elite press has urged Americans to be anxious about their Social Security
pensions. Newsweek, the New Republic, and the Economist,
among others, express a common fear that the system is going bankrupt and
dragging down the economy. Polls show that the public supports the principles
of Social Security but worries it will not be there when they retire. There
is a building sense that the system has somehow not kept up with the changes
in the nation's circumstances-in particular the age distribution of the
population and the performance of the economy.
Peter G. Peterson, the reigning guru of gloom and the angel of the Concord
Coalition, summed up these fearful attitudes in a recent feature
article in the Atlantic Monthly. On the cover, above the obviously
panic-stricken faces of Americans peering over the pension precipice, the
headline reads "Social Insecurity: Unless We Act Now, The Aging of
America Will Become An Economic Problem That Dwarfs All Other National
We too believe that Social Security pension reform belongs on the national
agenda. But what is the core problem to be reformed? Is there a financial
crisis that demands not only urgent action, but major revamping of the
system? Must we "privatize" Social Security in order to save
it? Or are circumstances that might warrant relatively minor adjustments
in finance being used as a pretext for a more fundamental shift in national
We think Social Security finance requires prudent adjustment, but not
major revision. Proposals to "privatize" substantial portions
of the pension package have no relationship to solving financing problems.
The real issues involve profoundly political choices, not technical ones:
Do Americans want a society that insures all workers and their families
against the dual risks of dying too young and outliving their private retirement
savings? If so, we can "socialize" these risks only through collective
social insurance. Or, do Americans want a society that merely mandates
savings and investment for retirement, while leaving the ultimate security
of workers and their families to be determined by their market success?
If so, privatization is an appropriate response. But proponents of privatization
are not practicing full disclosure. Privatization has much more to do with
ideological preferences and economic interests than with the solvency of
THE REAL CHOICE
According to Robert M. Ball, former commissioner of Social Security
in both Democratic and Republican administrations. [See "A Secure
System"], the system can be stabilized through moderate adjustments
in pension formulas coupled with a new investment strategy. As Ball observes,
the system is today accruing substantial surpluses, and total income will
exceed outlays until about the year 2020. Thereafter, Social Security reserves
must be retired to pay current benefits that exceed the level of current
taxes. By 2070--that is, 75 years from now--benefits are projected to exceed
taxes by about 5.5 percent of taxable wages. So unless some adjustments
are made in benefit levels, taxation levels, or trust fund earnings, Social
Security's retirement program would not be able--on current forecasts--to
pay all its bills, as early as 35 years from now. From this perspective,
Pete Peterson is technically correct: The current system is "unsustainable."
On the other hand, Peterson's assertion that something very like the
current system cannot be financed is nonsense. Indeed, by gradually shifting
to a partially funded system that invests in equity securities, there are
ways to close this projected gap in future funding with no tax increases
and extremely modest changes in current benefit levels.
For example, under the Social Security Advisory Council's option proposed
by Ball and five other members, the total 75-year deficit can be eliminated,
and then some, by six modest adjustments:
extend Social Security coverage to currently excluded state and local
increase the length of the computation period for workers' average
earnings from 35 to 38 years;
tax Social Security benefits that exceed already-taxed contributions,
as with private-defined benefit retirement plans;
correct the current overstatement of the consumer price index used
to calculate cost of living increases in accordance with the Bureau of
Labor Statistics March 1996 proposal;
credit income taxes on Social Security pensions to the pension rather
than to the Medicare trust fund;
shift approximately 40 percent of the Social Security trust funds,
now invested in Treasury securities, into equity securities.
Not only can something very close to the present system be financed,
but financing it is not very hard, so the proposals for more radical revisions
reflect other goals.
For example, 5 other members of the 13-person Advisory Council favor
substantial privatization. Every recipient would get a personal security
account (PSA) financed by a diversion of nearly 40 percent of the payroll
taxes that currently finance Social Security. Of the current FICA tax of
12.3 percent of taxable payroll, 5 percentage points would be diverted
system would provide an extremely modest basic pension of $410 a month,
which is considerably lower than the average benefit under the current
supplemental security income program (SSI), the means-tested portion of
Social Security. The money diverted to personal security accounts could
be invested in financial vehicles of a worker's own choosing. Upon retirement,
workers would receive the base pension, and whatever had accumulated in
their PSA would be available for lump-sum payment, investment, or annuitization.
Because the PSA proposal diverts 5 percentage points of FICA taxes from
the trust fund, additional revenues and benefit reductions are required
to maintain pension benefits for current and near-term retirees. The PSA
plan would raise the retirement age to 67 by 2011, increase payroll taxes
by 1.52 percent, and increase public borrowing by an additional $1.2 trillion
over the next 35 years. [For further details, see Joseph F. Quinn and Olivia
S. Mitchell, "Social Security on the Table,"
TAP, May-June 1996.]
