Birth of an Entitlement
Learning from the origins of Social Security
When a Social Security advisory council appointed by Health and Human Services Secretary Donna Shalala decides to issue a final report with three reform options, one of which would privatize half the retirement program, and when a Republican presidential candidate not only discusses Social Security privatization but also makes it a key element of his campaign, you know that business is definitely not as usual. In a remarkable turn of events, proposals that once were ignored or denounced as efforts to "smash and destroy" Social Security are being explored as possibly the only real means of saving Social Security. The ongoing support of middle-aged and younger people is clearly threatened by the woefully poor rates of return the program now offers. Numerous proposals circulating on Capitol Hill would move toward a system of true saving, where a portion of a worker's taxes would go directly into a personal retirement account that the worker owns, invests, and earns interest on.
As the idea of privatizing a portion of Social Security gains currency, a debate with the old guard is intensifying over what constitutes "radical" reform. This debate has a certain back-to-the-future quality to it. Far from being universally embraced when first considered, Social Security was bitterly contested in the 1930s and was, at the time, the radical alternative. With real reform now in the wind, it is worth remembering just how close this nation came to maintaining a basically private system of retirement pensions.
FDR's compulsory old-age pension program was nearly stricken from his grander "economic security bill" in the House Ways and Means Committee and again on the House floor, where an amendment to strike the program mustered a third of the votes cast. After this rocky start, the legislation moved to the Senate where an amendment was offered to permit companies to contract out of the public program if they could provide comparable pensions to their employees. Leading to more controversy in the Finance Committee and on the Senate floor than did any other, this amendment was killed in committee by a tie vote, then went on to be approved in the Senate by a wide margin and to stalemate House and Senate conferees.
No doubt the idea that Social Security lacked broad bipartisan support is at odds with many people's understanding of the birth of this mighty program. It is true that the Social Security Act moved through Congress quickly. Introduced on January 17 and signed into law on August 14, 1935, this landmark expansion of the role of the federal government wended its way through Congress and was adopted largely intact in just seven months.
However, what we know as Social Security--the old-age pension program--was just a piece of the Social Security Act that ushered in the modern welfare state. Many now-familiar programs got their start, or at least a federal boost, then too. Federal grants for aid to dependent children (now the AFDC program), aid to the elderly and to the blind (later merged with aid to the disabled into a single program of Supplemental Security Income), and maternal and child health services, to name a few, plus a tax-offset arrangement for unemployment compensation, were all contained in the original Social Security Act.
To appreciate the widespread and bipartisan resistance to Social Security, it is important to recognize the distinction that was made at the time between the problem of preventing poverty in old age and the problem of alleviating poverty among the elderly poor--a distinction that some find difficult to grasp today. Prevention was seen as a problem of retirement-income planning, of personal saving and continued employment, that could and should be addressed through voluntary arrangements--by individuals and families working together with employers, trade unions, fraternal organizations, and financial institutions. Alleviation ultimately came to be seen as a problem demanding at least some government intervention at the state or local level.
In the first three decades of this century, many states debated means-tested public assistance for the elderly poor and several states passed laws enabling counties to collect and dispense funds for this purpose. No one, however, introduced legislation to get the federal government involved in poverty relief for the elderly poor--let alone involved in the direct provision of retirement pensions for working Americans.
Advocates of social insurance worked hard to blur the distinction between prevention and alleviation, and between insurance and welfare, in the redistributive programs they promoted. They met with a decided lack of success. In historian Arthur Schlesinger' s words, "While the friends of social security were arguing out the details of the program, other Americans were regarding the whole idea with consternation, if not with horror." Samuel Gompers, leader of the American Federation of Labor for nearly half a century, put his feelings succinctly in 1917. "Compulsory social insurance," he said, "is in its essence undemocratic."
