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4225EconSeniorSeminarNovember13th,2014

TheRedistributionofIncomeintheUnitedStates:ASocialSecurityCase

Study

AbstractSocialSecurityisatopicofmuchdebate,asitiscurrentlythelargestsocialwelfareprogramintheUnitedStates.Thispaperwillprovideahistoricalbackgroundfortheprogram,whilealsoanalyzingthecurrentmechanicsoftheprogramastohowitredistributesincomeintheUnitedStates.Inaddition,thepaperwillgoontoprovidepoliticalandeconomictheorytoexplainwhySocialSecurity,aprogramwithmanyperceivedflaws,isstillregardedassacrosanct.Furthermore,byoutliningthemanyflawsoftheprogram,thispaperwillarguethatSocialSecurityshouldbedismantledthroughgradualprivatization.However,itisrelevanttonotethataconclusioncanbedrawnthatsuchreformstoSocialSecuritymaynotberealisticinthecurrentpoliticaleconomyoftheUnitedStates.

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INTRODUCTION 3

HISTORICALBACKGROUND 4

MODERNDAYSOCIALSECURITY 6

POLITICALANDECONOMICTHEORY 12

POLICYRECOMMENDATIONSANDHISTORICALBACKGROUND 20

CONCLUSION 25

CITEDSOURCES 27

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Introduction SocialwelfareisaportionoftheUnitedStatesgovernmentthatisdeeply

entrenchedinAmericansociety,andisconsistentlythelargestportionoftheUnited

Statesbudget.Specifically,SocialSecurityisthelargestsocialwelfareprogramthat

redistributesincomeintheUnitedStates.Inthefiscalyear2015,SocialSecuritywill

pay$744BillioninOld-AgeSurvivorsInsurancebenefitstoapproximately49

millionbeneficiariespermonth,whichincludes89percentofthepopulationaged

65andover(JustificationofEstimatesforAppropriationsCommitteeFY2015).At

present,SocialSecurityaccountsfor24%oftheUnitedStatesbudget,whichisthe

largestoverallportionofthebudget,withthenextlargestbeinghealthinsurance

programsat22percentofthebudget,andthethirdlargestbeingdefenseand

internationalsecurityassistanceat19percentofthebudget(CenteronBudgetand

PolicyPriorities).ToprovidefurthercontextforSocialSecuritybenefitsasa

percentageoftotalFederalBudgetOutlays,in1940,thispercentagewas.29percent

ofthebudget,increasingto12.58percentin1960,andreaching20.06percentofthe

budgetin1980(SocialSecurityasaPercentageofTotalFederalBudgetOutlays

1940-2002).WithSocialSecuritybeingthelargestportionofUnitedStates

spending,andarguablyaffectingthelargestportionofAmericancitizensofany

socialprogram,thispaperwillarguethattheSocialSecurityprogramshouldbe

dismantledthroughgradualprivatization.Inordertoprovidesupportforthis

hypothesis,thepaperwillanalyzethehistoricalbackgroundoftheprogram,

moderndaysocialsecurity,politicalandeconomictheory,aswellaspolicy

recommendationstoeffectivelytransitiontowardtheeventualdismantlingofthe

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programanditssustainabilityinitscurrentstructure.Itisalsorelevanttonotethat

thispaperwillspecificallyanalyzetheOld-AgeInsuranceaspectoftheprogram,and

willnotgointodetailonDisabilityInsuranceorotherprogramsthatareconsidered

tobeapartofSocialSecurity.

HistoricalBackground BeforegoingintofurtherdetailoftheevolutionofSocialSecurityinthe

UnitedStates,itisrelevanttoexplainwhySocialSecuritywasneededinthefirst

place.Acommontrendinthehistoryofthegovernmentindemocraciesisthatmany

federalandstateprogramsandpoliciesareimplementedasaresultofaproblemin

societythatneedsbeaddressed,ratherthananoverarchingagendaofthe

government.Inthissense,SocialSecurityisnodifferent,asitwascreatedin

responsetoconditionswithinarapidlyindustrializingeconomyaswellasthe

severeDepressionofthe1930s.AsAmericabecameincreasinglyurbanized,more

familiesbecamedependentonacontinuingflowofincome,ratherthanbartering,to

provideforthemselvesandtheirfamilies.Withamuchmoreindustrialized

economy,therewerefewerfarmers,andthusindividualscouldnotsolelyrelyon

cropsasasourcefortheireconomicsecurity(SocialSecurityProgramsinthe

UnitedStates).ThefirstsignsofsocialinsuranceintheUnitesSatesbeganin1911,

whenthefirstStateCompensationLawwasenacted.By1929,workercompensation

lawswereestablishedinallbutfourstates,whichmadeindustriesresponsiblefor

compensatingtheirworkersintheeventofaninjuryordeathinconnectiontotheir

job.RapidindustrializationrequiredtheUnitedStatestoprovidesomesortof

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compensationtolaborers,andthisformofbenefitstoworkerswouldeventually

helpleadtothecreationofSocialSecurityin1935.

