The bottom line on Clinton’s Social Security reform proposal is simply this – it is not workable, and it will not solve the problems of the program.

By saying he would use almost two-thirds of the budget surplus to "save Social Security", Clinton would apparently fund Social Security in part from general revenues. This would simply spread the problem to a different taxpayer pocket, as well as destroying the original, liberal, "social insurance" foundation for the program.

Clinton also proposes that the government would invest part of the Social Security trust funds in private stocks and bonds, which would grant the government broad new powers over the economy, and is overwhelmingly opposed by the American people.

Finally, Clinton’s plan does nothing to solve the biggest Social Security problem of all – the program has become a bad deal for today’s workers. His plan at best would only enable Social Security to pay its currently promised benefits. But as has been shown over and over, these promised benefits amount to a very poor return on the taxes paid into the program. Workers would now get several times these promised benefits investing the funds in personal investment accounts, as is increasingly being done in other countries around the world. Clinton would effectively deny workers these much greater benefits by leaving workers and employers to pay the same taxes into Social Security for no more than the current poor deal.

But Clinton has now put the Social Security issue on the national agenda, and opened up an enormous opportunity for conservatives and Republicans. For they have a far more popular alternative to Clinton’s plan, that actually does solve the problems of Social Security, and has proven workable in other countries around the world. That plan is to allow workers the freedom to choose to pay into a personal, private investment account in place of at least part of Social Security.

No other reform would do so much to increase the liberty and prosperity of the American people, and achieve the long term policy goals of conservatives:

  • With personal investment accounts in place of Social Security throughout their careers, at even below average stock market returns workers of all income levels would retire with large trust funds paying them several times the benefits promised by Social Security.
  • Such a personal account system would eliminate the $9.5 trillion unfunded liabilities of Social Security, eliminating more real government debt than paying off the national debt.
  • With such an account system, payroll taxes can be effectively cut by 20% in the short term, and eventually phased out altogether, reducing total Federal taxes by about 20%, the largest tax reduction in world history.
  • With workers receiving their retirement, survivors, and disability benefits from the private accounts, Federal spending would ultimately be reduced by about 25% as well, the largest reduction in government spending in world history.
  • With workers retiring on large trust funds invested in stocks and bonds, rather than dependent on government checks, the political culture would be transformed. Retirees would be powerful protectors of free market policies and vehement opponents of any new burdens on the private sector.

All of this will be discussed further in this report.

 

Clinton’s Social Security Confusion

Turning Social Security Into Welfare. Clinton proposes to use 62% of projected surpluses for Social Security. But Social Security is financed by the payroll tax, and limited to that. Using the surpluses for Social Security can only mean pouring general revenues into the program for the first time.

This does not in any sense solve the Social Security financing problem. It just shifts it partly to income taxes from payroll taxes.

Moreover, this would negate the whole, original, liberal, "social insurance" foundation for the program. If instead of workers funding the program with their own payroll taxes, it is funded in large measure from general revenues, then using such public funds to pay benefits to those in need cannot be justified. Why should we use general revenues to pay benefits to millionaires, or to those still earning large professional incomes? Once Social Security is funded in any significant way from general revenues, then it must be means tested. Ultimately, then, it would become just another welfare program. In this sense, Clinton’s proposal would, indeed, destroy Social Security.

Precisely for these reasons, liberals have always opposed using general revenues to finance Social Security. Franklin Roosevelt recognized that the link between payroll taxes and benefits was the key to the popularity and long term endurance of the program. This link enabled the program to be called "social insurance" rather than welfare, creating the notion that workers were paying for their own benefits and had an earned entitlement to them.

From a conservative view, using general revenues for Social Security opens the door to an unlimited claim against taxpayers for Social Security benefits. Any revenue shortfall, and unlimited benefit increases, could just be financed by higher and higher general taxes. General revenue financed Social Security just takes us back to Hobbes’ war of all against all, creating an all out, unending struggle between retirement benefits and the hard earned incomes of taxpayers.

 

Nationalizing the American Econom

Clinton would add to the disaster by having the government invest Social Security funds in private stocks and bonds. Any such government investment would become heavily politicized, with investment funds going to reward the "politically correct" companies that follow government preferences. Over time, investment funds would end up going to the best political contributors. Isn’t this exactly what Clinton and his people ended up doing with the Commerce Department and every other government program they could get their hands on?

These inevitable practices would ultimately undermine the investment returns on the Social Security funds. And they would greatly increase government control over the private economy.

Indeed, Clinton’s proposal effectively amounts to back door socialism. For through this government investment, the government would end up owning and controlling more and more of the formerly private economy.

