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Social Security Q&A: Separating
Fact from Fiction BY DOUG ORR
This article is from the May/June 2005 issue of Dollars and
Sense: The Magazine of Economic Justice, formerly available
at http://www.dollarsandsense.org/archives/2005/0505orr.html
Parts of this article are outdated, but it provides important
explanations of the SS system and financing, as well asdisposing
of secveral myths. JZ
The president just completed his 60-day, 35-state tour to
spread fear over the financial solvency of the Social Security
system and promote his plan to allow workers to divert nearly
a third of the 12.4% Social Security payroll
tax into private investment accounts.
At a stump speech in West Virginia in early April, Bush pointed
to a filing cabinet stuffed with paper representing government
IOUs and said, "A lot of people in America think there is
a trust--that we take your money in payroll taxes and then we
hold it for you and then when you retire, we give it back to you.
But that's not the way it works. There is no trust ‘fund'--just
IOUs.…" On April 28, Bush proposed indexing high-income
workers' benefits to inflation, a move he described as "progressive."
If these and other administration statements about Social
Security leave you scratching your head, you're not alone.
With all the fear-mongering falsehoods flying around, it
can be difficult to separate fact from fiction. Below, Doug Orr
helps D&S readers do just this, with clear, at times surprising,
answers to many common Social Security-related
questions. Congress is expected to vote on Social Security
"reform" in June. --Eds.
Has the president actually lied to the public about Social
Security?
Yes. President Bush has repeatedly said that those who put their
money in private accounts are "guaranteed" a better
return than they'll receive from the current Social Security
system. But every sale of stock on the stock market includes the
disclaimer: "the return on this investment is not guaranteed
and may be negative"--for good reason. During the 20th century,
there were several periods lasting more than 10 years where the
return on stocks was negative. After the Dow Jones stock index
went down by over 75% between 1929 and 1933, the Dow did not return
to its 1929 level until 1953. In claiming that the rate of return
on a stock investment is guaranteed to be greater than the return
on any other asset, Bush is lying. If an investment-firm broker
made this claim to his clients, he would be arrested and charged
with stock fraud. Michael Milken went to jail for several years
for making just this type of promise about financial investments.
In fact, under the most likely version of the Bush privatization
proposal, a 20-year old worker joining the labor force today would
see her guaranteed Social Security benefits reduced
by 46%. Bush's own Social Security commission
admitted that private accounts are unlikely to make up for this
drop in guaranteed benefits. The brokerage firm Goldman Sachs
estimates that even with private accounts, retirement income of
younger workers would be reduced by 42% compared to what they
would receive if no changes are made to Social Security.
President Bush also misrepresents the truth when he claims that
Social Security trustees say the system will
be "bankrupt" in 2042. Bankruptcy is defined as "the
inability to pay ones debts" or, when applied to a business,
"shutting down as a result of insolvency." Nothing the
trustees have said or published indicates that Social Security
will fold as a result of insolvency.
Until 1984, the trust fund was "pay-as-you-go," meaning
current benefits were paid using current tax revenues. In 1984,
Congress raised payroll taxes to prepare for the retirement of
the baby boom generation. As a result, the Social Security
trust fund, which holds government bonds as assets, has been growing.
When the baby boomers retire, these bonds will be sold to help
pay their retirement benefits.
If the trust fund went to zero, Social Security would
simply revert to pay-as-you-go. It would continue to pay benefits
using (then-current) tax revenues, and in doing so, it would be
able to cover about 70% of promised benefit levels. According
to analysis by the Center for Economic and Policy Research, a
70% benefit level then would actually be higher than 2005 benefit
levels in constant dollars (because of wage adjustments). In other
words, retirees would be taking home more in real terms than today's
retirees do. The system won't be bankrupt in any sense. On this
point, President Bush is "consciously misrepresenting the
truth with the intent to deceive." That is what the dictionary
defines as lying.
Is it true that the trust fund is just a bunch of government
IOUs and therefore worthless?
The trust fund does just contain IOUs, but they're not worthless.
