Private Solutions for the Social Security Crisis
February 3, 1999
Alan J. Auerbach, Preston Martin, Michael Tanner
- Introductory Remarks by David Theroux
- Michael Tanner, Director, Health and Welfare Studies, Cato Institute; Co-author, A New Deal for Social Security
- Alan J. Auerbach, Director, Robert D. Burch Center for Tax Policy and Public Finance; University of California, Berkeley
- Preston Martin, Former Vice President, Federal Reserve Board of Governors; Chairman, Martin Associates
- Questions and Answers
- Concluding Remarks
President, The Independent Institute
Were having a special program on a topic thats much in the news these days. This evenings program is one actually of a series. In fact, its the first of a series that were doing on a more regular basis of lectures, seminars, and debates on major public issues. And we invite you to participate in the future. Incidentally, if we dont have your mailing address or a fax or e-mail, well be notifying people of additional events and also changes, so please leave that with us before you leave.
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By even the most optimistic predictions, Social Security, a cornerstone of government policies since the 1930s, clearly cannot, in its current form, survive. As the system appears to be headed towards either bankruptcy or insolvency, however you want to describe it, a host of policy proposals have been forwarded ranging from a deferred retirement age to some sort of government investment of either part or all of Social Security assets or future assets. President Clinton has been the most recent to discuss that in his State of the Union message.
Other proposals have proposed various forms of privatization, partial privatization, or total privatization including ones that would allow individuals to own their own accounts. And the range of views on that is rather diverse and thats part of our purpose tonight in discussing some of these ideas. Our panel of speakers tonight consists of three noted experts. They represent a range of views on the topic of Social Security and privatization.
The topic of two of the books that we feature tonight relate to this. Many of you have probably picked up the book that one of our speakers, Mike Tanner, is the co-author of with Peter Ferarra, A New Deal for Social Security. Years ago when I was at the Cato Institute, the very first book that Cato published was on Social Security by Peter Ferrara, and in many respects launched a more public discussion of some of these ideas.
The second book that I also very seriously recommend to anybody whos seriously in this topic, was edited by Martin Feldstein from the National Bureau of Economic Research. Although one of our speakers, Alan Auerbach, is not an author in it, youll find his model heavily referenced and discussed throughout the book.
The format for our program tonight is to have each speaker speak for 15 minutes, after which I will ask each speaker if theyd like to respond to the other panelists and then open it up to Q&A from you.
So let us begin.
Our first speaker has been a leading figure in the discussion of Social Security for recent months. His book I just showed you. Mike Tanner is actually the author of eight other books including a book called The End of Welfare. He was past Director of Research at the Georgia Public Policy Foundation. He was also Legislative Director with the American Legislative Exchange Council. Hes currently Director of Health and Welfare at the Cato Institute and also directs the project on Social Security privatization. In the popular media, his articles and articles about his work are appearing almost daily. I just heard that there was one appeared in . . . I guess, it was todays Washington Post?
San Francisco. Anyway, his articles have appeared in the Wall Street Journal, USA Today and many, many city papers around the country as well as in various magazines and he appears regularly on different national TV talk shows. So Im pleased to introduce Mike Tanner. (applause)
Well thank you all very much, and I appreciate your having me out here, and I appreciate the opportunity to talk to you tonight about an issue that, Monica, notwithstanding, is probably the most important political issue in Washington today. I really do believe its going to dominate the political debate of this coming year and possibly the next couple of years. And thats Social Security Reform and whether or not we need a new Social Security system.
And whenever I come out to groups like this and I start talking about the need for a new Social Security System, usually the first thing someone says is why? I mean, after all Social Securitys now 63, going on 64, years old, and its really done its job over that period of time. It has remarkably reduced the rate of poverty among the elderly. It has enabled millions of seniors to retire with security when they might not otherwise be able to do.
But in looking only at what Social Security has done in the past is only part of the picture. In many ways, its sort of like the fellow who jumped off the top of the Empire State Building, and as he was falling, people would gather at the windows of each floor to watch him go by. This was New York, after all. And as he passed by they could hear him say, well, so far so good. The problem of course is at the bottom you get a big splat. And, unfortunately, thats exactly whats going to happen with Social Security. Theres a big splat coming. And its going to be a much bigger splat and its going to come much sooner than I think most people believe.
You see, in just about 14 yearsthe year 2013Social Security will begin to run a deficit. That is, it will begin to spend more on benefits than its taking in with revenues. I think all of you can understand that when youve got more money going out than youve got coming in, theres a problem. Well, of course, nothings ever quite that simple in Washington.
So in Washington, they actually have a theory that says, come 2013 when they have more money going out than coming in, theyre going to go back to the Social Security Trust Fund, and theyre going to take the money from the trust fund and use that money to continue to pay benefits until about 2032. After which the trust fund will be exhausted and Social Security will only be able to pay about three-quarters of the benefits thats promised with the revenue stream that it has.
Its a nice theory, has one tiny flaw. There aint no trust fund. And the simple fact is all the money in the trust fund was spent a long time ago.
What happens is the money from that trust fund is borrowed by the Federal government and, really, it cant do much of anything else, I mean the government is actually sort of structurally incapable of holding money, so it lends that money to the Treasury, and that money is then spent on the general operating expenses of the Federal government. Everything from roads and bridges, national defense, foreign aid, welfare, Ken Starrs latest investigation, whatever.
And leaves behind a trust fund thats composed of about half ofthe trust fund is composed of government bonds. And the government bond is essentially an IOU. It is a promise against future tax revenues. It may be a good promise but its still just a promise against future tax revenues. And the other half of the trust fund consists of an accounting entry with attributed interest to those bonds. Theres no actual money there.
I think Senator Moynihan can probably explain this best when he said, just consider what would happen if Social Security never ran a surplus and there never was a trust fund. Well, beginning around the year 2013, when Social Security begins to spend more than its taking in, if its going to continue to pay all the benefits its promised, the government has three choices: it can raise taxes, it can borrow the money, or it can find it somewhere in the budget, somewhere else in the budget.
All right now weve got a trust fund. What happens?
Well, beginning 2013 they have to go back to the trust fund and start redeeming the bonds. Where do they get the money to pay the bonds? Government has to raise taxes, borrow it or find it somewhere else in the budget. Makes absolutely no difference.
