Rogue Missives - Revising the System?, by Jim Surowiecki (Surowiecki)

Rogue Missives

ROGUE ARCHIVES

Tuesday, January 14, 1997

Revising the System?
by Jim Surowiecki (Surowiecki)
Social Security has been the bedrock federal program since its creation in 1935. No government program -- save perhaps that eternal subsidy to the mohair industry -- has earned the level of devotion and popular support that Social Security has. The introduction of Medicare in 1965 and the subsequent decision to index Social Security to inflation combined to reduce the number of the elderly who live in poverty by more than two-thirds. Prior to the 1960s, a larger percentage of the elderly were poor than was true of any other age group. Today, the opposite is true.
At the same time, Social Security has provided a model of how universal benefits work to engender civic responsibility and public faith in government. On the simplest level, it seems clear that the universality of the program has gone a long way toward cementing its hold on the public imagination as a right rather than a gift, and has therefore protected it from the hostility that has been visited on other government programs, including most notably Aid For Dependent Children. At the same time, the illusion that Social Security is a "pay-as-you-go" program, where you get out of the system what you put in, has helped disguise its redistributive effects.
Curiously, though, Social Security is also a program that for more than a decade has been depicted as perpetually in crisis. Although the payroll tax increase of the 1980s ensured that the Social Security trust fund would be running a massive surplus annually until 2013, and that it would have enough money to pay all obligations until 2029 (assuming that it's reasonable to make fifty-year forecasts about the economy and demographics), the specter of an exhausted trust fund and of workers forced to pay 50, 60, or even 80 percent of their earnings to support the elderly has loomed over American politics since the budget deficits of the Reagan years.
Though this specter has loomed all along, there has been remarkably little serious engagement with it on the part of American politicians, precisely because Social Security has created a bevy of interest groups -- most notably the American Association of Retired Persons -- which exist primarily to defend it and Medicare. And so we were treated to Bob Dole attacking Bill Clinton for taxing the Social Security benefits of the elderly rich, even as Dole himself at other times seemed to recognize the need to confront the problem of entitlements.
Paradoxically, this failure to confront the specter of the exhausted trust fund has made that threat seem more menacing than it needs to be. It has made the public discourse on Social Security far more histrionic and panicked than it should be, resulting in the now-famous poll that revealed that young Americans are more likely to believe in U.F.O.s than they are in the future of Social Security. And it has ceded too much ground to crisis-mongers like the normally sensible Peter J. Peterson, who in his new book on entitlements casually conflates Social Security and Medicare to magnify the problem beyond all imagining.
Some of the scenarios raised by writers like Peterson are obviously preposterous. No one really thinks that American workers would ever consent to pay 80 percent of their earnings in order to keep benefits to the elderly at their current levels. We do not live, in that sense, in a gerontocracy, even if the much higher voting percentage among the elderly sometimes makes it appear that way. Any changes that occur -- in taxes or in benefits -- will occur through democratic processes. In theory, at least, nothing that seems intolerable to the majority of citizens will be approved.
Nonetheless, the demographic problems raised by the Baby Boom that followed World War II, by extended life spans, and by the slowing rate of population growth are real. In the most extreme version, we are moving from a country in which there were 3.2 workers for every elderly person fifty years ago to a country in which, forty years from now, there will be three elderly people for every worker. And since Social Security is not a system where you get out what you put in, but in fact a program that redistributes wealth from the young to the old, these demographic changes have serious implications.
For writers like Peterson, those changes require the means-testing of all entitlements, cutbacks in benefits, reductions in annual increases, and pushing back the age of retirement. Benjamin Friedman, an economist at Harvard, gave a paper at the American Economic Association last week calling for dramatic changes along these lines, while arguing that the current standards of living to which the retired elderly have become accustomed are unsustainable.
While means-testing of Social Security seems eminently reasonable in theory -- why, as Ross Perot was fond of saying, should a billionaire be getting Social Security -- the history of entitlement programs, both in the United States and Canada, suggests that once the universality of the program is destroyed, popular support will be eroded as well. In a country like the United States where the wealthy have a disproportionate amount of political power, including everyone in a program may be the best way to ensure its survival. To be sure, taxing Social Security benefits is a necessary step. But eliminating benefits to the elderly seems like a recipe for disaster.
