Over the coming generation, the cost of federal spending commitments is projected to rise from 20 percent to 30 percent of GDP, largely because of Social Security and health-care entitlements. To avert the need for enormous tax hikes, Senate candidate Blake Masters of Arizona recently suggested: “Maybe we should privatize Social Security. Private retirement accounts, get the government out of it.”

Politicians have for decades hoped that tax-exempt personal savings accounts could finance health care, unemployment, and retirement benefits down the road. Yet they have struggled to develop specific policies appealing to American voters, who are preoccupied with the needs of those who can’t provide for themselves in the present. That being the case, the burden of entitlements could more easily be alleviated by focusing programs more narrowly on the essential purpose that voters care about, rather than by establishing complex systems of forced savings for the future.

The Social Security Act of 1935’s Old Age and Survivor’s Insurance (OASI) program was originally a fully funded system: it imposed payroll taxes on workers and set the revenues aside for benefits in retirement. But congressional Democrats wanted the system to pay out benefits immediately, while Republicans wished to prevent the accumulation of enormous investment reserves for the federal government to manage. As a result, bipartisan legislation in 1939 transformed the program into a pay-as-you-go system, under which retirees’ benefits are usually out of proportion to their prior contributions as workers.

This arrangement was very appealing to the initial cohort of retirees. Those reaching the age of 65 in the 1960s, for instance, received benefits averaging 8.8 times their prior contributions—after accounting for interest. But subsequent generations have had to pay for their forebears, as well as their own benefits, and so Americans retiring since the year 2000 have received less than they paid in. As a result of increased longevity and falling birthrates, the ratio of workers to retirees is also falling—from five-to-one in 1960 to two-to-one in 2040—and the system will lack the funds to pay benefits as promised starting in 2034.

Though Social Security’s OASI program does little in the way of redistribution from rich to poor within generations, the $1 trillion per year it spends does a great deal to displace personal responsibility. It crowds out private savings for retirement, depriving businesses of investment and retirees of rates of return they otherwise would have been able to achieve. It drives people out of the workforce earlier than they would choose. And its payroll tax accounts for the bulk of the federal tax burden on low-income Americans, which serves further to reduce work and economic output.

Many economists, such as the late Harvard economist Martin Feldstein, have argued that OASI’s structural shortfalls and distortions could best be averted by depositing payroll tax funds into accounts reserved for individuals. But attempts to turn this design into reality have been hindered by the priority of maintaining a safety-net for the present. This has generated the “double-payment problem”: current workers must pay benefits for existing retirees, while accumulating savings for their own future retirements in personal accounts. Furthermore, to prevent account funds from getting wiped out, investments would be subject to greater regulatory oversight, while a minimum return for beneficiaries would be guaranteed at taxpayers’ expense. Even then, much of the existing OASI program would have to be retained, to mitigate the risk of seniors outliving their savings. Because of this, Republican proposals to add private accounts to Social Security would have slightly raised federal spending on the program from 2020 to 2060.

The absence of immediate benefits from establishing private accounts in Social Security dragged down its popularity. While Gallup polls in 2005 found that 58 percent of voters supported the general idea of letting people invest their Social Security contributions privately, 56 percent were opposed to the Bush administration’s specific proposals.

A more appealing way to fix Social Security’s long-term flaws would be to allow younger workers to opt for a uniform benefit when they retire, in return for a payroll tax cut while they are employed. OASI was originally designed to provide benefits that increased in proportion to prior contributions, due to concerns from segregationist Southern legislators that providing equal payments to all seniors would undermine Jim Crow. Following the civil rights revolution, Supplemental Security Income established a nationwide floor on benefits for seniors, so providing higher benefits to wealthier seniors now serves little purpose other than to discourage work and smother private savings for retirement. Fusing both programs would also eliminate holes in the safety net, which left 9 percent of Americans over 65 with incomes below the federal poverty level in 2019.

