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What you don't hear on Social Security

Bush hasn't released his details yet but other plans for private accounts favor the government over the investor.


© St. Petersburg Times, published October 14, 2000

Eight years of prosperity offer Texas Gov. George W. Bush one nugget of political advantage.

Unprecedented stock market gains have fueled a clamor to divert part of Social Security taxes into private investment accounts, a key part of Bush's presidential platform.

"I want you to have your own asset that you can call your own," Bush tells voters. "I want to get a better rate of return for your own money than the paltry 2 percent that the Social Security trust fund gets today."

A campaign Web site describes how a 22-year-old earning $20,000 a year would amass a retirement account of $100,000 -- a powerful sales pitch to a generation that has little confidence that Social Security will be there when they retire.

What Bush and his advisers rarely discuss, however, is the underlying dynamic of privatization proposals already made by lawmakers and economists: Workers put stocks and bonds into individual accounts, all right. But then, the government cuts their regular Social Security benefits so much that they come out even at retirement, or maybe slightly ahead.

That's because privatization plans are actually mechanisms to keep traditional Social Security solvent for the good of all, not to enrich individual investors. By reducing benefits, the Social Security system funnels most of the individual stock-market gains back into the trust fund for the next 50 or 60 years.

"This is the dirty little secret they don't want to talk about," said Robert Bixby, executive director of the Concord Coalition, a fiscally conservative think tank that favors higher Social Security taxes or lower benefits.

"They call it a private account, but when you go to cash it in, they are going to claw it back from you. The government is going to let you look at the money, but they are going to take it back."

The Bush camp won't outline specifically what he has in mind. His advisers say that ensuring Social Security's long-run health requires bipartisan support. If they flesh out the plan before the election, they say, Democrats will feel obliged to shoot it down.

But private accounts are not virgin territory. Several proposals currently on the table all soak up individual gains for the sake of keeping Social Security solvent.

A bill co-sponsored by Rep. E. Clay Shaw Jr., a Fort Lauderdale Republican, requires individual workers to invest 2 percent of taxable wages out of the 12.4 percent now collected for Social Security. The trust fund then reduces their traditional Social Security benefits by all of what those investments earn.

A plan by Harvard economist Martin Feldstein and Dartmouth economist Andrew Samwick, which conforms most closely to Bush's public pronouncements, calls for the government to recapture three-quarters of the investment gains.

"It's like sharecropping," says Urban Institute president Robert Reischauer. "The government gives you the seeds, you tend them and grow them, then when it comes harvest time, the government reappears and says, "I want my share."'

This is not to diminish the importance of curing Social Security's long-run anemia. Preparing for the day when baby boomers swamp the retirement ranks is a critical national priority. Manipulating private accounts is one way to fend off this demographic onslaught.

But unless the trust fund recaptures the lion's share of investment gains for decades to come, private accounts will only hasten Social Security's demise. Then who would support today's retirees, millions of disabled people and children whose parents die young?

Bush understands this trade-off, he's just not talking much about it. Six-figure nest eggs pack more political punch than reforms that may or may not fix Social Security 50 years from now.

Here's the problem:

Social Security has always been a pay-as-you-go system. One generation's payroll taxes pay the previous generation's benefits. Congress has collected extra payroll taxes for years and salted them away in Treasury notes. Even so, this so-called Social Security surplus is scheduled to run dry in 2037.

At that point, swelling retirement rolls will present the country with bleak choices. Cut benefits for everyone by 30 percent, raise payroll taxes horrendously or take bigger and bigger chunks of cash from the general operating budget, which will squeeze other programs like education, defense and Medicare.

Vice President Al Gore proposes to pay off the national debt by about 2012. Since debt payments now represent about 13 percent of general budget spending, that would put future generations in a better position to pay the bills.

But Gore's plan does nothing to change the pay-as-you-go nature of Social Security. He says his plan would extend the Social Security surplus to 2054. Maybe so, but then we'll be right back to Square One. Too many retirees, not enough workers.

Bush would bring the stock market into play.

Even conservative pension fund managers outperform Social Security's Treasury-note strategy, which earns the trust fund about 6 percent interest. Subtract for inflation, and the T-bill number comes out somewhere in the neighborhood of the 2 percent real return that Bush talks about.

Shifting some of today's Social Security surplus into blue-chip stocks and high-grade bonds could beat that return by several percentage points with minimal risk. Compound that extra interest over three or four decades and Social Security could extend solvency for years.

Some economists favor direct investment by the federal government into an arms-length array of mutual funds. But Bush advisers and others worry that direct government investment could skew the economy in inefficient directions.