Now that means that come 2013, which is not that far off, theyre going to have to start looking to younger workers to make up that difference. And those young workers are going to get hit with a huge tax increase.
Right now the payroll tax in Social Security is 12.4 percent. Three out of four Americans pays more in Social Security taxes than they pay in Federal income tax. 12.4 percent now, if theyre going to raise taxes in order to keep Social Security solvent, that tax would have to increase to at least 18.3 percent.
And I wish that was the bad news, but actually thats the good news. I didnt even talk about Medicare in there, but I think I will just for a minute, because the total payroll tax is 15.3 percent, it includes Medicare. Well, Medicare is in even worse shape than Social Security. It actually begins running a deficit around 2004, its trust funds exhausted around 2010, and its costs are escalating rapidly. If you actually and want to include Medicare in there as well, then the payroll tax has to rise from 15.3 percent to about 28 percent.
And thats still the good news, because what I was just using is what the government calls its intermediate projections. Every year the government issues a new set of forecasts on the issue, an optimistic set of projections that have never been right in the history of the program. A set of intermediate projections which are right about half the time and a set of pessimistic projections which are right about half the time. If those pessimistic forecasts, which assume unlikely events such as a recession in the next 30 years, if they are more accurate, then the total payroll tax, according to trustees of the Social Security System (the total payroll tax necessary to pay both Medicare and Social Security) benefits would have to equal about 40 percent. Obviously, thats not sustainable.
The other alternative is to cut Social Security benefits by somewhere between 25 and 33 percent, either directly by cutting benefits or indirectly by raising the retirement age or so on. Again, I think thats not sustainable.
Now, lets assume that a miracle happens. Lets assume we find a way to finance all of this. We find a way to fix that financial problem. Would we be out of the Social Security wilderness? And I would suggest the answer is no. Even if that were the caseand believe me, miracles could happen. People have explained to me that if we just sort of double our economic growth in the next 20 years or so then we have no more problems. (laughter) Or someone from the AFL/CIO with a straight face explained to me that all we have to do to fix Social Security is to allow in an additional one million immigrants every year for the next 30 years, and then send them home before they start to collect their benefits. (laughter)
OK. But lets assume deus ex machina, we find a way to fix the Social Security solvency problem. Youre still left with the fact that Social Security has become a lousy deal for young people. It was a good deal. Someone who retired 20 years ago got back everything they paid into Social Security with interest and a heck of a lot more besides.
But if you retired this morning, the Social Security check you get will have the real rate of return on the money you paid in of about 2.2 percent. And for young workers, they can expect a rate of returnif theyre luckyof 1 percent, most of them will be zero, and a lot of them will likely see the negative rate of return. And if you raise taxes or you cut benefits in order to keep the system solvent, theyre all going to get a negative rate of return. Actually youll lose money on the Social Security system. You get back less in benefits than they pay in taxes.
So its not just one Social Security crisis. Its not just the financing crisis. At the same time you fix the financing crisis you have to raise the rate of return and find a way to make it a good deal again for young people.
Just let me mention very quickly a couple of other problems with Social Security that also have to be fixed at the same time. Social Security has a lot of unfairness in it. Social Security penalizes the poor, minorities, and working women.
Essentially it penalizes the poor and minorities primarily because how much you get back depends on how long you live. Now if you live to be 100 you do pretty well on Social Security. Drop dead at 66, thats not quite such a good deal. The fact is, in this country the poor dont live as long as the rich. A lot of reasons for that but its an unfortunate fact of life.
Same thing is true with a lot of ethnic groups in this country. African-Americans at all income levels have a shorter life expectancy than do whites, so they get back less on a comparable basis than a white counterpart.
Working women are penalized with what is called the dual entitlement rule. Under that rule it means that if you, essentially a woman, and I say a woman here, its a spouse in the law, but in about 96 percent of the cases its actually a woman, is entitled to 50 percent of her husbands benefits whether or not she works, whether or not she pays any Social Security tax.
But that means that if she goes to work and she earns half of her husbands wages, because of the disparity in pay and so on, she pays Social Security tax on her earnings, but doesnt receive one dime in additional benefits. The money she pays in taxes is just lost.
And they also suffer, the poor suffer, because theres no inheritability of assets. So if you take a women whos a single mother, who works maybe two jobs her whole life, now her kids are 18 so theyre no longer eligible for survivors benefits, and she drops dead. The money shes paid in taxes is lost. Just gone. Theres no money that she can then hand down to her kids so that they can go to college or start a small business or something like that. Its lost. Thats a problem that has to be fixed at the same time we fix the solvency of Social Security.
Fourth, we have to worry about the impact on the economy. Well, we have the lowest national savings rate in the world among any major industrialized nation. And we have to look at Social Security as being one of the causes of that.
The studies indicate that what happens is that people save less because they count on Social Security, but since Social Security doesnt really save any money, theyre substituting fantasy savings for real savings, and its depressing our overall national savings rate. And its also having an impact on the economy, because a 12.4 percent tax on labor is essentially a terribly aggressive, and a terrible way, to get people to work, and it has a terrible effect on productivity.
Lastly, I would just point out that theres a question of dignity involved. I think most people, at least most of the seniors that I talk to, believe that they have a right to their Social Security. They paid taxes all those years so they should have a legal right to those Social Security benefits. I hear it all the time. Social Security is an earned right. Its guaranteed.
Well, no its not. You see, the Supreme Court ruled in a case called Fleming vs. Nestor in 1960 that there is no legal right to Social Security benefits based on having paid Social Security taxes your whole life. Government can take away those benefits anytime they want. In fact theres discussions all the time in Congresswere going to raise the retirement age, were going to change the CPI, were going to do just this, just that and take away benefits.
Well, the simple fact is youve got no legal right to your Social Security benefits. That means you work your whole life, you play by the rules, you pay your taxes, and when you turn 65 you have to go hat in hand to the government and say please, please give me some money to retire on. I dont think thats the way we should be treating our seniors.