TheSocialSecurityActof1935cameasadirectresultoftheGreat

Depressionofthe1930s.Federalactionwasrequired,asneitherstatesnorlocal

communitieshadthefinancialresourcesnecessarytocopewiththegrowingneeds

oftheAmericanpeople.TheSocialSecurityActwasanaturaldevelopmentofthe

Depression,astheDepressionwipedoutmuchofthelifetimesavingsoftheelderly,

andalsosignificantlyreducedopportunitiesforemploymentintheAmerican

economy.Thus,onAugust14,1935,PresidentFranklinD.Rooseveltpassedthe

SocialSecurityActof1935.Thisactwascomprisedoftwosocialinsurance

programs,whichweredesignedtohelpmeettherisksofoldageandunemployment

intheUnitedStates.Thesetwoprogramsconsistedofafederalsystemofold-age

benefitsforretiredworkerswhohadbeenemployedinindustryandcommerce,and

afederal-statesystemofunemploymentinsurance(SocialSecurityProgramsinthe

UnitedStates).WhiletheoriginalSocialSecurityprogramfocusedontheeconomic

securityofanindividual,modificationsin1939changedtheOld-AgeInsurance

Systemintoafamilyprogram.Thesechangesaddedbenefitsfordependentsof

retiredworkersandsurvivingdependentsofdeceasedworkers.Inaddition,

benefitsfirstbecamepayablein1940,insteadof1942asoriginallyplanned(Social

SecurityProgramsintheUnitedStates).Afterprovidingahistoricalbackgroundfor

theprogram,thispaperwillnowgoontoanalyzethecurrentstructureand

mechanicsofmoderndaySocialSecurity.

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ModernDaySocialSecurity Atpresent,SocialSecurityisthelargestincome-maintenanceprograminthe

UnitedStates,withabudgetof$814billioninfiscalyear2013(AnnualStatistical

Supplement,2013).Theprogramprovidesmonthlybenefitsdesignedtoreplace,in

part,thelossofincomeduetoretirement,disability,ordeath.Thispaperwill

specificallyseektoanalyzetheOld-AgeInsuranceaspectofSocialSecurity.

Underthecurrentprogram,thereareavarietyofaspectsthatcontributeto

thefinancingofSocialSecurity.Workersfinancetheprogramthroughapayrolltax

thatisleviedundertheFederalInsuranceandSelf-EmploymentContributionActs,

alsoknownasFICAandSECA;employerspayamatchingamount.Thecurrentrate

is6.2percenteach,foratotalof12.4percentofpayroll.Revenuesaretakenfrom

payrolltaxesandarethendepositedintotwotrustfunds.Thesetrustfundsarethe

FederalOld-AgeandSurvivorsInsuranceTrustFund,andtheFederalDisability

InsuranceTrustFund.Thesetwofundspaybenefitsandtheoperatingexpensesof

theSocialSecurityprogram(SocialSecurityProgramsintheUnitedStates).Inthe

fiscalyear2015,thesebenefitpaymentswilltotal$744billion,whichisthelargest

sumofanyprogramintheUnitedStates.Currently,nearly3in5beneficiariesaged

65orolderrelyonSocialSecurityforatleasthalfoftheirincome(SocialSecurity

BasicFacts).

BeforegoingintofurtherdetailregardingthemechanicsofSocialSecurity,it

isrelevanttonotewhichindividualsarecoveredbytheprogram.In1935,Social

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Securityonlycoveredemployeesinnon-agricultureindustries1.Currently,nearlyall

jobsarecovered,with96percentofjobsintheUnitedStatesbeingcoveredby

SocialSecurity.Thiscoverageincludesall50StatesinAmerica,theDistrictof

Columbia,CommonwealthofPuertoRico,theterritoriesofGuamandAmerican

Samoa,theU.S.VirginIslands,andtheNorthernMarianaIslands.Workersexcluded

bySocialSecurityincludefederalcivilianemployeeshiredbeforeJan1,1994,

agriculturalworkerswhodonotmeetcertainminimumearningrequirements,and

personswithverylownetearningsfromself-employment(SocialSecurityPrograms

intheUnitedStates).

OverthecourseofthehistoryofSocialSecurityintheUnitedStates,avariety

ofchangeshavebeenmadetotheprogramthathavehadsignificantimpactsupon

taxpayersandbeneficiariesalike.Onesuchchangehasbeentheoverallincreasein

thepercentageofpayrolltaxes.In1937,duringtheinitialyearsoftheprogram,

payrolltaxesappliedtothefirst$3,000inearnings,withataxationrateof1%.This

taxationmaximumremainedinplaceuntil1951,whenthemaximumrateincreased

to$3,600asaresultoftheSocialSecurityAmendmentsof1950.Asof2014,the

maximumtaxableearningsare$117,000withapayrolltaxrateof6.2%.Intheyear

2015,themaximumamountoftaxableearningswillincreaseto$118,500.The

overallincreasesinmaximumtaxableearningshavebeenjustifiedbythedesireto

improvesystemfinancingandmaintainmeaningfulbenefitsformiddleandhigh

earners(SocialSecurityProgramsintheUnitedStates).Asof2013,thetaxcap

1“The1935actlimiteditsprovisionstoworkersincommerceandindustry.Thismeantthatthenewsocialinsuranceprogramappliedtoabouthalfthejobsintheeconomy.Amongthoseleftoutwerefarmanddomesticworkers.”http://www.ssa.gov/policy/docs/ssb/v70n4/v70n4p49.html

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coversapproximately83percentofwagesforAmericanworkers,with93.8percent

ofworkersrecordingearningsbelowthetaxationcap(AnnualStatistical

Supplement,2013).Therehavebeenmanyadvocateswhowishtoraisethetaxation

capinordertocoveratleast90percentofallwages.However,suchanincrease

wouldrequirenearlyadoublingofthecurrenttaxationcap,toavalueofnearly

$240,000(RaisingtheTaxableMaximum).WhenSocialSecuritywasfirstcreated,

thefoundersoftheprogramdidnotadvocateataxationcap.Onthecontrary,itwas

initiallyrecommendedthatindividualswhorecordedearningsabovethreetimes

theaveragewagebeentirelyexemptfromSocialSecurity.Workerswhofallunder

thiscategorywouldbeexemptfrompayingSocialSecuritytaxes,inadditiontonot

receivingbenefitsfromtheSocialSecurityprogram.Therationalebehindthis

recommendationwasaresultoftheinitialpurposeofSocialSecurity,whichaimed

topreventpovertyinoldage.Individualswhorecordedmorethanthreetimesthe

averagewageswouldlikelynotneedsocialinsuranceinordertoremainoutof

povertyduringretirement(ReportofTheCommitteeonEconomicSecurity).

