FDR himself stressed the notion of limits as the flip side of largess with Social Security. “This act does not offer anyone an easy life,” he said in a 1938 fireside chat. It would “furnish that minimum necessary to keep a foothold; and that is the kind of protection Americans want.”

Indeed, Phillip Longman, in a provocative new book, The Return of Thrift, argues that Social Security was enacted largely to beat back costlier demands for universal old-age assistance championed by Francis Townsend, whose 10 million followers made him the one-man aarp of his day. Confining Social Security’s benefits to those who had first contributed payroll taxes was the ingenious way to limit government’s exposure, while giving Roosevelt the illusion of insurance he famously needed so that “no damn politician” could ever scrap his plan. In both senses, this “contributory” design worked. In 1940, less than 1 percent of the elderly received Social Security. Even as late as 1953, less than half the elderly got benefits, since they’d either retired before the system started or hadn’t contributed long enough to qualify. Only in the ’60s did America’s new policy hubris spark the huge expansions that contained the seeds of today’s reckoning. But these were heady days.

sspIn 1967, Nobel economist Paul Samuelson wryly quipped that “the beauty about social insurance is that it is actuarially unsound,” relying on a growing population and rising real incomes to pay each generation of retirees more than they paid into the system. “A growing nation,” Samuelson concluded, “is the greatest Ponzi game ever contrived.” Bob Ball, a program official and advocate who has figured in these debates for half a century, captured the spirit when he wrote that “‘a minimum income for all’ might have been a stirring objective when it was proposed by Sidney and Beatrice Webb about 1910, but we can do much better than that in the United States in 1966.” For retirees, the pleasant surprises had just begun.

In 1972, benefits were increased across the board by 20 percent. Then, in what Richard Nixon would call his biggest economic mistake, they were indexed to inflation. Ironically, raising benefits each year by the consumer price index was conceived as an effort to cap the benefit bidding wars that had become a bipartisan pre-election ritual. Then came the great inflation of the 1970s. A disastrous and inadvertent “double indexing” in the new benefit formula made matters worse, showering billions in mistaken windfalls for several years. (When this error was finally fixed in 1977, the extraordinary “Notch Baby” lobby was born, furious at being denied their “entitlement” to this excess.)In the late 1970s, benefits were tweaked again to rise automatically in tandem with real wages, thus promising each successive cohort of retirees higher real benefits. All told, in the 1970s benefits grew ten times faster in real terms than did the number of Americans aged 65 and over. Not only were these growth rates unaffordable in the long run; in the short term, they unfairly helped seniors hog the entire “peace dividend” from the end of the Vietnam War. The prospect of ever-rising benefits, moreover, probably suppressed the savings people undertook to plan for their own retirement. Such personal responsibility seemed less urgent, after all, when the share of pre-retirement earnings replaced by Social Security was rising from 38 percent in 1974 to 51 percent in 1981. With payroll tax revenues unable to keep pace, this cost explosion brought the system’s finances to the brink of crisis, prompting the big bipartisan fix of 1983. Those reforms raised payroll taxes, taxed benefits for the first time and trimmed future costs by slowly phasing in the higher retirement age of 67 during the first quarter of the next century.

Still, typical workers retiring today with $11,000 in Social Security get three times more in real terms than did their grandparents in 1940. What’s the moral of this story? After decades of expansion, FDR’s “foothold” has expanded enough to make the tradeoffs foreseen by the system’s founders ripe for revisiting. Only a grinch could grumble about the most effective anti-poverty program in history; but only a fool would fail to ask whether the Ponzi scheme is sustainable, and at what price. Today, $15 billion in Social Security goes annually to households with retirement incomes of more than $100,000; $60 billion to those with more than $50,000.

“We have to go to seniors and say, ‘Look, we can’t keep this up,'” says Nebraska Senator Bob Kerrey, a Democrat. “Yes, poverty is a concern. But please don’t tell me that every American over 65 is foraging in the alley for garbage or eating dog food. They’re going to Vegas with their colas–while kids don’t have computers in class.”

Kerrey’s right: thanks to our aging population, longer lifespans, generous benefit hikes and stagnant growth, the one thing certain about Social Security is that before the baby boom retires something will give. Call it Ponzi’s revenge. There were seven workers paying into the system for every retiree in 1950. In 1990 there were five; by 2030 there will be fewer than three. Life expectancy, meanwhile, has increased by fourteen years since Social Security was enacted, while the retirement age has yet to budge from 65, meaning benefits are drawn far longer. Financially, these trends mean the “pay-as-you-go” nature of Social Security, in which today’s workers are taxed to fund the retirement of their parents, simply can’t continue without big tax hikes or benefits cuts for tomorrow’s workers. If you’re under 40, the first question is:

How high can taxes go?

