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February 26, 1996
"Shaking Up Social Security Options: Investment, Individual Accounts"
San Jose Mercury News
By Timothy Taylor
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TWENTY- and thirty-something workers are facing an ugly prospect from Social Security. First, we pay taxes to support the present generation of retirees. Then, we also pay taxes to build up a surplus in the trust fund - about $500 billion has accumulated to date - to assure that Social Security keeps its promises to retirees between about 2010 and 2025.

But after 2025, when we reach retirement age, the surplus in the trust fund will be used up. Given the projected numbers of workers and retirees, our benefits will end up being perhaps one-third lower than is now promised.

The painful task of saving Social Security means deciding how to close this gap. One possibility is higher payroll taxes for workers and employers, either now or in the future. There are also subtle ways of cutting Social Security benefits: raising taxes on benefits, delaying the retirement age, or reducing the cost-of-living increases.

Every four years, an Advisory Council on Social Security including academics, pension experts, and representatives of business and labor is appointed by the president. The report of the most recent Council, just released in draft form, recommends a fair share of that familiar bitter medicine. But it also discusses two options that many would find attractive even if the system wasn't faced with financial distress: investing Social Security funds in the stock market, and setting up individual Social Security accounts.

By law, Social Security trust funds have always been invested in U.S. Treasury bonds. But while such bonds are very secure, they have paid over the decades only about a 2 percent annual return (after adjusting for inflation), compared to average real returns of 6 percent in the stock market.

If Social Security were to invest about 40 percent of its growing $500 billion surplus into stocks, it would limit the system's exposure to additional risk from investing in stocks, and close about one-third of the system's fiscal gap.

The main worry about investing trust funds in the market is whether Congress can keep its mitts off. You can almost hear the heavy breathing as politicians think about trying to require investment in what they consider a preferred industry (high technology? cars?) or geographic area (inner cities? rural areas?), or forbidding investment in certain companies (those with layoffs or union disputes?) or industries (tobacco?).

The Advisory Council was in broad agreement that investing in the stock market made sense as long as it was in broad mutual funds.

But the Council fragmented when it came to individual accounts. Some favored continuing with the present system. Some favored a plan converting all of Social Security into individual retirement accounts, which could be invested in stocks or bonds. Some favored a compromise where people would receive a basic payment from Social Security, but would also save up other funds in an individual account for a supplementary payment.

The argument for individual accounts is that they would emphasize personal responsibility; in fact, they would be a legal requirement that everyone save for old age. Moreover, people might be willing to pay higher Social Security taxes now if they knew that the money was headed for a personal account, rather than being paid out to others.

However, an individualized system wouldn't escape political infighting. Congress will surely try to micromanage how people can invest their individual accounts. There would be disputes over whether the money in an individual Social Security account was locked up until retirement, or whether it could be withdrawn for a house down-payment, college tuition, medical expenses, a legal settlement, in a lump sum at age 62, and so on and so on.

Individualized accounts would also mean the end of redistribution within Social Security, from those with higher incomes to those with lower incomes. It would conclude a social compact between generations that has been popular and workable for 60 years.

But perhaps the most intractable problem with individual accounts involves financing the transition to such a system. Remember, those in their 20s and 30s are already paying both for present retirees and to build up a trust fund surplus that they won't get to use. If their Social Security taxes started going into individual accounts, then who will pay the $3-4 trillion which has been promised to present and future retirees who paid Social Security taxes all their own lives?

My own guess, for what it's worth, is that a fully individual retirement system will prove insurmountable, because of political resistance and financial obstacles. But once the 1996 elections are past, and politicians return to planet Earth, I expect a serious legislative push to combine basic Social Security with supplementary individual accounts.

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