Reinventing Retirement.

Fixing Social Security is just the beginning

Social security is not going "bankrupt," as a recent poll found three-quarters of Americans believe, but it is getting--well, a little frail. The root of the problem is that our current system is "pay as you-go": the money from today's payroll taxes goes straight back out the door to pay current retirees, whose contributions to the system vanished instantly to pay the benefits of the retirees who preceded them.

For the time being, more money flows into than out of the system. But as the population ages--particularly the 76-million strong Baby Boom cohort--and as life expectancy expands, the number of Social Security recipients grows inexorably relative to the number of workers paying into the system. In about 20 years the outflow will exceed the inflow, and little more than a decade later, if no changes are made, revenues will fund only 75 percent of the benefits due.

That means someone will have to pay more or get less: Either we raise payroll taxes by almost $500 a year for each worker, or cut benefits by even more. Perhaps this Gordian knot can be cut, though, if we recognize that Social Security poses two distinct questions: how best to care for those who are now, or soon-to-be, retired, and how best to structure retirement security for those who will retire as much as a half-century from now and will live with the system we design until the end of the next century. The competing one-size-fits-all solutions currently being advanced--the New Dealers (keep Social Security forever more or less as it is now, with minor tinkering to shore up the insolvency problem) versus the New Wavers (scrap this industrial-era, welfare state dinosaur and replace it as soon and completely as possible with private savings and stock market investments)--do not address the reality that different people and different generations need different answers.

We're not going to tell an 80-year-old widow dependent on Social Security that the social contract has changed and she's going to have to get a job. In fact, we're not even going to tell someone a year or so from retirement that his plans are out the window because the expected income he's based it on is being precipitously reduced. In short, any changes made in Social Security are primarily, if not entirely, going to affect younger Americans, those in their 20s and 30s. And they'll want and need a very different retirement system from what exists today--both public and private. After all, more than half the workforce, and more than 60 percent of those earning less than $30,000 a year, has no pension coverage. Employer-provided plans have steadily declined over the past two decades. Women, because their average income tends to be lower and because they are twice as likely as men to have part-time jobs, are more likely to have no pension.

These people deserve to benefit from the same retirement security which Congress has made increasingly available to the wealthy and upper middle class. What is needed, then, is a strengthened system of private retirement savings--but not the one that the Wall Street opportunists and latter-day economic Darwinists envision. Rather, it should mean a more universally available, nationwide, portable pension system--a private savings and investment mechanism that is accessible and familiar to low-and-middle income families. And it should continue to include a baseline guarantee of security--the kind that the government, not the market, will provide.

Mending the Net

First things first. Restoring Social Security's solvency--its ability to pay all promised benefits over the 75-year planning horizon used by Social Security Administration actuaries--is actually quite easy, at least in theory. Numerous proposals, most of them amounting to marginal change, abound. For instance, the Bipartisan Commission on Entitlement and Tax Reform--one of many federal commissions appointed in recent years to study and re-study the issue--considered 13 separate specific reforms, as well as two "comprehensive" congressional packages (one advanced by former Rep. Dan Rostenkowski of Illinois, the other by former Rep. Jake Pickle of Texas) containing a half-dozen small items each.

But ideally, we would also make the Social Security system fairer. Although the current benefit formula does contain a bit of means-testing, this hardly compensates for the larger inequity of the payroll tax that is central to Social Security. The payroll tax is inherently regressive: It is imposed only on earned income--and not on such income sources as capital gains, dividends, and interest, which accrue overwhelmingly to the wealthy--and at a flat rate. But, on top of all that, there's a cap on the income level to which it applies--meaning that if you make more, there's no tax on the extra. A top executive making $300,000 pays the same amount as a middle manager in the high $60,000s; everyone making more than the current cap of $68,400 pays a lower percentage in tax than everyone making less. It's means-testing, all right--in reverse.

That's why the single biggest thing we could do to make the overall Social Security structure more fair and solvent is to eliminate the cap on earned income subject to the payroll tax. That would mean that the $300,000 executive would at least pay the same tax rate as the day laborer earning $20,000. This change alone would solve about half of the total insolvency problem. And it would be paid for entirely by those most able to bear the burden--people still in their productive years and making more than $68,400. Of course, that is precisely its biggest problem in practical terms: Those best able to pay are also best able to flex the political muscle (and make the campaign contributions) necessary to keep from bearing this burden.