If they are, someone should tell that to the very smart and very
rich people who bought $475 billion in government bonds last year
to finance the deficits President Bush and Congress created, and
to the central banks of Japan, China, and many other countries
that hold a large share of their assets in U.S. government bonds.
When the trust fund was created in 1935, the law stipulated that
any excess revenues coming into the Social Security
system must be used to purchase federal government bonds. (At
the time, the stock market had just lost over 75% of its value
and was understood to be unsafe.) Federal bonds are absolutely
safe; the government of the United States has never defaulted
on any bond obligation. President Bush appears to be ready to
break this tradition.
If the president wants the Treasury to "selectively default"
on the bonds in the Social Security trust fund,
it means he feels the United States doesn't have to meet its obligation
to the working people of America the way it meets its obligations
to ultra-wealthy bondholders. His suggestion that the U.S. government
might not be willing to repay its debt obligations is remarkable.
What will happen when the assets held in the trust fund
are needed to help pay for benefits?
The trust will start selling the bonds. Currently it has to sell
them back to the Treasury, although the law could easily be changed
to allow sales to the same people, institutions, and governments
who were buying U.S. bonds this past year. But let's assume the
government has to buy them back.
If the government were running a surplus, as it did for the last
four years of the Clinton administration, it would use that surplus
to pay for them. If, on the other hand, the government were running
a balanced budget but not a surplus, it would need to issue new
Treasury bonds to pay for the bonds it would buy from the trust
fund. In finance, this is called "rolling over" debt,
and every major corporation in the world does it every day. At
no point would the government need to roll over more than $300
billion in any given year to pay for the trust fund bonds. We
already know the federal government can easily sell $475 billion
per year in bonds, because it did that last year and interest
rates did not even go up--in fact, they remained relatively low.
So there's no problem, right?
Actually, there is one thing that could cause a problem: the
government running a massive deficit, as it now does. In that
case, selling more bonds could put a very real strain the financial
system's ability to absorb the creation of this new debt.
This is the issue that Federal Reserve chairman Alan Greenspan
has been trying to raise for the past three years. Unfortunately,
Greenspan speaks in financial jargon, so it's hard for the general
public to understand what he's trying to say.
Even if the Social Security system isn't going to go
bankrupt by 2029, 2042, or 2058, won't the Social Security
trust fund begin cashing in the IOUs from the federal government
as early as 2018?
The contributions to Social Security will become
less than the benefits paid out in 2018, based on the trustees'
overly pessimistic assumptions. (See "Social Security Isn't
Broken" and "The SSA's Cracked Crystal Ball," D&S
November/December 2004, at <www.dollarsandsense.org>.)
But that doesn't mean that the Social Security
Administration will need to start selling bonds at that point.
The interest income from the existing bonds will be sufficient
to make up the difference until 2028. If the trustees' pessimistic
assumptions are true, they will need to start selling bonds in
2028 and the trust fund will be reduced to zero in 2042. At that
point, as I mentioned above, the Social Security system would
simply revert back to pure pay-as-you-go, operating just as it
did successfully from 1936 to 1983.
Shouldn't we consider benefit cuts today to help prevent
a potential shortfall in the future?
Congress, correctly, has not been willing to cut benefits. They
don't need to, and they shouldn't. Telling your kids today they
only get to eat one plate of rice each day and they have to get
their clothes at Goodwill, because there is a chance that you
might lose your job 40 years from now, would be irrational. It
would be equally irrational to implement benefit cuts immediately
on the chance that the trust fund might go to zero in 2042--especially
when future recipients would still be getting more in real terms
than recipients do today.
What would it mean to index Social Security benefits to
prices rather than to wages as is done now? David Brooks of the
New York Times and others say this would prevent the system from
going broke.
Right now, the formula for Social Security benefits
in the first year of retirement is based on an average of the
worker's wages over a 35-year period, accounting for productivity
increases and for inflation. Productivity is figured in by adjusting
the worker's earnings by the change in average annual wages. In
effect, the worker's own 35-year average wage is recalculated
as if it had been earned in the three years before retirement.
