Retirement Plans

Forget the acrimonious Beltway budget debate. Ignore the hysterics ginned up by the Democrat/union/seniors' lobbies over "extremist" Republican measures that would slash programs protecting "the elderly," "children," and "the environment." Something important has happened amid the screaming and the showdowns: Both political parties have agreed to put Medicare on an annual budget, ending its open-ended status.

The GOP's seven-year balanced-budget plan would get $270 billion of its budget savings–nearly one-third of the $815 billion the Republicans require–from reductions in projected Medicare spending. The White House initially countered with a proposal that would save $192 billion from Medicare over that seven-year period. All the Democrats' histrionics were based on a difference of $11 billion a year. You might find that much in loose change between the sofa cushions at the Department of Health and Human Services.

Before this year, had either political party proposed similar reductions in Medicare, the American Association of Retired Persons would have shut down the Capitol switchboard, led sit-ins at federal buildings, or asked its members to handcuff themselves to their representatives' desks. Weak-kneed politicians could have sought solace from welfare-state advocates on the left and right. After all, as recently as June of 1993, neoconservative icon Irving Kristol was chastising conservatives for attacking federal retirement programs. Writing in The Wall Street Journal, Kristol said "traditional conservative fiscal monomania" about entitlements "leads to political impotence and a bankrupt social policy….If the American people want to be generous to their elderly, even to the point of some extravagance, I think it is very nice of them."

Now all that's changed. Perhaps it's becoming possible (without ducking for cover) to publicly discuss major reductions in entitlements, which were believed to be the "third rail" of American politics as recently as a few months ago. As National Center for Policy Analysis President John Goodman points out, "The Republicans touched the third rail with [their Medicare reforms]. And nothing happened."

No matter how or when the current budget dispute works itself out, the failure of a few advocacy groups to use "Mediscare" tactics to cower wavering legislators bodes well for reforming Social Security, the 800-pound gorilla of retirement programs. Milton Friedman first suggested privatizing Social Security in 1962–a proposal that for two decades had few adherents outside of libertarian and other free market circles. More recently, however, advocates of privatization have been heartened as several dozen nations, including Great Britain, Chile, and Singapore have at least partially privatized their retirement programs. Goodman echoes the attitude of entitlement watchers from free market and deficit-fighting groups when he says, "By the end of this decade, I think we'll see a national consensus among Democrats and Republicans that something needs to be done about entitlement programs for the elderly in this country. And by something, I mean major privatization."

It's no secret that Social Security is a fiscal time bomb, but those facts bear repeating. While 65 has been the Social Security retirement age since 1935, average life expectancy for 65-year-olds has increased from about 13 years in 1935 to 17.5 years today. By 2040, 65-year-olds are expected to live another 20 years. In 1950 there were 16 workers for every Social Security recipient. Now there are 3.3, and it's projected that there will be fewer than two workers for every recipient by 2030. And as the baby boomers retire, the number of Americans older than 70 is expected to double, from 24.1 million today to nearly 48 million in 2030.

Social Security now runs annual surpluses of about $50 billion. But those boomers will soon prevent Social Security from paying its own way. Sometime around 2010, the program will have to finance some of its benefits from general tax revenue, and those subsidies will have to increase continuously. To keep Social Security from dipping into the general treasury, between now and 2030 payroll tax rates would have to increase from the current 11.2 percent to nearly 20 percent.

This sobering news has helped temporarily deaden the currents on the third rail. For more than a decade, a majority of opinion-poll respondents have doubted that they would receive enough benefits from Social Security to finance their retirements. Over the past four years skepticism about Social Security's future has intensified. In a March 1994 Gallup poll, for instance, 46 percent of those surveyed strongly agreed that taxes would have to be raised "dramatically" to pay Social Security benefits in the future; 74 percent said most people could get more money investing their payroll taxes privately rather than relying on Social Security; and 71 percent expected to get less out of Social Security at retirement than they put in during their working years.

