Laurence J. Kotlikoff, a Boston University Professor of Economics, has started a campaign and website aimed at fixing the “grave financial troubles” of Social Security (as well as other similar reforms for other government programs).  He points out the problems of the current system and then offers his own solutions, calling it “The Purple Social Security Plan.”  He calls it purple because it’s designed to be a reform that people on both the right and the left can agree.  While I certainly praise Kotlikoff for acknowledging that the current program is doomed to certain failure, his solutions, despite being well-intentioned, do not solve the overlying problems.

On his website, he begins his solution by laying out the “Principles of Social Security Reform.”  They are as follows:

1. Everyone must save for retirement.
2. The new system should be simple.
3. The new system should be transparent.
4. The new system should protect current retirees.
5. The new system should help those least able to save.
6. The new system should be fully funded.
7. The new system should be generationally equitable.
8. The new system should improve work incentives.
9. The new system should protect dependents.
10. The new system should have personal accounts.
11. The new system should invest in the market.
12. The new system should protect against market risk.
13. Wall Street should not profit from the new system.

Being an engineer by trade, I’m glad that he listed his principles this way.  In the engineering world (or any problem-solving environment), the first thing you do when you’re presented with a problem is find out what the requirements for a solution are.  Without telling that there’s a building sitting between two tanks that you want linked with piping, I won’t know that I am not able to simply link the tanks with a straight and direct line of piping.  By giving me the requirements, I can also tell you if what you desire is even physically possible (see perpetual motion machines).

The other thing that sticks out to me is the verbiage that he uses for his principles.  Once again, as an engineer, his use of the words “must” and “should” take special meaning with me.  You may accuse me of splitting hairs here, but according to the codes and standards that I am required to abide by (provided many times by private organizations, of course) in my job as an engineer, “must” means that whatever is being stated is required to be followed no matter what.  “Should,” on the other hand, is a practice is that highly suggested but not required for achieving the stamp of approval of the code or standard.

Of the thirteen principles laid out by Kotlikoff, only the first, “Everyone must save for retirement,” is required.  All of the other ones use the word “should,” meaning that it’s something he really would like to see included, but wouldn’t be required to meet his requirements.  Therefore, if the government correctly implemented his reform, Social Security wouldn’t necessarily have to be simple, fully funded, or fully transparent.  I don’t want to get too hung up in the language of these principles because I know what Kotlikoff means, but it does bear worth mentioning it.

My first critique not related to the language of the principles is the idea that everyone must save for retirement.  Of course I think it’s a great idea to save for retirement, and I am personally doing exactly that, it is none of my business to force anyone else to do the same.  And while some people may want to save for retirement, some circumstances arise that prevent them from doing so.  What happens if your parents are no longer able to live on their own and you have to move them into your house?  This requires additional money to support the additional people living in your home.  If you’re not allowed to tap into the funds being directed to some sort of retirement account (as what happens with any sort of tax on your income presently), you may not be able to adequately pay all of your bills.  Now you have to take on debt or tell your parents that they have to find another solution to their problems because you don’t have the money to take care of them.

Furthermore, “legally” requiring someone to save for retirement implies that you would throw them in prison for not doing so.  While refusing to save for your retirement when you are able to might not make much personal financial sense, it is insane to criminalize someone for distributing their money in a way that you and I, acting as “government,” would like.  Imagine knocking on the door to a house with a warrant to arrest someone for not saving for retirement and telling the man’s family that “Because he’s not setting money aside for your collective future, we’re locking him up to make sure that he can make no money while he’s serving his sentence.”  Unfortunately, this will happen to you right now if you figure out a way to get out of the FICA tax.

The second and third principles state that the system should be “simple” and “transparent.”  Is there a program in government that is simple and transparent?  Every reform sold to us has been touted as a simplification or a streamlining of a current program, but do we ever realize these goals?  To me, this is just hoping against hope.

The fifth and sixth principles look as though they are headed straight towards a clash.  They state that “the system should help those least able to save” and “should be fully funded.”  If Kotlikoff admits that there are some people who will not be able to save, is he implying that someone else will have to fill in gaps in savings for these people?  If the idea of Social Security is to have all of the money you’ve paid into the program be paid out to you when you’re ready for withdrawal, if some people will get paid more than they contributed, you have to either increase the money being put into the program (assuming that he would not decrease the money being paid to others).  The solutions for a government would be to either tax, borrow, or print.  But doing any of these would mean that the program is not fully funded (although Kotlikoff only says it should be fully funded) and are destructive on a macro scale.  The only way to keep the program fully funded while “helping” some people out would be to skim some of the dividends of the other invested money.  And there are no problems here, because markets never dip or crash, right?

Moving along, there is another pair of back to back principles (eleven and twelve) that don’t fit well together.  Kotlikoff wants the reforms to “invent in the market” and “protect against market risk.”  The problem is that if you want to make investments, there is no such thing as an investment without risk.  It is basic knowledge—the higher the risk, the higher the reward.  Sure, you can minimize the risk with a low return investment, but you’re not going to be able to even keep up with inflation.

The final critique of the principles that I will make is on the thirteenth principle: “Wall Street should not profit from the new system.”  Think about this for a second.  If you were to approach your financial advisor and be able to force him to invest your money without being paid any cut of the profits, how much effort is he going to put into investing your money?  I doubt there’s going to be much, if any.

