In a major speech on May 15th Presidential candidate George W. Bush proposed a radical change in the Social Security system in the United States. By doing so, he “began a debate that could dominate the presidential campaign,” according to the Star Tribune newspaper.

In his speech, Mr. Bush proposed that workers be allowed to take some of the money that they currently pay to the government in Social Security taxes and put that money into what some call a Personal Retirement Account, or PRA. The worker would be required to invest that money into some sort of approved stocks and bonds. At retirement, a worker would be able to draw out the funds, similar to a private pension. Mr. Bush’s speech lacked sufficient detail to be called a “plan,” but Mr. Bush nonetheless made a number of statements and assumptions that have far-reaching implications for the future of the nation’s largest and most popular government program.

More Than a Retirement Plan

There are fundamentally only two ways to deal with the proposed shortfall in funding for Social Security: increase the money coming in (i.e., raise taxes), or decrease the money going out (i.e., cut benefits). Mr. Bush says, “The payroll tax must not be raised.” So he must be thinking about benefit cuts.

Mr. Bush, and virtually every commentator who talks about his proposal, speaks about Social Security as if it were no more than a retirement plan. The failure to mention benefits paid to the dependents of workers who die or become disabled – or the disabled workers themselves – may be due to the fact that a movement toward a system of private accounts would likely result in a significant reduction in Social Security Disability and Survivor’s benefits – and no politician likes to talk about that.

Here’s why disability and survivors’ benefit cuts would be likely: Absent a tax increase, any diversion of tax money from the program into PRAs would necessarily involve cuts in the program’s benefits. Supporters claim that the funds provided by a PRA will more than make up for a worker’s lost benefits. This is conceivably true if we are talking only about retirement benefits, although it seems unlikely given current stock valuations and economic projections. (We’ll talk about this in a future ACCESS PRESS article.) It will almost certainly not be true for the benefits paid to workers who die or become disabled and their dependents – some 14 million people. Disability or death can happen at any time, and the individual accounts of workers who die or become disabled while young will not have had sufficient time to accumulate much money. As former Social Security commissioner Robert Ball puts it, “For workers who are disabled while young the compulsory saving plan is just about useless.”

Increasing the Rate of Return

Mr. Bush and many commentators refer to the superior “rate of return” that PRAs would earn in comparison to the return on the Social Security Trust Fund. This is highly misleading.

Social Security always has been, and still is, a “pay-as-you-go” system. That is, the Social Security payroll taxes that you pay this year go to pay for benefits to people this year. The benefits you receive later will be paid by workers who will be working at that time. This is pretty standard for an insurance program, which is what the Social Security program was intended to be. Since Social Security is a pay-as-you-go program, there is no “rate of return” at all on most of the funds, since they are paid out immediately. The only thing earning any “rate of return” is the Trust Fund, which is a relatively small part of the program (about 80% of our current taxes go to pay current benefits) and which was set up explicitly to help pay for the retirement of the “baby boom” generation. While it may be possible to increase the rate of return on the Trust Fund, this would not and could not restore long-term balance to the system, since the majority of the money used to pay benefits come from current taxes, and are not in the Trust Fund.

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If one considers Social Security to be a program of social insurance, as it was designed to be, then the talk about a low “rate of return” makes as much sense as complaining of a low “rate of return” on your auto insurance because you have not had an accident. In fact, you get NO return on your insurance premiums if you don’t file a claim – that’s how insurance works – yet most people would consider this to be a good thing, not a “bad investment.”

No one likes to pay insurance premiums, and no one likes to pay Social Security taxes. The difference is that private insurance premiums must pay for the necessary profits for stockholders plus overhead costs that average between 12 and 14 percent. The overhead costs for the Social Security program, on the other hand, remain at a remarkably low level of less than 1 percent, with no profits involved.

Making the Problem Worse

Without any changes, Social Security benefits will be fully paid by current taxes until 2015, then benefits will be paid using interest on the Trust Fund until 2025, and the Trust Fund is expected to be exhausted in 2037, at which time we will fall back on current taxes (which will pay only about 70% of benefits at that time). Mr. Bush does not say how much of our tax money he wants to pull out of the program and put into PRAs, but the number most cited is 2 percentage points, which is roughly 16% of the 12.4 percent payroll tax. Under his plan, the above-mentioned schedule shortens considerably: Current taxes would fall short in 2005; interest income would only last until 2014; and the overall shortfall would occur in 2023. Add this to Mr. Bush’s statement that “the payroll tax must not be raised,” and we can see benefit cuts as an unavoidable consequence. Being a shrewd politician, Mr. Bush has not specified whose benefits will be cut, nor by how much.