Theexistenceofmaximumtaxableearningsseekstopreventexcessively

highmarginaltaxrates,inadditiontopreventingworkerswithaboveaverage

incomesfromreceivingunnecessarilyhighbenefitsfromSocialSecuritypayments.

Withanever-increasingvalueofmaximumtaxableearnings,itisrelevanttonote

therationalebehindtheincrease.TheSocialSecurityAdministrationisableto

explainthisincrease.

“Althoughthenominalvalueofthetaxmaxhasgrownfrom$3,000in1937to$106,800today,ininflation-adjusteddollarsthetaxmaxdeclinedfrom1937untilthelate1960s,andthengrewonceitwasindexedtowagegrowthin

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1975.Inwage-adjusteddollars,thetaxmaxhasremainedroughlyconstantsincethemid-1980s.”(TheEvolutionofSocialSecurity’sTaxableMaximum)

Themaximumtaxationcaphasbeenafrequentsubjectofdebate,withmany

politiciansadvocatingforanincreaseinthelevelbeyonditscurrentwageindexed

values.ThisargumenthascomeasaresultofSocialSecurityfacingaprojected

fundingshortfall2.

AnothercriticalelementofmoderndaySocialSecurityistheoverallincrease

intheageatwhichanindividualcanreceivefullbenefits.Whentheprogramwas

firstcreatedin1935,theageatwhichanindividualcouldreceivefullretirement

benefitswas65.Asof2015,theagerequirementforfullbenefitshasincreasedto

67.Congresscitedthattheprimaryreasonfortheincreaseintheminimumage

requirementforfullbenefitsistheoverallimprovementinhealthofolderpeopleas

wellasincreasesinaveragelifeexpectancy(IncreasesinRetirementAge).Itisalso

relevanttonotethattherearemeasuresinplacetodeterindividualsfromretiring

atanearlyage.Forindividualsbornbetweentheyearsof1943and1954,theymay

retireatage62,buttheirbenefitswillbereducedby25percentasaresult.For

individualsbornin1960orlater,theymaybegintoreceiveretirementbenefitsat

age65,butthesebenefitswillhavearesultingreductionof30percent.Althoughthe

increaseintheageoffullretirementbenefitshasbeenabletopartiallyoffsetthe

increaseinhealthandlifeexpectancy,thepolicystillfallsabysmallyshort.

SocialSecuritywasinitiallydesignedtoprovideincomesupporttoa

relativelysmallpercentageofthepopulation;thosewholivedbeyondtheaverage

2ThecombinedSocialSecurityandDisabilityprogramsareprojectedtoremainsolventthrough2033(The2013OADSITrusteesReport).http://www.socialsecurity.gov/OACT/TR/2013/index.html

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lifeexpectancyandthereforewouldbelesslikelytocontinueworking,orthosewith

insufficientsavings.However,sincetheinceptionofSocialSecurityin1935,the

averagelifeexpectancyintheUnitedStateshasincreasedby17years(Raisingthe

AgesofEligibilityforMedicareandSocialSecurity).Withadvancementsinmodern

daymedicalcare,individualsareabletoworklongeraswellasincreasetheir

overalllifeexpectancy.Inthe1940s,whenSocialSecuritywasinitsinfancy,less

than7percentofthepopulationwasaged65andolder.Thus,thiswasatimein

whichindividualsessentiallywouldworkupuntiltheynearedtheendoftheirlife,

andthenretireforashortperiodoftimebeforetheirdeath.Atpresent,14percent

ofthepopulationisaged65andolder,anditisprojectedthatby2050,this

percentagewillhaveincreasedto22percent(ProjectionsofFutureGrowthofthe

OlderPopulation).Thus,astherehavenotbeencorrespondingadjustmentsin

eligibilityrequirementsandbenefits,theSocialSecurityprogramhasbeen

transformedintoapotentiallydecades-longincomesubsidyforanever-growing

populationofretiredbeneficiaries.Withthisinmind,SocialSecuritycannotfeasibly

financelengthierretirementsforacontinuallygrowingpercentageofthe

population.Withindividualsseekingtoretireandliveinleisureformultiple

decades,workingindividualshavetopaymuchmoretocontinuethefinancingof

theprogram.Thus,moderndaySocialSecuritynolongerservestheoriginal

purposethatwassetoutduringitscreation.Withthisinmind,thereeitherneedsto

bealargeincreaseoftheminimumageatwhichanindividualcanreceivefull

benefits,ortheprogramneedstobedismantledaltogether.Thiswillbeaddressed

laterinthepaperinthepolicyrecommendationsection.

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Inadditiontotheagerequirementforfullbenefits,itisrelevanttonotethe

significantdemographicsflawthatispresentwithmoderndaySocialSecurity.In

1940,onlyafewyearsaftertheprogram’screation,theratioofcoveredworkersto

beneficiarieswasroughly159to1.By1964,thisratiodecreasedto4to1,andasof

2010,theratiowas2.9to1(RatioofSocialSecurityCoveredWorkersto

Beneficiaries1940-2010).ThisposesasignificantstrainontheSocialSecurity

system,andhasbeenrecognizedasamajorproblembymanypolicyanalystsand

policymakers.ThisproblemwashighlightedduringPresidentBush’sStateofthe

UnionAddressin2005.

