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Social Security debate (United States)

This article concerns proposals to change the Social Security system in the United States. Social Security is a social insurance program officially called "Old-Age, Survivors, and Disability Insurance" (OASDI), in reference to its three components. It is primarily funded through a dedicated payroll tax. During 2006, Social Security was the largest budgeted federal spending category, at nearly $550 billion or 21% of overall spending. In 2008, spending of $610 billion is forecast.

Reform proposals continue to circulate with some urgency, due to a long-term funding challenge faced by the program. Starting in 2017, program expenses begin to exceed revenues. This is due to the aging of the baby-boom generation (resulting in a lower ratio of paying workers to retirees), expected continuing low fertility (compared to the baby-boom period), and increasing life expectancy. Further, the government has borrowed and spent the accumulated surplus funds, called the Social Security Trust Fund. During 2007, the Fund held $2.2 trillion in government bonds—essentially "IOU's" or claims on the government's general fund or tax revenues. This amount is part of the total national debt of $9.6 trillion as of August 20, 2008. By 2017, the government is expected to have borrowed nearly $4.3 trillion against the Social Security Trust fund.By 2041, the Fund is expected to be officially exhausted, as payments in excess of receipts draw it down to zero. There are certain key implications to understand under current law, if no reforms are implemented:

  • Payroll taxes will only cover 78% of the scheduled payout amounts after 2041. This declines to 75% by 2081. Without changes to the law, Social Security would have no legal authority to draw other government funds to cover the shortfall and payments would decline.
  • Between 2017 and 2041, redemption of the Trust Fund balance to pay retirees will draw $4.3 trillion in government funds from sources other than payroll taxes. This is a funding challenge for the government overall, not just Social Security.
  • The present value of unfunded obligations under Social Security during FY 2007 is approximately $6.8 trillion. In other words, this amount would have to be set aside today such that the principal and interest would cover the shortfall over the next 75 years.

President George W. Bush called for a transition to a combination of a government funded program and personal accounts ("individual accounts" or "private accounts") through partial privatization of the system. The personal accounts could be invested in various managed investment funds similar to the government employees' Thrift Savings Plan, in which the investor can choose between Treasury Bills, Corporate bonds and a stock market fund. Since the Report of the 1994-1996 Advisory Council on Social Security, the Social Security program has been the subject of widespread debate. After President Bush highlighted the issue in his 2005 State of the Union Address, the debate became especially intense.

However, critics argued that privatizing Social Security does nothing to address the long-term funding concerns. Diverting funds to private accounts would reduce available funds to pay current retirees, requiring significant borrowing. Federal Reserve Chairman Ben Bernanke said on October 4, 2006 "Reform of our unsustainable entitlement programs should be a priority." He added, "the imperative to undertake reform earlier rather than later is great." The tax increases or benefit cuts required to maintain the system as it exists under current law are significantly higher the longer such changes are delayed. For example, raising the payroll tax rate to 14.1% during 2008 (from the current 12.4%) or cutting benefits by 11.4% would address the program's budgetary concerns indefinitely; these amounts increase to around 16% and 22% if no changes are made until 2041, when the fund is exhausted.

As of September 14, 2008, the two leading 2008 Presidential candidates have indicated preliminary views on Social Security reform. For example:

  • Barack Obama - His website indicates that he "will work with members of Congress from both parties to strengthen Social Security and prevent privatization while protecting middle class families from tax increases or benefit cuts. As part of a bipartisan plan that would be phased in over many years, he would ask those making over $250,000 to contribute a bit more to Social Security to keep it sound." He has opposed raising the retirement age, privatization, or cutting benefits.
  • John McCain - Has indicated resistance to raising taxes, but otherwise is willing to work with a bi-partisan commission to address the program's solvency issues. He has indicated that current benefit promises "cannot be kept," indicating he prefers to reduce benefits at some future date, rather than raising taxes. He supports private accounts as a supplement to Social Security.

Based on the candidates' proposals cited above, neither has forwarded a plan indicating specifically how he would address Social Security's long-term challenges. However, both have committed to addressing the problem.

Understanding the funding challenges of the current Social Security system

Social Security is funded through the Federal Insurance Contributions Act (FICA), which is a payroll tax paid equally by the employee and the employer. During 2008, social security taxes were levied on the first $102,000 of worker income; amounts earned above that are not taxed. Covered workers are eligible for retirement benefits and for disability benefits; if a covered worker dies, his or her spouse and children may receive survivors' benefits. The program does not have individual accounts and tax receipts are not invested on behalf of the worker. Instead, current receipts are used to pay current benefits (the system known as "pay-as-you-go"), as is typical of some insurance and defined-benefit plans.

In each year since 1983, tax receipts and other income have exceeded benefit payments and other expenditures, most recently (in 2007) by more than $180 billion. However, this annual "surplus" is expected to change to a deficit around 2017, when payments begin to exceed receipts. The fiscal pressures are due to demographic trends, where the number of workers paying into the program continues declining relative to those receiving benefits. The number of workers paying into the program was 6.1 per retiree in 1960; this has declined to 3.3 in 2007 and is projected to decline to 2.1 by 2040. Further, life expectancy continues to increase, meaning retirees collect benefits longer. Federal Reserve Chairman Ben Bernanke has indicated that the aging of the population is a long-term trend, rather than a proverbial "pig moving through the python.

The accumulated surpluses are invested in Treasury securities (treasuries) issued by the U.S. government, which are deposited in the Social Security Trust Fund. At the end of 2007, the Trust Fund stood at $2.2 trillion. However, since the surpluses are not invested in the private sector, but are used for other purposes within the federal budget, the Trust Fund is "empty" or has been spent. Others look to the fact that the Treasury securities in the Social Security Trust Fund are backed up by "the full faith and credit of the United States" just like the U.S. Dollar. The $2.2 trillion amount owed by the Federal Government to the Trust Fund is also a component of the U.S. National Debt, which stood at $9.4 trillion as of April 7, 2008. By 2017, the government is expected to have borrowed nearly $4.3 trillion against the Social Security Trust fund.

