Political Hay

Retirement Plan or Insurance Program?

Critics of Social Security reform don't even know what they're defending.

By 3.22.05

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In his recent article "Blocking Move," Jonathan Chait made a case for obstructing Social Security reform. Although Chait displays some honesty bordering on cynicism (more on that here), his case rests heavily on the idea that (1) reformers want to dismantle the entire Social Security system; (2) reformers are overselling the likely return on personal accounts; and (3) Social Security was intended to be "social insurance," not an investment program. Let's take these in order.

Chait argues that Democrats must oppose all forms of privatization because "conservatives essentially want to do away with Social Security." To support that contention Chait gets out the paintbrush marked "Cato=Extremists" that was last used in late 2001. "Bush has raided the libertarian Cato Institute to stock his staff of Social Security advisers," Chait warns. He quotes liberally from former Cato employee Peter Ferrara: "A lot of conservatives thought Social Security was an unjustified invasion into the private sector," Chait quotes Ferrara as saying. "But they weren't getting anywhere, because that was all negative politics.... Personal accounts would work because that's positive politics."

Ferrara is an odd choice for making the case that conservatives want to eliminate Social Security since he was recently quoted in the Washington Post as as saying, "Cato wants to get rid of the entire Social Security system, and I don't." Indeed, Ferrara supports the Ryan-Sununu reform plan that creates large accounts that are progressive, includes safeguards for unsophisticated investors, and provides a guarantee based on current-law benefits. "That reform is some secret plot to abolish the social safety net is belied by the development of this plan," Ferrara told me in an interview. "It serves the social goals of Social Security far better than Social Security can."

The reality is that there is a wide array of opinion among conservatives on how far Social Security reform should go. Many, like Ferrara, want to preserve key aspects of the current system. Still others, like Bill Kristol and Irwin M. Stelzer, aren't even enthusiastic about reform. To suggest that Cato's thinking on Social Security informs everyone on the right is misleading.

Chait next claims that reform proponents are incorrect when they argue that personal accounts would earn a greater return than Social Security:

Now, any generation could decide to stop paying into the system and keep their contributions in private accounts for their own retirement. These private accounts would appear to earn a higher rate of return going forward -- but only if you ignore the cost of trillions of dollars that must then be borrowed to pay off current Social Security obligations. When these transition costs are factored in, private accounts don't earn a market rate of return either.

Chait's analysis fails to take into account the key fact that any generation that "stopped paying into the system" would also surrender its claims on the system in the future. Any costs today associated with borrowing to pay benefits to current retirees would be offset by savings in the future from not having to pay today's workers -- because their retirement benefits would come from their own personal accounts. He also overlooks the increased taxes and/or debt needed to support the current system that we will avoid having to pay in the future under a reformed system. When those are factored in, the accounts do earn a rate of return.

The President's proposal describes a "benefit offset" that would perfectly assure this, by offsetting the future benefits of anyone opting for a personal account by an amount equal to their lifetime contribution to those accounts plus a financing charge that would make the Treasury whole for any borrowing it had been required to do. Personal account holders would have to earn a rate of return greater than that financing charge -- currently set at 3% -- in order to come out ahead. Based on historical market returns, that should be easy.

Chait also falls back on the Social-Security-as-social-insurance argument:

Privatizers portray Social Security as a kind of low-performing 401(k) plan. But the program was never intended as a personal retirement plan. It's a form of social insurance, designed to spread risks throughout the population. One such risk is that you get sick or hurt and can't work anymore; 11.5 percent of Social Security benefits go to disabled workers (which is another reason why retirees get a lower rate of return).

Another risk is that your income will decline, perhaps because economic changes make your skills less valuable. (Today, for example, steelworkers could be made redundant by productivity increases. Perhaps in 30 years it will be accountants or software engineers whose work was outsourced overseas.) That's why Social Security gives low earning retirees a greater return on their taxes than high-income retirees. Still another risk is that you'll live a very long time and exhaust your savings, which is why old-age benefits are indexed to inflation and last for a lifetime.

It's hard to take this argument seriously for two reasons. First, liberals have spent the last decade defending every last red cent of government spending as an "investment," something that is spent today to yield a greater return tomorrow. Indeed, Chait not long ago zinged congressional Republicans for "cutting support for scientific research [as] an incredibly mindless way to solve the federal deficit." The reason, according to Chait, is that "scientific research is an investment in future prosperity. Cutting the NSF budget is like a family in debt pulling its children out of college but keeping its country club membership." [Italics added.] Now, suddenly, Chait wants us to believe that Social Security is not an investment but social insurance.

Second, if Chait is serious about Social Security being social insurance, why doesn't he go all the way? In other words, he should argue that Social Security ought to cover only those cases -- sickness, less valuable skills, longevity -- that he lists. Turning Social Security into only social insurance would probably solve the long-term solvency crisis. Chait might respond that there are a lot of people who rely on Social Security for retirement income, and since they have paid into the system it would be unfair to cut them off. True enough, but then one has to concede that regardless of what Social Security was intended to be, the outcome is that it now functions as a retirement program. Indeed, the left is not united in this view that Social Security is social insurance. For example, Dean Baker of the Center for Economic and Policy Research, a reform opponent, claimed at a recent America's Future Foundation debate that he saw Social Security as "a public retirement plan."

Since Social Security functions as a retirement plan, we need to acknowledge that it faces the same problems as defined-benefit plans in the private sector. Basically, it is an unsustainable Ponzi scheme because it relies on each generation being large enough to fund the preceding generation's retirement benefits. It is for this reason that much of the private sector is turning to defined-contribution plans.

If Social Security is to survive deeper into the 21st Century, it must likewise change.

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About the Author

David Hogberg is a senior fellow at the National Center for Public Policy Research.  Follow David Hogberg on Twitter.