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Social Security Is Working Just Fine, Thank You


Economic Viewpoint

Social Security Is Working Just Fine, Thank You

No other federal program is more successful or enjoys greater popular support than Social Security. Nor is any other program more misunderstood or more vulnerable to demagoguery. This election year, the airwaves will likely be filled with all manner of fatuous threats and promises about Social Security's future. When evaluating what they hear, voters should bear in mind the following propositions:

First, Social Security is not confronting bankruptcy. In fact, it is in sounder financial shape than most other pension programs, both private and public. Under conservative assumptions, Social Security's revenues will cover all of its promised benefits for nearly 40 years. Thereafter, a financing shortfall develops, but it amounts to only 2% of total payrolls, or less than 1% of gross domestic product over the next 75 years.

Second, making budget projections over a 75-year period--as the current law requires for Social Security--involves breathtaking uncertainty, not to mention hubris. Differences of a few tenths of a percentage point in economic growth, interest rates, or inflation can change annual budget outcomes by hundreds of billions of dollars. Given breakthroughs in the biosciences, can anyone seriously believe that meaningful predictions about longevity, birth, and retirement patterns can be made for the next 75 years? We should not introduce risky structural changes in a program that works in pursuit of solvency 75 years from now. Solvency through the next half-century is surely good enough.

Third, oft-repeated claims by critics of Social Security that any private investment scheme delivers a higher rate of return are misleading. Social Security is a pay-as-you-go social-insurance system, not a gigantic public pension plan. This insurance guarantees that all working Americans will receive an inflation-proof level of annual income linked to their earnings--not to the vagaries of markets--from retirement until death.

By design, most of the payroll contributions of working Americans are used to cover the cost of providing these guaranteed benefits to retired Americans. Since 1984, the system has purposely collected more than it has paid out in order to accumulate reserves needed to provide for the retirement of baby boomers. These temporary reserves are invested in government securities and earn exactly what a private pension plan investing in such securities would earn. These reserves could earn a higher rate of return if the government invested them in a diversified portfolio that included private stocks and bonds. I believe that such a diversification strategy for a portion of these reserves is sensible.

Fourth, in contrast with diversification proposals, so-called privatization plans that would let workers divert part of their payroll taxes into private pension plans would actually reduce the funds flowing into Social Security and hasten the date at which projected expenditures exceed projected revenues. For example, if all workers chose to redirect two percentage points of their payroll taxes into private pension accounts, as the George W. Bush campaign recently proposed, Social Security would lose about $950 billion in revenues over the next 10 years--and would become technically insolvent 14 years earlier than projected.FALSE HOPE. A recent study for the New Century Foundation by Henry Aaron and others found that if alternative revenues were not provided to offset a 2% diversion of payroll taxes to private accounts, Social Security benefits might have to be slashed nearly 30% for workers 50 and older, and nearly 55% for workers 30 and younger to maintain the system's solvency over the next 75 years. But wouldn't the higher returns from the private accounts more than offset the cutbacks in Social Security benefits? The New Century Foundation's answer is a resounding "no."

This study finds that even if the stock market performs as well in the future as it has in the past--a questionable assumption in light of current historically high valuations--after 35 years of investing two percentage points of his or her payroll tax in a private account, the average retiring worker's combined retirement benefits from both this account and Social Security would be 20% lower than the benefits guaranteed by current Social Security.

Privatization schemes that divert resources from Social Security are a Trojan horse for the average American worker. They promise to help solve Social Security's financing challenge but they actually make it worse. And while they promise to give workers greater choice and higher returns, they actually expose workers to more risk and lower retirement benefits.By Laura D'andrea Tyson


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