CRS Report for Congress
Social Security Reform: The Issue of Individual
Versus Collective Investment for Retirement
June 2, 2000
David Stuart Koitz
Specialist in Social Legislation
Domestic Social Policy Division

Congressional Research Service ˜ The Library of Congress

Social Security Reform: The Issue of Individual Versus
Collective Investment for Retirement
Of the many issues raised in the current Social Security debate, perhaps none is
more complex than whether and how the nation’s financial markets might be used to
reform the system. In its simplest form, the question of how it might be done has
brought attention to two possible approaches: (1) having individuals invest some or
all of their Social Security contributions directly in the markets or (2) having a
government appointed entity invest some of them in the markets for the Social
Security trust funds. The current system is a collective one; its resources are shared
in the sense that it does not set aside a person’s Social Security taxes for his or her
own use. Social Security benefits are based instead on a person’s “average” earnings
and most of a person’s taxes are used to pay the benefits of today’s recipients. Any
surplus is recorded to the trust funds for the potential future benefit of all recipients.
Proponents of a more individualized system of personal accounts say that taking
people’s money and using it to pay for someone else’s benefits is unfair. They argue
that it would be better if people invested some or all of their own money for their own
retirement. In this way, they contend, people would feel they had gotten what they
paid for based on their own decisions. If they want to take more risks, they should
be able to. If they want to be more cautious, they could do that too. Simply stated,
individual account proponents argue that people should have more choices.
Proponents of the current system say that it protects society, as much as the
individual, against poverty. They argue that in the absence of Social Security,
widespread destitution would exist among the aged and disabled. They do not dispute
the claim that people should be able to choose how to save and invest, but through
their personal savings and private pensions, not through Social Security.
Elements of both camps say that investing in the financial markets can help make
the nation’s retirement system more secure. Proponents of the current system who
do so (recognizing that not all do) contend that the higher yield from investing a
portion of the trust funds in the markets could help reduce the system’s long-term
funding problem. Proponents of personal accounts generally distrust the government
to invest without interfering with private enterprise and would prefer that people
grow their own accounts to supplement Social Security, perhaps allowing future
Social Security benefits to be constrained enough to make the system solvent. While
shoring up the system is the catalyst for discussion, much of the debate emanates from
a philosophical conflict about how much the government needs to be involved in
securing retirements. Proponents of the current system argue that to adopt a more
individualized system, where how well one invests becomes critical to one’s
retirement well being, would be too big a risk for many of society’s economically
vulnerable people. They see the current program as a necessary role for government
in assuring a minimal standard of retirement income. Others contend that society has
changed and is much more capable today than in the 1930s of sustaining a system that
does not rely on a mandated transfer of income from workers to recipients. They
argue that given adequate incentives, perhaps even a mandate, people could
effectively save the same Social Security tax dollars on their own, possibly achieving
greater economic returns than afforded by a politically-driven, governmental system.

Overview of the Issue........................................1
The Case for Collective Investment..............................5
The Case for Individualized Accounts...........................17

Social Security Reform: The Issue of Individual
Versus Collective Investment for Retirement
Overview of the Issue
While a myriad of issues have been raised in the current Social Security debate,
perhaps none is more complex than the question of whether and how the nation’s
financial markets might be used to reform the system. In its simplest form, the
question of how it might be done has brought attention to two possible approaches:
(1) allowing or requiring individuals to invest some or all of their Social Security
contributions directly in the markets or (2) having the government or some quasi-
government entity invest them for the collective good of all recipients.
The issue may sound academic, but it’s not. At its core, it is not about how
retirement investments are made or what the investments are. It is about who bears
responsibility for the decisions that are made. It is about individual versus collective
preparation for retirement. Who makes the investments? Who bears the risks? Who
reaps the rewards? Individuals or society in general?
The current Social Security system is a collective one; its resources are shared
broadly amongst those who are “insured.” Since participation in the system is
mandatory, “insured” means most people who work. Its purpose is to minimize the
risks of destitution in old age or because of disability for all who participate as well
as their dependents. Its resources are shared in the sense that it does not set aside a
person’s Social Security taxes for his or her own use. Instead, those taxes are pooled
for the collective use of all recipients. Simply stated, there is no savings account to
which the taxes that each individual pays are credited. The Social Security
Administration keeps a record only of a person’s earnings, not of his or her taxes.
Moreover, the amount a person pays does not determine how much he or she
receives; Social Security benefits are based instead on an “average” of a person’s
career earnings and the formula used is deliberately tilted to favor low lifetime
earners.1 Most of a person’s Social Security taxes are used to pay the benefits of
today’s recipients. Any surplus is recorded to the Social Security trust funds for the