“Intoday'sworld,peoplearelivinglongerand,therefore,drawingbenefitslonger.Andthosebenefitsarescheduledtorisedramaticallyoverthenextfewdecades.Andinsteadofsixteenworkerspayinginforeverybeneficiary,rightnowit'sonlyaboutthreeworkers.Andoverthenextfewdecadesthatnumberwillfalltojusttwoworkersperbeneficiary.Witheachpassingyear,fewerworkersarepayingever-higherbenefitstoanever-largernumberofretirees.”(CopingwiththeDemographicChallenge)

Thus,itisclearthereisamajordemographicchallenge,asamuchsmallernumber

ofcoveredworkershavetopayforever-increasingbenefitstoretiredworkers.

Therehavebeenanumberofproposedpolicysolutionsthatseektoaddressthis

demographicchallenge,suchasraisingtheretirementageandincreasingthelevel

ofmaximumtaxableearnings.Theseproposalswillbeanalyzedinfurtherdetail

laterinthepaperunderthepolicyrecommendationssection.

Thissectionofthepaperhasgoneintospecificdetailregardingthe

mechanicsofSocialSecurityintermsofhowincomeisredistributedfromcovered

workerstobeneficiaries.Inaddition,someofthecriticalproblemsoftheprogram

suchasmaximumtaxableearnings,agingpopulation,anddemographicchallenges

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wereaddressed.Theseproblemswillbefurtheranalyzedinthepolicy

recommendationportionofthepaper.However,beforedelvingintopolicy

recommendations,itisrelevanttoanalyzeSocialSecurityinthecontextofpolitical

andeconomictheory.

PoliticalandEconomicTheory AfterprovidinganextensivescopeofthecurrentsystemofSocialSecurityin

theUnitedStates,itisrelevanttoanalyzethefactorsthathavecontributedtothe

continuationofthisgovernmentprogram.In“SocialSecurityandPolitical

Investment”byPaulPeretz,theauthorseekstoexplainSocialSecuritythrougha

theoryofpoliticalinvestment.Thistheoryisbasedonessentialeconomicprinciples

suchassunkcosts,expectationstheory,andrisk-aversion.Theseeconomic

principlesareusedtocreateatheoryofsunkinvestment,whichholdsthat“making

irreversibleinvestmentsgivesindividualsareasontoseektochangethe

environmenttoprotecttheirinvestment”(Peretz).Peretzthenappliestheterm

politicalinvestmenttothistheoryinsituationswhere“therelevantenvironmental

factorisanexistinggovernmentprogramwhosecontinuanceisnecessaryforthe

investmenttobearfruit”(Peretz).

Togointofurtherdetailforthethreeeconomicprinciplesthatmakeup

Peretz’stheoryofsunkinvestment,wewillbeginbylookingatthetheoryofsunk

cost.Thetheoryofsunkcostsaysthatonceaninvestmenthasbeenmade,adecision

makershouldignoretheeffectsonthatinvestmentofsubsequentinvestments

(Peretz).Thus,sunkcostisacostthathasalreadybeenincurred,andtherefore

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cannotberecovered.IntermsofSocialSecurity,acoveredworkerhasalreadypaid

aportionoftheirpayrolltaxestowardsfundingtheprogram,andtheycannot

recoverthatcost.ThenextprinciplethatislistedbyPeretzisexpectationstheory.

Thistheoryholdsthatinmakinginvestmentdecisions,individualsincorporate

informationonlikelyfutureeventsthatwillaffectthevalueoftheirinvestments

(Peretz).Tofurtherexplainthistheory,ifindividualsanticipatereceivingbenefits

fromtheSocialSecurityprogram,theywilltakenoactiontodismantleorreformthe

program,astheywouldthenlosethebenefitsthattheyexpecttoreceiveupon

retirement.Thethirdeconomicprinciplethatislistedisrisk-aversion.Risk-aversion

isprimarilyattributedtofindingsmadebyRicardo,whichstatesthat“peoplefeel

lesspleasurefromapoundsterlinggainedthantheydopainfromanequivalentone

lost”(Peretz).Thus,investorswilllookforasaferinvestment,oraninvestmentwith

lowerassociatedrisks.ThisappliesdirectlytoSocialSecurity,asaworkermayview

thegovernmentprogramasasaferinvestmentthanprivatizedsocialsecurityin

whichtheirbenefitsmaynotnecessarilybeguaranteed,astheyaresubjecttomore

risks.Together,thesethreeprinciplesarecombinedtocreatePeretz’stheoryof

sunkinvestment.Thistheorywouldapplywhenadecisionisdifficulttochange

withouttheindividualincurringveryhighcosts.Thus,intermsofagovernment

programsuchasSocialSecurity,sunkinvestmentprovidesareasonforpolitical

actionfromindividuals.Individualswhoareunabletoreversetheirowninvestment

decision,suchasisthecasewithSocialSecurity,canusepoliticalpressureto

reverseorpreventthegovernmentalpolicychangethatmaymaketheirinvestment

abadone.Peretzmakesanimportantinsighttothis,statingthat.