Let me just close with this. Social Security was invented in the 19th century. That was a time, people communicated by giving someone on horseback a letter to ride it across the country. Now here we in the beginning of the 21st century, the Internet Age. You know push a button and your message will cross the world. Shouldnt there be a 21st century Social Security system and not a 19th Century one? Thank you all very much. I really look forward to the question and answer session. (applause)
Thank you, Michael. Our next speaker is someone Ive already mentioned. Professor Alan Auerbach is the Robert Birch Professor of Economics and Law and the Director of the New Burch Center for Tax Policy and Public Finance at the University of California at Berkeley, my alma mater. Having also taught at the University of Pennsylvania, Harvard and Yale, Professor Auerbach is Research Associate for the National Bureau of Economic Research, and he served as Deputy Chief of Staff of the US Joint Committee on Taxation. Hes a fellow of the Econometrics Society.
Professor Auerbach is also currently Associate Editor of several major journals in finance and statistics and tax policy, the author of over 60 scholarly articles and reviews, hes a contributor to numerous scholarly books and studies and he is the author of the book The Taxation of Capital Income. Im very pleased to introduce Alan Auerbach. (applause)
Alan J. Auerbach
Thank you very much. Im here as neither an advocate of privatization nor as a defender of the faith. Because I do think that Social Security is in need of more than these refinements to keep it humming for another 60 years.
So I start with the view that the Social Security system is in trouble and that we face hard choices in dealing with it. I also have the view that for a variety of reasons, privatization is attractive, but I think its important to say that these are, in some sense, separate issues. Theyre obviously related because the impact of the problems in the Social Security system is thatone of the impactsis that it causes us to focus more on the general issues of the security and whether were doing it the way we should be doing it.
Thats a good thing because were doing that, but I dont think we should mix up the two things, in the sense that there are certain problems in the Social Security system now which can be improved by privatization, but the financial crisis of Social Security and the poor rate of return associated with this financial crisis, the fact that were short of money and were going to get to be shorter still of money in the future, are in no way addressed by privatization.
That is, privatization could stand or fall on its own merits and may very well stand on and that may be the way to go for the Social Security system, but we should not view that as a vehicle for solving the financial crisis that Social Securitys in.
Put simply, the moneys already gone. Its not that, you cant make it come back by going to privatization. On a going-forward basis, you may feel that privatization is better, and we should talk about that. But we cant make money that has already been spent reappear.
So what Im going to talk about is: Whats the problem, briefly; what the problems are; and, what privatization can and cannot do? The current problems, as you just heard, are serious and getting worse. The Social Security system, as estimated through 75 years, needs about 2.2 percent of payroll, or just under 1 percent of GDP, to keep the trust fund from going into the red over that period. Indeed the problem is worse than that because the trajectory of the Social Security system at the end of that period is very unfavorable.
So, if you actually dare to look even farther into the future, which seems like a strange thing to do, but for programs that are demographically driven like this, its necessary, the gap is actually considerably bigger. So were not talking about under one percent but probably more like one to two percent of GDP, and, indeed, this is a smaller problem than Medicare, which is being driven by two factors, not just demographic changes, but also changes in relative spending on health care. But one problem at a time.
Now what can be done of this sort of privatization, because thats obviously the first thing that one might consider. Well, there are different approaches. There are the obvious approaches: cut benefits, raise taxes. This is the approach taken after the Greenspan Commission report in the early 1980s. Both of which, mostly raising taxes, but to a certain lesser extent cutting benefits at least in the future.
Now there isnt that much discussion about this right now. There may be in the future, and certainly if we do discuss this sort of, these sorts of options, we should keep in mind that there are some approaches that are far better than others. There are better and worse ways to cut benefits. There are better and worse ways to raise taxes. We shouldnt simply say, well, because this isnt privatization, it belongs in a specific category of solutions, all of which are equally viable. Some of them are really bad ideas.
And one fear that one might have is that if privatization strikes out and doesnt become the way we take, that we then end up with a really bad solution, that does things in a way that isnt that attractive.
Now theres a less obvious way of approaching things than simply cutting benefits and raising taxes, which is to find the money somewhere else. The government finds it easier to do that than an accountant (inaudible). The one proposal which has been around, only a little bit less in jest perhaps than admitting the immigrants, was quoted, for example, in the Social Security Advisory Council, was to enroll more workers. Find some people out there, like state and local government employees, who arent currently in the system, and force them into the system.
Now, given that we have to pay benefits to them in the future too, this is a little bit like losing a little bit on each sale and making it up on volume. Andor like, to use another analogy, pulling people out of the lifeboats onto the sinking ship.
Or we could use general revenues, which over the years has been discussed, usually rejected, by many people of different political stripes, who felt that the Social Security system should be best viewed as a separate entity and not have funds commingled with the rest of the government.
Interestingly, despite all the indirectnesses of the actual proposal, this is what President Clinton is proposing to do. Hes proposing not to put current general revenues into the Social Security trust fund, hes proposing to put the federal debtadditional federal debtinto the Social Security trust fund. And presumably that means in the future, when that debt has to be serviced, that money is going to come from federal and general revenues, because we dont use payroll taxes to fund payment on the national debt. We use general revenues, mostly income taxes.
So thats something that could be countenanced, but of course that doesnt make extra money for the government, thats taking money not from state and local workers, as in the first case, but taking money from other government programs, or from taxpayers, if it is involves a tax increase.
Again, this is a choice thats being made, but if its solving the Social Security crisis without raising revenue and without cutting other spending, then its causing a crisis somewhere else to get worse. So thats really an overall solution.
And finally, theres the possibility of investing the trust fund in equities to try to earn a higher rate of return. And here there are a couple of issues that come up, some of which also come up in the case of privatization, but additional issues that come up here have to do with government involvement, and this is an issue thats been discussed a lot. I think there is also the general issue, which Ill come back to in talking about privatization, which is, what if markets do badly rather than well? To what extent is there a political commitment, if not an explicit commitment, to make up the difference? We certainly have to think about it if its money within the government going to pay for benefits, but it will also come up in the case of privatization.
In short, there are no politically painless solutions to this problem, real solutions, within the context of the public Social Security system.
So what can privatization do? Well, Im going to talk about what I see as the true potential benefits of privatization. First, it can give greater access to equity markets for people who currently arent involved with them. People who dont do much saving outside of Social Security now have no involvement in the equity markets, and this would give them an opportunity, essentially by forcing them to save, but giving them the opportunity to choose where to put the money. And I know that is an argument given by proponents of privatization, and I think thats a real argument.
