Saving Social Security: Basic Principles for a New Approach John Atlee, 3/29/98

The fight to save Social Security is largely a battle of ideas -- concepts, definitions, relationships, perceptions. Those who define the terms of debate usually determine the outcome, and the enemies of SS now seem to be doing better at this. Friends of SS urgently need to put forward an imaginative bold new approach to the alleged "crisis" which will put opponents on the defensive and correct the many confusions, myths and intentional "misinformation" which now give them an advantage. To protect SS from partisan and ideological political tampering, and to restore public confidence in it, the public needs to understand much more clearly how the system really works.

This is a brief simplified summary, with comparisons to private pension plans, mainly for use in public education programs.

Safety net.  Social Security -- the Old Age, Survivors and Disability Insurance System -- is a basic financial safety net of almost every American family.

Financial asset.  What is not as generally recognized is that the SS retirement annuity is also, for the vast majority of families, their most important form of saving and most valuable financial asset. Together with the other SS benefits for dependents, survivors and disability, the whole package may now equal up to $1 million of private pension and insurance policies.

Individual accounts.  Each worker and his/her employer make FICA contributions into the individual worker's SS account -- much the way workers and employers make contributions into supplementary private pension plans.

Benefit amounts.  The amount of each worker's retirement benefit is determined largely by the amount of past contributions into his/her account -- much as with private pension funds -- but with these significant differences:

1. Before retirement, the value of FICA contributions and benefits are adjusted for the growth of average U.S. real wages, and after retirement benefits are adjusted for inflation -- something few private programs can do.
2. The relationship of contributions to benefits is "progressive;" lower-income workers "get back" a larger amount, in relation to their total contributions, than higher-income workers (one reason many upper-income people would like to opt out and "privatize" the system).
3. SS also includes benefits for dependents, disability and survivors, not available in most private plans.

Self-financing.  The SS System is essentially self-financing. Contribution and benefit rates are periodically adjusted so that total projected FICA contributions will be adequate to finance total projected benefit payments -- given the future demographic/actuarial relationships and future economic conditions assumed in the Social Security Trustees' 75-year projections, which are discussed in Section III.

Understanding the nature, effects and implications of these assumptions is essential to understanding the real nature of the purported "SS crisis" and proposed ways to solve it. (See also, on the IEA web site, "The Phony Social Security 'Crisis'")

Current contribution and benefit flows.  In terms of current financial flows, Social Security, like most private retirement and insurance programs, is financed mainly on a pay-as-you-go basis in which most benefit outflows are financed by contribution inflows from current workers. This superficial appearance allows enemies of SS to attack it as an "inter-generational transfer" system in which struggling young workers are financing aging retirees' high standard of living. However, as explained below, that is not an accurate picture of how SS really works. Ironically, one of the main functions of the SS System is to avoid the need for the pre-SS burdensome "inter-generational transfer" responsibilities within individual families. Fortunately, most young people realize this.

Funding and "unfunded liabilities."  Private business firms can go bankrupt or go out of business. When that happens, pension plans which operate on a pay-as-you-go basis leave their pensioners stranded. Thus, most private pension plans are now legally required to keep their pension funds independent of the business operating accounts and to be "fully funded," with their total pension fund assets always sufficient to finance all future pension obligations, even if the employer firm goes bankrupt. Because the United States will presumably never "go out of business", the SS System does not need to be fully funded for all future retirees.

The special problem of the large post-war "Baby Boom" generation (born 1946-63).   During their working years, Baby Boomer FICA contributions are much more than needed to finance current benefits to retirees. But this imbalance will be reversed when the Baby Boomers themselves retire, beginning about 2010; then the bulge in their own benefit payments will become much larger than the current FICA contributions of the smaller work force at that time.

To avoid the need for raising FICA rates or reducing benefits when that actuarial imbalance develops, provision was made for accumulating the Baby Boomers' work-life surplus contributions in the SS Trust Fund, and investing the funds in Treasury securities -- where most private pension funds also invest a large part of their assets. The current surplus FICA contributions, together with interest on the accumulated Trust Fund securities, is now about $100 billion a year and growing fast. If used as intended, and insulated from mismanagement of the economy, this would be sufficient to "fully fund" the Baby Boomer bulge.

