SS Reform or Deform?

Michael Eisenscher meisenscher at
Thu Jul 30 13:12:20 PDT 1998

At 10:19 AM 7/30/1998 -0400, Charles Brown wrote:
>I urge you to post the paper.

Here is an expanded version of what appeared in Z. Michael E.


Beginning in the 1970s, escalating during the Reagan/Bush Administrations, and continuing unabated under Clinton, the assault on the standard of living of the American working people continues unabated. From the signing of NAFTA and GATT to gutting the meager social safety net represented by the welfare system, the Clinton Administration has been a willing, cooperative, and even eager partner with the GOP in dismantling what remains of the New Deal social contract. Having had his way with welfare recipients, Clinton and his Republican and Democratic partners have turned their attention to the Social Security System.

Aided by a smokescreen of fear-stoking propaganda generated by a multi-million dollar campaign cooked up by corporate interests and their ideological storm-troopers in Washington think tanks, the public is being softened up to accept "an end to Social Security as we know it." Surveys are conducted to demonstrate that most young people do not believe Social Security will be there when they retire. Baby Boomers are warned they must save more if they want to retain their standard of living when they retire. Pundits issue dire warnings that we face a "crisis" unless we do something now to "fix" the Social Security program. Editorial pages and nightly newscasts echo the message without ever determining whether all this "sky is falling" brouhaha has any real substance to it.


The SS Trust Fund runs a current annual surplus of $60 billion. Based on current projections there are sufficient reserves to cover all retirees until 2029.

In 2012, with the retirement of baby boomers, benefit payouts will start to exceed taxes collected. At that point, the Social Security Administration will have to draw on interest earned to cover benefits. In 2019 benefit payments will exceed taxes collected and the fund will have to start drawing down its reserves. By 2029 the trust fund would be depleted. At that point, FICA taxes collected would only cover about 77% of benefits due.

To correct the gap, the Social Security Administration calculates that a 2.2% increase in payroll taxes would suffice. Alternately, a reduction of 15% in the value of benefits would accomplish the same goal.

However, these numbers are merely estimates. If any of the underlying assumptions are off, these estimates are either inflated or too low. In order to know for certain whether there is a problem and how serious it is, one must accurately project into the future changes in demographics, productivity, inflation, and wages -- as well as geopolitical events, like the OPEC oil embargo of the 1970s or the Vietnam War, as well as the consequences of natural disasters.

Assuming that these projections are reliable, we don't have to cover the entire amount all at once. There are many alternatives for generating additional revenue. A FICA tax increase on both employees and employers of just 0.05% each year between 2010 and 2046 (totaling 3.6%) would maintain current benefits into the foreseeable future.

The growth rate of the economy over the past twenty years averaged 2.8% per year. It is conservatively projected to drop to 1.8% over the next twenty years and then to 1.4%.

A slightly more optimistic protection, however, would require an even smaller increase in taxes.

In 1994, the Clinton administration appointed an advisory council on Social Security composed of 13 members, including three from labor (Gloria Johnson from CLUW and IUE, George Kourpias of the IAM, and Gerald Shea from the AFL-CIO). The balance of the council members included a former Social Security Commissioner, executives from the investment and finance community, corporate benefits consultants, academics, and other members from the business community, not one of whom is likely to depend on or need Social Security to survive when they retire.

At the end of 1996, the council issued its report. It was divided into three camps around three proposals with one common characteristic — each in its own way called for investment of some portion of Social Security funds in the private securities market.

The Ball Plan: Would gradually invest up to 40% of the trust fund in the market, with investment managed by a government-appointed board of trustees or fund managers. Investments would be in passively managed stock index funds.

The Gramlich Plan: Proposes that 1.6% of each workers' taxable income be set aside as an additional payment over and above the current employee contribution into a mandatory government-supervised retirement plan similar to a 401(k) savings plan. Workers would be offered choices of investments from several broad categories.

The Schieber Plan: Would split Social Security into a two-tiered plan. The first would offer a basic monthly benefit of up to $410 (in today's dollars); the second would set aside 5% from the payroll tax for each worker to personally invest tax-free for retirement in any way the worker chooses.

All three proposals include some number of other changes, including payroll tax hikes, taxing benefits that exceed contributions, shifting the Medicare portion of the tax into the trust fund, increasing the computation period from 35 to 38 work years, bringing state and local public employees into Social Security, cutting future benefits by changing the percentage of income on which benefits are calculated, raising the normal retirement age to 69 and pegging it to life expectancy tables, and cutting spousal benefits from 50 to 33%. These have different impacts on income different groups, but some are especially injurious to women, minority, and other low- income workers, whose work histories, job retention and tenure, and earnings already entitle them to much lower benefits.

The three labor members endorsed the Ball plan, and focused their fire on proposals that shift investment responsibility to individual workers. They have embraced the notion that government- managed investment of trust funds in the stock market would be a reasonably safe way to increase the earnings of the fund to solve the problem of a predicted future shortfall. They did not offer a separate alternative, and thus the entire debate has been framed around these three choices.

