The American Prospect, February 2005
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The word from President Bush and his minions is that Social Security is on its last legs, facing imminent danger of bankruptcy. Fortunately, Bush is prepared to rescue this antiquated program by offering workers the opportunity to invest a portion of their Social Security taxes in private accounts. He would like us to believe that this plan will both get the government out from under a crushing debt burden, in the form of future Social Security obligations, and provide younger workers with a more secure retirement.
Almost every part of this story is untrue. First, Social Security does not face any crisis in the normal meaning of the term. Second, private accounts would not give workers a more secure retirement; they reduce security. And third, the basic logic of the story is faulty; it is impossible to both reduce government spending on Social Security and increase beneﬁts, unless the plan somehow increases growth. And no economist seriously contends that putting Social Security money in the stock market will increase growth.
The Basic Numbers
Starting with the crisis story, the ﬁrst place to look is the Social Security trustees’ projections, the standard basis for analysis of the program. The most recent projections show that the program, with no changes whatsoever, can pay all beneﬁts through the year 2042. Even after 2042, Social Security would always be able to pay a higher beneﬁt (adjusted for inﬂation) than what current retirees receive, although the payment would only be about 73 percent of scheduled beneﬁts.
The Social Security trustees’ projections are based on extremely pessimistic assumptions about the future. (Four of the six trustees are political appointees of President Bush: the treasury, labor, and health and human services secretaries, plus the Social Security commissioner.) For example, the trustees assume that economic growth over the 75-year planning period will be less than half as fast as over the last 75 years. While most of this difference is due to the assumption of slower labor-force growth following the retirement of the baby-boomer generation, the trustees also assume that productivity growth will revert back to the rate of productivity growth during the slowdown years of 1973–95. Even so, the trustees themselves have begun using slightly more realistic assumptions. In 1997, they placed the year that Social Security would begin facing a shortfall at 2029. By 2003, they had revised that projection to 2042. Any system that gains 13 years of health in six years is hardly bankrupt.
The nonpartisan Congressional Budget Ofﬁce (CBO) did its own analysis of the program last summer. Using only slightly more optimistic assumptions, the CBO found that the program, with no changes at all, could pay all beneﬁts through the year 2052 and more than 80 percent of scheduled beneﬁts in subsequent years.
On the face of it, the fact that Social Security may face a shortfall in just under 40 years (according to the trustees’ report) or 50 years (according to the CBO) hardly sounds like a crisis. After all, the program faced projected shortfalls in the 1950s, ’60s, ’70s, and ’80s. Each of these shortfalls was dealt with -- usually with modest tax increases, and in the case of the ’80s shortfall, a phased increase in the retirement age beginning in 2003. In the past, no one seemed to feel the need to begin whining about a looming crisis 40 or 50 years ahead of time.
But the proponents of the crisis story have been largely successful in spreading fear. Part of this success is due to the use of deceptive language in framing the issue. The promoters of the crisis routinely speak of an $11 trillion “unfunded liability” for Social Security. But most of the people who hear the $11 trillion ﬁgure or use it (including reporters) probably have no idea what it means.
The $11 trillion is obtained by projecting Social Security taxes and spending for the inﬁnite future. The gap between projected spending and taxes for all time is then summed up (using a 3-percent real-discount rate) to get a projection of $11 trillion of debt.
However, more than two-thirds of this projected debt is due to spending beyond the 75-year planning period for Social Security. This means that the debt is not something that we are imposing on our children or grandchildren. Rather, it is a debt that we are projecting that our great-grandchildren would impose on their grandchildren -- assuming pessimistic economic projections.
The basic story is that life expectancies are projected to increase through time. This raises the cost of the program through time. If taxes are never raised and beneﬁts are never reduced, the shortfall would eventually be very large.
But serious people don’t worry about designing Social Security for the 22nd century. (The secret here is that we don’t actually get to design Social Security for the 22nd century anyhow -- the people who are alive in 50, 60, and 70 years will design the program in a way that makes sense to them. They will not care at all about what we thought was a good system in 2005.)
If we just conﬁne ourselves to the already lengthy 75-year planning period, the projected shortfall comes to $3 trillion. This may still sound very large. However, the Social Security trustees calculate that this shortfall is 0.7 percent of national income over the planning period. The CBO projects an even smaller number, just 0.4 percent of income over the next 75 years.
By comparison, the increase in annual defense spending since 2001 has been more than 1 percent of the gross domestic product, twice the size of the Social Security shortfall projected by the CBO. And Bush’s tax increases equal about 2 percent of the GDP. In fact, rolling back Bush’s tax cuts on the very wealthiest would raise sufﬁcient revenue to cover the shortfall for 75 years.
The Trust-Fund Scare Stories
The promoters of privatization have one other standard trick to promote fear about Social Security’s future: They point out that, beginning in 2018, Social Security will be forced to rely on income from the trust fund to pay beneﬁts. But this was deliberate. The 1983 Social Security Commission, chaired by Alan Greenspan, deliberately designed a system that would build up a surplus -- taxing more than was necessary to pay beneﬁts -- so that the income from this surplus could be used help pay the costs of the baby boomers’ retirement. Drawing on the trust fund is no more of a problem for Social Security than it is for any pension fund to use some of its accumulated assets to pay beneﬁts to retirees. Indeed, that is exactly what is supposed to happen.