It also would make the system more transparent. It would give people a better sense of the connection between their contributions and their benefits, because theyd actually see an account. There wouldnt be this mysterious organization in Washington to which taxes go and some time in the distant future benefits come.
And it would eliminate anomalies in the methods of benefit calculation. You heard about the way working wives are penalized. These sorts of things happen because benefit formulas are calculated in an arbitrary way not really related to payroll tax payments, and if they were related to payroll tax payments, this sort of thing couldnt arise except by intent. Government could say, were going to give a subsidy or were going to impose a tax on this particular group or another. But in many cases, one guesses that these arent there intentionally, they arose over the years by accident, and inertia has kept them there.
And finally, it would makeand this is in some sense viewed by some as a benefit and by others as a cost, it would make the redistributive element of Social Security more transparent. There are groupseven with shorter life expectancy of poorer people who do better through Social Security than higher income people. Not as well as might be implied by the formulas themselves, because they dont live as long. But on average, the poor do better because they get a higher so-called replacement rate, even if for a shorter period of time. But not all poor groups fare equally well, and there are all kinds of transfers based on different cohorts and so forth. And making itwhile one might fear what would happen to elements of redistribution if they were made more explicit, it certainly seems as though a rational political debate would benefit if whats going on was more evident.
OK, thats what privatization can do, and I think those are the appropriate grounds for discussion of privatization. What privatization cannot do is eliminate the funding imbalance.
Its often said that Social Security gives people a pretty bad deal in terms of rate of return on their funds, and thats under current rule, and its going to get even worse if we try to, say, cut benefits and raise taxes. All true.
But the major reason why the rate of return is so bad is because a large part of the money that people are not getting on what theyre putting away is money in the sense that its already gone, that is, to pay off the benefits of current beneficiaries who themselves made payments to past beneficiaries. The moneys not there, and thereforea lot of what current people enrolled in the system are paying for, and hence will not get from, in terms of their own benefits, is the paymentsthe benefits of the current and past generations.
Putting it another way, the system is not funded, its not adequately funded. There is a trust fund, but its nowhere near whats necessary to pay for the future Social Security benefits of people currently in the system. The moneys not there. Enacting a private system isnt going to make the money appear.
So how can we make the rate of return higher? Well, we can make it higher, I suppose, by reneging on benefits to existing generations, but were not going to do that. So if we dont do that, then the only option that remains is to seek a higher rate of return through the equity market. That has benefits, but it also has costs, because at least the way we teach it in economics, theres a risk/return tradeoff that causes equity to have a higher rate of return than the government than is currently in the Social Security trust fund.
Now, it might be that in general, people would be better off with more equity investment. Certainly historical rates, relative rates of return, suggest that to be true. But theres also a risk. I dont think that people should avoid taking risks in investment, In fact, its been suggested that a lot of people in their retirement savings are too conservative.
But given that this is a mandatory program, and not the investment that people are taking on their own, the question you have to ask is again, as in the case of a public system, what if the investments dont work out? What if a particular generation, contrary to long trends in historical experience, does badly in the stock market, and theyve got all their money in it? What happens then? The question is, are we going to come in and help them?
As a society, weve shown a commitment to do that in the past, and thats one of the reasons why we have mandatory Social Security pensions in the first place. Because we felt we were going to support the indigent elderly in any event, and if were going to support them, then we ought to make them save for their own retirement so that we dont have to.
So we have the problem of people whose investments dont pan out, and we have another kind of problem. We have the people who choose to invest, and invest too conservatively. Dont invest in equity markets and equity markets do well, and then relative to other members of the retired population, they look very poor. What do we do then? Do we help them out?
It seems to me that in the context of any system, whether private or public, we have to answer questions like that. And ultimately, we may end up with a mixed system, for example, where theres some minimum benefit guaranteed that takes care of this problem, or we may end up with a fully private system, but a private system which has certain restrictions and safeguards or requirements in terms of minimum accumulations. One of the original purposes of the Social Security system, which I think is a valid purpose, is still met, which is to ensure at least a minimum level of income for the elderly so that they are not indigent and then in need of further transfers. Thank you. (applause)
When I was at Cal, Im afraid we didnt have professors as good as Alanat least the courses I took.
Our next speaker has been a leading figure in the major economic developments of the past four decades. Preston Martin is currently Chairman of Martin Associates, a San Francisco based financial services firm. Dr. Martin has also been Vice Chairman of the Federal Reserve Board of Governors, and Chairman of the Federal Home Loan Bank Board, where he engineered the Federal Home Loan Mortgage Corporation.
In addition, he is the founder of Neighborhood Housing Services of America, dedicated to affordable housing in urban and rural areas throughout the United States, and The Social Compact, a group that recognizes affordable housing enterprise and minority-owned business financing.
One of the principal architects of the adjustable rate mortgage when he served as Savings and Loan Commissioner for California, he was also the founding Chairman and Chief Executive of PMI Mortgage Insurance Company and PMI Mortgage Corporation, and also served as CEO of Serico Corporation, part of the Sears Roebuck group at that time.
But before his extensive work in business and government, Preston was also professor of finance and director of executive programs at the University of Southern California. He received his Ph.D. in monetary economics from Indiana University, and more recently, hes the founder of graduate business schools in Italy and Pakistan. Surely a renaissance man. It gives me great pleasure to introduce Preston Martin (applause).
Thank you very much. Ladies and gentlemen, good evening. As you could tell from that overly lengthy introduction, Ive had a desperate time making a living. In and out of government, in and out of public life. And I do appreciate following such a distinguished pair here, each of whom have made very sound and very intelligent analyses, and made them understandable. I dont know whether that is going to hurt their tenure at their institutions or not, Iin my years at the University of Southern California, we were trying to develop a faculty the football team would be proud of.
I also notice that one of the outstanding participants in USC in those days, Richard Buxton, is here, the fellow who had the temerity to push all those corporations around the country into providing a methodology by which their employees could own stockown stock in the company. Talk about a radical approach. Welcome to the group, Dick.
So given the magnitude of this problem, and given the universality of its impactthink of the trillions of dollars that have been described here over the next 15 years, 20 years, and so forth. And consider for just a second what youre already considering, the importance of Social Security reform to every individual in this country. All of us. Everybody in this room, everybody in this nation. And you notice that neither of our (inaudible) mentioned that one of these successful programs in Chile, or if youll pardon the expression, United Kingdom, the more or less disunited kingdom, or other parts of the world. The efforts there based on a very different population distribution, age structure and so forth. Its a little easier in Chile, when you dont have so many old people to go onmore of them putting the money in than taking out.