According to the Office of the Actuary at the Social Security Administration,
each of the Advisory Council proposals satisfies the statutory requirement
that the scheme be in long-term (75-year) actuarial balance. But, if that
is true, why go beyond the Ball solution? The real debate is between those
who view social insurance as worth saving and those who want to reduce
government's role in retirement security in favor of market outcomes. To
simplify matters, we will illustrate the true stakes in this debate by
contrasting the Ball plan with the PSA proposal.
RISK AND REWARD
Both plans tie Social Security's fortunes more closely to the performance
of private capital markets. The Ball plan would retain a collective system,
while the PSA proposal would create individualized, funded accounts. Over
the last 60 years (the life of the Social Security pension system) capital
markets have out-performed real wage growth by several percentage points.
In principle, this change will improve the intergenerational equity of
the system by allowing future retirees (who will collect less of a windfall
than their parents) higher returns.
Nevertheless, there are risks. Tying Social Security retirement pensions
to the performance of the capital markets would have looked quite bizarre
in 1935, when the Social Security system was constructed. And even if we
do not experience another Great Depression, the events of October 1987
should remind us that the stock market can make quite precipitous "corrections."
Although on average, over long periods of time, one may do better by investing
in the market, some individuals and some cohorts of individuals will do
This concern about smoothing out the vagaries of market returns underscores
the first striking difference between the Ball plan and the PSA model.
In effect, the Ball approach puts the market risk on the government--on
all of us collectively. The PSA model puts that risk on individuals. The
choice between these proposals is thus similar to the choice between a
"defined benefit" and a "defined contribution" retirement
program. Private savings, whether in IRAs or otherwise, are the equivalent
of a defined contribution pension plan. Workers save a certain "individually
defined" amount and have assets at retirement equal to the performance
of their portfolio.
Social Security, by contrast, has always been similar to a defined benefit
scheme. The federal government makes long-term promises to pay certain
pension benefits and bears the risks that the performance of the economy
will make those promises either harder or easier to fulfill. Historically,
many private firms have also provided defined benefit retirement plans.
But only about 30 percent of Americans now retire with a company pension,
and companies are rapidly shifting from defined benefit to defined contribution
pension arrangements. In short, Social Security is the only vehicle available
to most Americans in which they do not bear market risks to their basic
The Ball proposal allows pensioners to capture the higher returns of
financial markets, while keeping the risk collectively shared rather than
individually borne. The projections for the PSA plan show it, on average,
outperforming the Ball proposal. But this has nothing to do with "privatizing"
the investment choices and everything to do with adding 1.52 percent to
the tax rate, and hence the total amount invested. If we added the same
tax hike to the Ball plan, the returns would be even greater than the average
PSA because the administrative costs are lower.
ECONOMICS OR IDEOLOGY?
The real issue here is not economics but political ideology. Most privatizers
want to privatize because they do not trust the government, or because
they believe that the American people do not trust the government, or because
of concerns that Social Security depresses savings rates.
The lack of trust argument takes two forms: In one incarnation it asserts
that Americans prefer market risk to political risk. Hence to preserve
the political acceptability of a mandatory retirement program, Americans
will demand that they, rather than a government agency, should have control
over investment decisions. The second form of the argument is that the
government cannot be trusted to invest in the private capital markets without
meddling with them as well. Neither argument is persuasive.
To give the first argument its due, privatization can be seen as an
attempt--indirect, to be sure--to shore up confidence in the system. Americans
who have "ownership" of an individual or personal security account
might view their investment as more secure than a claim on the Social Security
system. If so, this surely has more to do with the drumbeat of criticism
in the media than any reasonable judgment of the program. The Social Security
system avoids inflation risks, bankruptcy risks, and market risks. It has
been running for 60 years without ever missing a payment. It continues
to have the overwhelming support of the American populace, and Americans
say that they are quite willing to pay some additional taxes to ensure
the financial soundness of the system into the distant future. Nevertheless,
it is conceivable that Americans will come to prefer risky over non-risky
investments. Nor can we fully discount the Lake Wobegon effect--overoptimism
among young workers that their lifetime earnings will be above average.
If so, they would be increasingly susceptible to the argument that Social
Security provides an inferior return on their contributions.
The real risk, however, is that partial privatization will lead to inexorable
pressure for full privatization. Investment of some Social Security funds
in equities, rather than Treasury securities, will of course improve the
investment performance of Social Security. But if this investment is done
in a privatized form, it will appear that the improvement has come through
privatization of accounts rather than from a simple shift in investment
holdings. And, because most workers tend to ignore the life insurance,
dependents' benefits, and inflation protection that are a part of the Social
Security pension package, this argument may be persuasive.
