David R. Henderson  

Opting Out of Social Security

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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.

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. (italics in original)


This is an excerpt from the Econlib Feature Article by Robert P. Murphy, "Opting Out of Social Security," published this morning.

Along the way, he points out a problem with Megan McArdle's statement of the problem:

Although her other comments (not quoted) about worker productivity indicate that McArdle has some grasp of the situation, her statement quoted above is inaccurate. If a worker takes 10.6 percent (the combined employer and employee portions of Old-Age Survivors Insurance) out of his paycheck every month and buys private assets, there is an important sense in which this "provides for" his future retirement more than if the government takes the same amount (from him and his employer) and transfers the money immediately to a current Social Security beneficiary.

Specifically, when workers genuinely save some of their income (meaning it's not immediately spent by the government), their action frees up real resources that can be channeled into productive investments. When today's workers use (some of) their labor hours to create hammers, nails, 18 wheelers, and factories to rent and/or sell to young workers in 30 years, they amplify the productivity of the next generation. Armed with this higher stockpile of tools and equipment, the next generation of workers can produce more goods and services, out of which they can afford to pay the older, retired workers (who are now acting as capitalists). Contrary to McArdle's claim, the whole process is a normal win-win market exchange, which is not driven by mere altruism or expectations of gratitude.


Editing this piece and going back and forth with various drafts was a real learning experience for me. At first we both thought his proposal was straightforward with no major complications. But Bob, to his credit, kept noting complications and then we (usually he) figured out how to solve them or point them out. You'll see if you read the whole thing.


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CATEGORIES: Social Security , Taxation




COMMENTS (17 to date)
Maximum Liberty writes:

I almost hate to say it, but it would be easier to sell this proposal if it had at least some paternalism in it: yes, people can opt out, but only into some other kind of forced savings account, like an IRA.

The huge downside is that entrepreneurs' best investments are themselves.

Airman Spry Shark writes:

I think there's a misunderstanding of McMegan's point (although she doesn't do herself any favors).

No matter how you manage your retirement system, you are ultimately expecting to depend on the labor of people younger than you.
This is the crux of the issue; no matter whether your retirement is funded by mandatory government programs or voluntary private investment, you are consuming what someone younger is producing.
...without expecting more than gratitude in return.
This is where she goes a little too far; clearly conveying financial assets to the producers would be more than gratitude. I'd chalk it up to rhetorical and/or editorial flourish.

David R. Henderson writes:

@Maximum Liberty,
Check out Bob’s footnote 5.
@Airman Spry Shark,
This is where she goes a little too far;
Exactly. And it’s what Bob criticized her for.

Thaomas writes:

In what sense is a worker who opts out of SS and saves his and the "employer's" the contribution, freeing up any more resources than at present? That depend on how incentives for investment are changed and I do not see any necessary change coming from the employee's decision.

Actually, I think it makes more sense to finance old age and survivors pensions from a straight consumption tax, preferably a progressive consumption tax, rather than tying it so something as unstable as the employment/beneficiary ratio.

AlanG writes:

The Social Security deficit can be addressed in another manner as well. Removing the income cap will add more money to the Trust Fund. I always used to celebrate in July/August when I reached the cap and wasn't paying any further SS tax for the remainder of the work year.

Regarding the opt out proposal, this would certainly be taken advantage of by those who are financially savvy and have planned well for their retirement (and have had the luck of not seeing a major downturn in their investment portfolio such as took place in 2008-09). For the other 95% of Americans, enforced savings through SS taxes are probably their best bet as they would not otherwise put anything aside (this begs the question of whether SS payments would even provide for a decent retirement after Medicare premiums are subtracted).

We know from behavioral economics that lots of people don't even contribute to workplace retirement programs (certainly they don't max out contributions). The concept of opt out when it comes to 401(k) programs needs to be implemented as well.

As a retiree (my wife joins me in June), I know our living expenses down to the nearest $$ (thanks Excel) and it's a lot more than I expected. Though we have no home mortgage payments at all when you tally up food and all the other mandatory costs it's in the neighborhood of $35K. That might be shaved down some by dropping certain things like premium cable TV but not by much. Retirement is more expense than one thinks!

Hazel Meade writes:

I think this is the best proposal for a Social Security opt-out I have seen.

I'm assuming that basically a "net positive asset" will have to contribute until they pay into the system the amount that the SSA deems their net surplus would be. Then they can drop out and forfeit all future payouts. So, say, they contribute until age 35, then opt out at which point their money goes to a private 401(k). But they will never recover the money they paid in.

This way, the trust fund gets paid back and the obligations to the baby boomers are paid off with no change to the program for anyone who wants to keep it as is. And eventually the population ages and we end up with fewer people on social security. The only people who lose money are the "net surplus" people who basically are being compelled to pay off the debt to the trust fund, but that was going to happen anyway.


Hazel Meade writes:

@AlanG,

Definitely cancel cable. We bootleg every television show off the internet. It is unbelievably easy, and you get it commercial free and can watch at your leisure. Most of the time you can get a copy within minutes of the air time ending. And the other major benefit is that we're not tempted to waste time watching TV just because it happens to be there. We only watch specific highly rated TV shows - ala carte vs. bundled programming basically.
We would pay for Netflix (have in the past when it had the Starz network), but basically the studios and cable networks are colluding to fight online streaming, so you can't get the good shows via Netflix or Amazon. So it's actually impossible to get ala carte programming like this any other way.

