Reengineering Social Security for the
Thomas F. Siems
One of our nation's most challenging public policy debates concerns Social Security reform. The program is in crisis and in need of reform as a result of maturation of the current pay-as-you-go (PAYGO) Social Security system coupled with an aging American population.
People who have participated in Social Security since its inception have received much higher average annual real rates of return on their contributions than have later participants. This is due, in part, to the basic design of the PAYGO program under which earlier participants received windfall gains as the necessary result of moving from the start-up phase to a mature phase, while later participants receive below-market returns. In contrast, real financial market returns increased over this time frame, widening the gap between market returns and Social Security returns.
With demographic changes, including the retirement of the babyboom generation and increased life expectancy, looming on the horizon, action must soon be taken to ensure Social Security's future. Social Security gradually expanded from its inception through the early 1980s by increasing benefits and coverage for various groups. To pay for those modifications, payroll tax rates and the maximum earnings ceiling have been steadily raised. Now the Social Security trust funds are in long-term financial imbalance, and benefit cuts and more payroll tax rate increases seem inevitable if Americans are to retain the important social protections that Social Security currently offers.
Now is the time to consider more dramatic changes, including various proposals that allow for prefunding through individual
Originally published as Cato Institute Social Security Paper no. 22, January 23, 2001, and updated to reflect current information.