Even more importantly, workers may ignore the crucial protection that
social insurance provides to everyone against low average lifetime earnings,
poor performance of their individual investments, or against higher taxes
or intrafamily transfers to support those who do have these experiences.
The less stake that American workers believe themselves to have in the
collective provision of retirement benefits through Social Security, the
more likely political support for the system is to erode. Partial privatization
in this scenario would be destabilizing rather than anchoring. It could
lead to the very destruction of the economic security that "reform"
was supposed to preserve.
The argument about government "meddling" in capital markets
is even less compelling. Maintaining the soundness of and confidence in
financial markets by massive governmental "meddling" is one of
the great success stories of American public policy since the 1930s. Investing
Social Security funds in equity securities will not roil capital markets,
so long as investments are limited to broad "index" funds, these
funds are managed solely in the interest of beneficiaries, and government
is a passive shareholder. These constraints are not difficult to construct,
as the experience of the Federal Employees Thrift Plan, the Tennessee Valley
Authority and Federal Reserve Board's defined benefit retirement programs,
and many state retirement funds illustrate.
In short, workers would not, on average, be better off investing privately
for retirement than having those investments made through Social Security.
Because private investing exposes beneficiaries directly to temporal fluctuations
in the financial markets, privatizing accounts will make many worse off.
There is no reason, other than ideological antipathy to government money
management, for Americans to prefer the PSA to the Ball approach. There
are obvious reasons for private money managers to prefer PSAs.
Critics of Social Security make much of the supposed burden that retirees
place on the working young. By now, the image of the affluent old enjoying
a secure retirement on the backs of hard-pressed wage earners is an established
cliché. But the most recent complete data on the income of the aged
for 1994 reveal that 56 percent of persons over 65 would be below the poverty
line without their Social Security payments. Three-quarters of all recipients
have total income, including their Social Security benefits, under $25,000
per year. Fifty percent have income under $15,000 per year. Families with
an income of $50,000 or more represent only 9 percent of Social Security
beneficiaries. Most elderly are not rich.
Reform of Social Security really poses two distributional issues-intergenerational
fairness, and fairness within age cohorts. The intergenerational equity
issue is mostly a distraction. The first generation of pensioners indeed
enjoyed a windfall, but that is history. Both proposals aim to put Social
Security pensions into long-term actuarial balance. Given that the burdens
on current and future generations under the two schemes will be equivalent,
the real issue is equity within generations. Here an ideological chasm
separates the two proposals.
The Ball approach maintains the worker insurance model of equity that
currently undergirds Social Security. Distributional fairness in this social
insurance model is straightforward, but not always well understood. First,
workers are insured against a lifetime of relatively low-wage work by a
guarantee of a minimally adequate pension in old age. Second, recognizing
that the level of wages includes some combination of personal circumstance
and effort, the size of the pension increases with a worker's level of
contribution. But it redistributes by giving lower-wage workers a better
"return" on their lifetime earnings.
In other words, everyone signs up at the beginning of their working
lives for a system that makes two promises: a minimally adequate retirement
income for all workers, and a guarantee of higher returns (in absolute
dollar amounts) to those who make higher contributions over their working
privatization approach proposes significant distributional changes. Under
the PSA model, the pensioner is viewed as an investor. Supposedly, higher-wage
workers who save more (and those who make more fortunate investments) are
fully entitled to their better retirement situation. As a matter of individual
dessert, the "investor" notion of fairness seemingly rewards
individual prudence and self-denial--the decision to give up current consumption
as a hedge against an uncertain future. Yet a mandatory requirement to
save a fixed percentage of wages rewards neither prudence nor self-sacrifice.
The saver, after all, did not choose to save. And sacrifice is inversely
related to affluence.
The fairness of this shift is even more doubtful when the context of
America's overall retirement policy is considered. Tax policy already offers
greater subsidies to the retirement savings of higher earners than lower
earners. The home mortgage interest deduction and the nontaxability of
IRA, Keogh, 401(k), and defined contribution plans provide much more assistance
for wealth accumulation to high earners than to low earners. The current
structure of Social Security pensions somewhat reduces this imbalance.
A shift to PSAs would eliminate an important equalizing feature of the
overall retirement system. Given that "personal circumstance"
as a determinant of lifetime earnings includes being born black or white,
male or female, able-bodied or impaired, or into a rich or poor family,
the unfairness of this approach seems manifest.
The imposition of substantial market risks on lower earners is also
objectionable. The lower one's earnings over a lifetime, the more Social
Security pensions matter to one's retirement security. And, other things
being equal, the more Social Security provides one's bedrock protection
against destitution in old age, the less likely one would be to prefer
having that protection subject to market risks of the sort contemplated
by the PSA proposal. After all, if one's investments went south under the
PSA plan, one would be left with a guaranteed benefit of only $410 per
month in 1994 dollars--less than current supplemental security income payments
and much less than the poverty threshold.