Point is that it's easy to see what technology allows, and where it is obviously headed, but the cable industry is using it's market power to try to stop, and they've been pretty successful at it. There is zero technological reason why you shouldn't be able to download any show you want, any episode ever made, any time you want.
This has been possible for at least 10 years. People spend hundreds of dollars buying DVRs and paying for obsolete plastic disks to have access to programming that could be streamed over the internet in minutes for pennies.

AlanG writes:

@Hazel Meade - I have thought about this for some time. I watch a lot of European football (soccer) and it's hard to get that without cable. Believe me, I'm a master in watching pirate broadcasts but there is a part of me that "sometimes" thinks about the ethics of this. Hulu is doing a good job of streaming broadcast programs. We have both Netflix and Amazon Prime and like the original programming on each. Those only require a high speed Internet connection.

I don't pay for a cable box as I built my own and just have to pay for the cable card to get the premium programming so that saves $25/month right there. Yes, I could cancel cable but that would only knock off about $1K from our living expenses.

My main point is that when one adds up all the home owner expenses, car maintenance, food, etc. the bill is a lot higher than one expects (Medical insurance by itself is $14K/year for Medicare and Medigap!!! and that doesn't include co-pays).

Tom West writes:

> We bootleg every television show off the internet.

I understand lots of people pirate. After all, as a crime you can commit in your own home, it doesn't feel terribly illegal, and you are very unlikely get caught.

But nonetheless, I'm a little bit shocked to see it recommended as a retirement strategy quite so directly. Especially on a site were many of the readers presumably strongly believe in property rights.

Jonathan writes:

...forfeit accrued benefits? How does that work along the continuum and place to inject opt out? I'm twelve years out and have worked since age eighteen. Is there provision to refund all or a portion of years of contribution?

David R. Henderson writes:

@Tom West,
But nonetheless, I'm a little bit shocked to see it recommended as a retirement strategy quite so directly. Especially on a site were many of the readers presumably strongly believe in property rights.
I’m not shocked. We often get commenters making statements that show a lack of respect for property rights.

Ray Sun writes:

There's a paternalist objection that neither Murphy nor Henderson squarely address, and it goes like this.

Penalty-free opt-out is available only to people who the government expects to be net burdens to the system. Definitionally, a person who is a net burden on the system is a net beneficiary of the system. Social security is an attractive bargain to these people. And it's a bargain that takes the form of delayed gratification - giving up a chunk of your paycheck now in exchange for the promise of a big benefits check later.

Under what circumstances would a person opt out of such a bargain? Certainly, some who choose to do this will be rational, calculated risk-takers who are wisely investing that chunk of their paycheck. But I submit that many will be people who, due either to their circumstances or their temperament, unwisely elect to give themselves a raise today and leave the future to be figured out later. Lots of these people will not save on their own for retirement, just as most people today fail to do so. They will reach the ends of their productive lives with insufficient or zero assets, and will find themselves in poverty.

Such an outcome may be perfectly acceptable to those whose only concern about poverty is that each poor person have made sufficiently bad choices so that they in some sense deserve to be poor. It would not be acceptable to those concerned about negative social effects of widespread poverty, which occur regardless of whether the elderly poor deserve their fate.

Hazel Meade writes:

@Tom West,

Well, I think the ability of the cable networks to collude with television studios to compel you to purchase bundled programming rather than individual shows ala carte is a kind of rent-seeking behavior enabled by local cable monopolies, and the way the industry is regulated. I'd be happy to pay directly for a specific show, but they won't allow me to do that. I either pay for premium cable to get access to Starz and HBO, which comes with dozens of channels that I am not interested in, or I get nothing. My attitude is if you're not willing to sell me that one show I want, then I'm going to find a way to bypass your artifical, government-enabled cartel.

Winslow P. Kelpfroth writes:

putting 10.5% in a tax advantaged IRA rather than the same amount into social security is not equivalent, as the government program provides an insurance benefit to dependents and survivors as well as a disability benefit. Ball park estimate : that worker would need to fund that IRA/insurance package with 15-18% gross wage.
My main problem with the social security program is that it invests solely in government debt rather than in a basket of equities in addition to government and commercial paper. Seems like the program would then be on a sounder footing financially

David R. Henderson writes:

@Ray Sun,
There's a paternalist objection that neither Murphy nor Henderson squarely address, and it goes like this.
Actually, as I pointed out to Maximum Liberty, Bob does address it in footnote 5.
@Winslow P. Kelpfroth,
putting 10.5% in a tax advantaged IRA rather than the same amount into social security is not equivalent, as the government program provides an insurance benefit to dependents and survivors as well as a disability benefit.
Actually, it’s 10.6 percent. You’re wrong about the disability benefit: that is financed by the 0.9 percentage point tax on each of employer and employee. But you’re right about dependents and survivors.
My main problem with the social security program is that it invests solely in government debt rather than in a basket of equities in addition to government and commercial paper. Seems like the program would then be on a sounder footing financially
It would. The problem is that the Feds would own a huge percent of corporations, especially if they stuck with U.S. corporations.

Ray Sun writes:

My mistake. I should have read more carefully.

Charley Hooper writes:

The pattern never changes:

Those who love big government regularly violate the property rights of some and create win/lose government programs. Just look at Social Security and Obamacare.

Those who love liberty feel compelled to develop solutions that are win/win and don't violate the property rights of any.

The government makes reckless promises to some people and then we make policy recommendations so that those reckless promises aren't exposed/violated before their time.

The root of the problem is those reckless promises and property rights violations.

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