Social Security Reform

The Social Security reform is a central focal point of George Bush’s second term and an area that has raised a heated debate in today’s America. The system that operated more or less efficiently up to this point is now reported to be deadlocked in a demographic crisis. With more baby boomers retiring, the system may soon face a shortfall in funding for its current obligations. President Bush put forward a solution to forestall the crisis through introduction of privatized accounts. This paper will examine the proposed solution and explore its pros and cons.1. Is there a crisis in Social Security?The current Social Security system was created in 1935 under Theodore Roosevelt when social problems plaguing the nation in the time of the Great Depression necessitated the creation of a system that would provide benefits “to workers and their family members upon retirement, disability, or death” (Century Foundation). Since that time the amount of benefits to be received by a person after death was always tied to the amount of payments to the system made by an individual lifetime over the course of one’s career. Now the system is the only method of providing comprehensive coverage to retired Americans. Taxes are contributed to the system by over 96% of working US citizens, going out in payment to over 47 million people who are supported by the Social Security payments. The significance of Social Security to American retirees is illustrated by the fact that “although the average monthly payment to those individuals is a modest $895, Social Security constitutes more than half of the incomes of almost two-thirds of retired Americans” (Century Foundation). Its impact has to be considered against the background of the fact that for one-sixth of the payment recipients, the Social Security payments are their only source of income.The Social Security system is designed in such a way that current workers pay for the benefits of current retirees with 12.4% of their wages for those earning under $90,000 a year. So far the system “has been taking in more money than it has had to pay out since the 1980s” and “will continue to do so through 2017” (Sahadi 2005). In 2018, however, it will have to tap the Treasurys accumulated in the surplus years in order to continue to pay benefits in full, which it will be able to do until 2042. Then full payouts will no longer be possible as the collected revenue will not cover the liabilities. Instead, the funds will be available only to cover 73% of then existing obligations, in line with Social Security Trustees’ assessments. It is interesting to note that “in 1997, the Trustees predicted that the Trust Funds would run out in 2029” (Century Foundation). There are more optimistic projections for the state of Social Security offered by the Congressional Budget Office (CBO) in the report that pinpoints 2052 as the year in which Social Security funds are likely to run out of the excess formerly accumulated in the form of Treasurys, after which tax revenue will cover approximately 80% of the existing obligations (Sahadi 2005). Although more optimistic, these projections also point to the need to reform Social Security.The crisis looming in the pay-as-you-go system is caused by several factors: the large number of people in the Baby Boomer generation about to retire, lower number of children in today’s families and the rising life expectancy. All of these factors are not expected to disappear soon. That is why most agree that actions on reforming the Social Security system are long overdue. By the way, the retirement of the Baby Boomer generation is no longer a new issue in the history of the US Social Security. In 1981, the Greenspan Commission created by President Ronald Reagan and chaired by Alan Greenspan worked on the proposals to strengthen Social Security in order to prevent the exhaustion of the funds. The commission delivered a proposal for reforms that were implemented in 1983 and took the amount of reserves in the fund to the current $1.5 trillion (Century Foundation). But for the reforms in 1983, the Social Security would be depleted much sooner than in 2042.2. Privatization of AccountsThe current plan to reform Social Security hinges on three proposals submitted by the President’s Commission to Strengthen Social Security in 2002. The cornerstone of these proposals is switching to new private accounts that will divert some of the funds from current payments to Social Security and allow workers to invest a portion of their salaries in private accounts.  The privatization scheme permits employees to divert 4% of their taxable wages to these private accounts. This is roughly one-third of the payroll tax that constitutes 12.4%, and the “cap would be indexed to wage growth” (Sahadi 2005).Money in private accounts is available for investment in a few diversified portfolios, but employees cannot put it in individual securities. In some way these accounts will be similar to Individual Retirement Accounts (IRAs). Since some portion of funds has been diverted from Social Security payments, the workers who had used the scheme will see their Social Security payouts reduced at the time of their retirements proportionately to how much they have redirected to private accounts.With all this done, the Social Security still has to fund current obligations. If workers begin to divert part of the funds into private accounts, the system will experience a shortfall much sooner. The presidential plan is to overcome this shortfall through a combination of benefit reduction, federal borrowing and tax hikes that will amount to between $2 trillion and $3 trillion (Anrig, Wasaw 2004). This means, however, that the reform will most likely be a burden on the shoulders of those who are now only entering the workforce or are far from retirement age.The proposal for private accounts has now materialized in the so-called GROW accounts that are a stripped-down version of the private accounts initially suggested by the Republican administration. The bill sponsored by Louisiana Republican Jim McCrery, who is also Ways and Means Social Security Subcommittee Chairman, was motivated by the staunch opposition by Democrats in Congress to the original plan that was considered too risky as it included stock investments. To counter this argument, the Republicans introduced the so-called GROW accounts that would allow workers to invest their funds in Treasury bonds, based on the full faith and credit of the U.S. government. In fact, with GROW accounts the workers would parallel the functioning of the Social Security trust fund that also invests in Treasurys now. With GROW accounts, “workers who sign up would own a share of these bonds and the interest payments that would accrue from them over their working years” (Lambro 2005).GROW accounts offer