Interviewer: Hanako Cho

Hanako Cho: Developed countries around the world are struggling with an aging population and thus, higher spending on pensions. How do you view the current pension system?

Dr. Arthur B. Laffer: There’s one question that is, as the population gets older, does it get healthier at the same time?

When my father retired in 1972, he retired at age 65 and he was correct to have retired. He was old and was not really healthy. The signs of age had shown on him dramatically. He and my mother, who was at the time two years younger, moved out to California from Cleveland, Ohio. They moved to Rancho Santa Fe in 1977 or 1978. Rancho Santa Fe had a lot of old people around there. My children used to call it God’s waiting room, sort of the lobby for those people checking into the afterlife, if you know what I mean.

I had moved to California in 1976 and lived in a Los Angeles suburb. I would see them every week. Every weekend, I’d take all the kids and go down there to see them.

My mother shortly became ill, and in 1980, she was diagnosed with cancer and died at age 72. My father died a couple of years later. He was 76 when he died, so he died in 1983. That was sort of a normal life experience at the time.

In the United States, life expectancy is different depending on the segment of the population, so life expectancy amongst African-Americans or other Americans is very different than Caucasian Americans like us. But overall, the world has changed quite dramatically, not only in longevity but in health as well.

And the change in life expectancy has hit policies.

 

When It Was First Set Up, Social Security System Was Sound

Dr. Laffer: We had our first Social Security tax in 1937 at 1%, both employer and employee, paying the payroll tax. In 1939, it was scheduled to go up to 3% to take care of the elderly, but the Social Security tax had such an impact on the economy that they postponed the increases in the Social Security taxes. It only went up to 1% but they got rid of other taxes at the end of the Depression until we got into World War II. That was it.

Today, our population has changed and the laws have changed but not by very much. Back in 1937 or 1938, people started work very early since not many of them got their MBAs or PhDs. They were paying their payroll tax as young people and paid it through until about 62 years of age. After they finished paying their payroll tax, they died very quickly thereafter so we had a long period of collecting Social Security taxes and a very short period of Social Security benefits. At the time, the laws made quite a bit of sense that there was no mismatch between revenues and expenditures.

But what has happened over the years is that people are starting to work later in life. They go and get their high school degree, their college degree, some of them get MBAs. They start working later, thereby reducing the tax and they live a lot longer. Needless to say, when you look at this by itself, it should not surprise you that the system that was set up in that era under Franklin Delano Roosevelt was fiscal sound back then, given the life expectancy and wages that existed back then, but that this system would be unsound today.

Now, we have had a lot of changes in Social Security over the years. There have been a lot of minor changes but there’s been no overhaul of the system in its entirety.

 

What Did the Reagan Administration Do?

Dr. Laffer: In 1981 under President Reagan, the National Commission on Social Security Reform headed by Alan Greenspan was set up. In 1983, the Social Security Amendments of 1983 was signed into law.

Now, among the number of amendments that was signed into law, President Trump has criticized one of the amendments, that is, it made 50% of the Social Security benefits above a certain income level subject to income taxes. In other words, if you’re a Social Security recipient, you have to pay income taxes on half of the benefits while the other half are tax-exempt. President Trump understands that this amendment reduced people’s incentive to work so he has a proposal to get rid of it.

But what the Commission really did is it extended the age of retirement in 2009 from 65 to 66 years of age, and to age 67 starting in 2027. If you extend the age of retirement, that means people are paying taxes for a longer period of time and getting benefits for a shorter time. That’s what happened.

 

What’s the Very Simple Solution?

Dr. Laffer: Life expectancy has continued to increase in the world. Here we are dealing with a very significant demographic change in the world.

We have a system that has an automatic disconnect between benefits and costs as the health and the age of the population change.

How could you keep this problem from arising? There’s a very simple solution. If your health improves with your age, there should be no problem. You should set aside assets throughout your healthy years and then use that. You should extend the age of retirement, the age of working. You should make a privatized retirement fund where you put aside a percentage of your money for your own personal retirement. You take care of yourself and in that way, everyone would have the type of retirement he or she would really want to have.

It’s really simple. You’ve got to save the money during your lifetime. You put that money aside. You invest it the way you’d like to invest it. When you retire, you choose where you retire. When you do retire, you can get that money out and live. If you didn’t save enough, tough luck. If you saved a lot, have a party. But you’ve aligned the incentives. Every dollar you put into your savings account is yours and the returns are yours. There is a perfect alignment of incentives.

 

Government Intervention Creates Misalignment of Incentives

Dr. Laffer: But here the government intervenes. They like votes so they look at people who are old and retired and say, ‘I promise you more.’ All of these things have to be looked at through a political lens. And that political lens today is probably as strong and as powerful as it has ever been.

When you have the government taxing and putting the money aside, you remove that alignment. For every dollar in Social Security taxes I pay, what are my expected benefits from that dollar of working just the amount of time to pay one additional dollar in payroll taxes?

Cho: It’s zero.

Dr. Laffer: There is absolutely no association between what I pay personally now and what I will receive in benefits. The amount I pay in payroll taxes has no effect whatsoever on my individual returns.

