My new EconLib article. An excerpt:
My suggestion is that the government, before making any major changes to the Social Security formulas, first allow Americans to opt out of the system, thereby avoiding any future payroll taxes but also forfeiting any accrued benefits. However, if the person represents a net asset to the Social Security program from the government’s perspective, then he or she must contribute this amount before being allowed to opt out.5
An opt-out option would improve upon the status quo from the government’s perspective, because Americans can opt out only if they represent a neutral or net liability to Social Security. On the other hand, since it’s voluntary, it would seem that my proposal cannot hurt the Americans who opt out; anyone worried about being hurt by this procedure can choose to remain in Social Security.
The thing that I didn’t fully realize until writing this piece:
The Current System Relies on Forced Loans to the Government
How can allowing an opt out represent a win-win scenario? Why would some Americans—I suspect millions—remove themselves from Social Security if they currently represent a net financial liability to the federal government? The answer depends crucially on the fact that private households have a higher discount rate than the U.S. Treasury.
Currently the U.S. Treasury can borrow money (by issuing Treasury Inflation Protected Securities or TIPS) from bond buyers for very low interest rates, such as 0.9 percent on 30-year loans and 0.4 percent on 10-year loans.7 These are “real” rates of return, meaning that the Treasury adjusts for price inflation when paying back the lenders.
On the other hand, many households currently hold a substantial portion of their wealth in assets that they expect to earn a higher real return than inflation-protected bonds issued by the U.S. Treasury….
The large scope for win-win reform occurs because many participants in Social Security are implicitly being promised a real rate of return on their payroll taxes in between these extremes. For example, Leimer (1994) estimated that people born in 1975 will “earn” an average of 1.9 percent from Social Security, while those born in 2000 will earn 1.7 percent.9
So to me, that’s a critical factor. Rather than viewing Social Security as merely a tax and spend program, it is actually more of a mandatory participation in a pay-go retirement system. Or to put it in other words: By letting today’s workers opt out, the government doesn’t simply lose current tax revenue, but it also reduces its future obligations. This gives rise to “win-win” outcomes that I didn’t fully grasp before starting this project.
NOTE: If you are really a policy nerd, go see if my criticisms of George W. Bush’s Social Security privatization plan are consistent with my present piece. (I think they are, but I understand the issue better now than I did back then.)