SOCIAL INSECURITY
By GEORGE J. CHURCH AND RICHARD LACAYO PHOTOGRAPHS FOR TIME BY STEVE LISS
YOU KNOW A GOVERNMENT program is in trouble when it's less credible than a flying saucer. At a Senate committee hearing last month to reconfirm Shirley Chater as commissioner of the Social Security Administration, Republican Alan Simpson of Wyoming confronted Chater with a poll showing that more people under the age of 35 believe in UFOs than in the prospect that Social Security will pay them benefits upon retirement. Whatever the merits of their judgment on extraterrestrials, on Social Security the new workers have it exactly right. Given enough time, reality bites.
Long before they get their first serious wrinkle--in 20 years, more or less, when people now in their mid-40s begin to retire-the system will be lurching into its final crisis. For government to pay pensions to the advancing tide of baby boomers will almost certainly require stunning benefit reductions or huge tax increases. More likely both. After years of fiscal and political fecklessness, an explosive conclusion.
And years before it collapses altogether--starting this year--the Social Security system will begin to be a bad deal for increasing numbers of those who do collect benefits. Until now, just about all recipients have got back the sum of their lifetime contributions, plus interest, with just a few years of retirement checks. Everything after that was gravy. But some 1995 retirees will be the system's first losers--meaning the benefits they stand to collect will, on average, fall short of what they paid in Social Security taxes, plus the interest those taxes might have earned if the money had been invested in, say, a bank savings account.
The unlucky pioneers are higher-income men (they pay more during their working years) who have never married (so they won't get the additional 50% in spousal payments that can go to married male retirees). A small category, but prophetic. They will be the first to run up against the personal deficit in store for many younger workers, who pay much higher rates of Social Security tax than their parents' generation. If the system let earlier retirees make out like bandits, for everyone who follows it's hands up.
Or at least that's what will happen if Social Security endures in something like its present form. Should it? Though it's anathema to most politicians to say so, among the scholars and policy analysts who study the budget charts and chew their nails in suspense as the baby boomers inch toward later life, the verdict is just about unanimous: as Social Security nears its 60th birthday, it is ripe for retirement.
Most Americans, they argue cogently, would be better assured of a financially independent old age by a two-tier system. Part of it would guarantee a safety net to those who really need it. A second part, funded through mandatory private savings, would pay all Americans retirement benefits pegged to their actual contributions. But if the change is to take place, it would be better to have it before the immense claims of retiring baby boomers send the system into shock-and create a huge bloc of pensioners fiercely invested in the status quo. Also before a resentful younger generation, faced with the prospect of giant tax hikes, starts practicing reform with a sledgehammer.
HOW DO WE GET OUT OF THE PRESENT predicament? In the always conventional wisdom of Washington, legions of the elderly and those nearing retirement are terrified that any change, even the smallest, will lead sooner or later to slashing their none too generous government checks. And they will punish any legislator who doesn't swear to keep hands off the system with the electoral equivalent of burning at the stake. This attitude certainly exists, and not only among older Americans of modest means. Leonard Schwartz, 52, a lawyer in Austin, Texas, earns a six-figure income and has built up a sizable nest egg for the retirement he hopes to start early. Even so, he's worried. "I'm going to be relying in part on those [Social Security] benefits. If they start cutting in 10 or 15 years, after I've retired, there's going to be no way for me to adjust."
In the Senate earlier this month, the balanced-budget amendment was brought down largely because its G.O.P. sponsors would not give ironclad assurances that Social Security would not be touched. In opposition, a few Democratic Senators said they were trying to prevent Congress from "looting" the Social Security trust fund to cover the deficit in other operations.
That contention is, to put it politely, mendacious nonsense. It perpetuates one of the worst myths about Social Security--the idea that the system has piled up vast reserves to pay future pensions. In fact, the so-called trust fund is an empty cookie jar because the Treasury has already raided it for hundreds of billions.