After his principles, Kotlikoff lists the actual Purple Social Security Plan as follows:

1. Pays existing Social Security beneficiaries their full benefits.
2. Freezes existing Social Security system by filling zeros in workers’ earnings records for years after reform begins.
3. Requires all workers under 60 to contribute 8 percent of their wages to personal security accounts (PSAs).
4. Each worker’s contribution is allocated 50-50 to his/her own PSA and to his/her spouse/legal partner’s PSA.
5. Government matches contributions to PSAs by the poor, unemployed, and disabled on progressive basis.
6. All PSA balances invested in a global market-weighted index fund of stocks, government bonds, corporate bonds, mortgages, real estate trusts, and other financial assets.
7. Between ages 61 and 70, PSA balances for each cohort are gradually sold at market and converted to TIPS (Treasury Inflation Protected Securities).
8. All investing is done by a single government computer at zero cost.
9. Government guarantees that PSA balances at conversion equal at least what was contributed adjusted for inflation. I.e., government guarantees participants at least a zero real return.
10. PSA participants who die prior to age 70 bequeath unconverted balances to their heirs.
11. Starting at age 62, cohort TIPS pool makes payout to surviving cohort PSA participants in proportion to their age 60 PSA balances.
12. Distribution from TIPS pool is designed to ensure that real (inflation-adjusted) payout to surviving cohort members does not decline through time.

According to #3, Kotlikoff wants the government to take 8% out of my paycheck?  Geez, I thought the recent bump to 6.2% for FICA was bad.  Of course, he would tell me just to subtract the 2% of what I’m putting into my 401(k) or other retirement investment and there will be no change.  But that would be assuming that this new plan is going to work.  If you think I’m unhappy when my own personal investments lose money, imagine how I’m going to feel when the investments you make on my behalf and without my permission lose money.  And while you can try to convince me that your program will work, all I can think about is the ever-expanding list of government programs and policies that have failed.

#5 answers my issues with Principle #6, which states the program is to be fully funded…except that it doesn’t answer my issues.  The government is help out those who can’t save enough on their own, but it doesn’t say how.  Judging by the way things work now, they’ll probably just run the printing presses to supply the money.  But that causes inflations and damages the value of everyone’s retirement account.  That’s not fair.

The sixth point of the plan describes the types of investments that will be used for the PSAs (personal security accounts).  Who gets to make these investment decisions?  Is the whole pool of money invested in the same way or are individual accounts get invested separately?  What happens if my money gets invested in companies that I have moral objections with?  What happens if the market crashes?  And like I mentioned previously, if “Wall Street” isn’t allowed to make money off the funds, then what incentive is there to make money on them?

The next objection is to #7 and #12, which deal with allocating the investments of people between the ages of 61 and 70 to Treasury Inflation Protected Securities, or TIPS.  The purpose of this is “to ensure that real (inflation-adjusted) payout to surviving cohort members does not decline through time.”  This sounds great, but according to Peter Schiff in “The Real Crash,” TIPS are do not actually provide a hedge against inflation.  Schiff writes:

Asking the government to protect your money from inflation is like asking the fox to protect your hens.  The Treasury uses the Consumer Price Index to measure inflation, and so your principal rises or falls proportionally to the CPI.  But CPI is a bogus way of measuring inflation.  The Bureau of Labor Statistics tweaks the formula for CPI to make inflation appear lower.  Government has a vested interest in disguising the true magnitude of inflation, because inflation is a hidden tax on the people.  One last strike against TIPS: the semiannual interest payments are taxed when they are credited to your account, even though you don’t get that money until the bond matures—so government is taxing you on money it hasn’t even given you yet.¹

To put that into a few words, you’re losing wealth when you invest in TIPS.  This means that #9, which says that you would be guaranteed “at least a zero real return,” is proven false.

On top of this, what if I want to retire before I’m 62 (#11)?  This reform does not even attempt to fix the issue facing people who rely on the government to administer their retirement: you retire when the government says you’re able to retire.  So it really isn’t my money if I don’t get to choose when I use it.  According to #10, not only does my ownership of the money depend on when I retire, it also depends on when I die.  When I turn 70, my heirs are magically no longer entitled to certain assets in my name (well, according to estate taxes, no)?  Maybe this is the way that Kotlikoff plans on subsidizing the accounts of those who need help.  But like the other assumptions that are made with this reform, there is no guarantee that the money will be there to provide sufficient funds.

Finally, I take serious issue with the statement that “All investing is done by a single government computer at zero cost” (#8).  To me, this nicely sums up the good intentions that Kotlikoff may have with his proposed reform, but that statement just seems so “pie in the sky.”  I don’t know what to say about this, because I have no idea what he even means with this.  It’s a demonstration of the belief that government has some sort of magic wand to make things work exactly the way they want them to without much critical thinking as to how things will unfold in reality.

Again, I want to stress that I applaud Professor Kotlikoff for understanding, speaking up, and attempting to raise awareness about the failure of the Social Security system.  And while I do not personally think that his system would work much better than the current system, there is the chance that everything could go wrong goes completely right, and the system is able to sustain itself, however unlikely that may be.  But even if it does work, does that justify taking money from people without their permission?  Since all laws created by the government are enforced with the threat of violence against those who do not follow them, would Kotlikoff be comfortable with carrying out the violence against those who do not agree to follow his program?

Instead of figuring out the best way to make Social Security work, let’s allow people to decide on how best to plan and save for their retirement on their own.  Sure, some people may not save any money, but how is anyone ever going to learn if they see the government following everyone with a dustpan and broom to clean up any mistakes they make?

¹Schiff, Peter D., “The Real Crash,” p. 117