Edward M. Welch

Recent moves by many to privatize social security view the Social Security system as a savings and investment plan for middle-income workers. This view distorts the debate, because that is not what Social Security was intended to be and not what it has been up to this point. Social Security was created to prevent poverty in old age. To the extent it is privatized, its ability to perform that function will be reduced. Such proposals should therefore be carefully examined by those who take seriously the social teaching of the Catholic Church.

Social Security is not and has never been an investment plan. It is an intergenerational contract among workers, supervised by the government. Workers agree to pay to the government a certain amount in payroll taxes while at work. The government agrees that when they reach a certain age they can stop working, and it will pay benefits to them out of taxes it receives from those currently working. The proposals that are referred to as privatizing Social Security are basically plans that would change it into an investment plan. Workers would put funds into an individual account and would be allowed to draw out of that account to the extent that the investments of the account were successful.

The proponents of privatization can point to numerous ways in which the money collected for Social Security could have yielded a better return if it had been treated as an investment. When viewed as an investment plan, Social Security has not been notably successful. When measured as a program to prevent poverty, however, it has been very successful indeed. Without it, nearly 50 percent of retirees would live in poverty, as compared to about 10 percent who live in poverty under the present Social Security system. There are several ways in which the proposals to privatize part of the system will weaken its ability to prevent poverty.

To whatever extent funds are diverted to individual accounts, this change will substantially alter the system in two ways. First, these will be individual accounts. We will no longer be pooling our resources and agreeing to help one another. If each of us does well as an individual, we will profit. If we do badly, we will suffer. This is of course a very popular approach today, but it necessarily dilutes any commitment we might have had to take care of the least fortunate among us. Second, it will destroy the intergenerational aspect of the program. To the extent to which the program is privatized, I will be putting aside my own money for use in the future. I will not be able to expect future workers to assist me because they will be putting aside money for their own future. In both ways, private individual accounts will directly divert funds away from the ability of the program to prevent poverty.

But even if we assume that everyone invests his or her accounts wisely and earns a very good return, there will be a whole generation who paid into the system while they were working—expecting that during their retirement they could draw out of the system while the next generation was putting in. To whatever extent a change in the system allows future workers to put some of their Social Security contributions into individual investment accounts, it will mean less money to pay already retired workers. It is not clear how the transition problem will be dealt with under privatization plans, but it will be a serious problem for at least a generation.

Another way in which Social Security guards against poverty is by providing insurance. In addition to retirement income, it gives benefits to survivors of workers who die before reaching retirement and also to workers who become totally disabled. These programs are funded by the same contributions that fund retirement benefits. The funding for them will also be reduced to the extent that the contributions are put into individual accounts. It is true that many of us do not rely solely or primarily on Social Security for life insurance or protection against disability, but for everyone it is protection against poverty under these circumstances. Some of us build upon it while others of us must make do with what it provides. For all of us, privatization will weaken this protection. Those for whom it is the only protection will suffer the most.

The situation is made even more critical by a trend in private pensions. In recent years many private pensions have been converted from defined benefit plans to defined contribution plans. Under defined benefit plans, workers and employers contribute a set amount to the plan while the employee is working. The plan then promises to deliver a predefined benefit to the worker during retirement. Together with Social Security, these plans have provided a comfortable though not extravagant retirement for many American workers. They have, however, been expensive for employers. That is why many employers have switched to defined contribution plans. Under these plans, employers promise only to make a defined contribution to the plan. The retirement income available to the worker is dependent entirely on how well the investments of the plan do over the years. As defined benefit plans become more and more rare there is an increasing need for workers to have a guaranteed base, like Social Security, to fall back on. The proposed change would divert resources away from protection against poverty in old age just at the time when there are likely to be more people in need of such protection.

