It appears for now that President Bush's plans for social security reform are on the back burner. The idea proved to be politically unpopular, according to many polls, but I've never quite understood why. I've also never quite understood why privatization is viewed as such a bad idea by those who regard themselves as liberals. This essay will explain why.
The first thing that must be noted is that there is a genuine crisis in the social security system. For the first 50 years, Social Security (SS) was essentially a break even proposition. The amount of money taken in was roughly equal to the amount of money paid out. The problem with that was that the baby boom generation was so much larger than the generation that followed, which means that when the boomers begin to retire after 2010, the number of people paying into the system will be much smaller than the number of people taking out of the system, requiring higher SS taxes on productive workers to pay for the retired. In 1986, Congress ostensibly took steps to avoid this fate by increasing the SS tax to build up a surplus, to be put into the social security trust fund and invested so as to build up a huge nest egg out of which to pay future benefits. Since that time, SS has run a surplus (more money taken in than paid out) on the order of about $150 billion per year.
There's just one snag - there is no SS trust fund. SS receipts are a part of the general fund and have been since the late 1960s, so when the government runs a deficit, as it has all but one year since that time, there is no money to be invested. So rather than having $2.8 trillion invested to pay for the boomers' retirement, we have simply used that money every year to cover (partially) the shortfall in revenues caused by the Federal government spending money like Charlie Sheen in a whorehouse. So when the boomers begin to retire, there is no surplus there out of which to pay their benefits. Now, there won't be a crash right away, of course. The payroll taxes are still generating $150 billion a year in excess benefits, but as the boomers retire, the portion of that which is "excess" will be reduced dramatically over time because more and more people will be retiring and fewer and fewer people will be paying into the system. Sometime around 2030 or so, depending on whose calculations you trust, things start to become very serious.
Some liberals, like Kevin Drum of the Washington Monthly, have responded by saying that the government writing promissory notes they have to cover in the future is no big deal. It's just like paper money, they say, which isn't real or tangible but is backed only by the promises of the government. But this argument misses the point rather dramatically. The government doesn't actually have any money, it only has our money. The only way to cover these mounting future debts is by either A) printing more money (very bad idea) or B) raising the SS taxes considerably higher (an equally bad idea). And there are several reasons why liberals should be in favor of privatization.
First, because it will expand the number of people who have investments. One of the problems we have in this country is the split between the investing class and everyone else. The poor and lower middle class do not, as a rule, have a stock or bond portfolio because they can't afford it. SS itself is a forced investment account, but it's not actually being invested - it's just being given to the government to pay for more spending on the promise that they'll give it back to us when we retire. But of course, the only way they can do that is by upping the taxes even more on those who are not retired at that time. So what we have here is essentially a wealth transfer from those who, in most cases, do not have their own investments and retirement savings, to, in many cases, those who do (bear in mind that payroll taxes are only charged on the first $93,000 in income, which means those who earn more than that pay a far lower portion of their income into SS than those who don't). By giving the poor and middle class a chance at their own investment accounts, we increase the investing class considerably and give those people more of a say in the companies they invest in.
Second, investment accounts are transferable, while SS is not. Think about those who are affected the most by this, and take Jason and Scott as an example. Both of them will likely pay into SS for decades, but if one of them dies their money just gets absorbed back into the government, the other one cannot inherit it. But if they had investment accounts that they paid into, each of them could inherit the account from the other if one of them dies. The same is true for children. If a parent dies, sometimes the child gets a certain amount of SS payments until they turn 18, but with investment accounts the entire thing could be inherited rather than having it just go back to the government. And as Leanne Abdnor points out in a study for the Cato Institute, the outdated benefit structure of SS means that single women who work are penalized.
