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Can social security be fixed? - continued

The Social Security board of trustees, however, is required by law to try to predict the future - to guess birth and death and retirement rates, the growth of the economy, the costs of inflation and interest rate hikes - for the next 75 years. Using moderate economic assumptions, the trustees have concluded that somewhere around the year 2012, the Social Security trust fund will start to pay out more than it takes in. And somewhere around 2030, the trustees say, the fund will exhaust its reserves and run into the red - with a sizable chunk of the baby boom generation still expecting benefits.

The problem gets more serious when one considers Medicare and Medicaid. Modern medicine is expensive. The costs of keeping the baby boom generation alive and on Rollerblades through the first few decades of the new century will be huge. And, unlike Social Security, there is no surplus of Medicare and Medicaid funds to serve as a budgetary cushion. Without major changes, Medicare and Medicaid spending will continue to exacerbate the federal budget crunch and be larger than Social Security spending sometime in the next 10 years, according to a March report by the Congressional Budget Office.

Why the air of crisis now, when the showdown won't arrive for 10, 20, or even 40 years? Because of the compounding nature of these problems, the United States needs to act quickly. A 2 percent change now, reverberating over 75 years, cures a multitude of fiscal ills. But the cost of a ``fix'' rises with each passing month. ``If policymakers delayed action ... for five years, the cost of resolving those problems would increase by about 15 percent,'' the budget office warned. ``If action was delayed for 20 years, the total costs would shoot up by about 60 percent.''

To fund all these so-called entitlement programs at their current rates of growth would require either politically unpalatable tax rates (a doubling of the FICA payroll tax, to 28 percent, plus increased state and federal income taxes) or the largest budget deficits in US history, the budget office warned. Few in Washington think that either approach is politically feasible.

``You can't maintain the current burden of Social Security and Medicare - it's too great,'' says Barry Bosworth, a senior fellow at the Brookings Institution. But neither is there much appetite for the politically unpalatable alternative: massive cuts in benefits.

And so the search is on for a new source of easy money. Washington has turned its eyes to Wall Street - and privatization.

In theory, the notion of privatization is seductive. Because of the aforementioned demographic pressures, and the fact that Social Security's trust funds are invested in secure but low-paying US Treasury bonds, an average member of the baby boom earning $40,000 a year will reap a mere 2 percent return on his or her contributions to the system. Why not invest that same person's money in the stock market, which historically has paid investors a 7 to 10 percent return?

State Street's Shipman's calculations show that a low-income worker - that is, with an income of $13,000 - who was born in 1970 and retires at the age of 67 can look forward to a Social Security benefit of $770 a month. But if that same worker's money reaped a 10 percent return in the stock market, he or she would get $2,400 a month after retiring. A high-income worker - with an income of $65,400 - born in 1953 can expect a Social Security payment of $1,705 a month, but would collect $9,161 a month from investing in the stock market.

Aside from patching the budget, privatization would improve the nation's sickly savings rate, freeing funds for business investment and boosting productivity. Families would have a proprietary interest in a retirement account that they owned and could pass on to their heirs, and they would pay more attention to their finances in general.

There are dozens of privatization theories, from minor fixes to full-scale dismantling of the Social Security system. One of the three warring camps in this year's presidential advisory council concluded that the federal government should simply invest a share of the Social Security trust fund in the stock and bond markets, instead of keeping all the money in low-yield government securities. A second group urged a cut in benefits, hikes in the FICA tax, and the creation of regulated compulsory savings accounts. And a third, free-market faction wants to split Social Security in two: using half of the FICA tax to pay a reduced flat monthly benefit, and giving the rest back to workers who would choose their own investments.

The American Enterprise Institute's Weaver, for example, joined four market-oriented colleagues on the council in calling for the phased-in, two-tiered Social Security system built around ``personal security accounts'' for the baby boom and successive generations. Under her plan, payroll taxes would be hiked from 12.4 percent to 14 percent, with two-thirds of the money going to: (a) maintain existing benefits for anyone currently over the age of 55 and (b) finance a reduced, basic Social Security benefit for younger workers.

The remaining third of the payroll tax would be returned in the form of rebates to those under the age of 55 for investment in a personal security account, or PSA. They would own that money, choose a financial institution in which to save it, decide how to invest it, but not be free to withdraw it - as a lump sum or annuity - until the age of 62. Any remaining balance at the time of their death could be left to a spouse or to children.