So it is such a plus for this Institute to have brought all of our attention to this, perhaps the most fundamental economic and social issue, because there is a huge social side to it, of this country in which we live.
Now the Goldilocks economy, well there is a wolf there at the door, and it says Social Security on the helmet that its wearing. And yes, we are successful, yes, we have changed our economic system so successfully. Oh, there will never be a recession? Well, you know thats nonsense. Never will inflation come back? Right. The tooth fairys name is Sam. But we have fundamentally changed this economy and this society over these decades.
We are so productive, we are so information oriented, quantitativelyall those nerds, thats no longer a deprecation to say weve got all these nerds. They have their own language, too, are you catching up to some of it?
And our ability to restructure so much of our working labor force and to utilize the part-timers and to give people time off to work with their families and all the rest of it. What a fundamental change in the way we produce goods and services in the country.
And what is even more shocking is, some of our Washington institutions have changed in the deck. And that gives somehe said, using typical weasel wordsthat gives some expectation that there can be a feasible reformation of the Social Security system.
I give you the example of the Board of Governors of the Federal Reserve system, which has so fundamentally adapted to the globalization in the financial world, the tradings only $2 trillion today, on the foreign exchange and so forth. Its been a quiet day, only two tril, thats with a T.
And you have the use of the central banking organizations, and it isnt all over the newsprint, thank God, and I dont mention it when I was on CNN-FN today, believe me, but when the central bankers of the planet get together periodically in the ugliest city in Switzerland, namely Basle or Bahl as they call it, the Bank for International Settlements, and they cooperate in the management of the liquidity flows around the planet. Its done so much better than in those years I served at the Fed, and I went to Basle there, and tried not to get run over by the trains, theall that is is Switzerland where all the trains come together.
But the cooperative approach, and OK, so Brazil is changing its central banker about every other week, its not a perfect game. But think again of the crises, first in Asia, then Russia, then Brazil, and in my days back at the Fed, all around Latin America, and the provision of liquidity when needed.
Now will it always work? Well, some people say, well, it worked back last July, andof course it will not always work. But you have the setting of these goals internationally and the cooperativeness that is really unprecedented.
Now, what has that got to do with Social Security? Well, the reformation of the Social Security system does not easily provide an involvement of other Washington agencies in our nations capital. And I had that article this morning which Im sure you saw as you did your preparation for this program (I know you dont come in here and wing it entirely) to suggest that the Board of Governors of the Federal Reserve managed the trillion or two trillion, whatever its going to be, in the funds for Social Security in the future.
I could tell you some dirty little stories about how they have staff that manages the funds of their own retirement, and I wont. (laughter) I refuse to answer any questions that any of you people will come out about, about that side of the Federal Reserve.
But believe me, the Central Bank has enough to do, right now, ladies and gentlemen, more than enough in maintaining the international liquidity and in deciding is it still OK for the broadest measure of the money supply, the MZM, to increase 12 percent in the next 12 months? With inflation running at zero or half of 1 percent, youve got to increase the money supply 10 percent? Is that OK?
The implications of the making of policy, now, at 20th and Constitution, folks, does not lend itself to turning any part of the privatization of Social-not-very-Security over to the Central Bank of this country. Now, the proposals, of course, to have any government agency controlling the investment side40 percent or 30 percent or 20 percentwhatever percent it is of the revenues, I suggest to you to recall the last big money management reform that we have lived through. And its called The Savings and Loan Bail Out. (laughter) OK? You remember that one? Oh, boy, the governments going to fix that. Right? And what is it costing us tax payers? Oh, maybe its only $150 billion.
Audience Member #1
Yes, more like 6 or 700 billion. And I can still remember going back there and pleading with the various presidents and their august secretaries of the Treasury and whatnot and pointing that you pass that second Banking Act and tear up all those contracts for those tens of billions of dollars that have been raised to bail out. And it wasnt a bail-out to restructure these thrift institutions? Is that going to work? No, no.
And part of the $600 or $700 billion dollars its going to cost all of us, of course, is the litigation against the federal government for its august planning and changes of all those contracts for the tens of billions of dollars. Right? So, to forget about the Savings and Loan debacle and suggest that some good old federal government agencies can do all these things is absolutely to forget a rather vivid page of recent history.
So, what is my message today? My message today to you is stay involved in this. My message to you is its so important to those kids of yours, and your grandchildren, and the future of the financial side of this country. And again, I commend the Institute for holding this session. And I plead with you to be involved in any way that you see fit. And every time you see that bloody Congressman of yours, or Congresswoman, give them that jab, give them that requirement that they act. Bore them to death with some really good, well-structured program to do something constructive about the largest financial aspect of the futures of everyone of us in this room. Thank you very much. (applause)
QUESTIONS AND ANSWERS
(First Question Inaudible)
its if the rate of return on private capital of any kind, including government bonds, is zero. Because under the current system, no money is ever saved or invested for any individual in any way. All of the taxes that you pay for your retirement, none of that has been saved or invested. So any rate of return should be compared to that zero investment that takes place in the current system.
And lastly, I agree that you cant make it come back. Theres no way you can make up for bad policy in the past. Weve spent the money, thats gone. But you can stop spending in the future. If you have a credit card and youve run up a huge debt, you cant get out of paying it. But you dont go down and start charging again tonight. And the problem with Social Security is that every day it continues, it runs up additional unfunded liabilities and additional debts.
So if we move to a privatized system, weve got to pay off the past. But at least, from that point on, were not accumulating additional unfunded liabilities that we are every day under the current system.
OK, Alan, I see youre shaking your head.
Alan J. Auerbach
Well, I mean, I just think thats wrong. The first point about the sizethe magnitude of the deficit, I think its just a question of whether youre talking about Social Security or the overall government.
Its true that the Social Security trust fund is helping government debt, which means that as a whole, it doesnt help. Its not really there, and so there is a bigger gap, but that gap resides elsewhere in the government. And indeed, President Clintons proposal to put more national debt into the Social Security trust fund would simply increase that, maketo the benefit of the Social Security system, and to the detriment of the rest of the government.