To me, the whole concept of SS as it currently stands is absurd. Think about this for a moment. SS is a forced retirement savings plan; the government forces each and every worker to contribute 7.5% of their earnings (except those who earn more than $93,000 per year, who pay a smaller percentage) and their employer to contribute an equal amount. The theory here is that they are investing that money for you so that when you retire, they'll pay you back on that investment and you'll make a healthy return that gives you monthly benefits. But here's the important part - they're not actually investing the money. Now, if you gave 7.5% of your income to a private investment company on the promise that they would pay you a certain amount every month when you retire, but they didn't bother to invest that money as they promised, they would be put in prison for fraud. And if they told you, "Oh don't worry about it, when you retire we'll just take the money from our other clients and still pay out the same amount we promised to you", you certainly wouldn't believe them. And on top of that, if something happens to you, in many cases, they just get to keep your money. Yet the government does exactly this and the public seems pretty much unconcerned about it. If you're going to force people to save for their retirement, they at least should own that investment and those who promised to invest it for them should at least be doing what they promised.
So what should happen now? First, SS should be moved out of the general fund and off budget so the government can't just use it to make the deficit look smaller and make themselves look less irresponsible. Second, we should allow the social security trust fund to build up for a few years while slowly phasing in private investment accounts for younger workers. We don't want to risk a wholesale destruction of the system with so many older people relying on the promises made before, but we should phase in a new system for younger workers that allows them to own their investment accounts, not the government. There are lots of details that would need to be worked out and I'm not going to make too many specific recommendations about them. Would there be restrictions on the types of investments that could be made, say to mutual funds or IRA accounts? Can a person put additional money into their accounts along with the 7.5% currently required? Would such accounts be taxable at any point, including if or when inherited?
All interesting questions that would need to be answered. But the system now is completely irrational. We're giving money to the government to invest for us and they're not investing it at all, but promising that in the future they'll up the taxes on our kids to make sure they keep their promises to us. That's a recipe for disaster. On an even bigger level, we simply must get a grip on Federal spending. The only reason the trust fund is bankrupt and non-existent today is because both parties spend money like a drunken sailor on a 3-day pass, and neither has the slightest interest in changing that. Which is all the more reason to vote for anyone but the Republicrats.
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The money from the SS trust fund is invested in T-bills (what the fund gets when the government borrows it) at, I think, 3% interest. So it's not as if the money isn't invested, it's just that it's invested in the lowest yield (yet safest) investment possible. If people were to invest a portion of their SS taxes and chose T-bills, it would be a big wash. The current proposal offered up assumes that people will choose riskier and higher yielding investments, and that the government will use those higher yields to cover the proposed short-fall.
As for the T-bills in the trust fund, the government is bound to make good on that moeny just as it would with any other creditor. I'm pretty sure that this is what Drum was referring to, since a lot of conservatives (including the President) have intimated that the trust fund doesn't really exist, that it's nothing more than scraps of paper that may or may not be honored. If the financial markets took this kind of language seriously, of course, all hell would break loose.
The portion of SS that's not in surplus doesn't get invested for the obvious reason that SS is a pay-as-you-go system. Current taxes go to pay current retirees, and in the absence of a surplus, there's nothing to invest. A switch-over to a true investment system would require a massive influx of money so that we could pay current beneficiaries and allow current workers to invest. There was such a plan floated in 2000 by then Treasury Secretary Paul O'Neil. The plan called for 1 trillion dollars to be spent from the general fund in order to allow everyone under a certain age to have their own investment accounts, while everyone over that age would stay in the system as it is now. That plan, however, died a horrible death right along side the budget surpluses that it was predicated upon.
I consider myself relatively liberal but I've never understood the knee-jerk opposition to any sort of social security reform either. It seems like obligatory opposition more than rational opposition to me. As long as the social security safety net exists for the poor, I wouldn't be opposed to some level of privatization. The purpose of social security in the first place was to give people, gasp, security so that they would not be afraid of taking risks for the betterment of the economy. If the safety nets stay in place then this goal has not be sacrificed.
