Originally published in The Boston Globe
Tuesday, June 20, 2000

Bushs plan to close the gaps
By Martin and Kathleen Feldstein

"A way to turn Social Securitys losers into big gainers"

Debates about Social Security properly focus on the overall financial soundness of the retirement system. But proposals for reform should not overlook the sad fact that there are groups in the system, such as young widows and many divorced women, that are not well served. The current discussions about investment-based reform with personal retirement accounts provide an opportunity to close the gaps.

Texas Governor George W. Bush has proposed that individuals be allowed to set aside a fraction of their Social Security taxes and to deposit those funds in personal retirement accounts. The accounts would be invested in approved mutual funds that offer different mixtures of stocks and bonds.

At retirement, individuals would supplement their traditional Social Security benefits with annuities derived from their personal retirement accounts. If Congress passes a proposal like this, the country would avoid having to make a painful choice in the future between a large increase in the payroll tax or a cut in the retirement income of retirees. The inevitability of that choice if there are no changes in the current system is the primary reason to make a fundamental change.

But an additional benefit of introducing individual accounts is that the demographic groups who are particularly disadvantaged by the current system can become major gainers.

Consider women who have been married for less than 10 years before divorcing. Under current law, when these women reach retirement age, they are not eligible to receive any benefits based on the earnings record of their former husbands. Yet many of these women have made only small contributions to Social Security, because they didnt work or worked only part time. They are much more likely to be impoverished as they age than women who remained married.

In a mixed system, such as Bush proposes, divorced women will have improved security. If they worked before marriage, they will have their own personal retirement accounts, which will continue to grow even if they dont work during their marriage. Bush has not spelled out the details of how assets would be treated at divorce, but the proposals for mixed systems developed by others provide that divorced couples will share the assets accumulated by both of them while they are married. The natural rule under a mixed retirement system is for the personal retirement assets of a couple to be combined and split equally upon divorce. While those assets can be only a part of an overall retirement plan, they offer women far more potential for financial security than the current system.

Women widowed at an early age and who don't have significant earnings of their own are also poorly served under current rules. They are entitled to Social Security benefits based on the earnings of their deceased husbands, but those benefits do not increase because of compound interest and rising share values after death, as they would in a 401(k) type retirement plan.

Overall, women who are widowed, divorced, or never married typically receive Social Security benefits that are only about 60 percent of the benefits of a typical married couple. Under a plan in which 3 percent of earnings are contributed to personal retirement accounts, and in which spouses inherit the balance in these accounts when they are widowed or combine and split the accounts when they are divorced, these women could expect to see nearly a 50 percent increase in their combined retirement incomes from Social Security and their individual account annuities.

For women widowed before 50, the gain compared to their benefits under current Social Security alone is even more striking. They would see their current low benefits rise by more than 50 percent.

A common feature of proposals for individual accounts is the ability to bequeath assets that have accumulated in the retirement accounts. A major reason why young widows would benefit from a mixed system derives from this feature, because it allows growth in the real value of the assets after death. Widows (or widowers) might also bequeath their accumulated assets to children or others if they wanted to do so.

Under a mixed system that sets aside a small percentage of the current 12.4 percent employer-employee payroll tax for individual accounts and assuming stock market behavior similar to the average experience over the last 40 years -almost all retirees will be better off than they would be under the current system alone.

But what would be the cost to future taxpayers of making a rock-solid guarantee that no one would be worse off, even if there was a prolonged slump in the stock market? A statistical analysis shows the cost to future taxpayers would almost certainly be less than the cost in higher taxes that will be required to provide the currently projected benefits under existing Social Security rules.

In short, for future taxpayers a mixed system with such a guarantee is virtually a no-lose bet. Retirement incomes would be at least as high as they are projected to be under current law, but future taxes would almost certainly be lower. Such is the power of compound interest.

Martin Feldstein, the former chairman of the Council of Economic Advisers, and his wife, Kathleen, also an economist, write frequently together on economics.