Valuing the family

A proposal for Social Security reform

Security was attained in the earlier days through the interdependence of members of families upon each other and of the families within a small community upon each other ... [Social Security] does not indicate a change in values. It is rather a return to values lost in the course of our economic development and expansion ...

Franklin Roosevelt: Message of the President to Congress, June 8, 1934.

We are now trying, for obvious reasons, to get away from the system under which children must support their parents in old age. In a system of this sort we would merely defer the support of the aged from children to grandchildren and charge interest on the period of deferment. Such a result would be exceedingly hard to justify.

Murray Latimer, Committee on Economic Security, Senate hearings on the Social Security Act, 1935

Social Security ended the tradition of children supporting their parents by requiring children to support older persons generally. The current system is actuarially unsound and requires substantial increases in Federal spending in roughly ten years, increases continuing for decades. [This article appeared in the year 2000.] Valuing the family examines Social Security from a forgotten perspective by proposing an alternative system of retirement saving and parental support.

The proposal ignores the Medicare and Disability Insurance (DI) portions of Social Security. The proposal does not eliminate Medicare or DI. Most of us associate Social Security with a pension for retirees. The Social Security program providing this pension is called Old Age and Survivors Insurance (OASI). A 10.7% payroll tax funds OASI.

The proposal replaces OASI with a combination of parental support, returns on private investment and private insurance. An analysis of parental support and private investment as an alternative to OASI dramatically demonstrates a stunning neglect of parental contributions to future production by both Social Security and the Federal income tax system. This article outlines a system of retirement saving and parental support and contrasts the proposed system with Social Security.

Eliminate OASI, existing tax deferred savings programs (IRA, 401k, etc.), income tax exemptions and credits for children and the mortgage interest deduction. [These programs have reformed counterparts under the proposal, so don't stop reading yet.]

Persons over the age of 23 save 15% of income (capped at some level) in a mandatory, individual, tax deferred, investment account. Private investment companies (including banks) manage these accounts, and a Federal agency regulates the companies to require proper management and accounting. Government does not insure the funds against loss but does require some diversification. Ordinary, marketable, Treasury securities are permissible in the accounts, but no other direct Federal obligation is permissible.

Parents supporting one child are exempt from the obligation to save 5% of income and therefore must save only 10% of income. The exemption exists until a child is 23. While supporting two children, parents must save only 5% of income. While supporting three or more children, parents are not required to save. Parents receive a tax deduction, 5% of income per child, while supporting children until the age of 23. Parents invest in their children. [We discuss single parents, guardianship and other related issues below. This proposal does not suppose that supporting a child requires only five percent of income. Numerous careful studies report a much higher burden on typical parents.]

Children above the age of 23 contribute 5% of income to each parent's savings account until a parent's death. The contributions are taxable to the child.

At retirement, persons purchase an annuity with their savings to create a retirement income. Private insurance companies manage the annuities, and a Federal agency regulates the companies. Annuities are Federally insured. Parents continue to receive 10% of their children's income after retirement.

Parents must insure their children against death and disability to protect the children's contributions to their saving. Private insurance companies manage the insurance contracts, and the contracts are also Federally insured.

Parents must insure themselves against death and disability until their children reach the age of 23 to protect their children's support. Private insurance companies manage the insurance contracts, and the contracts are also Federally insured.

Persons may use their savings to pay the principal (including the down payment) on a first home mortgage.

Comments on each item of the proposal

Employees receive the employer's portion of the OASI payroll tax as an addition to their income. Defined benefit pension programs gradually disappear under this proposal, but these programs are disappearing anyway.

401k programs already permit covered workers to save 15% of income, plus an employer matching contribution, so the second proposal does not increase the existing entitlement to save with tax deferral; however, most people don't take advantage of the opportunity, particularly parents, so the second proposal could reduce income tax revenue.

A married couple could contribute 7.5% of joint income to each partner's account.

For most parents, 15% of income does not cover the cost of raising children. Typical nonparents can easily save 15% of income. I know nonparents who take full advantage of 401k programs, reducing their taxable income by 15%. I don't know any parents doing so.

The federal income tax exemption for a child is now $3,100. A family with two children and an income of $70,000 (two teachers) deducts 8.9% of income while investing more than 15% of income in the future production of their children. The idea that childless persons are overtaxed is a myth. Parents are overtaxed. Recently enacted, child tax credits correct much of the imbalance in tax liability, but parental investments are nonetheless ignored by a Social Security system harvesting the returns.