Payroll taxes, which hit low- and middle-income families the hardest (since they’re imposed only on the first $62,700 of earnings), have already risen 3 percent per decade since the 1950s. At today’s combined worker and employer rate of 15.3 percent (including Medicare and disability), they’re already higher than income taxes for most Americans. Flat taxer Steve Forbes could have saved his $30 million: thanks to the payroll tax, the effective rate paid by families earning the median $40,000 income is already the same as that facing families earning twice as much. And that’s just today. Without reform, as we slip the bill for an astonishing $8 trillion in unfunded Social Security promises to our kids, Social Security costs will rise from 12 to 17 percent of payroll by 2030. Toss in Medicare, and we’re talking a combined tab of 33 percent of payroll.

Skeptics argue reasonably that this payroll burden could soar as high as 40 percent, since the official forecasts–supervised by Commissioner Chater, of the Shady Statistic–are rosier than anything the economy has experienced in the last twenty years. The alternative to this tax holocaust? Benefit cuts of 20 to 35 percent, depending on how long we wait to act. Unfortunately, the forces leading the charge for inertia have the upper hand, thanks to the Three Great Myths of Social Security that they, and petrified politicians, refuse to debunk: You’re just getting back what you paid in. Consider the facts (as documented by Gene Steuerle of the Urban Institute). Early generations of beneficiaries paid in little and rode the rising benefit wave. The result? The average one-earner couple retiring in 1960 got back eleven times what they paid in (after accounting for inflation and interest). By the early 1980s, thanks to the growing payroll tax bite, that average couple had to scrape by on four times what they paid in. But in absolute dollars those retirees (many still collecting) enjoy the biggest windfalls Social Security will ever bestow. How big? On lifetime payroll contributions of $50,000, they receive an astonishing $210,000 in benefits for a net lifetime “profit” of $160,000 (all in 1993 dollars).

For many boomers retiring in 2010, and the bulk of the Generation Xers who come after, the lifetime loss will run to the hundreds of thousands. Social Security is “progressive.” It’s one thing to pay windfalls, quite another to save your biggest bonanzas for retirees with the highest incomes. But this fact–that Social Security is regressive within generations–is not well understood. It’s commonly argued that the regressive payroll tax through which the system is financed is more than offset by the progressive tilt of its benefit structure, which gives lower-wage workers a higher percentage of their pre-retirement pay. But, as the Urban Institute’s Steuerle has stressed, the system still ladles out larger amounts of money the richer you are. This isn’t a paradox, because the benefit formula is based on wages. A lawyer who gets a 25 percent “replacement rate” on his eligible earnings will collect more money during his retirement than a dishwasher who gets 50 percent of his. This trend is compounded by Social Security’s spousal benefit, which (unlike that of most other nations) gives spouses 50 percent of the worker’s benefit regardless of income level, so that more money goes to better-off spouses. In this respect, Social Security resembles our other great regressive entitlement, the mortgage interest deduction, which offers a big housing subsidy to someone like Arianna Huffington, while Arianna’s maid, if she rents, gets no subsidy at all. It’s OK, there’s a trust fund.

Remember how awful it was when you realized there wasn’t a Tooth Fairy? Well, brace yourself for another rude awakening: the Social Security trust fund is an accounting fiction. While it’s true that about $30 billion more comes in today via Social Security taxes than gets paid out in benefits, that “surplus” is immediately invested in Treasury bills, in effect loaning the money to Uncle Sam to mask the deep deficits in the rest of the budget. The so-called surpluses building up in this trust fund are thus nothing but IOUs. Making good on them when the baby boom retires won’t be pretty, since by that time (starting in 2013, if you believe Ms. Chater) we’ll be paying out far more in Social Security than payroll taxes bring in. The tragedy is that today’s “surpluses” were designed by 1983’s reformers to add to national savings, in hopes of boosting economic growth before the big bills came due. Instead, they became an easy way to evade hard choices in the rest of the budget. For the record, the head-in-the-sand crowd insists these trust funds (there’s one for Medicare, too) are as “real” as any private retirement account holding Treasury bonds. Maybe it’s time we switched to a clearer label: the “Pass the Huge Tax Hike to the Kids” Funds. The force of these myths in preserving the status quo adds generational insult to injury when it comes to government priorities already dramatically skewed to favor the elderly at the expense of children and long-term growth. The federal government spends eleven times more on each senior than on each child under 18. (Adding in state and local spending for public education lowers that ratio, but not materially.) Today’s deficits, a function of these choices and our refusal to pay for them, consume half our meager national savings, dooming the rising generation to a stagnant economy and depressed wages. Fear of the seniors’ lobby takes so many benefits off the table that both parties must slash forward-looking investments in R&D and infrastructure to show even bogus paths to budget balance, while half of eligible kids are told we can’t “afford” their Head Start. One in five American children–15 million, at last count–live in poverty, a higher rate than any other age group. Bill Clinton and Bob Dole, meanwhile, who differ little on these arrangements, will shortly swear that this presidential election is all about the future. What is to be done? None of this is a brief for generational war, though, given the long odds against halting the madness anytime soon, a little generational self-defense wouldn’t hurt. For starters, we could enact a successor package of modest 1983-style reforms, around which broad consensus has already gelled as analysts peer with dread over the horizon. By conventional standards, even these steps–likely to be offered by Social Security’s official Advisory Council, whose overdue report is expected by May–require political “courage.” But, compared to the Ultimate Fixes we’ll get to in a minute, they’re a walk in the park.