The current system of Unemployment Insurance (UI) faces similar challenges. Almost half of Americans who lose their jobs find themselves with zero net savings. States levy payroll taxes to fund UI benefits, which average about half of prior incomes for up to six months. But this arrangement has served to increase the duration of unemployment, while reducing pay for workers in jobs with higher risks of unemployment. The magnitude of benefits varies greatly between states—often arbitrarily and regressively. In Massachusetts, wealthier residents contribute the same UI taxes as those with low incomes but receive benefits almost five times as high. The UI system has required ad hoc federal bailouts in nine of the last ten recessions, and many states failed to distribute benefits on time during the Covid lockdowns. During the 2007–2009 recession, half of those eligible did not receive benefits to which they were entitled.

Feldstein proposed depositing unemployment payroll taxes into personal savings accounts as an alternative to UI, with federal loans provided if balances turned negative. Unspent savings would turn into tax-exempt retirement accounts. This arrangement would surely be an improvement on the current system. And the double-payment problem afflicting reforms of pay-as-you-go retirement programs wouldn’t come into play here. But UI savings accounts would serve a purely paternalistic function: forcing people to save for narrow, bureaucratically identified purposes. To do this, the program would likely have to retain rules restricting funds to a period following involuntary dismissal, along with limits on the amounts individuals could draw every month.

A better approach would be to let working-age adults borrow several months of Social Security benefits earlier in life, in return for delaying their retirement age. This would not limit households to a stream of payments during involuntary unemployment, but it could give them access to larger lump-sum payments to finance relocation in search of better jobs. Individuals could also draw on such funds for job training or for a leave of absence to attend to family needs. Because they would be using their own future benefits, early availability of funds would not serve to engender dependency or to increase the cost of government; it would merely shift OASI funds to purposes that individuals deem more useful and facilitate the elimination of unemployment payroll taxes.

Feldstein identified health care as a third entitlement challenge that tax-exempt savings accounts could address. He argued that U.S. tax policy has led to the purchase of “excessive health insurance” by exempting employer-sponsored insurance from workers’ taxable incomes. This, in turn, has inflated the price and volume of medical care purchased by individuals, who can rely on insurance to pay for it.

The Medicare Modernization Act of 2003 sought to address the problem by letting employers deposit pre-tax dollars in Health Savings Accounts (HSAs) for workers in high-deductible health-insurance plans to purchase medical services out of pocket. But while average annual deductibles for individuals receiving employer-sponsored health insurance rose from $303 in 2006 to $1,434 in 2021, the fastest-growing health-care cost has been the price of hospital procedures. While greater reliance on out-of-pocket payment may increase price sensitivity for low-cost services, it does nothing to nudge patients to receive hip surgery from a facility where the procedure costs $30,000 rather than another where it costs $50,000, as both greatly exceed insurers’ typical caps on out-of-pocket costs.

The main problem American health care faces is not over-insurance, but insurance insufficiently responsive to cost concerns. That issue calls less for an expansion of HSAs than for giving individuals more control over the purchase of insurance.

The notion that Medicare could be prefunded with savings accounts is even less promising, as it combines the shortcomings of savings accounts for Social Security and for health care. It would leave those who earned least, those who suffered the longest periods of ill-health, and those who lived longest short of funds for the care they need in old age. Nor would savings accounts provide adequate funds to keep the quality of health care for retirees in line with that for working adults. Though former House Speaker Paul Ryan’s proposals had their own shortcomings, his proposal to restrain the growing cost of Medicare by raising the eligibility age and increasing reliance on privately managed plans offered a sounder path forward.

Far from being a solid foundation for an “ownership society” as George W. Bush’s administration hoped, fully funded entitlements (such as those in prewar Germany and modern Chile) have proven highly vulnerable to inflation and politics over the long run.

Entitlements are inherently redistributive. Their essential purpose is to provide for individuals who cannot provide for themselves. We can best restrain their costs by shrinking them to that core function, which would reduce the degree to which they suppress private responsibility, rather than by imagining that we can eliminate the need for public aid by nudging people to boost their savings rates.

Photo illustration by Kevin Dietsch/Getty Images


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