The PSA scheme also trades a portion of Social Security's protections--survivor
benefits--for ownership of the PSA, which passes to one's heirs at death.
Security for younger workers and lower-wage workers' families is again
being traded for increased benefits to higher-wage workers, and particularly
to the survivors of those who do not outlive the value of their PSAs. This
is not a trivial trade. Social Security currently provides life insurance
valued at $1.3 trillion, more than all private life insurance policies
currently in force in the United States. In short, the PSA proposal piles
market and other risks on families who are poorly positioned to bear them.
The biggest winners in a shift to a PSA scheme would be families with
two moderate- to high-wage workers. Each worker will have an individual
account with no cap on expected returns. The PSA system thus would reinforce
the distributional shift toward high-wage, dual-earner families that is
occurring in the economy generally. Yet, while this is distributionally
perverse in one sense, the PSA corrects what some view as a major inequity
in current arrangements. Because spousal benefits now tend to smooth out
returns to one- and two-earner families, some people currently view the
FICA contributions of a family's second worker as "wasted." PSAs
would eliminate this "unfairness."
While this position is superficially plausible, it is not compelling.
First, the "loss" to high-earning couples is not nearly so great
as Social Security's pension payment schedules suggest. High income is
highly correlated with longevity. High earners will on average collect
pensions for a considerably longer period than lower earners. Moreover,
reforming the system to make it more favorable to two-earner families has
no necessary connection to privatizing it. The same thing can be done,
if we want to do so, through simple accounting changes.
Most importantly, this sort of group-by-group analysis of who gets what,
on average, misses the basic point of social insurance. At birth, none
of us knows for sure where we will end up socially or economically. We
may be low- or high-wage earners. We may marry or not. Our spouses may
work or not. Our working spouses may be low- or high-wage earners. We may
The current scheme ensures us that however things turn out in life,
our retirement benefit will not be too awful, and our dependents will be
provided for if we expire before retirement. Should we be high earners
with high-earning spouses, we will receive relatively low returns on our
FICA taxes viewed strictly in terms of the size of our Social Security
pension checks. But we will have insured ourselves against destitution
and against the risk of having to pay higher taxes to support the destitute.
This binding together of the interests of low and high earners in a common
enterprise, before they know for certain who they are, is the essence of
ALTERNATIVE AGENDAS AND RED HERRINGS
Some advocate privatization as a necessary means for increasing national
savings, which they see as key to increased prosperity. These claims should
have no bearing on the current Social Security debate for three reasons.
First, the Ball plan and PSA proposal are indistinguishable with respect
to savings rates. If we believe, somehow, that investing trust funds in
capital markets is good for savings and investment, the Ball plan does
the job just as well as PSAs. Second, neither plan necessarily increases
national savings. Both take money that is now invested in government securities
and put it into private securities. But, if the government continues to
tax and spend at the same rate, it will simply have to borrow at the same
rate elsewhere. National savings can increase only if overall private savings
goes up at a rate not equaled by government borrowing. Changing the form
of Social Security trust fund holdings will not do the trick, nor will
relocating those holdings into private security accounts.
Third, the capacity of the economy to pay projected benefits in 50 or
75 years is a function of the health of the future economy, not simply
of the private savings rate. And the rate of economic growth reflects a
variety of factors--public and private investment, technology, employment,
human capital, business profits--not just the rate of personal savings.
The latest attack on Social Security is only a variation on familiar
themes. Opponents today attack Social Security's "unfunded liabilities"
and "trust fund fakery"--two of the Concord Coalition's favorite
phrases. But conservative counterparts in 1939 demanded that the program
be put on an unfunded, pay-as-you-go basis because government was not to
be trusted with management of retirement-fund reserves. In 1983 and again
in 1996, Social Security opponents claimed the system was going bankrupt--yet
in 1989 they also attacked it for running huge surpluses. If bankruptcy
and surplus are both crises, something other than financial prudence has
to be driving these concerns.
the surface of a technocratic debate about Social Security's tax rates,
benefit schedules, and long-term financial projections, there is a deep
ideological divide between opponents and defenders of social insurance.
Defenders, like us, see necessary adjustments as a natural and inevitable
evolution. Opponents see these occasions as opportunities for radical revision--times
for convincing the American public that social insurance is an unfair,
Privatizing reforms can be a legitimate means to public objectives where
government failure is likely, and where private markets reliably produce
superior results. We can fairly debate whether private contractors, or
vouchers, introduce beneficial competition in many public programs, without
compromising their purposes. Privatizing Social Security, by contrast,
is a contradiction in terms. It not only fragments our most successful
and universal program, but changes the entire dynamics of the program in
order to fit the imperatives of private markets. By itself, the market
can provide investment vehicles, but it cannot supply social insurance.
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