Weaver assumes that a worker would invest half of the money in a PSA in stocks, with a 7 percent yield, and half in bonds, with a 2.3 percent yield, and pay 1 percent in brokerage and administrative fees. An average couple born in 1964 would earn a rate of return of 1.64 percent under the current Social Security system, Weaver calculates, but 2.08 percent under her two-tiered PSA plan.

A publicly financed system, the privatizers say, simply cannot maintain political support. It would take a payroll hike of about 2.1 percent to close the presumed gap in the 75-year actuarial forecast by which the Social Security trustees are bound to operate. While that's not much in economic terms (after all, even Weaver would raise taxes by 1.6 percent during a transition to her two-tier plan), it is enough of a hike to push the rate of return toward zero for many younger recipients - the Generation X'ers and thebaby boom's boomlet. For these young voters, Social Security would seem more and more like just another welfare plan, instead of the contributory pension plan with high returns that their grandparents loved.

``Payroll tax increases would raise the lifetime tax burden for younger workers much more than for older workers and, thereby, greatly exacerbate the problem of inter-generational inequity and further erode support for Social Security by younger workers,'' wrote the centrist Committee for Economic Development, a corporate think tank, in a report this year called ``Fixing Social Security.'' According to the Social Security system's own actuaries, high-earning single men born in the 1960s are already losing money on the program and will stand to lose more if payroll taxes are raised or benefits cut.

Under such circumstances, says Weaver, a partial privatization plan might actually rescue Social Security by building political support among younger participants, who will reap the most benefits from the PSAs. ``Surely,'' she says, ``workers would be more willing to pay a tax if they owned the benefit, rather than subsidizing somebody else's benefit.''

If Social Security is no longer a good deal, why should we keep it? The opponents of privatization come armed with an arsenal of arguments.

Liberal critics, writing in magazines such as Mother Jones and The Nation, for example, have focused their fire on the hundreds of thousands of dollars for privatization studies contributed by State Street and other business interests to think tanks like the libertarian Cato Institute or the moderate ``new Democrats'' at the Progressive Policy Institute. Such critics charge that State Street and other financial institutions are biased toward privatization by the lure of the millions of dollars of brokerage fees and commissions to be reaped from a hundred million new savings accounts.

Social Security, on the other hand, is a bargain: a simple, smoothly run program with only 1 percent administrative costs. The administrative and brokerage costs of 401(k) plans can be twice that and higher still for actively traded stock accounts. ``If we were to move toward a privatized system, which I think is going to happen, I think that State Street would benefit from it, and I certainly hope that it would,'' acknowledges State Street's Shipman. ``So would all our competition.

``But, more important than that, substantially more important,'' he says, ``is that the economy as a whole would benefit. And from my own personal point of view ... the individuals who benefit the most are low-income people. They are the ones that really get the benefit. And that is part of what drives me on this.''

Other skeptics have zeroed in on the actuarial assumptions that the privatization forces use. In a paper this year for The Twentieth Century Fund, a liberal think tank, economist Dean Baker argues that the privatizers try to have it two ways. When it comes to describing the Social Security crisis, the privatizers choose to use the miserly estimates of economic growth favored by the cautious Social Security trustees. But when hailing the advantages of the financial markets, privatization studies select the rosiest historic stock market trends.

``If the (optimistic) projections for the stock market turn out to be right, the economy will have to grow much more rapidly than the trustees predict,'' Baker says. ``In this case, there would be no reason to change Social Security at all, because payroll tax receipts would be sufficient to finance benefits.

``On the other hand,'' Baker argues, ``if the (pessimistic) projections for the economy turn out to be right, the ... forecasts for the stock market are vastly overstated. In this case, diverting Social Security funds into stocks might leave most retirees worse off.''

Though Wall Street has yielded a 7 percent return over the long span of the 20th century, and 14 percent over the last 15 years, there have also been a few dismal stretches. The ravages of the Depression and the great crash of 1929 may be fading from popular memory, but what about those investors who put money in the market in the 15 years between 1966 and 1982, when net growth was zero? asks Gary Burtless, a senior fellow at the Brookings Institution.