The reason for this adjustment is simple: With more education
and more and better machines, labor productivity (what each worker
can produce in an hour's time) rises. Thus, each worker produces
more real output and, assuming that wages rise with productivity,
workers' standards of living improve. If workers contribute more
to society's output, they deserve more in return. This is how
market economies are supposed to work.
If productivity rises by 3% a year, the standard of living should
go up by 3% a year. But what if inflation is also 3%? In that
case, if wages rise by just 3%, workers would not be able to purchase
any more real output than the year before. That's why the wage
increase must also be adjusted for inflation. To correct for this,
wages would need to rise by 6% (3% for productivity and 3% for
inflation).
When the Bush administration proposes indexing initial Social
Security benefits only to price increases, it is really
suggesting stripping out the part of wage increases that results
from rising productivity and only allowing for inflation. It's
the equivalent of linking your retirement benefits to the very
first job you take, rather than the job you hold at retirement.
It freezes your retirement standard of living at whatever the
standard of living was when you entered the workforce. According
to President Bush's own commission, if this "price indexing"
approach were implemented, future retirees would see their retirement
income drastically reduced--if you retire in 2022, benefits would
be 10% lower, in 2042, 26% lower, and in 2075, 54% lower.
Currently, once you retire, your benefit is adjusted annually
for inflation but not for the change in wages. This cost of living
adjustment (COLA), based on the inflation rate, helps maintain
retirees' standard of living at the level they had when they retired,
although their standard of living slowly falls behind that of
the rest of society as the overall standard of living rises with
productivity. Without the COLA, the individual's standard of living
would fall even below what it was when he or she retired. With
the private accounts plan proposed by President Bush, the reduced
benefit levels would still rise with prices but the income from
private accounts would not, so inflation would erode retirees'
income.
So what does Bush mean by "progressive" indexing?
This is just applying price indexing to only some workers. It
would change the current indexation of benefits for "high"
income and "middle" income individuals, leaving the
current formula in place for the bottom 30% of wage earners. The
highest wage earners' benefits would be adjusted for inflation,
but not for productivity growth. Middle wage earners (those between
30% and 70%) would have their benefits only partially adjusted
for productivity growth.
When he talks about his tax cuts, Bush defines "middle income"
as $200,000, which is actually in the top 5% of income. In this
case, though, he defines middle income as $36,500 in 2005, and
high-income as $58,400. Under his plan, the retirement benefits
of all workers would ultimately be reduced to match those of low-income
workers regardless of how much they contributed to the system.
This would result in a massive increase in poverty among the elderly,
undermine political support for the system, and destroy Social
Security. This does not fit the definition of a "progressive"
policy.
What impact will Bush's plan have on the national debt?
Unless taxes are raised, the government will have to borrow up
to $4 trillion over the next 20 years to make up the money that
is drained out of the system by private accounts. Bush and Congress
already racked up a $475 billion deficit in Bush's first term.
Social Security privatization will raise the
size of the government's deficit to nearly $700 billion per year
for the next 20 years, almost tripling the size of the national
debt.
How will the rest of the U.S. economy be affected if the
president's plan is enacted?
Put simply, moving to a system of private accounts would not
only put retirement income at risk--it would likely put the entire
economy at risk.
The current Social Security system generates
powerful, economy-stimulating multiplier effects. This was part
of its original intent. In the early 1930s, the vast majority
of the elderly were poor. While they were working, they could
not afford to both save for retirement and put food on the table,
and most had no employer pension. When Social Security
began, elders spent every penny of that income. In turn, each
dollar they spent was spent again by the people and businesses
from whom they had bought things. In much the same way, every
dollar that goes out in pensions today creates about 2.5 times
as much total income. If the move to private accounts reduces
elders' spending levels, as almost all analysts predict, that
reduction in spending will have an even larger impact on slowing
economic growth.
The current Social Security system also reduces
the income disparity between the rich and the poor. Private accounts
would increase inequality--and increased inequality hinders economic
growth. For example, a 1994 World Bank study of 25 countries demonstrated
that as income inequality rises, productivity growth is reduced.
Market economies can fall apart completely if the level of inequality
becomes too extreme. The rapid increase in income inequality that
occurred in the 1920s was one of the causes of the Great Depression.
Won't having people invest in stocks strengthen the business
sector?