No doubt Clinton will attempt to defend this proposal by arguing that he would contract out this investment to a private investment manager. But that cannot insulate public funds from government and ultimately political control. Politicians can still enact mandates and requirements on the investment manager to do their bidding. Or they can just hire one who they know will carry out their political preferences. After all, they will say, the manager works for the government and is investing public funds. So this would all just be appropriate government oversight and administration. Fed Chairman Alan Greenspan recently took the same position on this issue.

Fortunately, the public understands this issue and overwhelmingly opposes government investment of the Social Security trust funds, even in polls where it strongly favors investment through personal accounts. Republicans only need to frame the issue as government investment of the funds in a centralized pool versus worker investment through their own personal accounts. That is a big loser for Democrats.

 

A Bad Deal for Workers

Most devastating of all, Clinton’s plan does not address the biggest problem of Social Security. As has been shown over and over again, even if Social Security somehow pays its promised benefits, the program would still be a bad deal for today’s workers. These workers could now get much higher returns and benefits saving and investing the same money in the private sector.

To see just how bad this problem is, take this example from Cato’s new book, A New Deal for Social Security, co-authored by Michael Tanner and myself. A husband and wife enter the work force in 1985, each age 22. The husband earns the average income for male workers each year and the wife the average income for female workers each year. They raise 2 children.

Suppose they could save and invest in a personal account what they and their employers would otherwise have to pay into Social Security. Some of the money is set aside each year to buy private life and disability insurance covering the same survivors and disability benefits as Social Security. The rest is devoted to retirement investment.

Suppose those investments earn just a 4% real rate of return over the years, which is just over half the average return earned in the stock market over the last 75 years, going back before the Great Depression. By retirement, the couple would have a fund of almost $1 million in today’s dollars. That fund would pay them more out of the continuing investment returns alone than Social Security promises but cannot pay, while allowing them to leave the $1 million to their children. Or the fund could be used to buy an annuity paying them over 3 times what Social Security promises but cannot pay.

At a 6% real return, which is still less than the average stock market returns, the couple would retire with $1.6 million in today’s dollars. That fund would pay them about 3 times as much as promised by Social Security, while allowing them to leave the entire $1.6 million to their children. Or it would finance an annuity paying them 7 times what Social Security promises but cannot pay.

The same is true for all workers of all income levels, family combinations, and ethnic groups – rich or poor, black or white, married or single, with children or without, one earner couple or two earner couple. They would all get several times what Social Security promises, but cannot pay, through the private investment accounts instead, even at below average investment returns. Even low income workers who receive special subsidies through Social Security would receive much more in benefits from the personal investment accounts.

Take the example of a low-income couple with 2 children. Husband and wife enter the work force in 1985 and each earn the equivalent of today’s minimum wage each year throughout their careers. Through a personal investment account, at a 4% real return, the couple would retire with a fund of about $375,000 in today’s dollars. At a 6% real return, this low income couple would retire with a trust fund of almost $700,000 in today’s dollars. That fund would pay them more than twice what Social Security promises out of the continuing returns alone, while allowing them to leave almost $700,000 to their children. Or they could use the fund to buy an annuity that would pay them about 5.5 times what Social Security promises, but cannot pay.

Quite similar results have now been found in study after study, and are even now being achieved in the real world in other countries that have adopted private investment account systems.

These vastly greater benefits result not because the private sector makes better investments than Social Security. They result because Social Security makes no real investments at all. Social Security is a tax and redistribution scheme where almost all taxes paid today are immediately paid out to current beneficiaries on a pay-as-you-go basis. The private, invested system, by contrast, pours its funds into real private capital investment that produces new income and wealth. That increased income and wealth is what finances the far higher returns and benefits of the private system.

Clinton’s plan does not remotely solve this problem. He would still force workers to pay the same 12.4% of wages into Social Security for benefits representing a low, inadequate return on those benefits. This problem can only be solved by allowing workers a personal investment account option for Social Security, where they can earn full market returns.

 

Further Irrelevancies

Finally, Clinton proposes some sort of supplemental private account as an add-on rather than an alternative to Social Security. Public funds out of general revenues would apparently be rebated to these accounts, matching worker contributions, with special subsidies for low income workers.

These accounts would do nothing to solve the problems of Social Security. They would not address the program’s long term financing problem. Nor would they affect the bad deal imposed by the current program. With these accounts, workers and their employers would still be paying 12.4% of the worker’s wages into Social Security for miserably low benefits compared to what they could get investing the same money in the private sector.

