Op-Ed ¦ June 24, 1996
Social Fund Isn't Really a Ponzi Scheme of IOUs

By David Langer

Enormous potential business income is at stake, if the Old-Age, Survivors, and Disability Insurance portion of the Social Security system is privatized. The investment management, brokerage and administration expenses arising from individual investment accounts under the two privatization proposals now being considered by the Social Security Advisory Council will rise to $14 billion by 2010 if the worker contribution rate to the individual accounts is 1.6%, and $44 billion if the rate is 5%. At the 1.6% contribution, assets would total $1.418 trillion. Ten years later, the expense becomes $45 billion and $141 billion, respectively. (Annual investment and administrative expenses are assumed to be 1% of assets and the inflation rate 4%.)

The public, thus, needs to prepare itself to be inundated for the foreseeable future by the intensive media and political campaign being waged by groups that will participate in the profits to be derived from privatizing Social Security. The public will be informed, as it has been for many years now, that OASDI is going bankrupt, and there isn't going to be enough money to pay the benefits for today's young people, who don't get their "money's worth" anyway. Suggested fixes include cutting benefits, raising the retirement age, setting up separate 401(k)-type accounts for all workers, and investing part of the OASDI trust funds' half-trillion dollars in equities.

Well, OASDI is not your typical employer retirement, life and disability insurance plan. It covers 141 million workers, plus their dependents, and pays an average monthly benefit of $671 to 43 million retirees and beneficiaries. Congress could be making a serious, if not irretrievable error, if it were rushed into a hasty solution of perceived problems. The OASDI trust funds are expected to be able to pay full benefits until the year 2030, which suggests there's adequate time to study and deliberate on the issues and solutions.

The place to begin a study, of course, is by examining the validity of the criticisms of OASDI.
OASDI is going bankrupt. Young people won't get their benefits Those who maintain that OASDI is going bankrupt point to the projection of income to and payments from its trust funds, which indicates a shortfall developing in the year 2030 on the basis of "best estimates" prepared by Social Security actuaries for the board of trustees. As a matter of definition, for OASDI to be deemed bankrupt, it would have to be unable to make benefit and expense payments in full as they come due. However, OASDI's benefit payments are a statutory obligation of the federal government, and the benefits must be paid: Bankruptcy is not a possibility.

Furthermore, and more appropriate in this case, the government can take action to correct projected imbalances, and there are measures that will accomplish this fairly easily. For example, Robert J. Myers, former chief actuary of Social Security, has suggested to Congress that the only changes needed are gradual increases in the retirement age to 70 and, starting in 2015, an increase in the payroll tax rates to 1% over a 20-year period. Such a policy of incremental change seems called for, because it is entirely possible the economy will improve at some point thereby creating more jobs, some highly paid, which will increase the inflow of contributions and mitigate the need for further changes.

Young workers don't get their money's worth
The "money's worth" or individual equity argument is based on the savings account concept of getting back your contributions plus a reasonable rate of interest, or on the individual life insurance policy analogy of classifying similar risks for premium purposes and getting the same value of protection for your dollar.

However, these comparisons overlook that Social Security is a social insurance program with objectives that emphasize benefit adequacy as well as individual equity. To achieve such adequacy, the benefits are deliberately skewed to favor lower-paid persons. In return, the payment of adequate benefits helps avoid the need for a means test for sustaining lower-income workers and their families upon retirement, disability, or death. Unsatisfactory past experience has shown that means testing is costly, intrusive and damages self-esteem. Providing sufficient income to maintain at least a minimum lifestyle also can smooth family relations by reducing the need, for instance, for parents to have to rely on their children for help, which can be a double whammy: It can be humiliating to the parent and also create resentment on the part of financially strapped children.

The typical money's worth calculations are considerably enhanced by OASDI's policy of paying larger benefits to those who contributed little at the outset of Social Security and from later benefit liberalizations. The intention of the policy is to avoid penalizing those who worked during prior periods in the absence of the program or the later amendments. This approach, it must be noted, was not invented by the government, but is also used in corporate, public and collectively bargained multiemployer defined benefit plans. Employers and unions routinely take care of the older long-service employees by allocating contributions in large part to enable those employees to retire with benefits equitably reflecting the value of their earlier years of service. The contributions on behalf of older workers are typically a much larger percentage of their pay than for younger employees.