Tax benefits.

Unlike most advanced nations, we tax only a small portion of Social Security benefits today. That’s not fair. Why should an elderly couple with $40,000 in retirement income pay far less in taxes than a young family with two kids and the same earnings? (Especially when you consider that the seniors have put their mortgage and college expenses behind them.) Bring uncovered state and local workers into Social Security. While participation in Social Security is compulsory for virtually all forms of employment, 4 million of today’s 22 million state and local government workers still aren’t included, thanks to old sensitivities about federalism that have eroded only piecemeal over the years. Bringing them in would help fund the system with new payroll taxes immediately, while most of these workers won’t collect benefits for many years. Raise the retirement age faster. We agreed to go to 67 in 1983, but, in the usual gutsy way, that increase proceeds incrementally–by two months each year starting in 2003. Then, inexplicably, between 2008 and 2019, there’s no increase at all. Legend has it that congressional staffers intervened to make sure their own eligibility wouldn’t be delayed. Raising it instead by three months a year, to 68 by 2008, would be fairer, given our lengthening lifespans. Remember, it’s really an eligibility age, not a retirement age. You can always retire earlier; you just won’t be entitled to full Social Security benefits. Together, these and similar reforms too dull to detail would push the system’s cash-flow crisis back a few years and shave up to a third from today’s long-term imbalance. Yet they do nothing for the two biggest problems we face: the big losses younger workers can now expect on their payroll taxes; and the urgent need to raise national savings (and thus investment) to spark the growth to pay for all those graying boomers. Broadly speaking, the big thinking on these questions falls into three camps: Social Democrats, Privatizers and Progressives. Social Democrats. Brookings Institution economist Henry Aaron, typical of the breed, says the “beginning of wisdom” on Social Security is to calm down, since its cost will rise by only 2 percent of GDP when the baby boom retires. Well, that may be the beginning of wisdom, but the next installment is that 2 percent of GDP is a helluva lot of money–in today’s dollars, an extra $140 billion a year. And that’s before we add the bill for Medicare, slated to rise by another 5 percent of GDP! If you think public budgets are shortchanging the future today, such complacency is appalling.

What inspires it? Social Democrats argue that entitling everyone to similar government benefits creates common interests across social classes. They’re convinced that, without this, support for programs that redistribute money to the needy would erode. (See “It’s Christmas: Let’s Means-Test!,” tnr, January 8 & 15.) Such faith can be so blinding, however, that it’s led Bob Ball, the preeminent Social Democrat on today’s Advisory Council (and Ms. Chater’s predecessor from 1962-73), to proffer a deception masquerading as an innovation that “saves” the system. Ball’s plan, which enjoys the support of six of the Advisory Council’s thirteen members, leaves soaring benefits untouched. To be able to pay them and raise returns to young workers, he’d invest up to 40 percent of the trust fund in the stock market, to take advantage of the higher returns historically available there. As details have come out, concerns about Ball’s plan have focused on the risk that market crashes could imperil retirement security; or on the specter of Robert Reich’s secret plan for corporate America once Uncle Sam owns one-seventh of the stock market.In economic terms, however, the real sin is that Ball’s scheme is a shell game. Here’s why: if trust fund monies are put into stocks, then someone in the private sector will have to buy the Treasury bills that Social Security picks up today. The net result (along with a risk of higher interest rates) is merely to shuffle asset ownership in the economy, with Social Security’s higher paper returns offset by somebody else’s lower returns. There’s no increase in overall national savings and investment, the first litmus test a reform plan must pass to be credible.

