by Eric Singer
Years ago, my young teenage daughter turned to me at the dinner table and said, “My social studies teacher wants me to talk tomorrow to the class about Social Security. Do you have any ideas that I could use?” Remembering her progressive teacher, I replied, “Why, yes I do.”
The next day she told the class how Social Security worked and how people paid money in and eventually sometimes got their money back or more. And then she told the teacher in her best Gossip Girl voice she thought it was “mean” that on average people got only 1% back on their money when banks were paying 5% on everyone else’s savings.
“Who took the other 4%?” she asked. “That’s enough,” he replied, “sit down.”
But now we have an entire country where short-term rates have been fixed at zero by the Fed. Not just Social Security beneficiaries, but every saver in the country is now asking, “Who took my interest?”
Bill Gross of Pimco calls it “financial repression” when savers are forced to get a below-market rate for their interest. Recently, Texas Gov. Perry called Social Security a “Ponzi scheme.” The SEC website says: “With little or no legitimate earnings, the schemes require a consistent flow of money from new investors to continue. Ponzi schemes tend to collapse when it becomes difficult to recruit new investors or when a large number of investors ask to cash out.”
With 78 million baby boomers starting to cash out, each entitled to benefits at age 62 continuing for over 22 more years on average, Social Security fits within the definition of a Ponzi scheme. Just because the government can currently coerce new participants doesn’t mean today’s young workers want to pay in or that boomers won’t want their cash. It’s not self-sustaining as originally presented.
President Obama has included in his major jobs initiative a proposal to deepen the existing cut in the payroll tax from 2% to 3.1% — for one year only. In his Keynesian vision, the average household with $50,000 income will immediately spend most of the $1,500 saved in taxes.
However, an honest economist will tell you that when tax cuts are temporary, people tend to hoard the savings and not “jump-start” the economy by spending the proceeds. And with the S&P downgrade of the U.S. debt, many Social Security participants are starting to discount their ability to get all, or even any, of their promised benefits. This is the opposite of a wealth effect: it’s a loss effect.
Republicans are concerned that opposition to this cut will be painted as mean-spirited to poor people. It’s time for jujitsu on this issue. Let’s use the 3.1% cut to open up private savings accounts (PSAs), and make the payroll tax cut permanent. Let that permanent account accrue capital gains, interest and dividend income in perpetuity without any tax.
As a nation, we have a collective memory of what it was once like to earn interest on savings. If you are 35 years old today, and can save an extra $1,000 a year tax-free for the rest of your life, that is something much more valuable than a one-year tax cut. And if you know it can never be taken away from you, those animal spirits start flowing.
Even better if in the back of your mind you think it might earn interest again someday. A rough discounting of all these benefits back to the present totals thousands if not tens of thousands of dollars, far more than the temporary cut.
It is here that the Chilean experience, recently mentioned by Herman Cain, is so compelling. Jose Pinero, the architect of Chile’s PSA plan, described his office secretary as having saved $400,000 through a PSA, or enough to buy a new house and have a good pension, or to buy two or three houses.
By comparison, the average retiring U.S. worker has a net worth of $50,000 from private savings, enough to buy a third of our average house, but only gets a small payment from Social Security. Relative to their expenses, the Chileans seem to be several times wealthier than we are. In fact, they are rated AA and rising and we are rated AA+ and in danger of falling further.
What does all this mean for the short-term policy fight over jobs? It means that letting workers keep an additional 3.1% that they can put in PSAs will do the most to make them feel a true wealth effect.
The Republicans should agree with President Obama about cutting the Social Security tax, propose eventual adjustments to benefits but emphasize letting Americans use their savings to start to privatize Social Security. There is no time like the present for letting this camel’s nose into the tent.
Eric Singer is Portfolio Manger of the Congressional Effect Fund (CEFFX) which only invests in the broad stock market when Congress is on vacation. Learn more at http://www.congressionaleffect.com. Reprinted with permission from Investor’s Business Daily.