Well, whaddaya know ... it ain’t the third rail after all! “Touch it and you’re dead” used to be the conventional wisdom on the politics of suggesting any change to Social Security. (That’s the name for the American national scheme for post-retirement income.)
But the Republican presidential candidate, Governor George W Bush of Texas, challenged that wisdom by suggesting a fundamental change. Democratic nominee Vice-President Al Gore responded with his standard rhetoric: “risky and reckless”. Then he was forced to announce his own proposal on the subject a few days later. Clearly the public has some understanding of the issue and takes it seriously.
Here’s the background. Financed on a pay-as-you-go basis, Social Security has run into the predictable demographic crisis. First the baby boom generation took the ratio of beneficiaries to contributors from 2 to 100 in 1945, to 29 to 100 in 1975. There it has stabilised. Now, with increasing longevity but no sign of the birth rate increasing, benefit payments will expand past contributions by 2015. By 2075 contributions will pay only 72% of promised benefits. Citizens show no inclination to raise contributions from 12.4% of covered payroll to over 19%. What then to do?
Only three possibilities: raise contributions, reduce benefits (perhaps indirectly, via a higher retirement age), or bring in a new source of money. Both candidates have taken the third route. (Surprise!)
Bush wants to add capital market returns to the equation. He wants a portion of the contribution to be credited to an account for each individual, to be invested in the capital markets, and to become part of the individual’s estate if he or she should die before retirement. This makes it a property right, unlike current Social Security benefits, which can be reduced if Congress and the President so agree. Bush’s proposal particularly helps racial minorities, who typically die earlier than whites, are too poor to save anything beyond their Social Security contribution, and therefore lose these potential savings on early death.
Bush adds no further details. He will accept whatever bipartisan bill Congress sends him along those lines. This is politically astute, as the details can’t be criticised. But in fact this is how he has governed in Texas, forcing both parties to compromise on issues, and earning himself popular acclaim.
In addition, the House of Representatives and the Senate are already considering bipartisan bills espousing exactly those principles. Not unreasonably, these are considered blueprints for what might reach his desk if Bush is elected President.
They have three important features. They make no change to the promised benefits of retirees and those within a few years of retirement. For everyone else, they divert two percentage points of the 12.4% contribution to individual accounts, creating a defined contribution (DC) scheme. And they reduce the current level of defined benefit somewhat, but by less than what the new DC scheme should produce, given reasonable capital market returns.
Over time, as actuaries know well, capital market returns pay far more of the benefit than contributions,
so it should be possible eventually
to pay higher benefits with lower
contributions.
“Eventually” – aye, there’s the rub! Meanwhile there is less money available to meet the required cash flow for benefits, and support will inevitably be required from the projected budget surpluses.
That’s what the Gore campaign is focusing on. He accuses Bush of putting benefits at risk by reducing the contributions immediately available for paying existing benefits. He wants Bush to admit, as both bipartisan bills do, that some support from the budget surplus will be required.
How does Gore propose to bridge the cash flow gap from 2015? By using the budget surplus to redeem the national debt. This will reduce debt service. Gore will apply the saving to supplement Social Security contributions (though it won’t be enough after 2053). He also proposes a new entitlement: a DC scheme outside Social Security — thus acknowledging the electoral popularity of this aspect of Bush’s proposal. Gore’s government will add 300% to 30% to a worker’s voluntary contributions to the scheme, depending on the worker’s income.
Doesn’t Gore’s scheme require a diversion of budget surpluses? Yes. Does it solve the projected Social Security contribution shortfall in the long term? No.
If workers build up wealth in Gore’s DC scheme, will they have less need for Social Security, leading to a case for reducing Social Security benefits? Yes.
In fact, the competing proposals might end up working in much the same way. But you’d never know it if you simply listen to election rhetoric.
Yet the campaign has already taught us much. Social Security is no longer the third rail.
With 50% of the population invested in mutual funds, DC schemes are appealing rather than frightening. And Congress, realising that rational discussion is unlikely in the heat of a Presidential campaign, already has some markers down.
Whoever becomes President, there is hope that the problems of the national scheme will be addressed.
22 August 2000.
Don Ezra is director of strategic advice for Frank Russell Company

Topics