Why Privatizing Social Security Is a Terrible Idea





Mr. Skidmore is University of Missouri Curators' Professor of Political Science and Thomas Jefferson Professor at the Univ. of Missouri-Kansas City. His most recent books are After the White House: Former Presidents as Private Citizens (Palgrave/Macmillan) and Presidential Performance: A Comprehensive Review (McFarland), both published in 2004.

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When President Franklin D. Roosevelt signed the Social Security Act into law in 1935, he launched the most ambitious program of social reform in the country’s history. It was destined also to become the most popular and the most successful, and to operate with unparalleled efficiency. There was strong opposition, but it became muted after the unprecedented FDR landslide in 1936. The opposition did not die, though; it went underground. It emerged a generation later, when encouraged by the political success of Ronald Reagan and his anti-government message.[1] It now has reached its peak. Never before has a sitting president -- not even Reagan, who became more cautious when he took office -- called openly for privatization (even if, on the advice of his consultants, Bush now avoids the use of the word).

The consensus that Social Security must be “reformed” is an outgrowth of Reagan’s successful conservative movement. Adopting the term “reform,” presupposes that something is wrong. Powerful interest groups foster that assumption, and compliant media have long carried their message. Moreover, even supporters of Social Security have fallen into the trap of its enemies. It is insufficient, they frequently say (Nicholas Kristof is an example), merely to be “nay-sayers.” It is necessary to come up with “reform” proposals to counter the president’s, rather than to “do nothing.” Certainly, that makes no sense -- unless it is clear that indeed something must be done. Despite the propaganda, that is not at all clear. (Note: in the interest of full disclosure, I must say that I am in no way a mere “nay sayer.” As I have outlined elsewhere I have my own proposal to improve Social Security. It would eliminate any question about the viability of the Trust Funds, it would not involve privatization, it would stimulate the economy, and it would provide a tax cut for nearly every worker. It is not, however, needed to prevent Social Security from going “bankrupt,” a word that in any case is inappropriate when applied to a government program.)

The annual reports of Social Security’s Trustees currently include three projections. Alternatives II and III project ultimate depletion of the Trust Funds. Alternative I, however, projects a continuing balance -- no deficit and no future trouble, yet the “Intermediate Projection,” calling for the money to run out is the only one publicized.

In 1983, following revisions to the system based upon recommendations of the Greenspan Commission, the intermediate projections were actuarially balanced. Since 1988, however, they have reflected a depletion year. That date, though, has always been at least thirty-two years away, and in recent years it has progressively receded. The Trustees themselves warn that their projections are not predictions. The fact that the projected depletion year changes constantly demonstrates that cannot be precise. The projections, then, are merely educated guesses.

Oddly, hardly anyone ever asks the obvious question: “what happened to the surpluses projected earlier?” The reports explicitly spell out the answer: nothing happened to them. The Trustees merely adopted more pessimistic assumptions for their calculations! Yet only a few observers ask, “Why revise a superbly successful system because of shaky projections?” Instead, conventional wisdom has come to accept the necessity of “reforms.”[2] People have been frightened by misleading, and largely irrelevant, statistics regarding the number of workers supporting the system. More important by far are productivity and the rate of economic growth. If these continue at historic levels, the Trust Funds will be fully adequate.

As would be expected under the circumstances, there are varied reform proposals. [3] All involve either increases to the Trust Funds, or reductions in benefits. Bush’s proposed “reform,” the administration now admits, would not enhance the ability of the Trust Funds to continue to pay benefits indefinitely, and would involve great benefit reductions for those currently under age 55. [4] Bush’s plan calls for permitting participants to divert a portion of the FICA taxes into private accounts.

Those favoring Bush’s idea allege that privatization in other countries has been a great success. They are wrong. If they believe what they say, they are misinformed. The British experiment is disastrous, as the Wall Street Journal has conceded [5] The UK now looks to a much better system as the British seek to remedy the defects of privatization. That system they are examining is America’s Social Security.

Bush has praised Pinochet’s plan in Chile as being “a great example for other countries.” He has said that the U.S. could “take some lessons from Chile, particularly when it comes to how to run our pension plans.” [6] The Pinochet plan, though, requires huge subsidies, and has saved the government nothing. [7] Moreover, its administrative costs are huge, and it has greatly reduced benefits.

There is a clear warning here. The most highly privileged segment of Pinochet’s military dictatorship -- the one treated most favorably and the one that imposed privatization on the rest of society -- was, of course, the army. The army protected itself, however, and remained in the public system. As a result, it has fared far better in terms of benefits than has the rest of the population.