Moreover, how can we ask workers to pay more into supplemental accounts without addressing the bad deal we are forcing on them through Social Security? If we allowed them to choose private investment accounts in place of Social Security, they wouldn’t need to pay any more into supplemental accounts. Indeed, because of the much higher returns on the private investments, they could pay significantly less into the private accounts than they are paying into Social Security today. Clinton and his liberals should know that most workers in any event cannot afford to pay more into supplemental accounts than what they are already paying into Social Security.

 

The Republican Response

How should Republicans respond to Clinton’s proposal? They should propose a personal investment account option for at least part of Social Security to start. They could allow workers the freedom to choose to pay, for example, at preferably 5 and at least 3 percentage points of the total 12.4% Social Security tax into personal, individual, investment accounts. Workers would then choose an investment manager from a list of major banks, insurance companies, brokerage firms, mutual funds, etc., approved and regulated by the government. These investment managers would then choose the particular investments for the worker’s accounts. This is a simple system accessible even to unsophisticated workers, or those who simply don’t have the time to follow the markets.

For workers who choose this option, their future Social Security benefits would be reduced proportionally to the amount of Social Security taxes they were able to shift to these accounts over their careers. For example, a worker who paid into the private accounts over his career one half of what he would otherwise pay into Social Security for retirement benefits would receive 50% less in Social Security benefits. But the private accounts would then pay far more in place of these Social Security benefits, leaving the worker with far higher benefits overall. Over time, this option should then be expanded to the full Social Security tax.

With this proposal, Republicans would have the overwhelming support of public opinion behind them. Poll after poll after poll is showing about two-thirds to three-fourths of the American people supporting a personal investment account option for at least part of Social Security. Luntz Research found the public favoring such a private option by 77% to 14%. Bill McInturff’s Public Opinion Strategies found the public favoring the idea by 68% to 11%. A USA Today poll just a few months ago found the public strongly opposed to every major change regarding Social Security except one, a personal, investment account option, which was favored by 66%. An AP poll taken in December, 1999 found that 75% would favor "allowing people to invest part of their Social Security taxes in the stock market." Indeed, a poll by mark Penn, one of President Clinton’s pollsters, found that 73% of Democrats would favor a private option for part of Social Security.

Republicans would also be at the forefront of a trend that is sweeping the world. Along with Chile, 8 countries in Latin America have now adopted such reforms. Indeed, the World Bank recently reported that by 2000 every country in Latin America will have a private Social Security option except Cuba. In Europe, Great Britain has led the way, with almost 80% of workers there relying on private accounts in place of most of their Social Security program. Hungary and Poland have followed, and last year even that socialist haven Sweden started a private option for part of their system.

Indeed, in supposedly communist China workers now pay into personal investment accounts for half the system there. In the early 1990s, a labor government in Australia completed the phase in of a personal investment account system for that country.

Major, establishment institutions are supporting this trend. The World Bank has been promoting such reforms worldwide at least since the publication of its breakthrough study in 1994 Averting the Old-Age Crisis. In America, the National Bureau of Economic Research is strongly advancing such change under the leadership of Harvard Economics Professor Martin Feldstein. Also strongly supporting the idea have been Economics Nobel Prize winners Milton Friedman, James Buchanan, and Gary Becker, as well as recent American Economics Association President Arnold Harberger.

The U.S. Chamber of Commerce has issued papers supporting a private option by this author, through its National Chamber Foundation. The National Association of Manufacturers (NAM) has created the Alliance for Worker Retirement Security, led by Leanne Abdnor, formerly of the Cato Institute, to work for such a private option. Besides NAM, the group includes the U.S. Chamber, the National Federation of Independent Business (NFIB), the National Restaurant Association, the National Retail Federation and the Small Business Survival Committee.

Even the last Social Security Advisory Commission jumped on the bandwagon. Under the law, the President appoints such a Commission every 5 years, and it is staffed by the Social Security Administration. Usually the Commission reports that Social Security is all perfect and wonderful, except maybe benefits should be higher.

But the last Commission, appointed in 1995 by liberal President Clinton of all people, was different. All of its 13 members agreed that some type of new, invested Social Security system was needed. Most remarkably, 5 of the 13 commissioners supported a private account option for 5 percentage points of the 12.4% Social Security tax, almost half the system.