The fourth proposal imposes a substantially smaller burden on children than OASI. OASI effectively requires children to contribute to the savings of their parents and other persons alike. In fact, it requires children of lower income parents (most children) to contribute more to higher income, childless persons than they contribute to their own parents.

If a child is born when a parent is 25 and begins work at 23, and the parent lives to be 88 (much longer than average), the child pays parental support for only 40 years, less time than he pays Social Security taxes. To avoid supporting parents who live very long lives, children could pool their support obligations with a contract similar to an annuity, providing 10% of income for a fixed period, say 40 years, regardless of how long their parents live.

An annuity is a contract between a person and a group of other people (a company). Each person gives their savings to the company, and the company pays each person an income until death. The income is roughly the income each person receives if his savings is paid to him with interest for a typical duration of retirement.

A government agency could administer the annuities, but a reasonably large company (a few thousand people) can provide this type of annuity at very little risk and low cost. Government could regulate the companies and protect annuitants with a government administered insurance program while allowing annuity companies to compete.

Since parents rarely outlive their children, this type of insurance is inexpensive, a small fraction of total parenting costs. The death/disability benefit could gradually increase until a child reaches 23, then gradually decrease until the parent dies. The cost of the insurance might shift from parent to child after age 23.

In the following analysis, I don't account precisely for the cost of this insurance. As an example, the insurance might replace the accumulated value of saving 5% of income per child. Saving 5% of income for 23 years accumulates about 200% of income, and the mortality rate for 23 year olds is about 100 per 100,000, so the cost per child of the life insurance component could rise from zero to about 0.2% of income at age 23. Paid in equal installments during childhood, the life insurance component could cost less than 0.1% of income per child per year.

The benefit from the required insurance could gradually decrease as a child approaches the age of 23. The cost of this insurance is greater than the cost of the insurance in proposal six; however, parents already commonly insure their lives to create an immediate estate for their children. Combining the two types of insurance is sensible, since the benefit from one decreases while the benefit from the other increases. In the following analysis, I don't specifically account for the cost of this insurance either.

If you need a home, and the home does not depreciate in value, paying off a mortgage early is like investing at the mortgage interest rate. Mortgaging a home to the maximum extent to get a tax deduction is not at all like investing and may be much more costly than paying off a mortgage as quickly as possible, even with the mortage interest deduction.

The mortgage interest deduction creates an incentive for indebtedness and inflates the cost of housing. The real beneficiaries of the deduction are lenders and real estate brokers. If you've ever been a home owner, as opposed to a home debtor, you know what a tremendously satisfying experience it is. We should encourage home ownership, not mortgage interest.

Case studies

A few examples illustrate how well this system could work. The following assumptions make the calculations simple and the comparisons meaningful.

Parents in the examples are born at the same time and retire at age 65.

Mothers, fathers and children earn the same income between the ages of 23 and 65, $30,000 per year.

The average retirement duration is 20 years after age 65. Twenty years is too long, but a longer estimate is more conservative. A longer average retirement requires a smaller retirement income. According to the Concord Coalition, the current average retirement duration is 17.4 years after age 65.

The real rate of return on invested savings is three percent annually. A real interest rate is the interest rate minus the rate of inflation. Using the real interest rate in savings projections effectively adjusts retirement income for inflation. Three percent is a conservative estimate.

Table 1 projects retirement income for couples earning $60,000 annually. The income estimates are conservative. Assuming a three percent real interest rate, the incomes are adjusted for inflation. The second column is the percentage of retirement income attributable to parental support rather than parents' saving.

		Retirement income	Parental support
1	No children:	$50,375 (84%)	0%
2	One child born at 25:	$46,796 (78%)	16%
3	One child born at 30:	$46,786 (78%)	13%
4	One child born at 35:	$46,778 (78%)	10%
5	Two children born at 25 and 30:	$35,279 (59%)	38%
6	Two children born at 30 and 35:	$36,365 (61%)	29%
7	Three children born at 25, 30 and 35:	$39,610 (66%)	45%
8	Three children born at 30, 35 and 35:	$39,590 (66%)	38%
9	Four children born at 25, 30, 35 and 40:	$39,008 (65%)	55%
Table 1

I chose a 15% saving rate to illustrate a point about the financial burden on parents and the inequity in our tax code. The table above doesn't look so bad for parents, but the current system divides the parental support portion of parents' retirement income equally between everyone in this example, including the childless couple. Imagine taking a portion of the income of couple five, provided by the couple's children, and giving it to couple one. Now, think about Social Security.