Should not workers who can afford it be able to put their money in more productive investments if they want to? This question brings us face to face with a basic issue of social justice. Can we expect those who are doing well to make some sacrifice for the good of others? Clearly Catholic social teaching says yes. But it is not really necessary that we get to that issue. Since the creation of Social Security, we have all been told that if possible, we should not count on it as our only income in retirement. That is why employers created pension plans, why we have more recently started 401(k) plans and individual retirement accounts, and why we have all tried to save a little money for retirement. At the same time, Social Security has provided a base upon which we can build and a guarantee that if all else fails, we will not face a retirement in serious poverty. So the guaranteed base of Social Security is an important part of retirement planning for everyone. Workers who have sufficient income have always been able to put some of their savings into more speculative investments, but Social Security has provided them with a safe base upon which to build.

What about the warnings that Social Security is running out of money? First of all, this is not an urgent issue. Most recent estimates indicate the money currently in the trust fund—combined with future contributions at the present tax rates—will be enough to pay benefits for about 40 more years. The increases in taxes needed to make up any shortfall are small compared to gains in productivity that we will experience over this time period. The upcoming generation should therefore be able to pay the benefits it has promised to its predecessors and still enjoy a substantially higher standard of living. More important, private accounts would not solve this problem. At least during a long transition period, they would make it worse, because they would result in less money coming into the trust fund.

Even from the perspective of workers who will not need it to avoid poverty, there are reasons to question the wisdom of converting Social Security to an investment system.

1. It may be wise for everyone to keep some part of his or her reserves in a system that guarantees protection from poverty at the cost of higher possible returns.

2. At about 1 percent, Social Security is an extremely low-overhead system. To the extent that any new system is less efficient, more money will go to brokers and bankers rather than retirees.

3. The average American is notoriously bad at making investment choices. We can construct scenarios in which wise investors do very well, but it is not at all certain that a system that brings many new people into even marginally speculative investing will result in all of them getting a good return.

4. This may be a particularly bad time to make such a move. The 1990’s were a period during which wise investors were able to earn a surprisingly good return on their investments. This has raised expectations. If we move to an investment system at this time, it is almost certain that the results will not meet those expectations.

5. Finally, it can be argued that one of the reasons the value of stocks has recently been so high compared to the basic value of the companies they represent is that we now have a very large cohort of middle-aged workers who are looking for places to put their investments. They are thus bidding up the price of stocks. This trend will be reversed when they all begin to retire. There will be an increase in the people seeking to sell stocks and a decrease in people seeking to buy them. This will tend to lower the value of these investments just when retirees are counting on their value being high. Diverting Social Security resources into this system will make matters even worse.

In short, the proposal to privatize Social Security is a proposal to change the system from an intergenerational social contract to a system of individual investment accounts. A system that was designed to reduce poverty in old age—and has done so very effectively—will be sacrificed for a system that may help middle-income workers make retirement investments. It may represent a shift toward the popular view that everything should be determined in a competitive, free market. But it is certainly a shift away from what the U.S. Catholic bishops have called a preferential option for the poor.

Edward M. Welch is a professor in the School of Labor and Industrial Relations at Michigan State University, East Lansing, Mich.

Comments

Patrick Flynn | 8/16/2002 - 2:48pm
I read with interest the article on social security. I am not sure what your author means when he pronounces dogmatically on what social security was intended to be. I am certain that it was a politically designed compromise intended to rectify a number of social evils. But it was always sold as an insurance program, where each participant had an "account". This was, of course , a fraud. No one is guaranteed anything under the current scheme, and the term "account" is a deception, intended to make us erroneously believe we have a vested right to certain benefits. I think it way past time that some small part of the huge payments currently put into this Ponzi scheme by working people actually be placed out of the reach of grasping politicians. I don't want the middle class relying on the largesse of politicians for their retirements.

William A. Pauwels, Sr. | 8/16/2002 - 12:41am
Is Edward Welsh dealing with reality in his thought provoking article? Has he done the arithmetic? Times have changed. Demographics have changed and are changing.

When Social Security was initiated by FDR in the '30s, there were many workers, like maybe 10, to support every retiree. Today, there are far few workers, perhaps 3 to 4. However, as the baby-boomers retire, the number of workers per retiree will go to 2. If the birth rate in the USA mimics the birth rate in Western Europe in the years ahead, the number of workers supporting each retirees will decrease even further.

Furthermore, as people live longer and require more and more medication and medical procedures, the per capita cost of retirement will increase.