But instead of being saved for this intended purpose, the Trust Fund surplus is now, in effect, being "embezzled" and used to offset (and hide) the continuing large deficits in the operating ("Federal Funds") component of the "unified" federal budget -- a practice which is rightfully illegal for private business pension plans. (The "unified" budget was introduced in 1969, reportedly partly to hide Vietnam War deficits.)

The basic reforms needed.  To restore public trust in Social Security, restore federal fiscal responsibility, clarify SS issues and counter the many misconceptions, confusions and "misinformation" which have caused so much cynicism these basic reforms are necessary:

• The SS account must be separated completely from the rest of the federal budget.
• The financial soundness of the SS System must not be held hostage to government mismanagement of the whole economy.

The whole Social Security account -- benefit payments, FICA contributions and the Baby-Boomer's Trust Fund -- must be completely separated from the federal operating budget.  This reform is now being actively espoused by more leading politicians and economists (e.g., former Clinton advisor Alicia Munnell in The American Prospect for May/June 1998). SS must be treated as a federally-sponsored but financially independent agency -- as the Post Office and most other federally-sponsored financial agencies are now. The President and Congress should both be required to present their proposed budgets in this form -- particularly in the pie charts and other visual presentations which provide the main basis for public understanding of the budget.

This reform would produce several important benefits:

1. Safeguard the Trust Fund.  Clearly separating the Trust Fund surplus from the operating deficit would expose to clear public scrutiny the way the present "unified" budget actually "embezzles" the Baby Boomers' Trust Fund, and would make it politically much more difficult for Congress and the President to continue doing this. This would probably do more to reduce young people's cynicism regarding the future availability of their SS benefits than any other currently discussed reform.

2. Facilitate comparisons with private pension and insurance plans.  Viewing the SS System as an independent agency would help to highlight its similarities to, and differences from, private pension and insurance plans, as outlined in Section I. This would help to clarify many key sources of confusion and misunderstanding.

3. Clarify the "funding" confusion.  The fact that the federal government does not need to "fund" its retirement benefit obligations except for demographic/actuarial anomalies like the Baby-Boom generation is not a weakness of the SS System (as alleged by critics when they call it a "ponzi scheme" with "huge unfunded liabilities"). It is merely recognition of the special credibility of the federal government -- a credibility which will be vastly increased by putting SS into a completely separate account, completely out of the operating budget -- as is now required for private corporate pension plans.

4. Clarify the "entitlement" confusion.  Taking SS completely out of the federal operating budget would clearly separate SS benefits, both conceptually and politically, from other so-called "entitlement" outlays which are very different in function and financing from Social Security -- such as means-tested "welfare," farm income supports, college loan subsidies, mortgage-interest tax deductions, "corporate welfare" tax breaks, etc. This linkage has been a main source of confusion in the SS debate, and lends important support to those who want to link SS with "welfare" in order to "privatize" or reduce it.

   A March 12 Washington Post business page article, "Victory in the War on Poverty: So Near, Yet So Far," provides a good example of this confusion. In a pie chart labeled Components of government transfers to the poor," 66% was "Social insurance, including Social Security, unemployment, workers' compensation." It is likely that most of those receiving SS benefits, which they earned themselves by their FICA insurance contributions, would resent these benefits being called "government transfers to the poor." The only way to end this confusion is to take such self-financed social insurance completely out of the federal operating budget.

5. Clarify the "Contributions" vs. "taxes" confusion.  "Taxes" are levied on the general public, usually without any direct link to a particular type of spending or beneficiary. FICA payroll deductions are explicitly called "contributions" -- the "C" in FICA -- (rather than "taxes") to emphasize that these deductions are for the specific benefit of the individual worker. When the SS accounts are independent of the main budget, current FICA contributions will no longer be combined with taxes in budget presentations. A side benefit will be that the main measure of total federal taxes will be reduced in a way that will make them a more difficult target for those who would "reduce the size of government" by reducing taxes.

6. Counter the basically false perception that FICA contributions are "regressive taxes."  Keeping benefits and contributions together in a separate SS account will make it easier for ordinary people to understand that FICA contributions are not "taxes" (as explained in #5, above) and are "regressive" only in that better-paid workers don't have to make FICA contributions on income above $61,000. More importantly, it will make it easier for people to understand that the SS System is clearly progressive, in a redistributive sense, because low income workers "get back" proportionately more in benefits, in relation to their FICA contributions, than do higher income workers.