The next biggest step would be to raise Social Security's "Normal Retirement Age" (NRA) early in the next century. Despite the way it sounds, this would affect younger, not older, Americans: Clearly, the retirement age can't be suddenly raised just as someone is about to reach it. But changing demographics suggest something must be done: When Social Security was started, life expectancy was age 62; now it is age 76. With medical advances and healthier lifestyles, life expectancy will continue to grow, in turn lengthening the receipt of Social Security benefits. Thus, in 1983, when Congress last tried to save Social Security, an increase in the NRA was adopted over a long phase-period: The age will rise from its current 65, to 66 for people now in their early fifties over a period of six years ending in 2008; twelve years later, in 2020, it will then begin to creep upwards again in two-month intervals until it hits age 67 for people now in their late thirties. If we wipe out this 12-year hold so that the age rises to 67 that much sooner, let it continue to rise to an even more realistic 70, and then index it further for actual growth in average life spans, we would obtain almost 40 percent of the savings needed to make Social Security solvent long-term--but it would be paid almost entirely by those now below the age of 40. No one over age 57 today would be affected at all. That still leaves us a little shy of the total savings needed to restore long-term solvency, but that can be made up by simply requiring new state and local government employees to join Social Security like everyone else.

With those three steps, Social Security could be made more fair, more inclusive, more reflective of current realities--and solvent for the foreseeable future. And all without changing the basic premises and structure of the system.

Future Shock

These answers for keeping Social Security paying its full retirement benefits demonstrate that the solution of the system's infirmities isn't likely to be an "elderly issue" at all. We're talking about what Social Security will look like four decades from now, in the 2030s--a century after its inception. The nature of work, retirement, and the social safety net are all changing radically, and will be even more different in 2032; Social Security, the program designed to address these specific issues, must necessarily change, as well.

One way to approach Social Security's long-term future is to ask, What would an "ideal" retirement system look like? Stanford Ross, Social Security Commissioner under President Carter, argues that any intelligent system rests on an assortment of pillars--public and private, individual and employer-based, defined-contribution and defined-benefit. The old principle of strength in diversity counsels us not to rely on just one.

An "ideal" retirement system would therefore embrace several components. First, everyone would save and provide for her own retirement. This could be achieved through individual savings. Or, as started to happen this century, employees who "invest" many years of their life in a firm might, like other investors, receive some kind of financial stake--whether equity in the firm or an employer-based pension--that would continue to pay dividends even after they were no longer contributing new inputs. Society could encourage and augment such efforts through the tax system. Finally, since we don't live in an ideal world, either an intra-generational "insurance pool" or a trans-generational welfare program would support at minimally decent levels those who find themselves with insufficient means in their old age.

This is, in fact, more or less the system we have now. Social Security--formally known as "Old Age, Survivors, and Disability Insurance" (OASDI)--achieves the purposes of saving (the government does it for you), regulating the safety of your retirement investments (the government, again, invests the money in ultrasafe Treasury bonds), and providing minimum benefits, very mild income redistribution, and insurance payoffs if death or disability renders family self-support difficult.

These different aspects of Social Security need to be approached differently. Retirement saving might very well be done better through the market than the government, but income redistribution, by definition, cannot be. Fundamental philosophical questions about the nature of retirement and the role of government in the mid-21st century, therefore, should properly precede the current facile political debate about Social Security "privatization". If they did, America would likely come out with a long-term plan providing not one answer, but a mixture of approaches. And it also turns out that that's what we'd likely get if we asked young Americans--the ones who will actually have to live with the retirement system we design for 2032 and beyond--to design it themselves. That's what Linda Rhodes did when President Clinton nominated her to serve as Deputy Commissioner of the Social Security Administration, and as her accompanying article notes, she found that today's young Americans have a distinctive generational viewpoint that renders most of their elders' polarized ideological debates, especially on this issue, irrelevant. And, as a serious analysis of the policy questions involved reveals, they're right.

Of its various component functions, Social Security's "pension plan" aspect is by far the largest: The "Survivors & Disability Insurance" function, protecting the widowed, orphaned, or disabled, consumes only about 3 percent of the nation's payroll. The remaining 9.4 percent of the payroll tax goes to "Old Age" payments--a government-run, underfunded, defined-benefit pension savings plan. (Out of that, about one percent goes to provide the guaranteed minimum benefit to those who, under a strict contribution-based system, would receive even less).

