Social Security: The Basics, With a Tally Sheet

When President Clinton unexpectedly used his State of the Union Message last week to propose vast changes in the way Social Security is financed, he touched off what may become the hottest policy debate of the year.

No other Government program has ever been relied on by so many people. Nor has one been so popular or so expensive. And probably no other measure affecting the general public is so complicated and so misunderstood.

As a guide in following the debate, here is a primer describing the basics of the program, its problems and its politics and what the President and the Republicans in Congress want to do about it.

Social Security and How it Works

A payroll tax is imposed on almost all workers and their employers - 6.2 percent each on all wages below $72,600. (The workers and employers pay an additional 1.45 percent each in Medicare taxes.)

Nearly 90 percent of the money is now used to pay monthly benefits. Most of the money goes to retirees and their widows and widowers. A much smaller amount is paid to the survivors of workers who died before they retired and to disabled people.

Today's workers are taxed to pay retirement benefits for their parents' generation. When today's workers retire, their benefits will be covered by their children's generation. The principle is different from an investment or an insurance policy, in which individuals pay premiums and the income from those premiums is used to pay their benefits later.

When, as is now true, the Government receives more money in Social Security taxes than it must pay in benefits, the reserves are credited to a trust fund. The money is invested in Government bonds. The interest on the bonds is credited to the fund.

The trust fund is no more than a bookkeeping entry, a collection of Government i.o.u.'s promising to pay benefits to future retirees. This obligation will be fulfilled only to the extent that politicians are willing to raise the necessary money through taxes or borrowing. But as a political matter, it is an obligation that would be hard to ignore.

For years, the surplus in the trust fund has been used to meet part of the operating expenses of the Government and to offset part of the overall budget deficit. But this is no longer necessary because, for the next 15 years, the Government is expected to run a total budget surplus of $4.4 trillion.

The Problem: Graying of the Babies

Despite today's surplus, the future is far from rosy.

The ratio of workers paying taxes to retirees drawing benefits has long been shrinking. In 1950, there were 16 workers for each Social Security beneficiary. Today, there are slightly more than three. By the second or third decade of the next century, when most baby boomers will have retired, actuaries project there will be only two people at work for each person receiving benefits. When that happens, unless changes are made, the trust fund will go into the red.

The latest estimate is that Social Security taxes will continue to exceed benefits until 2013. Because of interest payments owed on the bonds credited to the trust fund, the income in the fund will be more than what is paid out until 2021. After that, the trust fund will begin to shrink rapidly year after year until the money runs out in 2032.

Economists and politicians agree that the sooner the problem is addressed, the less painful and abrupt the solution will be.

The President's Proposal: Surplus, Stocks and Savings

The President's plan would keep the Social Security tax and benefit structure. He has proposed giving 62 percent of the budget surplus over the next 15 years to the Social Security trust fund, $2.7 trillion of the $4.4 trillion projected surplus. (The rest would be spent on Medicare, the military and other programs.)

Of the $2.7 trillion, Mr. Clinton proposed that the trust fund invest $700 million in the stock market. The White House insisted that steps would be taken to insulate the investments from political tampering, but no details were offered.

The other $2 trillion would be used to buy Government bonds from the public to lower the outstanding public debt - the sum of all the annual budget deficits over the decades - from nearly $4 trillion to less than $2 trillion. As a proportion of the total economy, the national debt would fall from about 45 percent today to 10 percent in 2014, the lowest level since the nation entered World War I.

Mr. Clinton sees three advantages for Social Security in this approach:

Historically, the average return on stock investments over a long period has been much higher than the return on Government bonds. The return on stocks is about 7 percent above the rate of inflation, as against 3 percent for bonds. Over the next 50 years, based on the long-term average return of stocks, investing $700 billion in the stock market instead of Government securities would extend the life of the trust fund by five years, the White House says.

Paying off $2 trillion in public debt over the next 15 years should strengthen the economy by lowering interest rates and opening the way for more productive private investments. A stronger economy would increase the number of people working and the size of their paychecks and make it less painful for workers to pay the taxes needed to support Social Security.

The interest on the $2 trillion in additional bonds would be credited by the Treasury to the Social Security trust fund, increasing the amount promised for retirement benefits.

These proposals, the President believes, would extend the life of the Social Security trust fund until 2055.

In addition, the President would allow people ages 65 to 69 to continue to work and receive full benefits. Under the existing law, their benefits are reduced by $1 for each $3 earned. And the President would improve benefits for widows. But he offered no means of paying for these additional benefits.

Outside of Social Security, Mr. Clinton would set aside $500 billion from the surplus to create "universal savings accounts." To encourage workers to save and invest, the Government would give low- and middle-income Americans seed money to invest in their own accounts in financial markets. Then the Government would match a portion of people's own money that they invested, similar to the way that many companies match their employees' contributions to 401(k) plans.

The White House concedes the plan would not fit Social Security's problems for good and that ultimately, to keep the program solvent for the next 75 years, taxes will have to be raised or benefits cut. But Mr. Clinton avoided dealing with this question. For the present, his proposal would not require any sacrifice by taxpayers or retirees.

The G.O.P. Position: A Work in Progress

The Republicans, who control Congress, have not developed a single proposal of their own. But they are united on three points:

The Government should not invest in the stock market.

The Social Security system should be overhauled so that workers could themselves invest in financial markets some of the money they now pay in taxes.

The 62 percent of the surplus that the President wants to use for Social Security is the proper proportion,, but much or all of the rest of the surplus should be used for tax cuts.

Republicans say Government investments in financial markets would be a mistake as a matter of principle and of economics. They say it would give the Government too much control over private companies. And they argue that the return on investments would be reduced because politicians could not be prevented from abandoning fiduciary responsibility and voting, for instance, to prohibit investments in companies that make cigarettes or firearms or contraceptives.

One approach considered by Republicans would allow workers to invest part of what they now pay in Social Security taxes. Guaranteed Social Security benefits would have to be reduced accordingly.

Another Republican approach would be to maintain the current Social Security tax and benefit structure but give workers an income tax cut if they invested the money in retirement accounts. This would eventually cause the Federal deficit to rise again if other taxes were not raised or spending cut to offset the income-tax cut.

The Politics: Tinkering with an Icon

Social Security was born in 1935 over Republican opposition, and Democrats from Franklin Roosevelt through Bill Clinton has trumpeted it to their political advantage.

Whenever Republicans have tried to tinker with the system, they have suffered politically. For instance, Republican support for a cut in benefits was seen by many as a reason the party lost control of the Senate in the 1986 elections. In the 1995 budget struggle with Congress and in his 1996 race for re-election against Bob Dole, President Clinton made headway with his accusation that Republicans wanted to cut Medicare, Social Security's close cousin, in order to give a tax cut to the wealthy.

The President and Republicans in Congress agree that sooner or later a solution must be found and that it must be bipartisan. But given this history of political mistrust and the added divisions arising from the President's impeachment, it will be extraordinarily difficult to reach an accord this year.