The present value of unfunded obligations under Social Security during FY 2007 is approximately $6.8 trillion. In other words, this amount would have to be set aside today such that the principal and interest would cover the shortfall over the next 75 years.

Because Social Security receipts currently exceed payments, the program also reduces the size of the annual federal budget deficit. For example, the budget deficit would have been $182 billion higher in 2007 (i.e., $344 billion rather than $162 billion published) if Social Security were accounted for separately from the overall budget.

Current projections

Projections were made by the Board of Trustees of the Federal Old-Age and Survivors Insurance and Federal Disability Insurance Trust Funds (OASDI) in their 68th report dated March 25, 2008. The board at the time was commissioner Michael J. Astrue, who was nominated for the position by President Bush in 2006, and acting commissioner Jason J. Fichtner, and three members of President Bush's Cabinet: Elaine Chao, Mike Leavitt and Henry Paulson. At the time of publication the two positions called "Public Trustee", or members of the public to be appointed by the president, were vacant.

According to these projections based on the system's current revenue and benefit structure, expenses will exceed tax receipts beginning in 2017. The Trust Fund is projected to continue to grow for several years thereafter because the analyses assume interest income from loans made to the US Treasury is available to cover the difference. However, the funds from loans made have been spent along with other revenues in the general funds in satisfying annual budgets. At some point, however, absent any change in the law, the Social Security Administration will finance payment of benefits through the net redemption of the assets in the Trust Fund. Because those assets consist solely of U.S. government securities, their redemption will represent a call on the federal government's general fund, which for decades has been borrowing the Trust Fund's surplus and applying it to its expenses to partially satisfy budget deficits. To finance such a projected call on the general fund, some combination of increasing taxes, cutting other government programs, selling government assets, or borrowing would be required.

The balances in the Trust Fund are projected to be depleted either by 2041 (OASDI Trustees' 2008 projection), or by 2052 (Congressional Budget Office's projection) assuming proper and continuous repayment of the outstanding Treasury Notes. At that point, under current law, the system's benefits would have to be paid from the FICA tax alone. Revenues from FICA are projected at that point to be sufficient to cover only about 73% of projected expenses if no change is made to the current tax and benefit schedules.

Framing the debate

Retirees and others who receive Social Security benefits have become an important bloc of voters in the United States. Indeed, Social Security has been called "the third rail of American politics" — meaning that any politician sparking fears about cuts in benefits by touching the program endangers his or her political career. Accordingly, advocates of major change in the system generally argue that drastic action is necessary because Social Security is facing a "crisis" — Bush described it as a "structural problem" and then, in his weekly radio address of January 15, 2005, said that Social Security "is on the road to bankruptcy" . In succeeding months, he pressed this theme even more forcefully, arguing in April that "without changes this young generation of workers will see a UFO before they see a Social Security check."

Not everyone agrees. The Center for Economic and Policy Research says that "Social Security is more financially sound today than it has been throughout most of its 69-year history" and that Bush's statement should have no credibility. Liberal economist Paul Krugman, deriding what he called "the hype about a Social Security crisis", writes:

[T]here is a long-run financing problem.

But it's a problem of modest size. The [CBO] report finds that extending the life of the trust fund into the 22nd century, with no change in benefits, would require additional revenues equal to only 0.54 percent of G.D.P. That's less than 3 percent of federal spending — less than we're currently spending in Iraq. And it's only about one-quarter of the revenue lost each year because of President Bush's tax cuts — roughly equal to the fraction of those cuts that goes to people with incomes over $500,000 a year.

Given these numbers, it's not at all hard to come up with fiscal packages that would secure the retirement program, with no major changes, for generations to come.

Other critics allege that Bush is opposed to Social Security on ideological grounds, regarding it as a form of governmental redistribution of income to the wealthy, which libertarians strongly oppose. Critics, such as Nobel Laureate economist Milton Friedman, say that Social Security redistributes wealth from the poor to the wealthy. Workers must pay 12.4%, including a 6.2% employer contribution, on their wages below the Social Security Wage Base ($102,000 in 2008), but no tax on income in excess of this amount. Therefore, high earners pay a lower percentage of their total income so some would argue this results in a regressive tax. Others would argue the tax is a flat tax. The benefit paid to each worker is also calculated using the wage base on which the tax was paid. Changing the system to tax all earnings without increasing the benefit wage base would result in the system being a progressive tax.

Furthermore, wealthier individuals generally have higher life expectancies and thus may expect to receive larger benefits for a longer period than poorer taxpayers, often minorities. A single individual who dies before age 62, who is more likely to be poor, receives no retirement benefits despite his years of paying Social Security tax. On the other hand, an individual who lives to age 100, who is more likely to be wealthy, is guaranteed payments that are more than he paid into the system.

A factor working against wealthier individuals and in favor of the poor with little other retirement income is that Social Security benefits become subject to federal income tax based on income. The portion varies with income level, 50% at $32,000 rising to 85% at $44,000 for married couples in 2008. This does not just affect those that continue to work after retirement. Unearned income withdrawn from tax deferred retirement accounts, like IRA's and 401(k)'s, counts towards taxation of benefits.

Still other critics focus on the quality of life issues associated with Social Security, claiming that while the system has provided for retiree pensions, their quality of life is much lower than it would be if the system were required to pay a fair rate of return. The party leadership on both sides of the aisle have chosen not to frame the debate in this manner, presumably because of the unpleasantness involved in arguing that current retirees would have a much higher quality of life if Social Security legislation mandated returns that were merely similar to the interest rate the U.S. government pays on its borrowings.

