A Secure Social Security Plan

Social Security, for years untouchable on the sidelines of American politics, has finally been called into play in this election. Unfortunately, fear of an oncoming collapse has given strength to those who call for speculative, unworkable and possibly very unfortunate changes in the program's fundamentals. Social Security must be patched up through wise economic policy, not through appeals to magical market forces; specifically, investment of social security funds in private securites is not likely to improve the system's finances and would only further the political agenda of its advocates.

While Texas Gov. George W. Bush has not completely outlined his Social Security plan, he has indicated that he would support taking a portion of money out of the current system and placing it in private accounts. This money could then be invested in stocks and bonds, as has been advocated by Bush advisor and Baker Professor of Economics Martin S. Feldstein '61. Feldstein has argued that private investments will create a "All-Gain, No-Pain" fix for Social Security, as the swirling stock markets buoy the program to higher and higher returns. Yet pleasant fantasies may not serve as the basis for future policy, and there are several persuasive reasons why such painless gains will not be realized--and should not be pursued--outside the theoretical realm.

First, investment in private securities will not bring the benefits that its supporters have claimed. Both stocks and bonds are evaluated on the same scale of risks and return; to argue that stocks will continue to provide higher risk-adjusted returns than bonds in the future is to say that the market is frightened and overestimates the dangers of holding stock. The stock market's high returns over the last 50 years may have been unprecedented, but so was the recent rise in stock prices, which seems to indicate that investors have arbitraged away any misperceptions. Economists widely dispersed across the political spectrum, from MIT's liberal Paul Krugman to Harvard's conservative Waggoner Professor of Economics Robert J. Barro, have described past gains as a result of historical mispricings and written that there is little reason to expect stock gains to continue to outpace those of Treasury bonds. Indeed, some of Bush's closest advisors have argued that the stock market is overvalued and is due for a correction, making now a particularly bad time to invest society's nest eggs in the market.

Second, simple-minded comparisons of a two percent Social Security return with seven percent returns from stock investments ignore the cost of pre-funding the system. As Barro has written, Social Security's return is so low--lower, in fact, than the Treasury bonds in which it invests-- because today's workers must pay for today's retirees. No program that takes money out of the system and puts it into private accounts can avoid the obligation to pay for current retirees, which would lower the returns. Bush's repeated comparison of the returns on Social Security and safe government, which surfaced again in the first presidential debate, therefore approaches the level of a simple falsehood.

Third, taking money out of the current system introduces significant new risks. If a stock downturn comes, there could be serious shortfalls requiring additional spending. Furthermore, administrative costs are likely to be far higher than supporters have predicted, resulting in lower returns. Even Feldstein's plan calls for a period of Trust Fund bankruptcy from 2031 to 2052--bankrupting the system six years early. During that period, the government would have to borrow immense sums to fund the benefits without raising the real interest rate above three percent. The plan relies on further increases in returns and additional infusions of corporate tax revenue, but our generation should not have to rely on the aid of the bond market.

Fifth and finally, such a partial privatization of Social Security would be regressive. Current Social Security benefits provide higher returns to lower-income individuals; that would not be the case in individual accounts. Placing money in private accounts would undermine the concept of a system for common provision. So far, the fears of Social Security shortfall have been used as a club to advance the cause of privatization as a way of "doing something" about the crisis; however, private accounts should appeal only to those who, like Barro, favor them for ideological and not economic reasons.

In contrast to Bush's large-scale reforms, the Social Security proposals of Vice President Al Gore '69 have been far more modest, consisting mainly of using the Social Security surplus to reduce government debt (the infamous "lock box") and a commitment to prolong the program through 2050 with general revenues--which must come from other taxes or from deficit spending. Gore has also argued in favor of a separate program to match the savings of lower- and middle-income Americans with tax credits. This proposal, which would improve personal savings in a progressive way, deserves serious attention.

The unsuitability of private securities as a panacea does not end the need for serious plans to shore up the program. Infusions of cash will be necessary and increased national saving essential. Furthermore, we would like to see retirement security addressed as part of a general policy to reduce poverty and improve income security for all Americans, rather than as an isolated program. In this election, however, the more pressing needs are to resist self-delusion and to avoid speculating on Social Security.