Birth of an Entitlement

Learning from the origins of Social Security

Carolyn Weaver from the May 1996 issue

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Clark and his supporters argued that the amendment would preserve competition in the supply of pensions and allow freedom of choice for workers, while ensuring the nation's elderly a level of protection at least as generous as the federal program. Why stifle the development of private pensions, they reasoned, that potentially could provide higher benefits for retirees while building good will with workers? Company pension plans were spreading rapidly among large companies in the 1920s, having first emerged in the 1880s, and coverage was destined to expand as the tax and business environment improved .

It was in 1926, for example, that the basic features of the tax code pertaining to pensions were established, effectively eliminating the double taxation that penalized ordinary savings. (The favorable tax treatment of employer-sponsored pensions did not extend to individual retirement savings until much later--individual retirement accounts and Keogh plans are creatures of the 1960s and 1970s.)

But critics recognized that the Clark amendment, if passed, would put the federal government in the position of regulating and competing with private pension plans rather than monopolizing its own. That competition would have profound implications for the ability to use Social Security for purposes of income redistribution. As Sen. Robert LaFollette (Prog-Wisc.) put it, "If we shall adopt this amendment, the government...would be inviting and encouraging competition with its own plan which ultimately would undermine and destroy it."

The critics' key argument was that contracting out would leave the public program at a great disadvantage. The feds' benefit formula, weighted in favor of those near retirement (and with lower earnings), would attract people who were relatively more costly to "insure," thus making the government program more expensive, if not prohibitive ly so. Critics reasoned that firms with relatively young workers would establish or maintain pension plans, choosing to contract out of the public plan (at a savings). Firms with older workers would discontinue or fail to establish plans, allowing their wo rkers to gain retirement protection through the government (also at a savings). Said Sen. Robert Wagner (D-N.Y.), one of the bill's sponsors, "I am firmly convinced that if this amendment were adopted we should find the government holding the bag for older men... while industries would take care of only the younger men who earned every bit of annuity they received" (italics added).

Undoubtedly the critics were right. In a competitive setting and in the absence of coercion, workers would be compensated--whether in the form of wages, pensions, or some other form of benefit or payment--in relation to the value of their output. There wou ld be little room for anything unearned. But, as proponents of the Clark amendment reasoned, if the purpose of the new program was to provide pensions based on earnings and contributions, not to redistribute income, the private sector was perfectly capable of performing this function. Unearned benefits, not competition, were the source of the problem.

FDR and his allies went to some lengths to kill the Clark amendment, including threatening to veto the entire bill--and thus to block all federal assistance for the poor--if the amendment were passed. Such efforts didn't work, at least initially: The Clark amendment was passed by the Senate (where Democrats held a 44-vote margin) by a vote of 51 to 35. Paul Douglas later acknowledged that, "In view of all the safeguards, it seemed to the majority of the Senate and to a goodly section of the public that there was really no legitimate objection against granting such an exemption." The Senate then approved the economic security bill as amended by a vote of 77-6. The House had already approved the legislation--without the Clark amendment--by a vote of 372-33.

When the House and Senate bil ls reached conference early in July 1935, negotiators spent a couple of weeks resolving all matters of disagreement in the various welfare programs, the unemployment compensation program, and the compulsory old-age pension program, with the exception of one--the Clark amendment. The House strongly opposed the amendment on the grounds that it would ruin the federal program and could, by resulting in different tax treatment of employers who had and had not contracted out, render the federal program unconstitutional. The Senate refused to budge. On July 16, conferees returned their reports to their respective houses, seeking approval on all issues except the Clark Amendment and seeking further instructions. Both houses responded with instructions to adhere to their positions.

Negotiations dragged on for several more weeks until the conferees decided that a further delay of the entire economic security bill--over a single amendment to a single program--could not be justified. They dropped the Clark amendment with the understanding that a special joint legislative committee would be formed to prepare an amendment, for consideration during the next session of Congress, that embodied the essence of the Clark amendment without raising the constitutional complications .

This, of course, was a major victory for FDR and his allies. The House and Senate accepted the conference report on August 8 and 9, respectively, and the president signed the Social Security Act into law on August 14. The Clark amendment was never reconsidered.

Just five years later, Social Security's income-transfer machinery began churning out checks to elderly people who had paid taxes for at most three years and to people who had paid no taxes at all (elderly spouses and widows, young widows with children, an d children of retired or deceased workers). Financed on a quasi-pay-as-you-go basis, the program grew in size and scope in the decades that followed, delivering lifetime annuities to a broader and broader segment of the population at a fraction of the true cost--and piling up larger and larger liabilities to be met by younger generations. Worries about the political risks attached to the government's long-term benefit promises seemed to evaporate.

It was not until the 1970s that reality began to pinch. This is when Social Security first began running gaping long-term deficits and when, as a "mature" pay-as-you-go system, its ability to produce large windfall gains to retirees was fast disappearing. Nothing's been quite the same since.

Today, middle-aged and younger workers, who face the prospect of potentially large wealth losses under the system, naturally seek the right to save privately for retirement, both to reap the gains of investing in higher yielding real capital and to secure their rights t o future income. Neither steeped in the traditions of New Deal programs nor beneficiaries of the windfalls those programs delivered in decades past, these workers question the value of Social Security as a retirement savings vehicle in the next century and seek new solutions to the age-old problem of retirement-income security. In this case, the best new solutions lie in some old ideas.

When Congress takes up the issue of Social Security reform, it can aim much higher than proponents of the Clark amendment were able to in the 1930s. With modern financial markets, a mature private pension system, and extensive experience with IRAs, 401(k) plans, and other self-directed investment plans, there is no reason to be limited by the idea of company-wide contracting out. Giving individual workers the right to fund and control the investment of their own retirement accounts is now a viable alternative that demands consideration--whether on a limited basis, as envisioned in the legislation introduced by Senators Kerrey (D-Neb.) and Simpson (R-Wyo.), or on a large-scale basis, as under the system adopted in Chile over a decade ago.