Proposals

Privatization

There are countries other than the U.S. that have set up individual accounts for individual workers, which allow workers leeway in decisions about the securities in which their accounts are invested, which pay workers after retirement through annuities funded by the individual accounts, and which allow the funds to be inherited by the workers' heirs. Such systems are referred to as 'privatized.' Currently, the United Kingdom, Sweden, and Chile are the most frequently cited examples of privatized systems. The experiences of these countries are being debated as part of the current Social Security controversy.

In the United States in the late 1990s, privatization found advocates who complained that U.S. workers, paying compulsory payroll taxes into Social Security, were missing out on the high rates of return of the U.S. stock market. They likened their proposed "Private Retirement Accounts" (PRAs) to the popular Individual Retirement Accounts (IRAs) and 401(k) savings plans. The sharp downturn of the stock market in 2000–2002 temporarily moved the issue of privatization to the back burner. But in the mean time, several conservative and libertarian organizations that considered it a crucial issue, such as the Heritage Foundation and Cato Institute, continued to lobby for some form of Social Security privatization.

Partial privatization

Bush has discussed the "partial privatization" of Social Security since the beginning of his presidency. But only since winning reelection in 2004, has he begun to invest his "political capital" in pursuing changes in earnest.

In May 2001, he announced establishment of a 16-member bipartisan commission "to study and report specific recommendations to preserve Social Security for seniors while building wealth for younger Americans", but this general instruction was narrowed by the specific directive that it consider only how to incorporate "individually controlled, voluntary personal retirement accounts". . The "Commission to Strengthen Social Security" (CSSS) issued a report in December 2001 (revised in March 2002), which described three alternative plans for partial privatization:

  • Plan I: Up to two percent of taxable wages could be diverted from FICA and voluntarily placed by workers into private accounts for investment in stocks, bonds, and/or mutual funds.
  • Plan II: Up to four percent of taxable wages, up to a maximum of $1000, could be diverted from FICA and voluntarily placed by workers into private accounts for investment.
  • Plan III: One percent of wages on top of FICA, and 2.5 percent diverted from FICA up to a maximum of $1000, could be voluntarily placed by workers into private accounts for investment .

In Bush's 2005 State of the Union speech, which sparked the current debate, it was Plan II of CSSS's report that he outlined as the starting point for changes in Social Security (see "Bush's proposal" section below).

Other proposals
A range of other proposals have been suggested for partial privatization, such as the 7.65% Solution. One, suggested by a number of Republican candidates during the 2000 elections, would set aside an initially small but increasing percentage of each worker's payroll tax into a 'lockbox', which the worker would be allowed to invest in securities. Another eliminated the Social Security payroll tax completely for workers born after a certain date, and allowed workers of different ages different periods of time during which they could opt to not pay the payroll tax, in exchange for a proportional delay in their receipt of payouts.

Both wholesale and partial privatization pose questions such as: 1) How much added risk will workers bear compared to the risks they face under current system? 2) What are the potential rewards? and 3) What happens at retirement to workers whose privatized risks turn out badly?

According to the AARP:

Revenue raisers

  1. Raise the cap to 90% of taxable earnings
    Approximately 43% reduction in shortfall
    • PRO:Affects only 6% of taxpayers.
      Can be phased in gradually.
      Not a new tax, restores prior policy.
    • CON:It’s a tax increase for higher earners.
  2. Increase payroll tax rate
    100% reduction in shortfall
    • PRO:A gradual increase would maintain 75-year solvency.
    • CON:Tax increase would adversely affect workers.
  3. Raise taxes on benefits
    10% reduction in shortfall
    This amounts to a reduction in the benefit to high wage earners so the pros and cons are purely subjective.
  4. Preserve tax on estates over $3.5 million
    27% reduction in shortfall
    • PRO:Improves tax progressivity, affects only 1/2 of 1% of all estates.
    • CON:Would alter the president’s tax-cutting plans.
  5. Extend coverage to newly hired state and local government employees
    10% reduction in shortfall
    • PRO:Makes Social Security universal, with all sharing obligations and benefits.
    • CON:State and local governments employees might get less retirement benefits.
  6. Invest a portion of the trust funds in indexed funds
    15-45% reduction in shortfall
    • PRO:In the most optimistic scenario, the trust would earn higher returns on its investment.
    • CON:Since the US government has a debt, this amounts to borrowing money in bonds to invest in the stock market, or margin trading.
      Cost of transition between $600 billion - $3 trillion.
      Less likeley scenarios involve lower or negative returns.

Cost trimmers

  1. Adjust the COLA
    18% reduction in shortfall
    • PRO:Saves money.
    • CON:This would set the standard of living afforded by Social Security to the level the individual could achieve at their date of initial benefit.
      The current plan allows for an increased standard of living based on productivity increases made in the US economy.
  2. Increase normal retirement age to 70
    36% reduction in shortfall
    • PRO:Links retirement more closely to life expectancy and increased worker health since program inception.
    • CON:Reduces benefits.
      Unfair to those forced to retire early but not otherwise eligible for other Social Security benefits.
  3. Index benefits to prices, not wages
    100% reduction in shortfall
    • PRO:Could eliminate shortfall.
    • CON:Reduces the growth in scheduled benefits over time.

This solution would reduce the shortfall because wages historically grow faster than prices via a process known as economic growth. Because Social Security benefits are currently indexed to wages, benefits are scheduled to grow faster than inflation, resulting in an increase in the monthly benefit check as the economy becomes more productive.

It is important to note that there is disagreement about what actually constitutes a "benefit cut". The Center for Budget and Policy Priorities considers any reduction in future promised benefits to be a "cut". However, others dispute this assertion because under any indexing strategy the purchasing power of Social Security checks would never decrease, they would just increase at varying rates.

A variant of this approach, proposed by President Bush, is called "progressive indexing". Progressive indexing would maintain benefits for the lowest wage workers while phasing out the currently larger benefits for higher-wage workers. The net result is essentially one level of benefits for all workers who earn at least $20,000 per year.

