Socializing America’s Retirement, Part 1
The way Social Security goes, so will America. With the current retirement-funding model being unsustainable, Congress is faced with its most pivotal ideological decision since the vote on Hillarycare in 1994: expand government, or expand individual and economic freedom.
The choice is no smaller than that, but it is also a decision of tremendous economic importance. In three parts I am going to explore the reform problem itself – Social Security and its future – as well as the alternative and the broader repercussions of a choice to socialize or privatize retirement funding.
Social Security: More Economic Redistribution
It is no secret that Social Security is in bad shape. It almost doesn’t matter if the system goes into the red ten or twelve years from now – the point-of-no-return is approaching, and it is approaching fast. We could have saved the system with thoughtful reforms, such as the private-account model I developed a bit over a decade ago and published in my policy-reform collection Ending the Welfare State: A Path to Limited Government That Won’t Leave the Poor Behind. Unfortunately, today the time for such foresightly reforms is almost up; if we cannot get a good reform going before the next presidential election, only two alternatives remain:
- A collapse of our retirement system, leaving tens of millions of Americans out to dry; or
- A socialization of the system where government seizes control of all retirement funding.
From a fiscal and even macroeconomic viewpoint, both of these alternatives are undesirable. Politically, the vast majority in Congress views the collapse as unacceptable; barring a privatization reform, that leaves only the socialization option on the agenda.
This should worry all of us, as it would mean both lower pensions – or less lifetime pension benefits under a higher retirement age – and higher taxes to fund those pensions. It will also, with a high probability, mean the end of the 401(k) retirement option. The key element of a socialized-retirement reform is, namely, to make sure that the system does not add a dime to the budget deficit; without budget balance, any government-centered change to the current system is pointless.
According to the Democrats, this is indeed the direction we should be going in. A case in point is H.R.5050, also known as the Social Security Enhancement and Protection Act of 2021. It combines increased benefits primarily for lower-income retirees while raising taxes on higher-income earners. The former is achieved with a few technical changes to eligibility and the calculation of benefits; the tax hike comes in the form of a gradual removal of the cap for the Social Security tax.
President Biden’s own plan for Social Security follows a similar, ideologically explicit path of increased economic redistribution. Last year a research group with the Wharton School at the University of Pennsylvania analyzed his reform and found that its proposed tax hikes would have permanent negative effects on GDP growth. While their study did not explicitly look at the potential for Biden’s reform to improve Social Security solvency, the permanent reduction in GDP combined with higher benefits is a strong signal that his reform would not at all be fiscally solvent over time.
The fundamental problem with tax-paid retirement is this formula:
- Benefits are earned based on the individual retiree’s income during his or her active years in the workforce;
- Taxes funding those benefits are based on the aggregate personal income of the active workforce.
As I explain in detail in my book Ending the Welfare State, with mathematical examples and empirical evidence, this formula is always unsustainable at any given tax rate. You simply cannot build a retirement system that will pay benefits as our Social Security does, if the tax rate is to be constant over time and if funding is based on aggregate personal income. The only way to maintain that system is to gradually – and perennially – raise taxes.
That is not a rhetorical point. As I explain in my book, it is a logical necessity.
Initially, Congress recognized this and raised the Social Security tax 20 times in 40 years: on average, every Congress elected from 1950 to 1988 raised the Social Security tax. In total, the tax rate increased six-fold, which sends a clear signal as to why retirement benefits cannot rely on the aforementioned funding-benefits formula.
Yet as things look now, Congress keeps forging ahead along the same lines as H.R.5050 lines out. Senator Mitt Romney (R-UT) wants a bipartisan group that can come up with a new funding formula for Social Security. At no point in his TRUST Act does he mention privatization of the existing system; his goal appears to be to find a bipartisan platform for a balance between higher taxes and adjustments to (i.e., cuts in) benefits.