Few in the labor movement would argue that allowing individuals to manage their own investments is a prescription for wholesale social disaster. Even well trained investment professionals and fund managers have been known to make lousy market investments that resulted in huge losses. Millions of unskilled or unlucky individual investors, competing with the likes of Ross Perot and Warren Buffett in the market, would be playing Russian roulette with their retirement funds. As in every gaming establishment, the odds favor the house not the gambler.

Needless to say, the Wall St. crowd are tripping over themselves to get their hands on the trust fund, which could generate $100 billion in management fees by 2020. Free-marketeers are rushing to embrace and promote the concept of privatization. Investment houses, insurance firms, and outfits like the libertarian Cato Institute have mounted a multi-million dollar in support of privatization. If the Ball Plan were implemented, it is conceivable that a government-managed plan could end up owning as much as 10% of the shares of major corporations, making the public the largest single stockholder with potential influence over corporate policy. This drives the free marketeers right up a wall. If, however, investments are made only in passive index funds, government effectively forfeits that opportunity — one of the few possible arguments for labor to support something like the Ball Plan

Thus, under any of these three proposals it is possible that Social Security funds could provide the investment financing of the next wave of overseas investment, mergers and buyouts, acquisitions, automation, corporate reorganization and restructuring, and down-sizing, resulting in further losses of stable permanent well-paid jobs and further threatening the environment, both here and in the countries to which capital and jobs are exported.

The present Social Security System has an administrative cost of just 0.7% of benefits paid out. The operating costs of the life insurance industry run in excess of 40%. Chile's completely privatized Social Security system has an administrative cost of about 15%. Risk aside, investment in the stock market would subject the fund to larger administrative costs, potentially lowering benefits (but lining the pockets of brokers and investment consultants).

How risky is the market? Would the trust fund really be at risk?

We are presently in an over-inflated boom market, which many sober investment analysts believe to be near its peak. The market has been inflated by a wave of speculative investment which has no relationship to the underlying value of corporate assets. The ratio of stock prices to dividends is at the highest level since modern record keeping began in 1871 (meaning that dividend yields are at record lows).

Currently the P/E ratio stands at 22 to one, a record high. In order for the market to maintain its record of about 7% inflation-adjusted return on investment the price-to- earnings ratio of stocks must continue to soar. The Economic Policy Institute (EPI) estimates that to generate a 7% return, the market will have to rise over 60 to one by 2030, and 460 to one by 2070.

When compared to underlying profits, stocks are more expensive now than in all but 12 of the last 125 years. This is what is known as a "speculative bubble." We have been here before. It was in precisely this kind of overheated market that innumerable people lost their life savings in the 1929 crash. Even if post-crash investment reforms could prevent that kind of financial disaster, nothing can insulate the market from another radical drop.

The market under even best of circumstances is highly volatile. In 95 years there have been 53 declines in the market of 10% or more. Of the 53, fifteen were losses of 25% or more. In the bear market of 1973-74, stocks were down 50-60%. Would you be willing to bet your future retirement income on the assumption that the market will perform in the next seventy-five years as it has in the last 75? Even if the market were to yield 10.5% on average for all the years until the year you were to retire, that average is irrelevant if the market takes a dive just when you are ready to retire. Market performance "averages" are just a statistical expression -- handy for arguments; lousy for predicting the future. But if we want to look to the past, keep in mind that in the last ten bear markets stock prices dropped on average to their level four years earlier, for an average price drop of 48% for Dow Jones Industrials. If that holds for the future, a comparable drop from today's market peaks would result in every mutual fund stock purchase or investment since 1992 showing jumbo losses.

We don't have to speculate about this. There is a current example available in the Japanese market. Just over seven years ago the Nikkei stock index (comparable to our Dow Jones) hit a record high, and most folks expected it to continue to climb. The index started tumbling in January of 1990 and did not stop until it had lost 63% of its value by August of ‘92. It continued to languish in the toilet and now stands at less than half its 1989 high.

One statistical model of market performance predicts that the stock market is in line for a 68% decline over the next ten years. Another less pessimistic estimate is a real decline of 38% in stock prices over the next decade. The Social Security Trustees forecast of lower economic growth over the next 75 years suggests that real returns on stock will average only 4.36%, according to EPI.

Privatizing Social Security now means buying into the market at its highest prices on an assumption it will continue to climb. If it does not — if it takes a plunge — the investments would be sold at below the price at which they were purchased. The consequence would be dire: benefits would have to be reduced, taxes would have to be raised, and in the case of individual investments, workers could find themselves without any retirement income. We can take this gamble today, but if we are wrong, we and future generations will pay the price tomorrow. Those most directly affected are those who are most vulnerable, the folks who depend on Social Security for most or all of their retirement income.

Social Security has been substantially responsible for significantly reducing poverty among the elderly and disabled.

Social Security benefits are a primary source of income for most elderly Americans. It provides 53% of total income for all retirees 65 and older. For 23%, it constitutes 90% of as or more of their total income; for 14%, it is their only source of income.

