240 Million Risky Pieces

David Smith

February 15, 2005

Social Security was designed to pool risks. That's the social part of the program. The security comes from knowing that none of us will have to go it completely alone after retirement, if we become disabled or if a breadwinner dies. But President Bush's plan for private accounts takes both parts of the program away and tears the fabric of Social Security into tiny, risk-laden pieces. David Smith of Demos explains.

David Smith is a senior fellow for business and society at  Demos. This piece originally appeared in the Demos monthly journal, Around the Kitchen Table, at www.aroundthekitchentable.org

With a stunning absence of specifics, President Bush used his State of the Union address to propose a radical "reform" of Social Security that would result in lower guaranteed retirement benefits for virtually all Americans born after 1950, add trillions to the national debt, and jeopardize our best program to provide for workers and their families in the event of disability or death.

The president suggested that by 2018, the system would be paying out more than it would be taking in, and that by 2042 it would be exhausted and bankrupt. He is wrong on both counts.

Since 1983, the system has been building reserves in a trust fund so that when current payroll taxes are not sufficient to pay current benefits, the difference could be made up. Today's workers—precisely those whose benefits would be cut if the president has his way—have paid to build up those reserves. Those funds are invested in treasury securities, the world's safest and most widely held asset. The securities would, after 2018, be sold to allow full benefits to be paid without interruption or reduction.  By 2042—or 2052 using more reasonable economic assumptions—those reserves will be used up. But the system will not be either exhausted or bankrupt.

If we do nothing at all, and the economy grows at the very slow rate projected by the Social Security Trustees, the system will still be able to meet about 80 percent of its obligations indefinitely, providing a benefit, that, fully adjusted for inflation, would be larger than the $20,000 that the average retiree will receive this year.  The pessimistic projection the Trustees are using assumes that over the next 75 years the economy will grow at less than half the rate that it has over the last 75 years. 

And, of course, there are many things that we could do to avoid the shortfall that the pessimistic projections tell us might happen four decades from now.

We could raise the current earnings cap and apply the Social Security tax to all wages.  Today, upper-income workers pay no tax on earnings above $88,000.  As income distribution has become more unequal, a larger share of the income earned by the wealthiest has become exempt.  And, of course, those earners are the same folks who benefited most from the tax cuts proposed by President Bush and enacted by Congress.

To make matters even more unfair, those same high-income households earned the lion's share of investment income and capital gains, which escape the Social Security tax entirely. Bob Ball, who went to work for Social Security in 1939 and later served as the system's commissioner, calculates that even a small increase in the earnings cap could almost completely eliminate the long-term shortfall. If we were to eliminate the cap entirely and apply it to all income, not just wages, we would be able to cut the tax rate for both employers and employees while securing the system permantently.

Another idea is to invest part of today's surplus in an equity index fund rather than in Treasury bonds. These investments would be owned by the trust fund and not placed in individual accounts.  While riskier, investments in equities have, over the long haul, earned higher returns and thus would work to extend the life of the fund. And, because no individual would be exposed to stock market risks, we would avoid the problems of the private accounts that the president favors. Those proposed accounts would replace today's guaranteed lifetime benefit with an individual account that would have no inflation protection or protection against market risk.

Since we don't all live in Lake Woebegone, and some of our accounts would be below average, the universal Social Security safety net would be torn into 240 million risky pieces. Like all insurance schemes, Social Security is designed to pool risks, realizing that none of us, on our own, can prepare for the risks that all of us are exposed to—like the disability or premature death of a breadwinner. Social Security works because we are truly all in this together. The president's private account scheme tears that social bargain apart.

The president was right about only one thing. Our three-legged retirement stool—Social Security, pensions and individual savings—is weak and wobbly. Only Social Security is strong. We do need to address the other two legs. We should develop a portable universal pension that would add to Social Security and help make up for the difficulty that—faced with stagnant incomes—most Americans have with saving. We could pay for such a system by repealing the part of the president's tax cuts that went to the wealthiest 2 percent of households.  On a range of fronts, we should take steps to get wages growing again so that families can save—the minimum wage should go up, it should be easier to form a union, tax policies which encourage the export of good jobs should be repealed— and we should make affordable heath care for all a reality. Those steps—not reduced benefits and private accounts—would bring us closer to real social security.