The concept of "money's worth," with its stress on individual equity, needs to be expanded to recognize the other benefits that arise from the social adequacy principle.

The trust funds hold worthless IOUs
Charges have been made that the OASDI trust funds are made up of worthless IOUs, are not inviolable, are a pot that can be dipped into for ordinary government expenses, and are even vulnerable to embezzlement.

The trusts have been set up to receive, disburse and account for all OASDI assets and are combined for actuarial and financial purposes. Surpluses have been generated for many years. The estimated surplus for 1996 is $75 billion, made up of the $34 billion excess of income over outgo over payments and $41 billion in interest from investments in U.S. Treasuries. OASDI's assets consist of such investments and will total around $577 billion by the end of 1996. The investments are required by federal law to be largely in special Treasury issues. Interest is set at the average market yield of all long-term federal obligations not due or callable for at least four years. The Treasuries are about the same as available to the public and are backed by the government's full faith and credit. Interest is paid (8.3% in 1993 and 8% in 1994) with official Treasury checks, as a result of 1994 legislation to help dispel charges that the finances are a sham. The Treasury cashes the checks and credits the amounts to the trust funds. If the Treasuries are mere IOUs and subject to embezzlement, then the mutual funds that carry Treasury securities should, of course, label them as risky, instead of promoting them as the safest of investments, and demand higher interest rates from the Treasury.

Social Security is a Ponzi scheme
It is not unusual to read that Social Security is "a giant Ponzi scheme where they're relying on new contributions to make payments to existing retirees."

But there is a world of difference. Carlo Ponzi promised initial investors high profits from fictitious sources, which then were paid with funds obtained from later investors to encourage victims to take bigger risks. Social Security, on the other hand, is not the result of a swindler's scheme to enrich just himself, but is the result of openly and fully debated public policy to create a national program as an important resource for millions of persons to cope with the problem created by non-existent and inadequate retirement plans.

CPI overstates price increases
The claim is being made that the Consumer Price Index overstates the real increases in the cost of living. It would be political manna from heaven, indeed, if this could be demonstrated - what better than a technical fix to the projected OASDI imbalances with few political repercussions. Given the temptation this creates, the adjudication of the appropriateness of the CPI level needs to be examined by a thoroughly non-partisan group of technical experts. This is crucial, too, given that a counterclaim is also being made that the CPI is understated.

The political stakes rise sharply if one takes into account that the federal unified budget incorporates the annual surpluses arising from the OASDI and certain other trust funds. This amounted to about $100 billion in 1995 ($65 billion from Social Security) and the regular deficit was cut by such an amount. A reduction in the CPI and concurrent cut in Social Security benefits would therefore also increase the trust funds' surplus, which in turn would further cut the federal unified budget deficit. This is certainly a political and highly questionable use of the trust funds' surpluses. Given the funds' income can't be used for other than their stated purpose and that outgo is payments are not met from general tax revenue, neither is properly includable in the general budget. To do so is to manipulate the budget deficit to make it look more favorable than it truly is.

Criticisms like these have been appearing in books, the press and TV for perhaps three decades, and the campaign to privatize OASDI undoubtedly will intensify in the next year or two. It has had the effect to date of leading many to believe, particularly those with some years to go to retirement, that Social Security benefits will not be there for them when their time comes to receive them. This has made them fearful and more receptive to proposals for change than they might otherwise be. Adding momentum to the drive is the long-lived bull market for stocks (over a 35% return last year); conversely, a prolonged downturn will create a damper. Those behind the drive, therefore, may feel the need to push for legislation as quickly as possible. However, precipitous action would be a mistake.

- David Langer, a consulting actuary and president of David Langer Co., Inc.
New York

See the response to David Langer's article by James B. Gardiner.

Copyright 1996 Crain Communications, Inc. Pensions & Investments, June 24, 1996
Reproduced with permission.