It is also Social Security's pension role that raises the most questions: Why not transform the program from a defined-benefit plan into a defined-contribution plan, and let the pensioner bear the risk of whether his investments produce enough to live on down the road? Why not at least give the pensioner the benefits and risks of investing her nest-egg in something more exciting than low-risk, low-yield US Treasury bills? Why not convert the current pay-as-you-go system--a pyramid scheme that would never be permitted in the private sector--into one where each worker's investment actually finances his own retirement? In fact, why is the government doing all this for us instead of simply mandating that we save and (perhaps) regulating our investments' safety? For that matter, why have government do anything at all? Just let people have their 12.4 percent back in cash!

"Privatization" has therefore become an increasingly central topic in the Social Security debate. The prospect gained momentum from the amazing stock market surge, the attendant increase in the number of Americans investing in the market, and the large number of financiers salivating at the thought of what it could mean for them if billions of dollars now held in T-bills were suddenly turned into brokerage accounts. Early in 1997, members of a national advisory commission on Social Security issued dueling reports on how to stabilize Social Security; while they could not reach consensus, each proposal contained some type of privatization component.

It's important to understand, however, that, in this context, privatization doesn't mean precisely what it does in most policy disputes: ending entirely the government's involvement in favor of purely private activity. No one is suggesting--yet--simply abolishing Social Security and letting the private sector provide for old people's retirements as it sees fit. Even in this age of market-worship and general public hatred of government, few Americans are ready to treat the real world as simply a more exciting version of the old Milton Bradley "Game of Life," letting old folks end up in some pathetic "Poor Farm" if they made the wrong choices or got a few bad spins along the way. This may be what many ideologues pushing privatization eventually envision, but for the time being, what's meant by privatizing the program comes in three basic flavors:

"Vanilla": Social Security invests some of its funds for you in private securities instead of government bonds. This option, preferred by adherents of Social Security in its more-or-less traditional form, isn't really privatization in any meaningful sense--in fact, it is designed to head off privatization. It would simply allow Social Security to take advantage of the higher yields--and higher risks--of investing in stocks and bonds instead of just T-bills.

At the opposite end of the taste spectrum is: "Chocolate," which would allow you to invest all or part of your Social Security contribution however you see fit, by giving you the money back in a Private Retirement Account. Chocolate's supporters include not only right-wingers who want to dismantle social insurance systems and stock-brokers who want to profit from investing all those funds, but also people who want higher returns on the nation's trillion-dollar collective nest-egg but find scary the "vanilla" prospect of the government owning voting stock in private companies amounting to one-sixth of the entire US economy.

Chocolate itself, however, is viewed as a distinctly dark alternative by those who worry about tens of millions of Americans who have never seen a proxy statement being asked to make sophisticated investment decisions--which leaves us with the option Washington is likely to embrace, which, as usual, is: "Fudge"--something that masquerades as chocolate, but with a vanilla twist. Under this plan, an individual could choose from a government-provided list, kind of like the United Way campaign, as to how a small share of her Social Security "account" is invested. The rest would continue to be handled by the government as it is now. While this is now the most likely proposal from the Clinton Administration, debate rages over the exact contours of such a fundamental change and what fraction of the current payroll tax citizens would be allowed to earmark.

This line of thinking, of course, begs the question whether the government in a free society should mandate that citizens save at all. But the people you would normally expect to fixate on this question--the laissez-faire types of the right--seem all too happy to support a government mandate here because, after all, we're talking billions in potential commissions. And isn't that what laissez-faire policies are all about?

Whatever the philosophical issues, the reality is that some sort of mandated savings program is simply less problematic than all the alternatives: If you just let people manage their finances as they choose, you'll eventually wind up with some starving seniors, and are you really going to let them eat dog food? If not, that means allowing people onto the gravy train in the end without imposing any commensurate responsibility on them to try to look after their retirements themselves. The government mandating that all Americans save for their future and then regulating what they may invest in to ensure that no one squanders their basic nest-egg is therefore the route that winds up making the most sense; the right-wing ideologues who want to privatize everything and the old-time lefties who want no changes are thus both out of step with reality.

