Originally published in The Wall Street Journal
Thursday, August 2, 2001
Democrats Play Politics With Social Security
By Martin Feldstein
The interim report of the presidents Social Security commission was attacked by leading congressional Democrats and denounced in labor-organized rallies across the country. The reaction seems totally out of proportion to the content of the report, which essentially repeated earlier official actuarial estimates that annual Social Security taxes will no longer be enough to pay benefits after 2016, forcing a reduction in benefits, an increase in taxes, or borrowing from the public.
Why did critics trash a report that presented a widely accepted analysis of Social Security, and that was supported unanimously by a distinguished bipartisan group? The commission is equally divided between Democrats and Republicans and has, as one of its two co-chairmen, Daniel Patrick Moynihan, the leading Democrat who retired earlier this year from the Senate. Mr. Moynihan has been a long-time defender of Social Security and a proponent of many liberal causes. So why is the commissions report the object of such unwarranted attacks?
The critics paid little attention to the substance of the report, focusing instead on the commissions presidential mandate to develop an operational plan for adding individual investment-based personal retirement accounts to the current pay-as-you-go, tax-financed Social Security system. It is the idea of a mixed system with investment-based personal accounts that generates a vitriolic partisan response.
A mixed system is neither radically dangerous nor the mark of a conservative government, as a review of experience in other countries makes clear. Sweden, the leading welfare state in Europe, allows employees to shift a portion of their tax payments, equal to 2% of earnings, into individual investment accounts. Those who choose this option -- and most Swedish workers do -- have their pay-as-you-go benefits reduced accordingly, but can expect that the combined benefits from the two sources will exceed what they would get from the full pay-as-you-go system alone.
Australia had a Labor government in 1986, when it shifted from a pure pay-as-you-go system to a mixed one with personal retirement accounts invested in stocks and bonds. Germanys Social Democratic government recently announced that it could not afford the pension benefits projected in current law. The legislation that followed reduces future pay-as-you-go benefits, but gives individuals the opportunity to increase total benefits through personal investment accounts. And Britains Labour government has shown no interest in reversing the shift to a mixed system put in place by Margaret Thatcher.
There are other such examples around the globe. They illustrate not only that mixed social security pension systems are technically feasible, but also that they have been attractive to left-of-center welfare states as well as to politically conservative regimes in countries like Chile. They have switched to mixed systems because they recognize that the investment-based component lowers the future taxes required to provide social security retirement benefits. The political incentive to make this shift is amplified by the effect on future benefits of an aging population. Ownership of the investment-based accounts also gives individuals a greater sense of security at a time of uncertainty about the future payment of traditional tax-financed benefits.
The Social Security actuaries in the U.S. project that maintaining current benefit rules in the present pure pay-as-you-go system would require raising the employer-employee payroll tax rate to more than 18% from the current 12.4%. This increase can be avoided by shifting to a mixed system. Calculations show the same expected benefits could be provided by a combination of personal retirement account annuities and the pay-as-you-go benefits that can be financed with the existing 12.4% tax rate.
George W. Bush proposed switching to such a mixed system as a key part of his presidential campaign and subsequently appointed the commission to work out how such a system might function in practice. The commission will look at issues such as how much of existing payroll-tax revenues should go into the personal retirement accounts, how the funds would be invested, what guarantees would be available, and how married couples would be treated.
Which brings us back to the question of why the commissions report and the presidents proposal have been attacked so ferociously. Some of those who oppose shifting to a mixed system may fear that doing so would hurt low-income individuals. Research has shown, however, that a mixed system could raise benefits for all groups, with particularly favorable effects on those low-income groups like older widows and divorced women for whom the current system performs very badly.
Some opponents of a mixed system express concerns about the investment risks that would be imposed on future retirees. But the higher return on investment-based accounts means that the system could reduce the risk of a benefit decline to a very low level, or even guarantee that the combined benefits would be at least as large as those projected in current law.
These are technical problems that can be resolved by the conimission, the president and Congress. They do not explain the partisan attacks and demonstrations. The most likely explanation is that the Democratic Party leaders see Social Security as a potentially winning issue in the 2002 congressional elections, as well as in the 2004 presidential election. Although a majority of voters in polls now favor the shift to a mixed system, opponents believe that they can change their minds. Im betting the opposite. As American voters see what a mixed system would mean to each of them individually, the popularity of this reform will rise even higher.
Mr. Feldstein, chairman of the Council of Economic Advisers under President Reagan, is a professor of economics at Harvard. He is a member of the Journals Board of Contributors.