Retirees Today

A Shaky Future for Social Security?

A Presidential panel favors investing Social Security funds on Wall Street but downplays the risks.

Millions of Americans have relied on Social Security benefits for the last 62 years. But a report issued in January sent an earthquake through this bedrock of American life -- and possibly through the financial planning of millions of working people.

In its report, President Clinton's 13-member Advisory Council on Social Security offered three options to help Social Security remain strong into the next century. Each of these included controversial proposals for investing a portion of Social Security's resources in the stock market and other forms of private securities that are more risky than today's government-sponsored investments.

"There is no immediate crisis in Social Security and there are many possible solutions to the expected shortfall in the next century. But we're skeptical of plans for privatization," says AFSCME Pres. Gerald W. McEntee.

"Social Security is the foundation of retirement income. It's a guaranteed benefit that's essentially risk-free," he emphasizes. "Most AFSCME members build on this foundation with their public employee pensions and private savings -- both of which are dependent on market forces and contain some element of risk. Why would we want to add risk to Social Security and jeopardize the one retirement benefit that is absolutely guaranteed?"

Social Insurance. Social Security was never intended to be an investment plan. Pres. Franklin D. Roosevelt, who presided over the creation of Social Security, considered it social insurance designed to help Americans protect themselves against the hazards of life.

As social insurance, the system provides assistance to disabled workers and their families, to the families of deceased workers and to retirees and their spouses.

Roosevelt's program has succeeded and has become an indispensable lifeline for millions of Americans. In fact, if it were not for Social Security, fully 50 percent of seniors would be living in poverty today.

But Social Security is not a welfare program in which the government provides assistance free of charge: Workers and their employers pay into the system. Benefits are based on employee/employer contributions and replace a percentage of lost earnings.

Solvent Security. For virtually all of the 62 years since Social Security's enactment in 1935, the system has operated primarily on a pay-as-you-go basis. Payroll taxes have been set at rates that cover current benefits and little more. As a result, most of the payroll taxes collected from employers and employees pass through the Social Security Administration and exit SSA immediately in the form of benefit checks. SSA has never failed to meet its monthly benefit obligations.

The relatively small amount of money that's left over is placed in a "Trust Fund" and invested, by law, in government securities. In short, the government borrows the money and pays interest to Social Security at market rates.

In recent years, this scenario has been slightlyaltered. A 1983 bipartisan commission foresaw the coming of the huge baby-boom generation and decided that Social Security needed to save for the future. A small increase in payroll taxes at that time insured that the Trust Fund reserve would reach a trillion dollars by 2001. Currently $500 billion, the entire Trust Fund reserve is invested in essentially risk-free government securities.

As the baby boomers begin to retire around 2011, they will draw down the reserve until it disappears around the year 2029. At that time, with no changes in the system, current payroll-tax levels will be sufficient to pay about 75 percent of scheduled benefits. To go beyond 75 percent, the system will need to take in additional revenue or make benefit adjustments. How to do this is the challenge that faces Social Security.

Privatization. Each of the three Advisory Council options seeks to use a form of private-market investment to make up part of the shortfall. Here is a brief description of the three privatization proposals.

• Maintain Benefits Plan. This is the least revolutionary proposal because it would retain the system as a social insurance program and would continue to pay benefits directly linked to lifetime earnings. To increase revenue to the system, however, the plan would invest 37.5 percent of Trust Fund reserves in the private market rather than in government-backed securities.
• Individual Accounts Plan. This plan imposes an additional 1.6 percent pay-roll tax on workers (not shared by employers), with the proceeds to be earmarked for mandatory IRA-style investment accounts. The permanent cost to working families would be about $13 billion a year (in 1998 dollars). At the same time, the plan would cut currently scheduled benefits by 30 percent.
• Personal Security Accounts (PSA) Plan. This plan would earmark a portion of the current payroll tax (5 percent of the 12.4 percent employer/employee tax -- a little more than a third of the total) for mandatory IRA-style investment accounts. Retirees would receive a flat benefit of $400 a month (the current average benefit is $745); the rest of their Social Security income would be based on their personal investment skills and the general health of private markets.

High Costs. Since current retirees and those who will retire shortly must be assured the benefit levels they expect to receive, the PSA plan recognizes the need to continue the current system at the same time that it introduces the new system for younger workers.

The cost of doing this is astronomical. It would require a massive tax hike that would drain family income and corporate profits at the rate of $12.5 billion a year for the next 72 years (a total of $6.5 trillion). The PSA proposal also calls for borrowing an additional $2 trillion from the Federal Treasury over the next 33 years.

The cost of maintaining the system would also soar. Today it costs under one percent to administer Social Security. Under the new system, the estimated cost would skyrocket to at least 7 percent, payable as commissions to private investment firms. This would come directly out of benefits.

And then, of course, there's the basic issue of risk. "The stock market is hot today," McEntee says, "because the baby boomers are pouring money into it. But what will happen when they all start retiring at the same time and pulling their money out of the market? We just don't know."

Add to these factors, the potential investment of more than a trillion dollars in Social Security funds. According to McEntee, the introduction of Social Security funds could force other investors out of the stock market or depress the overall value of stocks. "Who knows what could happen to the economy," he says, "if we were to take this leap into the unknown."

The International president urges AFSCME members to continue to follow this issue as it makes its way through the White House and Congress. "We just can't risk Social Secutity benefits -- and possibly our pensions and personal retirement savings -- on so risky a venture," McEntee says.