There’s a disassociation from effort and reward. This takes us to what is called the ‘transfer problem.’ It is a transfer from those who are paying the taxes to those who are receiving the benefits. As you will remember, the taxes on those who are paying the taxes reduce their incentives to work and it reduces total output. Those benefits I received that I did not pay into also reduce my incentives to work since I’m provided an alternative source of income other than working. I, too, will work and produce less.

So, Social Security as it’s currently structured, especially in the United States but also in the world, is disassociating individual incentives in the system and thereby reducing output, employment and production. There are methods to try to make that come back in line like private savings accounts and supplemental health care benefits that you can put aside for health care. All of these are trying to realign those incentives.

But they’re relatively small, and I don’t see any country at present trying to solve that problem on an individual level.

There is a collective level that matters as well, which is the state budget, the state borrowing and the solvency of the benefits system going forward. We can set up a Social Security system that reflects the change in life expectancy going forward, the change in health, the change in how long people receive Social Security benefits, and do it in a way that benefits are matched with taxes. We can make it so that government never has to change its benefit programs and it is fiscally sound going forward. This is what Jose Pinera did in Chile. This is what they had done in Sweden.

This is also what we did in the white paper for Ronald Reagan, by extending the age of retirement and taxing half of the benefits by the income tax, it reduced the benefits.

They have made it such that the discounted present value of all cash flows coming from taxes is exactly equal to the discounted cash flow of all the Social Security benefits, and that system is aligned going forward, never to miss.

All of these discussions today have to do with finding the solvency for the aggregate of Social Security benefits. Not one of the plans that I know of really focuses on the misalignment of personal incentives. To me, the misalignment of personal incentives is really the critical issue and there is no government anywhere looking at that issue at present.

 

How to Avoid Misalignment of Incentives? Privatize Social Security.

Dr. Laffer: When I was in the White House from 1970 to 1972, I wrote a piece for the National Tax Journal on Social Security. That was in 1970. Today, we’re 54 years beyond 1970 and it’s still the same problem, still the same discussion, and still the same scare.

All of the solutions to date have been ad hoc, they’re all one-offs, and so every year we come to the same crisis. Let me just say that the world has never handled this problem correctly. Each time we go, it muddles through a little bit more. One year we extend the age of retirement. Another year we raise the tax. One year we allow investments in higher returns, in equities, and not just government bonds.

Cho: What’s the solution?

Dr. Laffer: My answer to this would be to have a Social Security system that is privatized accounts, in other words, to privatize public pension funds into private funds so that if I decide to put in another dollar, the discounted present value of the benefits coming from that dollar will accrue to me and me alone. Therefore, there is no misalignment of personal incentives. That also guarantees there will be no fiscal problem whatsoever as well.

The second best solution is to put aside enough money while you’re working to pay for all your expected benefits later on so there’s no burden on the young. The third solution is to tax the young people and give the money to the old people but this again creates the transfer problem.

What the government needs to do is to make sure that there are no people left dying on the streets.

What we need is an insurance program. For example, some people will live much short of their life expectancy, others will live longer. You can have a private solution that would work for not only countries that are growing slowly and aging rapidly, but also countries that are growing rapidly and aging slowly. All of these things can be done through a private system. If you have the proper privatized insurance that reflects risks, that system will take care of itself for taking care of those people who do not have enough, live too long, or are sick early. That is the system that economically makes the most sense.

Now, if the government invested in the private market, there are some big downsides to that. Do you want the government to be the biggest shareholder of a private company? There are lots of negatives to the government investing those funds in private markets. Believe me that if the government is a big owner of private equity, it will exercise its influence a lot. You will not like what the government does with the private companies.

The one I would suggest doing that I think can be done is extending the age of retirement. If we extended the age of retirement today in the United States to something like 70 or 71, all of the unfunded liability would disappear because we’d be collecting taxes much longer from 67 to 71 and the benefits would start much later. So the cost of benefits would go down and tax revenues would go up. That would leave a much lower unfunded liability, if not even a surplus. I would recommend it not only to extend it so that the unfunded liabilities goes down, but extend it quite substantially so that we could reduce taxes on the taxpayers and maybe increase some of the benefits to the retirees.

 

The Real Damage of Pension Systems Is to Reduce Incentives to Work

Dr. Laffer: I would not make it a redistribution program. I would get rid of the taxes on the Social Security benefits. Reagan reduced the benefits by taxing 50% of the benefits. Bill Clinton raised that to 85%. But what Trump is proposing is to get rid of that tax on benefits.

The real detriment of the Social Security program is its effect on output, employment, and growth and its effect on the willingness of older people to work. Most of the people would work if they didn’t get the government benefits.

If you were to reduce those benefits, you would find healthy people working longer. They may not like that but that’s what would happen. Our Social Security system has reduced our growth rate, and because of our increased longevity, that Social Security system prohibits or encourages people not to work longer. Many elderly people are very healthy and active. They’re very smart. Why shouldn’t they be working? They enjoy working. They enjoy being busy. Taking the incentives away from work and putting it on leisure and consumption causes them to make risky decisions.

