Retirement Plans: Genuine Social Security Reforms Appear Surprisingly Likely

Article excerpt

In 1992, presidential candidate Bill Clinton, needing to shed the liberal baggage that then accompanied Democrats on national campaigns, promised to "end welfare as we know it" if elected. In 1996, after President Clinton twice vetoed bills that would have done so, Dick Morris whispered in his ear, and the president signed a bill that ended Aid to Families with Dependent Children.

Cut to January 1998. The president's Lewinsky period begins. Facing a hostile press and Congress, President Clinton needed to come up with a zinger or two for his State of the Union address. With his favorite subject - children - temporarily off the table, Clinton shifted his attention to the other end of the age spectrum. Preempting Republican dreams of tax cuts, the president promised to use "every penny of any [budget] surplus" to "save Social Security."

Whether Clinton meant it at the time isn't important. Political leaders often set forces in motion they cannot control. And just as Clinton's pre-presidential promise eased the way for welfare reform, his State of the Union speech may mark the beginning of the end for the unsustainable Ponzi scheme known as Social Security.

It is far from a sure thing, but the political planets are in alignment for real reform in 1999: Congressional Republicans have long wanted to reform the system; polls show the public understands something must change for Social Security to remain intact; the budget surplus is accumulating to cover some of the short-term costs that any reform will generate; and high-profile Democrats such as Sens. Daniel Patrick Moynihan (N.Y.) and John Breaux (La.) are joining Republicans in offering serious reform plans.

One reason action is likely is that Washington's policy makers - and many Americans - already know what's wrong with the system: It's a raw deal on the verge of long-term insolvency. They also know what needs to be done to fix it: Transform the system from an intergenerational transfer program to one that is based on invested wealth.

Social Security, as currently structured, faces the twin problems of insolvency and poor rate of return. According to the latest Social Security Trustees report, by 2013 Social Security will begin to pay out more each year than it collects in taxes. At that point, the system's obligations will put pressure on the general budget, as the cash-flow shortfall will have to be made up by some combination of spending cuts, tax increases, or debt finance.

Even as its solvency slips away, Social Security promises to provide Americans currently compelled to contribute to it an extremely poor rate of return. Calculations by the Heritage Foundation show that an average two-income family with 30-year-old parents can expect a dismal 1.2 percent return from the 10.7 percent of its income devoted to Social Security's retirement benefit.

Here's the rub: Under the current pay-as-it-goes structure, the problems of solvency and rate of return cannot be simultaneously addressed. Everyone knows how to increase the system's solvency: Implement a politically unpalatable combination of increased taxes and reduced benefits. But to do this would make Social Security an even rawer deal for those toiling to pay its taxes. Doing the reverse - reducing taxes and raising benefits - would increase the rate of return. But the system's solvency would slip away.

The only way out of this bind is to make the system's assets work harder. And the only way to make the system's assets work harder is for it to actually accumulate assets. As Sen. Phil Gramm (R-Texas) quipped at a Heritage Foundation luncheon, "You cannot set up a wealth-based system without wealth." There are many ways for the Social Security system to begin to rely on wealth, some better than others, some downright dangerous, and all requiring legislative change.

There are three general approaches to fund the system with real assets. One is to maintain the structure of the current system but have its administrators supplement the investment in government bonds with private securities. …