Social Security Q&A
Separating Fact from Fiction
This article is from the May/June 2005 issue of Dollars and Sense: The Magazine of Economic Justice available at http://www.dollarsandsense.org
This article is from the May/June 2005 issue of Dollars & Sense magazine.
at a discount.
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.
Parts of these questions and answers are derived from an online chat posted at www.spokesmanreview.com.