In November 1995, a poll conducted by the Charlotte, North Carolina-based polling firm GrassRoots Research, found even stronger doubts about Social Security's future. When asked what changes, if any, the respondents would make to Social Security, only 24 percent would leave the program alone; nearly as many (22 percent) would make Social Security completely voluntary; another 29 percent would either raise the retirement age or cut cost-of-living increases for current retirees.

This skepticism has no doubt been fueled by the willingness of prominent individuals and organizations to harp on Social Security's long-term troubles. During the 1992 presidential campaign, former Massachusetts Sen. Paul Tsongas lectured Democrats about the possible collapse of the program. Since then, the Perot voters' obsession with deficit reduction, the Tsongas-founded Concord Coalition's focus on the entitlement time bomb, and the 1994 Bipartisan Commission on Entitlement and Tax Reform's widely reported findings that entitlement programs are the major source of the federal deficit have made it possible to suggest substantive reforms of retirement programs in polite company.

In addition, says Concord Coalition Legislative Director Demetri Coupenas, "People are becoming more cynical about government. We think cynicism is unfortunate in general, but it's fortunate for [moving the debate] on this issue." Scott Rasmussen, president of GrassRoots Research, notes that confidence in government has eroded dramatically since Franklin Roosevelt first proposed Social Security. "In the 1930s," Rasmussen says, "we were in the middle of the Depression. People didn't have any confidence in the private sector. Now people don't trust government any more. They would rather have their Social Security money invested privately."

Advocates of privatization in the United States can also look to other countries that have started reforming their retirement programs. An October 1995 NCPA study co-authored by Goodman, Peter Ferrara, and Merril Matthews lists more than 40 nations that incorporate some private component as part of their "public" retirement programs. In Singapore, for instance, the forced-savings plan incorporates retirement investments along with savings for home ownership and medical care. South Korea, Germany, and Ireland are but a few of the countries that let the self-employed opt out of the government retirement program.

And this year New Zealand will have its first parliament elected not in single-member districts but under a scheme of proportional representation. A new political party expected to lead a center-right coalition there, the Association of Consumers and Taxpayers, has made social security privatization one of its four platform planks. Republican activist Grover Norquist, who is advising the ACT, believes success in New Zealand could help reformers in the United States. "New Zealand is an English-speaking, democratic nation," says Norquist, "not a former dictatorship" like Chile, which privatized its social security program 15 years ago. If privatizing old-age entitlements can becomes a winning issue in a Western-style democracy like New Zealand, Norquist asks, why not here?

While there's hope for sweeping changes in Social Security, reformers still have some tough rows to hoe. The AARP, labor unions, and other defenders of the welfare state will remain political impediments to change. And along with winning electoral battles, reformers must satisfy three constituencies with different demands: younger workers who may face crippling payroll taxes as their parents retire; people at or near retirement age, who expect to receive the benefits promised to them; and those in between, who fear they may pay much higher taxes and still get little in return when they retire.

Privatizing Social Security isn't merely a matter of fiscal responsibility, an issue (as Irving Kristol wrote in the Journal) only for those "whose Good Book is the annual budget." The current system discourages thrift, encourages dependency, and, yes, even undermines families by breaking the economic bonds between generations. And it is based on a lie: that retirees are simply collecting money they "paid in." There is, of course, no real economic relation between the taxes working people pay and the benefits they collect as retirees. Both are simply set politically, giving all retirees a vested interest in the welfare state. Freeing Americans from dependence on Social Security would change that, giving tens of millions of people control of their own destinies. As investors in private retirement plans, each would have a stake in the success of the American economy. National Development Council Chairman Sam Beard, who has devised a privatization proposal, speaks of creating "minimum-wage millionaires."

Fortunately, there's no shortage of reform proposals circulating among policy groups and on Capitol Hill. "Everybody's got his own plan," says Ferrara, general counsel at Americans for Tax Reform, who has written dozens of books, studies, and articles about Social Security reform. "I can't keep up with all of them."