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“evenforindividualsoriginallyopposedtotheprograminquestion,sunkinvestment,basedontheexpectationthattheprogramwillcontinue,givesthemareasontolobbyforitscontinuation”(Peretz)

Thus,intermsofSocialSecurity,individualswillcontinuetosupporttheprogram,

eveniftheydisagreewithitsprinciplesinnature,sothattheymayseetheir

investmentsbearfruit.However,itisrelevanttonotethatdifferentindividualsmay

havevaryingmotivesforlobbyingforthecontinuanceofsuchaprogram.Peretz

listsfourdifferentconstituencies,whichhavevaryinginfluenceonagovernment

program.Theseconstituenciesincludethedirectandindirectbeneficiariesofa

program,orthosewhowouldseelossesifprogrambenefitswerecut.Thesecond

wouldbetheprovidersoftheprogram,whowouldhavesomelevelofsunk

investmentinthecareersprovidedbytheprogram.Thethirdwouldinclude

individualswhosympathizewithprogrambeneficiaries,andwhofeelthatif

promisedbenefitsweretakenawayfrombeneficiaries,beneficiarieswouldseea

resultingsunkinvestmentthatwouldbeunfair.Thefourthwouldbeindividuals

whoarguethatwiththesunkinvestmentsthataprogramhasgenerated,cuttingor

dismantlingtheprogramwouldleadtomorecoststhanbenefitsforsuchanaction

(Peretz).Allfouroftheseconstituencieshavevaryingmotivesforwhythey

advocatethecontinuanceofagovernmentprogram,andthispaperwillnowgointo

furtherdetailregardinghowthisappliesdirectlytoSocialSecurity.

Thetheoryofpoliticalinvestment,whichisoutlinedbyPeretz,hasparticular

strengthwhenappliedtoSocialSecurity,themostimportantaspectbeingthedirect

sunkinvestmentbybeneficiariesandfuturebeneficiaries.Peretzarguesthatifthe

SocialSecurityprogramdidnotexist,individualswouldanticipateaperiodafter

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retirementwhentheirownincomewouldbezero.Thus,iftheprogramdidnot

exist,individualswouldbeinducedtosavemorefortheirownretirement.If

individualsanticipatereceivingbenefitsfromgovernmentpensions,theywouldbe

lessinclinedtosavefortheirretirement.Withthisinmind,ifSocialSecuritywereto

bedismantledorexperienceseverereductions,long-termworkerswould

experienceadverseimpacts.Thelongerthoseindividualshaveworked,themore

severetheseimpactswouldbecome.Inaworst-casescenario,inwhichretired

individualshavelittletonoopportunitytosave,theirinvestmentinSocialSecurity

wouldbealmostcompletelysunk.Forthecaseofindividualsjustenteringthework

force,theseworkerswouldbeabletochangetheirsavinghabitstoprovidefortheir

retirement,whereaslong-termworkerscannotgobackandchangetheirpast

savingsorregaintheirSocialSecuritytaxes(Peretz).Tonowprovidefurther

contexttothepoliticalinvestmenttheory,welookathowindividualswould

respondtoproposedreductionsordismantlingofSocialSecurity.Forlong-term

workerswhohavespentthemajorityoftheircareerspayingintoSocialSecurity,

theywillexpectapensionuponretirement.Iftheseindividualsanticipatethe

dismantlingoftheprogram,itwouldbeexpectedthattheserecipientswould

increasepoliticalactionastheirsunkinvestmentintheretirementsystembecomes

greaterovertime(Peretz).Thus,asanindividualincreasestheirinvestmentin

SocialSecurityovertime,theywillbemoreinclinedtotakepoliticalactionifthese

benefitsappearedtobeinjeopardy.

Tocontinuethissectionofpoliticalandeconomictheory,wenowlookat

“SocialSecuritySurvival:APublic-ChoicePerspective”byJamesM.Buchanan.Inthis

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journalarticle,BuchananseekstoexplainthesurvivalofaSocialSecurityprogram

thatappearsatfirstglancetobeneitheraviableintergenerationalsocialsystemnor

anefficientwelfaresystem.

BuchananbeginshisanalysisbyportrayingSocialSecurityasasystemthatis

treatedbyalllevelsofelectedpoliticiansassacrosanct.Ithasbeenwidelyaccepted

thatanyproposedchangestothebasicstructureofourSocialSecuritysystemis

essentiallypoliticalsuicide.Althoughtherehavebeenminorpolicychangestopatch

overtheprogram,thereislittletonosupportforbasicinstitutionalchangestothe

programasawhole(Buchanan).Buchananarguesthatthereisnowidespread

supportforbasicstructuralreformamonganydemographicgroupintheAmerican

politicalsystem.Therationalebehindthislineofreasoningisthatallofthese

demographicgroupshavetheirownself-interestconsiderations,whichissufficient

supportfornotwantingtochangethestructureofSocialSecurity.Thisreasoning

tiesindirectlywithPeretz’stheoryofsunkinvestment,asthedemographicgroups

whohavepaidintotheSocialSecurityprogramwishtobearthefruitoftheir

investments.Ifweassumethatindividualsareutilitymaximizing,theywilldo

everythingintheirpowertoprotecttheirinvestments,whichcorrelatestothelack

ofsupportforinstitutionalchangeforSocialSecurity.