The Trust Fund

Although Access Press has previously explained the nature of the Trust Fund (see “Social Security: Where’s the Money?” January 1999), it is worth repeating here. Since the Trust Fund was set up in 1984, the law has required that those funds be invested in the safest place possible. The safest place possible is U.S. Treasury Bonds. As with any “safe” investment, T-Bonds pay a lower rate of interest than more risky investments (since there is no need to entice people into taking a risk; the existence of different levels of risk is why interest rates are not all the same). Since so many millions of Americans are counting on their money being there whenever they might need it, the law chose to go with the safety of U.S. Bonds over the higher return that could be found elsewhere. As with any bonds, the bond-seller (in this case the U.S. Government) is free to spend the money raised by the selling of bonds any way it wants. This is completely irrelevant to the future of the Trust Fund, unless you think the U.S. Government is going to default on its bond obligations, which no investor believes. The wild claims that the government is “dipping into” or “raiding” the Trust Fund, or that the Trust Fund is “nothing but worthless I.O.U.s” thus reveal either a startling ignorance of the nature of bond investments or a desire to deceive the public, or both.

The “Great Risk”

Mr. Bush states that “without reform, younger workers face a great risk – a lifetime of paying taxes for benefits they may never receive.” This is a remarkable statement, considering that the Social Security administration has paid benefits on time and in full to hundreds of millions of people every month for 62 years. As for workers not receiving benefits in the future, that could only occur if 1) Congress eliminated the Social Security program, which doesn’t seem likely; 2) Congress decided to privatize the program (in which case some people would receive higher benefits and some lower benefits), which seems to be getting less unlikely every day; or 3) The United States government loses its ability to raise taxes or fails to make good on its promises to pay its debts. (If that happens, then all of our money will be worthless.)

As far as the future, a payroll tax increase of less than one percentage point would fully fund the program at current levels for as far as we can project. And if we take into account even the pessimistic projections of future wage levels for American workers used by the Trustees, “the average before-tax wage in 2030 will be 34.8 percent higher than it is now,” according to economist Dean Baker. What this means, according to Baker, is that “even after raising taxes by enough to fully fund the program for seventy five years, workers [in 2030] would still enjoy an after-tax real wage that is more than 30 percent higher, on average, than workers get at present.”

Of course, these numbers assume that we rely solely on a payroll tax increase to address the shortfall. In fact, there are numerous other adjustments we could make that would reduce the funding gap, and thus the size of any proposed payroll tax rate increase. The obvious example is to lift the ceiling on taxable wages (currently any wages above $76,200 are exempt from Social Security taxes.) Another example is to partially fund the program with income taxes rather than payroll taxes, which is what candidate Al Gore (indirectly) proposes, and which we’ll talk about in a future article.

“Saving” Social Security?

In his May 15th speech, Mr. Bush stated that “Social Security is the single most successful government program in American history” and that “When I am elected, this generation and this president will save Social Security.” Yet, ironically, his idea to “carve out” some of the program’s tax revenues to fund private accounts may pose the greatest threat to the program since the 1964 presidential campaign, in which Barry Goldwater suggested making the program voluntary.

To allay fears about the risks involved in his proposal, Mr. Bush states that “personal accounts are not a substitute for Social Security,” and that under his proposal “the safety net remains strong.” The problem here is that Social Security was not designed as a means-tested “safety net,” but rather as a universal program of social insurance. His wording suggests either a misunderstanding on Mr. Bush’s part of the character of Social Security or a desire to change that character.

Mr. Bush’s choice to define Social Security as a “safety net” rather than a universal system into which every worker pays and from which every worker is eligible to draw benefits is another threat to the program. By equating Social Security with the already-demonized “welfare” system, the effect – intended or not – will likely be to weaken political support for this immensely popular program.

Since the Social Security program is projected to be fully funded for almost another four decades, and since a relatively minor tax increase – about $7 a month for the average household – could fully address the projected shortfall, it is arguable whether “we are nearing Social Security’s greatest test,” as Mr. Bush claims. Crisis or not, by placing the issue in the forefront of the presidential campaign Mr. Bush has opened the door to perhaps the most interesting and important presidential campaign in recent memory.

Jeff Nygaard publishes a weekly newsletter on politics called Nygaard Notes, in which he discusses Social Security – and many other things – at much greater length. E-mail subscriptions are free; paper subscriptions are $25/year, which covers printing and postage. To subscribe, send a check to Nygaard Notes at P.O. Box 14354, Minneapolis, MN 55414, or visit the Nygaard Notes website at www.freespeech.org/nygaard_notes.