“I think there’s a lot in what you say,” Ball admitted when I raised this critique.

Then why go this route? Ball didn’t think it politically feasible to call for an immediate tax hike and to put these new monies (which would represent increased national savings) into equities. Between the rock of his reluctance to cut benefits and the hard place of his refusal to raise taxes Ball–whose career has heretofore been a testament to enlightened public service–has essentially told the next generation, “You’re on your own.” Privatizers. A motley crew that includes drooling Wall Street brokerages, the libertarian Cato Institute and Fidel Vargas, the 27-year-old Democratic mayor of Baldwin Park, California (and the Advisory Council’s token Generation Xer), privatizers are obsessed with the higher returns young workers could earn on their own. But the only question that matters is the one they typically duck–how to get from here to there. The trick in switching midstream from “pay-as-you-go” to a pre-funded private retirement system is that one generation has to pay twice: first for the retirement of its parents and then for its own, since younger folks in a private scheme will start paying for themselves. Chile, whose successful privatization of Social Security these reformers love to tout, paid for the change thanks in part to the 5 percent of GDP budget surplus they were running when they switched. No such luck here.

The Advisory Council’s privatization option–which, in testament to how fast the debate is changing, will get five of thirteen votes–would spread the transition costs, relying on a seventy-year sales tax of 1 percent and more than $1 trillion in new debt, both sure to be political showstoppers. It would dedicate half the current payroll tax to a safety-net pension pegged at 70 percent of the poverty line, while forcing workers to put the other half into personal accounts they’d invest among dozens of approved plans. Notice, by the way, what’s happened: even the “right” in these debates would compel workers to save, demonstrating the consensus for paternalism in making sure citizens plan for retirement. Indeed, in a glimpse of what entitlement debates will look like in the future, the old labels serve as poor guides to instincts and alliances. In June, for example, former Colorado Governor Richard Lamm, a social liberal, will unveil a bold “thrift plan” developed jointly with the conservative National Taxpayers Union Foundation that would abolish the trust fund. The risk for well-intentioned privatizers, of course, is that the Social Democrats could be right; in their lust to replace Social Security entirely, we’ll end up so far from today’s communitarian ethic that even a minimum floor of pension protection will lose political support. Progressives. Fortunately, there’s an equitable and sensible middle ground, occupied by those like Ned Gramlich, the University of Michigan economist who chairs the Advisory Council, and Senators Kerrey and Simpson, who aim to increase national savings while preserving the essence of Social Security. The Kerrey-Simpson legislation, for example, would divert 2 percent of today’s payroll tax into mandatory worker savings accounts. To fund the “gap” they’d create, without having to raise payroll taxes, they’d impose limits on benefits and cost of living adjustments for better-off senior citizens, assuring today’s windfall winners a share in the solution. They’d also phase in a higher retirement age of 70 and index it after 2030 to rise with increases in lifespan, a step Bob Dole supported as far back as 1983.

For equity’s sake, they’d allow heavy laborers, who can’t be expected to work as long, say, as New Republic editors, to collect generous disability earlier. If Bob Ball’s stock market shuffle offers no solution, and the Chilean imitators’ looks too final (and impractical), the Progressive combination of mandatory private savings and fair benefit reductions is our best hope to preserve the original spirit of Social Security and still give the rising generation a fighting chance. Politically, this option has the virtue of being every zealot’s second choice. Yes, critics will say it’s a way station on the path to replacing Social Security. And over time, if the outlook isn’t stabilized by these reforms, that’s possible. But small, officially mandated accounts could instead have a multiplier effect as part of broader government efforts to persuade Americans to save more. A renaissance of thrift would make all these problems more manageable. With the Advisory Council’s imminent report, the curtain is just rising on this debate. Unless Ross Perot makes reform a battle cry in his latest quixotic effort, however, the bipartisan doctrine of Mutually Assured Demagoguery should keep Social Security a million miles from the campaign. “The only thing comforting about an unsustainable trend,” says Herb Stein, an economist at the American Enterprise Institute and former Chairman of the Council of Economic Advisers, “is that it can’t go on forever.” Whether we start now, however, or wait until the solutions and the politics become even tougher, could spell the difference between phased-in fixes and generational showdown.

One thought on “Fixing Social Security

  1. Wow. Really great article here. Certainly “fixing” Social Security is something most politicians don’t even want to imagine, never mind talk about. They should, but we all know that 4 years about as far ahead as any of them look.

    We need reform, badly. I hope one day that occurs.


Leave a reply

<a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <s> <strike> <strong>