Many conservatives praise Peter Ferrara’s ambitious privatization plan, but it is based on great optimism, and enormous borrowing. [8] It is clear that diverting money from Trust Funds would worsen any imbalance -- and it is not clear that there even is an imbalance. Nor is it clear why it is that anyone -- for reasons other than ideology or greed -- under the circumstances would advocate privatization (by whatever name).

There is no doubt that privatization would increase administrative costs. There also is no doubt that it would eliminate income transfer, survivors’ and disability coverage, inflation protection, and spousal benefits. These would be terrible losses. Beyond these, privatization would introduce risk, disparity of return, and the possibility of outliving benefits. None of these exist under Social Security.

There can be little doubt, at least among those who view the issue objectively, that it is purely iIdeology (or misinformation), not economics, that generates the enthusiasm for privatization.

NOTES

[1] See Skidmore, Medicare and the American Rhetoric of Reconciliation (Tuscaloosa, Ala: University of Alabama Press, 1970).

[2] See Eric Kingson and James Shulz, eds., Social Security in the 21 st Century (New York: Oxford University Press, 1977).

[3] See Robert M. Ball and Thomas Bethell, Straight Talk About Social Security (New York: Century Foundation Press, 1988), chapter 2; Arthur Benavie, Social Security Under the Gun (New York: Palgrave Macmillan, 2003).

[4]See David E. Rosenbaum and Robin Toner, “Bush Says a Gradual Overhaul of Social Security is Essential,” New York Times (February 3, 2005), p. 1ff.

[5] Benavie, pp. 59-64; Skidmore, Social Security and Its Enemies: The Case for America’s Most Efficient Insurance Program (Boulder, CO: Westview Press, 1999), p. 4.

[6] Larry Rohter, “Chile’s Retirees Find Shortfall in Private Plan,” New York Times (January 27, 2005), p. 1.

[7] Benavie. 2003, 65-68.

[8] Robert Greenstein and Richard Kogan, “The Ferrara Social Security Plan.” Center on Budget and Policy Priorities (December 22, 2003); http://www.centeronbudger.org/12-10-03socsec.htm .

REFERENCES

Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds. Various years. Washington: U.S. Government Printing Office

Baker, Dean and Mark Weisbrot. 1999. Social Security: The Phony Crisis. Chicago: University of Chicago Press.

Eisner, Robert. 1998. Social Security: More, not Less. New York: Century Foundation Press.

Peterson, Wallace C. 1999. The Social Security Primer. Armonk, NY: M. E. Sharpe.

 

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Arnold Shcherban - 3/7/2005

... Which, I can add, very typical of Mr Lederer's debating tactics I know of.


Arnold Shcherban - 3/6/2005

The core internal problems of this country are the wealth
distribution and the practically unchecked corporate power, as the cause of it.
Essentially all moves of Bush administration only exascerbate and deepen these problems.
Until those two main and major problems are adressed nothing really good will happen on national scale for
the majority of the US populace, period.
I forsee the permanent economic decline of this country in 20-30 years with grave social and political consequences followed.


Max J. Skidmore - 3/5/2005

Since Mr. Lederer dealt with none of the points I made, and since others answered him quite thoughtfully, I have not commented further until now. His remark about Social Security transferring wealth from the poorest class (ie those under 35) to the wealthiest (ie those over 65), however, is the kind of misconception based upon propaganda that needs correcting.

Nearly a third of all Social Security checks go to those who are under retirement age. It is a mistake to conclude that payments go only to the elderly. Social Security, either directly or indirectly, benefits every age group.

Moreover, those over 65 as a group are not "the wealthiest." The wealthiest age group is the one that includes only working adults. Without Social Security the elderly would again sink into poverty.

The outrageous rate of childhood poverty skews the results when comparing all under 65 with all who are over. This is a national tragedy, and should be corrected. It is not, however, caused by Social Security, nor is empoverishing the elderly the way to correct it.

How about some humane programs funded by eliminating a portion of the enormous tax cuts recently showered upon the very wealthy? How about providing health care to all, so that we no longer are shamed by being the only advanced industrial country that permits citizens to go without health care because of inability to pay astronomical costs that include huge inefficiencies and great profits to insurance companies?

If you reply to this, please don't whine about taxes inevitably dampening production, incentive, and economic growth. American business is stronger than that, and American executives don't quit working because they must pay tax. The best economic periods in modern history--perhaps in all of human history--were the high-tax years following World War II, and those following the Clinton tax increases of 1993.