Buchanangoesontoprovideanargumentforandagainsttheprivatizationof

SocialSecurityinapoliticalandeconomicalcontext.Hebeginsbyshowingthat

potentialandactualparticipantsintheSocialSecuritysystemcouldsubstantially

improvetheirpositionsiftheywereallowedtowithdrawfromthesystemand

investvoluntarilyintheirownprivatelymarketedinsuranceplans.Itisarguedthat

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ifanindividualthathasrecentlyenteredtheworkforceweretowithdrawfromthe

SocialSecuritysystem,andtherebyrelievethemselvesofpayroll-taxobligationsand

futurebenefits,theycouldobtainprivatelypurchasedinsurancethatwouldproduce

eitherthesamelevelofexpectedbenefitsatmuchlowercosts,orsubstantially

higherbenefitsatthesamecost(Buchanan).Thus,anindividualwouldhavea

substantialcomparativeadvantagethroughprivatelypurchasedinsurance.With

thisinmind,therewouldbeanaturalinferencethatsuchanindividualwouldcease

tosupportthecurrentSocialSecuritysystempolitically,onthegroundsofeconomic

self-interest.Thus,thereshouldbesomepotentialinthepoliticaleconomyof

Americaforapoliticalconstituencythatwouldsupportthisalternativeofopting-

outforprivatizedinsurance.However,Buchananarguesthatnosuchinferencecan

bedrawn,asalthoughtheremaybeanindividualdisparitybetweenratesofreturn

oninvestmentwithintheSocialSecuritysystemandoutsideofit,thisdoesnot

necessarilyprovideabasisforpoliticaloppositiontothecurrentstructureofthe

program.Thereasonforthisbeingthatindividualizedopting-outfromtheprogram

isnotarelevantalternative,andcurrentparticipantsintheSocialSecuritysystem

donotviewitassuch(Buchanan).Iftherewerestructuralreformsthatallowedfor

individualizedopting-out,therewouldeventuallybeaninducedabandonmentand

breakdownoftheintergenerationaltransferschemethatcurrentlyexistsinthe

program.

Buchanangoesfurtherinhisargumentstoanalyzethepotentialimpactsofa

situationinwhichtheexistingSocialSecuritysystemisabandonedwithoutany

governmentalinstitutionalreplacement.Ifthiswereapotentialinstitutional

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alternativetothatofindividualizedopting-out,therewouldbeavarietyofimpacts

toconsider.Firstlywouldbethatifindividualswouldseriouslyconsider

abandoningSocialSecurityandtherebydefaultontheSocialSecuritydebt

obligation.Inthe1980s,theimplicitdebtoftheexistingSocialSecuritysystemwas

estimatedtoberoughly$8trillion,incomparisontoanominallymeasureddebtofa

littleover$1trillion(Buchanan).Buchanangoesontolistavarietyofpolitical

factorsthatneedtobeweighedwhenconsideringwhetherindividualswould

supportabandoningSocialSecurityanddefaultingonitsdebtobligation.Thefirst

factorwouldbetheconstituencyofindividualswhoarecurrentlyreceivingbenefits,

aswellasthosewhowouldstandtocollectbenefitsinthenearfutureupon

retirement.Itisarguedthatthisconstituencywouldneverbeinsupportof

defaultingontheimplicitnationaldebtthatSocialSecurityclaimsrepresent,onthe

basisofself-interests.Anotherfactortoconsiderwouldbethemorallegitimacythat

existingclaimsrepresent.Iffutureclaimsweretobeeliminated,therewouldbe

individualswhowouldarguethemorallegitimacyofsuchareform,asmanyold-age

individualswouldbeleftwithoutbenefits.Inadditiontomorallegitimacy,there

wouldalsobethedirectwelfareobligationthatwouldpresentitselfintheabsence

oftheexistingSocialSecuritysystem.Evenifindividualsdismissmorallegitimacy,

somewillrecognizethattheaged-poor,nowwithoutbenefitpayments,mustbe

keptaliveandprovidedfor.Thus,theremaybelittlesupportforthetotaldisregard

forthosewhowouldbeunabletosupportthemselveswithouttheprotectionthat

SocialSecurityprovidesinitscurrentstructure.Finally,anindividualmusttakeinto

considerationanestimateforinducedincreasesinpaymentsthatmaybenecessary

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forthemembersoftheirfamilywhomaybecurrentrecipientsofSocialSecurity

benefits,butwhosebenefitsmayhavebeenreducedoreliminatedunderan

alternativeprogram(Buchanan).

Afteroutliningthesevariousfactors,Buchanangoesontoarguewhich

constituencywouldmostlikelybethemostpoliticallyinfluentialinAmerica’s

representativedemocracy.

“public-choicetheorysuggeststhatthemoreconcentratedinterestsofpotentialbeneficiariesarelikelytocarrysomewhatmoreweightthanthediffusedinterestsoftaxpayers,particularlyifthebeneficiaries’interestisaccompaniedbymoralargument,whetheronthegroundsofdefaultondebtoronthegroundsofcommitmenttowelfare.”(Buchanan)

Inthiscontextofpublic-choicetheory,itisarguedthatcurrentorfuture

beneficiarieswouldhavethemostinfluencepolitically,astheystandtolosethe

mostfromstructuralchangestoSocialSecurity.Withthisinmind,thegovernment

isnotlikelytodefaultontheimplicitrealdebtthathasresultedfromthedecisions

ofpastgenerations.Therefore,Buchananarguesthattheeffectiveandrelevant

alternativetotheexistingSocialSecuritysystemwouldbeatax-transferscheme.

However,suchatransferschememaynotbesubstantiallydifferentfromtheone

thatalreadyexists(Buchanan).

Thissectionofthepaperhasgoneintodetailregardingwhichfactors

influencepoliticalactionintheAmericaneconomy.Thesefactorsincludepolitical

investmenttheory,sunkinvestmenttheory,andalsopublic-choicetheory.These

factorsalsoseektoexplainthedifficultiesassociatedwithreformingtheSocial

Securityprogram,asthesystemiswidelyacceptedassacrosanct.

