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Sunday, November 15, 2009

A New Way to Look at Payroll Taxes

If you are an employer you could pay up to 15.3% of your income toward payroll taxes. Those payroll taxes include money set aside for Social Security and Medicare. Both those programs are on the verge of bankruptcy. What if there was a better way to spend that money?

That's what former accountant, now retired, Dick McDonald thought. Imagine if all the money currently taken out of your paycheck for pay roll taxes could be placed into an investment account and that investment account invested in index funds.

An index fund or index tracker is a collective investment scheme (usually a mutual fund or exchange-traded fund) that aims to replicate the movements of an index of a specific financial market, or a set of rules of ownership that are held constant, regardless of market conditions.

Tracking can be achieved by trying to hold all of the securities in the index, in the same proportions as the index. Other methods include statistically sampling the market and holding "representative" securities. Many index funds rely on a computer model with little or no human input in the decision as to which securities are purchased or sold and is therefore a form of passive management.


The S&P 500 index, for instance, has averaged a yearly return of 10% over the last 25 years. So, had you just invested $1000 25 years ago, your total would currently be $10,834.71.So, just imagine a janitor that only makes $20000 yearly. You'd have about $1500 put away for you every year. If you were to work for 40 years, you'd accumulate about $660,000 over the life of the investment.

Currently, if you max out the system, you'd receive just under $2000 monthly from your Social Security check. In fact, Social Security pays out the equivalent of 2% annually and that's only if you live into your 80's.

This program would be entirely voluntary. It would expand upon George Bush's idea of privatizing some of social security. Under George Bush's plan only 4% of your entire Social Security account would be privatized. Under this plan, all of it would be privatized and invested on the stock market. If all goes according to plan, not only would it create enormous retirement wealth for most citizens, but it would expand the economy exponentially, pay off half our debt, and lead to sustained economic growth.

That's the positive. Here's the negatives. Under this plan everyone that pays into social security and Medicare would still get all the benefits promised them. Now the hope by McDonald is that the wealth generated by the plan would create so much in new tax receipts that it would pay for itself. If not, however, that would mean that the U.S. would have to monetize the debt. This means that any shortfall beyond that which McDonald anticipates would be financed through printing money.

When Mr. McDonald and spoke last week, he assured me that under his plan there would be no massive inflation. On the other hand, basic economics says that if you print money ad nauseum you will create inflation.

The other problem is political. Such a plan would immediately lead to demonization from the left that "you're jeopardizing people's Medicare and Social Security". For this, McDonald told me he would take his plan "directly to the people". I've heard such statements before, and I wish him well. That said, George Bush was excoriated and demonized for simply suggesting that we move just four percent of the payroll tax into a private account. This plan would call on privatizing the whole thing. While I may agree in principle with such a plan, in practice, unless you have a real media campaign, it has no hope of ever seeing the light of day.

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