None of the reform plans under consideration would make Social Security voluntary and let individuals withdraw from the system by renouncing any benefits they might receive. Instead the proposals are all variations on forced savings plans; some rely more on private savings than others. The plans coalesce around two models:

? The two-tiered approach. These proposals deal with obligations to current and soon-to-be retirees by directing most payroll taxes either into traditional Social Security or into tightly regulated private investments. Younger workers, however, could invest some of their payroll taxes into higher-risk, potentially higher-yield, Individual Retirement Accounts. Proponents of this approach assume that payroll taxes from the work force will perpetually support current retirees.

The first legislative proposal along those lines was initially offered by Rep. John Edward Porter (R-Ill.) in 1989, and re-introduced in slightly varied forms since then. Since only about three-fourths of Social Security payroll taxes are spent on benefits for current retirees, Porter's plan would let workers invest most of their "surplus" payroll taxes privately. Specifically, the Porter proposal would cut the 11.2 percent Social Security payroll tax by two percentage points, let workers set up Individual Social Security Retirement Accounts, and invest the 2 percent tax in a limited number of mutual funds or other retirement vehicles. Workers would have a property right in their ISSRAs, and those who set up ISSRAs would reduce their claims to tax-funded benefits by the amount their Social Security taxes were reduced.

Along similar lines, last year Sens. Bob Kerrey (D-Nebr.), head of the entitlement commission, and Alan Simpson (R-Wyo.), a member of the commission, made a more detailed proposal. Among other things, the Kerrey-Simpson plan would increase the retirement age from 67 to 70 over 35 years, reduce the formula for Social Security cost-of-living increases, and force workers to invest two percentage points of their payroll taxes privately. (It would, however, also allow Social Security's trustees to invest as much as 25 percent of the $480-billion Social Security trust fund in commercial stocks and bonds–a sure legislative nonstarter. "Great," quips the NCPA's Goodman. "Let's have the government [buy up] a bunch of private businesses.")

Advocates of the two-tiered approach have a real-world example to look at: Great Britain. In what Peter Ferrara calls "one of the unreported stories" about entitlement reform, "70 percent of British workers have opted out of the state retirement plan." Since 1978, British workers' payroll taxes have gone to finance two retirement programs: a basic benefit that's roughly equal to 18 percent of the mean national income, and a second benefit. Workers can choose where their second-tier payroll taxes go: to fund a government pension that will pay at least twice the basic benefit or to a private pension that is operated by their employers. The NCPA report on private social security options in other countries says about 45 percent of British workers have contracted out of the state pension plan and invested in employer pensions.

Beginning in 1988, the British government gave workers a third option for their second-tier payroll taxes: tax-deferred individual retirement accounts. Individuals who choose this option can supplement their individual accounts with additional tax-deferred contributions. About 25 percent of British workers have chosen the personal retirement option over state or employer pensions.

Several private groups are pushing variations of the British plan. The National Development Council's Sam Beard has outlined his own plan to create "100 million millionaires." In his proposal, to be published in book form by the Institute for Contemporary Studies, the first $500 of payroll taxes each employee and employer pay would go into an individual retirement account instead of to the government, for a total nest egg of $1,000 a year. Beard would also let individuals add as much as $2,000 a year to their accounts–up to $1,000 in personal savings, matched dollar-for-dollar by shifting payroll taxes into the IRA.

From Beard's formula, a person earning $50,000 a year who wanted to max out her IRA would invest $1,500 from payroll taxes. A $10,000-a-year earner who pays $1,240 a year in payroll taxes could max out by adding $120 in voluntary contributions to the $500 that would automatically go into the IRA. Beard says that, over a 45-year working career, a $10,000-a-year worker investing $1,240 at 8 percent would accumulate a portfolio worth $1,026,524, making our minimum-wage worker a millionaire. (Workers who pay more than $3,000 a year in Social Security taxes couldn't invest all of their payroll taxes privately; benefits for current retirees would come from the payroll taxes these higher-wage workers pay.)