Some conservatives have even derided the Social Security trust fund as an “accounting ﬁction.” Like most claims to wealth in a modern economy, it exists primarily as an accounting entry (how much gold does Bill Gates have in his basement?), but it is hardly ﬁction. Under the law, the federal government is obligated to repay the government bonds held by the Social Security trust fund, just as it is obligated to repay other government bonds. While tax revenue will be needed to repay these bonds, it is slated to come from personal and corporate income taxes, both very progressive forms of taxation. By contrast, the Social Security tax is a highly regressive wage tax. The meaning of the trust fund is that workers effectively prepaid their Social Security taxes. Now, the government is obligated to tax the Bill Gates and Pete Petersons of the world to repay this debt.
Funny Numbers on Private Accounts
After telling people that Social Security poses the risk of economic disaster, the privatizers promise that individual accounts would provide everyone with a secure retirement. The basic argument is that high returns in the stock market would allow workers to get more money from their Social Security taxes than what they can get through the current system.
There is a simple and obvious problem with this logic. When they project rates of return in the stock market, the privatizers routinely assume that the returns in the future will be equal to the returns in the past, 6.5 percent to 7 percent above the rate of inﬂation. But the whole basis for projecting a Social Security shortfall is the assumption that the future will have far slower growth than in the past.
Given the much slower projected rate of proﬁt growth, and the fact that price-to-earnings ratios in the stock market continue to be far higher than the historic average, it will be impossible for stock returns to be as high in the future as they were in the past. Projections of stock returns that are consistent with projections of proﬁt growth and current price-to-earnings ratios are approximately 5 percent above the rate of inﬂation. Because most projections assume a 50-50 mix of stocks and bonds, the implied return on private accounts, after deducting administrative costs, would be about 3.5 percent. This is not much different than the 3-percent return projected for the government bonds held by the trust fund.
In short, there is no untapped bonanza to be claimed by putting Social Security money in the stock market. This step would add little, if anything, to average returns. It would simply add risk. Individual workers may do worse than the average because they make bad investment choices or they happen to retire during a downturn in the stock market. Going in this direction makes sense if the purpose is to increase fees for the ﬁnancial industry, but it is not a step toward increasing workers’ retirement security. Moreover, with individual accounts, retirees would have to worry about living too long, whereas Social Security is guaranteed for life.
Even with individual accounts, most workers would still see large beneﬁt cuts under the second plan produced by President Bush’s Social Security Commission, the one that Bush indicated would be the model for his proposal. An average wage earner who is age 20 at the time the plan is implemented could expect his or her basic Social Security beneﬁt to be cut by $200,000, or more than 30 percent, over the course of his or her retirement. He or she could expect to make back less than $70,000, or about one-third of this cut, through his or her private account.
But it is not just the retirement security of individual workers that would be threatened by privatization. President Bush’s plan would also lead to transition costs that could be as high as $200 billion a year (almost 2 percent of the GDP) for more than 30 years. The transition problem stems from the fact that workers would begin placing their money in private accounts immediately, leading to large losses of revenue to the government. However, the commission’s plan proposes phasing in cuts to new retirees, beginning ﬁve years after the plan takes effect. These cuts would not get large enough to offset the lost revenue (and resulting interest burden) for more than three decades, which would lead to a substantial deﬁcit increase in the intervening years.
In order to avoid the appearance that his plan would lead to record-breaking deﬁcits (measured as a share of the GDP), President Bush wants to take this transition by not counting this borrowing as part of the budget. The argument is that we would pay this money back (with beneﬁt cuts) 40 or 50 years in the future, so the current borrowing should not be viewed as adding to the deﬁcit.
The question of whether the transition borrowing could be taken off the books is a political one, but politics won’t determine the impact of this borrowing on the nation’s economy. There is little evidence that ﬁnancial markets look 40 and 50 years into the future (and it’s not clear what they would see if they did). But every other country that has privatized its Social Security system has felt the need to offset the immediate loss of tax revenue with some spending cuts and/or tax increases. And none of them started with deﬁcits that are as large as those the United States is currently running.
There were already grounds for believing that the Bush deﬁcits were too large and would lead to a substantial increase in interest rates if not reduced quickly. Adding $200 billion a year to these deﬁcits makes it far more likely that the country would face considerably higher interest rates in the near future.
There is also a good example of what can happen when a country tries the Bush approach to Social Security privatization (even if it didn’t go quite as far). In 1994, Argentina partially privatized its social-security system. While there were some cuts included in this package, it cost the government an amount of tax revenue equal to approximately 0.9 percent of the GDP, equivalent to $100 billion a year in the United States. In 2001, Argentina went into bankruptcy and defaulted on its debt. If the social-security revenue had still been coming to the government over the period between 1994 and the default, Argentina would have been running a balanced budget in 2001.
The United States is obviously very different from Argentina, but this example is not encouraging for proponents of privatization. The ﬁnancial markets were not impressed with the fact that Argentina’s social-security payments would be lower 20 years in the future. The markets focused on the deﬁcits the country was running in the present. It is likely that they would also focus on the $600 billion (plus deﬁcits) that would result from President Bush’s Social Security plan.
In short, Bush’s plan would undermine a system that has provided security for tens of millions of workers, and their families, for seven decades, and which can continue to do so long into the future if it is just left alone. His private accounts would provide far less security, while hugely raising costs in the form of fees to the ﬁnancial industry. Finally, the cost of transitioning to this new system could throw the country into an economic crisis. It’s small wonder that Bush is facing increasing skepticism.
Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of The Conservative Nanny State: How the Wealthy Use the Government to Stay Rich and Get Richer (www.conservativenannystate.org). He also has a blog, "Beat the Press," where he discusses the media's coverage of economic issues. You can find it at the American Prospect's web site.