I could have retired many years ago, Hanako. I have plenty of money. I love my gardens up in Kentucky. I love my gardens here in Nashville. When I travel, I like taking a little bit of time to look around and see things. But I love working.

I get in my truck with my dogs every Thursday morning and drive to my farm in Kentucky. I turn off my phones. I turn off everything. And I have my day and a half of real peace. I have 50 heads of cattle, I have my geese, my turtles, my chickens, my cat that lives under the house. When I come, the cat comes and jumps in my arms. I’ve got trees and I’m very busy planting trees and looking at all this stuff. But then come Saturday morning, I’m back on the road. I come back to Nashville and I start reading emails from Hanako Cho, from Japan, from Liberty, figuring out how I’m going to answer these questions.

 

Covid-19 and Failed Government Policy Had a ‘Double Whammy’

Dr. Laffer: At the very beginning of Covid, I suggested to President Trump that we should not have a huge spending program to people and do big transfer payments to people not working and all that. Instead, I suggested that we waive payroll taxes for the same amount of money.

So it would be the same amount of benefits, but it goes to people who work. They don’t have to pay taxes and encourage the least amount of production loss per dollar of benefit to society in reimbursement. That was my criterion for doing that, to do the least damage to GDP for every given dollar of benefit.

I lost that argument because people don’t think like I do. Secretary of Treasury Steven Mnuchin went and made a deal with Senate Leader Chuck Schumer and House Speaker Nancy Pelosi to spread it to people who don’t work, and in fact, pay them not to work.

These people don’t think that when you give money to X, that affects X’s behavior. But when you take money from people who work and give money to people who don’t work, you’re going to get a lot less people working.

So, [Covid-19 and failed government policies] had a double whammy. We kept the payroll taxes high and we paid people more not to work. By my calculations, that led to a very sharp decline in output, employment and production, much sharper than what’s necessary for the pandemic. That’s what they did.

During the Great Recession of 2008, the W. Bush budget had a trillion dollars of subsidies, and in the Obama budget, another trillion dollars, all in new spending programs.

At the time, I proposed a solution in the Wall Street Journal to have a year and a half of federal tax holiday. There will be no federal taxes whatsoever, no payroll taxes, no income taxes, no capital gains taxes, no debt taxes, no taxes, no Medicare and Medicaid taxes, no taxes of any sort, no federal taxes for a year and a half. I think total federal taxes at the time were $2.1 trillion, but my proposal was to take the same amount of money that Bush and Obama spent on people who didn’t work and instead get rid of taxes to increase the incentive of people to work.

What do you think would happen to the U.S. economy if we had no federal taxes for a year and a half? We would have exploded as an economy and grown enormously.

You can see how I think differently than other people. No one even thought of that.

 

We Can’t Reduce Young People’s Incentive to Work

Dr. Laffer: How can you benefit society with the same amount of dollars, only do it in a pro-growth way and not in an anti-growth way?

Social Security has to do with ‘transfer payments’ of all sorts. All of these programs come down ultimately under the same thing. The thing that’s so interesting about Social Security and the aging population is it’s huge and has an enormous impact.

In the same way I thought about government intervention during the Covid pandemic, I always take my answers to keep the work level the highest. I always tilt towards taking less away from those who work and providing less to those who don’t work. In other words, why should old people receive money from young people who do work? You don’t want to take from young workers and producers and give it to the elderly. All of the money that the young people pay in Social Security taxes should go to their benefits, not to paying additional benefits to the current elderly people. That is not the way it should be run.

That’s the way I handle Social Security. That’s the way I handle the pandemic. That’s the way I handle everything in my life. I worry about countries becoming unproductive and becoming incapacitated in their ability to take care of their populations. The last thing you want to do is to discourage those who are productive from working and encourage those who are over-consumers from working.

 

The Reason Why Dr. Laffer Keeps Working

Dr. Laffer: I’ve had a successful business and a successful life. But I don’t want to stop working. It’s not just that I don’t want to. I feel a moral obligation to my country, to my world, that I need to keep providing things to make the world a better place. Isn’t that why you work? Don’t you feel good about your work?

Cho: Yes.

Dr. Laffer: Now, if I were a drug dealer, that’s work too, but that’s making the planet a worse place. It matters very much how you work and what you work.

For me, work is moral as well as financial. I like to work because I make money. I do like providing that money to my grandchildren. But I also love the work I do because I think I make people better off. I think I’m doing the Lord’s work, if you will.

I do feel I have a moral obligation to make the world a better place, to eliminate poverty by creating opportunity, not by paying welfare but by creating prosperity. Prosperity will end the wars. We have these problems in the Middle East. We have these problems in Ukraine. We have all of these problems between Taiwan and China. Prosperity solves all of those problems. It does.

Prosperity solves broken legs. Prosperity solves bad eyesight. Prosperity solves hunger. I think I’m doing the Lord’s work. That’s why I love working.

When I check out of this world, when I go to the hereafter, I want to go with a smile and with a phrase on my deathbed, “I did all I could do to make the earth a better place.” Isn’t that the way you feel?