Beard has established Equal Capital Opportunity Now, a Concord Coalition-like group to push his plan. ECON's public-relations efforts are geared at those at or near college age–the group most likely to believe they will receive no Social Security benefits at retirement. Two twentysomething organizers, Jonathan Abshire and Beard's daughter, Hillary, are approaching the Concord Coalition, other deficit-fighting organizations, local Perot activists, and groups on college campuses, hoping to focus attention on Social Security among younger people in a "Now Do You Care?" day in April.

And even as political operatives in the White House were trying to whip seniors into a frenzy with their Mediscare campaign, a panel appointed by Health and Human Services Secretary Donna Shalala almost endorsed a British-style, two-tiered Social Security system. The 13-member Advisory Council on Social Security, which has advised every president since Franklin Roosevelt, considered three options for Social Security reforms: Maintain the current benefit structure, increasing payroll taxes as necessary to pay retirees; raise payroll taxes by two percentage points and let everyone invest the extra money in IRAs; or establish a two-tiered system that allows even more private investment. Under this third option, workers younger than 30 could invest five percentage points of their payroll taxes in any private investment vehicle that meets the financial and reporting standards of the typical 401(k) plan. They would also get a tax-funded retirement benefit that would vary with their tax contributions. Those older than 55 would continue to get traditional Social Security but might see the retirement age rise. Those between 30 and 55 would receive a hybrid of the privatized/tax-funded system.

When the council made its final recommendations, five of the 13 presumably Clinton-friendly advisers voted for the two-tiered plan. Two others supported the 2-percent IRA plan. A commission insider was pleasantly surprised that seven of the 13 members sympathized with some form of privatization. "Most [on the panel] believe there needed to be some direct investment of payroll taxes in the private sector," the insider says. But the more market-oriented advisers would embrace neither having the federal government directly invest Social Security trust funds in the private sector nor establishing government-managed "private" retirement-investment vehicles. The advisory council's support for this two-tiered proposal indicates how mainstream previously "radical" views on Social Security have become.

? The stock-and-bond option. The two-tiered proposals offer individuals a partial property right in their payroll taxes and guarantee a stream of money to pay benefits to future retirees. But because they continue Social Security's pay-as-you-go funding, these plans also contain a potentially serious flaw: If some future generation of retirees puts the heat on Congress to increase Social Security benefits, Congress can merely ratchet up the payroll-tax rate.

Another set of reforms could circumvent this possibility. Based on the Chilean social security program, these reforms would let workers either remain with the current system or invest all of their payroll taxes in private accounts. The government would also create a new debt instrument that would let all workers who have paid Social Security taxes get at least some of their money back.

Chile began privatizing its social security system in 1981. Until 1986, workers had the option of remaining in the government retirement system or entering a private pension program. (As of 1986, all new workers must enter the private plan.) In the private system, each worker must invest 10 percent of his wages in a tax-deferred, portable individual savings account and can add as much as 10 percent more of his wages to the account monthly. The government has authorized 21 pension funds to manage and invest money in the individual accounts. Workers must invest in one of the funds, but they can change funds as frequently as every month.

At retirement, workers can use their accounts to purchase an annuity or they can let the account continue to build value, making periodic withdrawals as needed. The government does guarantee a minimum benefit that's based on the minimum wage. If a pension account can't cover that benefit, the difference is made up out of general revenue.

The NCPA report authored by Goodman, Ferrara, and Matthews reports astounding results. The funds have earned, on average, a 13 percent rate of return above inflation, and the national savings rate now exceeds 25 percent. And even though payroll taxes are 60 percent lower now than they were before 1981, retirement benefits under the private system are 70 percent higher in real terms than those the government plan offered.

What about those workers nearing retirement who have paid payroll taxes for years in the now-shrinking government system, an unfunded liability of nearly $7 trillion in the United States? The Chileans established a new debt instrument, known as recognition bonds. These are interest-bearing bonds of amounts that vary with how much each individual had put into the old system. The value of the bond is added to each person's individual account at retirement.

Goodman and Ferrara, among others, have cited some problems with the Chilean approach–most notably the rather strict government regulations on how people can invest their retirement savings. But the overall outline has gained adherents on and off Capitol Hill. When freshman Rep. Mark Sanford (R-S.C.) visited Chile on a trade mission in 1995, he returned singing the praises of its social security plan. While he hasn't recommended a proposal along the lines of the Chilean program, he remains interested in major Social Security reforms.