At the heart of these efforts to somehow shore up the current Social Security system is the idea of a broader payroll tax, one that would not be subject to an income cap. As the law is written today, an expansion of the tax base above the statutory limit – currently $142,800 – would also expand the benefits formula to apply to every dime of personal income. This means, e.g., that people earning millions of dollars would be eligible for Social Security in proportion to those millions. That, of course, is unpalatable for those who want to save the current system by raising taxes, but it is also an unsustainable idea for the very funding-formula reason that I pointed to. The higher the personal income that produces benefits claims, the bigger the discrepancy between benefits accrual and growth in the tax base.
Therefore, the only way to motivate a reform that “saves” the current system is to decouple the tax base from the benefits base. This is in itself a radical idea, one that would actually redefine Social Security as a retirement benefits system. The idea with tying the tax base to the benefits base is that the system will “pay for itself”; we already know that this does not happen in reality, but by defining the system as such, Congress has formally separated it from the rest of the federal government’s finances.
A decision to sever the tax base from the benefits base does not automatically bring Social Security over the line into the federal government’s General Fund budget. It is, however, a necessary condition for such a step. Other cash entitlements, such as the Earned Income Tax Credit, operate under the same funding-benefits dichotomy, for one simple reason: the benefit is ideologically defined:
- Our current Social Security system is predominantly designed to be an individual retirement savings plan, administered by government;
- The Earned Income Tax Credit is designed to be an entitlement that benefits a defined population at the direct or indirect expense of another defined population.
By paying money into the Social Security system, generations of Americans have, figuratively speaking, saved up for their own retirement. There is a redistributive element within Social Security, such that workers with lower incomes get a larger portion of their earnings in retirement benefits than do those who make more. Nevertheless, the default design has been one of a savings plan, not a traditional entitlement program. (The fact that Social Security is referred to as an “entitlement” is a matter of conceptual misapplication.) By contrast, the EITC, which is paid for through the General Fund, offers no connection between funding and benefits. Its purpose is to redistribute income from the taxed population to the entitled population, which is why the tax funding applies to all federally taxable income.*
If Congress had removed the income cap for Social Security taxes in 2018, the tax base would have increased by 87 percent or $3,674.4 billion. The next step – which does not appear to have been proposed anywhere yet – is to expand the tax to all income, not just payroll-based earnings; if this feature were added to a cap removal, the tax base would (again based on 2018 income data) expand by 178 percent.
All these numbers are based on a static calculation and do not take into account the dynamic effects that the aforementioned Wharton study included. But the purpose here is not primarily to demonstrate the macroeconomic detriments of such a broad tax increase; my intention here is to highlight the ideological character shift that Social Security would undergo. Even with the “limited” expansion under a cap removal, the tax base effectively changes character from funding a retirement savings plan to funding an entitlement comparable to the EITC. This means, plain and simple, that Social Security would become an ideologically designed entitlement program; if the benefits reforms proposed under H.R.5050 are included, this ideological profile is reinforced.
As I explained in my book The Rise of Big Government: How Egalitarianism Conquered America, the ideology exhibited in an entitlement program disproportionately benefiting lower-income individuals is socialism. The prevailing wisdom in the American public discourse contradicts this statement, but that does not change the fact that socialism is an ideology the political practice of which is economic redistribution. Every entitlement program that
- Pays out benefits with a profile to benefit lower-income individuals more than higher income individuals, and
- Places more of the funding burden on higher-income individuals than on those with lower incomes,
is by definition a socialist entitlement program. Any Social Security reform along the lines of H.R.5050 is therefore socialist in practice.
That does not mean that anyone supporting H.R.5050 or any similar reform is a socialist. It is probably the case that those who designed this reform bill are unaware of the ideological architecture it applies to Social Security. Nevertheless, that does not change the facts about what the bill actually would do, should it become law.
