Cato Policy Report, September/October 1996
Social Security Reform: The Progressive Case
Social Security reform, especially privatization, has often been considered a "conservative" proposal. But there is increasing support for reform among liberals and Democrats. At a recent Cato Institute Capitol Hill Briefing, speakers examined "The Progressive Case for Social Security Privatization." Among the speakers were Tim Penny, former Democratic member of Congress from Minnesota and now a fellow in fiscal policy studies at Cato; Robert Shapiro, vice president of the Progressive Policy Institute; Sam Beard, president of the National Development Council and author of Restoring Hope in America: The Social Security Solution; and Michael Tanner, director of health and welfare studies and of the Social Security Privatization Project at the Cato Institute.
Tim Penny: In July 1988 I offered to the Wall Street Journal my first opinion piece titled "A Case for the Return to the Original Intent of Social Security." That title may sound provocative, but what I discussed in that piece was not at all radical. My column explored the shaky status of the Social Security trust fund-- based on projections that were far rosier than the projections we're now seeing from the Social Security trustees.
Among my recommendations were a gradual increase in the retirement age and a limit on cost of living allowances. I also mentioned that the baby-boom generation had an abysmal savings rate and was doing little to prepare for retirement. My recommendations and legislation that I subsequently introduced were met with less than enthusiastic interest here on Capitol Hill. Now it's eight years later and nothing much has changed except the proximity of the crisis.
The Social Security system will be effectively bankrupt by the year 2013, when annual payroll taxes will be insufficient to meet annual benefit demands. Not coincidentally, that is when the baby boomers will start retiring.
Demographics, not to mention increasingly generous benefit levels, have long threatened the viability of the Social Security system. In 1950 there were 16 workers for each retiree. Today there are fewer than four workers for each retiree, and by the year 2030 there will be only two workers for each retiree. The declining worker-retiree ratio has traditionally led to higher payroll taxes to fill the void. If policymakers were to continue that approach, payroll taxes would need to double to nearly 25 percent by the year 2030 simply to cover the costs of the program. I don't think any of us would want to explain to our children the need for the doubling payroll taxes.
A recent Cato Institute study concludes that the choice now is between continuing to support a bankrupt system and building a financially sound structure for the future, and I have come to believe that the reforms I once proposed to save Social Security--raising the retirement age and limiting COLAs--should instead be implemented to contain the costs of the system as we phase in a privatized system. We're 20 years away from the crisis; the time has come to begin the transition.
In the 1930s, clearly, too many workers found that their lifetime savings were inadequate to provide for a decent retirement. And we Democrats should be proud that President Franklin Roosevelt correctly proposed that American workers make defined contributions toward their own retirement through a payroll tax. I don't know of anyone who would suggest that we should not continue to have a payroll tax supporting retirement. The only argument is about how that money ought to be handled. Should the government remain in control, or should the individual have more say about how those monies are deposited and invested?
The federal government has proven to be an unreliable manager of Social Security. Frankly, calling any government account a trust fund is dubious. The distinction from other accounts in the budget amounts to no more than a book-keeping exercise. In a unified budget all funds are transferable. Overages in one area are covered by surpluses in another area. And that means there is no true Social Security surplus unless all non-trust-fund accounts are in balance. While it is true that for the present we are building so-called reserves in the Social Security trust fund and it is not therefore technically creating any problems in terms of the deficit, that situation will reverse in the year 2013, when Social Security will become a major driving factor in deficit spending.
Social Security has been described as the third rail of American politics, and in this election year we're hearing precious little discussion of the impending crisis in the system. But more and more Americans are coming to the conclusion that the system is in very shaky state and are having doubts that the system will be there when they need it. When a poll conducted for the Cato Institute asked whether Social Security is in financial trouble now, will be in trouble within the next five to ten years, or will be in trouble by the time the baby boomers retire, a total of 88 percent of Americans responded that the system is either currently in trouble or will be in trouble within 5 to 20 years.
The politics of Social Security is changing dramatically with each passing year, and politicians need no longer fear an honest dialogue. Americans like the idea of having more control over their own retirement plans and moving gradually--so as to absorb the transition costs that will certainly be entailed--toward privately directed savings accounts.
That is the plan that makes the most sense for the next generation. As Democrats who are proud of having created Social Security, we could perform no better service for the American public than to revise the program and make it relevant to the future so that for the next several decades we once again can be identified as the party that secured a decent and reasonable income for those in their retirement years.
Robert Shapiro: Social Security has been the third rail of American politics for good reason. It is the single most popular program in America. It has helped to ensure that millions of economically vulnerable Americans can live in dignity.
The current system does, however, require fundamental reform. Social Security in its present form is fiscally unsustainable, because it has an unfunded basis and its benefit schedule provides transfers that exceed the value of contributions adjusted for both inflation and an average rate of return. The system has been based on a benefit schedule that increases the basic premium every year so that someone retiring in 1995 with the same real lifetime income as someone retiring in 1994 will receive a larger base benefit than the 1994 retiree. Such a system can sustain itself only so long as the number of workers in the economy's payroll tax base expands faster than the number of beneficiaries and the size of their benefits. Unfortunately, that will soon cease to be the case in this country.
The problems are likely to worsen. The demographic aspect is well known, but, except through immigration policy, we can't directly affect demographics. We may be able to modestly influence the rate of economic growth on which the provision of benefits depends. In particular, the system could be reformed to encourage higher personal savings, which in turn should support modestly stronger growth through higher investment.
Those are the issues that Social Security reform must address if we are to ensure that everyone has adequate resources for retirement, and we must do so from a mandatory and progressive basis. That requires a two-tiered system: a provision for mandatory personal savings and a publicly financed, means-tested pension benefit. Under the first tier everyone would continue to save for his or her own retirement through the current payroll tax system. Mandatory private saving would shift the major part of the system of retirement security from today's unfunded basis to a funded basis by very gradually shifting five, six, or even seven percentage points of the payroll tax to mandatory personal savings accounts that would be owned and managed by the contributors. As that occurs, the publicly financed Social Security benefit could be gradually reduced both across the board and on a means-tested basis.
The management of personal accounts raises a lot of important questions. Those accounts will probably have to be carefully regulated to ensure the general security of each person's retirement resources. We might require that a major part of those accounts be invested only in broad index stock and bond funds or in government securities. Contributors should not be able to withdraw from their accounts until they retire. At retirement some major share of people's accounts should be dedicated to the purchase of annuities to ensure that they have an income throughout the rest of their lives. Finally, in the event of an economy-wide crisis that would sharply reduce the value and income of all financial assets, the treasury would guarantee the maintenance of a basic annuity.
The second tier of this system would maintain a supplementary, publicly financed pension for lower income people, preserving the 46 progressivity of the Social Security system. The difficulty lies in designing a workable transition from the generous, unfunded system we have today. There are, in essence, three ways to pay for the transition. First, we could borrow. That is, we could shift everyone to personal savings accounts and borrow the funds to maintain current Social Security benefits. That is fundamentally unsound economically. All of the additional savings we would get from mandatory personal savings would have to go to finance the debt for maintaining current pension benefits.
The second possibility is to raise taxes. I think both the economic cost and public support for that would be very problematic.
The third way is to reduce spending on Social Security retirement benefits. Net windfall transfers through the current system ought to be significantly reduced for high-income people. And we can spread part of the cost of effective benefit reduction to everyone in the workforce by raising the retirement age. It's already being raised to 68 very, very gradually over the next 35 years. We can accelerate that substantially and raise retirement to age 70 in increments of three months every year and get significant savings. We can also make adjustments in the benefits schedule, particularly at the high-income level. Managing the transition is the largest challenge for advocates of change in Social Security.
Social Security can be changed only if there is a broad bipartisan consensus. We cannot do it with 55 percent of the votes of Congress. We can only do it with majority support from both parties and a 75 percent vote. This will be a long debate, and we have to come up with a consensus solution in order to preserve the enormous achievement of the Social Security system while promoting the general economic health of the country.
Sam Beard: I'm not going to talk about Social Security. I'm going to talk about the fact that it's a disgrace that the top 20 percent of the country is cut into wealth accumulation and 80 percent of the country is cut out. When I started on the streets of Bedford-Stuyvesant with Bobby Kennedy in the 1960s, the strength of America was the middle class, and yet there were 30, 40 million Americans living in Bedford-Stuyvesant and in Appalachia who were cut out of that opportunity. Working on that problem became a lifetime goal. Thirty years later, I see a shrinking and disappearing middle class, and I think we've got to focus on that, too.
I'm going grassroots to try to create interest in this and start a groundswell. The top 20 percent of Americans have 49 percent of the income. In terms of wealth accumulation, the top 20 percent have 68 percent of the net worth. And take out home ownership, which is the best example of everybody having a chance to be cut into ownership--61 million Americans own their own homes at an average value of $110,000--and the top 20 percent have close to 90 percent of the financial assets. That's fundamentally wrong.
Now the reason I dwell on wealth distribution is because that's one of the promises of America. That's what America is supposed to be all about. Equal opportunity for everybody. A chance to come to America, have a stake, work hard, look after my family, build assets, and pass on a better opportunity to my kids.
As I go across the country, I find that 85 to 90 percent of the people I talk to think they had better opportunities than their parents, but only 10 to 15 percent think we're going to pass on better opportunities to our kids. That's a crisis and we need to address it. Let's put opportunity back on the table for all Americans.
For 100 years, 1873-1973, economic growth in this country was about 3.5 percent a year. Since 1973 it's been about 2.3 percent, more than 1 percent less. As we're talking about saving opportunity for our kids and grandkids and competing in the world economy, we had better come up with an economic growth agenda for the country. We are on a bad course, and it all relates to demographics. We're living longer. But all our entitlement systems are pay as you go. As long as you have an expanding workforce and the seniors don't live too long, that really works well. But we have just the opposite going on. We're going from 40 million to 80 million seniors, and birthrates are down. So the Kerrey-Danforth entitlement commission said the only way to pay for our promises is to double federal taxes by the year 2030 when the baby boomers have retired. I can assure you that doubling federal taxes is not a formula for economic revitalization and growth.
Now I'll talk about Social Security. I had no intention of getting into Social Security, but I was into wealth distribution and I did want to cut everybody in for an opportunity. Individual retirement accounts and 401(k) plans are not the answer because 80 percent of Americans don't have them. Then I looked at Social Security. And what I found was that Social Security reform potentially offers an opportunity to avert fiscal disaster and cut everybody in on the wealth. If I'm a high school dropout in Washington, D.C., I can get a service job paying $10,000 a year; out of that, I'm paying $1,240 a year in Social Security payroll tax, the most regressive tax we have. If I put that money into a 401(k) plan, I'd retire with $182,000 in today's money, over a million dollars in future inflated money. If I buy an annuity, my retirement income goes from Social Security's about $9,000 to $14,500, a 50 percent increase. If I'm a $30,000 worker, I'm paying $3,720 a year to Social Security. Put that money into any sort of a reasonable investment vehicle and I'll be able to retire with close to $500,000 in today's money. That's much more than the $110,000 value of the average home.
I am 100 percent against the privatization of Social Security, if privatization means disbanding the Social Security Administration. President Roosevelt created the assumption of a decent retirement income for all Americans. Privatization means 100 million Americans have private accounts, and if you make bad investment choices, you've got 15 million seniors eating cat food. We need a third option.
Option one is to keep the system the way it is--which will mean raising payroll taxes 50 percent or cutting benefits 30 percent. Option two is to privatize Social Security, disband the agency, break the federal safety net, break the pledge of a decent retirement income. Absolutely not! Option three is to look at the models of Chile and Singapore, which have mandated savings plans. Save Social Security, put it under two tiers, have the individual accounts, cut all Americans into the chance to accumulate wealth, and pass that on to the kids and give them choices. But keep tier one, which is the safety net.
Let's put the power of compound interest to work and cut all Americans into the chance to own something--and let's talk about increasing Social Security benefits 50 to 200 percent.
Mike Tanner: Let's face it, if Social Security goes under, everyone on this panel will survive. We have other methods of paying for retirement. We have 401(k) plans, IRAs, investments, equity in our homes--but the poorest elderly do not. The poorest 20 percent of the elderly receive 81 percent of their retirement income from Social Security. Social Security, despite its progressive benefits structure, still leaves them with a fairly low retirement income. If through privatization we can realize a higher rate of return, two to three times higher in fact, that's one of the best things that we could do for the elderly poor. We will need to maintain the safety net of minimum benefits, but private capital markets can offer a far higher rate of return for everyone than can Social Security.
We also need to look at the lifetime total benefit. The total amount you get back in Social Security depends on how long you live. If you live to be 100, you do pretty well on Social Security. If you die at 66, you don't do very well in terms of total dollar return on what you paid in. In this country it's an unfortunate fact that how long you live is linked to how wealthy you are. There's a big difference between the life spans of people in the lowest 20 percent income bracket and those in the upper 80 percent income bracket. The poor simply don't live as long and therefore they don't do as well in terms of total benefits that they get out of the system. That actually results in the net transfer over a lifetime from poor to rich, from men to women, and from blacks to whites. A privatized system would break the link between longevity and total benefits. In fact people who died early would have retirement accounts that could help their heirs to build capital that would then help lift them out of poverty.
The alternatives to privatizing Social Security are a really bad deal for the poor. The payroll tax is one of the most regressive taxes. First, it is a tax on employment, which is a very bad thing to tax if you want to create jobs and expand the economy. Second, it exempts income from interest and dividends, and it taxes income from wages, which is regressive. The fact is that 71 percent of Americans pay more in payroll tax than they pay in federal income tax, and those tend not to be the 71 percent who are the richest Americans; they're the 71 percent at the bottom of the scale. Raising the payroll tax significantly will be a burden on poor and working-class Americans. But if we don't do something about Social Security, we are going to have to have a significant payroll tax increase, which is going to fall on them.
Slashing benefits is also going to affect the people who depend on Social Security for 81 percent of their income. If you cut benefits directly, you are going to cut benefits to those people. And if you raise the retirement age but don't have a private option to increase benefits, you are going to have a significant impact on people who have physically demanding jobs. It's much easier to raise the retirement age for a policy analyst than for a coal miner.
We have to do something to fix the Social Security system in a way that preserves a retirement system for future generations and raises retirement benefits for the poor.
This article originally appeared in the September/October 1996 edition of Cato Policy Report.