Your Social Security taxes pay for insurance
in case you’re disabled and insurance for your survivors in case you die. The largest
part of your Social Security taxes go to a forced savings plan that provides income when
you retire. It is reasonable that we ask what sort of return one can expect from this forced
savings plan. To answer this, let’s look at what the average
American worker pays into and receives from Social Security. We’ll filter out inflation,
so the figures you will see are all in today’s dollars. To be conservative, let’s assume
that our average worker doesn’t start working full time until age 22.
Economists generally agree that employers pass on their halves of Social Security tax
to workers in the form of lower wages. This means that our worker pays 12.4 percent of
his wages in Social Security taxes, but only 63 percent of those taxes go to paying for
retirement benefits. So the total amount of Social Security tax the worker can expect
to pay toward his retirement is just over $216,000 in today’s dollars.
Our average worker can expect to pay that amount from age 22 to age 66. According to
the Social Security Administration, our worker can expect to receive retirement benefits
of almost $25,000 per year in today’s dollars, starting at age 67. The average 22-year-old
can expect to live to age 78, so he can expect to receive just under $300,000 in retirement
benefits. Now, to evaluate Social Security as a retirement
plan, we combine the worker’s expected Social Security tax payments and his expected Social
Security retirement benefits. Our average worker pays $216,000 toward retirement, receives
almost $300,000 in retirement benefits. That’s the equivalent of an annual real return of
1.2 percent on his Social Security taxes. In other words, the Social Security taxes
that went toward the worker’s retirement earned him an interest rate that is about
1 percent better than inflation. How does this rate compare to other interest rates?
Over the past 50 years, stocks in the S&P 500 have generated a return that is 5.1 percent
higher than inflation. If our worker were able to invest his Social Security taxes in
a private account then invest it in stocks, he could expect to collect over $950,000 in
retirement, or more than three times the return that Social Security provides.
The counter argument is that stocks are risky and that the whole point of Social Security
is to provide guaranteed retirement benefits. This is in fact false. The only thing that
is “guaranteed” is that the Social Security Administration will invest the taxes it collects
in government-issued Treasury bills. There is no guarantee that Social Security will
give you the money back. At any time, Congress can change the rules and reduce your Social
Security benefits. If a person truly wants safety, one can use
a private retirement account to obtain an investment that is safer than Social Security:
Treasury bills. By investing privately in Treasury bills, the retiree gets the same
safety of government-issued securities that Social Security claims to provide but without
the risk of the Congress changing the rules and reducing Social Security benefits.
Historically, one-year Treasury bills have paid an average of 1.7 percent more than inflation.
If our worker were able to invest his Social Security taxes in a private account that invested
in one-year Treasury bills, he could to expect to collect more than $345,000 in retirement,
or about 17 percent more than Social Security provides.
Today, Social Security retirement benefits cost the federal government about half a trillion
dollars a year. And under current law the program is projected to be insolvent within
25 years. If the government started a 20 or 30 year phase out of Social Security today,
the government could honor its obligations to current retirees, shut down a program that
cost half a trillion dollars a year, and allow Americans to transition to private accounts
that would yield more safety and better returns than Social Security provides.