Andrew D. Todd - 3/2/2005

Age groups are not different classes. They are as likely as not to be members of the same family, and families have linked economic interests. Exemptions, progressive rates, taxation of benefits, etc., can be cranked in and out to create whatever degree of net progressivity you happen to want.

At some point, someone has to say the obvious. The stock market is in a prolonged period of doldrums. Investors who were previously tolerant of their stockbroker's percentage are becoming intolerant, because the market is no longer rising, and are insisting on lower fee schedules. The whole point of Social Security "Reform" is to bail out Wall Street by pumping in lots and lots of new money. As politics, this is foolish. The Wall-Streeters would vote Republican in any case-- they haven't got any alternative, and there is nothing much to be gained by appeasing them. On the other hand, if the lower middle class is made to invest its retirement savings in high-tech companies which have no real assets, and which are in the process of being rapidly outflanked in the marketplace, they may very well lose 80-90% of their money within five years. The consequence will be that the Republican Party will be reduced to minority status for a generation, the way it was after 1929. Bear in mind that the most vital cluster of ideas running around the high-tech world at the moment is open-source, not just in software, but increasingly in genetics and molecular biology. You cannot buy into the probable winners, because they are not for sale.

The modern corporation was a product of a definite set of historical circumstances, having to do with the rise of mass production. The whole idea was that you took a complex job of work, and broke it down into a lot of simple jobs, to be performed, monkey-fashion. Eventually you added "fixed automation," tools designed to one micro-job and one micro-job only. As an engineering idea, mass-production is practically dead. The practice of mass-production lives on, but only as a legacy, the "mangy mule in the back pasture," as the railroad writer Don Phillips phrased it. Nowadays, engineers are thinking in terms of small machines which can automatically do many things, and which are cheap enough to be owned by individuals. The computer is of course the most perfect example, but there are others, such as prototyping machines.

In the year 1800, corporations were still confined to a narrow area of economic activity. Generally speaking, they did not exist in manufacturing, merchandising, or most services. The wealthy working proprietor, the small businessman, provided as much economic organization as was needed. Textile machinery existed, but it was still not of sufficient scale to drive corporatization. An individual who owned a steam engine, carding machine, spinning frame, and power loom was in a position to set up in business making cloth. The Lowell Company, the first modern manufacturing corporation, was an anomaly because it was driven by a large scale hydropower development. This involved building dams miles away to give a reliable flow on the Merrimack River. Corporations existed in transportation infrastructure (canals and turnpikes), finance (central banks, such as the Bank of England), and in quasi-governmental colonial operations (eg. the East India Company).

I would argue that corporations have essentially surrendered the initiative. For example, in the field of education, I can only think of only one reasonably prestigious degree-granting corporate school, Embry-Riddle Air University. Even that is a special case, because flight training is economically a matter of renting airplanes. There are a number of proprietary schools which give training in business administration, but no one would consider them remotely comparable to the Harvard Business School, or the Wharton School at the University of Pennsylvania, or to the MBA program of the local state university, for that matter. When corporations cannot even dominate the teaching of their own key subject, that is a sign of intellectual decadence. This intellectual decadence has been building for fifty years or so. Corporations have become increasingly dependent on universities for basic research. The significance of open-source software was that academic research reached the point of becoming a usable product without having to pass through a corporation first.

I think corporations are going to go into a period of long decline, rather like agricultural landlords in the nineteenth century. In the production of knowledge, they will be unable to compete with the university; in the production of services, unable to compete with small businesses; and in the production of goods, unable to compete with the third world. The survivors will be the ones who ruthlessly reduce their costs faster than their income, like the nineteenth-century landlord who stayed afloat by rapidly turning out the peasants and replacing them with sheep, even at the cost of his personal prestige.


James Spence - 3/2/2005

So far your replies in this discussion are simply denials and fail to produce any evidence to support all of of your statements.


John H. Lederer - 3/1/2005

"Remember who the people behind this reform. Most of them have been schooled, in some form or other, in the political philosophy Leo Strauss, "that an elite recognizes the truth, however, and keeps it to itself." Therefore this falls right into the hands of the neoconservatives who use this philosophy to create myths, create fears under various ruses, for the good of the people. Bush has the ear of these people and it is directly relevant to the discussion on social security as well as other issues we see in the news."

That is a pretty long extension from left wing journalist William Pfaff's rather ignorant characterization of what Strauss said about philosphers up to Immanuel Kant.


James Spence - 3/1/2005

I have no claim to being an expert on social security but I feel I do know a few minor things. That it’s kept a great many people from sinking into complete, abject poverty. It’s done so for a long time and will continue to do so with the necessary adjustments.

