For nearly three-quarters of a century, Americans have taken Social Security for granted. Now we had better learn how it works, what it has done, and what the true facts are regarding its future -- or else we are going to lose it.
Superﬁcially, Social Security resembles traditional employer pensions: Americans pay into the system during their working years and receive a monthly pension during retirement. But the differences are fundamental. Social Security beneﬁts are based on a balancing of two principles: equity and adequacy. Equity means that what you put in is related to what you get out; in other words, workers with higher wages, who pay more into the system, receive higher beneﬁts later on. But under the principle of adequacy, the Social Security beneﬁt formula overlooks years of low earnings (for example, when a worker may have been disabled or unemployed), and it replaces a higher proportion of earnings for the poor than for the rich. That's why it's our most successful anti-poverty program. In addition, Social Security beneﬁts are indexed against inﬂation and protected from the ups and downs of the economy and ﬁnancial markets. That's why the program provides security for the middle class.
Privatization would do away with the idea of guaranteeing a minimally adequate income for the elderly who have worked all their lives. From their own earnings, low-wage workers would be unlikely to generate enough funds in an individual account to maintain a decent standard of living in retirement. Even middle-class workers would be at greater risk of poverty in old age. It's intrinsic to ﬁnancial markets that they yield unequal returns; many of those who did badly with their individual accounts wouldn't have enough from other sources to live on. And markets ﬂuctuate: Some generations would retire during one of the long downturns that periodically hit the markets, when their investments would be convertible only into paltry annuities. Those who lived into their 80s or 90s would be especially likely to outlast their individual accounts, or, if they had bought annuities at retirement, see those annuities severely eroded by inﬂation.
The elderly used to be an age group with an especially high rate of poverty. One of the signal achievements of Social Security, hardly noticed today, is that poverty has fallen dramatically among Americans over age 65 to just 10 percent, lower than the 12-percent rate for the population as a whole. For millions of the elderly who would otherwise be poor, Social Security is the single biggest source of income, the ﬁnancial bedrock of their lives. Indirectly, their working-age children are beneﬁciaries of the program because the elderly no longer have to move in with them. People under age 65 also beneﬁt from two other elements of Social Security that often get forgotten: beneﬁts during long-term disability and survivor beneﬁts for dependents if a worker dies before retirement. These are also important anti-poverty programs that don't carry the stigma of welfare.
Social Security was never expected to be the sole source of retirement income for the middle class, who ideally also have employment-based retirement plans and personal savings. But if one thinks of these various sources of income as making up a “portfolio” of retirement assets, Social Security's distinct value is even clearer. While other assets typically erode or become exhausted with advanced age, Social Security pensions keep their value because they have an annual cost-of-living adjustment. Moreover, as many employers convert from pension plans with a deﬁned beneﬁt to 401(k) and other plans with uncertain payouts, workers are already bearing more risk for retirement. In that context, Social Security provides a valuable hedge against the ﬁnancial markets.
But what's wrong with voluntary and partial privatization -- giving people the option of holding back 3 percent or 4 percent of their Social Security contributions to deposit in individual accounts? Although we haven't yet seen the details of the Bush plan, these proposals typically come with sharp reductions in future beneﬁts for younger workers who opt to remain in the system. These are really proposals to cut Social Security in which the individual-account option is an eye-catching decoy. Voluntary in appearance, these proposals would make Social Security such a bad deal that they'd trigger a run on the system: Workers, especially those with higher earnings, would likely not only opt for private accounts but demand that the entire program become optional.
Social Security works because it is a compact that extends across income groups. If the afﬂuent leave the system, it would become a welfare program, shorn of the political clout that comes from universal participation. The result would be a self-reinforcing cycle of decline.
Social Security also works because it has been a rolling compact across generations. For decades, the basis of the program was entirely pay-as-you-go -- the taxes paid by workers went to pay for current retirees. When those workers retired, they depended on the next generation to support Social Security. Then, in 1983, Congress raised payroll taxes above the level needed for immediate beneﬁts in order to accumulate savings for the baby-boom generation's retirement.
These funds have been invested in Treasury bonds -- that is, the federal government itself has borrowed from the trust funds. Though opponents of the program question this practice, it's no different from individuals investing in Treasury bonds. Ever since the founding of the republic, the federal government has paid off its debts; it must fulﬁll these obligations to the elderly no less than its debts to bondholders in Japan. But what this highlights is that future Social Security beneﬁciaries, like previous ones, ultimately depend on the next generation of workers to pay taxes and keep the system going for themselves and their children.
Republicans opposed Social Security when it was introduced, Barry Goldwater suggested making it voluntary in 1964, and ever since the 1980s, conservative think tanks have sponsored proposals to shift from Social Security to individual retirement accounts. The opponents' biggest resource in this effort has been public skepticism about government. When a 1981 opinion survey asked how much money out of $100 in Social Security taxes went to administration, the median answer was $52, though the real ﬁgure that year was $1.30. Today, Social Security continues to deliver beneﬁts with overhead at a fraction of what private accounts would cost, but few people understand that in this case the government enjoys a huge edge in efﬁciency.
President Bush and others have also sought to fan distrust in Social Security by contrasting a grim picture of the system's future solvency with bright prospects for individual investment accounts. Their game here involves using two sets of assumptions: The Social Security projections invoked by Republicans assume a 1.7-percent future growth rate for the economy; the investment returns look back to a 7-percent historical growth rate for the stock market. But if the economy grows at 1.7 percent, the stock market can't grow at 7 percent. And if economy grows as smartly as is being assumed for private accounts, there will be no crisis in Social Security.
The ultimate consideration is this: Social Security protects people against a variety of risks to ensure them a basic ﬂoor of income in old age and to enable many people who have struggled all their lives to look forward to a decent standard of comfort and dignity when they retire. It would be a crime to take that away from them.
Paul Starr is co-editor of The American Prospect.
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