From the Congressional Research Service:

“progressive indexing,” would index initial benefits for low earners to wage growth (as under current law), index initial benefits for high earners to price growth (resulting in lower projected benefits compared to current-law promised benefits), and index benefits for middle earners to a combination of wage growth and price growth.

Pros and cons of privatization

Generally, privatization advocates believe that individuals are the best decision makers about how much risk they should undertake with their own retirement funds but do not show in any detail how individuals would have this power under as-yet-not-described privatization plans. The reality almost surely would be that individuals would be able to make choices at defined times among a limited set of investment options chosen by a government panel. This may fall very short of individuals truly being given the power of making their own decisions about how to invest their retirement money. Stabilization proponents (see 'Stabilization' section below) counter that if those risks turn out badly, a political push by the same individuals to raise state benefits will be all but inevitable, which means that the risks such individuals may be willing to take under a privatized system are not without moral hazard.

Supporters of the current system maintain that its combination of low risks and low management costs, along with its social insurance provisions, work well for what the system was designed to provide: a baseline income for citizens derived from savings. From their perspective, the major deficiency of any privatization scheme is risk. Like any private investments, PRAs could fail to produce any return, and could even suffer a reduction in principal.

Advocates of privatization have long criticized Social Security for lower returns than the returns available from other investments, and cite numbers based on historical performance. The Heritage Foundation, a conservative think tank, calculates that a 40 year old male with an income just under $60,000, will contribute $284,360 in payroll taxes to the Trust Fund over his working life, and can expect to receive $2208 per month under the current program. They claim that the same 40 year old male, investing the same $284,360 equally weighted into treasuries and high-grade corporate bonds over his working life, would own a PRA at retirement worth $904,982 and paying an annuity of up to $7372 per month, (assuming that the dollar volume of such investments would not dilute yields so that they are lower than averages from a period in which no such dilution occurred.) Furthermore, they argue that the "efficiency" of the system should be measured not by costs as a percent of assets, but by returns after expenses (e.g. a 6% return reduced by 2% expenses would be preferable to a 3% return reduced by 1% expenses). Other advocates state that because privatization would increase the wealth of social security users, it would contribute to consumer spending, which in turn would cause economic growth.

Supporters of the current system argue that the long-term trend of U.S. securities markets cannot safely be extrapolated forward, because stock prices relative to earnings are already at very high levels by historical standards. They add that an exclusive focus on long-term trends would ignore the increased risks that privatization would cause. The general upward trend has been punctuated by severe downturns. Critics of privatization point out that workers attempting to retire during any future such downturns, even if they prove to be temporary, will be placed at a severe disadvantage.

They also point out that, even conceding for sake of argument that such highly optimistic numbers are true, they fail to count what the transition will cost the country as a whole. Gay Thayer, chief economist for A.G. Edwards, has been cited in the mainstream media saying that the cost of privatizing — estimated by some at $1 trillion to $2 trillion — would worsen the federal budget deficit in the short term, and "That's not something I think the credit markets would appreciate." If, as in some plans, the interest expenditure on this debt is recaptured from the private accounts before any gains are available to the workers, then the net benefit could be small or nonexistent. And this is really a key to understanding the debate, because if, on the other hand, a system which mandated investment of all assets in U.S. Treasuries resulted in a positive net recapturing, this would illustrate that the captive nature of the system results in benefits that are lower than if it merely allowed investment in U.S. Treasuries (purported to be the safest investment on Earth, probably safer than Social Security given the general taxing powers of the federal government).

Meanwhile some investment-minded observers among those who do not support privatization, point out potential pitfalls to the Trust Fund's undiversified portfolio, containing only treasuries. Many of these support the government itself investing the Trust Fund into other securities, to help boost the system's overall soundness through diversification, in a plan similar to CalPERS in the state of California.

There are also substantive issues that do not involve economics, but rather the role of government. Conservative Nobel Prize-winning economist Gary S. Becker, currently a graduate professor at the University of Chicago, wrote in a February 15, 2005 (PDF)article that "[privatization] reduce[s] the role of government in determining retirement ages and incomes, and improve[s] government accounting of revenues and spending obligations." He compares the privatization of Social Security to the privatization of the steel industry, citing similar "excellent reasons."

Management costs of privatization
Opponents of privatization also decry the increased management costs that any privatized system will incur. In Chile and the United Kingdom, as much as 30% of savings are reportedly being absorbed by fees. Since the U.S. system is passively managed — with no specific funds being tied to specific investments within individual accounts, and with the system's surpluses being automatically invested only in treasuries — its management costs are very low.

Advocates of privatization at the Cato Institute, a libertarian think tank, counter that, "Based on existing private pension plans, it appears reasonable to assume that the costs of administering a well-run system of PRAs might be anywhere from a low of roughly 15 basis points (0.15%) to a high of roughly 50 basis points (0.5%)." They also point to the low costs of index funds (funds whose value rises or falls according to a particular financial index), including an S&P 500 index fund whose management fees run between 8 basis point (0.08%) and 10 basis points (0.10%).

A Windfall for Wall Street?
Opponents also claim that privatization will bring a windfall for Wall Street brokerages and mutual fund companies, who will rake in billions of dollars in management fees.

Austan Goolsbee at the University of Chicago has written a study, "The Fees of Private Accounts and the Impact of Social Security Privatization on Financial Managers," which calculates that, "Under Plan II of the President's Commission to Strengthen Social Security (CSSS), the net present value (NPV) of such payments would be $940 billion," and, "amounts to about one-quarter (25%) of the NPV of the revenue of the entire financial sector for the next 75 years," and concludes that, "The fees would be the largest windfall gain in American financial history." Other analysts argue that dangers of a Wall Street windfall of such magnitude are being vastly overstated. Rob Mills, vice president of the brokerage industry trade group Securities Industry Association, in a report published in December 2004, calculates that the proposed private accounts might generate $39 billion in fees, in NPV terms, over the next 75 years. This amount would represent only 1.2% of the sector's projected NPV revenues of $3.3 trillion over that timeframe. He concludes that privatization is "hardly likely to be a bonanza for Wall Street." At the same time the watchdogs at FactCheck estimate that the financial management sector will receive only 0.05% and 0.27% of its total revenues from fees on PRAs.