All the arguments I’ve heard so far for getting rid of social security are never backed by sources which are indisputable. In fairness, my sources, like everyone else’s can be also disputed. Therefore, all this is nothing but discussion and opinion. But one really has to look at the political angle. Not to acknowledge it is to ignore something very essential to the whole point here.

Remember who the people behind this reform. Most of them have been schooled, in some form or other, in the political philosophy Leo Strauss, "that an elite recognizes the truth, however, and keeps it to itself." Therefore this falls right into the hands of the neoconservatives who use this philosophy to create myths, create fears under various ruses, for the good of the people. Bush has the ear of these people and it is directly relevant to the discussion on social security as well as other issues we see in the news.


John H. Lederer - 3/1/2005

"If the cap on income subject to Social Security taxation set at $90,000 in wages was eliminated so that all income was subject to the tax, there would be no shortfall in the trust fund in 2042, in 2075, or ever."

We would also subject those with high taxable incomes to a large tax increase with a very high marginal rate. Most would suspect that would lead to redesign of compensation packages to avoid the payroll tax, with concomitant distortion of the economy.


It would also lead to increased political pressure on Social Security as people compared what they get to what they would get from Social Security to what they would get were the money in a private plan.

I already see a form of distortion from the increase of the base. Many tax lawyers will make the same observation. A common redesign is to restructure firms in the skilled trades s so that the workers are independent subcontractors doing job work. What takes it on the chin in the process is other worker benefits like health insurance, unemployment compensation, workmen's compensation, etc.

Nor would such a massive tax increase solve the problem. The estimate that I saw was that it would postpone the problem about 7 years.

Don't you see something wrong in a program that has moved from a 2% tax on $3,000 to a 11+% tax on 90,000 over the years that suggests it is a problem.?




John H. Lederer - 3/1/2005

"That is to miss the whole point. Of _course_ Social Security is not a funded actuarial plan. It is secured by the power to tax, to conscript, to eminent-domain, and to print money."


Isn't the power to tax bounded by a limit? Payroll taxes are, I think, a particularly noxious tax.

As a social welfare program, social security traduces the concept. We take from the poorest class (those under 35) and give to the wealthiest class (those over 65).


Andrew D. Todd - 3/1/2005

That is to miss the whole point. Of _course_ Social Security is not a funded actuarial plan. It is secured by the power to tax, to conscript, to eminent-domain, and to print money. If necessary, pension payments can be funded out of a "millionaire's tax." During the Vietnam War, there was a special "doctor's draft," to procure sufficient M.D.'s. Over the last few years, the Social Security Trust Fund has lent money to the general revenue, enabling the reduction of tax rates applicable to rich people. There is no reason why the process should not run in reverse if necessary.

Similarly, your calculations about ratios of workers to nonworkers, even if correct, do not mean much. Luxury goods, produced in small quantities, tend to employ much more hand labor than mass-produced necessities, mostly because the conditions for automation are not present. At this stage, manufacturing in general is so automated that manufacturing per se is probably not an issue. The difference is mostly in the bundled services. Of course the real issue would be in services per se. If it were necessary to economize on labor, there would be a lot fewer waitresses, a lot more self-service, that kind of thing. I gather the Germans are doing a partial preview of this sort of thing, because they have an educational system set up in such a way as to discourage teenagers from working at dead-end jobs. They are forced to do things like discovering the extent to which a store can be converted into a vending machine. Similarly, in parts of Switzerland, there are unmanned convenience stores run on the "honor" system.

What impresses me about your posts on Social Security is the extent to which you rely on classical macro-economics at the expense of practical details. We do not have one big undifferentiated lump, called Labor. We have a variety of different occupations, some of which are more essential than other occupations. Similarly, we do not have a big lump, called Share Capital. We have a variety of industries and companies, each of which have their particular circumstances. I realize that reasoning from Adam Smith may be a lawyer's way of thinking about issues, but I am very doubtful whether it is valid in economics. I think Barbara Ward was a much greater economist that Milton Friedman, for example. See for example, her classic work on village shopkeepers in Malaysia. Instead of drawing abstract supply and demand curves, she looked at what village shopkeepers actually did, and considered what the implications of this would be.


James Spence - 3/1/2005

The 2042 projection by the Social Security Administration was a conservative projection made a few years ago based upon unreasonably low estimates of future economic growth.

The Congressional Budget Office and most independent economists say that the trust fund should enable the system to cover all benefits through at least 2052 and perhaps through 2080 and beyond.