significantly less risk than the originally suggested private accounts. First, bonds carry in general less risk than stocks and therefore can be regarded as more dependable. Treasurys, in particular, are considered to be very safe investments that have won trust in the international financial community and make up a significant proportion of the reserves in many central banks. The fact that GROW accounts replicate the functioning of the Social Security trust fund itself, there is little reason to say that the risk will increase with the introduction of such accounts. Commentators approve of the accounts saying “that instead of having nothing but promises that they will get their future benefits, [retirees] would own secure, tangible assets no one could take away from them when they are ready to retire and which could be left to their heirs” (Lambro 2005). There is also less chance that money in these accounts will be diverted to the financing of different government projects as it happens today, when the surplus in the Social Security trust fund is simply diverted into various programs the government has to sponsor. GROW accounts have a much better chance of winning support in Congress than the originally presented version of private retirement accounts.;;3. The Benefits of Privatization of AccountsProponents of the privatization claim that workers using private accounts will own their pension funds and will acquire a source of capital that will be more or less free from political will and whims of the ruling elite. So far, they claim, Americans making contributions to the system have no vested rights to subsequent payouts and merely act on a social contract “whereby the next generation implicitly promises to pay for the retirement of the previous generation” (Borden 1995). The ruling of the U.S. Supreme Court in Fleming v. Nestor (1960) denied workers any rights to their contributions or future benefits.Besides, private retirement accounts (PRAs) will function much like current IRAs and enable their users to choose from a larger choice of investments. Hopefully, they will be able to rake in a better return than is brought now by the extra-conservative Social Security. This, too, opens the road to losing money due to more risk, since risk-return trade-off is an inherent in any financial system. The analysis of the General Accounting Office shows that for those born in 1930 the return on Social Security comprised 3%, and for those born in 1960 this return is 2% (Borden 1995). This is a level that will be easy for balanced portfolios to outperform given that the economy does not hit a downturn.The supporters of the proposal point to the successful experience of private pension accounts in Chile. The Chilean privatization plan was very cautious, with the requirement to place at least half of the assets in government securities and the guarantee of the minimal pension on the part of the government. Even such incomplete privatization has generated considerable benefits, among which analysts cite “overall cost of labor, higher net wages, increased national savings, greater retirement system equitability, and a large infusion of capital into domestic financial markets” (Borden 1995). In addition, the average rate of return on the pension plan in Chile equaled 13% at the time when economy returned only 7%. The success of the Chilean experiment points to the possibility that private accounts prove successful in the US too.4. Objections to the Privatization PlanThe most important objection to the privatization of pension accounts is that it is a measure directed at benefits far removed in time and for today’s generation the problem of funding Social Security will get only worse. Indeed, if the portion of payroll taxes that now goes towards repayment of benefits for other retirees is diverted, the shortfall will be even larger. As stated above, the federal government expects to reduce benefits and borrow funds, which raises little optimism in a country that is already running unprecedented budget deficits. Opponents of the reform insist that budget deficits will raise “the likelihood that national savings will decline-all of which could reduce long-term economic growth” (Anrig, Wasaw 2004).Thus, the presidential proposal does little to avert the crisis in Social Security. Instead, the implementation of the plan will only aggravate the crisis that as the need to pour funds both into the private accounts and formerly promised payments to current beneficiaries “requires drawing down the Trust Funds’ reserves much more rapidly, resulting in their depletion about twenty years sooner than they otherwise would be” (Century Foundation).Most objections are raised by the fact that individual welfare appears to be in jeopardy. There is no guarantee that people will make successful investments, and they van end in a financial deadlock because the economy hits a recession at the time of their retirement. In the stock-bullish past century, three times there have been 20-year spans when stock markets showed little growth or decline. An individual who gets into such a time span will be in trouble. On the contrary, Wall Street bankers stand to pocket sizeable amounts of money from the privatization when managing privatized accounts. The privatization will hit mostly today’s young who will bear the brunt of funding the costly transition, as well as women and minorities who usually have less wealth at the time of retirement which makes them more dependent on Social Security benefits (Anrig, Wasaw 2004). Now, as mentioned above, the amount of funds accumulated by the worker over the lifetime is the sole factor in defining the amount of payouts, while implementation of the President’s plan will make this amount dependent place on the performance of the investments in the retiree’s portfolio over the course of one’s career.The presidential team has been charged with the attempt to dismantle Social Security as a system and to change the very ideology of the state from the social protection to the “ownership society” in which the poor will be left on the sidelines. The idea that the state will offer support for those citizens unable to provide for themselves in their old age is still valid, although it may be regarded with suspicion by neo-conservatives. The Social Security debate then turns into the debate about the core values of the American society.Another, more practical objection has to do with the need to create new government apparatus that would engage in monitoring the workers’ private accounts. The new accounts that would parallel current trust fund accounts would require almost the same amount of administrative work as the current system, doubling the bureaucracy. Greg Anrig (2004) points out that “many workers’ accounts would be so small that they would be of no interest