By design, Social Security involves massive subsidies from the next generation of retirees to this one, from single workers to married couples, from two-earner families do one-earner families, from high-income earners to low, from those who die early to those who die late. It is also a program designed to redistribute wealth. Low income workers receive a higher proportion of their lifetime earnings than do high income workers. Privatization, even partial privatization, creates an incentive to abandon this redistributive objective as workers with investment portfolios come to resent even the small percentage of their income that is diverted to help support lower paid workers. As such, privatization pits better paid workers against the working poor.

Other Impacts of Massive Market Investment of Social Security Funds

There are other consequences. Dumping billions of dollars into the market would have the same effect as if the fund dumped Treasury bonds. Their prices would be depressed, pushing interest rates up. This would diminish the value of reserves held by many banks and other lending institutions, reducing their ability to make loans and pushing up interest rates for borrowers. As interest rates climbed, so too would the cost of servicing the federal debt. Local and state government bond financing would face higher interest rates and public bonds would have to be offered at lower prices.

Right now the surplus in the trust fund is invested in Treasury bonds that cover other government spending. By diverting a large portion of the fund into the market, funds would no longer be available to reduce the deficit. That would mean further cuts in government programs, increased taxes, or both. If a "Balanced Budget" amendment to the Constitution were to become a reality, further dramatic reductions in government services and aid to the most vulnerable and needy populations would become inevitable, since the well-connected wealthy will probably be able to resist any increase in their tax burden.

Some have argued that market investment will pay off in growth created by expansion of investment funds available for corporate construction of new plants, and acquisition of equipment and expanded inventories. Yet Federal Reserve studies show that most of that kind of corporate investment is paid for out of profits and depreciation credits, not from stock sales. Since 1952, internal funds have covered 95% of corporate expenditures on new plant, machinery, and inventories. As Doug Henwood (Left Business Observer) observes, rather than being a corporate fundraising mechanism, the stock market is an institution for organizing the ownership of large corporations. That privilege actually belongs to a tiny minority of investors. In 1992, the richest 1% of households owned 39% of stock owned by individuals; the top 10% owned over 81%. So much for shareholder democracy and peoples' capitalism!

The poverty-reducing effect of Social Security is possible because it is a system that was never designed to produce the highest feasible financial return on each worker's contributions. It is not a pension plan. It is a social program — a social contract between generations. It binds this generation to the future.

Is there an alternative?

At present FICA taxes apply only to the first $65,400 of income. Why not tax all income? By one estimate, that one reform could reduce Social Security taxes by $53 billion. Why not tax other sources of income, unearned income that feeds the wealthy who earn the majority of their money not from wages but from interest and dividends? Why not place a small transfer tax on sale of securities held as short-term speculative investments? This would discourage speculation (market churning), discourage takeovers, and encourage asset-building rather than empire-building.

But we could be bolder yet! Why not demand that a portion of the Social Security Trust fund be invested in creating stable decent-paying jobs? The fund could sell special bonds, the proceeds of which would be targeted to rebuilding our inner-cities and national infrastructure, financing mass transit, building low-income housing, and other projects with broad social benefits. This would have a long-term impact on economic growth and social stability. The jobs created could be made part of a major program designed to put chronically unemployed and under- employed people to work. It could develop marketable skills and extend job training for workers who are victims of downsizing and corporate restructuring.

The real solution to any future problem with funding Social Security is decently paid, stable, permanent full time jobs! A fully employed working class will increase FICA contributions that will prevent any shortfall. The second most significant solution is organization! Workers in unions earn substantially more than those without union protection. Higher incomes mean higher FICA contributions. The "problem" of Social Security" (along with innumerable other social ills) can be readily solved not on Wall St. but on Main St. with real jobs instead of McJobs and union contracts rather than temp agency contracts. Rather than invest in the stock market, why not invest in the American working class and the quality of life and future of our country?

Wouldn't this be a preferable program for the labor movement to advocate? Shouldn't the Labor Party propose such an alternative?

The relevant measure should not be the rate of return provided by Social Security benefits relative to taxes paid in, but rather the improvements in living standards over generations.

The fact that the three labor members of the Social Security Reform Council embraced the idea of trust fund investment in the market should not be taken as the final word from labor. They acted without approval or instruction from the General Executive Council of the AFL-CIO. The Federation can be moved to a better position if the affiliates demand it. To achieve that, however, will require that union members press the issue in their locals and labor councils, pass resolutions demanding real worker-friendly solutions to any perceived future problems with Social Security, and communicate their displeasure to their national unions.

The Labor Party has an opportunity — no a responsibility — to provide leadership in this struggle. If the LP claims to offer a better alternative to that offered by the political status quo, it must speak to the immediate as well as long-term needs of working people. It ought not tail the AFL-CIO by remaining silent while the Federation uncritically embraces the stock market as a solution to the future problems of Social Security. This is one of what academics like to describe as critical decision nodes for the LP. As a political party it will be judged by how it responds to this challenge.

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