So the gap is bigger if you look at the whole government, but it still I think is useful to think about where the gap is in the government. OK. So I dont know that we have a big disagreement there.
In terms of the zero rate of return, the reason why the rate of return is zero is because for whateverin a more general case, however quickly the economy is growing, is because its a pay as you go system. If it were a funded system, you could have a funded federal system. We dont have one. But you could have a funded federal system, and if it were funded, the money would be invested in government bonds or something else, and it would be earning some rate of return.
But the point is, you cant go from an unfunded system to funded system by going to a private system. Youve still got the overhang of existing liabilities, and that has to be resolved.
Preston, do you have a comment?
OK, so well open up for questions, and Ray has a mic, if you can use that, and
Audience Member #2
I know the current surpluses that were running are really not surpluses, theyre counting the Social Security surplus. But the projections weve seen recently are that we will have a real surplus instarting in 2002 or some year like that. Can we use that to do what youre talking about, get us through this transition period, whetherI mean, I agree the problem betweenhow are wethe current people have to pay twice. They have to pay for their own retirement, and they have to pay the people who are currently retired. Could wein your view, could we use these projected surpluses to do that?
Who are you asking the question?
Audience Member #2
Anybody who wants to answer.
Alan J. Auerbach
Let me just answer a piece of it. Just in terms of numbers, theres not enough there. So if you took that amount, and you said, were going to take everyall of that money, and as we buy back that national debt, well put it into the Social Security trust fund, its way too expensive. Even if it comes to be.
I agree with that. The only point is that there, for the current system as well, its not enough to prop up the current system as well.
Theres no way around the past debt, whether you goyou keep the current system or you go to a privatized system, youve got that cost. But because the privatized system stopped accumulating debt, the long run, it will always be cheaper.
No matter what mechanism you choose to fund the transition, whether you raise taxes, whether you cut other government spending, which is what I recommend, whether you issue debt, it is always less to do itto stop now and then move to a privatizationto make simply a transition to the private sector than it is to prop up the current system indefinitely into the future.
Audience Member #3
I have a question concerningyou guys are doing a wonderful job of popularizing the problem, but in terms of coming up with a solution, it seems like its coming upon us pretty quickly, andwhat do you guys make of pure voluntary ideas such as tax sheltered annuities? If youre worried about risk, you could buy a whole life insurance policy; if youre not worried about it, you can get into mutual funds, 401Ks, that kind of thing.
What do you think about educating people and not forcing them to do anything that they dont want to do with their money, but also showing the benefits of planning for the future?
Well, Im all in favor of any savings vehicles in any way we can convince people to save. The problem is, the people who can afford to do it generally are. A lot of people cant afford to do it.
That minimum wage worker, after hes done paying his food and his rent and clothing and his medical bills, doesnt have a whole lot of discretionary income to save. Especially since hes being forced to put 12.4 percent of his income into the Social Security system. If were going to find a way for him to save, weve got to find a way to give him back some of that 12.4 percent, or hes simply not going to be able to participate in any way in the system.
And thats actually, if there was no other reason to privatize Social Security, thats why I would do it. Because right now we have a problem in this country with a growing wealth disparity. Onetop one percent of incomes owns more than half of all the wealth in this country.
If you want to look at, for example, the difference between blacks and whites, the black/white wage gap is shrinking, continuing to shrink, which is a good thing. The wealth gap between black families and white families is growing. And the reason is that blacks have not been able to participate by and large in the savings boom thats been going on in the growth in equities and the bull market. We need to find a way in which we can take people of middle and lower incomes and allow them to participate in real wealth accumulation, which is what privatization would do.
Go ahead Preston.
I think your question is well posed, but I urge each of you, again, to participate in pressure to begin Social Security reform, to take the very first steps, however minor.
Let me remind you of another situation of the last decade or so. Many, many of us have been working in the so-called financial institution reform process, attempting to widen the purview of the services that financial institutions can offer, and its been 10 years, and weve made a little progress, but you dont give up in political matters, in the political world. You do an increment, something this year, you do an increment the next year. Its going to be a big issue in the presidential campaign. OK fine, lets get some steps toward reform over time.
How about right up here?
Audience Member #4
This is addressedwell actually, it refers back to something Mr. Tanner said about the fact that we are entering the 21st century with a 19th century vehicle. Im just wondering, and Id like to have the panels reaction to this, no one mentioned means testing, and the way I see the world, people have changed very much.
The generation thats receiving the Social Security benefits lived through the Depression, has a completely different take on what risks are, on howwhere theyre going ortheyre not going anywhere anymore, but many of those people have retired on really very good retirement plans, and are extremely well off, and they are being supported by the person who is spending 12 percent of his wages, holding three jobs, and not having any hope at all in life.
Now, the people who are now young people, and just recently I read an article about how jobs have changed, you alluded to that, but a number of people are now privateare self-employed. They pay twice as much, that is, they pay the full 12 percent themselves. They dont have an employer.
So the way the world of work has changed, and Im just wondering whether it would be possible to say, OK, we stop right now, if youre 40 years old, whatever the arbitrary number is, this is a transfer thing, its notthis is a transfer payment, this is a way of moving money from people who have it to people who dont. But from now on, everybody else can invest in the private sector, and build up a nest egg, and then it is something thats transferable from one generation to the next, so when a woman dies at the age of 56 and has two children who are in their 20s, and shes worked all her life, something remains of that that her children can have.
I think that is what we should do, the only caution I would offer on means testing is that theres just not enough money there. I hear this a lot, Ross Perot brought it up, it was great, and Ross Perot would say, why should I get a Social Security check? Well, I dont know why he should, but theres not enough Ross Perots out there to save Social Security. The fact is, if you really wanted to finance the future Social Security benefits through means testing, you have to start means testing at around $30,000 a year, which is something that politically would never fly.
OK, over there.
Audience Member #5
Yes. Arent there really three issues that need to be addressed in order to get at reform, and that is that you need to address government spending, you need to address the debt, and Social Security, and that theyre all intertwined and one cant be dealt with without dealing with the other?
Alan J. Auerbach
No, I dont agree with that. I mean, theyre all problemstheyre problems, theI mean, first of all, the debtI think we focus too much on the current level of the national debt.
