Social Security: Adjustment Yes, Privatization No

A year late, the Advisory Council on Social Security has rendered its final report. As long rumored, the panel is split, between those who would preserve Social Security as a government-run program, and those who would convert it to saving accounts owned by individuals free to choose where to invest their funds. But the right-wing crusade against "big government" has thrown the defenders of Social Security on the defensive, so that even they support partial privatization -- allowing the government to invest some of the Social Security trust funds in the stock market.

Privatization advocates reject such half-measures. "We oppose giving government that much control" over financial markets, possibly corporations too, replies Michael Tanner of the Cato Institute, which wants Social Security dismantled and all payroll taxes remitted to 401(k)-style privately-owned accounts. It is a prospect Wall Street relishes -- an opportunity to sell billions of dollars of "financial products" to millions of new customers.

A key argument for privatization is that workers could enjoy higher returns. "Historically," the Council members state, "returns on equity have exceeded those on Government bonds (where all Social Security funds are now invested)." Maybe so, but there have been prolonged periods when the stock market performed very badly, as it will again some day. In real (inflation-adjusted) terms, the Standard & Poor's 500 index took 25 years to regain the ground it lost after 1929. It also fell from 1968 through 1980 and did not reach new highs until the late 1980s. Suppose all your savings were in common stock and you retired in 1930? 1940? 1970? For that matter, suppose that the stock market performs well but that you made poor investment choices -- as many surely will in a complex financial environment which baffles experts at times, let alone those with less financial acumen?

Another privatization argument is that Social Security faces long-term insolvency after 2012, when baby boomers start to retire. This is the disaster scenario that has convinced so many young people that Social Security will not be there for them when they retire, so that their hard-earned dollars should not be put into a "collapsing" system.

It is a false picture. In one of the few instances of consensus, Council members agreed that payroll taxes will fall behind benefit payments about 15 years from now, but that the ensuing deficits can be closed without radical changes. Two-thirds of the projected deficit of 2.17 percent of taxable payroll over the next 75 years could be eliminated by extending Social Security coverage to all newly-hired state and local government employees, increasing taxation of benefits, slowing down cost of living adjustments based on the Consumer Price Index, and some other modest adjustments. Here too, however, the pressure from the right is evident: the Council shys away from another solution, namely, an increase in payroll taxes of little more than 1 percentage point for employers and employees.

There is a better way to do this. Payroll taxes are regressive, since they take 6.2 percent of incomes, but only up to $65,400. Why not remove the cap so that the payroll tax is applied to incomes without upper limit? This would appear desirable, particularly in light of the dramatic surge in income inequality since the late 1970s, when all income gains have gone to the top 20 percent of households. It makes little sense that Michael Jordan or Madonna or Bill Gates stop paying FICA once their incomes rocket past $65,400. The point has not been lost on the Social Security Trustees. One problem, they note, is that the ratio of taxable earnings to all earnings in Social Security-covered employment has dropped since 1984, "due to the higher proportion of total covered wages earned by very high wage earners."

Conservatives claim that free markets are always more efficient than government solutions. But a privatized retirement system would be far less efficient than Social Security, because millions of small accounts, with diverse investment choices, would be expensive to administer. The costs of operating Social Security are less than 1 percent of benefit payments; in Chile's privatized system, costs are estimated at 10 to 20 percent, typical for private insurance contracts everywhere. And this excludes other costs inherent in private markets. Two World Bank economists report that "In Chile, insurance agents receive large commissions up front, giving them an incentive to withold information or to shade the truth in order to gain a customer."

Meanwhile, Social Security remains portable from job to job, insures workers against disabilities that curtail their earning power, and provides inflation-adjusted benefits to retirees and survivors of workers who die before retirement. Its benefit formula keeps millions of elderly out of poverty, since it is weighted in favor of workers with lower average lifetime earnings and guarantees that they will not outlive their means.

The drive against Social Security is led by conservatives who have always disliked it, as a "bad example": it demonstrates how private markets can fail, in providing pension and disability insurance for all, and how government can be reasonably effective in dealing with these failures, given adequate resources and popular support. This is really why they want to "end Social Security as we know it." It remains to be seen whether the "new Democrat" in the White House will cave in on this one too.