superannuation account, their living standards in retirement have been a lot higher in the last 20 years than they probably were before that, and the retirees who were really struggling with poverty, the ones who probably should be the focus of government attention in the retirement space, tend to be those who have little or no savings in super and don’t own their own home. And as long as our system keeps pushing people towards something of the savings nesting, and alongside that principal residence, then it’s… There are estimates that suggest something like 90%-95% of retirees will have a comfortable income in retirement.

0:50:45 Paul Matzko: Hmm. Now, we’ve talked about this a little bit already, but my understanding is as the… As more and more workers spend more of their career contributing into the scheme and a higher percentage of their wages are going into the scheme, all of that should get better over the next 10, 20 years. The numbers will keep climbing. Simply put, 25 years of paying in means our… People retiring right now have only been contributing since say, their 40s, since they’re maybe 40, late 30s. That’s a lot of… Another 20 years of annualized returns makes a big difference. So, what is the… How do we measure success or failure for the superannuation system? How do we know… ‘Cause it sounds like… A few times you referenced here that returns have been below what was expected. 4%-5% is below the… It’s certainly below the SMP average here in the US of about 7% over a 30-​year time horizons. Real, real returns, obviously, adjusting for inflation. So, that seems low. It’s of course, much higher than let’s just say the return on social security in the US, where the return is… Approaches zero, for most people. So what’s the bench… What’s the appropriate benchmark? How will we know if superannuation is a success or a failure?

0:52:15 Simon Cowan: That’s a really good question, and it depends very much on the perspective that you look at it from to what you think. So, in terms of, “Is the Australian super system a success?” Well, on the plus side, our means-​tested age pension is a relatively low percentage of our level of government spending compared to a lot of other countries. We have a relatively low system, and one that’s not overly penal, it’s not low because the rate of the pension is very low, but because we have all these other elements to the system. We don’t have a situation where there is a massive unfunded liability, either. One of the big advantages of Australian super compared to a lot of other systems is it’s a defined contribution system, it’s not a defined benefit system, where you see the real problem, I think, and even to an extent we saw this in Australia, was unfunded defined benefit systems that were draining the public purse. So, we don’t have those particular problems.

0:53:23 Simon Cowan: I think one of the challenges of the system in particular, though, is there’s been a lack of clarity around the goals of the system. Until very recently, we hadn’t even sort of legislated a purpose to the superannuation system, so, there was a lot of different thoughts as to what the system was supposed to do: Was it supposed to generate self-​sufficiency in retirement? Was it supposed to reduce the pension burden? Was it basically supposed to be additional spending money on top of the government-​funded age pension? And whichever characterization you put on the system, it depends whether or not you think it’s been a success. Until very recently, we haven’t had a lot of evidence that even when the system was mature, it would reduce pension spending very much, that largely what it would do is move people from full reliance on our age pension to a partial reliance on the age pension. With some tightening of our pension means-​test recently, the evidence is suggesting the longer-​term burden on the age pension will be lower, which is very much a good thing. But that superannuation is really a system that is universally applied but is of far greater benefit to people who are on average incomes or above-​average incomes compared to those who are on below-​average incomes.

0:54:46 Paul Matzko: If you have a piece of advice for American policy-​makers, it’s not really in the conversation right now, it was 20 years ago back during the Clinton and then Bush administrations’, proposals to privatize social security, it wouldn’t have looked exactly like the Australian system because again, we don’t have that old age pension corollary, but what advice… Eventually, this crisis is gonna hit the United States, eventually, social security will have to cut back on its benefits, there’ll be a lot of public pressure to enact some kind of reform. And so, for future policy-​makers, as they think about retirement issues, what advice would you give to them from the Australian case? If you got to redesign superannuation at the outset, what changes would you make to it to avoid some of these pitfalls?

0:55:45 Simon Cowan: Yeah, absolutely. So, possibly two slightly different questions there. But let’s start with, what advice would you give to people? And the primary advice is don’t make things worse. So, identify the things that are putting pressure on the system. As I understand, from the US system, there is increasing pressure coming on to this system that it’s already underfunded, but the problem is actually getting worse. And in a number of cities in particular, there’s a significant problem of funding the pension system that we already have. So, one of the elements of that, obviously, is to shift more from a defined benefit model to a defined contribution model. So, rather than sort of saying, “You’re going to get this particular level of social security payment or this level of pension from the city,” that whatever you contribute, the returns on that money will be the amount that you receive in terms of your benefit. That at least stops the system from getting any worse. It doesn’t necessarily solve the problem, but it does stop it from getting worse.

0:56:51 Simon Cowan: I think in terms of how we could make the Australian system better, one thing that would have been better is if we’d started with the most efficient tax model in our super system. So, the most efficient tax model is for contributions to be exempt from taxation, earnings to be exempt from taxation, but any earnings in retirement to be fully taxed so that retirees have an interest in the income tax system, they have to pay into the system, and they’re not simply in the position of infinitely drawing out of government spending without contributing to government spending. And that’s a problem that we have now, with 12% of our population in retirement. There’s a huge percentage of retirees who no longer pay any tax directly, so they no longer have any interest in the efficiency of our tax system. I think that would be one thing that would work quite well.

