Welfare to Wealth-Fair: The Case for Social Security Reform
President Clinton’s State of the Union Address confirmed that Social Security reform is the issue of the year. The Republicans ought to have applauded more because the President has again adopted the better part of a Republican proposal to prevent the Social Security Trust Funds from going broke.
The President’s support signals an effective consensus that some of Social Security’s current surplus should be invested in private markets. The next step is to decide who will “own” and manage these assets. A consensus may be developing here as well that reform should personalize the pension part of the program so that individuals own and manage some of their current payroll tax contributions.
Today’s payroll tax receipts cover current benefits and the excess is used for other government spending. None of the payroll tax receipts collected today are invested in real assets to pay future benefits. Under Social Security reform, initially two or three percentage points of the current 12.6 percent payroll tax would be directed into an account at a regulated financial service company such as a bank or brokerage house. These accounts are sometimes called “Personal Security Accounts,” or PSAs. Individuals would invest their PSA money in real assets like corporate equities, corporate bonds, government bonds, and money-market instruments. In effect, worker’s payroll tax “contributions” would build a real pension as opposed to contributing to other government spending priorities.
To be sure, the idea of giving individuals ownership and control of more of their retirement income is frightening to some. Many Americans save little or nothing at all outside their company-managed pensions. Unaccustomed to the process, they are concerned about the safety of their investments and their own ability to invest prudently.
Most reform proposals have a long list of safeguards to address these concerns. For example, PSA owners could not make premature withdrawals from their accounts. PSA owners would be required to diversify their investments. They would not be permitted, for example, to make investments in obviously high-risk and speculative instruments like derivatives and options, nor could they invest most of their PSA funds in any one company or industry. And the financial institutions that maintain the PSA accounts would be subject to strict regulation, similar to those on deposit-taking banks today. The government may even set up a special agency to invest PSA savings solely in government bonds for individuals who so desire.
For those concerned about the level of retirement benefits, both current and promised, reform would likely leave the existing benefit structure unchanged. In effect, reform would change the source of the benefit from taxes on workers to personally controlled assets, but would not change the level of benefits.
The political right quickly trumpeted Social Security personalization because it would reduce the level of taxes and government spending and the role of government. The political center is slowing coming around to favor personalization because we have learned that a regulated private sector generally outperforms government. Only the political left has been slow to embrace the principles of personalization. They, too, should soon come around because Social Security reform directly addresses the core goal of the left – elevating the economic status and dignity of workers, including the poor and disadvantaged.
Over the next 10, 20, 30, 40 years shareholders and bondholders will receive hundreds of billions of dollars in dividends, interest, and capital gains. Who are these lucky people? They are the people who have wealth – people who save or who have inherited the savings of their parents and grandparents. The wonderful thing is that anyone can get a piece of this action by saving and investing prudently. Unfortunately, if you don’t save and you don’t inherit a chunk of capital from Aunt Bessie’s estate, you’re left out of the money. In short, the wealth-y will get this wealth. The old saw is true – it takes money to make money.
When President Clinton said, “I want every American to have a savings account and have a part of this country’s wealth,” he was referring to his proposed Universal Savings Accounts, which he wants to enact along with Social Security reform. But a personalized Social Security program can accomplish the same goal. When everyone with wage and salary income is saving and investing in the private sector through PSAs, low- and middle-income workers will own more of America and have a legitimate claim on the economic gains in America’s future.
The left should champion Social Security reform because it is a positive and effective means of creating a more level distribution of the wealth in America. The current system condemns payroll tax payers to an abysmally low rate of return on their investment, generally far below that paid even by Treasury bonds. And, because the payroll tax is so high, particularly when added to federal and state income taxes, workers have little extra income to save and invest more wisely.
As a pension system Social Security guarantees workers a minimum benefit, and then virtually condemns them to doing no better. Reform would break this cycle. And the more fully reform returns payroll taxes to the workers to invest on their own behalf, the more completely the cycle will be broken. When Social Security is personalized, the American worker will see his wealth grow over time. He will see manifested in his own Personal Security Account the advance of his economic status and the dignity and security of owning wealth.