One possible way of dealing with the problem relies on the Boskin Commission's recent assertion that the Consumer Price Index (CPI) overstates the cost of living by 1.1 percentage points. The implications of that assertion are complicated, and the political ramifications are far from clear. But if Social Security cost-of-living adjustments (COLA) were reduced by that 1.1%, the trust fund would remain in balance until 2052, and other solutions could be deferred until we had a better sense of what life will be like in 2052.
Unfortunately, the sanctity of Social Security is such that not even the most ferocious budget-cutters are willing to take the lead in calling for the implementation of the Boskin Commission's recommendations. The Republicans in Congress have made it clear that they will only support a COLA adjustment if President Clinton serves as the point man. And Clinton, in turn, seems ready to let the Bureau of Labor Statistics, which compiles the CPI, make any adjustments quietly and without fanfare. All of which means that a real public debate on the issue of adjusting Social Security benefits will not take place.
At least for the moment, what is taking place instead is a debate over how those benefits should be financed. Last Monday, the Advisory Council on Social Security issued a report -- or, more accurately, three reports -- suggesting that some portion of the Social Security trust fund should be invested in the stock market. Since stocks have returned an inflation-adjusted 7 percent over the sixty years since 1935, while government bonds have returned somewhere between 2.3 percent and 4 percent over the same period, putting excess payroll taxes into the market seems like a painless way of increasing the size of the trust fund without asking current workers to pay more.
As matters now stand, the trust fund lends billions of dollars to the U.S. Treasury every year, purchasing government bonds with the surplus it runs. In doing so, the government trades return for a lower risk, since it can be relatively certain that it will not default on its obligations to itself. Like any bondholder, the government has preferred the certainty and safety of its own securities to the risk of equities markets.
At least in theory, the Social Security trust fund is therefore considerably smaller than it would have been had at least a portion of its assets been invested in the U.S. stock market. And at a time when public confidence in stocks as both a safe and high-performing investment is unparalleled, it's unsurprising that even the most conservative members of the advisory panel would recommend that the fund turn to equities.
It's telling, of course, that no such recommendation emerged out of the early 1970s when the value of the market was halved in the space of a year, or in 1982, when the market was suffering the ravages of Volckerism. But we're living in a historical moment analogous to the mid-1960s, when people began to believe that the business cycle had been tamed and that steady, sustainable growth was in the cards for the long-term future. Although most mainstream economists have unthinkingly reconciled themselves to the idea that such growth will be considerably slower than the United States was accustomed to in the postwar era, the possibility of sustainable growth seems a real one.
Hand in hand with this has come a resurgent faith in the stock market as the best place for one's money, both in the short and long terms. After nearly fifteen years of a bull market and a 68 percent rise in the Dow Jones Industrial Average over the last two years, the only naysayers are the perpetual bears like James Grant, who has been predicting demise for so long that even he might be surprised if it finally comes.
Nonetheless, it remains true that the stock market is riskier than government bonds, especially if at a certain point you know that you will need the money in order to live on. If, to take only one example, a sizeable percentage of the Social Security trust fund was invested in the market and it suffered a downturn comparable to that of 1973-1974, a government bailout would be necessary in order to keep payments at the same level. And to the degree that investing in the market will work to make people think of Social Security as independent of the government, support for such a bailout will be less powerful than one might imagine.
The curious thing about an investment of Social Security payroll taxes in the stock market -- as much as $1 trillion according to the most moderate suggestion offered by panel members -- is that those stocks would eventually have to be sold in order to pay for the benefits. The whole point of the panel's mission, after all, is that after 2013 the trust fund will be taking in less money than it pays out, and it will have to make up the difference with the funds that it has been accumulating since the mid-1980s. Investing in the market will, in all likelihood, make those funds larger than they would otherwise have been. But it also means that at a certain point, as the Baby Boomers retire, huge sums of money will be pulled out of the market every year. The same is going to be true, of course, of all these defined-contribution pension plans that Boomers are relying on for their retirement. Again, because of demographics, there are going to be many more people looking to sell stocks than people looking to buy them.
At the same time, it's important to see that, without an accompanying payroll tax increase, the money that would go into stocks will be taken out of bonds, not out of consumption. In other words, the amount of capital in circulation will not increase. And the government, in order to continue to meet its obligations, will have to sell bonds to other investors, with the possible effect of driving up interest rates. That, in turn, could slow the economy, which would presumably reduce the rate of growth in the stock market.