Right now the process makes everybody look good. The Social Security Administration this year will collect about $58 billion more in taxes than it pays out. The surplus goes into the trust fund, and is "invested" in Treasury bonds. Which means the Federal Government borrows the $58 billion and spends it on aircraft carriers, welfare checks and the like. The government gets to report a deficit of $193 billion, rather than the $251 billion it would have to confess to if it did not have the use of that Social Security money. At the same time, the Social Security trust fund shows an increase of $58 billion in the money it supposedly has stashed away to pay future pensions.
Ah, but what happens when the fund needs hard cash? That day is coming, maybe in 2013, maybe in 2019; estimates vary. Sometime around then, Social Security taxes paid by people still working will no longer cover the pensions owed. The trust fund will have to turn the Treasury bonds it holds into real money.
Good luck, guys. The Federal Government will have long since spent the proceeds. To redeem the bonds, it will have to raise income taxes sharply or slash spending on things other than pensions severely, or borrow the money from the general public and drive up interest rates, or print money and give a big boost to inflation. Or Social Security taxes will have to be raised heavily yet again. (They have already multiplied 10 times since 1950, from 3% on the first $3,000 of a worker's earnings to 12.4% on the first $61,200 of earnings, with employer and employee theoretically each paying half.) Or pensions will have to be reduced greatly.
Nor will that be the end. Assume, for the moment, that the Treasury does somehow come up with the cash to redeem the bonds in the trust fund. Some time around the year 2029, when Generation X starts to retire, the trust fund--even if it existed at all--would be empty. At that point, to maintain pension payments, even at a reduced level, the Social Security tax by some calculations will have to be raised to 17% of wages--a level that would devastate the economy.
Why did the system fall into this trap? Primarily, says Nobel-prizewinning economist Milton Friedman, because it was "designed for a world that no longer exists." In 1935--or even in January 1940, when the first checks were mailed--the U.S. was a much smaller, poorer country, still ravaged by the Great Depression that struck with special savagery at the old. Those people lucky enough to have jobs were overwhelmingly male. Even more important, the world had yet to hear of organ transplants and the manifold other wonders of modern medicine. Once they were available, along with the better nutrition and sanitation that accompanied postwar prosperity, Americans began living--and collecting pension benefits--longer than the architects of Social Security could ever have dreamed.
In 1940, only 54% of American men and 61% of women could expect to celebrate their 65th birthdays; after they did, the men could expect to live 13 more years, the women 15. By 1990, though, 72% of men and 84% of women could count on reaching the age of 65-and those were percentages of a much larger population. Once past retirement age, the men would live an additional 15 years and the women 20. Some experts think most babies born this year will live for 85 or even 90 years.
The irresistible force of demographics has changed the most important of all Social Security figures-the ratio of workers to pensioners--beyond recognition. In 1950 there were 16 workers paying taxes for every retiree collecting benefits. Now three workers support each pensioner. And that is before the system gets hit with a double whammy as a result of the baby boom. Beginning around 2012, and extending over more than a generation, the boomers will be retiring by the millions each year. As they leave the work force, they will be replaced by the much less numerous members of the baby-bust cohort, born between 1965 and 1975. By year 2030, there will be only two workers to support each pensioner-and at current rates of tax and benefits, it can't be done. No way.
Many people flatly refuse to believe Social Security was sold to the populace as social insurance, with disastrous effect. Legions of people take it as an article of faith that each person gets back in benefits exactly as much as he or she has paid in contributions during the working years. Some seem to think that somewhere in the depths of the system is an account bearing each person's name and number, containing the exact amount of taxes paid over a lifetime, in cash or readily cashable securities, to be paid back penny for penny on retirement. This idea lends a note of moral fervor-almost fanaticism-to the demands that benefit formulas never be touched.
But it is a mirage. To finance Social Security, Congress set up a pay-as-you-go system that is still in operation: each year's pensions are paid out of the taxes contributed by workers that year. In the early days it was a fabulous money-and-votes machine. Workers paying taxes, even at what now look like phenomenally low rates, so heavily outnumbered retirees that Congress could raise benefits every few years, to the glee of pensioners and the ballot-box profit of their representatives. Even when the money began to run out in 1983, a bipartisan commission saved the day--for the next 75 years, it was then thought--by recommending rather minor cutbacks in benefits and very major increases in taxes, the last of which took effect only in 1990.
