A Secure System

There is no financial crisis in Social Security. But it does need adjustment. Three simple changes would reduce the projected Social Security 75-year deficit from 2.17 percent of payroll to about 0.80 percent. These changes would reduce benefits only an average of 3 percent below what present law provides and no Social Security tax increase would be required for 50 years. These changes would:

  • Extend coverage to new hires in the 3.7 million state and local positions still excluded from the Social Security program (most are covered);
  • Increase from 35 years to 38 years the period over which average indexed wages are computed, which in turn forms the basis for determining benefit amounts;
  • Apply the income tax to benefits in excess of what the worker paid in, as is now true for other contributory-defined benefit plans, and deposit the taxes in the trust fund. Although the special exemption for low-income beneficiaries would be eliminated, 30 percent would still not pay taxes. Also, from 2010 on, the taxes on Social Security now going to Medicare would go to Social Security.

When these changes are added to a slight adjustment in the Consumer Price Index, as recommended by the Bureau of Labor Statistics, the projected 75-year deficit declines to 0.80 percent of payroll. Investing part of the fund in stocks makes up that remaining deficit and greatly improves the contribution/benefit ratio for young workers and future generations.

It is time for the Social Security system to depart from pay-as-you-go financing and turn to partial advance funding. Developing a substantial and permanent reserve fund would reduce the long-term contribution rate. In the past, Social Security has never developed a large reserve for advance funding, so the rate of return on the small contingency reserve has made little difference in long-range financing. Now that the system is moving toward partial advance funding, and the fund will become quite large, the rate of return does make a major difference.

Under these circumstances, the funds should be invested to earn a higher return. These investments should be indexed to the broad stock market and passively managed by portfolio managers selected by bid. The portion in private stocks would be limited to 40 percent and would remain considerably under 10 percent of the value of all stocks.

As with the Federal Employees Thrift Plan, an independent expert Investment Policy Board, which would select the index and the portfolio managers, would operate under a fiduciary standard requiring that trust fund investment policy "be solely for the economic benefit of Social Security participants and not for any other economic, social, or political objective." It would also be important to neutralize the effect of Social Security holdings on stockholder voting on company policy. Barring the voting of Social Security-held stocks might be enough. Or the voting of Social Security shares could be scored in the same proportion as other stockholder votes.

Other federal retirement systems invest in stocks. Besides the Federal Employees Thrift Plan, the defined benefit plan of the Federal Reserve System has about two-thirds of its reserves in stocks, and the Tennessee Valley Authority has about 40 percent.

The difference for Social Security financing in having part of the fund invested in equities is substantial. It would reduce the 75-year deficit by 0.82 percent of payroll; when that gain is added to the other proposals, investing in equities would completely eliminate the 75-year deficit. Beyond that, the twin proposals of partial advance funding and investment in stocks would greatly improve the benefit/contribution ratio for younger workers and future generations.


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APPRECIATING SOCIAL SECURITY

Individual return is not the most important criterion for Social Security, but it is nevertheless important. Young workers need to see their generation as treated fairly. The more important criteria for judging the usefulness of the program are its contributions to society as a whole-for example the fact that it provides disability and life insurance protection without regard to the health of the individual, and that it reduces the need for the less desirable means-tested programs such as supplemental security income (SSI).

Social Security keeps some 15 million people above the poverty line and millions more from near poverty. As recently as 1967 the poverty rate among the elderly was 28 percent, about 2.5 times the rate of the rest of the population. Social Security has been the key factor in bringing this rate down to about 12 percent today (about the rate among other adults). Without Social Security, well over half of the elderly would have incomes below the federal government's rock-bottom definition of poverty.

But Social Security is much more than an anti-poverty program. Because Social Security benefits are not means-tested, those above the poverty level are able to add other income to Social Security, and thus provide a level of living in retirement not too far below what they had while working. Social Security thus functions as the bottom tier in a three-tier system that also includes private pensions and individual savings.

Social Security follows the worker from job to job and the protection before retirement rises as wages rise. Benefits once awarded are inflation-proof, a guarantee that no private pension has made. Administrative costs take less than 1 percent of receipts.

Closing the Gap

(Projected 75-yr deficit=2.17% of payroll)

Extension of coverage to new hires in excluded state and local positions -0.22%
Increase in length of computation period from 35 to 38 -0.28%
Change in benefit taxation -0.62%
Correction of CPI by BLS -0.29%
Interaction among the proposals +0.04%
Investment in stocks -0.82%
New balance (percent of payroll) 0.02%

Social Security is a family protection program, a mechanism for spreading the cost of caring for the current elderly and those with disabilities. Thanks to Social Security and Medicare, no one family has to bear alone what could be the huge cost of caring for parents who are sicker than average or who exhaust their private savings.

Social Security provides $12.1 trillion in life insurance protection, which exceeds the amount of all private life insurance. Disability benefits are paid currently to 5 million adults, and 3 million children under 18 receive benefits. Protection is extensive. A 27-year-old couple with two small children, earning average wages, currently has survivors' protection worth $307,000 in the event of death, and disability protection of $207,000.

Social Security is far from broken. The more dynamic the economy, the greater the need for individual protection against major economic hazards. Social Security's benefits may be modest, but the protection is secure.

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