A 'cure' worse than the cold
Fire and freedom captured the headlines of the president's stirring inaugural address, but it was a handful of words toward the end of the speech that are likely to have the most profound impact on the daily lives of millions of Americans. After a nod to landmark legislation like the Homestead Act, the Social Security Act, and the GI Bill of Rights, the president said, "And now we will extend this vision by reforming great institutions to serve the needs of our time. . . . We will . . . build an ownership society."
It is clear that President Bush's first "ownership" priority is Social Security. Typically, this is presented as "reforming" Social Security or "saving" it from collapse. But what are the realities behind the easy rhetoric? Social Security is the most popular and universal of any of our government programs because it guarantees a pension to anyone who has contributed to the system throughout his working years. It's the cornerstone of life for nearly 48 million people--retirees, dependents, survivors of deceased workers, and the disabled--all of whom receive a check like clockwork every month. Millions more of today's workers will come to rely on those checks in the years ahead. Many don't think much about that fact, and few realize just how much of a nest egg they're going to need. An American reaching the retirement age of 65 today has an average life expectancy of 18 years, which means that roughly half of those who reach 65 can expect to live longer than 18 years. Four out of 10 have no non-work-related retirement savings. Six out of 10 haven't even tried to estimate what they'll need. They rely vaguely on Social Security, but how far will it carry them into their 70s and 80s? How serious is the "crisis" they hear about? What are the implications of "reform" ?
Hand-wringing. Social Security pensions were indexed to the rate of inflation in the 1960s and 1970s, transforming the lives of millions of Americans by dramatically diminishing poverty among the elderly. Now only 10 percent of those over 65 live in poverty--2 points lower than the national poverty rate. Roughly two thirds of people ages 65 and over depend on Social Security for at least half their income, and roughly 20 percent rely on it for their entire income. Currently, the payroll tax brings in more dollars than it pays out in benefits. The surplus, now roughly $180 billion a year, is invested in treasury securities and deposited into a trust fund, which now holds over $1.5 trillion of these notes. As the baby boomers begin to retire, the system will go into deficit around 2018, requiring drawing down on the fund. By that time the fund will exceed $3 trillion, so it will be in the black until around 2042, using the Social Security Administration's conservative economic and demographic assumptions, or 2052, using the assumptions of the nonpartisan Congressional Budget Office. Even if the system exhausts its reserves, payroll taxes will continue to roll in, enabling at least 73 percent of scheduled benefits to be paid out.
In other words, there is no current financial crisis in the program. So, what's with all the hand-wringing? Well, if you make pessimistic predictions about economic growth, immigration, and wage inflation, the projected revenues may not be enough to pay benefits. The Social Security actuaries, for instance, project that growth will average only 1.6 percent after 2010, about half the rate we have enjoyed in the past century. But if the economy grows at anywhere near the levels that Bush's own budget experts project, the surplus, in effect, would never run out. And more-optimistic forecasts than those of the Social Security actuaries are supported by the recent history of economic and demographic trends.
Most important, to the extent that there is a deficit, it could be covered by a variety of modest combinations of tax hikes and benefit cuts--each of them quite manageable.
There are many options that would not put at risk the essential elements of Social Security. A careful study by AARP estimates that 43 percent of the Social Security deficit projection would be met by raising the cap on taxable wages from $90,000 to $140,000; 38 percent would be covered until 2083 by raising to 70 the retirement age for full benefits; a quarter-percentage-point increase in the payroll tax for employees and employers would cover 24 percent; requiring state and local government workers to join would cover 9 percent. Yet another approach implicit in the president's program is to decelerate increases in benefits by raising them in line with prices, not wages. This readjustment would eliminate the 75-year projected deficit of Social Security, but it would have a major impact on low-wage earners who depend almost entirely on Social Security, and it would reduce benefits for middle-income workers by as much as 25 percent over 30 years. It would thus preclude many seniors from enjoying the benefits of rising standards of living. A solution here is to protect workers at the lower end of the income spectrum by retaining benefits according to wage rises for them but lowering benefits to price indexing for the higher levels. Or some mix of the two.