None of this means that the idea of investing a portion of the trust fund in the market is a bad one, as long as guaranteed benefits remain at the heart of Social Security. In other words, to the degree that Social Security comes to resemble a traditional corporate defined-benefit plan, with the government in essence assuming the risk of investing in the market, it provides a way of reaping the benefits of sustained economic growth while protecting the half of all Americans who have no private pension plan. Six of the thirteen advisory panel members, led by former Social Security Commissioner Robert Ball, recommended this tack, while suggesting that the government invest up to 40 percent of the trust fund's surplus in stocks.
Five members of the panel, by contrast, favored raising the existing Social Security payroll tax by 1.6 percent and putting that extra money into "individual defined contribution accounts," essentially 401(k)s. These accounts would be administered by the government but would have certain constrained choices available to individuals. And two members of the panel favored a far more radical revision of Social Security, creating larger, personally funded individual retirement accounts that could be managed privately and would be funded out of the current payroll tax.
This last plan, while it would increase individuals' control over their own finances, would essentially spell the end of Social Security as we know it, and would eradicate the redistributive impact of the current program. It would also excuse the government from any real responsibility for the well-being of the elderly and, obviously, magnify the impact of any serious market crash.
The five-member proposal has the virtue of increasing private saving, albeit by a compulsory mechanism. But here again, care would need to be taken in order to ensure that Social Security did not just become an elaborate 401(k) program. The great triumph of Social Security has been that it has ensured that the elderly are able to live out their lives in relative financial security and dignity, even when their lifetime earnings were small. Returning to the days before the 1960s, when class inequalities among the old were even sharper than they were among the young, is hardly the direction a revision of Social Security should take.
The wild card in all of this discussion is what the implications of a trillion-dollar state investment in the stock market would mean. In recent years, public employee pension funds have become more and more aggressive in their relationship to the managers of the companies they own. If the Social Security trust fund was to become the equivalent of a giant fund, the leverage it could exert would be dramatic, not because of its affiliation with the state but simply because of the size of the investment. That, in turn, would increase public access to private decision-making. The productivity of markets and the virtues of democracy: it's an interesting recipe for the future.

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ROGUE ARCHIVES

Tuesday, January 14, 1997
Revising the System? by Jim Surowiecki (Surowiecki) Social Security has been the bedrock federal program since its creation in 1935. No government program -- save perhaps that eternal subsidy to the mohair industry -- has earned the level of devotion and popular support that Social Security has. The introduction of Medicare in 1965 and the subsequent decision to index Social Security to inflation combined to reduce the number of the elderly who live in poverty by more than two-thirds. Prior to the 1960s, a larger percentage of the elderly were poor than was true of any other age group. Today, the opposite is true. At the same time, Social Security has provided a model of how universal benefits work to engender civic responsibility and public faith in government. On the simplest level, it seems clear that the universality of the program has gone a long way toward cementing its hold on the public imagination as a right rather than a gift, and has therefore protected it from the hostility that has been visited on other government programs, including most notably Aid For Dependent Children. At the same time, the illusion that Social Security is a "pay-as-you-go" program, where you get out of the system what you put in, has helped disguise its redistributive effects. Curiously, though, Social Security is also a program that for more than a decade has been depicted as perpetually in crisis. Although the payroll tax increase of the 1980s ensured that the Social Security trust fund would be running a massive surplus annually until 2013, and that it would have enough money to pay all obligations until 2029 (assuming that it's reasonable to make fifty-year forecasts about the economy and demographics), the specter of an exhausted trust fund and of workers forced to pay 50, 60, or even 80 percent of their earnings to support the elderly has loomed over American politics since the budget deficits of the Reagan years. Though this specter has loomed all along, there has been remarkably little serious engagement with it on the part of American politicians, precisely because Social Security has created a bevy of interest groups -- most notably the American Association of Retired Persons -- which exist primarily to defend it and Medicare. And so we were treated to Bob Dole attacking Bill Clinton for taxing the Social Security benefits of the elderly rich, even as Dole himself at other times seemed to recognize the need to confront the problem of entitlements. Paradoxically, this failure to confront the specter of the exhausted trust fund has made that threat seem more menacing than it needs to be. It has made the public discourse on Social Security far more histrionic and panicked than it should