Nevertheless, Goolsbee's study has been deemed damaging enough at the Heritage Foundation that they have produced their own study, written by David C. John, specifically to counter Goolsbee.

Libertarian criticism
Libertarians commonly criticize Social Security's pay-as-you-go funding as being closer to an illegal Ponzi scheme — where investors are paid off out of the funds collected from more investors, instead of out of profits from business activity — than it is to a Trust Fund. William G. Shipman of the Cato Institute argues:

In common usage a trust fund is an estate of money and securities held in trust for its beneficiaries. The Social Security Trust Fund is quite different. It is an accounting of the difference between tax and benefit flows. When taxes exceed benefits, the federal government lends itself the excess in return for an interest-paying bond, an IOU that it issues to itself. The government then spends its new funds on unrelated projects such as bridge repairs, defense, or food stamps. The funds are not invested for the benefit of present or future retirees.

This criticism is not new. In his 1936 presidential campaign, Republican Alf Landon called the Trust Fund "a cruel hoax". The Republican platform that year stated, "The so-called reserve fund ... is no reserve at all, because the fund will contain nothing but the government's promise to pay." Defenders of pay-as-you-go respond that the system is a Ponzi scheme only if the United States intends to repudiate its debts. On the occasions when the Social Security Administration has needed to redeem some of those securities, they have always been honored. Although Social Security benefits to future retirees do not represent debt in the legal sense (Fleming v. Nestor, 1960), the treasuries held by the Trust Fund do. The Social Security Administration, while noting the "superficial analogy between pyramid or Ponzi schemes and pay-as-you-go insurance programs," has described the latter as "a simple pipeline" that "could be sustained forever ... [i]f the demographics of the population were stable".

Proponents argue that a privatized system would open up new funds for investment in the economy, and would produce real growth. They claim that the treasuries held in the current Trust Fund are covering consumption rather than investments, and that their value rests solely upon the continued ability of the U.S. government to impose taxes. Opponents respond that there would be no net new funds for investment, because any money diverted into private accounts would produce a dollar-for-dollar increase in the federal government's borrowing from other sources to cover its general deficit.

Analysis

The claims of the probability of future difficulty with the current Social Security system are largely based on the annual analysis made of the system and its prospects and reported by the governors of the Social Security system. While such analysis can never be 100% accurate it can at least be made using different probable future scenarios and be based on rational assumptions and reach rational conclusions, with the conclusions being no better (in terms of predicting the future) than the assumptions on which the predictions are based. Some but not all of the projections reported by the governors of the Social Security system show a possible future problem - but at least the predictions are made using a real analysis. With these predictions in hand it is possible to make at least some prediction of what the future retirement security of Americans who will rely on Social Security might be. Until analysis similar in rigor and in its assumptions about the economy are made and published for the personal account scheme there is no factual basis of any sort for an effective rational evaluation of "personal accounts." It would be extremely useful (it would seem) to see such an analysis but the proponents of "personal accounts" have not shown anything of that nature.

Stabilization

The other major sector of opinion is that privatization accomplishes nothing, that rational investors would neutralize any benefit of, effectively, selling Treasury Notes and buying equities (see Modigliani-Miller theorem) — that it places more risk on individual workers than it gives back in rewards, since they cannot effectively vote their shares, but have no more protection than any other owner of common stock — and that it does nothing to change the budget situation in the future, that if and when the trust fund runs out, there will still be the choice of raising taxes or cutting benefits, or both.

Believers in this position argue that "privatization" is a fraud, that there is no specific Social Security crisis, but instead a general budget crisis: namely that the federal government outside of Social Security is already in persistent deficit, that revenues are far too low to cover expenditures, and that absent this problem being solved, it does not matter how social security is set up.

Stabilization advocates say that the projected "deficits" in Social Security are identical to the "prescription drug benefit" enacted in 2002. They say that demographic and revenue projections might turn out to be too pessimistic — and that the current health of the economy exceeds the assumptions used by the Social Security Administration.

Stabilization advocates argue that the correct plan is to fix Medicare, which is the largest underfunded entitlement, repeal the 2001–2004 revenue reductions, balance the budget, and then, when a growth trendline emerges from these steps, alter the Social Security mix of taxes, benefits, benefit adjustments and retirement age to avoid future deficits. The age at which one begins to receive Social Security benefits has been raised several times since the program's inception.

Bush's 2001 advisory board discussed ways that the system could be adjusted to deal with the projected future deficit without privatization. For example, the income subject to Social Security taxation is capped, with the result that people with higher incomes pay a lower percentage tax than do people with lower incomes. Eliminating the cap would remove this regressive tax feature and would reduce or eliminate the projected deficit. The commission stated:

Making all earnings covered by Social Security subject to the payroll tax beginning in 2002, but retaining the current law limit for benefit computations (in effect removing the link between earnings and benefits at higher earnings levels), would eliminate the deficit. If benefits were to be paid on the additional earnings, 88 percent of the deficit would be eliminated. (Social Security Advisory Board report July 2001 (rev. ed.), p. 23)

Stabilization advocates argue that when the risks, overhead costs and borrowing costs of any "privatization" plan are taken together, the result is that such a plan has a lower expected rate of return than "pay as you go" systems. They point out the high overheads of "privatized" plans in England and Chile, and that while "risk for reward" applies to the individual, the macro picture means that for every winner, there will be losers, and the government will be responsible for preventing those losers from slipping into poverty. This will mean an increase in expenditures for anti-poverty programs for the elderly, as it has for both Chile and Argentina.