At the same time, it is important to note that other legislative and regulatory initiatives under the realm of the Democrat-controlled federal government have similar ambitions. This includes a new retirement-related regulation from the Department of Labor. While concerned with 401(k) plans, this new regulation is ideologically profiled in a way closely reminiscent of how the Democrat initiative for Social Security reform would apply. Explains Fox Business:
An important Trump Labor rule last fall reinforced that the Employee Retirement Income Security Act (Erisa) requires retirement plan fiduciaries to act “solely in the interest” of participants. The rule prevented pension plans and asset managers from considering ESG factors like climate, workforce diversity and political donations unless they had a “material effect on the return and risk of an investment.” The rule effectively barred plans from placing workers who don’t select a 401(k) fund option into a default ESG fund.
This is another form of ideological expansion than the one I just discussed. The transformation of Social Security is an exhibit of how government usurps responsibility for our needs, i.e., socializes them; the regulatory change that Fox Business refers to is an example of how socialism advances by injecting ideological mandates into our consumer choices. This happens across the spectrum of household spending, from health insurance (which many of us purchase through our employers) to cars (with safety and other features mandated), and has the effect of forcing us into an ideologically preferred spending pattern.
In the case of 401(k) plans, the ideological mandate is not as pronounced as in the proposed Social Security reform, but it is nevertheless there. Fox Business again:
The Biden DOL plans to scrap the Trump rule while putting retirement sponsors and asset managers on notice that they have a fiduciary duty to include ESG in investment decisions. The proposed rule “makes clear that climate change and other ESG factors are often material” and thus in many instances should be considered “in the assessment of investment risks and returns.”
Yes, that’s right. The Department of Labor wants your 401(k) investments connected to the government’s so-called climate agenda. This ambition becomes more pronounced as we dig into the regulation itself, published with the Federal Register:
The current regulation also contains a prohibition against adding or retaining any investment fund, product, or model portfolio as a qualified default investment alternative (QDIA) as described in 29 CFR 2550.404c-5 if the fund, product, or model portfolio reflects non-pecuniary objectives in its investment objectives or principal investment strategies.
For example, the Department of Labor explains,
the selection of an ESG-themed target date fund as a QDIA would not be prudent if the fund would provide a lower expected rate of return than available non-ESG alternative target date funds with commensurate degrees of risk, or if the fund would be riskier than non-ESG alternative available target date funds with commensurate rates of return.
In other words, the Trump administration wanted to make sure that investors responsible for your private retirement savings would not be led astray by some ambition of ideological benevolence and put your money into high-risk investments motivated by Environmental, Social and (moral) Governance preferences. That is now changing under Biden. The following sounds technical, but keep reading until you get to the italicized part:
The Department is concerned that the current regulation has created a perception that fiduciaries are at risk if they include any ESG factors in the financial evaluation of Start Printed Page 57276 plan investments, and that they may need to have special justifications for even ordinary exercises of shareholder rights. The amendments proposed in this document are intended to address uncertainties regarding aspects of the current regulation and its preamble discussion relating to the consideration of ESG issues, including climate-related financial risk, by fiduciaries in making investment and proxy voting decisions, and to provide further clarity that will help safeguard the interests of participants and beneficiaries in the plan benefits.
Your 401(k) portfolio managers are now supposed to start calculating possible financial losses to your retirement plan based on “climate change”. I am not going to explain in detail here, but this is impossible to do while maintaining legally and professionally mandated standards for responsible financial investments. Just the concept of “risk” loses its meaning in this context, and that is already while we are still discussing it at the theoretical level.
Yet Biden’s DOL is adamant to raise the ideological profile of how you can, and by extension can not, invest your retirement funds. They state bluntly that
climate change is already imposing significant economic consequences on a wide variety of businesses as more extreme weather damages physical assets, disrupts productivity and supply chains, and forces adjustments to operations. Climate change is particularly pertinent to the projected returns of pension plan portfolios that, because of the nature of their obligations to their participants and beneficiaries, typically have long-term investment horizons. The effects of climate change such as sea level rise, changing rainfall patterns, and more severe droughts, wildfires, and flooding are expected to continue to pose a threat to investments far into the future.
