Securing Social Security

Thursday, October 30, 1997

Because virtually every American is affected in one way or another by the Social Security system, it has been called "the third rail of politics": Touching it in any way has the potential to "electrocute" members of Congress and the White House.

For example, there are nearly 40 million elderly people and survivors receiving a Social Security benefit, more than 5 million disability beneficiaries, and 135 million workers paying payroll taxes on their wages at an effective rate of 12.4 percent. In 1995, Social Security--officially known as the Old Age and Survivors Insurance Trust Fund (OASI) program--took in a whopping $326 billion dollars in taxes and interest and paid out $288 billion dollars in benefits. ("Survivors," by the way, are the spouse and children under eighteen who survive the death of a primary breadwinner.)

Almost every adult is directly affected by the benefits or taxes supporting such benefits; the few adults who are not have relatives or close friends who are.

But by 2013, Social Security will be well on the road to bankruptcy. It will pay out more annually in currently legislated benefits than it will receive in tax revenues and interest. It is in a long-run fiscal imbalance.

Founded about sixty years ago, the system is being derailed by demographics. People on average are living twelve years longer and drawing many additional years of monthly benefits. Workers are retiring earlier.

Moreover, the U.S. fertility rate, which determines almost entirely (except for immigrants) the future number of workers who will pay the payroll taxes, has fallen substantially, from 3.8 births over a woman's lifetime in 1957 to below the population replacement level of 2.1 births. Today, the fertility rate is 2.0, and it is expected to fall lower and match at times the even lower lifetime births per woman of a few countries in Western Europe, where the fertility rate is at or below 1.6.

Thus, the baby boomers, born between 1946 and 1964, will experience old age with few children, relative to past generations, for emotional and material support.

Another of the system's problems is inequity: It redistributes income from current workers to retirees, from singles to marrieds, from two-earner to single-earner couples, from those with higher incomes to those with lower incomes, and generally to whites and Asians because they live longer than African Americans.

To illustrate the unequal intergenerational redistribution of income, a recent Social Security Bulletin estimates that persons born between 1917 and 1922 get on average a 5.9 percent rate of return, as compared with those born between 1904 and 1910, who get a 9.4 percent return rate. Those born in 2000, it is estimated, will have only a 1.7 percent return.

"Privatizing" Social Security

The 1994–96 report of the Advisory Council on Social Security, released last winter, has raised the issue of investing some Social Security funds in private equities or the stock market. Doing so moved the U.S. debate on how to assure the trust fund's financing over the long run away from the traditional battlefields of reducing benefits and increasing taxes.

Privatization promises a solution because returns on common stock are historically much greater than on government bonds. Although this solution appears attractive on its face, problems loom.

One major stumbling block is the high transition cost and who would bear it. No matter how carefully the transition is fashioned, one or two generations must shoulder its costs. Those generations will pay for their own retirement benefits and most of the benefits of the already retired and those close to retirement.

Under the current pay-as-you-go system, workers' taxes support retirees, their spouses, and survivors. Current employees depend on future workers to pay their benefits.

Some analysts argue that individual stock investment savings funds could accumulate capital to a far greater extent than the present system, with each worker having his own fund under individual management that would pay out in the worker's old age.

Such private funds are successfully used in other countries, notably Chile, and by the federal civil service retirement systems. The higher returns could help solve the long-run imbalance in the Social Security program.

Other analysts argue that this is too risky. They say that the stock market will take periodic, devastating plunges and that individuals will


make un-wise investment choices. Therefore, a compromise has been proposed to assure a dollar amount below which no worker's benefit will fall.

By contrast, some critics of privatization oppose it because they view the federal government as not competent to manage private investment. They ask why they should expect Washington to invest people's money wisely. If the government makes the investment decisions, the critics say, politics will influence its choices. Thus, these critics support investing in private equities only if the taxpayer makes the investment decisions.

Alan Greenspan, chairman of the Federal Reserve Board, stated in Washington, D.C., in February 1996 that he is against privatization because he does not see that it will increase private savings. But in December he stated in Philadelphia that there is a strong argument for privatization because "it would replace an unfunded system with a fully funded system" and that "such a change could boost domestic saving." Nowhere in either talk did Greenspan discuss the largely unknown impact on the private stock markets of a greatly increased flow of funds, perhaps scores of billions of dollars a year, entering to buy mutual fund stocks.

The council proposed reducing benefits of early retirees, saving 13 percent of the long-term deficit. In November 1996, 78 percent of males fifty-five to fifty-nine years old worked, but only 54 percent of those sixty through sixty-four years of age were employed.

Political Viability

It's hardly surprising that such a complicated subject, with so many variables, requires a complicated solution. And a complicated solution depends more on politics than on economics.

In 1981, at the beginning of the first Reagan administration, the Policy Task Force on Social Security, which I chaired, issued its report, which was locked up as too "hot" to release. That report recommended restructuring benefits to eliminate gender, marital, and other inequities and increasing retirement age for a full benefit, whereas the more politically oriented 1983 Greenspan Commission report relied on increasing taxes, reducing cost-of-living allowances (COLAs), as well as raising the retirement age for a full benefit from sixty-five to sixty seven, all to be gradually phased in. The benefit structure was left intact.

The 1983 recommendations were sold with the phrase "everybody shares the pain"--workers from payroll tax increases, retirees from a reduced COLA indexing their benefits, and younger workers from the increase in the required age for entitlement to the full benefit. The deal was, in Greenspan's words, "the best I could get."

The law requires that the Quadrennial Advisory Council be a tripartite panel with equal representation from unions, employers, and the public. As always, the value systems of the 1994–96 council members differed. For example, one block stressed the welfare, or "social," part of the Social Security system. Another emphasized that citizens' getting their "money's worth" should be the most important criterion; "Could people do better by investing their money in the private markets?" they asked. All three blocks favored at least exploring some form of partial privatization.

Is There a Solution?

Lack of political viability rules out cutting benefits directly or raising taxes. Once in the past, not permitting the full cost-of-living adjustment was an accepted way of containing future benefits.

In addition, the 1983 recommendation to require sixty-seven as the age for entitlement to a full benefit might be pushed closer to 2010. And the government could eliminate ages sixty-two and sixty-three for entitlement to an early benefit.

On the tax side, it does not seem politically viable to raise the tax rate for Social Security (12.4 percent). The earnings base is already indexed. Currently, only income up to $62,700 is taxed for Social Security.

By contrast, since January 1, 1994, the 2.9 percent Medicare payroll tax has been levied on all earnings, without any dollar limit. The unlinking of Medicare and Social Security tax bases was done in two steps and with little publicity. Because of the magnitude of the Social Security rate, however, expanding the earnings base would cause an uproar. Many Democrats oppose even gradually phased-in minimal privatization. Republicans favor it because diverted tax dollars would go into private investment. Investing in the private stock market would give workers greater incentives to support the capitalist system.

There are problems--political problems--with virtually every solution that has come under consideration. Yet if nothing is done to solve the long-run imbalance of paying more out in benefits than is taken in as tax revenues, there will be a daunting price to pay. That includes, as promised benefits are not paid in full, nothing less than economic depression and skyrocketing loss of faith in government.