Former Sen. Malcolm Wallop (R-Wyo.), a member of the entitlement commission and chairman of Frontiers of Freedom, is pushing reforms along the Chilean outline, emphasizing the establishment of a property right for workers' retirement contributions and suggesting the sale of federal lands and other assets to finance the recognition bonds. And Ferrara, who had previously pushed a two-tiered system, now prefers a stock-and-bond approach. He is developing (but has not yet completed) his own proposal for the Cato Institute. Two advantages Ferrara sees in the Chilean approach are that it gives individuals control over their own retirement investments and that the recognition bonds "let people get some of their money back."

The potential weakness of the Chilean approach is political: It doesn't offer a stream of tax dollars to pay for current retirees and those near retirement age–a tough sell to people older than 50. University of Nebraska economist Karl Borden has proposed a detailed hybrid plan that could offset some of this political opposition by offering some of the strongest features of both approaches. Outlined in a Cato Institute paper, Borden's plan would let workers stay in the current system, with the understanding that their benefits could be reduced, or join the private system. The private plan would invest all payroll taxes in tax-deferred personal retirement accounts. Individuals could also add as much as 25 percent of their incomes a year into these PRAs, which would then be used to purchase stocks, bonds, or mutual funds.

PRA funds would be divided into "basic" and "enhanced" accounts. Money would accumulate in the basic account until the account could purchase an annuity that would provide 110 percent of an annual minimum-wage income through retirement. The basic account could only be invested in a limited number of "safe" investments. After accumulating that amount, the rest of the PRA could be invested in any financial security.

Borden's plan would also establish a recognition bond based on the present value of the estimated retirement benefit the Social Security Administration calculates for every worker today. Each person would get a bond, which would be deposited in your PRA. Bond holders could wait and hope that there will be enough money in the treasury to redeem their bonds when they mature, or they could sell the bonds on secondary markets. If confidence in the government's solvency is low, people might only get a few cents on the dollar for their bonds. But something beats nothing. The Borden proposal may be too complicated to sell politically. But others will no doubt emerge.

ATR's Grover Norquist has mapped out a possible timetable for privatization. He's urging Republicans to drive a stake through the heart of Washington's social engineers by making a flat income tax the campaign issue of 1996. If the GOP wins the White House and increases its majorities in Congress, he says, the party can spend 1997 on tax and regulatory reform. After the 1998 mid-term elections (in which he predicts even bigger Republican majorities), the Republicans could then turn to Social Security in 1999.

An overly ambitious scenario? Perhaps. But even if Clinton is re-elected, ATR's Jim Lucier thinks the move towards privatization will continue. After all, the most prominent advocate of partial privatization is former Democratic presidential candidate Kerrey. And he's not alone in his party: At a Concord Coalition-sponsored "entitlement summit" in Fresno last August, Rep. Cal Dooley (D-Calif.) suggested converting Social Security into a genuine social-insurance program. People purchase insurance to protect themselves from unexpected events, he said. Living until retirement age is something people expect to do. Dooley suggested at least partially privatizing the retirement portion of Social Security's old-age and disability program, which amounts to 11.2 percentage points of the 12.4 percent payroll tax.

As a lame duck, Clinton might embrace a proposal along the lines of the Kerrey plan. If Democrats open with a mild privatization proposal, Republicans could easily raise the stakes. Once the policy debate focuses on which privatized plan to adopt, Goodman says the free-marketeers will have won. "Once there's a broad consensus about privatization," he says, "you can argue over the details."

The Concord Coalition's Coupenas says there's no time like the present to start this debate. "If it does take five or six years" to implement reforms, he says, "who knows what other problems we may face?" A recession, war, or other financial troubles could derail entitlement reforms. "The longer we wait," he says, "the tougher it is to solve the problem."

Rick Henderson (DCReason@aol.com) is Washington editor of REASON.