I'm not opposed to moving away from the pay-as-you-go system to some sort of investment system either. The problem I have is when people think that the switch-over will have a net-zero cost, and all we have to do is funnel current payroll taxes into investment accounts, and voila, we're all richer. Tain't so. If we're going to switch to an investment system, we'll have to have two parallel systems for a period of time at double the cost, and then slowly phase out the pay-as-you-go system. With our budget already deep in the red, that doesn't sound too likely right now. I cannot see borrowing massive amounts of money only to turn around and invest it in personal accounts, with the hope that they earn enough interest to cover the interest we pay on our borrowing. That's what you call buying on margin.
I will admit to having one kind of knee jerk opposition, and that is to the Bush administration. Give me a competent administration, Republican or Democrat, and I'm far more likely to give privitization proposals a shot. In this case, however, I just say no.
I will admit that when it comes to economics, I am an ignoramus. But one thing puzzles me that I have never heard addressed anywhere.
Why can we spend $5 billion a month on the war effort, $500 billion for medicare, $1.7 trillion in tax cuts, all of with add to the deficit? I always hear that deficits don't matter, we'll grow our way out of them. Until we a faced with the possibility of a $200 billion SS deficit 30 years from now. All of a sudden, the system is bankrupt?
I am quite conservative, so I am not condoning deficit speding, but why is a SS deficit unacceptable when all other deficit spending is managleable?
Steve Reuland said:
But t-bills are government debt, which they must pay off with interest when they come due. So we've taken approximately $150 billion per year and exchanged them for a promise to pay $160 billion in 10 to 30 years when they mature. Now, I don't doubt that the government will make good on them, but remember again that the government doesn't have any money, they only have our money, which they get through taxation. We currently pay over $200 billion per year in Federal taxes just to pay the service on the bonds we sold to finance debt in our past. With this additional debt on top of the criminal amount of other Federal debt we're running up, what is that going to be 20 years from now? Estimates run as high as a trillion dollars per year solely in debt service of this type, PLUS we have to balance the payments in this pay as you go system. It's a recipe for financial disaster, and at a time when we are already courting big problems by risking a switch away from the dollar as the world's reserve currency.
I think that's why it's a good idea to do it in two steps. First, move SS off budget and let the trust fund actually build up for a few years, then phase in private accounts.
John wrote:
It's all the same, SS is part of the general fund at this point. None of those deficits are acceptable to me. If it was up to me, there would be drastic cuts in Federal spending (and I mean real cuts, unlike the fake "draconian budget" that Bush claimed to give to Congress and that Congress went along with).
Ed,
I agree with you completely, but my point was that the current goverment attitude towards current deficits is lackadaisical. But they seem to be alarmed at the posibility of a higher SS deficit later on.
Yes, but they're a debt owed by the government's general budget, not the SS system. The SS system will not be in the red for many decades. Hence, the problem we have is fundamentally one of government-wide fiscal irresponsibility, not something intrinsic to SS.
As you phrased it in the OP, we'd have to repay the money in the trust fund either by raising SS taxes or by devaluing the dollar. Actually, the proper thing to do would to be to pay it back with revenues from the general fund -- increased income taxes or spending cuts -- because that is where the money went to begin with.
The trust fund will eventually run dry, of course, but according to the Trustees' Report, this won't happen for betwee 40 and 75 years, depending on how optimistic your assumptions are. At that point we'll only be able to fund something like 70% of SS benefits. Minor changes could probably keep that from happening. Whatever you think is best, my point is that any impending fiscal crisis has little to do with SS and everything to do with large tax cuts and spending increases within the general budget. Blame the supply-siders.
As for taking SS off-budget, that wouldn't really change anything, it would only make explicit what is already true: The goverment has to pay back what it borrows from the trust fund, with interest. Keeping SS separate would still mean that the US government would borrow the surplus money, because it has to borrow the money from somewhere, and the SS trust fund has to invest it somewhere.
