President Bush has clearly indicated that he wants more people to take more responsibility for their own retirement.  The most talked about proposal is to allow younger workers to keep 2 percent of their current social security tax to use in their own self directed retirement account. 

The benefit to the government from this change is a reduction in the unfunded liability of future social security payments.  Benefits would fall by the same percentage as the amount withdrawn by younger recipients for their entire retirement life. 

A further benefit to the average contributor who withdraws funds from the program is the higher return that can be achieved from investing those funds than the government receives by foregoing interest payments on some of its debt.  Of course, there will be deviations from average.  Will we still try to keep the elderly out of poverty regardless of their investment acumen?

If these benefits sound too good to be true, and they are true, why are we hesitating to make this change?

The fly in the ointment is that the current and near retirees are depending upon the contributions of young workers to pay for their promised benefits.  Anything detracting from the contributions of the young also detracts from the cash flow needed to meet already promised benefits to the old. 

In the first ten years of change, some studies show that social security receipts will fall relative to outflow by more than $800 billion.  A large gap also will exist in the second ten years and even in the third ten years before the reduced obligations begin to turn the tide.  Overall, the cash deficiency before declining benefits offset reduced income may be nearly $2 trillion. 

An additional $2 trillion deficit upon the nearly $1.8 trillion that many economists already believe will occur in the next ten years may be poor policy.  Yet, cuts in government spending or increased alternative revenues are unlikely to be forthcoming.  Thus, the cash flow dilemma stays the hand of the administration. 

Now I have not done the necessary analysis, but I would like to offer an alternative proposal. 

First, the Treasury will be required to raise sufficient funds in short order to pay the trustees of social security the accumulated surplus that social security has contributed to Treasury financing.  Thus, a true insurance capital pool would be made available to the trustees for investment purposes. 

Second, the trustees would hire managers to invest these resources in a responsible fiduciary manner.  No investment interference with the managers would be allowed except for performance issues.  (Thus, the concern that social security investing could favor socially desirable investments over alternatives would largely be removed). 

This will result in a substantial increase in government bonds but an equal increase in investment funds.  I would expect relative prices between stocks and bonds to change but total investment returns should not be significantly altered

Third, anyone could opt out of future benefits by requesting that the social security taxes paid by the employee be sent to a self directed Roth type IRA (with the proviso that no withdrawals occur before age 65 except in extreme emergency). 

Fourth, the employer will pay taxes for all workers for the entire wage income earned.  Those choosing to remain in the system also would pay for all income earned rather than up to a wage ceiling.  (Property income would continue to be excluded).  These additional employer and employee taxes (for those electing to remain in the system) would fund the cash deficit created by those who withdraw. 

I must admit, I do not yet know if those additional taxes would be sufficient to eliminate the cash flow deficit.  However, if the cash flow is more than needed, employer tax rates would be cut to rebalance the system.  Under no circumstances would a wage ceiling be restored. 

Ultimately, enough youth and high paid older workers would opt out of the system to significantly reduce unfunded liabilities.  Those without high incomes and without investment skills might remain in the system.  Benefits would be indexed to inflation rather than to wages for those who remained. 

Medical benefits for retirees would remain a separate program that would not be impacted by these changes.