Plan Weighed to Privatize Portion of Social Security
A Social Security advisory group may recommend a radical change that would permit workers to set aside part of their Social Security payroll taxes in individual accounts for investment in stocks and bonds.
The controversial proposal, if adopted by Congress, would be the biggest change in the philosophy and operation of the system since its creation in 1935.
The plan, to be unveiled next month by the Social Security Advisory Council, would leave about half the payroll taxes in the current system to provide a basic benefit and would place the rest in a personal security account, with each worker selecting how the funds would be invested.
Under the current system, payroll taxes are collected from workers and paid out as benefits to retirees. The money is invested in special issues of Treasury securities. Historically, the Treasury securities yield about 4%, compared with about 7% for corporate bonds and about 10% for stocks.
The advisory council, appointed by the secretary of Health and Human Services, is wrestling with the task of assuring long-run solvency for the retirement and disability insurance system. The trust fund, which now collects money from 125 million workers to pay benefits to 43 million people, is projected to run short of money in 2029 to pay its obligations.
The plan could send $150 billion a year in new money pouring into stocks and bonds, an investment bonanza for Wall Street of the kind generated by the popular 401(k) salary set-aside programs.
The advantage of the new plan is that it offers the potential for significantly higher retirement benefits for workers who make the maximum contribution, those who earn $62,700 or more.
The drawback is that the new system transfers the risk from the government to the individual, whose retirement income would be likely to suffer in a stock market crash or an extended slump.
Lower-income workers probably are better off under the current system because the existing benefit formula gives them a greater subsidy from payroll taxes paid by higher-income workers. Under the new system, the government-invested part of their benefits would provide a lower subsidy.
The transition also would require either a payroll tax increase, or an expanded federal deficit. If payroll taxes are diverted to individual accounts for future retirement, additional money would have to be raised to pay for current benefits.
But the appeal of the proposal may be significant to younger workers, who face the prospect of having to work longer for relatively less generous Social Security benefits than their parents and grandparents will receive.
GOP presidential candidate Steve Forbes has advocated letting younger workers opt out of the Social Security system, diverting part of their payroll taxes into investments. Senate Majority Leader Bob Dole of Kansas, the Republican presidential front-runner, this week also endorsed the idea after criticizing Forbes earlier for supporting it.
The advisory council, whose reports every four years set the tone for legislative changes in Social Security, is deeply divided over the controversial issue. Liberal and labor members could be expected to fight any such plan, which they regard as a betrayal of the basic Social Security system.
Sharp disagreements over the concept have delayed the council’s report, originally scheduled for delivery at the end of last year.
The private accounts plan has the backing of six of the 13 members on the council and could have the support of a majority when the report is issued in March, sources said Thursday. At present, the other seven members are divided between two alternative plans.
Five panelists support a proposal by council member Robert Ball to maintain the current system of mandatory tax collections and benefits, but to invest about 40% of the tax revenues in stocks and bonds. Two favor a third proposal calling for more modest reforms.
If none of the plans gains majority approval, the council will send all three forward. But even if the private accounts plan does not win majority backing, it is expected to open a major new debate.
“For the first time we have a serious group having a serious discussion of Social Security with . . . privatization,” said Robert Friedland, executive director of the National Academy on Aging, a Washington think tank.
Hardly anyone would have predicted a serious look at the proposal when the council began its discussions in 1994, said council member Sylvester Schieber, who is an author of the proposal. But over the course of 15 or 20 meetings, “the issue kept coming up and coming up,” said Schieber, a vice president of Watson Wyatt Worldwide, an employee benefits and consulting firm.
The appeal of the plan is that “everybody ends up getting higher benefits,” Schieber said.
A high-wage worker born in 1970 would retire with a benefit worth $1,908 a month under Social Security, but could enjoy returns as high as $5,243 a month if the payroll taxes were invested in bonds, and $11,729 a month if all the money were placed in stocks, according to an analysis issued by the Cato Institute, a conservative Washington think tank that is a strong advocate of the proposal.
The current Social Security payroll tax is 12.4%, with workers and employers each paying 6.2% on the first $62,700 of income.
The plan under consideration at the advisory council would keep 7.4% of payroll flowing into the current system, enough to generate a monthly benefit of $360 in 1995 dollars. This part of payroll taxes also would keep the current financial protection for disabled workers and the payments to survivors of workers who die before retirement.
The second tier of retirement would be funded with the remaining 5% of payroll, called a personal security account, or PSA. It would be mandatory.
“You have to invest it in individual accounts. You can’t use the money to go to the Bahamas, or eat more TV dinners,” Schieber said.
Anyone 55 or older would remain in the current system, with benefits linked to the traditional Social Security formulas. All other workers would participate in the new two-tier system.
Moving to the new system would cost $1.2 trillion over 35 or 40 years because half the money that now goes directly to today’s retirees would instead be set aside in individual accounts for workers to use in the future. That money would have to be replaced to pay benefits to current retirees.
Choices for financing this burden could include higher payroll taxes, with a jump from 12.4% to 16.4% of payroll, a special national sales tax or a special issue of government bonds.
Senior citizens groups and other advocates of the current system are deeply skeptical about the virtues of the private accounts proposal.
“When we go down the road to privatization we undermine the universality of Social Security--we turn it into a Merrill Lynch investment program rather than a government program out there for all people,” said Evelyn Morton, a legislative representative for the 32-million-member American Assn. of Retired Persons. “Having private accounts assumes that people make informed investment decisions but that is not necessarily the case,” she said. “Even smart investors make mistakes.”
The AARP and other advocates of the current system are more likely to favor the alternative developed by Ball, a former head of the Social Security system.
Under that plan, 40% of tax revenues would be invested in stocks and bonds--but the Social Security Administration rather than individual workers would make investment decisions, putting the money in passive investments, perhaps indexed to stock funds.
A third plan would retain the current 12.4% payroll tax structure, but add a new 1.6% tax, with the extra money flowing into individual accounts.
