How to fix Social Security

by Ron Ross

The largest category of government expenditures is Social Security. It might surprise you to know that most people pay more in Social Security taxes than they do in income taxes. Furthermore, the trends do not bode well. Demographics will place an enormous burden on the system as the baby boomers begin to retire around the year 2010.

Our basic options are fairly straightforward: reduce benefits, raise taxes, or improve the rate of return on the system's assets. The third alternative is by far the least painful.

A presidential advisory council recently reported that it could not agree on any one way to address the system's coming problems. The one common element of the council's three alternative recommendations is that at least some of the system's assets should be invested in the stock market. This would mean that as much as $1.5 trillion dollars would be added to the stock market by the year 2015.

As the discussion about partially privatizing Social Security gathers momentum, one of the issues is bound to be whether such a change would be too risky. Sure, the stock market has historically higher rates of return than government bonds, where Social Security funds are now invested, but can we prudently put something as centrally important as the Social Security system in something as volatile as stocks?

Ultimately, the soundness of the Social Security system depends on the strength and size of the U.S. economy. Our ability to provide for a large population of non-working senior citizens depends on the volume of output produced by the working-age population.

The larger the size of the economic pie, the easier it will be to give retirees large slices without skimping the rest of the population. The more we grow economically, the less the conflict of interest between the generations.

Anything we can do to increase the available pool of capital with which to expand our productive capacity should be our focus. One of the foremost reasons why Americans are so productive is that workers in our economy have so much capital and equipment to work with. You produce much more and you're paid much more when you run a backhoe rather than when you hold a shovel. The stock market is a vital conduit in the process of allowing our capital stock to expand.

If a significant fraction of the money collected through Social Security taxes went into financing business development and expansion, the available pool of investable funds would be greatly enhanced. It would help give us the capacity to fulfill our promises to future retirees.

Privatizing Social Security is not a radical proposal. Privatization would simply bring the system into conformity with virtually all other public and private pension plans in the U.S.

Government employees in California, for example, participate in CalPERS, the California Public Employees Retirement System. CalPERS has assets exceeding $100 billion. Over the past ten years, their investments have achieved a rate of return in excess of 12%. That track record is extremely good news for California taxpayers. It means that future promises to state employees can be met without the necessity of tax increases.

In a narrow sense, investing in government bonds is less risky than investing in the stock market. But from the standpoint of the overall economy, the stock market is a better route to true security.

The primary disadvantage to investing in the stock market is short-run volatility. The stock market does take significant drops in value from time to time. It has, however, always recovered.

But what, you might ask, would happen if the market dropped and did not recover? Would such a contingency damage the Social Security if the trustees had invested in the stock market?

About the only imaginable reason why the stock would take a permanent fall is if we have some form of economic collapse. If that happens, retirement will no longer be an option for most people anyway. If the economy isn't functioning, we'll all be working as hard as we can just to make ends meet.

The promise implied by government bonds will not mean anything. There is no real additional risk to investing Social Security funds in the stock market. There are, however, profound benefits for doing so.

A former professor of economics, Ron Ross is a financial planner with Premier Financial Group, Eureka.