Is Social Security Bankrupt?

       It is nice to see that the Jan. 6, 1997, report by the Advisory Council on Social Security made somebody happy. But I’m not sure that pleasing those who do not support the program’s goals should have been the idea.
       Gov. du Pont’s editorial in IntellectualCapital.com analogizes Social Security to some sort of Communist myth. Apparently, he foresees some victory comparable to the fall of the Berlin Wall. Having campaigned against Social Security for years, he now exults that his formerly “dumb” proposals seem to be becoming more like conventional wisdom.
       He might be right in a few ways. Five of the 13 council members endorsed ideas that six other members (and I) think come too close to endangering the system’s stability. And two others provided at least rhetorical support for the governor’s (and perhaps some readers’) misconceptions of what Social Security does, and why.
       But the only serious threat to Social Security is from such misunderstandings, not from any real-world necessity.
       Those who threaten the program not only seek and promote, but exult in, ignorance. My favorite example is this boast: “More young people believe in UFOs than believe they will ever see a Social Security check.” Pete Peterson, du Pont, and others love to cite that survey response.
       But what is the logic here? That if we believe in UFOs, we certainly should not believe in Social Security? OK … That levels of public opinion determine the truth of propositions? Interesting … That if more people believed Elvis were alive than believed in UFOs, du Pont would conclude Elvis was alive? Well, maybe he would. But would you?
       Let’s try highlighting facts instead of confusion. There are lots of little ones, but the biggies are in the governor’s assertion that Social Security is an “unfair investment” and and “unstable system.”
       The most important thing to remember about Social Security is that it’s not really an investment, in the normal financial sense, to begin with, because of both its history and goals.
       Instead, it is pay-as-you-go social insurance, with a small advance-funding component, otherwise known as the “surplus.” Basically we pay into a pool of funds, from which we withdraw if we experience certain risks. The biggest risk, compared to what we could accomplish with personal investments, is the risk of living longer than the average number of years past age 65.
       This may, of course, seem like a pretty nice risk. But it does cost money, if the extra life is not to be miserable. Unlike a private investment, Social Security pays its return for as long as you live, without regard to how long that is likely to be. (An insurer might sell you an annuity, but it will pay less per month if you are likely to live longer.) Social Security transfers money from people who have shorter lives (so in a sense need it less) to people who live longer (so need it more). You may approve or disapprove, but this clearly isn’t a normal investment.
       Social Security also pays a survivor’s benefit (essentially insurance against long life for a spouse) and is the nation’s major form of disability insurance. The thing to remember about Social Security as insurance is, you would never compare “return” on private-market insurance to return on a normal investment. People do worse on average (pay extra to the insurer) in return for the protection against a risk that they cannot save for alone.
       It’s also not like the investments that du Pont prefers, because Social Security’s benefits are partially related to need. People with lower earnings (so lower contributions) get higher benefits relative to their contributions (though less absolutely) than people with higher earnings. But the redistribution is not just by income: Social Security pays greater benefits, based on the same worker’s earnings, to a couple than to a single worker, since couples need more.
       There are other ways the program protects people against risks and redistributes income. All mean that Social Security accomplishes social and personal goals beyond those of personal investments. You can like them or not. But it’s just silly to judge the program’s performance by comparing average return to personal investments. That was never the idea.
       Instead, it’s a government guarantee of protection. It resembles an investment, morally, because you have to contribute to have a right to benefits. It also does pay more (on average) to people who contribute more (who, among other things, tend to live longer). So there’s a balance between redistribution to guarantee adequacy, and making contributions the basis of one’s rights to benefits. This makes Social Security different from “welfare” programs, not only because people claim to have “earned” benefits, but because we aren’t asked to pay for people who we might believe have done nothing to help themselves. But it’s still a government program, providing something–a minimum retirement pension, insured against long life, with survivor’s, disability, and redistributive elements–that cannot be provided in the private market anywhere near as well.
       And, as a matter of history, Social Security is not an investment, because your payments are not for yourself. They pay mostly (except for the surplus percentage) for current beneficiaries. We can speculate about whether that’s the best possible system. In practice it’s hard to see how the program could have been set up with no benefits and all contributions for years. But at any rate, here we are. And, as Michael Kinsley explained a few weeks ago in this cyberspace, acting as if the money could be turned into personal savings–without explaining how current benefits would be paid for–makes little sense. We can argue (as all members of the Advisory Council in some sense do) for treating the annual surplus more like a private investment. We can argue for creating extra private investments (as seven of the members essentially do). But nobody on the council joined du Pont in acting as if the whole program were private savings.
       The second key confusion about Social Security is the sense that it is in trouble or “unstable.”
       What we have here is a government program, the need for which will grow because the problem that it addresses will grow. There are going to be more old people as a share of society. So, in 15 to 20 years, given current benefit promises, it will cost more of our economy to pay for the program. To be more precise, following the estimates that have so many people so worried, Social Security is about 4.68 percent of the economy (GDP) now; will be 4.85 percent in 2010, rise to 6.42 percent in 2030, and peak for the following 25 years at 6.47 percent in 2035. So we’re looking at an increase of roughly 1.8 percent of GDP over the next 38 years, and 1.6 percent during the 20 years from 2010 to 2030.
       Absent pure ideology, one would think that government should grow or shrink as the need for what it does changes. And we usually think so. The need for military spending rose around 1940. From 1940-’51, federal military spending increased from 1.7 percent of GDP to 7.5 percent (of course it was much more for a while). Federal spending as a whole rose by 4.6 percent of GDP–much more than the expected Social Security need, over a much shorter time. Nothing terrible happened (unless you count winning World War II and eventually winning the Cold War).