Private Problems

Getting over the ideological objections to privatization turns out to be the easy part. The hard part is getting past the technical difficulties. The thing that people who promote privatization as a panacea overlook is that there are costs involved. And when you take those into account, the change-over isn't quite so painless or profitable.

First of all, we're not writing on a clean slate: Millions of older Americans are expecting Social Security checks to show up in their mailboxes next month, and that money's not coming from what they paid into the system years ago--we've already spent that. This is the fly in the ointment for those who want to privatize the whole system right away: It's one thing to tell a 24-year-old to start saving some of her income for her retirement; it's another to tell that to someone who's already retired. Benefits for current retirees will simply have to continue being paid--and that means current workers can't just be allowed to take all their payroll taxes and invest them for themselves: For the time being, 94 cents of every dollar of payroll taxes will be needed to pay current beneficiaries.

If everyone's going to start funding their own retirements, then the entire system must first undergo a massive change-over to a fully-funded system, from the current "pay-as-you-go" funding scheme. This raises the "someone pays twice" problem: Not only must the money be made available to pay current and looming retirees, but the current working generation's "pensions" must be funded now. Dealing with this change-over problem will cost the equivalent of an additional one percent of payroll, or $30 billion per year.

Privatization proponents insist that putting taxpayer funds into private investment vehicles will yield far higher payoffs, meaning we can get by in the future with lower contribution levels. Ultimately this is true--assuming, of course, that the current refusal of the stock market to keep rising is an aberration--but this only compensates for some of the transition costs. Restoring solvency, and converting from a pay-as-you-go system and the continuing, though declining, need to keep paying current retirees' benefits under the old system mean that such a change--even if phased in over the next 30 years--would wind up saving less than one-half of one percent off current payroll tax rates (a 100 percent, immediate conversion would actually require a tax increase).

Even then, we'd have to ignore Social Security's two other components: social insurance and a guaranteed minimum income for the elderly. But unless we're just going to throw dependent widows and the disabled out into the cold, the "insurance" portion of Social Security--for survivors and the disabled--will have to remain in effect, and that requires, you'll recall, a payroll tax of three percent. Ensuring a minimum level of retirement for all beneficiaries requires another one percent of payroll: That need won't disappear simply by letting intermittent, minimum-wage workers play the stock market with their excess spending money. If we maintain these commitments, the total cost of a solvent, privatized Social Security system would be slightly less than 15 percent of payroll through the first third of the next century, compared to the 12.4 percent rate of today. And a private system would also abandon the current system's mild redistributive effect by which lower income workers get back proportionately more on what they pay into the system.

In sum, even in a privatized world, we'd still have to raise taxes substantially or cut someone's benefits (and it would probably be the poor). There's no such thing as a free lunch, even--if not especially--in the private sector.

Port-a-Plan

This doesn't mean that privatization isn't part of the solution. It is: To deny that is to insist that either the trillion dollars of retirement income we now set aside in Social Security should, at a time of looming insolvency, earn the lowest return possible or that, while the money should indeed be put to work producing higher returns, Alexis Herman and Donna Shalala should then control one-sixth of all equity in Corporate America. Attempts to "fudge" the issue by providing for private investment of only one or two percent of current Social Security taxes might make sense as a way to test the waters, but are rather unconvincing as ultimate solutions. If personal retirement accounts do make more sense than government-managed investment in T-Bills, then it makes sense for more than a mere two percent. If they don't, then why bother with them at all?

In fact, it makes perfect sense to let Americans handle their own retirement savings instead of doing it through the current Social Security system. We still rely primarily on private retirement planning in this country--we just don't think of it as part of the same "system" as Social Security. Perhaps it's time we did.

President Clinton and Congress have in fact taken some steps in the past two years to promote private retirement savings, making it easier for small businesses to set up pension plans. What is really needed, however--and we are slowly creeping in this direction--is a coherent approach to retirement savings that makes them universally available and portable: no more complicated vesting and roll-over rules, no more loss of savings just because one changes jobs, just a simple, tax-assisted system that encourages workers to sock money away for tomorrow and employers to provide some compensation in deferred form, as well.