Most of the problems we have now, as we heard, its the wolf at the door, and its because we know that were going into debt in the future, and so focusing on the current level of the national debt as mosta lot of the current discussion tends to do, I think is probably not that productive. Because congratulating ourselves on the level of the national debt doesnt really get us very far in solving these problems. Weve got a lot of different problems, weve got a problem withtwo big problems right now are Medicare and Social Security. Thats where the long run problems come from, and Medicare is about three times as big as Social Security. And if you take Medicare and Social Security away, we dont have a problem. We dont have a problem with the debt, we dont have a problem with an imbalance between taxes and spending.
Spending, aside from Social Security and Medicare as a share of GDP is much lower now than it was 10 years ago. So theres not a general problem, theres two very big and very specific problems.
How about on this side, we had a question.
Audience Member #6
One question, addressed to Professor Auerbach. You mentioned in your talk but didnt give any specifics that there are better and worse ways of approaching these problems, and Id be interested in what you think are some of the better and worse ways.
And then a second question for anyone on the panel is, if there were to be someand there would presumably have to be some sort of transition to any sort of changed regime, how would you envision that happening both over some period of time, over various demographic groups, over various income groups? Sort of any ideas along those lines.
Alan J. Auerbach
Ill give you some examples. Although I think if you wanted to get some bad ideas, being closer to Washington would probably help. Goodall rightgood idea. I think indexing the retirement age, for example. Weve had a retirement age of 65, were slowly moving up to 67, but weve had a retirement age of 65 since the 1930s, when life expectancy was much, much lower than it is right now. And much lower still than
Admitted by von Bismarck.
Alan J. Auerbach
Right, yeah. I mean, then it was aand then when it was originally conceived, it was a plan that virtually nobody would live to see. Theso indexing the retirement age is certainly one thing thats an obvious thing to do.
Bad ideas: I dont think uncapping the payroll tax is a good idea. And again, I think thats in a sense making the system larger, bringing more money into the system involves also bringingmaking more commitments. So anything that would expand the system in the long run by bringing in more workers or bringing more wages, I think is a bad idea. So those are just two examples.
Yeah, IfIll answer your second question, I just want to comment on the retirement age real quick.
This is one thatyouve talked about disconnect to society. If you had all the economists and actuaries and policy wonks in Washington in the room, 99% of them would say, raise the retirement age, including myself. Take that out to the public, and it doesnt fly at all.
And there are a lot of problems with it. Its one thing for those of us who are going to be teaching and shuffling papers into our 90s, its another thing for a coal miner and a longshoreman out there.
Now what do you do? The life expectancy of black men today is 65 years and six months. If you raise the retirement age too much, then none of them are going to see any Social Security. So there are a lot of problems with it, even though as an academic exercise, its one that has so much support in Washington. And in fact, I think we should do it, but I think we need to be aware of the problems with it.
In terms of the transition, essentially, theres onlytheres a limited number of sources of transition funding. You can borrow money, you can raise taxes, which I dont think you should do, you can cut government spending, and I think theres a lot of places we can do that, both foreign and domestic defense. Corporate welfare would be a good place to start.
Catos identified some $75 billion a year in subsidies we currently give to corporations. We think we could begin to use that as part of the transition, ratherand we should dedicate any general revenue surplus, beyond ourto that, rather than to any spending initiatives or to any junk tax cuts that are out there.
But theres no painless way to make the transition. Theres also no painless way to preserve the current system. The question is at the end of the day, have we created a better system? Or have we suffered all that pain just to keep going on and suffering more pain into the future?
Audience Member #7
Yes, I wonderI appreciate the comments about where government spending could be cut, especially corporate welfare, I think thats an area that has been overlooked.
But out in the field, Im also a Cal graduate, I administered in a law practice to middle and lower income people, and I can see where they can really be hurt, and I think we have to think about that. We have a community ethic, a national community ethic. Perhaps we should think about some kind of national healthcare program that would be fine tuned and would be able to serve the whole public and save money and not have the dilemma were having now with the HMOs, the fiascoes were having right now. Or perhaps think about a progressive tax system. Just throw that out to all the members.
Alan J. Auerbach
Im not so confident that we would do very well trying to have a national health system. I think we tried that a few years ago. And although that discussion may not have been
Audience Member #8: We never had it, though.
Alan J. Auerbach
Well, youre raising a point, which is that as difficult as Social Security is to solve, its much, much easier than Medicare. Or healthcare, for that matter.
I would just add that the national healthcare system, whatever its merits, and I disagree with the idea, but whatever its merits, it doesnt solve essentially the problems that are affecting the healthcare system, which is essentially the miracles that healthcare provides, and the fact that they cost money. And people want a lot of healthcare, they want it now, they want to see thebasically, Americans want all the healthcare they want, whenever they want it, with the doctor they want it, as long as they dont have to pay for it. And there is no way to resolve that contradictionand no healthcare system in the world has.
Other national healthcare systems hold down costs, they do it by rationing care. They do it essentially by saying, you cant have the healthcare you want, and that way well save money. Our system says, if you can afford it, you can get all the healthcare you want, as long as you pay for it. Now that creates a different sets of inequities in the two systems, but the inequities are still there. There is no way to have essentially an unlimited amount of something, which is what we want out of healthcare.
And the more you get the government, however structured, into the decision making as to what kind of medical health, what kind of medicines and so forth you can receive, the worse it gets. Talk to some of your family or some of your friends in the U.K., and ask them how wonderful that health system is. When the kids get sick in London, there are 12 banksthere are 12 beds for those kids. What is the population of London today?
We have a book coming out this fall on American healthcare, which deals with a lot of these kinds of questions. There was a question in the back here. (inaudible) Oh, Im sorry. Go ahead.
Audience Member #9
OK. Yeah, I just wanted to say, when it gets down into the trenches, what happens is going to be in the year 2000 election, and this issue is going to be demagogued all over the place by unions, the White House and so forth, as we know.
And it seems to me that people that are making $8, $10, $12 an hour should understand that if they had something with a proprietary interest in it, they might look at it a little differently than being frightened about having to drop down into poverty. And the only way I see is if they do have an individual account, aside from funding the money thats not there, which is different. ,Lets say that the principals guaranteed with a zero coupon or an insurance product underneath it, and the moneys invested in bonds, preferred stocks, and things like that, even passbook savings, the power of compounding is what these people need, and then turn that into insurance products, and they have a proprietary interest in something, and their family has some capital. Because these people have nothing, except perhaps a small house.