There is another worry--that the trust fund is a tempting piggy bank for congressional spendthrifts. The head of the Social Security Administration made an interesting proposal that would both protect the fund and possibly increase it: Free the program to invest in stocks and bonds. Properly invested in standard balanced accounts, the fund could earn about 4.9 percent a year after expenses--much higher than the return on all those treasury bonds, thus improving its long-term solvency.
President Bush has a different answer to all of the above. In pursuit of his "ownership society," he wants to move Social Security toward "greater individual opportunity, risk, and reward" by allowing individuals to carve themselves private investment accounts out of Social Security payroll taxes, much like a 401(k) plan. This raises a whole host of problems. It discriminates against poorer workers, for one thing. Why? Because the lower your income, the less you have to invest, and the smaller your return will be. The Bush plan offers nothing close to the financial security of the existing program. Then there's this: Are individual investors sophisticated enough to match the higher returns now being forecast? At least 10 studies analyzed by the Securities and Exchange Commission indicate a disturbing level of financial illiteracy. Only 12 percent of the investors studied could distinguish between a load and a no-load mutual fund; only 14 percent understood the difference between a growth stock and an income stock; only 38 percent knew that when interest rates rise, bond prices fall; almost half somehow believed that diversification guarantees that their portfolio would not suffer if the market dropped; and 40 percent thought that the trust fund's operating costs would not be deducted from their investment return.
Experience with 401(k) retirement plans shows that many people fail to invest and to diversify sufficiently to maximize their returns. Many make mistakes at each step of the way, not because they are stupid but because they live busy, complicated lives, focusing on work and family, and lack the time to become financial experts. Many people are shrewd enough to understand this, which is why they invest in mutual funds. Those 50 percent or more who are not in the stock market presumably have even less knowledge and experience.
Furthermore, historical stock-market returns are not a guide for future performance. A lot depends on when you buy or sell, especially when America faces not only dramatic fiscal problems but a threat to profit margins in growing global competition, particularly from India and China. If someone retires after the market dives, he or she could lose a good chunk of retirement savings. The market, after all, fell by 45 percent in real terms between 1968 and 1978--never mind the bust between 2000 and 2002. Individuals would be glad to pocket gains, but if millions of retirees suffered dramatic losses, there would be enormous political pressure to come to their rescue. We would very likely end up privatizing gains and socializing the losses.
Upside down. The macroeconomic consequences of privatization of Social Security are equally significant. Privatization fails to address the long-term gap in the program's financial resources. It would make things worse because the government would have to borrow the money that otherwise would be paid into the system. This amounts to roughly $2 trillion in the first decade, over $3 trillion in the second decade, and approximately $5 trillion in each of the third and fourth decades--a run-up of about $15 trillion in the national debt, based on a Congressional Budget Office estimate widely believed to be close to the Bush plan. Privatization does not begin to save money until 2050--hardly a solution to a crisis the administration has described as imminent. Even worse, it might create a fiscal crisis, inflating future budget deficits to unprecedented levels and sending the economy into a tailspin.
Of course, the idea of an "ownership society" is to change the relationship of Americans to their government so they look less to Washington than to themselves (and, just maybe, vote more Republican). No doubt some Americans could build savings and more wealth and have a nest egg for retirement. No doubt there is value in savings and self-reliance, in making private investment decisions, planning ahead, and increasing distance from the government. But there are other values in the very title of the program--Social Security. "Social" surely implies a contract to help manage poverty among the old and to know that our society provides a minimum income for all of our fellow citizens in their retirement years. And "security" means buffering the harshness and cruelty of the markets so that the well-being of the elderly is not dependent on shrewd stock picks and hot mutual funds that enrich some but fail the very people who need Social Security benefits the most.
Privatization thus gets things upside down. Social Security was not meant to re-create the free market; it was intended to insure against the vagaries and cruelties of the market and to permit Americans to count on the promise that the next generation will take care of them in their old age.
This story appears in the January 31, 2005 print edition of U.S. News & World Report.