It would seem that all of these numbers are moving in the wrong direction from the perspective of the average working guy. The average American already works five months or more each year to pay his taxes and Social Security. The above trends, along with the additional ongoing cost of homeland security, strongly suggest taxes will have to increase. How many months a year will even the most devout Christian be willing to work to pay taxes before he rebels?

Social Security, like most socialistic programs, is not a financially sound concept. Politicians don't like to admit it. It is a political hot potato! And socialists don't like to admit it. Like communism, Social Security System sounds good in theory, but it ignores economic reality.

Furthermore, if Mr. Welsh wants to introduce Catholic social justice into the discussion, our present Social Security System seems inherently unfair and is probably immoral . . . .strapping future generations of workers, as it does, with a retiree-serving but financially unsound approach.

The American way of life and our economic success as a people has always been based on equality of opportunity, competition, incentives and personal responsibility. It may not always be pretty, but over the long haul it works. Socialists the world over have been trying to find a better way, but for over 250 years America has outrun them all. And we have spent more on behalf of other countries than all the socialistic countries combined.

Burying our head in more of the socialistic sand to fix a financially unsound socialistic program is to throw good money after bad and is unjust to future generations. A better way must be found. America has proven that unfettered market-capitalism is the only economic system that has enabled mankind to create more wealth in his lifetime than he consumes . . . so why not put it to work for the benefit of all Americans, including retirees?

Patrick Flynn | 8/16/2002 - 2:48pm
I read with interest the article on social security. I am not sure what your author means when he pronounces dogmatically on what social security was intended to be. I am certain that it was a politically designed compromise intended to rectify a number of social evils. But it was always sold as an insurance program, where each participant had an "account". This was, of course , a fraud. No one is guaranteed anything under the current scheme, and the term "account" is a deception, intended to make us erroneously believe we have a vested right to certain benefits. I think it way past time that some small part of the huge payments currently put into this Ponzi scheme by working people actually be placed out of the reach of grasping politicians. I don't want the middle class relying on the largesse of politicians for their retirements.

William A. Pauwels, Sr. | 8/16/2002 - 12:41am
Is Edward Welsh dealing with reality in his thought provoking article? Has he done the arithmetic? Times have changed. Demographics have changed and are changing.

When Social Security was initiated by FDR in the '30s, there were many workers, like maybe 10, to support every retiree. Today, there are far few workers, perhaps 3 to 4. However, as the baby-boomers retire, the number of workers per retiree will go to 2. If the birth rate in the USA mimics the birth rate in Western Europe in the years ahead, the number of workers supporting each retirees will decrease even further.

Furthermore, as people live longer and require more and more medication and medical procedures, the per capita cost of retirement will increase.

It would seem that all of these numbers are moving in the wrong direction from the perspective of the average working guy. The average American already works five months or more each year to pay his taxes and Social Security. The above trends, along with the additional ongoing cost of homeland security, strongly suggest taxes will have to increase. How many months a year will even the most devout Christian be willing to work to pay taxes before he rebels?

Social Security, like most socialistic programs, is not a financially sound concept. Politicians don't like to admit it. It is a political hot potato! And socialists don't like to admit it. Like communism, Social Security System sounds good in theory, but it ignores economic reality.

Furthermore, if Mr. Welsh wants to introduce Catholic social justice into the discussion, our present Social Security System seems inherently unfair and is probably immoral . . . .strapping future generations of workers, as it does, with a retiree-serving but financially unsound approach.

The American way of life and our economic success as a people has always been based on equality of opportunity, competition, incentives and personal responsibility. It may not always be pretty, but over the long haul it works. Socialists the world over have been trying to find a better way, but for over 250 years America has outrun them all. And we have spent more on behalf of other countries than all the socialistic countries combined.

Burying our head in more of the socialistic sand to fix a financially unsound socialistic program is to throw good money after bad and is unjust to future generations. A better way must be found. America has proven that unfettered market-capitalism is the only economic system that has enabled mankind to create more wealth in his lifetime than he consumes . . . so why not put it to work for the benefit of all Americans, including retirees?