be, resulting in the now-famous poll that revealed that young Americans are more likely to believe in U.F.O.s than they are in the future of Social Security. And it has ceded too much ground to crisis-mongers like the normally sensible Peter J. Peterson, who in his new book on entitlements casually conflates Social Security and Medicare to magnify the problem beyond all imagining. Some of the scenarios raised by writers like Peterson are obviously preposterous. No one really thinks that American workers would ever consent to pay 80 percent of their earnings in order to keep benefits to the elderly at their current levels. We do not live, in that sense, in a gerontocracy, even if the much higher voting percentage among the elderly sometimes makes it appear that way. Any changes that occur -- in taxes or in benefits -- will occur through democratic processes. In theory, at least, nothing that seems intolerable to the majority of citizens will be approved. Nonetheless, the demographic problems raised by the Baby Boom that followed World War II, by extended life spans, and by the slowing rate of population growth are real. In the most extreme version, we are moving from a country in which there were 3.2 workers for every elderly person fifty years ago to a country in which, forty years from now, there will be three elderly people for every worker. And since Social Security is not a system where you get out what you put in, but in fact a program that redistributes wealth from the young to the old, these demographic changes have serious implications. For writers like Peterson, those changes require the means-testing of all entitlements, cutbacks in benefits, reductions in annual increases, and pushing back the age of retirement. Benjamin Friedman, an economist at Harvard, gave a paper at the American Economic Association last week calling for dramatic changes along these lines, while arguing that the current standards of living to which the retired elderly have become accustomed are unsustainable. While means-testing of Social Security seems eminently reasonable in theory -- why, as Ross Perot was fond of saying, should a billionaire be getting Social Security -- the history of entitlement programs, both in the United States and Canada, suggests that once the universality of the program is destroyed, popular support will be eroded as well. In a country like the United States where the wealthy have a disproportionate amount of political power, including everyone in a program may be the best way to ensure its survival. To be sure, taxing Social Security benefits is a necessary step. But eliminating benefits to the elderly seems like a recipe for disaster. One possible way of dealing with the problem relies on the Boskin Commission's recent assertion that the Consumer Price Index (CPI) overstates the cost of living by 1.1 percentage points. The implications of that assertion are complicated, and the political ramifications are far from clear. But if Social Security cost-of-living adjustments (COLA) were reduced by that 1.1%, the trust fund would remain in balance until 2052, and other solutions could be deferred until we had a better sense of what life will be like in 2052. Unfortunately, the sanctity of Social Security is such that not even the most ferocious budget-cutters are willing to take the lead in calling for the implementation of the Boskin Commission's recommendations. The Republicans in Congress have made it clear that they will only support a COLA adjustment if President Clinton serves as the point man. And Clinton, in turn, seems ready to let the Bureau of Labor Statistics, which compiles the CPI, make any adjustments quietly and without fanfare. All of which means that a real public debate on the issue of adjusting Social Security benefits will not take place. At least for the moment, what is taking place instead is a debate over how those benefits should be financed. Last Monday, the Advisory Council on Social Security issued a report -- or, more accurately, three reports -- suggesting that some portion of the Social Security trust fund should be invested in the stock market. Since stocks have returned an inflation-adjusted 7 percent over the sixty years since 1935, while government bonds have returned somewhere between 2.3 percent and 4 percent over the same period, putting excess payroll taxes into the market seems like a painless way of increasing the size of the trust fund without asking current workers to pay more. As matters now stand, the trust fund lends billions of dollars to the U.S. Treasury every year, purchasing government bonds with the surplus it runs. In doing so, the government trades return for a lower risk, since it can be relatively certain that it will not default on its obligations to itself. Like any bondholder, the government has preferred the certainty and safety of its own securities to the risk of equities markets. At least in theory, the Social Security trust fund is therefore considerably smaller than it would have been had at least a portion of its assets been invested in the U.S. stock market. And at a time when public confidence in stocks as both a safe and high-performing investment is unparalleled, it's unsurprising that even the most conservative members of the advisory panel would recommend that the fund turn to equities. It's telling, of course, that no such recommendation emerged out of the early 1970s when the value of the market was halved in the space of a year, or in 1982, when the market was suffering the ravages of Volckerism. But we're living in a historical moment analogous to the mid-1960s, when people began to believe that the business cycle had been tamed and that steady, sustainable growth was in the cards for the long-term future. Although most mainstream economists have