There is a commonly accepted myth that buying stock in the stock
market provides funds directly to businesses that they can use
for new investment. This is completely incorrect. Only when someone
buys stock that is part of an initial public offering (IPO) does
the money go directly to the firm. If you were to buy a share
of General Motors stock tomorrow, the money you pay would go to
the stockowners and not to General Motors. If a large number of
people were to suddenly enter the stock market, it would drive
up the selling price of stock and create a windfall for those
who currently own stock, but it would not provide a penny to the
firms whose stock is traded. Economists Dean Baker and Bob Pollin
did a study a decade ago during the IPO boom that illustrates
this distinction. They found that for every $113 in stocks traded,
only $1 actually went to businesses to finance real investment.
Your question does point to a change that could greatly strengthen
Social Security in the future. Many economists, both conservative
and liberal, support the idea of a tax on speculation in the stock
market. This is often called a "Tobin tax" after one
of its proponents. The tax rate would not have to be very high
to have a big impact. Using data from 1992, a tax rate of just
0.5% on stocks that are held for less than five years would generate
revenues of more than $15 billion per year. If this revenue were
allocated to the Social Security trust fund, the shortfall projected
by the trustees would be completely eliminated.
Given that England initiated private accounts in 1984
that failed miserably, what guarantee is there that the Bush plan
won't also fail?
The British experiment with private accounts has indeed failed
to provide an adequate and stable retirement income for the majority
of citizens. The United Kingdom is now trying to figure out how
to switch back to a defined-benefit system of retirement insurance.
The problem is that the trillions of pounds that were diverted
into the stock market can't be brought back into the defined-benefit
system.
Chile's system is one that President Bush often mentions. His
proposal is likely to be similar because one of his advisors,
José Piñera, designed the system in Chile for the
Pinochet military dictatorship. Under that government, workers
were encouraged to opt out of the system of pension insurance
and into private accounts. Over the past 25 years, the return
on stocks in Chile has averaged over 10%--a higher return than
we can expect in the U.S. stock market over the next 25 years.
Yet, even with that extremely high rate of return, the average
Chilean retiree relying on private savings will receive a benefit
less than one-half as large as someone who had remained in the
old system, and that benefit lasts only 20 years. If a retiree
is "unlucky" enough to live longer than that, he will
simply run out of retirement income. Those in the old system not
only receive a higher benefit, but the benefit lasts as long as
they live, and continues to provide benefits to their surviving
spouse.
A recent survey shows that 90% of Chileans who opted for the
private accounts wish they had remained in the old system. The
only people who have benefited by the new system are the wealthiest
top 2% of the population.
The United States' Social Security system is
the most efficiently run insurance program in the world, with
overhead of only 0.7% of annual benefits; for every $100 paid
into the system, $99.30 is paid out in benefits to retirees. In
the British and Chilean systems, at retirement, workers convert
their private accounts to annuities provided by private insurance
companies. In the United States, overhead for annuities provided
by private firms averages about 20%; for every $100 paid in, $20
gets siphoned off. And almost no annuities are indexed for inflation.
There is a third important experiment with "private accounts"
to consider: the United States' own experiment with defined-contribution
retirement plans. Since 1975, corporations have been phasing out
their old defined-benefit pensions and replacing them with private
savings accounts such as 401(k)s. In 1975, 39% of private-sector
workers were covered by defined-benefit pensions, and only 6%
by defined-contribution savings plans. By 1998 the share covered
by real pensions had plummeted to just 18% and the percent relying
on private accounts had risen to 38%. What has this rapid reversal
done to retirement income security?
A 2002 study by New York University economist Edward Wolff defines
retirement income insecurity as having less than half of your
final working income in your first year of retirement. In 1989,
less than 30% of workers aged 47 to 64 faced retirement income
insecurity. Yet by 1999, after the shift to greater reliance on
private accounts, even after the most rapid run-up in stock values
in U.S. history, almost 43% of workers in this age group faced
retirement income insecurity. We don't have to look to other countries
to see the results of a shift to private accounts. That experiment
has already been tried in the United States, and it failed.