7. Encourage more rational public discussion of budget allocations.  With SS out of the budget (and thus separated from other "entitlements") the relative size of other government expenditures such as military, debt interest, education, welfare and foreign aid becomes much easier to understand.

8. Help focus analytical and policy attention on the real federal deficit.  Contrary to general public perception -- based on the "unified" budget presentations -- the federal operating deficit is not even close to zero (it is $155 billion in '98 and doesn't go below $100 billion for the foreseeable future); it is only being masked by SS and other Trust Fund surpluses. And the SS Trust Fund has a surplus only in the current-flow perspective, because every cent of the Fund balance is needed to pay Baby Boomer retirement benefits. Taking SS Trust Fund surpluses out of the unified budget and bringing the continuing large operating deficit into full public view will help stave off demands for tax reduction until the remaining operating deficit is also eliminated -- to the extent that that is appropriate economic policy, as discussed below. Every $100 billion reduction in the deficit directly saves about $5 billion of interest cost -- funds which can be used elsewhere -- and indirectly saves much more by general reduction in interest rates.

9. Help clarify the key economic relationship between the federal deficit and the rest of the economy.  Every recession "automatically" increases federal deficits by reducing tax receipts and increasing "depression-relief" spending. In particular, It reduces additions to the SS Trust Fund by stopping FICA contributions from the unemployed and by adding retirement benefits for those forced into involuntary retirement.

   Economists call such a recession-induced increase in the federal deficit an "automatic stabilizer" because it helps compensate for the corresponding recession-induced reduction in business and consumer borrowing which tends to cause a recession to "feed on itself." Thus the economically appropriate size of the federal operating deficit depends very largely on the current amount of private consumer and business borrowing. It would be easier to understand these relationships if the effects of the SS and other Trust Funds were taken out of the operating budget.

   Technical note:  Traditional Keynesian economics is based largely on the National Income and Product (NIP) economic accounts, which produce the well-known GDP measure of economic output and growth. Because the NIP accounts are conceptually and statistically unable to deal directly with the crucial financial (saving and borrowing) aspects of the economy, they measure the "saving" of each economic sector (including the federal government) by subtracting its borrowing from its positive financial saving. As a result, many traditional Keynesian economists oppose taking the SS Trust Fund out of the budget and treating it as an independent component of our national financial saving, simply because their non-credit conceptual framework has no way of effectively dealing with the data in this way. They justify their opposition by saying that when the Treasury borrows from the SS Trust fund, the government is just "borrowing from itself." Treating SS as an independent entity and taking the Trust Fund completely out of the main federal budget would help clarify this issue.

10. Help pave the way for clearly separating the "Policy Deficit" from the "Stabilization Deficit."  It would be much easier to understand and manage the operating deficit if the effects of government policy decisions -- the "Policy Deficit" -- were separated from the effects of the economy on the deficit -- the "Stabilization Deficit." (cf. "A Twin-Deficit Perspective on the Federal Budget.") Separating SS and its Trust Fund surplus from the operating deficit would provide impetus for this improvement of federal deficit management.

To understand the present SS "crisis," and to protect it from political tampering, three basic facts about the relationship between SS and the economy must be recognized:

The myth that the Social Security System will go bankrupt by 2029 is not based on inherent actuarial relationships but on the Social Security Commission's obsolete and inappropriate economic assumptions.  The SS Commission's 1996 Annual Report calculated its 75-year projections based on economic conditions with three levels of unemployment: 7%, 6%, and 5% -- see the attached charts adapted from that report. Their highly publicized "bankruptcy" warnings are based on their "intermediate" 6% unemployment assumption.

But In their analysis and public statements, they paid almost no attention to their own 5% unemployment projection -- in which SS is financially sound for the foreseeable future. With the 4% unemployment rate mandated by the Humphrey/Hawkins "Full Employment and Balanced Growth Act of 1978," it should even be possible to reduce FICA contribution rates, rather than increase them, as is now being considered. (The dashed 4% unemployment lines on these charts are my own rough guess at what this projection would look like if the Commission were to attempt a systematically researched version comparable to the other two.)

