Social Security: Win The Battle And Lose The War?

By Dan Cornwell

Many progressive groups are fighting privatization of Social Security by embracing an investment-based plan and refusing to budge on raising the full-benefit retirement age. This strategy may or may not be a short-term winner, but it is certain to be a long-term loser.

Criteria for an Effective Social Security System

The purpose of Social Security is to protect workers and their immediate families against loss of income due to old age, disability, and death of the worker. All three components must be preserved.

To meet these objectives, benefits must be a) well-defined and predictable, b) tied to the cost of living at each year's standard of living, c) progressive.

Superiority of Pay-As-You-Go Funding

A pay-as-you-go funding system, in which benefits are paid from revenues from a tax on wages, is perfectly suited to meeting these criteria. This is so because wages represent the actual cost of living at each year's standard of living. Benefits therefore can keep up with annual increases in the cost of living. The payroll tax provides a reliable revenue stream

The superiority of pay-as-you-go funding over any investment-based plan is the strongest argument against privatization.

Social Security today is close to pay-as-you-go, and it meets all the criteria listed above. But there is a long-term problem, namely, the insistence on keeping the full-benefit retirement age constant (at 65 or 67) when longevity is rising. The cost of doing this will be borne by workers. So, what's fair?

The Retirement Age Issue

For any retirement system, whether pay-as-you-go or investment-based, there is a trade-off between retirement age and contribution or tax rate.

Keeping the payroll tax rate constant over time is fair to successive generations of workers because it means that each generation is giving up the same fraction of its taxable wage income to the system.

Keeping the tax rate constant requires indexing the full-benefit retirement age to longevity. Indexing is fair because it assures retirement income to each generation, on average, for the same fraction of its adult life.

The Ball Plan

The plan advanced by Robert M. Ball would keep a single, public trust fund but would invest it partially in stocks. Even with optimistic assumptions about returns on stock investments, the system drifts out of balance and would require tax increases from time to time. This is so because the plan does nothing at all to address the demographic problem.

Why not face the facts now? No investment-based plan can outperform pay-as-you-go with the same tax input.

The Ball Plan (1998 version) would also cut COLAs so that they would not keep up with real wage growth. This would be a severe cut in benefits for the most elderly retirees and for the disabled.

Strategy

The strategy of those who endorse the Ball Plan amounts to accepting the proposition that investment-based funding is superior to pay-as-you-go while refusing to accept indexation of the full-benefit age to longevity. This strategy will eventually lose on the age question and will have already abandoned the strongest argument against privatization.

Also, there are strong objections on public policy grounds to such massive investment in Wall Street by government. If adopted at all, the plan is almost certain to be combined with an individual accounts option. If the superiority of investment-based funding has been conceded, it becomes difficult to argue against such further moves toward privatization.

Conclusions

Those who want to preserve the current type of system should be cautious about taking a firm stand against any increase in the full-benefit retirement age. Don't fight privatization by crippling Social Security!

The views expressed here are those of the author and do not necessarily represent those of The Madison Institute.