Plans such as the Diamond-Orszag plan propose stabilization of Social Security, by gradually ending the process by which the general fund has been borrowing from payroll taxes. This requires increased revenues devoted to Social Security. Their plan, as with several other Social Security stabilization plans, relies on gradually increasing the retirement age, raising the ceiling on which people must pay FICA taxes, and slowly increasing the FICA tax rate to a peak of 15% total from the current 12.4%.

Bush's proposal

On February 2, 2005, President Bush made Social Security a prominent theme of his State of the Union Address. He outlined, in general terms, a proposal based on partial privatization. After a phase-in period, workers currently less than 55 years old would have the option to set aside four percentage points of their payroll taxes in individual accounts that could be invested in the private sector, in "a conservative mix of bonds and stock funds". Workers making such a choice might receive larger or smaller benefits than if they had not done so, depending on the performance of the investments they selected.

Although Bush described the Social Security system as "headed for bankruptcy", his proposal would not affect the projected shortfall in Social Security tax receipts. Partial privatization would mean that some workers would pay less into the system's general fund and receive less back from it. Administration officials said that the proposal would have a "net neutral effect" on the system's financial situation, and that Bush would discuss with Congress how to fill the projected shortfall. The Congressional Budget Office had previously analyzed the commission's "Plan II" (the plan most similar to Bush's proposal) and had concluded that the individual accounts would have little or no overall effect on the system's solvency, and that virtually all the savings would come instead from changing the benefits formula.

As illustrated by the CBO analysis, one possible approach to the shortfall would be benefit cuts that would affect all retirees, not just those choosing the private accounts. Bush alluded to this option, mentioning some suggestions that he linked to various former Democratic officeholders. He did not endorse any specific benefit cuts himself, however. He said only, "All these ideas are on the table." He expressed his opposition to any increase in Social Security taxes. Later that month, his press secretary, Scott McClellan, ambiguously characterized raising or eliminating the cap on income subject to the tax as a tax increase that Bush would oppose.

In his speech, Bush did not address the issue of how the system would continue to provide benefits for current and near-future retirees if some of the incoming Social Security tax receipts were to be diverted into private accounts. A few days later, however, Vice President Dick Cheney stated that the plan would require borrowing $758 billion over the period 2005–2014; that estimate has been criticized as being unrealistically low. .

On April 28, 2005, Bush held a televised press conference at which he provided additional detail about the proposal he favored. For the first time, he endorsed reducing the benefits that some retirees would receive.

The current system sets the initial benefit level based on the retiree's past wages. Each past year's wage amount is brought forward to the year of retirement by being increased according to average wage growth in the interim, so that the retiree is credited with what a comparable wage would be at the time of retirement. The benefit level is based on the 35 highest years.

One mechanism that had been suggested for reducing expenses is to replace this wage indexing with price indexing. Initial benefits would be lower if the past wages were brought forward based on the changes in the consumer price index, which tends to grow more slowly than average wages. Bush endorsed a version of this approach suggested by financier Robert Pozen, called "progressive indexing", which would mix price and wage indexing in setting the initial benefit level. The "progressive" feature is that the less generous price indexing would be used in greater proportion for retirees with higher incomes. The San Francisco Chronicle gave this explanation:

Under Pozen's plan, which is likely to be significantly altered even if the concept remains in legislation, all workers who earn more than about $25,000 a year would receive some benefit cuts. For example, those who retire in 50 years while earning about $36,500 a year would see their benefits reduced by 20 percent from the benefits promised under the current plan. Those who earn $90,000 — the maximum income in 2005 for payroll taxes — and retire in 2055 would see their benefits cut 37 percent.

As under the current system, all retirees would have their initial benefit amount adjusted periodically for price inflation occurring after their retirement. Thus, the purchasing power of the monthly benefit level would be frozen, as it is now.

Substance of the dispute over Bush's proposal

Although Bush's State of the Union speech left many important aspects of his proposal unspecified, debate began on the basis of the broad outline he had given. Opponents argued that the plan would result in high transition costs, with the midline estimates to be in the vicinity of over $2 trillion over 10 years. For workers, privatization would mean smaller social security checks, with the likelihood based on historical returns of increased compensation from returns on investments. There is debate over the advisability of subjecting workers' retirement money to market risks.

Bush's proposal, according to its supporters, would compensate young future retirees for needed cuts in money spent on benefits in the future, and thus spare a "crisis" in Social Security, which would occur when it exhausts its "trust fund" surplus in 2042, according to the SSA, or 2052, according to the CBO. Each worker's benefit would be the combination of a minimum guaranteed benefit and the return on the private account. The proponents' argument is that optimistically projected high returns and ownership of the private accounts would allow lower spending on the guaranteed benefit, but possibly without any net loss of income to beneficiaries. The savings to the government would come through a mechanism called a "clawback", where profits from private account investment would be taxed, or a benefit reduction meaning that individuals whose accounts underperformed the market would receive less than current benefit schedules, although, even in this instance, the heirs of those who die early could receive increased benefits even if the accounts underperformed historical returns. Proponents of privatization argue that Social Security is headed for "bankruptcy" and therefore benefits are on a path to be reduced anyway when the "trust fund" is expended. Finally, they argue that private accounts have the added benefit of being politically and morally more difficult to take away than mere transfer payments, if the overburdened labor force of the future exerts political pressure for relief.

Opponents, citing the CBO analysis, argue that the upfront borrowing costs mean that this plan would not produce a lower total deficit in the Social Security fund against current law until around 2030. The expected savings projected do not include interest on this debt nor the benefit of paying back the debt in cheaper (inflated) dollars, nor is the expected borrowing figured into their GDP and productivity assumptions in the model. Opponents also dispute the economic projections used, pointing out that they require low economic growth, and still have high stock market returns, which would require that stock price/earnings ratios reach historically unsustainable levels of 70, or corporate earnings/revenue ratios to triple over the course of the next 70 years. Neither of these events has happened in the course of modern economic history, and therefore, they argue, the projections that are used to support the plausibility of the privatization plans are contradictory. The proponents have so far not produced or published any analysis of the proposed plan nor a description of it adequate for anyone to make an analysis.

