Taking The Plunge

By Daniel Kadlec Eric Roston; Jyoti Thottam

Just two days after the election, President George W. Bush was already teeing up the mother of all political issues, Social Security reform, declaring it a top priority for his second term. In a bold admission, Bush warned that "there are going to be costs." No other President or candidate for the office has been willing to say it so plainly and then tackle the issue head on--even though Social Security's looming insolvency has been apparent for decades. It's a daring gambit on Bush's part, and he can expect a difficult fight. But he has made it clear that he's eager to spend his newfound political capital on Social Security reform. The President sees reforming Social Security as a linchpin in reaching his broader goal of creating an "ownership society."

If he gets his way, Bush's legacy may surpass even his vision. He could literally remake politics, as Roosevelt did with his New Deal, which during the depths of the Depression created a vast web of entitlements that raised Americans' living standards and gave Democrats a lock on Congress for many decades. Bush's ownership society would embrace a new philosophy, shifting to working stiffs the responsibility for spending and investing wisely--and in the process fundamentally changing Americans' relationship with the government. They would own their own risk, essentially, with a direct stake in things like their retirement and health-care dollars. They would be able to watch benefits accrue, knowing the funds could never be snatched away as the result of a policy shift. Bush's Social Security reforms would cement this ownership society, with personal savings accounts, which would allow taxpayers to invest some portion of their Social Security taxes in exchange for reduced payouts. But as a result, Americans would no longer be able to count on a promise they have grown up with--that the next generation will take care of them in their old age.

Not surprisingly, Bush faces daunting arguments against these reforms on multiple fronts--political, social and financial. Personal savings accounts "weaken the system because they dismantle the system," asserts Barbara Kennelly, head of the National Committee to Preserve Social Security and Medicare. "They hurt the economy. They put workers' retirement at risk." Millions of taxpayers in Britain opted into a comparable system in recent years and, amid a poor investment climate, fared worse than those who stuck with the old state-run pension system. The government ended up cutting incentives to shift into private accounts, and unscrupulous financial advisers put many workers in unsuitable investments, leading to new calls for reform and a raft of lawsuits.

Then there's the question of how Bush would pay for the new plan. The current Social Security is a pay-as-you-go system: new deposits from workers fund payments to today's retirees. Launching personal savings accounts would siphon away some of those deposits. The result: a massive near-term shortfall, which the Congressional Budget Office estimates will reach $1 trillion to $2 trillion over 20 years. With the federal budget deficit already stretched to a record $400 billion, the prospect of borrowing any more to establish personal savings accounts leaves Democrats and many economists gasping. "I can tell you they will be walking through a legislative and political minefield," says New York's Charles Rangel, ranking Democrat on the House Ways and Means Committee. Robert Matsui of California, ranking Democrat on the House Ways and Means Subcommittee on Social Security, says, "Unless they have a credible funding mechanism, their proposals don't really exist."

The powerful AARP, a lobby for older Americans, is also lining up opposite Bush, reasoning that private accounts would only drain resources for retirees faster. The group would augment Social Security with investment incentives but sees the current debate as merely delaying a hard-nosed discussion about the program's solvency. And the battle won't necessarily play out strictly along party lines. "There will be a lot of Republican push-back" from those worried about swelling the deficit, says Republican Senator Lindsey Graham of South Carolina, who has introduced a reform bill and says he will spend the holidays working on a funding solution.

In other quarters, the call for action of some kind has grown deafening. With the oldest baby boomers set to retire in 2011, the costs of paying out Social Security benefits will soon swamp tax revenue flowing into the system. As things stand, in 2018 Social Security will start paying out more than it collects, and it will exhaust a $2.3 trillion surplus by 2042. The costs from there only steepen. Economists note that the surplus exists only as a book entry on the government's balance sheet. The reality is that the money has been spent on other programs. To replace the surplus would require more borrowing. Many argue that the only way to fund the future shortfall is by raising the retirement age, cutting benefits or increasing taxes--measures that Bush has ruled out.

