(originally printed in the Stony Brook Press, February 10, 1999)

By Stephen Preston

There is a story about a Vietnamese family who is too poor to afford anything for dinner except a bowl of rice. On their wall is hung a picture of a fat fish, and to the left of it is a picture of a roast chicken, and to the right is a picture of a juicy steak. The family stares at these pictures as they eat, imagining. One night, the younger child sees that his brother has stopped eating and is just staring at the pictures, so he complains to his parents, "No fair! He's just eating his meat and not his rice!"

The American public sometimes seems to operate this way. They will accept corporate welfare for downsizing corporations, while dreaming of "new jobs" for the unemployed. They will applaud a war in Iraq to save the royalty of Kuwait, while visions of "democracy" dance in their heads. And now, as the government prepares to use Social Security surpluses to buoy the stock market, the people are presented with the fantasy that this will "save Social Security!" But is the government ready to destroy Social Security in order to save it?
 
 
How Social Security Works

Social Security was created in 1935, during the Great Depression, in part to encourage older people to retire in order to ease unemployment, and primarily because of the problem of poverty among the elderly. Social Security taxes are collected from all workers, even low-income workers, at a constant percentage (7.5%) of the first $68,400 of income annually. Thus it is a regressive tax, meaning the poor have a higher percentage burden than the wealthy. Social Security is the largest tax most low-income workers pay, since other taxes are generally refunded.

However, Social Security benefits are progressive, in the sense that the poor will generally get a higher percentage of their contributions back than the wealthy. Although lower-income people are less likely to have regular employment during their lifetime, resulting in smaller contributions to the system, and although lower-income people have shorter life expectancies, the progressive formula used for Social Security benefits outweighs most of these factors, resulting in a small redistributive effect.

Social Security is a pay-as-you-go system, which means that the money you pay in taxes is not saved for you when you retire, but rather is used to pay benefits for current retirees. Although Social Security is now building a "trust fund" using each year's surplus, this trust fund covers only a small percentage of total Social Security payments, so that the system is still largely pay-as-you-go.
 

What's the Problem with Social Security?

Since working people always pay the current benefits to older people, as "baby boomers" retire, there will be less workers to pay for the benefits of more retirees. The Social Security Trustees have projected that new revenues will fall short of scheduled payments in the year 2032, under a set of fairly conservative assumptions and assuming that no changes are made to the system. After this time, Social Security will only be able to meet 75% of scheduled payments to retirees.
(Read a summary of the Trustees' report here: http://www.socialsecurity.gov/OACT/TRSUM/trsummary.html)

The Trustees actually have three projections: the most pessimistic of them states that Social Security payments will exceed taxes far earlier than 2032, and the most optimistic says that Social Security will never have any trouble. The question, assuming the pessimistic projections are valid, is how to ensure that payments will be available, without raising payroll taxes or cutting benefits.
 
 
Saving Social Security

By some estimates, there really is no need to worry about saving Social Security. Some say that the Trustees have estimated too conservatively: They have assumed that over the next 75 years, the GDP (Gross Domestic Product) will grow at an average of only 1.5% per year. In the past 75 years, the GDP has actually grown at an average of about 3.5% per year. If a growth rate similar to this were to continue, Social Security would never reach a deficit.

Even if the Trustees' forecast is correct, there are many minor changes that could be made now to prevent the collapse of the system. The current payroll cap could be raised from $68,400 to $100,000. Very slight tax increases would also eliminate any possible problem. The retirement age could be raised. Social Security benefits could be means-tested, or benefits above a certain subsistence level could be taxed.

Or, if the government would really like to see the stock market subsidize Social Security, it could implement a tax on stock transactions or a tax on profits from short-term investment; this would not only provide a new source of revenue to Social Security, but, as investors like Warren Buffett have argued, it would decrease a lot of the speculation and volatility in the stock market.
 