That road to salvation, however, has probably hit a dead end. Social Security taxes, once negligible, have become a severe burden, and one of the most regressive taxes that government collects. An estimated two-thirds of all workers, especially younger ones and the working poor, pay more Social Security tax than federal income tax. In 1991 a family of four earning half the median U.S. income--$43,000 that year-paid 4.8% of its meager earnings in income tax, but 12.4% to Social Security. Those figures, it is true, include the half share of Social Security taxes supposedly paid by employers--and so they should, say economists; in reality the worker pays the whole tax. A business owner who must pay an amount equal to 6.2% of a new worker's wages to the Social Security Administration simply reduces the worker's starting wage by that much.
So what's the answer? The thoroughly conservative Heritage Foundation would have us privatize the system altogether, allowing anyone who so desires to opt out at once and receive from the government a check for their contributions to date. They would then be obliged to invest that money, plus all future contributions that would have otherwise gone to the Social Security trust fund, into a mandatory IRA. Dan Mitchell, a Heritage analyst, calls that "a reasonable way of cutting our losses."
How reasonable? Under that arrangement the workers most likely to leave the system would be the youngest and the most prosperous, taking with them their larger tax contributions. Those most likely to remain would include a disproportionate number of low-wage, low-tax workers, who rarely have the kind of jobs that come with good pensions. In no time the government's obligations to retirees would exceed its Social Security revenues, leaving it without funds to continue paying checks to the current crop of retirees or to those nearing retirement who were counting on Social Security. "The system is obligated to them," says Eugene Steuerle, an expert at the Urban Institute, a middle-of-the-road Washington research institute. "Society does have this obligation."
For the larger number of Social Security critics who don't want to send the system into tilt but still want to see it radically revised, there are still a number of major changes that could have a real impact:
CUT THE OUTFLOW: That could mean raise the retirement age from 65. And raise or abolish the early retirement age, now 62, at which recipients can collect partial benefits. Or institute a means-test denying full benefits to those with huge incomes from other sources. Or reduce annual cost of living increases. Or do them all. The general idea is to reduce the total of benefits payable and thus put off the evil day when the system crashes.
The retirement age is already scheduled to rise very slowly, to 67 by 2027. Many think it should be boosted faster, and to age 70. "It is absurd to keep the same retirement age as when life expectancy was 10 to 15 years lower," says economist Friedman--still active as a senior research fellow at Stanford's Hoover Institution at the age of 82. It is also very expensive to prompt people to retire at what now seems to be an early age and collect pensions rather than pay taxes that might finance others' pensions for a vital five years or so. The counterargument, voiced by International United Mine Workers of America president Richard Trumka, among others, is that many blue-collar jobs are too physically demanding to be continued beyond, or even up to, 65.
As for means-testing benefits, Peter Peterson, the investment banker and former Secretary of Commerce who helped found the antideficit Concord Coalition, proposes a detailed plan: households with annual incomes of more than $35,000 would have all their federal benefits, including Medicare, civilian and military pensions, farm subsidies as well as Social Security, reduced on a sliding scale starting at 7.5% and going up an additional 5% for every $10,000 of extra income. At $185,000 or above, households would lose 85% of federal benefits. Peterson figures his plan would save $36 billion annually in Social Security outlays by the year 2000.
Opponents argue that the scheme would introduce bad incentives into the system by tempting high earners to conceal income. What some of them would prefer to see is a gradual, across-the-board reduction of benefits. One way that could be accomplished is by ending the special protection against inflation granted to Social Security pensions, which are increased every year to offset the full amount of inflation. Cost of living adjustments in most private pensions and in workers' wages are limited to part, if any, of the annual increase in prices. Why should Social Security pensioners alone be fully protected? Political clout, and no other reason.