I think you make a fair point, and I tried to make it as well, that the real problem is the growth in spending in general. The SS trust fund is being used to subsidize the outrageous Federal budget and if we continue like this, the tax rates in 20 years are going to be off the charts - and they're bad enough already. But the social security trust fund helps hide the real size of the deficit, which perhaps helps avoid the public's alarm that might trigger calls for more restraint.
I think I'm uniquely qualified to discuss this because I live in a country with a massive socialized health care plan, the collapse of which will make Social Security look like a burp and not a particularly impressive one at that.
The continued existence of Social Security is threatened by the same two things that threaten Canadian health care. Unfortunately, those two things are demographics and math.
The problem with the President's plan is that it first gained serious attention in the wake of Enron, Worldcom, etc. Politically, the President was forced to say that the investments would be allowed only for pre-approved plans.
It seems to me that this would create an undue government influence in the market as it creates a "government favoured" class of stock. Also, there would be incredible political pressure on the government to "correct" any market adjustment. That doesn't seem like a predictably Republican thing to do, as it would be meddling in the markets. The 1981 Chrystler bailout was highly controversial at the time. Can anyone say that wouldn't be necessary for dozens of publicly held companies in the future because "Social Security" money was diverted there by the goverment?
Furthermore, what if a pre-approved company were found to violating anti-trust or other laws? Would the government forego prosecution because of the Social Security investment? If so, would this create two tiers of corporate justice? If I'm not mistaken, Microsoft stock is part of most private plans and they faced such a prosecution in the 90s. The plan as it stands would put the government into a direct conflict of interest.
I agree that something has to be done to fix Social Security but I'm not sure that turning the stock market into a federal retirement insurance system is the way to do it. All things being equal, I'm surprised that a Republican even suggested it.
As an economist, and a liberal, I am against SS "privatization" for the very simple reason that it is financially untenable. As others have noted, the system is NOT an investment system, it is a tax transfer and is in trouble because the ratio of tax payers to retirees is going down. As people live longer and have smaller families, the amount of money going into the system does not grow as fast as the number of retirees. While certainly a problem it does not follow that the only way to handle the issue is to move the system to private investments.
SS is really a pension system, not a retirement plan. The government is promising everyone who supports current retirees that they will get the same level of support when they retire. Anyone who thinks that they are saving X% of their income when they contribute to SS is misinformed.
But pension systems are ALWAYS a better deal than retirement accounts, because pensions are open-ended. With a retirement account, you have to estimate both how long you are going to live and how much you will need each year to determine how much to save now. If you miscalculate, and don't save enough, you're eating cat food, skipping medication, or moving into your kids' garage. With a pension, the amount is guaranteed for life. Given a typical life expectancy, the amount of $$ you get out of SS will be more than the amount you could save, unless you were extremely lucky in your investments. The only people who lose out on SS are those, like my mother, who die before they retire at all.
Now, I am not opposed to private retirement investment accounts, and even have one myself. My issue is that losing the tax transfer of SS and relying solely, or even very much, on private accounts leaves too many people at risk of not having enough for retirement. SS and Medicare (which, BTW, will bankrupt far more quickly than SS) were the greatest anti-poverty measures of their time. Older people now have some of the best assurances of a decent standard of living of any of our citizens.
Furthermore, if we remove the certainty of SS, we may actually hurt our economy. If people start seeing their grandparents and parents in poverty as old people they may, in addition to supporting their loved ones, reduce their own consumption by a lot, in order to save $$ for retirement. Now, that would not be a bad thing, but if they are only investing in the safest, lowest-paying, investments (e.g., T-bills), their money is actually less productive to the economy than if they had transferred it to elderly people to buy products. Purchasing products provides funds to industry, who often are more willing to risk that $$ on investments with higher potential future payoffs, but also higher risk, that can help the entire economy in the future.
If the government really wants to do something about SS, they should raise the ceiling on SS taxes, increase the retirement age, and provide tax incentives to those people who have saved more than enough in private retirement accounts to exempt themselves from the SS system. The government should also implement tax policies to expand and increase the use of 401(k), IRAs and 403(b) accounts.