That's because the Social Security surplus will be counted in the trillions of dollars until it runs dry. Shifting even a small block of it from one mutual fund to another could substantially inflate the price of some stocks while deflating others, all because of political decisions.

Individual retirement accounts decentralize those investment decisions. The question then becomes: Who benefits from the higher returns?

Say today's workers diverted 2 percent of taxable wages into private accounts, as the Bush camp usually suggests. That's one-sixth of Social Security's intake. If Social Security then reduced those workers' regular retirement benefits by one-sixth, it would be an even exchange. In that case, today's individual workers really would enjoy the higher stock market returns.

But mainstream privatization plans don't work that way; they take back way more than they let people divert. The trust fund uses those extra resources to cover its ongoing obligations while gradually shifting from a pay-as-you-go system to one where to each generation saves for its own retirement, instead of the previous generation's.

Depending on other aspects of these plans -- like contributions from general revenue and reduction in benefits -- the trust fund finally arrives at a long-term balance in 50 to 70 years. At that point, much smaller payroll taxes can support retirement because they don't pay for current benefits. Taxes are invested in individual accounts and build up wealth up for decades before the retiree needs to start spending them.

It's a long-term solution, if it works. But few people in today's work force will collect more benefits than what Social Security now promises them.

The plan proposed by Shaw and House Ways and Means Committee Chairman Bill Archer, would divert 2 percent of payrolls into private accounts -- 60 percent in stocks, 40 percent in bonds.

When workers retired, those accounts would convert into annuities providing a monthly income. Retirees would also receive regular Social Security benefits, but only enough to bring their combined income up to what they would receive under today's system.

Whether most workers earned 5 percent on their investment account or 10 percent, their total retirement benefit would come out the same -- no greater than today's system provides.

Why would workers join such a system? They wouldn't have a choice. The bill requires participation by all. Also, if the stock market keeps booming, highly paid workers who contribute the maximum payroll tax might save enough in their investment accounts that they wouldn't need any contribution from the trust fund to match today's benefits. If that happens, the plan lets them keep any excess.

The Archer-Shaw plan also would shift trillions of dollars of general revenue into Social Security over the years. This transfusion, added to the investment gains, would put Social Security permanently in the black by about 2050.

The plan "is primarily about the solvency of Social Security," Shaw says. "It's about raising the savings level in this country, which is critically low. If we don't do anything, which is basically what Gore does, we are looking a $20-trillion deficit over 25 years."

A plan promoted by Rep. John Kasich, R-Ohio, doesn't require workers to open private accounts. But it might as well, because it penalizes them severely if they don't.

Right now, Social Security raises benefit levels an average of 4.2 percent a year to account for higher costs of living. For people now younger than 55, Kasich would drop that annual rise to 3.3 percent. Today's retirees would not be affected, but just that little whittling away, compounded every year, would reduce regular Social Security benefits by 35 percent by 2050 and 48 percent by 2075. All workers would lose benefits, whether or not they chose to open a private account.

To make up for this loss, Kasich would allow people younger than 55 to divert some of their payroll taxes into private accounts, from 1 per cent for higher-income workers to 3.5 percent for low-income workers. He would then subtract an additional 0.33 percent from their regular Social Security benefit for every year they divert payroll tax.

That's a heck of a deal; presumably all but the most faint-hearted would sign up.

Kasich would also help finance his plan by gradually raising the retirement age, beyond today's already scheduled increases.

According to an actuarial analysis by the Social Security Administration, the Kasich plan would provide some workers a smaller combined retirement check than today's system would; other workers might enjoy slightly richer benefits. But on balance, workers as a whole would make about what they would today.

Translation: The trust fund captures all the investment gains until Social Security reaches long-term balance in 2060 or so.

Bush says his plan would be optional, and he has said nothing about raising the retirement age or reducing the cost-of-living increase for future retirees. With those elements, his scenario most closely follows the Feldstein-Samwick plan. That plan assumes a 2 percent diversion of payroll into private accounts and a reduction of traditional benefits.

If stocks and bonds perform as they have over the long haul, the trust fund would recapture three-quarters of the investment gains. Workers would get the same Social Security benefit as they would today, plus one-quarter of their investment gains.

If the stock market performs better than expected, workers would keep more of their investment. If it tanks, they'll actually come out worse than under today's system.

According to projections, workers who invest all their working life would have a 71 percent chance of enjoying higher retirement benefits than they would under today's system; 29 percent would lose out.

The plan presumes that most workers would accept those odds and sign up, putting Social Security on solid footing by about 2060.

Under the Feldstein-Samwick plan, the general revenue fund would loan trillions of dollars to Social Security to help finance the transition, getting paid back decades later. In addition, another big chunk of general revenue would be transferred permanently to the trust fund.

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