Clash of the Titans

The coming collapse of Social Security pits the baby boom against the New Deal -- and the New Dealers have come out swinging.

Carolyn Lochhead from the March 1997 issue

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This is the essence of privatization's appeal. Workers would still be required to pay for their retirement, but instead of their payroll taxes going to the government to finance current retirees, the money would go into a personal savings account that would be invested in private securities markets, and the returns from the worker's taxes would flow directly to the worker. Chile pioneered the model with enormous success, and Argentina, Peru, and Colombia are following suit. Chile's returns have averaged 12 percent since the program's inception. The other countries are leaving the old system intact and giving new workers the option of joining a privatized or state-run system.

The transition costs to a fully privatized system would be enormous, because payroll taxes would be diverted from current retirees into private accounts. A full privatization now would cost around $100 billion. To cover payments to current beneficiaries, the government would have to borrow the bulk of the money. Critics point to the transition costs as the killer of any full-scale privatization plan. However, the change-over merely makes explicit a debt that already exists. And over time, as economist Martin Feldstein notes, privatization would gradually transform Social Security from an unfunded, pay-as- you-go system to a fully funded pension with real assets instead of promises.

Because Social Security redistributes income from high earners to low earners, partial privatization, or a two-tier system that would preserve this redistribution function, is now under the most serious consideration in Washington. Under these proposals, a portion of the payroll tax, say 5 percent, would be invested in personal saving accounts. The rest would maintain a safety net under poor retirees, the disabled, and their dependents. The remaining 7 percent would go to current beneficiaries and the poor.

This points to the real reason why privatization has its critics up in arms, warning of the demise of the "social contract." Any privatization plan would make Social Security's redistributive function very explicit. Workers could clearly distinguish between their tax money that was being deposited in their private accounts and their tax money that was being diverted to current retirees, particularly poorer retirees. As soon as that distinction becomes clear, worker support for the current program would begin to dissolve. Social Security in its current form would be seen much more clearly as a welfare program, and for the first time in its existence would stand in danger of losing political support. That is why attacks on privatization so quickly shift to "Wall Street greed."

Without better facts to make the "no problem" case, Social Security's defenders will have to rely on emotional and political arguments, and Wall Street greed fits the bill. Such attacks will gain currency in the media and on the Senate floor and in the White House briefing room. Whether they will catch on with the millions of people who already traffic with Wall Street in their own stocks, bonds, and mutual funds, along with 401(k) and pension investments, remains an open question. There is no question that Wall Street financiers stand to benefit greatly if billions of dollars shift from the public sector to the private capital markets. Then again, future retirees similarly stand to benefit greatly.

As to stock market risk, it does indeed exist, but not in a vacuum. It must be viewed in the context of the equally real political risk to current Social Security benefits, including the potential for drastic cuts in benefits and increases in taxes that would hurt poor people most. A RAND Corporation study in 1995 found that the entire net worth of nearly all poor workers and about half of the middle class now consists of promises of Social Security and other old-age government entitlements. The risk those people face right now under the current Social Security system is enlightening.

Similarly, those who do have savings and 401(k) plans and have invested them in stocks and bonds and other financial instruments face big political risks if the system is not changed. Unless action is taken soon to reduce U.S. debt, there is clear potential for a debt- induced economic collapse as outlined in a May 1996 report by the CBO: Spiraling debt and soaring interest rates begin a vicious feedback cycle leading to economic contraction, inflation, and a collapse of the stock market and the currency.

Argentina, Brazil, and other Latin American countries in the late 1970s provide the model for ruin. Unsustainable debt burdens--fueled by populist promises and harangues against "capitalist greed"--destroyed the economies of once-rich countries, eviscerating their middle classes and leaving their poor in destitution.

In essence, the arguments over Social Security follow the same paths that for a century have divided right and left, between faith in individuals and faith in the state. As EPI's Mashaw warned, under privatization, "People would get to choose what to invest in and what to do with the money when they take it out." He predicted that people would take their life savings to Indian casinos.

One side sees casinos and the end of the social contract; the other sees booming capital markets and personal freedom and responsibility. Trust fund or mutual fund, which will it be? The race to decide is on, and the stakes are very high indeed.