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
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
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
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