Additionally, a government-sponsored, privately-managed pension pool--already proposed in pending legislation--could create a universal and portable system allowing businesses or their employees to "buy in," as has been proposed with government employee health benefit plans. (See "A Health Care Plan Most of Us Could Buy," April 1998.) There's no real reason to differentiate new private savings devices--except to continue the increasingly disparate treatment afforded higher-income savers. Just let savings, up to some reasonable, middle-class level, accrue tax-free until retirement, whether the payor into the Retirement Account is the worker, her employer, or Social Security.

But ultimately, individual responsibility for retirement saving isn't a complete answer. Not everyone will be able to care adequately for his own future--and not just because of poor judgment: The lower one's income, tine more saving is a luxury. That's why we got Social Security to begin with. If we want to continue to ensure that the unlucky or unwise can still live at a minimum standard of decency in old age, we'll have to pay for it through a Social Security program perhaps reduced somewhat in importance relative to beefed-up private pensions and savings, but nonetheless restored to solvency.

Would younger Americans be willing to bear the bulk of this burden, especially if it's for the purpose of preserving transfers to the needy? Let's face it: They have no choice. If we're utterly irresponsible and do nothing to change Social Security, they'll eventually wind up bearing the entire burden, anyway. But as Linda Rhodes writes below, today's younger Americans are perfectly willing, where their parents apparently are not, to ensure that other generations, as well as the less fortunate members of their own, are ensured a decent retirement. It's just that, along with this responsibility for others, they want to be given responsibility for themselves. Unlike their elders who have made such a mess of Washington, younger Americans seem to be interested in both the "security" and the "social" aspects of Social Security. Let's hope someone in the capital starts listening to them soon.

RELATED ARTICLE: Listening to Generation X

Tony Ross is in his mid-twenties. He feels like he's one of the lucky ones his age because he, unlike many of his friends, actually has a job in an area that he studied--and he has health benefits (one in three Americans between the ages of 20 and 34 don't). He's delaying marriage, stayed with his parents after college to save on rent and isn't so sure his younger cousins will be able to go to college like he did because student loans are too hard to come by now--that's why the poorest 25 percent of families are actually enrolling their kids in colleges at lower rates than they did fifteen years ago. His view of the future is somewhat hopeful, but he strongly believes that things will not be as good for him as they were for his parents.

"I'm not being cynical, it's just the way it is," he says. In fact, Tony and his counterparts are already making 32 percent less in real median weekly earnings than were young men back in 1973. Nevertheless, when it comes to Social Security, he thinks the regular deductions from his paycheck are a good idea: "My grandmother couldn't get by without it, so I really don't mind paying for her. But I'm not going to count on it for me." So, although still in his twenties, he's already investing in a pension plan, the first in his family to do so.

Tony doesn't sound like the typical young American today--termed "Generation X," to their annoyance--often portrayed as ungrateful, cynical, bored and unengaged. But rather than Tony being atypical for his generation, it's the stereotyped Generation Xer that's atypical.

It is "Generation X" who will be most affected by Social Security's insolvency in 2032, when they're beginning to retire. Quite simply, their Baby Boomer parents will have spent one-quarter of their children's Social Security checks. Some legacy to leave behind.

So now we find ourselves in a great public debate and discussion to remedy this broken intergenerational compact. And though the President is to be commended for holding town meetings across the country to engage the public, the generation so obviously missing from the table--a table set by the mistakes of the generations now hosting the soiree--is the generation with the most at stake.

I set out to understand what's important to Generation X--Americans born between 1960 and 1982, who at 79.4 million outnumber even the Baby Boomers--on behalf of the Social Security Administration after the President nominated me in 1995 to become the agency's new Deputy Commissioner. After a year of talking with Xers and pouring over the latest research on their generation, I left the experience not only with a better understanding of them but with a sobering and apologetic view of my own Boomer generation.

Of course, there is no true, all-encompassing description of any generation. But generational personalities do emerge, due in large part to cultural experiences their members all shared when they came of age. My generation grew up with Ozzie and Harriet, the Mickey Mouse Club, the Camelot of the Kennedy years, and unprecedented economic boom times. We entered our late teens with a sense of optimism and conviction that we could go off and change the world--we could even conquer space or end a war.