How large is the employer's contribution for every dollar
put into the system by the wage earner? What happens to the employer's
contribution to Social Security under the Bush proposal?
The employee pays a payroll tax of 6.2% on every dollar earned,
up to an income level of $90,000. The maximum amount of tax paid
annually is $5,580. The employer pays a tax that is exactly equal
to that paid by the employee.
It's difficult to answer the second part of the question precisely,
since the president has refused to detail his actual proposal.
While the plan developed by Bush's first-term Social Security
advisory commission does not speak to this issue directly, in
his first term he suggested that employer contributions should
be reduced by the same amount as employee contributions. If Bush
gets what he said he wanted, employers would see their portion
of payroll taxes drop from 6.2% to 2.2% (a reduction of 64.5%).
This would be a windfall for corporations.
Other economics writers, such as Newsweek's Robert Samuelson,
believe the system does need revision, and suggest reforms including
raising the eligibility age and lowering benefits to wealthy people.
What, if any, changes do you think need to be implemented?
I do not think either of those changes should be implemented.
Raising the retirement age is simply a benefit reduction, because
retirees would receive benefits for fewer years, and fewer workers
would live to see retirement. As I mentioned before, there is
no reason to cut benefits out of fear of the remote possibility
of a shortfall 47 years from now.
Lowering benefits for the wealthy is also a bad idea. That's
like proposing that, after an accident, someone who drives a Lexus
should only get half of the replacement value of their car, while
someone who drives a Ford Focus should get the full replacement
value. Social Security is a universal insurance
system. This change would make the system less universal and pit
one group of workers against another.
In answer to the last part of your question, I mentioned the
possibility of a "Tobin tax" above. Another change would
be to remove the cap on the Social Security payroll
tax. Payroll taxes take 6.2% of every worker's first $90,000.
Income above $90,000 is not subject to the tax. For the nine out
of 10 Americans who will never make more than $90,000, this represents
a constant financial burden. But those who make more than $90,000
per year pay progressively smaller percentages of their total
income, as their incomes rise. Eliminating the cap and subjecting
high-income salaries to the same tax rate paid on lower incomes
would make the system fairer. The actuaries of the Social
Security administration estimate that removing the cap
on all wage and salary income would eliminate 90% of the projected
shortfall. Those same actuaries found that raising the cap to
just $147,000 would eliminate more than 57% of the shortfall.
Finally, Social Security funding currently relies
on taxing only wage and salary incomes. Over the past two decades,
as corporations have driven down the real wages of the vast majority
(80%) of employees, the share of total national income going to
wages and salaries has declined, and the share going to capital
income (from financial assets) has gone up. This erosion of the
wage share of total income has reduced the share of total income
flowing into the Social Security system, which explains a large
part of the projected shortfall. The retirement systems of the
rest of the industrialized world are funded out of general tax
revenues. The logic is that everyone in society benefits from
the efforts of workers, so all should contribute to the support
of retired workers. So another possible change to the system would
be to expand the Social Security tax to cover
all forms of income. If this were done, the tax rate could be
significantly lower. This would provide an enormous benefit to
small businesses and the self-employed as well as to everyone
who works for wages and salaries.
President Bush's top five campaign donations last year
were from large brokerages. For instance, Morgan Stanley gave
$600,480 and was the largest contributor to the Bush campaign.
Do these brokerages stand to benefit financially from the privatization
of Social Security?
This industry was the biggest contributor to President Bush in
both the 2000 and 2004 campaigns. How much it stands to gain depends
on how many people decide to opt for the private accounts; estimates
range from $40 billion to $80 billion per year.
It's likely that only the 16 brokerage firms that are allowed
to interact with the Federal Reserve Bank would be permitted to
manage private accounts. Divide $40 billion by 16 and you get
$2.5 billion for each firm. A $2.5 billion annual return on a
$600,000 "investment" in the Bush campaign is pretty
amazing!
The reason so many Enron employees lost so much is that
they forgot the first step of investing--diversify! Isn't diversification
the key?
You are correct that history shows that diversified investing
provides the best opportunity for success. But it does not guarantee
success.
My research, and that of others, addresses this issue directly.