Politics of the dispute over Bush's proposal

The political heat has been turned up on the issue ever since Bush mentioned changing Social Security during the 2004 elections, and since he made it clear in his nationally televised January speech that he intends to work to partially privatize the system during his second term.

  • To assist the effort Republican donors were asked after the election to help raise $50 million or more for a campaign in support of the proposal, with contributions expected from such sources as the conservative Club for Growth and the securities industry. (In 1983, a Cato Institute paper had noted that privatization would require "mobilizing the various coalitions that stand to benefit from the change, ... the business community, and financial institutions in particular ..."

Soon after Bush's State of the Union speech, the Club for Growth began running television advertisements in the districts of Republican members of Congress whom it identified as undecided on the issue.

  • On January 16, 2005, the New York Times reported internal Social Security Administration documents directing employees to disseminate the message that "Social Security's long-term financing problems are serious and need to be addressed soon," and to "insert solvency messages in all Social Security publications".

Coming soon after the disclosure of government payments to commentator Armstrong Williams to promote the No Child Left Behind Act, the revelation prompted the objection from Dana C. Duggins, a vice president of the Social Security Council of the American Federation of Government Employees, that "Trust fund dollars should not be used to promote a political agenda."

In the weeks following his State of the Union speech, Bush devoted considerable time and energy to campaigning for privatization. He held "town meetings" at many locations around the country. Attendance at these meetings was controlled to ensure that the crowds would be supportive of Bush's plan. In Denver, for example, three people who had obtained tickets through Representative Bob Beauprez, a Republican, were nevertheless ejected from the meeting before Bush appeared, because they had arrived at the event in a car with a bumper sticker reading "No More Blood for Oil".

  • Opponents of Bush's plan have analogized his dire predictions about Social Security to similar statements that he made to muster support for the 2003 Invasion of Iraq; see, for example, this advertisement(80k external PDF file).
  • A dispute between the AARP and a conservative group for older Americans, USA Next, cropped up around the time of the State of the Union speech. The AARP had supported Bush's plan for major changes in Medicare in 2003, but it opposed his Social Security privatization initiative. In January 2005, before the State of the Union Address, the AARP ran advertisements attacking the idea. In response, USA Next launched a campaign against AARP. Charlie Jarvis of USA Next stated: "They [AARP] are the boulder in the middle of the highway to personal savings accounts. We will be the dynamite that removes them."

The tone of the debate between these two interest groups is merely one example among many of the tone of many of the debates, discussions, columns, advertisements, articles, letters, and white papers that Bush's proposal, to touch the "third rail," has sparked among politicians, pundits, thinktankers, and taxpayers.

Some of the critics of Bush's plan argued that its real purpose was not to save the current Social Security system, but to lay the groundwork for dismantling it. They note that, in 2000, when Bush was asked about a possible transition to a fully privatized system, he replied: "It's going to take a while to transition to a system where personal savings accounts are the predominant part of the investment vehicle. ... This is a step toward a completely different world, and an important step." His comment is consonant with the Cato Institute's reference in 1983 to a "Leninist strategy" for "guerrilla warfare against both the current Social Security system and the coalition that supports it."

Immediately after Bush's State of the Union speech, a national poll brought some good news for each side of the controversy. Only 17% of the respondents thought the Social Security system was "in a state of crisis", but 55% thought it had "major problems". The general idea of allowing private investments was favored by 40% and opposed by 55%. Specific proposals that received more support than opposition (in each case by about a two-to-one ratio) were "Limiting benefits for wealthy retirees" and "Requiring higher income workers to pay Social Security taxes on ALL of their wages". The poll was conducted by USA Today, CNN, and the Gallup Organization.

Bush's April press conference, in which for the first time he expressly endorsed benefit reductions, sparked disagreement about where the burden would fall. Bush referred to "people who are better off". Many media summaries accepted the characterization that "wealthy" retirees would be affected, and that benefits for lower-income people would grow. Opponents countered that middle-class retirees would also experience cuts, and that those below the poverty line would receive only what they are entitled to under current law. Democrats also expressed concern that a Social Security system that primarily benefited the poor would have less widespread political support. Finally, the issue of private accounts continued to be a divisive one. Many legislators remained opposed or dubious, while Bush, in his press conference, said he felt strongly about the point.

It has been suggested that "even without broad Congressional or public support, President Bush just may... enact his private accounts idea... [b]y executive order" as he did with his faith based initiative, parts of the war on terror, and relaxation of business regulations.

Despite Bush's emphasis on the issue, many Republicans in Congress were not enthusiastic about his proposal. In late May 2005, House Majority Whip Roy Blunt listed the "priority legislation" to be acted on after Memorial Day; Social Security was not included. In September, some Congressional Republicans pointed to the budgetary problems caused by Hurricane Katrina as a further obstacle to acting on the Bush proposal. Congress did not enact any major changes to Social Security in 2005, or before its pre-election adjournment in 2006.

During the campaigning for the 2006 midterm election, Bush stated that reviving his proposal for privatizing Social Security would be one of his top two priorities for his last two years in office. In 2007, he continued to pursue that goal by nominating Andrew Biggs, a privatization advocate and former researcher for the Cato Institute, to be deputy commissioner of the Social Security Administration. When the Senate did not confirm Biggs, Bush made a recess appointment, enabling Biggs to hold the post without Senate confirmation until December 2008.

