The New Republic October 23, 2000 GENERATION X Does Bush Understand His Social Security Plan? By John Geanakoplos Social Security is the third rail of American politics. So why hasn't George W. Bush been harmed for proposing to transform it into a system of private accounts? Probably because his plan relies on simple and seemingly compelling logic. Today, retirees get a measly 2 percent rate of return (in the form of Social Security benefits) on the money they paid into the system (via payroll taxes). Since even ultrasafe bonds offer much better returns, Bush says, people would be better off investing their money themselves. In an era of dizzying stock market heights, this argument has the virtue of being timely. Unfortunately, it does not have the virtue of being true. Under Social Security, the money you put into the system during your working years doesn't actually sit there collecting interest, waiting for you to claim your checks at age 65. Most of it goes back out as benefits for today's retirees. This is why Social Security is called a "pay-as-you-go" system: Today's workers pay for today's retirees; when today's workers retire tomorrow, tomorrow's workers will pay for their benefits; and so on. It's an imperfect design. In an ideal world, each generation would pay for its own benefits. In other words, each worker would pay into the system, have his or her money accumulate interest (either as part of one giant trust fund or in individual accounts), and then take it back out upon retirement. Indeed, when FDR created Social Security in the 19305, he envisaged a system more or less along those lines. But there was a problem. It was the Great Depression; many elderly people literally faced starvation. They had made virtually no Social Security contributions, but Roosevelt felt they needed relief. So Congress decided to pay the destitute elderly of the '305 and early '40s with the contributions of contemporary workers, with the understanding that those workers would get their retirement benefits from the next generation of workers, and so on. As a result of this decision, the first generation of Social Security recipients got a windfall-receiving full benefits after paying little into the system. Of course, once Congress started paying out full benefits, it couldn't stop. The elderly of the 19505, '60s, and '70s hadn't paid enough into the system to cover full benefits, either, since their working lives began before i937, the year the government started collecting Social Security payroll taxes. So each of these generations got a windfall, too. You might think this pattern finally ended in the '70s, when the first wave of people who began working after 1937 -- and thus paid Social Security taxes for their entire working lives-started to retire. But Congress raised benefits for retirees, so the transfer continued even longer. In today's dollars, the "windfall" to these generations totaled a staggering $10 trillion. Was it A bad decision to start this cycle? Only if you think it would have been preferable to let those elderly people suffer or to force the workers in the '30s and beyond-who really didn't have the resources-to bear the cost of their parents' retirement all on their own. Consider a concrete example, similar to one I have written about with fellow economists Olivia Mitchell and Stephen Zeldes. Your father reaches retirement age, but he has no savings. Letting him starve isn't an appealing option, ~ but neither is bearing the cost of his retirement all on your own -- it's simply too much. Assume, to borrow an example f that reflects the real Social Security numbers, his retirement would soak up 12 percent of your lifetime earnings.) That leaves one other choice: You can spread the cost across the generations, promising to support your father in exchange for an implicit promise from your children to support you. That way your father gets what he needs to retire (12 percent of your lifetime earnings), while you and your children get what you need (12 percent of the lifetime earnings of successive generations). Everyone shares the cost of supporting the first father, but if anybody stops paying, it is his own father who is left holding the bag. What does this have to do with Bush's Social Security plan? When Bush bemoans Social Security's "2 percent Page 1 of 2 Generation X -- Does Bush Understand His Social Security Plan? 10/31/2011 http://cowles.econ.yale.edu/news/gean/jg_00-10-23_genx.htm