How Not to Save Social Security

NY Times
September 23, 2004

How Not to Save Social Security

Among the clear-cut policy differences between President Bush and Senator John Kerry is each man's take on Social Security. In his acceptance speech at the Republican convention, Mr. Bush said, "We must strengthen Social Security by allowing younger workers to save some of their taxes in a personal account." Mr. Kerry, in his acceptance speech, said, "I will not privatize Social Security."

Mr. Kerry is right, and Mr. Bush is wrong. The president's plan would do the opposite of what Mr. Bush claims. It would weaken Social Security, hurt the economy and endanger many workers' retirements by pushing them into unreasonable risks in the stock market. If Mr. Bush were a broker peddling stocks to low-income, uninsured, indebted individuals like many of the Americans who would be included in his plan, he would be violating rules that require brokers to recommend only suitable investments.

When responsible politicians talk about "fixing" Social Security, what they generally mean is finding a way to guarantee a basic level of financial security for the elderly while closing the gap that will develop over time in the system's finances if nothing is done. Social Security's trustees plan for solvency over 75 years. Currently, the program is projected to come up short in 2042, when it will be able to pay about 70 percent of the promised benefits. That's a lot of money, but the gap can be bridged over the next 38 years with a package of modest reforms, which we will discuss in a future editorial.

What Mr. Bush proposes - allowing workers to divert some of their Social Security taxes into personal investment accounts in exchange for agreeing in advance to receive a much-reduced guaranteed government benefit when they retire - would neither provide retirement security, nor take care of the solvency of the Social Security system. And it would wreak havoc with the overall federal budget.

In proposing personal accounts, Mr. Bush has promised to retain the current benefits for today's retirees and for those who are nearing retirement. So for some 40 years, workers would be making deposits into their accounts with tax money that - under the current system - would have been used to pay the benefits of those who are retired. The government would have to make up the difference, and Mr. Bush has no reasonable plan for covering this cost, which is estimated to be at least $1 trillion.

That leaves three general possibilities: immense government borrowing, draconian cuts in other programs or higher taxes. In a 1997 report by President Bill Clinton's Advisory Council on Social Security, those who favored ample mandatory personal accounts proposed a national sales tax of 1 percent and $1.2 trillion in government borrowing.

If offsetting steps were not taken immediately, the reduced cash flow in the transition period would drive the Social Security trust fund into the red about 15 years earlier than is currently projected. That, too, would require wrenching fiscal moves - borrowing, spending cuts, tax increases - to avoid default on the government's obligation to retirees.

When workers in a partly privatized system reached retirement, they would find that higher interest rates caused by huge deficits, reductions in government services or higher taxes had offset some - if not all - of the sums they had accumulated in personal accounts. And they would get smaller government benefits than they would if Social Security had been reformed in a more sensible way.

However Social Security is reformed, when younger workers retire, their benefits are likely to be smaller than the benefits promised to current retirees. But a partly privatized system would produce a cut that's likely to be bigger and an income that would be far less reliable. That's because the government benefit is cut more deeply under privatization, and how much you can actually accumulate in a personal account would depend on the stock market. Anyone who lived through the 1990's knows that investing in stocks can leave you with less than you started with.

Privatization would invite overexposure to the stock market - a risk that is not justified by the potential return. Most people who already save for retirement rely heavily on stock investments through 401(k)'s and other savings plans. Even workers who have traditional pensions are more exposed to the stock market than ever, as employers increasingly strive for outsized stock market returns to make up for inadequate contributions to their plans.

And people without pensions or enough income to save money in retirement plans generally do not belong in the stock market at all. Stock investing makes sense only after you have accumulated an emergency cash reserve, are adequately insured and have paid off consumer debt. Personal accounts within Social Security would perpetuate the wrongheaded notion that the stock market can bail everyone out. It can't. Mr. Bush does everyone a disservice by implying that it will.

The personal account idea also does nothing about another big reason that Social Security needs reforming: people are living longer. Unless the government mandates that people convert their personal accounts into private annuities, retirees are in danger of outliving their money, leaving them to survive on the meager government benefit. And they would lose the inflation protection built into government benefits, which is increasingly important the longer you live. Those most at risk of impoverishment are old women, who live three years longer than men on average and are far less likely to have private pensions.

There is a broad social argument against privatization, which is that we all lose if our fellow citizens come up short in their quest for secure retirements. By taking the financial risk out of growing old, Social Security has had remarkable results for society at large. Poverty among the elderly is now 10 percent, down from 30 percent in 1960. Like any sound insurance system, Social Security works by broadly pooling risks. It protects everyone because it includes everyone. Personal accounts move Social Security away from a comprehensive system to one in which it's increasingly every man for himself.

None of these arguments deter Mr. Bush and other advocates of personal accounts. For them, Social Security is primarily an ideological struggle. Social Security supports retirees by shifting income from the young to the old via taxes, and from the rich to the poor via the formula for calculating benefits. To Mr. Bush and his supporters, taxation and redistribution are anathema, and Social Security is an anticapitalist ploy to squelch initiative and growth. Those same arguments were leveled against Social Security when President Franklin Roosevelt established it in 1935, and when its constitutionality was upheld by the Supreme Court in 1937.