to profit-making firms”, considering that an average US employee earns about $25,000 in taxable earnings. The two percent that have to be diverted into the accounts have to amount to about $500 annually. The administrative costs can consume whatever benefits are to be reaped from investment in higher-yielding stock markets, much like administrative costs eat up returns of actively-managed mutual funds.5. Are There Other Options on Social Security Reform?Bush’s plan for account privatization is not the only possible solution. There are at least four other discernible options, including:1)                 A drop in benefits available to retirees of the next generations. These are certainly unpopular measures, but “the president is said to be considering a change in the formula used to calculate starting benefits” (Sahadi 2005).2)                 As the current payroll taxes may not be enough to cover the existing obligations, these taxes can be raised. Alternatively, the government can raise the cap on the taxed income. This, too, will hardly generate enthusiasm as it will mean that current generations of Americans will have to pay more than their predecessors while counting on approximately the same amount of benefits.3)                 Use a portion of the general revenue to pay for the shortfall in Social Security. This solution is going to affect the whole population as general revenue is not unlimited and has already been overstretched to pay for the current programs. Various federal programs will have to take a cut in funding if allocations are redirected towards Social Security instead of these programs. Instead, deficits can be raised, but this is going to be a grave problem since the US already has huge budget deficits.4)                 Finally, the government can consider raising the retirement age from the current 65. This seems to be the most viable solution. As life expectancy grows, Americans would enjoy approximately the same number of years of leisure, if retirement age is raised proportionately to the increase in expected longevity. This would offset the effects of population aging by offering people to stay longer in the workforce. Those who do not wish to work until a new limit, can choose to save money that will last them, for instance, from 65 to the new retirement age when they can start receiving benefits from Social Security. Alternatively, the government can allow withdrawal from IRAs at the same age – 65, while pushing Social Security benefits till an older age.6. Proposals on Reforming Social SecurityIn my view, a reform of the system is long overdue, and the sooner the changes are implemented, the better for the economy that will have to suffer a lot more if the administration chooses to wait. The privatization proposal may be a good option if the accounts are well-structured, but it does not solve the main problem – depletion of the Social Security trust fund and in fact will precipitate such depletion. Under these conditions, the privatization of accounts will have to be combined with some other measures.In my opinion, this measure would be the rise in retirement age. Rise in the retirement age, as mentioned above, would offset the increase in life expectancy and reflect the demographic changes that happen in society. As aging is one of the main causes of the crisis in Social Security, a rise in the retirement age would provide a fair solution to the problem, affecting all prospective retirees born after a certain year. Establishment of this cutoff (for instance, application of this later retirement to everybody under 30 now) would allow solving the problem of funding obligation in 2042. The number of retirees would not rise so drastically, but the number of people who will be paying for them would increase. The burden of payment would then be spread out over a vast mass of people which would make funding less of a problem.The government can also increase the requirements for companies that are currently obliged to provide pensions for their employees. Today, the guarantee extended by the Pension Benefit Guaranty Corporation to corporations, urges them to underfund their pension obligations, which in turn may generate a crisis. If a large number of companies go bankrupt, the P.B.G.C. will be forced to back them all according to its obligations. For this reason, making the rules for corporate financing more stringent would add to the probability that companies can take care of their former employees.In my view, workers should be allowed to choose between private accounts and former Social Security system. If they accept the risks associated with private investments, they have to brace themselves for the risks that are inevitably present in these investments. Otherwise, they will have to reckon with lower payments that today’s retirees can count on. This will provide an incentive for employees to opt for the private accounts, simultaneously making the process of retirement provision more democratic, giving employees some choice between options.ConclusionThe Social Security reform has been a highly controversial issue. On the one hand, most recognize that the continuation of the current pay-as-you-go system is impossible due to demographic causes. On the other hand, the proposal to reform the system through account privatization is not welcomed by everybody. Some see the proposed change as a way to once again deprive the less wealthy at the expense of rich bankers, while others envisage in the reform salvation from the looming shortfall in Social Security. If President Bush’s scheme is adopted, the few next decades will show how successful the idea will be. The strong opposition encountered by this plan in Congress shows that private accounts will most likely be adopted in the abridged form, most probably as the currently proposed GROW accounts. As the proposal involves measures that will affect the solvency of the Social Security trust fund, they need to be combined with the measures that will raise the amount of future contributions, such as increase in payroll tax or rise in the retirement age.Works CitedAnrig, Greg Jr., and Bernard Wasow. “Twelve Reasons Why Privatizing Social Security is a Bad Idea.” Social Security Network, the Century Foundation, December 14, 2004. 14 December 2005 <>.Borden, Karl. “Dismantling the Pyramid: The How & Why of Privatizing Social Security.” Social Security Privatization (CATO Institute) 1 (August 14, 1995). 14 December 2005 <>.Century Foundation. The Basics: Social Security Reform (Revised for 2005). 1 February 2005. 14 December 2005 <>.Lambro, Donald. “’Grow accounts’ beckon”. The Washington Times 22 August 2005. 14 December 2005 <>.Sahadi, Jeanne. “Social Security reform: A guide”.  CNN/Money January 8, 2005. 14 December 2005 <>. 

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