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PolicyRecommendationsandHistoricalBackground Thissectionwillbeginbyanalyzingpreviouspoliticalcampaigns,which

soughttoprivatizeSocialSecurityintheUnitedStates.Todothis,welookatthe

article“Thegreatsocialsecuritydebate”byDanielBeland,whoanalyzesthe

differentpoliciesattemptedbytheClinton,Bush,andObamaadministrations

respectively.ThosewhowouldargueforprivatizationofSocialSecuritypointtothe

long-runfeasibilityoftheprogramasgroundsforamajortransformation.Thereis

strongevidencewhichshowsthatinthelong-run,therewillbeasteadilyincreasing

percentageofelderlycitizensintheUnitedStates.Withthepercentageof

individualsaged65orolderprojectedtoreach22percentbytheyear2050

(ProjectionsofFutureGrowthoftheOlderPopulation).Withadecliningratioof

coveredworkerstobeneficiaries,expendituresshouldeventuallyexceedrevenues

generated,therebyerodingsocialsecurityreserves.Belandcitesthe2008trustees’

reportinhisarticle,whichpredictsthatSocialSecurityfundwillfacefiscalshortfalls

in2042(Beland).Withthisinmind,therearemanyinfavorofSocialSecurity

privatizationtohelpaddressthelong-termfiscalimbalancesoftheprogram.

Beforegoingintofurtherdetailforthepoliciesproposedbydifferent

presidentialadministrations,itisrelevanttonotewhatexactlySocialSecurity

privatizationmeansinthecontextoftheUnitedStates.Belandprovidesadefinition

forthisinhisarticle,

“theideaofsocialsecurityprivatizationreferstothediversionofallorpartofthepayrolltaxmoneytopersonalsavingsaccounts,whichwouldfavourashiftfromadefined-benefittoadefined-contributionlogic”(Beland)

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Theideaofattemptedprivatizationcorrelateswiththeexpansionoftax-sponsored

savingsaccountsanddefined-contributionpensionplansintheprivatesector.Such

planscontinuetogainsupportintheUnitedStates,asemployersseektotransfer

economicrisksfromthemselvestoworkers(Beland).Furthermore,the

developmentofprivatizedpensionplansarefavoredinacultureinwhich

individualsseekeconomicindividualismthroughmakingchoiceswhichwill

maximizetheirownindividualutility.

AfterprovidingcontextforSocialSecurityprivatizationintheUnitedStates,

wewillnowlookatthepushmadeinthe1990stowardpartialprivatization,which

wouldonlydivertafractionofpensioncontributionstoprivatesavingsaccounts.

Thisbecameoneofthemostdebatedpolicyalternatives,withtheargumentthat

personalsavingsaccountswouldmakeworkerswealthierbycreatinghigherrates

ofreturnoninvestmentthantheexistingSocialSecuritystructure.Acounter

argumenttosuchapropositionwouldbethatprivatizationwouldexposelong-

incomeworkers,orthosewhohavepaidintothepensionprogramforlargenumber

ofyears,tounnecessaryfinancialrisks(Beland).IntheUnitedStatespolitical

economy,SocialSecurityprivatizationgainedmuchgroundduringtheClinton

administration,from1993through2001.DuringClinton’ssecondterminoffice,

WhiteHousestaffersexploredavarietyofpossibleplanstoreformSocialSecurity.

Themostnotableoftheseplans,wouldbethecreationofpersonalsavingsaccounts

asapartoftheSocialSecurityprogram.However,theseplansquicklylosttraction

andsupportasaresultoftheLewinskyaffairandClinton’sattempttoconsolidate

hisdemocraticbase.By1999,inClinton’ssateoftheunionaddress,headamantly

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rejectedSocialSecurityprivatizationandinstead,supportedthenotionthatthe

federalgovernmentshouldinvestsocialsecuritysurplusesinequality.However,

Republicansstronglyopposedthisproposition,andthustheproposalwas

terminated(Beland).Althoughtheseproposedreformsnevercameintofruition

duringClinton’stimeinoffice,itpavedthewayforGeorgeW.Bush’scampaignto

partiallyprivatizetheSocialSecurityprogram.

AsthepresumedRepublicannomineeintheyear2000,Bushendorsedthe

partialprivatizationofsocialsecurity,ashefavoredpermittingindividualstoinvest

aportionoftheirSocialSecuritypayrolltax.WhenBushtookofficein2001,the

presidentappointedasocialsecuritycommission,whosemembershadagreedto

embracethecoreprinciplesofhisreformagenda.Onthedaythecommissionwas

launched,Bushonceagainemphasizedhissupportforindividualizedaccounts,

whichwouldbecarvedoutoftheexistingpayrolltax(Beland).BelandquotesBush

onhisstatementforthetopic,

“PersonalsavingsaccountswilltransformSocialSecurityfromagovernmentIOUintopersonalpropertyandrealassets;propertythatworkerswillownintheirownnamesandthattheycanpassalongtotheirchildren.Ownership,independence,accesstowealthshouldnotbetheprivilegeofafew.They’rethehopeofeveryAmerican,andwemustmakethemthefoundationofSocialSecurity.”(Beland,quotingGeorgeW.Bush)

TheSocialSecurityCommissionpublisheditsfinalreportinDecember2011,which

includedthesecoreprinciplesforreformthatPresidentBushhadlaidout.However,

socialsecurityreformwaspushedoffofthefederalagendaasaresultofan

economicdownturnandtheterroristattacksofSeptember11,2001.Althoughthere

wereattemptstorevisitSocialSecurityreforminthelateryearsofBush’s

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presidency,thesereformsnevergainedenoughbipartisansupport,andthereforms

nevercametofruition.