1 Benefits are computed by applying a three-step formula to a worker’s “average indexed
monthly earnings” (AIME) calculated using as many as 35 years’ worth of earnings. For
workers reaching age 62 in 2000, monthly benefits are the sum of 90% of the first $531 of
AIME, 32% of the next $3,202, and 15% of the remainder. Both the earnings used to
compute the worker’s AIME and the so-called “bend points” in the benefit formula (“$531"
and “$3,202") are indexed to reflect growth in average wages in the economy. For retirees,
each year’s earnings are indexed from the year they were earned to the year the worker
reaches age 60 (earnings at age 60 and beyond are included in the calculation at their nominal

potential future benefit of all Social Security recipients.2 And perhaps most pertinent
to this discussion, neither the individual nor the trust funds’ account manager (who
by law is the Secretary of the Treasury) makes investment decisions about what to do3
with Social Security funds.
Proponents of a more individualized system say that the current system is unfair
– that it takes people’s money and uses it to pay for someone else’s benefits. They
argue that it would be better if people invested some or all of their own money for
their own retirement. In this way, they contend, people would feel they had gotten
what they paid for based on their own decisions about how to prepare for retirement.
If they want to take more risks, they should be able to. If they want to be more
cautious, they could do that too. Simply stated, proponents of a more individualized
system argue that people should have more choices.
Proponents of the current system say that it serves social purposes as much as
those of the individual – that it protects society, as much as the individual, against
poverty. They argue that in the absence of Social Security, widespread destitution
and income disparity would exist among the aged and disabled, the cost of which
would have to be borne by society in some way – through higher welfare spending,
higher governmental spending on social and health services, less tax revenue, and
other adverse social effects. They do not dispute the claim that people should have
investment choices, but contend that the current system should continue as a

2 The costs of the Social Security program, both its benefits and administrative expenses, are
financed by a tax on wages and self-employment income. Commonly referred to as FICA and
SECA taxes (because they are levied under the Federal Insurance Contributions and Self-
Employment Contributions Acts), these taxes flow each day into thousands of depository
accounts maintained by the government with financial institutions across the country. Along
with many other forms of revenues, these Social Security taxes become part of the
government’s operating cash pool, or what is more commonly referred to as the U.S.
Treasury. In effect, once these taxes are received, they become indistinguishable from other
monies the government takes in. They are accounted for separately through the issuance of
federal securities to the Social Security trust funds — which basically involves a series of
bookkeeping entries by the Treasury Department — but the trust funds themselves do not hold
money. They are simply accounts. Similarly, benefits are not paid from the trust funds, but
from the treasury. As the checks are paid, securities of an equivalent value are “written off”
the trust funds.
3 The Secretary of the Treasury basically follows a passive investment policy under which the
management of the federal securities acquired and held by the trust funds is dictated by an
administrative process that does not involve the Secretary in buying and selling securities in
the financial markets. The process is largely an “in-house” operation. The Secretary does
have authority to buy and sell federal securities in the open markets on behalf of the trust
funds, but since the program’s inception has rarely done so. The implied policy is that such
action would be taken only to stabilize the markets. The Secretary also has authority to buy
and sell other securities for the trust funds that are guaranteed “as to both principal and
interest.” In the past, the trust funds have held such securities in the form of obligations of
the Federal National Mortgage Association, Government National Mortgage Association, and
Federal Home Loan Bank Board.

“bedrock” of protection against the “vicissitudes of life.”4 They argue that people can
still make choices, but through their personal savings and private pensions, not
through Social Security, which should provide a foundation of economic security.
Elements of both camps say investments in the nation’s financial markets can
help make the system more secure. Although the system’s income currently exceeds
its outgo, Social Security’s current board of trustees projects that over the next 75
years the system’s expenditures will exceed its income by 14% on average and by
2037 its trust funds will be depleted.5 At that point its ongoing receipts would be
sufficient to cover only 72% of its benefit commitments. By the end of the 75-year
period, its expenditures would exceed its income by nearly 46%. Proponents of
current system who support collective investment – i.e., who support investing a
portion of the Social Security trust funds in the markets – contend that the higher
yield to the funds from doing so could eliminate some or all of this problem without
modifying the basic structure of “assured” support. Proponents of individualized
investment distrust the government to invest without intruding into the investment
process and private enterprise and would prefer that individuals grow accounts on
their own that would provide a supplement to Social Security, perhaps allowing future
Social Security benefits to be constrained enough to eventually balance the system’s6
income and outgo.
While shoring up the system is the catalyst for discussion, much of the debate
emanates from a philosophical conflict about how much the government needs to be
involved in securing workers’ retirement incomes. In the 1930s, when Social Security
was established, the condition of society was much different from circumstances