Low unemployment helps SS finances in several ways. It reduces the number of older and partially disabled people who can't find jobs and the number forced into involuntary retirement, and employers have more incentive to tailor their working conditions to attract and hold onto older workers. More people working means more FICA contributions and less benefit payments.

The SS Commission's pessimistic "intermediate" projection was based (explicitly or implicitly) on four highly dubious economic assumptions, which should be given very close scrutiny in the 1998 nationwide discussion of SS:

1. that all capitalist economies have an inescapable "business cycle" which fluctuates between boom and depression;
2. "that the increasingly discredited theoretical NAIRU -- Non-Accelerating-Inflation Rate of Unemployment -- is still about 6%;
3. "that the U.S. government cannot or will not adopt more systematic economic policies which could get the average unemployment rate down to pre-1973 levels;
4. "that to be considered credible and responsible, an economic forecast and SS financial plan must be based on the above three assumptions.

Most Commission critics question the long-run assumption of 1.4% growth -- less than half the U.S. historic average. But the assumption of continued high unemployment is even more egregious. To talk about a "SS crisis" without focusing attention on these assumptions and better ways to deal with them is really to perpetrate a fraud on the American public.

1. Recessions, depressions and high unemployment are not natural disasters and are not inevitable.  As the present Asian Crisis is again demonstrating, they are man-made by poor economic policy. Today, the U.S. has one of the best managed economies in the world, with unemployment down close to 4 1/2%. But for 14 straight years before the 1974 four-fold OPEC oil price increase was allowed to wreck the world economy most other major industrial countries kept their unemployment below 2%. During the 28 years from 1945 to 1973, U.S unemployment was below 4% in ten, close to 3% in four, and above 6% in only two. We can and should do that again.

2. Rational discussion and management of SS finances (as well as the rest of the federal budget) can be greatly enhanced by clearly separating the effects of policy decisions from the effects of economic fluctuations -- and from economists' unreliable and frequently changing economic forecasts.

   Demographic and other actuarial variables can be predicted with reasonable accuracy for a fairly long period ahead, but cannot be controlled. Economic conditions cannot be predicted with any great accuracy, but can be much better controlled by more responsible and systematic economic policy. Thus, these two elements in the long-term SS projections should be separated.

   For SS, the best way of doing that is by presenting and analyzing SS projections on a stable "full-employment" basis (which the CBO also calls a "standardized employment" basis). The future inflow of contributions and outflow of benefit payments should be estimated at the levels which would pertain in a stable full-employment economy.

   Any shortfall of actual contributions from the full-employment levels, or excess of actual benefit payments above those levels due to economic conditions should be made up by explicit transfers of operating budget funds to the SS Trust Fund, and thus reflected in the operating budget's deficit -- just as now results from recession-induced reductions in income tax receipts or increases in unemployment and "welfare" payments.

   Initially the full-employment budget for the SS account should be based on the 4% unemployment target mandated by the Humphrey/Hawkins "Full Employment and Balanced Growth Act of 1978." However, as noted above, we should ultimately be able to do much better than that.

1. Require the President and Congress, in their budget proposals, to completely separate the entire SS account, including the Trust Fund, from the federal operating budget, so that the Baby Boomers' crucial Trust Fund surpluses are no longer being "embezzled" to hide operating budget deficits.

2. Require the Social Security Commission to:
   • Shift its three economic projections from the present 7/6/5% unemployment to 6/5/4% unemployment.
   • Put its primary publicity emphasis on the 5% projection (which is financially sound for the indefinite future).
   • Pay much more attention to the potential implications of the 4% projection.

3. Require that if economic conditions cause the relationship between FICA contributions and benefit payments in any year to be less favorable than the 5% unemployment projection, the shortfall in the resulting addition to the Trust Fund must be made good from general funds (with resulting increase in the reported operating deficit). Conversely, if economic conditions are more favorable, the surplus would be transferred to the operating budget.

These three measures will pave the way for later putting the SS projections on a 4% unemployment basis and for separation of the reported operating deficit into its policy and "stabilization" components.

Many other minor modifications of the SS system would undoubtedly be useful and appropriate. But these three measures that will most effectively "save" it, financially and politically. If they are actively and adequately discussed in the various public forums on SS this year, they could also become key issues for political debate prior to next November's election.

The Social Security Trust Fund's own report shows that under reasonable unemployment-rate assumptions, the system is financially sound into the indefinite future: