A New Social Security Debate

January 9, 1997 • Commentary

It was more than a year late in coming and clouded by internal disagreements, but the report released Monday by the Social Security Advisory Council represents an important breakthrough in the debate over Social Security reform.

The 13‐​member panel, appointed by Health and Human Services secretary Donna Shalala, split three ways over the specifics of restructuring Social Security.

* Former Social Security commissioner Robert Ball and five other members, mostly representatives of organized labor, support a plan that would rely on a series of small measures in the short term, primarily small tax increases and shifting funds from other programs. To close the long‐​term deficit, this group suggests that the government be allowed to invest up to 40 percent of the Social Security trust fund in the stock market.

* A second group of five council members, led by Sylvester Scheiber of the accounting firm Wyatt‐​Watson Worldwide and Carolyn Weaver of the American Enterprise Institute, would allow individuals to divert 5 percentage points of their payroll tax to individually owned accounts that would be privately invested, similar to 401(k) plans or individual retirement accounts. The remaining payroll tax would be used to provide a flat floor benefit to all Social Security recipients.

* The final group of two members, including council chairman Ned Gramlich of the University of Michigan, would gradually reduce Social Security benefits while imposing a new mandatory savings program of 1.6 percent of payroll on top of the current payroll tax. Individuals would be able to invest this new savings in a limited number of government‐​developed plans.

Although its members could not reach a consensus on what type of reform should be pursued, the council’s recommendations are significant for two reasons. First, the debate over whether or not Social Security needs reform is over. There is now a consensus that Social Security must be restructured for the future. Second, and most important, there is now consensus that private capital markets can provide a better return on investment than can the government.

Rather than centering on whether Social Security should be privatized, the debate will now be focused on how much private investment should be allowed and who should control that investment–individuals or the government. However, this does not mean that the debate is any less important.

For example, the Ball proposal–allowing the federal government to purchase stock in major American companies–is one of the most dangerous ideas to come out of Washington in a long time.

It is easy to see the superficial attractiveness of such an approach. The Social Security trust fund is currently “invested” in special government bonds, a procedure that allows the federal government to borrow the trust fund and hide the real size of the federal deficit. Allowing the trust fund money to be invested instead in private capital markets would provide an opportunity to earn a much higher rate of return. Using that return to fill in some of the gap between future revenues and benefits would reduce the need for future tax increases or benefit cuts.

In reality, however, this approach is fraught with danger. Allowing the government to invest the trust fund in private capital markets would amount to the socialization of a large portion of the U.S. economy. The federal government would become the nation’s largest shareholder, with a controlling interest in nearly every major American company.

Those, like Mr. Ball, who suggests that the government could resist meddling in the companies it owned vastly underestimate the political pressures that government faces. Moreover, in addition to questions of direct control, government investment of the trust fund invites a host of questions about what types of investments should be allowed. For example, should Social Security be allowed to invest in cigarette companies? Companies that pay high corporate salaries or do not offer health benefits? Companies that do business in Burma or Cuba? The list of such questions is virtually endless.

The Ball approach is an attempt to gain the benefits of privatizing Social Security without surrendering government control. The Scheiber‐​Weaver proposal provides a much better answer to Social Security’s problems–giving control to individuals. This approach would preserve Social Security’s solvency while allowing workers to earn far higher returns. Given that most young workers will actually lose money under today’s Social Security system, this appears to be the only fair one.

Ideally, we should go even further than the Scheiber‐​Weaver plan and give today’s young workers total control over their Social Security taxes. By allowing them to invest even more of their money, we can provide even higher retirement benefits. This is particularly important for low‐​income workers. Moreover, Scheiber and Weaver are wrong to suggest financing the transition to the new system through a temporary 1.5 percent increase in the payroll tax. It would be far better to use reductions in current government spending to fill the gap.

For more than 60 years America’s elderly have relied on Social Security to ensure a dignified retirement. But, as we enter the 21st Century, the program requires major reform if it is to serve the next generation as well. The Social Security Advisory Council has begun the debate over what form the needed changes will take.

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