While politicians have been hesitant to discuss reforming Social Security, an issue long considered to be the third rail of politics, things are different this presidential election. Emboldened by optimistic surplus projections and increasing public support for overhauls to the system, Texas Gov. George W. Bush and Vice President Al Gore have both put forth proposals they claim will strengthen retirement policy.
On their own, neither will. While Bush's plan abandons much of the progressivity of the current system, Gore's creates a large new entitlement program that actually does nothing to strengthen Social Security. And the financing of both plans is too dependent on optimistic projections of budget surpluses. But by taking the strengths of each plan and combining them, one could create an even better reform package.
"Partial privatization," as recommended by Bush, would allow workers to divert 2% of their payroll taxes into newly created private investment accounts. Once the accounts accumulated sufficient assets, they could be used to offset future benefit reductions that will be needed to keep Social Security afloat. While Bush has neglected to explain how he would pay for his plan, it addresses one of the fundamental problems facing the Social Security program: unacceptably low returns. A phenomenal deal for early generations who received double-digit returns, Social Security has become a second-rate deal for younger workers and those just entering the system. Current returns on contributions are expected to be in the neighborhood of 1% to 2% or even negative. This bad deal already has created an erosion of support from younger generations.
The centerpiece of Bush's proposal, private accounts, addresses the problem of low returns head-on. By shifting funds out of the current direct-transfer program, in which each generation's taxes are used immediately to pay for benefits, into productive investments, workers would benefit from savings and compounding interest over the decades of their working lives. Their returns would far outweigh what they can expect from Social Security today. But though it is likely that most workers would benefit to some extent, the wealthiest would benefit the most. For example, assuming 6% real returns and 2% real wage growth, a worker earning $15,000 would accumulate $130,000 by age 70. An average earner making $35,000 would have $300,000 and a high-income earner making $75,000 would have $640,000. Additionally, the accounts would be used in part to replace future Social Security benefits, which are structured to be progressive. So under partial privatization alone, much of the system's progressivity would be lost.
This is where the Gore plan comes in. Under "retirement savings plus," a separate program would be established in which workers would contribute funds on top of their payroll tax into tax-deferred investment accounts. Savings of low- and middle-income workers would be augmented through generous government matching grants and tax credits. As currently proposed, the government would match private savings at a rate of 3-1 for couples earning below $ 30,000, 1-1 for those earning between $ 30,000 and $ 60,000, and 1/3-1 for those making up to $ 100,000, with no matches for those earning more than $ 100,000.
There are three major weaknesses with this plan. First, it is not part of Social Security and therefore does nothing to strengthen the system or increase its returns. Second, most poor workers do not have the additional funds to save, even in the face of generous incentives, so the program would become a costly subsidy to middle-class Americans. Finally, if by some miracle all workers took advantage of the available matches, the program would become prohibitively costly. As the vice president readily admits, this initiative is one of the largest programs of tax-free, private savings ever proposed. Realistically, the level of matches would have to be scaled back to keep the program affordable.
But suppose the Bush and Gore plans were combined to create a "progressive privatization" plan. Under this scenario, smaller, better-targeted Gore matching grants would be made a part of Social Security by applying them to Bush-like private investment accounts. The private accounts would be combined with a scaled-back Social Security system offering a guaranteed minimum benefit for anyone whose account was not sufficient to support their retirement. Since both private investment accounts and progressive matches would help workers build wealth and decrease their dependency on the traditional Social Security system, this up-front investment would decrease the long-term expenses of Social Security. All workers could opt to use part of their payroll tax to build investment accounts so no one would be left out, including those who could not afford to save on top of their existing payroll tax. Workers could expect to retire with accounts of at least a couple hundred thousand dollars; returns on the accounts probably would be at least double what is expected in Social Security. Most important, the commitment to helping those who most need it would continue to be a fundamental tenet of Social Security, but it could be achieved in a less costly, more efficient manner.
As does any legitimate reform proposal, progressive privatization comes with a price tag. The inclusion of private accounts and matches would contribute to the costs of Social Security in the short term. Additional funds would be required during the transition, when workers were saving in their private accounts but current benefits still needed to be paid. Both Bush and Gore have tied their own hands on this front by ruling out many of the options available to bring income and expenditures into alignment. It is virtually impossible to avoid some combination of benefit reductions and tax increases if the solvency of the system is to be addressed. Politically undesirable options such as further increasing the retirement age, adjusting cost-of-living calculations and even means-testing benefits will have to be included in any reform package.
Progressive privatization would create a permanently solvent Social Security system offering increased savings and returns while maintaining the important progressive elements of the current system. Perhaps it is even a plan on which Bush and Gore could agree.
Copyright 2000, Los Angeles Times