06 Mar 2017

Opting Out of Social Security

Social Security 5 Comments

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.)

5 Responses to “Opting Out of Social Security”

  1. LordBlagger says:

    first allow Americans to opt out of the system, thereby avoiding any future payroll taxes but also forfeiting any FUTURE accrued benefits.


    Why should the lose what they have already paid for?

    However, if the person represents a net asset to the Social Security program from the government’s perspective

    Can you own people? I thought a war was fought to prevent that.


    I’ve crunched the numbers for the UK welfare state and its pensions.

    A median wage earn will have paid in 235K of value. [47 years working at the current contribution]. That’s payments in, all in today’s value terms.

    They get back 6K of value, for an average retirement lifespan of 18 years. 108K back. Not a good deal is it.

    So how you get the 1.7 percent return for the US?

  2. Scott says:

    Great article.

    I have also wondered about people’s personal discount rate vs. the market vs. the very wealth, etc., and the dynamic it sets off.

    It seems like most people’s rate is way above the market rate, which is why most people don’t *really* start saving for retirement until their 50s or so — they discount ‘retirement’ to a value of basically zero until they are about 10-15 years out, which implies a pretty steep rate. Then they (try to) save like mad in the last few years.

    Most people don’t have regular brokerage accounts that they consistently use because their rate is much higher than what they perceive the market to offer. About the only way they’ll consistently save for retirement is through tax advantaged accounts (401Ks etc) that offer employer matches and immediate tax incentives (and then they often just borrow the money back out — as if, once they get the one-time payoff, the rate is no longer high enough to attract them). Or, I guess, if they’re forced to as with SS. So, you’re probably right — most people would opt out, and then just spend the money, until they turn 50 or so. Then they’ll probably start sweating and wringing their hands (and lobbying government).

    Most people borrow like crazy (for mortgages, etc), it seems, mostly because of the relatively large discrepancy. OTOH, the wealthy have rates more in line with the market (and even lower), I guess because the market rate is dominated by the lending characteristics of the larger players (and, of course, the banks).

    My idle speculations….

    • Scott says:

      One more complication — it may be that many people attach a unique valuation to a government guaranteed ‘investment’, in which case there is some value created by having SS vs a private arrangement and those people will be willing to accept a lower discount rate to get the government program. In which case, fewer people would quit the program than you might guess from ‘naked’ discount rates alone.

  3. Adrian Gabriel says:

    Great article. In order to fund Social Security companies are taxed and then later remove the funds from an employee’s income, or the income itself is taxed by the government before the payroll check is received by the employee. Either way, the employee is taxed for an inflationary program.

    In order for the government to fund these entitlements, they must expand credit, which is then paid for with tax receipts they expropriate at the end of the year. The government expands credit often, a few times a month as a matter of fact.

    I am quite sure that there would not be a possibility of privatizing Social Security, as this pension program is made up of government debt. The Social Security funds are paid for with Treasuries, which are then paid back with extortion of purchasing power as well as stolen income. We can only cut Social Security outright.

    I enjoy reading your idea about opting out of the entitlement. If there were a policy proposal where individuals could opt out of the program, meaning they would not receive it, as well as not have taxes extorted from their paychecks, we could seriously get rid of this program altogether. This would be a true policy of opting out.

    In so allowing this, the money stock would fall, as would prices. The business cycle would be less severe. As you have taught many of us, only a true free banking society would lead to a properly market-oriented money stock.

  4. Scott says:

    OK, couple more thoughts, just because I know how very, very deeply FAers care about my opinions (sorry, you’ve just tangentially hit on something I think about a lot…)

    — Despite being perpetually nagged and guilt-tripped about saving for retirement, most people find it uninteresting and tiresome and simply don’t do it (at least to the degree that financial writers would believe was minimally ‘responsible.’) One exception to that tendency (at least that I know of) is a substantial swath of Millennials who have cobbled together an early retirement/financial independence movement (for example, see Mr. Money Mustache). But basically they motivate themselves with an emphasis on *early* — the target is usually something like 7-10 years only in the workforce, then you’re ‘done.’ Some of these guys will move heaven and earth to make it happen, saving 50-70% of earnings. It seems ‘moving the goalposts closer’ is a much better motivator than promising people ‘7-8% over the long term’ in mutual funds. There’s those discount rates again…

    — When people talk about this stuff, they typically do not include a bunch of income sources as retirement — including SS, but also another really important one — imputed, non-cash income from their accumulated possessions, especially their houses. A reasonably nice, paid off house has to be worth ~$20K per year or so. Add in SS and Medicaid, and most people don’t really need just a ton more than that. So, despite all the harping of the financial writing community about ’20X’ your income (or whatever) and how irresponsible Americans are about retirement, actually, when you think about it, most people are positioned much better than they are given credit for (at least, if you’ll grant them the charity of not expecting them to question government promises. But anyway…)

    I would note — if you think about imputed incomes, many of our personally held possessions, like houses, actually pay better than the stock market — especially when leveraged. Investing in them ‘first’ actually makes a lot of sense. And on top of that, people have been forced to ‘save for retirement’ through SS and Medicaid taxes most of their lives, curtailing consumption at least to that degree the whole time.

    But don’t tell that to the financial writers….

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