SUNDAY NEWS (LANCASTER, PA.)

November 25, 2001, Sunday

SECTION: PERSPECTIVE, Pg. P-1

Patching Social Security's safety net

by William O. Jewett, Special to the Sunday News

President Franklin Roosevelt made a dramatic proposal in the midst of the Great Depression, when I was a teen-ager. It had the overwhelming support of the public and Congress. It became the Social Security Act of 1935.

It seemed to me that most older adults, including my parents, became enraptured by it, probably because most of them had been hard-hit by the Depression. Their enthusiasm rubbed off on me. When I started my first job, I was told that 1 percent of my salary would be deducted as a contribution to Social Security.

I had been conditioned to believe in it, so I was happy to pay. But as time went along, I noticed that my payroll tax had increased from 1 to 4 percent (it's now 6.2 percent). I began to wonder about Social Security.

To my horror, I read many years ago that some actuaries were predicting that the Social Security system would eventually go broke. It has missed my generation, but their predictions are getting closer and closer to reality.

More recently, some of their projections say that the payroll tax (including employers' contributions) will have to be increased in stages by 2020 to 18 percent if nothing is done. Beyond then, things can only get worse.

Social Security must be preserved -- and strengthened for low-income workers. Millions depend heavily on this "safety net" in their retirement years -- some almost entirely. But can it be preserved indefinitely under the present "pay-as-you-go" system? I think not.

President Bush is to be applauded for his initiative to "modernize" the Social Security system, but I disagree with his approach, which he has enunciated in six principles. Four of these concern maintenance of the present structure, with which I agree. The others are: 'Modernization must include individually controlled, voluntary, personal retirement accounts. As applied to a "safety net" program, this is a terrible idea. Many workers, whether through greed, inattention or ignorance, will make poor investment decisions. Furthermore, the cost of maintaining millions of "private accounts" would reduce the overall return by 30 to 40 percent.

'Government must not invest Social Security funds in the stock market.

Why not? As a long-term investment, the total stock market (as opposed to individual stocks or mutual

funds) will produce an average return of about 11 percent per year. Of course, even the total stock

market has its short-term ups and downs, so a reserve must be established to smooth out the bumps.

Instead of the president's proposal, I support a plan by John C. Bogle, founder of the Vanguard Group of mutual funds, who proposes the "creation of a Social Security Retirement Board, which would run a "stock- market index fund" to generate market returns on our Social Security contributions.

The "magic of compound interest" would be so powerful that the market earnings over a 40-year career would far surpass the contributions. Eventually, larger pensions with lower payroll taxes would result.

How do we provide the monies to begin investing in the stock market when virtually all of the payroll taxes paid this month are used to pay next month's pension benefits? The Social Security surplus, which had been growing, could have been used to start the ball rolling, but this option evaporated with the events of September 11.

The only options left are to raise taxes, borrow money or reduce benefits, which would destroy the "safety net" purpose of the plan.

There are no cheap, simple, perfect solutions. Here is one suggestion:

'Establish a new Social Security Trust Fund II (in a true "lock box") into which the payroll tax contributions of new employees would flow after a certain date, say Jan. 1, 2003. Money in this fund would be invested in a stock-market index fund.

'Seed Trust Fund II with a repayment by the Treasury of money "borrowed" over the decades from Trust Fund I. This would necessitate the issuance of "war bonds" and/or a temporary surtax to cover the bond interest cost. The fund would have to be of a size that would produce earnings to replace the diverted contributions of new employees needed for the payment of benefits to current retirees, build reserves that would assure the funding of pensions for the "new" employees, and retire the "seed money" bonds.

'While we are at it, we could increase the eligibility age slightly, use more realistic cost-of-living adjustments and establish minimum pensions for low-income workers.

Over several decades, Trust Fund II would grow exponentially as a result of the high stock-market returns until the system finally becomes "fully funded" like pensions in the private sector. Once this occurs, pensions can be increased and/or payroll taxes reduced.

There will be many short-term market slumps before a satisfactory reserve has been established, in which case the system may sometimes have to increase borrowing to get through the downturn.

It may take two or three generations to get all the way home (absent further increases in the payroll tax), but it can be done if we start soon.

William O. Jewett, a retiree, lives in West Lampeter Township.