And you need something like that, rather than talk about throwing money in the stock market, because youre talking about capital gainsand thats only if youve got a stock you can sell to somebody. So I think playing on whats happened the last 10 years in the stock market is really risky if youre going to have a political agenda coming out and telling everybody were going to privatize. Because you can get a massive correction, youre going to be wiped out in the political sphere.
Yeah. Politically I agree with you on that. In terms of the actual economics of it, while theres no guarantee of what happens in the future, its not just the last 10 years in the stock market.
We actually in calculatingmaking our calculations for my book, we discounted the last five years. We said, the last five years in the stock market have been such an anomaly that they cant be seriously. We just look at the historical rate for that core.
For someone entering the work force today, theyll be investing for 45 years. We said, what is the worst average rate of return over any 45-year period in U.S. history? And it was seven and a half percent. The worst 20 year period, including the Great Depression, was three percent. Now we said, Could we enter a position in the future where we have 45 years of less than 3 percent? Well yes, I guess we could, but if our economys in that bad shape, I dont know how youre going to keep going to the Social Security system, either.
Yeah, one more. Two more questions.
Audience Member #10
Yeah, Id like to address Mr. Martins concept to bother your congressman about incrementally solving the problem. You cant cross a chasm in two small jumps. As to Professor Auerbachs position that government is going to take care of the poor people at all times, thats not going to happen, and it didnt happen up until about 45 years ago. Fraternal organizations, charities, that was the purview of helping the poor, and you cant help the poor at the point of a gun. Thats all.
You had a question in front here, Ray?
Audience Member #11
The topic of so-called mutual aid societies, there were about 10,000 mutual aid societies in the United States in the 19th century, the latter half of the 19th century, and they were extremely effective and widespread, and it wasnt based on those who had versus those who did not. The most successful ones were among the most demographically impoverished and discriminated against people. So its a good model of what people can do if theyre not subject to some central plan from a bureaucracy (inaudible).
Audience Member #12
My first point is just a brief addition to what Professor Auerbach meant when he said that under the administrations program, additional debt would be put into the trust fund. And that however does not mean the creation of net additional debt, but rather it means the shifting of debt from privately held into publicly held, which I take it is what he meant.
Secondly, we have been talking about the transition problem, I mean, getting out of the mess we got into because somehow things went wrong, and then we have been talking about what we want to end up with. But I wonder how the pain of the transition problem relates to what we want to end up with, Mr. Tanner.
And then Mr. Martin, when we talk about privatizing, I like to think of it this way, that theres a basic difference between saying what you do about your old age is your private business, afterif there was no government. People can insure or not insure, if they dont insure, they prefer to die when they are lying on the street, when they are old, old age, thats their business, let them do what they want.
Now as against that, there is a question ofthere is a position by which the insurant has made a social responsibility. Now if it is made a social responsibility, it can then either be required and supervised, regulated private insurance, or it can be insurance through the publicthrough a public system.
The point which I want to make is that the basic difference is whether you let people do what they want, or whether it is a social responsibility, and notand the question whether it is privately regulated or through a public institution is quite minor compared to the first choice.
Alan J. Auerbach
Theres a third way to interpret it, too, you can also interpret it as saying theres a community responsibility or a civic duty, but that you dont believe that that duty is best fulfilled through a state enterprise.
Any comments? OK, one quick one, then we gotwere bringing (inaudible).
Audience Member #13
My question is about Medicare and Social Security together. The Medicare Commission is going to be reporting in a few weeks, and stories about the Medicare Commission suggest that theyre going to be creating a model thats based upon the program that federal employees have.
And theres a lot of talk also in Washington about creating a system for Social Security similar to the federal thrift savings plan, which is what federal employees have for their pensions. Do you think using those models for federal employees is a good idea for both Medicare and/or Social Security?
Let me address first the Medicare one. I think its a very good start in the right direction. It will not solve Medicares problems, and in fact, it may not be sufficient savings to offset the increase if we add a prescription drug reform to Medicare. So it should be seen as a very limited reform along the way.
A much better approach, I think, is one thats been suggested by Professor Tom Saving at Texas A&M University, which is to move in the direction Im talking about for Social Security, which would in effect allow individuals to take their 2.9 percent Medicare tax, save that, use it at age 65 to purchase an annuity which would then in turn pay for health insurance premiums with a catastrophic insurance type of program. Still needs a lot of work on that, its in the very early theoretical stages of being modeled, and Im not sure if thats going to work.
Medicareagain, I come down to, its alwaysI love to talk about Social Security, and I hate to talk about Medicare, because there are no good solutions to Medicare. In the end, the only answer to Medicare is to tell people were not going to pay for all the things we promised them, and thats not going to fly politically, and Im not sure aboutwhether its a good policy. But there is no way, I think, to keep up with the costs in the Medicare system without making major shifts.
Real quick on the federal thrift savings program, it might be a good first start, but its a limited approach. You only have three options for investment, and I think we should open it up to a much wider range of options, but it certainly is something in the right direction.
But it is appropriate to remind ourselves that the federal Medicare supplement system is so much more liberal and soserves its retirees from the federal government so much more completely that theres a question of fairness here.
Is it fair that these people whove been in those lovely places on Constitution Avenue all those years, and never really having to produce, but always to, to fill out those forms and do all this other stuff that the bureaucracy does, and then to have a superior medical program when they retire, including their prescriptions? Whereas the ordinary citizen is stumbling around and being cheated in this way. Is that fair?
One other aspect of that is when a firm has a financial problem, they liquidate assets, they downsize, they do other kinds of things. They try to recapitalize. And Ive heard very little in the discussion in Washington and elsewhere about liquidating federal assets, for example, which are huge. Which is another dimension of approaching privatization as vesting assets for this liability.
Its another thing that perhaps we could discuss at another time. But I want to thank each of our panelists very much for excellent presentations (applause). And to all of you for joining with us. For those, again, who have not gotten either Michaels book, or if youre interested in the Martin Feldstein book or others, please feel free, theyre upstairs, and Michael is very happy to autograph copies of his book if youre interested. We hope that you will join us in the future at future Independent Institute events. Thanks for coming (applause).