 
Partial Privatization

The plan that President Clinton has proposed involves investing some portion of the Trust Fund in the stock market. The Trust Fund is currently invested in Treasury bonds, and the idea is that since the stock market pays, on average, a higher rate than Treasury bonds, it will generate more revenue for Social Security without any sacrifices. Clinton's plan is presented as the "liberal" plan, as in the Wall Street Journal's editorial calling it "a desperate effort by an irrelevant president to regain support from the only group that's remained loyal to him, the far left wing" (2/1/99).

Then, of course, there is the "conservative" plan, which is to slowly phase out all or part of Social Security, replacing it with mandatory savings accounts, which would be invested in much the same way that 401k plans and IRAs are currently invested. Some variation on this plan is favored by many Republicans in Congress. The most radical formulation of the proposal is to simply follow the example of countries like Chile, Argentina, El Salvador, Peru, and Colombia (which are all countries notorious for military governments, government crackdowns on poor dissidents, death squads, and dirty guerrilla wars, though economists insist that the same reforms could probably be done in a democracy too), and make the system completely private.

As often happens in public debates nowadays, most of the media presents the Clinton option and the Republican option as the only two ideas, and offers some superficial debate about them. The argument is currently not over whether Social Security funds should be invested in the stock market, but rather whether some government commission would control these investments, or whether some investment firms such as Merrill Lynch et. al. would control them.

This debate has all the relevance of a debate between Medieval Christians about angels dancing on the heads of pins. Like most of the political debates since Clinton's election, the substance of the plan is already agreed upon, and the arguments are only over style. Recall that Clinton has essentially agreed with the Republicans on NAFTA, welfare/workfare programs, the MAI treaty, every single military action, Pentagon funding, environmental treaties, Internet censorship and surveillance, and every facet of foreign policy since 1992. In fact, except for abortion, it's quite difficult to find issues where they don't agree.

Even if the debate over government control of Social Security assets in the stock market had any substance, the issue would be moot. Walter Burien has estimated that about 53% of common stock in this country is currently controlled directly by federal, state and local governments, through pensions and other investment funds (see http://www.buildfreedom.com/cevi/cevi_2.htm for more on this). So if government control over a portion of the stock market is socialism, then we certainly have already achieved that.
 
 
Why Privatization Is a Scam

Privatization, in whole or in part, has been proposed by Clinton, the investment firms, our own Senator Moynihan, several lesser-known Republicans, and much of the major media, with essentially one rationale: to "save Social Security." One who points out problems with this plan is refuted with, "What, you don't want to save Social Security?"

But the idea that the stock market will cure our ills rests on faulty assumptions. For example, a common argument in favor of investing in the stock market goes something like this: "If one computes the total amount of money the average citizen gets after retirement, it is equivalent to what, on average, an individual would get with an investment earning a certain interest (between 4% for high-income workers and 6% for low-income workers, according to the Cato Institute's webpage at http://www.socialsecurity.org/studies/ssp10.html). However, the stock market historically returns about 7.5% to 8.5% (depending on how much risk is assumed), so it would be better for all individuals to invest their money privately, rather than in Social Security."

However, the problem with this argument is that actual returns from the market will probably not be this high. According to Dean Baker (http://www.socsec.org/facts/stocks_intro.htm), the rate of return could be lower for at least two reasons:

1. In estimating Social Security funds in the future, the Social Security Trustees assumed that the GDP will increase far more slowly over the next 75 years than it has over the previous 75 years. Since stock market prices are correlated with GDP growth, this would imply a corresponding reduction in the rate of stock return, to probably less than 5% per year.

2. Private account managers would likely charge maintenance fees of between 1.5% and 2.5% per year, if fees for current IRAs, mutual funds, and 401k plans are any indication. In contrast, Social Security currently uses less than 1% of funds for administrative expenses. So the advantage of investing in the private market disappears when the probable maintenance fees are taken into account.

In fact, analysis of the GDP projection just mentioned shows a fundamental contradiction in the crisis projections: According to standard economic theory, if the GDP growth is as low as projected, then the stock market will do poorly; but if the GDP is high, then wages will be high and there will be no crisis. Aaron Bernstein makes this point clearly in Business Week (2/8/99).
 