This is a highly irresponsible paragraph, presenting as facts a number of speculative assertions that have been suggested off and on for about four decades now. A scholarly evaluation of the so-called climate research from the 1980s and 1990s would easily expose the speculative nature of this DOL rant, specifically with reference to quantitative predictions of sea-level changes, depletions of polar ice caps and increases in temperatures across the world. This is particularly important: it is not until climate-change proponents reach the quantitative level of their predictions that they can also propose to have any impact on calculations that guide financial investments.
Even then, though, their support for such investment calculations is extremely tenuous. There exist no macroeconomic, microeconomic or finance models that can confidently translate suggested climate-change scenarios into professionally acceptable estimates of risk.
Plain and simple: there is no way on God’s Green Earth that anyone can apply the DOL climate-change rant in 401(k) investments.
Yet that is precisely the direction in which the Biden administration is moving. But the aren’t satisfied with suggesting that armchair theorizing be used to determine your retirement benefits – they also let us know that government regulations will affect our future finances:
Additionally, imminent or proposed regulations, for example, to reduce greenhouse gas emissions in the power sector, and other policies incentivizing a shift from carbon-intensive investments to low-carbon investments, could significantly lower the value of carbon-intensive investments while raising the value of other investments. This could create a potentially serious risk for plan participants and beneficiaries. Taking climate change into account, such as by assessing the financial risks of investments for which government climate policies will affect performance and account for the risk of companies that are unprepared for the transition, can have a beneficial effect on portfolios by reducing volatility and mitigating the longer-term economic risks to plans’ assets.
This one is actually fairly upfront. If you put your retirement savings into businesses that government has picked as winners, you are more likely to make money than if you invest in businesses that government has decided they are going to turn into losers. Or, in the DOL’s own words, broadening the scope of ESG-based investments beyond the alleged climate change issue:
paragraph (b)(4) of the [proposed regulation] provides examples of factors, including climate change and other ESG factors, that a fiduciary may consider in the evaluation of an investment or investment course of action if material, including: (i) Climate change-related factors, such as a corporation’s exposure to the real and potential economic effects of climate change, including its exposure to the physical and transitional risks of climate change and the positive or negative effect of Government regulations and policies to mitigate climate change; (ii) governance factors, such as those involving board composition, executive compensation, and transparency and accountability in corporate decision-making, as well as a corporation’s avoidance of criminal liability and compliance with labor, employment, environmental, tax, and other applicable laws and regulations; and (iii) workforce practices, including the corporation’s progress on workforce diversity, inclusion, and other drivers of employee hiring, promotion, and retention; its investment in training to develop its workforce’s skill; equal employment opportunity; and labor relations.
Did you get that? The Biden administration’s Department of Labor wants your 401(k) managers to invest in companies based on whether or not they pursue “workforce diversity” and the ethnic, racial, religious and gender identities of its board members. It also wants your nest-egg managers to consider “labor relations”, in other words unionization.
The purpose behind this new regulation is to force the private sector to act according to certain ideological preferences harbored by the president and members of his administration. When the conversation lands on “labor relations” and “executive compensation”, the pursuit of economic redistribution is almost completely visible under the surface.
This regulatory dictate by the Department of Labor does not explicitly say that investors should abandon financial returns as a goal for their portfolios. However, they are within striking distance of saying just that.
The question is: what will Congress do when these regulations on private retirement investments have driven down returns enough to materially affect people’s retirement security? Will they propose that 401(k) plans simply be forcefully rolled into Social Security?
No, they wouldn’t do that… would they?
*) Strictly speaking, EITC entitlees also pay income taxes, but for the vast majority of them the benefit exceeds their tax payments, leaving them as negative taxpayers.