4 In signing the original Social Security legislation, the Social Security Act of 1935 (P.L.
271–74th Congress) on August 14, 1935, President Franklin Roosevelt described the concept
in this way: “We can never insure one hundred percent of the population against one
hundred percent of the hazards and vicissitudes of life, but we have tried to frame a law
which will give some measure of protection to the average citizen and to his family against
the loss of a job and against poverty-ridden old age.”
5 The Social Security Board of Trustees, comprised of three members of the President’s
Cabinet, the Commissioner of Social Security, and two members representing the public at
large, annually projects the long-range financial condition of the Social Security system.
Traditionally, the Board uses a valuation period extending 75 years into the future. Although
the measure of solvency was refined in 1991 to encompass shorter and more recent periods
of valuation, generally long-range solvency — or what is technically referred to as “close
actuarial balance” — is assumed to exist if the system’s average income over the 75-year
period as a whole is projected to be within 95% of its average costs. See 2000 Annual Report
of the Board of Trustees of the Old Age, Survivors, and Disability Insurance Trust Funds,
Government Printing Office, Washington, D.C., March 30, 2000.
6 Not all proponents of the current system support using the financial markets to help shore
up the system. Vice President Al Gore, for instance, supports using current federal budget
surpluses to reduce outstanding government debt and crediting the Social Security trust funds
with a portion of the interest savings – the crediting would be only in the form of federal
securities as is the practice today. Although not yet proposing or endorsing a specific reform
plan, Presidential candidate George W. Bush has stated that he favors allowing people to use
some of their Social Security taxes to create individual accounts that could be invested in the
financial markets.

today. The country was just emerging from a depression, unemployment was high,
and poverty was widespread. In the aggregate, the nation is much wealthier today.
In 1935, the unemployment rate stood at 20%, down from 25% in 1933. For much
of 1999, it was under 4.5%. Disposable per capita income (adjusted for inflation) is
more than four times higher now. Average earnings, similarly adjusted, are 2.3 times
the 1937 level. By some estimates, in the early 1930s more than half of the elderly
were in a state of economic dependency. In 1998, the overall poverty rate for people
age 65 and older was 10.5% – lower than the rate for the total U.S. population.
While much of the drop can be attributed to Social Security, 63% of the elderly had
income in 1996 from personal assets, and 41%, from other pensions. Almost half of
employed workers over age 15 today have employer-provided pension coverage; 62%
of full-time, year-round workers age 25-54 have it. Some 41% of households own
stock; 43% have IRAs, Keogh plans, or other tax-favored savings arrangements; 31%
have life insurance; 23% own savings bonds; and 65% own their own homes with an
even a higher percentage, between 70% and 80%, for the elderly. While these figures
show gaps as well as economic advancement, they raise the question of whether the
program established in the 1930s is the program needed for the 21st century, and,
specifically, whether the societal “floor” that Social Security affords today’s retirees
needs to be as large and extensive in the future as was assumed necessary in the past.
Those who advocate for the current system argue that while economic conditions
have improved, Social Security still fulfills much of its original purpose. When the
system was created, its role was generally viewed as earnings replacement, not wealth
accumulation. It was a response to the dire economic conditions of the early 1930s,
and its proponents saw it as an eventual means of keeping a large segment of the
workforce from slipping into poverty in old age. It was to provide a lasting “floor of
protection,” a means of affording the nation’s workers with at least a minimal income7
during retirement without having to rely on welfare. While, on the whole, the elderly
are much better off today — in many respects, they have achieved economic well-
being equal to or greater than the non-elderly — Social Security remains the dominant
source of their retirement income. All other things held constant, Social Security
lifted some 41% of the elderly out of poverty in 1996. Certainly for some, it simply
adds to their wealth, augmenting an already ample income from other sources.

7 Reinhart A. Hohaus, an actuary with the Metropolitan Life Insurance Company and a
member of two of the earliest Social Security Advisory Councils wrote in 1938 that: “Social
insurance ... aims primarily at providing society with some protection against one or more
major hazards which are sufficiently widespread throughout the population and far-
reaching in effect to become ‘social’ in scope and complexion. Usually these risks are not
many in number. Yet, if not guarded against by some organized means, they produce large
dependency problems that take their toll in terms not only of financial but of human values
as well. Directed against a dependency problem, social insurance is generally compulsory
– not voluntary – giving the individual for whom it is intended no choice as to membership.
Nor can he as a rule select the kind and amount of protection or the price to be paid for all
... Indeed, social insurance views society as a whole and deals with the individual only as
so far as he constitutes one small element of that whole. Consistent with this philosophy,
its first objective in the matter of benefits should, therefore, be that those covered by it will,
so far as possible, be assured of that minimum income which in most cases will prevent their
becoming a charge of society ...” (From Reinhart A. Hohaus, Equity, Adequacy and Related
Factors in Old-Age Security. The Record, v. 37, American Institute of Actuaries, 1938).