GO PRIVATE: This is a variation on the Heritage Foundation idea, but one that would not allow younger and more affluent workers to abandon the system altogether. The basic concept: require workers to place part but not all of their Social Security contribution into a system of mandatory iras. The funds' managers, selected by the government for integrity and competence, would invest the money in corporate stocks and bonds. In most versions, workers would get to choose funds that pursued very conservative or more adventuresome investment strategies.
At retirement, workers would get a pension based on the amount of contributions, plus accumulated earnings, in their individual account, the way many people wrongly think Social Security runs now. It's also the way many corporate pension and savings plans work, including the ubiquitous 401(k).
This plan differs from the Heritage scheme, however, in that it would still require some mandatory payment into government coffers as well, which would be used to provide a safety net for indigent retirees and to guarantee benefits to current retirees and those soon to come who have not spent a lifetime accumulating a private account. But younger workers would be on notice that when they reach retirement, they will have to depend largely on what they have built up in their IRAs.
COMBINE IDEAS: No one solution is likely to cure all the ills of Social Security. "There's a good argument for doing many things at once," says economist Neil Howe. "First, we should be raising the retirement age to 70. Second, there should be an affluence test to shift the system toward a floor-of-protection concept. Third, we should gradually move to a private plan."
Why not just declare Social Security a failure and eliminate the entire program, with the exception of a welfare-style safety net for the elderly poor? Originally, it was the safety-net concept that was most popular. But before long, that function was eclipsed by the act's more controversial provisions, which guaranteed all workers an earnings-related benefit. F.D.R., the architect of the system, also knew that spreading the benefits around to everyone would shield Social Security from political attack. He funded it through a separate payroll tax to keep it closely identified in the minds of voters as a payback for their working years. That way, he once said, "no damn politician can ever scrap my Social Security program."
Lawmakers still regard talk of reforming the system as the supreme act of political recklessness. A detailed program was recommended last year by Senators Bob Kerrey, a Nebraska Democrat, and John Danforth, a Missouri Republican (since retired), who were appointed by President Clinton to head a bipartisan commission on entitlement reform. Their plan called for raising the retirement age to 70, cutting the benefits of upper-income retirees, and recalculating the Consumer Price Index.
Kerrey and Danforth's principal idea was to slash the worker's share of the Social Security tax from 6.2% to 4.7% (the employer's share would remain the same), but require workers to invest the tax money saved in iras or 401(k)s. Future Social Security pensions would also be reduced to reflect the drop in taxes. In a superb example of the political cowardice that blocks any change in Social Security, Kerrey and Danforth could not even get the backing of their own commission. They had to submit their plan to the White House on their own, and Clinton has ignored it.
But is Social Security really such an untouchable issue? As younger workers become a larger proportion of the electorate, they can be expected to assert their own interest in the matter, which is not the status quo. And it's even possible to hear at least a peep of compromise from the American Association of Retired Persons, the huge lobby that has treated most prior talk about changing Social Security the way the National Rifle Association of America reacts to new gun-control bills. "It's probably true that in the future we're going to have to lower benefits and get a little more revenue,'' says John Rother, AARP's legislative director. "As long as we give people as much lead time as possible to plan and adjust.''
In a sense, the political system is more at stake than the Social Security system. The problem is the sort that representative governments are not good at solving: a potential disaster that can be clearly foreseen but is not imminent, and that can be escaped only by accepting some present pain as the price of avoiding much worse future pain. So long as the crisis is not about to burst next month, Democrats will see political profit in portraying any proposal to change Social Security as a Republican conspiracy to starve the poor and elderly. Republicans will think the only defense is to swear eternal fealty to the system as it is. Whether both parties can overcome the impulse to demagoguery and agree on some reasonable reforms poses nothing less than a severe test of democratic government. Most of them already know the urgent question: How can the country honor the promise it has made to the current crop of older Americans without fleecing younger ones? The trick is to get them to ask it out loud.
--Reported by Jon D. Hull/ Chicago, Ratu Kamlani/New York and Suneel Ratan/Washington
With reporting by JON D. HULL/ CHICAGO, RATU KAMLANI/NEW YORK AND SUNEEL RATAN/WASHINGTON