This example understates the inequity. Assuming a higher, more realistic rate of return on investments, the difference between the retirement income of the couples is much greater. More incredibly, imagine the working income of couple one is $100,000 annually. Couple one then saves a retirement income of $84,000 annually on these assumptions, and Social Security gives them a larger share of the children's contributions, regardless of the parents' income.

We also impose a lower tax burden on the childless couple during working years, because they may easily save 15% of income in a 401k, while many parents, who invest in children instead, receive a tax exemption worth less and credits widely perceived as charitable. Finally, the cost of raising children is more than 15% of income for most parents. Parents have less discretionary income during working years, even if childless persons save more than necessary. A 15% saving rate is adequate for retirement, but 10% of income is not adequate for both retirement saving and parental support.

Pooling parental support with an insurance fund might be sensible. Including childless persons in the benefit pool is not sensible. Ignoring the number of children is not sensible. Basing the benefit on parental income rather than children's income is not sensible. Social Security does all three. The illustrated retirement incomes are reasonably balanced; however, the childless couple has much more discretionary income than the parents and could save more. The table does not imply that the "return" on child rearing is comparable to the return on capital investment. No one profits by raising children in this example. The proposed system does not lead a rational person to have children for financial gain.

Transition

Transition is a sticky issue, because the current system is manifestly inequitable and makes promises it can't keep. This situation cannot change unless someone loses promised benefits, either the promise of Social Security benefits or the promise of income free of increased taxation. Without data I don't have, I can't project the cost of the following transition proposal, but any reform of Social Security is costly to someone.

Immediately replace existing tax deferred saving programs with uniform, individual investment accounts. Immediately eliminate income tax exemptions for children and the mortgage interest deduction.

Immediately entitle persons to contribute 15% of income to the individual investment account with tax deferral, and immediately create the 5%/per child deduction for all parents supporting children. Immediately entitle persons to deduct the payment of principal on a primary residence. Phase in the saving requirements described above over five years for all persons.

Immediately require parents to insure themselves against death and disability to protect their children's support.

Allow anyone (including current retirees) to move immediately into the new system. Current retirees are the parents of the baby boomers, and Social Security replaces only about a third of income, so many retirees could benefit from the transition, even without their children's contributions prior to retirement.

Immediately move every person under the age of 25 into the new system to fund their own retirement. Their parents may remain in the Social Security system, but their children enter the new system.

Immediately move persons (workers and retirees) above an affluence threshold into the new system. The threshold depends on age. If a person has saved more than the new system requires, s/he enters the new system, and s/he may move assets into the new, tax deferred retirement account.

The child of any person who remains in the Social Security system continues to pay the payroll tax until 65; otherwise, s/he pays parental support.

Continue to provide Social Security benefits to persons who do not move into the new system under the preceding proposals. The benefits are funded by a combination of remaining payroll taxes, the maturing bonds in the Social Security trust fund and other general revenue (income tax increases and spending cuts).

Conclusion

A system of saving and parental support can provide retirement income and replace OASI on sound financial assumptions. Because the proposed system has no defined benefits, it is fundamentally free of actuarial problems associated with changing demographics. It properly characterizes the support of aging parents as consumption and the support of children as investment, and it remedies a fundamental inequity in the treatment of parents by Social Security.

Clearly, a proposal of this scope begs many questions. What if a parent does not support a child for years or spends years on public assistance? What if a child has only one living or identifiable parent? What if a parent dies and is replaced by a guardian in the middle of childhood? How should those factors affect the obligation to pay and the right to receive parental support? How is the program phased in? Events other than death and disability can prevent family support. Are additional forms of insurance for family support desirable? These questions require answers, but Social Security raises more fundamental questions.

Elder support and child support are the purest forms of consumption and investment respectively, but Social Security actually disguises elder support as investment and child support as consumption. Social Security is fundamentally based on a false premise. We pretend to save while supporting our elders and expect the next generation to support us as though our elder support had been investment. A retirement system based on more realistic assumptions can hardly fail to produce a more satisfying result.

U.S. population (thousands) in 1970, 2000 and projected in 2030
1970		2000
Children (0-19)	77,170	83,236	+8%
Workers (20-64)	106,706	166,515	+56%
Retirees (65+)	20,106	35,061	+74%
Retirees/worker	19%	21%	+12%
Children/worker	72%	50%	-31%

2000		2030
Children (0-19)	83,236	95,104	+14%
Workers (20-64)	166,515	197,027	+18%
Retirees (65+)	35,061	71,453	+104%
Retirees/worker	21%	36%	+71%
Children/worker	50%	48%	-3.4%

Source of the projection