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December 15, 1994
"Social Security Myth Needs a Reality Check"
San Jose Mercury News
By Timothy Taylor
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SOCIAL SECURITY was deliberately and consciously built on a myth: that Americans are making "contributions" to an "insurance" system. Every proposal to amend the system, like the recent Danforth/Kerry deficit reduction commission, has foundered on this myth.

The birth of the myth behind Social Security is easy to date. The original Social Security Act of 1935 carefully did not mention "contributions" or "insurance," as Paul Romer of the University of California at Berkeley has pointed out. The reason was that during the mid-1930s, the Supreme Court was striking down many pieces of Roosevelt's New Deal legislation, on the grounds that the Constitution did not give Congress such power to interfere in the economy.

Of course, the Constitution doesn't specifically give Congress the power to set up a retirement system, but it clearly gives the power to tax and spend. So the original version of Social Security simply described a new system of payroll taxes and a set of old age benefits, without making any explicit link between these parts.

In 1938, the Supreme Court did uphold the constitutionality of the Social Security Act. So in 1939, Congress repealed the 1935 taxes, and created the Federal Insurance Contributions Act, the FICA payroll deduction that still appears on your paycheck. The ac-count for paying out money had been called the Old-Age Reserve Account; it was renamed the Old-Age and Survivors Insurance Trust Fund.

All the pamphlets and public information surrounding the system were rewritten as well. A myth had been born. To economists, the terminology of the system mattered little. They just called it a "pay-as-you-go" system, where working people pay taxes to support retired people, and very little money accumulates in the "insurance trust fund." As recently as 1986, for example, the trust fund held just $34 billion, or about two months worth of payments.

But for the public, the myth of "contributions" and "insurance" mattered a great deal. A surprising number of people still firmly believe that their Social Security taxes are stored up in an account, waiting for their retirement. People also believe that Social Security payments were nothing more than paying off what they had contributed; in fact, the average retired person was receiving several times the value of that worker's contributions.

As a simple matter of arithmetic, a pay-as-you-go system is only sustainable if there are enough working people to support those who are retired. In 1950, there were about seven workers to support every retiree. By 2020, thanks to longer life expectancies andthe retirement of the baby boom generation, the ratio of workers to retirees will drop to about three to one.

To those of us in the 30-something generation, the myth of "contributions" and "insurance" sounds like a betrayal. Social Security may be a sacred promise for our parents and grandparents, but given a future of fewer workers, for us it will be a moderate supplement to retirement income.

Given the demographic reality, the younger generation needs to save for itself. The questions are whether young workers should save by paying higher FICA taxes, and building up the trust fund, or whether they should be encouraged or required to save outside the Social Security system.

I don't begrudge my current Social Security taxes. I have two grandmothers and several great-aunts and uncles who receive a monthly check. In a few years, my parents, in-laws, aunts and uncles will be eligible. As I see it, my FICA taxes are supporting my folks. More broadly, the current generation of retirees did pay into the system over many years, and they deserve something back.

But the idea of paying still higher taxes into the "trust fund" doesn't appeal to me. This was tried in 1983, when FICA taxes were raised to start building up the trust fund. By 1999, the fund will have almost two years of payments stored up. However, the Danforth-Kerrey commission projects that the trust fund will still be spent down to nothing in about 20 years -- well before I retire -- and then we're back in a pay-as-you-go system, with relatively few workers paying in.

One answer is to build on the mythology of "contributions" and "insurance," with a '90s twist. Require that people contribute both to Social Security and a minimum amount to a personal retirement account. Guarantee a basic level of retirement income, but let people save more, if they wish, in their personal account.

There should be two main restrictions. First, to prevent excessive risk- taking, limitations would be placed on how personal retirement funds could be invested. Second, once money goes into the personal retirement account, it can't come out until retirement.

All such plans for privatizing Social Security, in whole or in part, are fiercely opposed by people who talk about "breaking promises." But for the retirement plans of my generation, pay-as-you-go Social Security is already broken.

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