The University Record, March 20, 2000

Gramlich details objectives to keep in mind for Social Security reform

By Bernie DeGroat
News and Information Services

Last year, 45 million people in the United States received $387 billion in benefits from Social Security. About 40 percent of income received by older Americans in 1999 came from Social Security, which accounted for more than 80 percent of the income among the poorest elderly. In fact, Social Security has helped reduce the poverty rate among the elderly from 35 percent four decades ago to 11 percent today.

It is little wonder then that politicians in Washington treat Social Security much like the electric “third rail” of that city’s subway system—“touch it and you die,” said Edward (Ned) M. Gramlich, a member of the Federal Reserve Board of Governors and former dean of the U-M’s Gerald R. Ford School of Public Policy.

“Because of its support to aged people of all incomes, poll after poll has indicated Social Security’s unique political popularity,” he said. “(It) has become the ‘third rail’ of American politics.”

Gramlich, author of a new book on Social Security reform and past chairman of the Social Security Advisory Council, returned to campus last week to deliver the School of Social Work’s annual Leon and Josephine Winkelman Lecture in Gerontology.

Speaking before a full house at the School of Education’s Schorling Auditorium, Gramlich addressed the history and current problems of Social Security, as well as objectives that he believes should be “kept front and center” in dealing with system reform.

The most fundamental objective, he said, should be to preserve Social Security’s social protections—guarantees of high returns for low-wage workers (vis-a-vis their income) and protection against financial consequences of workplace disabilities or workers’ premature deaths.

“Social Security benefits are also real annuities, which means that payments go on as long as retirees live, with added protection for surviving spouses,” Gramlich said. “Not only that, but these benefits are automatically protected from inflation. Social Security is one of the few pension programs in America that has this feature.

“All of these social protections have existed for some time now, so long that they may be taken for granted. Preserving them should be the first order of business.”

This is not to say that some aspects of the system should not be modified, such as changing the so-called normal retirement age for the computation of benefits, he added.

“Proposals to raise the normal retirement age are hugely controversial, perhaps because they are generally misunderstood,” he said. “If workers are still permitted to retire and collect benefits at age 62, raising the normal retirement age really means only a slight cut in benefits for workers retiring at any fixed age. It does not mean that these workers would have to work until these older ages.”

Another objective in reforming Social Security, Gramlich said, should be to strike an “actuarial balance.” That is, the system should continue to build on its cash surplus of about $150 billion a year to help meet the financial needs of retiring baby boomers and others well into this century.

Right now, he said, actuarial forecasts predict that the system will continue to build its assets for another 20 years, but then run down fairly quickly as many in the huge baby boom population retire—eventually exhausting the system by 2035.

“There is more than widespread political confusion in Washington about what all this means,” he said. “You can probably turn on the radio at any given time on any given day and hear somebody accusing somebody else of stealing from Social Security. But this is not true.”

According to Gramlich, even when the federal government was running a deficit and borrowing from the Social Security system, the fund was building up its holdings of Treasury securities and charging full interest on loans to the rest of government—as any prefunded pension plan might do.

“So you can object or not object to the fact that the rest of government is running a deficit, but that has very little to do with Social Security,” he said. “There is no theft going on. No waste, fraud or abuse or anything like that. These kinds of allegations are just a form of political gossip.”

Instead, Gramlich said, we should worry more about the fact that Social Security is simultaneously running a short-term cash surplus and a long-term actuarial deficit—due to of the aging of America’s population. It would take an immediate 2.6 percent increase in the combined employer-employee payroll tax rate (currently 12.4 percent) to extend Social Security’s assets for the normal forecast period of 75 years.

An even higher tax increase—estimated at 7.7 percent—will be needed to finance benefits beyond the 75-year forecast period. Growth in entitlement spending (retirement, disability, Medicare) will roughly double as a share of federal revenues in the next three decades—thereby crowding out other types of government spending or requiring new federal tax increases, he said.

“These indicators suggest that some changes should be made on the benefit side, and it is far better to make the changes early rather than late,” Gramlich said. “It is widely viewed as unfair to change benefits for present retirees who have already quit their main job and is nearly as unfair to cut the benefits of workers nearing retirement ages for precisely the same reason.

“Hence, if benefits are to be cut enough to matter, they should be cut in a very gradual way, beginning early, and with the largest cuts in store for the youngest workers, for whom retirement is a long way away and retirement planning is still very flexible.”

In addition to the objectives of social protection and actuarial balance, a third goal of the Social Security system should be to improve the rate of returns on workers’ payroll contributions, Gramlich said.

As the Social Security program, established in 1935, continues to mature, future retirees of average income and life span can expect a 1 percent real rate of return (equal to the sum of the trend rates of real wage and labor force growth), he said. High-income workers born now are even likely to get negative returns, while lower-wage workers may do better than the average due to internal redistribution in the system.

Gramlich believes that as rates of return continue downward, prefunding—new national saving—represents a fair way to pay for future benefit costs and should continue to pay high returns.

“Any new funds devoted to the retirement system can, in effect, be invested in new capital and can pay at least the marginal real return on such funds, now roughly 4 percent, if funds are invested in bonds and perhaps even more if some funds are invested in equities,” he said. “Moreover, new saving represents a way to place some of the costs of future benefits on those now in the workforce who are already likely to receive higher rates of return than will future cohorts.”

While several different plans have been proposed to solve the problems of Social Security, all of them essentially preserve the present system of benefits and social protections, as well as try to restore the long-run actuarial solvency of the fund, Gramlich said. Where they differ is in their economic dimensions—whether they prefund some future benefit costs, raise national saving and take advantage of the higher return on this new saving, and/or increase payroll tax rates.

Gramlich’s plan, which he first proposed several years ago as a member of the Social Security Advisory Council, would raise national saving without raising taxes. Instead, workers would contribute to their own mandatory individual accounts—in addition to paying Social Security taxes—by freely investing in stock and bond index funds, much like today’s employer-controlled, defined-contribution private pension accounts.

Gramlich concedes that such a program would cost Social Security more to administer than its present system and that some gradual cuts in the growth of benefits over time would still be needed to bring the fund into long-term actuarial balance, but he believes the rates of return to retirees would be much higher than present payroll contributions to the current pay-as-you-go system.

While his idea has not proven highly popular in Washington, he believes that similar competing proposals—all with their own variations on individual savings accounts—are not so different that a compromise plan is out of the question.

“We could respond to the massive aging of the U.S. population and attendant rise in future benefits by further increases in payroll tax rates, as was the case throughout most of the 20th century,” Gramlich said. “Or we could try some new approaches, such as add-on individual accounts, general revenue transfers or various mechanisms for investing in equities.

“All of these can, in principle, pay for the presently scheduled level of future benefits and preserve the actuarial soundness of the Social Security trust fund. But only some of them imply new national saving, the high rates of return on this new saving and new investments in American productivity. Our hardest job now is to find reform measures that really generate this new saving.”