Peter Peterson, a former Commerce Secretary turned author and banker, calls the mess "a significant moral issue" because Social Security costs pose "a hidden tax increase on our children and grandchildren." In a speech last August, Federal Reserve Chairman Alan Greenspan pleaded for honest bookkeeping, saying, "As a nation, we owe it to our retirees to promise only the benefits that can be delivered." Jeffrey Immelt, CEO of GE, told TIME that people who oppose change are "sticking their head in the ground." He has no position on personal savings accounts but thinks something must be done. "There are new dimensions to health care," Immelt said. "This program was designed some 70 years ago. The odds of their having gotten it right for 70 years are almost zero."

Bush has in hand a 2001 blue-ribbon President's commission report that concluded that personal accounts can work as part of a long-term fix. The commission's work is expected to be the starting point for reform discussions. A member of the commission, Robert Pozen, CEO of mutual-fund firm MFS Investment Management, says he believes future benefits must be cut to fix the system. He endorses personal savings accounts as "the sugar to get people to accept some slowdown in the growth of benefits." So far, advocates of reform have promised that people near or at retirement age will not be affected by personal savings accounts. Whether the program will be voluntary for others is open to debate.

Personal savings accounts emerged as a Social Security component in academia as far back as the 1950s, but the idea remained dormant until the 1980s, when Ronald Reagan ignited a Republican revolution and the recently formed libertarian think tank the Cato Institute latched onto personal accounts as a free-market fix. Retirement savings, in the free marketeers' view, should be seen as dynamic investments rather than welfare-state safety nets. Indeed, the Cato economists and others concluded that Social Security just wasn't a good investment, based on what taxpayers put in and what they ultimately get out. The President's commission underscored that point, noting that the typical man born in 2000 could expect his Social Security benefits, after inflation, on average to equal less than the 1% annual return on the taxes he paid into the system over his life.

Presumably, private accounts with some assets in the stock market would perform better. But free-market solutions come with free-market problems. What happens if individuals don't invest wisely? Or if the stock market tanks after they retire? Some economists are worried that the plan is especially risky for the two-thirds of seniors who rely on Social Security for their main source of income. "The burden of [cutting benefits] is going to fall on lower- and middle-income households," says Mark Zandi of Economy.com Yet supporters say the dangers could be easily mitigated by allowing investments only in broad stock and bond indexes, which are relatively safe, and by limiting the size of personal savings accounts to a fraction of one's Social Security taxes--say, 2 to 4 percentage points of the 12.4% annual levy.

Advocates of partly privatized Social Security point to a system of personal savings accounts in Chile that is widely regarded as a success. In contrast to Britain's plan, Chile's is compulsory and presents workers with only a handful of conservative, income-oriented investment options. The architect of Chile's plan, Jose Pinera, is now a co-chairman of the Cato Institute's Project on Social Security Choice and has conferred with Bush on the subject.

An overhaul of the Social Security system--in theory welcoming millions of the working class into the investing class--might aid G.O.P. mastermind Karl Rove's plan to fashion a permanent Republican majority. "What does it mean when every truck driver and waitress becomes a stockholder?" asks Michael Tanner, an economist at the Cato Institute and one of the architects of the private-account movement. "You can create inheritable wealth for low-income people and minorities. If you turn those truck drivers and waitresses into stockholders, they vote and behave very differently."

Bush long ago started down this road. During the 2000 campaign, he argued that "ownership in our society should not be an exclusive club. Independence should not be a gated community. Everyone should be part owner in the American Dream." Last year he signed into law health savings accounts, which allow workers to build a kitty that can be rolled over from year to year and can be used to pay for unreimbursed medical expenses. Bush wants to boost homeownership too by making nothing-down loans available to low-income buyers and by helping anyone who is willing to pick up a hammer and contribute sweat equity.

But the funding issue may be an insurmountable obstacle for the President's Social Security ambitions. In the long run, personal savings accounts pay for themselves and then some, because in exchange taxpayers receive reduced traditional benefits. In the short term, though, an already huge federal budget deficit would continue to swell, potentially driving up interest rates and slowing the economy. Even if all parties agreed on the promise of an "ownership society," it remains unclear how we would get there. --With reporting by Eric Roston/ Washington and Jyoti Thottam/New York