Even the corporate-funded Committee for Economic Development study warns: ``Of course, it is not likely that everyone would receive higher returns on their contributions; higher returns come with higher risk, and there will be losers as well as winners.''

Burtless says the losers will fall into two groups under privatization: low-income workers who don't have the funds to pay for a financial consultant, nor the time or talent or luck to play the market shrewdly on their own, and those retirees whose bad fortune it is to retire at the end of a long bear market.

``Not all workers have the fiscal planning to make these investments wisely, nor the resources to accept the risk,'' says Burtless. ``Some are going to enter retirement knowing their investment plan has not done as well as others.'' Will future Congresses have the fortitude to turn away a generation of retirees whose investments have soured? Is it not more likely that the losers will ask, and get, a federal bailout?

``The political wars of the future,'' Burtless says, ``would be over people who had unfortunate investment experiences - whole generations of people like those who invested in the stock market between 1968 and 1982 and had negative experiences.'' Nor, says Burtless, would the creation of personal security accounts necessarily boost the national savings rate. Families may simply meet their legal mandate that they invest in a PSA by not saving as much money in their current 401(k) or other savings plans. Though the financial markets would benefit from the infusion of new funds, there is also a risk that a huge tide of new pension money could create an inflationary ``bubble.''

Social Security's defenders, meanwhile, have come up with a wide range of ``fixes'' to keep the current system solvent.

Acommission headed by Bush administration economist Michael Boskin, for example, has concluded that the consumer price index - the official gauge by which the government tracks the cost of living - overstates inflation by 1.1 percent. That simple correction would cut cost-of-living adjustments enough to cure three-fourths of Social Security's problems - without meddling with its form or charter.

The retirement age for the baby boom could be further extended to 69, or the formula by which benefits are paid could be recomputed, to reflect today's longer life expectancy and years in the work force. The government could tax, like ordinary income, any Social Security benefits that exceed what a worker has paid into the system. State and local public employees could be moved into the system, thus extending coverage to 100 percent of Americans and tapping a new group of high-income contributors. The cap on income subject to the payroll tax could be lifted from $62,700 a year to $100,000 a year. The Social Security payroll tax could be hiked by 1 percent, and income taxes reduced, on the theory that as America ages there will be proportionately fewer taxes needed for Head Start, elementary and secondary education, and other government programs that benefit children.

All of these solutions require sacrifice. But even if privatization brings about significant hikes in the long-term rates of returns, Burtless says, in the near term there will be multi-billion-dollar transition costs as Americans try to cover both the current commitments of the pay-as-you-go system while simultaneously setting aside the new ``privatized'' funds for younger workers. There is no magic way to escape the cost of paying for the baby boom's retirement - and that is why the argument about Social Security is at heart a matter of politics, not economics.

``From an economist's point of view, privatization is not needed. The same exact advantages can be obtained by public funding,'' Burtless argues. ``So, whatever we do, it is a political decision, not an economic decision. There's no pixie dust that comes from privatization.''

``People who favor privatization don't trust the government,'' says Burtless. ``And people who oppose privatization don't trust the privatizers to protect the low- or middle-income Americans who rely on Social Security.''

And so the great American question has been posed once again: Are we a nation dedicated to ``life, liberty, and the pursuit of happiness'' - or a people on a mission to ``promote the general welfare''? Are we cowboys riding the range - or settlers banding together in a wagon train? Lonely inventors tinkering in a workshop - or farmers helping a neighbor raise a barn?

Liberty or equality? There is no easy answer. The genius of the founders is that they left each succeeding generation the task of choosing the best mix of values for its time. The legacy of the New Deal may be bureaucratic, but even President Franklin D. Roosevelt defined his reign as an era of ``bold, persistent experimentation.'' And so the crisis over Social Security provides us an opportunity - either to restate an old and fruitful contract we have struck with one another or to seize the challenge of innovation.

President Clinton's aborted attempt to bring national health insurance to the country, and Newt Gingrich's unsuccessful attempt to cut the costs of federal entitlement programs, do offer one lesson. Despite the increased costs that will accrue if we take our time reaching consensus on this issue, it's probably still best that we jump from the cliff holding hands.

As John F. Kennedy often said, quoting Thomas Jefferson: ``Great innovations should not be forced on slender majorities.''