 
The Stock Market as Pyramid Scheme

It is generally believed among economists that stocks represent holdings in a company, and have some intrinsic value. How, then, to explain the fact that annual turnover is over 100%; that is, on average, every stock is sold at least once every year? If people were actually investing in companies, it would hardly make sense to sell stocks so often. In fact, as Louis Lowenstein has written in "What's Wrong with Wall Street?", most money managers' pursuit of short-terms gains in the market has resulted in an institution built primarily on speculation, "in which the whole enterprise begins to resemble nothing so much as it does gambling, except that the stakes are much larger."

It is well-known among economists that the ratio between the prices of stock and the earnings of the companies are higher than they have ever been. It is also well-known that, historically, such overinflation of stock prices has led to collapse (this was the problem both in 1929 and in 1987), and thus some people quite reasonably suspect that the current wave of stock market success cannot last much longer, without some outside influence.

This is where you come in. The market always seeks new sources of income; in the 1920s, the explosion in stock prices was fueled by reports of the stock market being a sure thing, luring many middle-class people to invest their savings there instead of more traditional, less risky investments. Eventually, of course, the bubble burst. Later, there was the impetus to get new money from foreign countries, which was part of the reason that trade between nations has been liberalized so extensively in the past 20 years. But foreign money could only provide so muc growth. Eventually, the market started to depend on the pension funds held by many companies, as well as relying on 401k plans and IRA accounts. This was helped by friendly government policies, such as tax deferments, which induced many people to contribute to such accounts, and thus to the market.

Now that there is not much more money to be gained from private investment, the market has embarked on an audacious plan: to require people, through Social Security taxation, to donate to the stock market. The possibility of this boosting stock prices for current investors is generally not discussed in public view, but in some places, one can see a veiled jubilance at the potential windfall. From the New York Daily News (1/21/99):

"Anyone with a sharp pencil will calculate how much new buying power [Clinton's] proposal will bring to the stock market: $3.6 billion a month. This amount, when compared with $11 billion a month from individual investors, is a significant positive force in the stock market. It can serve as buying support in difficult market conditions, as well as an opportunity for even better performance in rising markets. In effect, it is the ultimate case of what the mutual fund industry calls dollar-cost averaging. This is to say that, over time, a regular program of investment yields the best result."

In fact, it may be that the stock market is not doing as well as is generally believed. For example, what is meant by the phrase "the stock market has performed well"? Generally this means a certain index, such as the S&P 500 or the Dow Jones Industrial Average, has increased. But since these indexes only cover a small number of companies, 500 in the former and 30 in the latter, one might reasonably ask what happens to the others. The answer is surprising: According to U.S. News (1/11/99), "these traditional indexes disguise huge losses in the overall market. As of December 30, the average stock on the New York Stock Exchange was down 7 percent, and half of all stocks on the big board had fallen by more than 10 percent for the year." (Full article: http://www.usnews.com/usnews/issue/990111/11outl.htm)

So the real question might be why these indexes are doing so well in spite of everything else. The answer lies in index funds, a very popular form of investment in which a company just buys shares in all the S&P 500 companies. Then, when the S&P 500 does well, more managers copy their behavior by investing in the same 500 companies. In fact, one of the current arguments that Clinton and his supporters make is that when the government invests the Social Security money, it will avoid potential conflicts of interest by only investing in index funds. Is there really any difference between all this follow-the-leader investing and more traditional pyramid schemes?

Failing to address this question could lead us to dire consequences. Will we end up in the same situation as Albania, where the government officially sanctioned pyramid schemes, people invested their life savings, and then everything came crashing down? Perhaps we are already going even further, by making it mandatory to invest in the schemes. This is the real danger in starting, even with small steps, down the road to putting Social Security into the stock market. What happens when the bubble bursts? Who will we have to blame when it happens? When will we notice that we've been deceived? Will we just keep staring at fish, even after our rice is gone?