If the cap on income subject to Social Security taxation set at $90,000 in wages was eliminated so that all income was subject to the tax, there would be no shortfall in the trust fund in 2042, in 2075, or ever.

Most crucial fact that right-wing critics of Social Security fail to mention: by 2045 nearly all of the Baby Boom generation will be dead

there is no crisis

The president and right-wing politicians who want to wreck the system know that the crises is not for Social Security but for their political agenda . The "third rail" of electoral politics it will become the Molotov cocktail, exploding the political status quo.

By 2025, when the bulk of Baby Boomers will be in the 65–80 age bracket, retirees will represent 25 percent of the voting-age population, an increase of 45 percent in their relative voting power

The right talking about a generational conflict between older retirees collecting pensions and younger workers paying the taxes to cover them is a ruse—a reflection of a panicky effort to destroy Social Security before the Baby Boomers realize where their real political interests lie.

If this happens, God forbid, a movement to expand Medicare from a niggardly program that only barely covers the medical care of the elderly to a full-fledged national healthcare program that covers everyone may also be in the cards.


John H. Lederer - 2/28/2005

There are two main problems with social security.

1) First it is an essentially an unfunded pension plan. As the system needs money to pay benefits, it goes to the current taxes being paid by future retirees.

This subjects it to all sorts of problems. One is that it is very sensitive to demographics. The four main parameters of social security are average benefits, average taxes, the number of workers and the number of benficiaries.

(avg. taxes) x(number of workers)=
(avg. benefits)x(number of retirees)

OR

avg. taxes = avg. benefits x ( retirees/workers)

Congress has repeatedly attempted to stave off Social Security insolvency by varying these parameters. It has, since 1935, increasedthe tax rates 35 times either by increasng the FICA rate or by increasing the amount of wages taxed. It has also gradually increased the number of workers paying social security taxes by expanding those who must pay into social security -- the original act excluded farmers, civil service employees, domestics, the military, and other groups.

It has also, for politial reasons increased benefits and the number of people entitled to them --though that effect is not as great as the ratio of retirees to workers.

These repeated tax increases have generally each been explained as "fixing" the problem, only to be succeeded by subsequent tax increases as the fixes prove to be faulty.

The principal problem is demographics. Social Security cannot tax many more workers because almost all are now taxed. It cannot, other than by increasing the retirement age reduce the number of retirees -- that is controlled by historical birth and immigration rates, and by advances in longevity.

That this is the principal problem is easily seen by the change in the ratio for retirees to workers from 1:40 in 1935, to 1:16 in 1960 to 1:3 today and a projected 1:2 in the not distant future. Changing those numbers in the simplified formula above easily lets one see the problem -- we have gone from a .025 multiplier to a .33 multiplier, and we will likley go to a .50 multiplier. Most of the rest of the chnage in parameters is relative peanuts.




Social Security needs to be changed to a pre-funded pension plan.



2) Compounding the problem is what we have done to put aside money to cover the increasingly obvious looming shortfall ( a step, if properly done, towards pre-funding).

The extra money was paid in taxes, lent to the treasury, with demand notes received in return (actually the "notes" are just a few pages of figures). The treasury then spent the money it borrowed.

What this means is that when social security starts to demand money for the notes (in 2018 in the "middle" estimate), the treasury will have to obtain the money -- from the taxpayer. In other words, John Q. Citizen will have to pay again.

Congress can, of course, provide adequate funds for social security by increasing the tax rate -- but many believe that we are well into the area where the payroll tax rate has serious negative consequences for economic decisions. Congress could also reduce benefits or raise the retirement age -- but those seem politically improbable.

Note that switching from a non funded plan to a pre-funded plan is largely a matter of shifting the timing of obligations, rather than increasing or decreasing them (if the time value of money is taken into account).

Right now the Social security system has a huge unfunded obligation to all the people covered by social security. As they retire they will want their checks, We do not have the money. If we shift people to another prefunded plan, it will mean that we have to come up with money now to replace their tax income to the present social security fund, but we will not have to come up with money when they retire. It is a wash, but we do convert a long term obligation to a short term one.

Th "trillions in conversion cost" that critics of chnage bruit about is not really a conversion cost. It is forced recognition of the hole --in the form of huge unfunded obligations-- that the system presently has.

Notice that this discussion does not mention privatization. A prefunded plan could have the government invest the money in the private markets (in something other than government obligations). This was Pres. Clinton's proposal. Alternatively people could choose their own investments regulated to a greater or lesser degree by the government. Bush's proposal. Both have plusses or minuses and the decision of which, I suspect, has strong ideological components.

But the main thing is to change from an unfunded pension plan to a funded one.