Ask Xers what national events they remember from when they were coming of age and they wilt recall America held hostage, long gas lines and a space shuttle exploding with a teacher on board as they watched live in their classrooms. They've grown up with the threat of AIDS, the Wall Street Crash of 1987, and terrorists on American soil. As "latchkey" children, they've been fending for themselves since the ripe old age of six while Harriet worked; they saw Ozzie mostly' on weekends--maybe: Forty percent of Gen Xers are children of divorce. The message? Life is insecure. Times can be tough. Institutions--marriage, government, religion--are unreliable. You can only count on yourself. Is it any wonder that a poll found more Gen Xers believing in UFOs than in Social Security? They're not cynical, they're just realistic.

What would such a generational outlook contribute to the Social Security discussion? Plenty. Take, for instance, the debate over privatization. Rather than being "slackers," as so often described in popular media, GenXers are great at digesting deluges of information and at multi-tasking (listening to a Walkman, surfing the Internet, and answering the phone at the same time). Perhaps as a result, they are in fact more financially savvy at their age than any Americans before them: These young people are investing more in their twenties than their parents or grandparents did. Taco Bell recruits young workers today by offering them stock options and 401 (k) plans. How many Boomers were thinking about stock options when they went looking for their jobs at age sixteen? They are pragmatic and entrepreneurial: Rather than simply accepting that their economic prospects are being downsized for them by our generation, they have ventured off into the world of small business and today dominate the software world.

Generation X appears, on the whole, well suited to handle the demands of self-directed investing of a portion of Social Security. They are, as a group, far more committed to saving for themselves, far more financially sophisticated, far more self-reliant, and far more capable of handling the information tasks of personal financial management in the future than were past generations.

For those who might interpret Gen X's financial savvy as a green light for an everyone-for-himself privatization of Social Security, however, think again. Having grown up in the most diverse population in American history, Generation X is much more racially and socially tolerant than its elders, and having been brought up largely in divorced and/or latch-key homes, they yearn for a sense of community very much evidenced in the popular sitcom, "Friends." For them, the Brave New World of the next century does not mean an individualistic abandonment of each other, their parents or grandparents, or of social cohesion; they are not a go-it-alone or survival-of-the-fittest bunch. As a result, they envision a Social Security that is both secure and "social." And unlike their want-it-ail-now forebears, they are willing to pay for it. They just want a better return on investment, a more modernized program that takes advantage of information technology, and a decentralized program that gives them more control over the funds. One survey of 18- to 29-year-olds found that 94 percent believed that Social Security payments were essential and even though the majority thought they might do better investing4heir own money, 90 percent wanted Social Security to be there just in case.

If we listened to Generation X, we would construct a system that retained Social Security's current guarantee of a minimally decent retirement for all working Americans and helped those hindered by misfortune, while still trusting most Americans to take care of themselves. Ideologues who believe that the political changes of the '90s are the wave of the future are no more in touch with tomorrow's leaders than are those trapped in the '60s, '70s or '80s. A politics dedicated to both individual autonomy and responsibility on the one hand, and social commitment and compassion on the other, would be reflective of the values of Generation X. That makes these young people a far better bet to uphold these essentially American values than some of their self-interested and ideologically absorbed elders (those of us over thirty) who have dominated the debate over their children's retirement while their own remains virtually untouched and secure.

This doesn't mean we need an intergenerational war over Social Security: As far as I can tell, Generation Xers certainly don't want one--despite press reports to the contrary. But we do need to reach out to this younger generation to learn from them and engage them in designing what is their future. Reaching them is going to take some work. They won't be found as some well-organized lobby group in the Beltway (a real Xer disdains such associations). Nor will their voices be heard through a few token appointees to a panel or at well-staged town meetings--they see through the hype.

We will need to cast a wide net and tap into them through the places and institutions where they--not we--like to "hang": the Internet, campuses, vocational schools, electronic magazines and MTV, the local coffeehouse or micro-brewery, on the loading docks of employers like UPS and the retail stores in America's malls, on the floors of computer shows, and through television talk shows.

It will take a real commitment to involve our young people in this great debate. But solving the future of Social Security without their values will yield results poorer than what they deserve and surely less than what prior generations would have wanted left to them.

LINDA COLVIN RHODES spent a year studying Generation X as a consultant to the Social Security Administration. [e-mail]

ERIC B. SCHNURER, is president of Public Works, a public policy analysis and consulting firm.