Social Security: Let's Not Trade It In For A Lemon

Once the debate on balancing the budget finally ends, America faces another great fiscal issue: how to stabilize Social Security. The hysteria about looming bankruptcy is exaggerated, but even defenders of the present system admit that Social Security is not in long-term balance. Early in the next century, we will need to raise the retirement age, pare benefits, or raise taxes. This is simply the result of shifting demographics--people living longer and a declining ratio of workers to retirees.

A more radical change would divert some of the income stream from the payroll tax to create privatized annuities. To make up the loss, Social Security pensions would be more heavily taxed or capped. Senators Bob Kerrey (D-Neb.) and Alan K. Simpson (R-Wyo.), for example, would take two percentage points of the current payroll tax to create super individual retirement accounts.

A more sweeping revision is being promoted by Sam Beard, author of a forthcoming book titled 100 Million Millionaires. Beard's idea is to use four percentage points of the Social Security tax to finance private retirement accounts. The proceeds would underwrite retirement and could be passed along to heirs. He calculates that after 45 years, every individual with $10,000 or more annual income would accumulate at least $1 million in savings (or $182,000 in today's dollars). Eventually, thanks to compounding, a fully funded retirement system would replace the present one and create a society of secure rentiers.

PINOCHET'S CRAPSHOOT. There are problems with this scheme, however. Obviously, it diverts money from the Social Security system earmarked to finance pensions for current and future retirees. Beard proposes to make up that shortfall by raising the retirement age to 70, reducing the inflation adjustment of Social Security pensions, and increasing federal borrowing during the 30- to 40-year period in which the new system matures.

Beard's proposed system is also highly redistributive (just as the current Social Security program is), since it uses the taxes paid by more affluent workers partially to subsidize the retirement accounts of less affluent ones. The risk is that Beard's proposal would become a stalking horse for the dismantling of Social Security as a universal system.

Enthusiasts of this approach often invoke the experience of Chile, where the Augusto Pinochet regime and its University of Chicago-trained economist-advisers privatized the public retirement system. Today, Chilean workers pay taxes into one of several private retirement plans. Supposedly, the government will make up the difference if retirement benefits do not equal at least 75% of the subsistence level. The funds are currently doing well, but genius is a rising market. One or more of the funds could tank. Stocks fall as well as rise--remember the U.S. in the 1970s? When the first retiree begins claiming benefits in 2005, the "privatized" Chilean system could face a public bailout crisis--or simply shortchange retirees.

Still, there is the germ of an important idea here. The current Social Security system is almost pure income transfer. Taxes from today's workers pay the pensions of today's retirees. Unlike a funded pension plan or annuity, most of the payouts are not a return on capital. The current capital surplus in the Social Security system generates income that finances a small fraction of total payouts.

PIES IN THE SKY. Turning Social Security into a funded pool of capital would raise the national savings rate and restore the system to solvency. However, this approach poses highly charged policy choices. Do we retain a collective system or do we splinter it into individual accounts? And if money is to be diverted from current payroll taxes, who makes up the loss?

In principle, there is a left-right grand bargain to be had. The left gets Social Security solvency but allows partial privatization. The right concedes the need for a universal, state-mandated system but gains one with privately invested capital.

Beard's plan is reminiscent of populist schemes for spreading the wealth, most of which in practice were captured by the usual suspects: The populist crusade of the 1890s for an elastic currency turned into the safely conservative Federal Reserve System. Louis O. Kelso's plan to turn every worker into a capitalist spawned Louisiana Senator Russell B. Long's employee stock ownership plans--most of which are used by ordinary corporations as a cheap way of raising capital. The one share-the-wealth scheme that actually worked as advertised is none other than...Social Security. Before we cash it in, we should be sure what we are getting in return.