The public was not naive about the political difficulties of controlling public income-transfer programs. The federal government had long provided pensions and other special programs for veterans, and the generosity and cost of these programs had been a subject of continuous controversy. In 1920, the federal government set up a retirement program for its own employees, spending on which quickly outstripped original projections. And, of course, two or three decades' worth of experience with state and local pension funds for teachers, firemen, and other public employee groups revealed the inevitable pressures to increase benefits, defer tax costs, and shift burdens to future generations. Overexpansion, severe underfunding, and even cutbacks in benefits were not unheard of. In some ways, the political risks attached to long-term benefit promises by government were better understood in the 1920s than they have been since--or at least until very recently.
With the onset of the Great Depression in 1929 and the election of Franklin Roosevelt in 1932, the political landscape began to shift. Old-age assistance programs cropped up in many states, but were strained severely by burgeoning numbers of poor people and shrinking local tax bases. Pressures mounted--especially in the larger, more industrialized states--for federal assistance and a redistribution of tax costs. In 1934, a bill to provide federal matching funds to states operating old-age assistance programs received unanimous approval in both the House Labor Committee and the Senate Finance Committee, revealing broad, bipartisan support for public assistance for the elderly poor.
In a masterful political ploy, however, FDR refused to support the bill and it died at the end of the session. FDR's strategy, clear to all observers at the time, was to take the substantial momentum behind federal assistance for the poor--especially the elderly poor--and leverage it into support for his Social Security Act, a comprehensive legislative program whose heart was the compulsory, government-administered pension program.
Across party lines, members of Congress recognized and complained that they were being put in the position of voting for everything or being labeled as opposed to "social security." As Abraham Epstein, an early proponent of social insurance, described the dilemma for members of Congress, "Their choice was 'all-or-none,' [so] they voted for all and left it to the Supreme Court to separate the good from the bad. " (Interestingly, the terms pension, annuity, and insurance appeared nowhere in the original Social Security Act because of the concern that a compulsory pension program would be found unconstitutional.)
FDR was well aware of the battle to be waged over compulsory old-age pensions. When his Committee on Economic Security submitted its comprehensive legislative package to Congress in 1935, the Great Depression had been raging for six years. The Depression wreaked havoc on everyone--nearly 20 million Americans were on direct relief from the government--but it hit the aged especially hard. Yet not a single bill had been introduced into either chamber of Congress to establish a compulsory old-age pension program. FDR's social-insurance proposal was the first of its kind, even though social insurance had emerged in Europe nearly a half-century earlier, had spread widely among industrial nations, and had been a topic of debate in the United States for more than two decades.
The battle for Social Security began in earnest in the Senate when Sen. Bennett Clark (D-Mo.) offered an amendment to allow companies with private pensions to opt out of the public program. Under the amendment, any company could contract out of the public program if it had a pension plan that offered benefits at least as generous as the federal program, provided that the plan was available to all employees, that premiums were deposited with an insurance company or approved trustee, that employee contributions plus interest were refunded to the government in the event an employee's job was terminated, and that the company was willing to subject its books to federal scrutiny. Employees of companies that contracted out would have their choice of the public or private plan. (Those familiar with modern social security systems will recognize the concept of company-wide contracting out from systems in the United Kingdom and in Japan.)
While the Clark amendment conceded a great deal to Social Security proponents--it accepted, for instance, the premise of compulsory participation and left companies exposed to substantial federal regulation--it nevertheless would have given workers some degree of choice and given employers the right to compete with the government in providing retirement pensions. Individual choice and competition in supply would help ensure maximum value for workers' tax "contributions," protect workers' non-contractual rights to future benefits, and provide a much-needed check on the use of Social Security for the purposes of income redistribution
According to University of Chicago economist Paul Douglas, a leading figure in the social-insurance movement and later a U.S. senator, the fight over the Clark amendment was "the most vigorous" of the debates surrounding the economic security bill. And little wonder: In less than 10 sentences, the amendment cut through the "insurance" rhetoric and exposed the redistributive underpinnings of Social Security.
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 bills 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, and 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 to 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.
Carolyn Weaver is resident scholar and director of Social Security and Pension Studies at the American Enterprise Institute, and was a member of the 1995-1996 Social Security Advisory Council. She has written widely on the economics, politics, and history of Social Security.