If the amount contributed to Social Security by a median-income
worker had been put into a diversified portfolio, and if that
individual were to live 20 years into retirement, and if the economic
outcomes (real wage and stock market growth rates) of any 10-year
period during the 20th century were applied to that portfolio,
only the period of the 1990s would result in higher retirement
income from the portfolio than the existing Social Security system.
If that person were to live longer than 20 years, even the decade
of the 1990s would not have outperformed Social Security. The
only reason that anyone is willing to look seriously at private
accounts is because of the aberrant behavior of the stock market
during the 1990s.
Today, most retirees relying on 401(k) plans have significantly
lower retirement income than those who were able to hold on to
their old defined-benefit pension plans. It is not only workers
at bankrupt companies like Enron who have been hurt; Enron highlights
the level of risk imposed upon all workers by private accounts.
We've been told repeatedly that if we diversify our holdings in
private accounts sufficiently, we don't face much risk. But when
the stock market goes down significantly (e.g., 45% in 2001-2002),
diversification does not provide much protection.
Bush Social Security advisor Sylvester Scheiber,
who works for the corporate benefits consulting firm the Wyatt
Group, wrote an article in 1994 predicting that the financial
markets are likely to lose as much as half of their value as the
baby boom generation retires and starts to sell its financial
assets to pay for food and rent. This is why he has been advising
his corporate clients for decades to replace their real defined-benefit
pension plans with 401(k) plans. It shifts the cost of a financial
collapse from the corporation to the employees.
How important are the assumptions being made about economic
growth and stock market returns to Bush's privatization proposal?
The growth numbers underlying the talk of a shortfall in the
trust fund are extremely pessimistic, while the stock market projections
behind the privatization proposal are extremely optimistic. Bush
assumes that long-term GDP growth will be only 1.8%, yet claims
the return on stocks will be 7% per year. Other than the Great
Depression, the slowest decade of growth in U.S. history was the
1980s, with a growth rate of 2.4%. If the economy grows at 2.4%,
the Social Security trust fund never goes to zero.
But what if we use Bush's own assumptions? In 2004, the GDP was
almost $12 trillion, and the value of publicly traded stock was
about $40 trillion, a ratio of 3.3 to 1. If, as in the past, half
of the return on stocks takes the form of an increase in stock
prices, in 60 years the value of the stock market will be a lopsided
nine times the size of the economy. If the other half of the return
came from dividends, fully one-third of GDP would need to be paid
out in dividends at that time. This scenario is impossible. The
assumptions don't make sense.
Young people say they want more control over their Social
Security investments. How do you explain the purpose of Social
Security to today's young workers?
The best way to explain Social Security is to say what it is.
It's an insurance system that protects your income when you retire
or face disability, and provides income to your children if you
die. President Bush wants you to look at Social Security as an
investment--but it is a form of insurance that guarantees you
a constant stream of income in retirement or in case of disability,
adjusted to protect against inflation, for as long as you live.
Social Security can be compared to other types of insurance such
as home insurance. You insure your home because if it should burn
down, you would not be able to afford to rebuild it with your
personal income alone. If your house never burns down, you will
pay into the insurance fund and never get a penny back. But fire
insurance isn't a "bad investment" because it isn't
an investment at all. You are purchasing security.
Unlike fire insurance, Social Security inevitably
gives most of us our money back. But the fact that we get money
back does not change the fact that Social Security
is a form of insurance, not an investment. Only the richest of
the rich can afford not to have insurance and to rely solely on
their own savings and investments to fund their retirement or
risk of disability.
Young people must also understand that financial investments
are inherently risky. Many investments fail, and when they do,
you lose all of the money you invested. Today's 25 year olds have
only seen the stock market go up, except for one (very large)
drop. But you don't have to go back to the 1930s to see a different
picture: If you put money into the stock market in 1970 and waited
until 1980 to take it out, you would have lost money. There is
absolutely no guarantee that stock investors will see the high
returns Bush is falsely promising.
Doug Orr is a professor of economics at Eastern Washington
University. He speaks and writes regularly about Social Security.
His e-mail is dorr@ewu.edu.
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