Duringthe2008presidentialcampaign,SocialSecurityreformwasnolonger

ahighprofileissue,whichmaybeattributedtothefailureofthepasttwo

PresidenciesattemptsforSocialSecurityprivatization.Anotherfactorthat

contributedtothiswasthefinancialcrisisthatemergedintheAmericanEconomy

during2008.Withthefinancialcrisis,therewasaresultingtrendofweakened

confidenceinpersonalsavingsandtax-deferredsavingsplan,whichprovideabasis

forSocialSecurityprivatization.Thus,presidentialnomineeBarackObamaavoided

thetopicofprivatization,andinsteadproposedtoraisetheearningscapforthe

SocialSecuritypayrolltaxinanattempttoaddressthelong-termimbalancein

financingfortheprogram.Itwasarguedthatsuchapayrolltaxreformwouldhelp

tokeepSocialSecuritysolventforatleastthenexthalfcentury(Beland).Thus,

althoughthereisclearlyaneedtoreformSocialSecurity,politicianshaveshied

awayfromimplementingbasicinstitutionalchangetotheprogram.Thishascome

asaresultofpreviousfailuresofpresidenciestoimplementreform,aswellasthe

hesitationfromAmericancitizenstohavetheirinvestmentsandbenefitsbeputat

risk.

AfterlookingcloselyatpreviousproposalsforSocialSecurityreformbythe

Clinton,Bush,andObamaadministrations,thispaperwillnowgoontoproposea

theoreticalreformthatwouldentailagradualprivatizationofSocialSecurity,

eventuallyleadingtothedismantlingoftheprogramaltogether.Consideringthat

thereisstrongoppositionfromavarietyofconstituenciestowardthefull

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privatizationofSocialSecurity,thisproposalwillmarrysomeoftheideasoutlined

throughoutthepapertohelpmaketheproposalappealingtoawidearrayof

constituencies.

ThereismuchoppositiontoprivatizationofSocialSecurity,especiallyfrom

individualswhohavespentthemajorityoftheircareerspayingSocialSecurity

payrolltaxes.Thisconstituencyisvehementlyopposedtoprivatization,assucha

reformwouldputtheirexpectedbenefitsatrisk.Ontheothersideofthisargument

arethosewhobelievetheymayvastlyincreasetheirratesofreturnoninvestmentif

theyweretopayaportionoftheirpayrolltaxesintoaprivatelyinsuredretirement

programinstead.Consideringbothsidesoftheargument,thispaperarguesthat

throughagradualprivatizationofSocialSecurity,bothconstituenciesmaystandto

benefit.Throughaprocessspanningseveraldecades,averysmallpercentageof

payrolltaxeswouldbegintogointoindividualizedprivateaccountsandgradually

increasetothepointatwhichindividualsarenolongerpayingintotheSocial

SecurityTrustFund,butrathersolelyintotheirownaccounts.Thus,full

privatizationwouldbeachieved,ultimatelyappeasingbothconstituencies.Those

whohavepaidintoSocialSecuritywouldstillreceivethemajorityoftheirbenefits,

whilethosewhohavejustenteredtheworkforcehaveampletimetofundtheirown

retirementthroughprivatizedaccountsovertime.Inthelongrun,individualswould

entertheworkforceandonlypaytaxesthatgointotheirownprivateaccount,

whichtheywouldreceiveupontheirretirement.Byimplementingsuchareform,

SocialSecuritymaybephasedoutovertimethroughgradualprivatization,thereby

eliminatingthepay-as-you-gointergenerationaltax-scheme.Thiswouldcombatthe

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demographicflawoffewercoveredworkershavingtopayforanever-increasing

percentageofretiredbeneficiaries,andendthecycleofeachgenerationfundingthe

retirementofthosewhocamebeforethem.

Conclusion Althoughinanidealsetting,thistheoreticalpolicyreformmayhavesome

groundsinaddressingmanyoftheflawsassociatedwiththecurrentstructureofthe

SocialSecurityprogramandleadtoitseventualdismantling,realistically,sucha

proposalwouldbeextremelydifficulttoimplement.SocialSecurityhasmany

perceivedflaws,buttheprogramisdeeplyentrenchedinAmericansociety.Any

attemptthatwouldtakedrasticactiontodismantletheprogramcouldverywellbe

politicalsuicideforthepartythatattemptssuchaproposal,andwhenpushcomes

toshove,neitherpartyisgoingtomountaseriousattempttorepealtheprogramfor

thisveryreason.Instead,politicianswillcontinuetoshyawayfrombasic

institutionalchangestotheprogramandonlypatch-upflawstotheprogramwhen

suchpoliciesarerequired,suchisthenatureoftheAmericanpoliticaleconomy.

ThisconclusioncanbedrawnfromtheexperienceoftheClintonandBush

administrations,whichshowthatacompleteinstitutionalchangeofSocialSecurity

isnotlikelytohappen,andsurelywouldnothappenconsideringthesubjectisso

politicallytoxic.Ifthislineofreasoningisarealisticreadingofwhatwouldhappen,

thenexpertswhoseeflawsinthecurrentSocialSecurityprogramshouldfollowthe

maximthatpoliticsistheartofthepossible,andthereforetheyshouldfocusonthe

ideathatthebestwayofmovingforwardistoengageinfine-tuningSocialSecurity

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tomakethebestofanimperfectsystem.Thus,thebestapproachmaybetotakea

principledstandagainstthesystemsflawsforpurposesofpublicenlightenmentand

possiblelong-runsuccess,whilesettlingintheshort-runforseekingimprovements

tothesystem.

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