0:57:48 Simon Cowan: And then the other thing would be to focus on what it is that we want superannuation to achieve. And I think for workers who are likely to receive a full age pension or almost a full age pension in their retirement, they’d be better off having access to that superannuation to support them through medical bills, to allow them to buy a home, to support their family. Basically, they’d be better off with that income because that income won’t really add too much their retirement, and it is diminishing their living standards while they’re working. Those are the sort of reforms, and a lot of that is more tinkering of the ages than fundamentally changing the system. I, personally being a libertarian, would prefer the system to be voluntary. I think there’s a lot of benefit in terms of increasing competition when the only people who are in the system are those who wanna be there, but given how entrenched our system is in terms of industrial relations, in terms of tax, in terms of that entrenchment of the system, it seems very difficult to go from here to a voluntary system, and I suspect that the reverse is also true in America: Moving from a voluntary private contribution system to a compulsory one is very difficult.

0:59:07 Paul Matzko: The conversation’s been fairly abstract so far. We’re dealing with these huge sums of money, obscure federal government policy, but what might these reforms mean for ordinary folks who depend on social security and retirement? Let’s consider the case of a hypothetical person who just because we need the name, we’ll call him Regis Philbin. Let’s compare Regis’ expected outcomes in retirement under two very different scenarios. First, what he’d receive under our current social security system, then how he might do with a privatized individual account system. Let’s say that in both worlds, Regis worked his entire 50-​year career, all the way from age 18 to retirement at age 68, in the minimum wage job making just $7.25 an hour for 40 hours a week. And that’s a little bit under $14,000 a year. Now, to be conservative, we’ll stipulate that his earnings, they adjust with inflation but they never functionally go up. He’s making very little money, much less than most Americans make. This is not generally how it works in the job market, but we’re gonna be conservative here.

1:00:12 Paul Matzko: Under our current system, Regis would be putting the equivalent of 12.4% of his earnings into social security, which comes out to $1726 a year. Now, when he retires, he’s gonna receive a benefit of about $9552 a year. I use the social security agency’s own online calculator for this. And that’s not nothing, I mean, it represents a real annualized return on his contributions, so long as he doesn’t die early, maybe 2%. But $9500 isn’t a lot to live on when you’ve gotten used to living on $14,000 a year. And when the Social Security Trust Fund runs out of money in the mid-​2030s, Regis’ benefit will be cut to somewhere around $7500, which could have a negative real return on his contributions. Still, it’s better than nothing, it’s fairly stable, and we’re familiar with it.

1:01:04 Paul Matzko: But consider how much better Regis’ retirement would be if he had been able to invest that 12.4% instead. And again, we’ll make all the conservative assumptions, we’ll assume 6% return across the 30-​year investment horizon, conservative, pessimistic. And it’s Regis’ bad luck to be working during a bad economic cycle. But even so, when he retires at 68, he’ll have retirement savings worth just over half a million dollars, and three-​quarters a million, if the market performed closer to its historical average. Our minimum wage working Regis is halfway to being a millionaire. And then based off a 4% withdrawal rule of thumb, which should preserve his account for the rest of his life, Regis would have a retirement income of $20,000 a year, more than double that he would have received from that antiquated social security system of yesteryear. Double.

1:01:55 Paul Matzko: But imagine how much better his life would be as a result. He’s less likely to have to choose between paying the heating bill and buying groceries. Furthermore, if Regis dies early, and in most cases, even if he lives beyond average age, he’ll leave a large inheritance for his family, perhaps hundreds of thousands of dollars. It is his money, after all, not just the vague government promise that has no real legal obligation to honor. Think of the effects this would have on intergenerational cycles of poverty, functionally acting as a kind of trust fund for every family in America.

1:02:30 Paul Matzko: Now, in this example, I’ve used the most conservative lower estimates, but if you bump Regis’s average lifetime annual earnings to just $28,000 a year, which is still less than most American workers average, then Regis Philbin would retire a millionaire and effectively join the middle class in retirement. Even dual-​income households working minimum wage jobs would have combined half a million dollars at retirement, meaning that the overwhelming majority of Americans could be millionaires. Who wants to be a millionaire like Regis Philbin? I do. Don’t you? Let’s reform social security to make it happen. Until next week, be well.

[music]

1:03:11 Paul Matzko: Thanks for listening. Building Tomorrow is produced by Tess Terrible. If you enjoy Building Tomorrow, please subscribe to us on iTunes or wherever you get your podcasts. If you’d like to learn more about libertarianism, find us on the web at www​.lib​er​tar​i​an​ism​.org.