Notes

  1. Bernanke: Baby Boomers Will Strain U.S.. Retrieved on 2006-10-03..
  2. Federal Insurance Contributions Act. Retrieved on 2005-12-03..
  3. OASDI Trust Funds. Retrieved on 2005-12-03..
  4. OASDI Trust Funds (See above). Retrieved on 2005-12-03..
  5. http://www.ssa.gov/OACT/TR/TR04/II_project.html#wp105724. Retrieved on 2005-12-03..
  6. http://www.ssa.gov/OACT/TR/TR04/II_project.html#wp105724 (See above). Retrieved on 2005-12-03..
  7. http://money.cnn.com/2005/01/11/news/economy/bush_interview.reut/. Retrieved on 2005-12-03..
  8. Guardian Unlimited: World Latest: None. Retrieved on 2005-12-03..
  9. http://www.fortwayne.com/mld/beaconjournal/11411337.htm?template=contentModules/printstory.jsp. Retrieved on 2005-12-03..
  10. Basic Facts on Social Security and Proposed Benefit Cuts/Privatization, by Dean Baker and David Rosnick, March 2005. Retrieved on 2008-04-14..
  11. "Inventing a Crisis". Retrieved on 2005-12-03..
  12. Social Security, George W. Bush — And the "L" Word (No, Not Liberalism). Retrieved on 2005-12-03..
  13. The Heritage Foundation: Policy Research and Analysis. Retrieved on 2005-12-03..
  14. President's Commission to Strengthen Social Security. Retrieved on 2005-12-03..
  15. Strengthening Social Security and Creating Personal Wealth for All Americans. Retrieved on 2005-12-03..
  16. The Heritage Foundation — Personal Retirement Account Calculator. Retrieved on 2005-12-03..
  17. Wall Street steers clear of Social Security debate — Martin Wolk: Eye on the Economy — MSNBC.com. Retrieved on 2005-12-03..
  18. February 15, 2005 (PDF). Retrieved on 2005-12-03..
  19. Administration Costs and the Relative Efficiency of Public and Private Social Security Systems. Retrieved on 2005-12-03..
  20. Index Fund "Price War" Shows Low Costs of Investing (Commentary). Retrieved on 2005-12-03..
  21. ssfinal.doc. Retrieved on 2005-12-03..
  22. Wall Street steers clear of Social Security debate — Martin Wolk: Eye on the Economy — MSNBC.com (See above). Retrieved on 2005-12-03..
  23. False Attacks Over "Windfalls" to Wall Street. Retrieved on 2005-12-03..
  24. http://www.heritage.org/Research/SocialSecurity/wm573.cfm. Retrieved on 2005-12-03..
  25. Why is Social Security often called a Ponzi scheme?. Cato Institute. Retrieved on 2007-10-23..
  26. Retiring with Dignity: Social Security vs. Private Markets. Retrieved on 2005-12-03..
  27. http://www.nytimes.com/2005/01/16/magazine/16SOCIAL.html. Retrieved on 2005-12-03..
  28. Is Social Security a Ponzi scheme?. Retrieved on 2005-12-03..
  29. Kinsley, Michael Social Security: From Ponzi Scheme to Shell Game. Slate.com. Retrieved on 2007-10-23..
  30. "Social Security Trust Fund". Retrieved on 2005-12-03..
  31. Social Security Advisory Board report. Retrieved on 2005-12-03..
  32. STATE OF THE UNION / Bush honors Iraq sacrifices, vows Social Security overhaul / ANALYSIS: President skirts talk of benefit cuts, tax increases. Retrieved on 2005-12-03..
  33. Long-Term Analysis of Plan 2 of the President's Commission to Strengthen Social Security. Retrieved on 2005-12-03..
  34. Press Gaggle with Scott McClellan. Retrieved on 2005-12-03..
  35. Talking Points Memo: by Joshua Micah Marshall: February 6, 2005 - February 12, 2005 Archives. Retrieved on 2005-12-03..
  36. Republicans broaden strategies for overhauling Social Security. Retrieved on 2005-12-03..
  37. AlterNet: Lynching Social Security. Retrieved on 2005-12-03..
  38. Privatization of Social Security. Retrieved on 2005-12-03..
  39. The Club For Growth — The Club for Growth Blog: Our New TV Ad and Press Release. Retrieved on 2005-12-03..
  40. http://www.nytimes.com/2005/01/16/politics/16benefit.html?oref=login&hp&ex=1105851600&en=8adcb7ce5d74cac7&ei=5094&partner=homepage. Retrieved on 2005-12-03..
  41. Gazette.com. Retrieved on 2005-12-03..
  42. http://cdn.moveon.org/content/pdfs/SocialSecurity_WMD.pdf. Retrieved on 2005-12-03..
  43. http://www.latimes.com/news/politics/la-na-outlook28feb28%2C0%2C2366341.column?coll=la-home-utilities. Retrieved on 2005-12-03..
  44. Blocking Move. Retrieved on 2005-12-03..
  45. Privatization of Social Security (See above). Retrieved on 2005-12-03..
  46. http://www.usatoday.com/news/polls/tables/live/2005-02-07-poll-results.htm#socsec. Retrieved on 2005-12-03..
  47. Press Conference of the President. Retrieved on 2005-12-03..
  48. TV media echoed Bush spin on Social Security be ... [Media Matters]. Retrieved on 2005-12-03..
  49. An Analysis of Using "Progressive Price Indexing" To Set Social Security Benefits, 5/2/05. Retrieved on 2005-12-03..
  50. Republicans broaden strategies for overhauling Social Security (See above). Retrieved on 2005-12-03..
  51. CNN.com — The ace up his sleeve — March 29, 2005. Retrieved on 2005-12-03..
  52. Social Security in limbo. Retrieved on 2005-12-03..
  53. FT.com / In depth / Hurricane impact — Hurricane dims Bush's hopes on Social Security. Retrieved on 2005-12-03..
  54. Bush Plans to Revive Social Security Proposal With New Congress. Retrieved on 2006-10-24..

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