unthinkingly reconciled themselves to the idea that such growth will be considerably slower than the United States was accustomed to in the postwar era, the possibility of sustainable growth seems a real one. Hand in hand with this has come a resurgent faith in the stock market as the best place for one's money, both in the short and long terms. After nearly fifteen years of a bull market and a 68 percent rise in the Dow Jones Industrial Average over the last two years, the only naysayers are the perpetual bears like James Grant, who has been predicting demise for so long that even he might be surprised if it finally comes. Nonetheless, it remains true that the stock market is riskier than government bonds, especially if at a certain point you know that you will need the money in order to live on. If, to take only one example, a sizeable percentage of the Social Security trust fund was invested in the market and it suffered a downturn comparable to that of 1973-1974, a government bailout would be necessary in order to keep payments at the same level. And to the degree that investing in the market will work to make people think of Social Security as independent of the government, support for such a bailout will be less powerful than one might imagine. The curious thing about an investment of Social Security payroll taxes in the stock market -- as much as $1 trillion according to the most moderate suggestion offered by panel members -- is that those stocks would eventually have to be sold in order to pay for the benefits. The whole point of the panel's mission, after all, is that after 2013 the trust fund will be taking in less money than it pays out, and it will have to make up the difference with the funds that it has been accumulating since the mid-1980s. Investing in the market will, in all likelihood, make those funds larger than they would otherwise have been. But it also means that at a certain point, as the Baby Boomers retire, huge sums of money will be pulled out of the market every year. The same is going to be true, of course, of all these defined-contribution pension plans that Boomers are relying on for their retirement. Again, because of demographics, there are going to be many more people looking to sell stocks than people looking to buy them. At the same time, it's important to see that, without an accompanying payroll tax increase, the money that would go into stocks will be taken out of bonds, not out of consumption. In other words, the amount of capital in circulation will not increase. And the government, in order to continue to meet its obligations, will have to sell bonds to other investors, with the possible effect of driving up interest rates. That, in turn, could slow the economy, which would presumably reduce the rate of growth in the stock market. None of this means that the idea of investing a portion of the trust fund in the market is a bad one, as long as guaranteed benefits remain at the heart of Social Security. In other words, to the degree that Social Security comes to resemble a traditional corporate defined-benefit plan, with the government in essence assuming the risk of investing in the market, it provides a way of reaping the benefits of sustained economic growth while protecting the half of all Americans who have no private pension plan. Six of the thirteen advisory panel members, led by former Social Security Commissioner Robert Ball, recommended this tack, while suggesting that the government invest up to 40 percent of the trust fund's surplus in stocks. Five members of the panel, by contrast, favored raising the existing Social Security payroll tax by 1.6 percent and putting that extra money into "individual defined contribution accounts," essentially 401(k)s. These accounts would be administered by the government but would have certain constrained choices available to individuals. And two members of the panel favored a far more radical revision of Social Security, creating larger, personally funded individual retirement accounts that could be managed privately and would be funded out of the current payroll tax. This last plan, while it would increase individuals' control over their own finances, would essentially spell the end of Social Security as we know it, and would eradicate the redistributive impact of the current program. It would also excuse the government from any real responsibility for the well-being of the elderly and, obviously, magnify the impact of any serious market crash. The five-member proposal has the virtue of increasing private saving, albeit by a compulsory mechanism. But here again, care would need to be taken in order to ensure that Social Security did not just become an elaborate 401(k) program. The great triumph of Social Security has been that it has ensured that the elderly are able to live out their lives in relative financial security and dignity, even when their lifetime earnings were small. Returning to the days before the 1960s, when class inequalities among the old were even sharper than they were among the young, is hardly the direction a revision of Social Security should take. The wild card in all of this discussion is what the implications of a trillion-dollar state investment in the stock market would mean. In recent years, public employee pension funds have become more and more aggressive in their relationship to the managers of the companies they own. If the Social Security trust fund was to become the equivalent of a giant fund, the leverage it could exert would be dramatic, not because of its affiliation with the state but simply because of the size of the investment. That, in turn, would increase public access to private decision-making. The productivity of markets and the virtues of democracy: it's an interesting recipe for the future.