The tidal wave has reached Congress as well, where again the developments are simply startling. Moderate Republican Rep. John Porter (R-Ill.) introduced a carbon copy of the Cato proposal for a full private option to Social Security, as has the pathbreaking Sen. Rod Grams (R-MN). Sen. Phil Gramm (R-TX) has introduced a bill that would phase in a full option quite similar to the Cato plan, though over a far too long 40 year period. His plan has won the endorsement of Senate Budget Committee Chairman Sen. Pete Domenici (R-NM). Other Republicans who have proposed full or partial private options, and have been quite articulate leaders on the issue, include Sens. Rick Santorum (R-PA), and Judd Gregg (R-NH), as well as Reps. Mark Sanford (R-SC), Nick Smith (R-MI), and Jim Kolbe (R-AZ).

Even more startling is the Democrat support for the idea. No less a Democrat establishment figure than Sen. Daniel Patrick Moynihan (D-NY) has introduced a small private option, however weak. Sen. Bob Kerrey (D-NE) has been one of the most articulate national leaders advocating such change, and has introduced different private option plans as well. Other Democrats who have introduced private option bills include Sen. John Breaux (D-LA) and Rep. Charles Stenholm (D-TX).

Even Clinton’s proposal, bad as it is, adds to the momentum for a personal investment account option to Social Security. His proposal concedes that we need to move to real private sector investment, and even accepts the viability of personal investment accounts for retirement, through his supplemental account plan.

But unlike the Clinton plan, such a personal account option would solve the problems of Social Security, and produce overwhelming benefits for the American people.

First, the long term financing crisis of Social Security would be alleviated and eventually eliminated as future workers would draw less and less from bankrupt Social Security when they retire, and more and more from the personal accounts. Otherwise, on our present course, payroll taxes would eventually have to be increased by 50% to 1005 to pay promised benefits. Moreover, from 2013 to 2032, the Federal government will have to come up with over $2.5 trillion to cash in Social Security trust fund bonds so that benefits can continue to be paid over that time. This will likely come from higher taxes or borrowing savings out of the private economy by issuing more government debt.

Most importantly, the personal accounts will open up a new realm of prosperity for average and even lower income working people. As described above, with even below average investment returns, these workers would receive through the accounts 3, 4, 5 times the benefits promised by Social Security, and more. They would accumulate large trust funds by retirement that they could leave to their children. For the first time, they would be able to participate in the capital side of the economy as well as the labor side.

In addition, a full, private account option would ultimately eliminate the current $9.5 trillion in unfunded liabilities of Social Security, as worker’s future retirement accounts would be financed through their fully funded private accounts rather than unfunded Social Security. The $9.5 trillion unfunded liability of Social Security is more than the recognized national debt outside of Social Security. As a result, such reform would do more to reduce real government debt than paying off the national debt.

A full, private account option would also ultimately involve a huge tax cut. Workers and employers do not need to be required to pay as much into the private accounts as Social Security requires, due to the much higher returns of the private investments. Therefore, under the reform plan advanced in the latest Cato book, and now introduced in the House and the Senate, workers and employers would pay 20% less into the private accounts than Social Security, providing an effective 20% payroll tax cut. Indeed, as workers came to rely on the private accounts the payroll tax would eventually be phased out altogether, reducing the overall Federal tax burden by about one-fourth.

In addition, with retirement, survivors, and disability benefits eventually privately financed under the reform, federal spending would be sharply reduced as well. With an eventual, full, private option, Federal spending would ultimately be reduced by about one-fourth as well. This would be the biggest reduction in government spending in world history.

Finally, there would be a free market political revolution as a result of such reform. Under the current Social Security framework, conservatives and Republicans are going to continue to get beat up over it. Their efforts to reduce government will be distorted over and over into some kind of threat to Social Security. Last year, for example, liberals and Democrats were even able to stop a general tax cut in a time of great projected budget surpluses with an argument that this would somehow threaten Social Security.

By contrast, consider what politics would be like if retirees, instead of being dependent on government benefits, were independently living off of substantial accumulated private trust funds invested in stocks and bonds. Then every government threat to the private economy would be a direct threat to the incomes and security of retirees. Anti-market policies that would tank the stock or bond markets would no longer be politically viable. A new political culture of independence through the private economy would flourish.

The Grand and Glorious Opportunity

Clinton’s unworkable and ineffective proposal is good at only one thing. It opens up a grand and glorious opportunity for conservatives and Republicans by putting the Social Security issue at the top of the political agenda. In the battle over that issue, it is conservatives and Republicans that have the winning hand in fighting for Social Security freedom and prosperity for working people. Now is the time to join the fight. For as Shakespeare said, there is a tide in the affairs of men which, taken at the flood, leads on to fortune; omitted, and all of life is wasted in shallows and miseries.