       The expected increase in government spending–if Social Security were paid for entirely with a pay-as-you-go tax hike–is also smaller than another effect of the baby boom. Between 1950 and 1970, spending on public primary- and secondary-school education alone rose by 2.1 percent of GDP.
       These comparisons do not mean that spending could not be cut in other programs, so that government spending would not be increased by the full size of Social Security needs. If people in, say, 2015 decide they need less of some other government functions, that’s fine. But only time can tell if that will happen. It’s not a disaster if it does not. From this perspective, Social Security is “unstable” in the sense that public-education financing was unstable in 1950, and no more. The idea that the money won’t be there is quite implausible. Moreover, there is already agreement within the council on a series of minor steps that cut the long-term deficit by a third.
       What, then, is all the fuss about? One answer is, the very device of having long-term estimates of Social Security causes us to define its status only in its own terms, not as one of many government programs (though the most popular and maybe best). By financing it with dedicated taxes, we encourage comparisons that say, for example, that the dedicated taxes would pay for only 75 percent of the benefits at some time far in the future.
       In order to encourage the principle that the program depends on contributions, then, even the program’s strongest advocates would like to find ways to pay the difference within the program’s own basic design. Moreover, an aging population does mean that, in general, younger people will get a worse deal–that is, paying more for the value of the insurance and redistribution–than some prior generations. (Though actually, using the “moneysworth” calculations favored by people who attack the program, the boomers are getting a much worse deal already than the Generation Xers are expected to get.)
       Meanwhile, for reasons having not much to do with Social Security, many economists and policy-makers worry that our national savings rate is too low. Greater savings now could mean a larger economy later. So they want people to save more, and one way to convince them to save more might be to argue that the future Social Security shortfall requires higher payments now. This is clearly the purpose of the chairman of the Advisory Council, Edward M. Gramlich. In the best guide to Social Security issues, a new book edited by Eric R. Kingson and James H. Schulz, Social Security in the 21st Century, Gramlich writes that, “the United States Social Security system could even provide a convenient way to mobilize new national saving and provide for higher future living standards.” Essentially, his proposal along with council member Marc M. Twinney accomplishes that goal by requiring that individuals contribute an extra 1.6 percent of covered payroll to a separate savings scheme. The 6.2 percent that they contribute now, which is matched by 6.2 percent from their employers, would still go for the basic benefit package. The earnings from the new savings would mostly replace cuts in the benefits. But earnings from the new fund, plus the measures on which all council members agree, would allow benefits to be paid later with smaller or no tax hikes. And the economy would grow by whatever the result of the new savings might be.
       The largest faction on the council, six of the 13 members, is very leery of arguments that benefits should be cut as part of a scheme to increase national savings. But they accept the savings argument in one sense. Like most economists, they agree that if the Social Security surplus increases national savings, it eventually increases national product. That is true no matter how the surplus is “invested,” and even if the effect is rather small. If the surplus is used (as now) to reduce other federal borrowing, for example, that means there are more private savings available for private investment. That means, by the way, that if the surplus were invested in stocks instead, then–since somebody who used to buy stocks would now be buying the federal bonds that Social Security did not–there would be no overall effect on the economy. That is why Federal Reserve Board Chairman Alan Greenspan, along with most other economists, argues that there is little point to “privatizing” the surplus unless national savings are somehow increased. But the six-person faction points out that if the surplus makes the economy bigger anyway, Social Security should be credited for the good that it does. So they want to “privatize” the program only in the sense that they would invest some of the surplus in private investments, so Social Security would get credited for some of the private growth.
       A third faction of five members goes further, dedicating five points of the current 12.4 percent contribution to separate savings accounts; lowering benefits from the remaining program; and then getting extra savings from a new 1.52 percent of payroll “transitional” (70-year!) tax. They get a bigger overall return essentially because they borrow to pay for current benefits at the federal debt’s relatively low interest rate, and then beneficiaries of the new savings earn at the higher, private-sector rates. But, along the way, they eliminate many of the program’s insurance advantages, including large cuts in disability benefits and much weaker guarantees of benefits against risks–such as one would run by investing unluckily, or retiring at the time of a market downturn. They justify their position on the grounds that the extra savings would mean a bigger economy; that the remaining minimum benefit is adequate (though a lot less adequate for most people than the current program guarantee); and because they have a lot more faith than the other council members that individuals’ private investments will turn out well.
       Whatever you may think of this latter proposal (and I don’t like it much), not even its proponents believe, with du Pont, that a “market-based system … can increase our monthly retirement check by a factor of two or three.” At least, their proposal does not claim anything of the sort.
       Du Pont still has reason to crow. Too many people are conducting the debate on his terms, as if Social Security were a personal investment rather than social insurance. Any talk of privatization, even from the six council members who totally reject his perspective, may seem to casual readers to support it. The many mainstream–and even liberal–economists (such as Professor Gramlich) who seek to use the Social Security issue to encourage larger savings also play into du Pont’s hands, by encouraging the confusion between social insurance and investments–even if, like Professor Gramlich, they not only understand the difference but would utterly reject the governor’s position.
       But if you believe with him that the trouble with Social Security is that it is an “unfair investment” that is unaffordable, then I suggest you prepare for your visit from the little green men in the UFOs.