However, the elderly are economically diverse. While only 4% of aged married
couples had incomes below the poverty line in 1996, the figure for single men was
13%, and for single women, 20%. To the extent that Census Bureau surveys
accurately reflect the elderly’s well-being, Social Security accounted for 40% of the
aggregate income of the population 65 and older. As such, it was their largest single
source of income, with earnings from work, pensions, and asset income running a
distant second, third, and fourth. For 66%, Social Security represented more than
half of their income; for one-third of Social Security recipients, it represented 90% of
their income; and for 18%, it represented 100%.
Calling it the nation’s most successful social program, advocates of the current
system seek to preserve its so-called safety net features and want its benefit provisions
held constant to the maximum extent possible. They contend that to adopt a more
individualized system, where how well one invests becomes critical to a worker’s
eventual retirement well being, would be too big a risk for too many of the most
economically vulnerable in society. They see the current program as filling a
necessary role for government arguing that it would be too difficult for too many to
successfully navigate personal investments into an adequate retirement income.
Others, however, contend that society has changed; that its large “middle class”
is much more capable today than in the 1930s of participating in a retirement
investment system that does not rely on the government and that doesn’t have at its
roots a mandated transfer of income from workers to the aged and disabled. They
argue that Social Security perpetuates itself as the dominant source of retirement
income because people have become too dependent on it. They argue that employers,
workers, and the nation’s infrastructure of financial and investment institutions have
evolved to the point where provision of a retirement safety net no longer needs to be
as large a governmental function as it is today. They argue that given adequate
incentives and governmental encouragement, perhaps even a mandate, people would
be able to use the same Social Security tax dollars to save effectively for retirement
on their own, possibly achieving greater returns and economic well-being than
afforded by a politically-driven, governmental system.
The Case for Collective Investment
The investment process used by the current Social Security system is a collective
one, meaning that it is for the benefit of Social Security recipients overall, not any one
recipient. Social Security taxes go into the U.S. treasury and two Social Security8
trust funds are credited with federal securities. There is no segmenting of these trust

8 The Social Security tax rate is divided into three components under the law. One is for the
Old Age and Survivors (OASI) part of the Social Security system; the second is for the
Disability Insurance (DI) part; and the third is for the Hospital Insurance (HI) part of the
Medicare program. The combined rate of tax for the three parts, paid by employees and
employers, is 15.3% – 10.6 percentage points are credited to the OASI trust fund, 1.8
percentage points are credited to the DI trust fund; and 2.9 percentage points are credited to
the HI trust fund (employees and employers each pay half of these rates on the earnings of the
employee). In 2000, the OASI and DI portions are levied on earnings up to $76,200 (indexed

funds into separate accounts for each taxpayer, and no person’s Social Security
record is credited or in any other way affected by the payment of these taxes. As with
income taxes and other levies the government takes in, Social Security tax dollars are
commingled in the treasury for general use, not for any one individual. An
individual’s Social Security record reflects only the earnings and wages on which his
or her taxes were levied.9 The benefits a recipient receives are not based on the taxes
he or she paid as they would be in an IRA or 401(k)-type account, but on a record of
those earnings averaged over much of the person’s working years. A formula is
applied to that average and a benefit is then derived. That benefit is paid from the
treasury and the balance of the Social Security trust funds is reduced accordingly. In
most months, the aggregate benefit outgo to all recipients is relatively close to the10
aggregate income received from all taxpayers.
Since the money is commingled, any excess Social Security cash the government
receives is used for any of the government’s many other functions. The trust funds11
are then given a higher level of federal securities to reflect the excess. The securities
represent the investments of the trust funds, which are limited by law to U.S.
government or government-backed securities.12 The range of investment options has
been deliberately limited to federal securities since the inception of the program. And
even with this constricted practice, the Treasury Department has rarely been a market
player.13 Instead of going into the markets to buy and sell federal securities, the

8 (...continued)
thereafter to wage growth). The HI portion is levied on all earnings. Approximately 67% of
aggregate Social Security tax receipts are currently credited to the OASI fund; 11% are
credited to the DI fund; and 22% are credited to the HI fund.
9 A worker’s Social Security record is credited with earnings derived from the annual
submission to the government of W-2 information by employers and Schedule SE’s from the
self employed. This action occurs totally independently of FICA and SECA taxes being
withheld and deposited in the treasury. The Social Security record does not, nor is there any
need for benefit or eligibility purposes, reflect whether and how much tax a worker actually
10 In the year 2000, tax income credited to the system is estimated by the trustees at $501
billion; expenditures are estimated at $410 billion. In effect, 82% of the system’s current
income goes to meet current expenditures. Tax income is projected to fall below expenditures
in 2015 and remain so indefinitely thereafter.
11 It should be understood that the commingling of funds is no different than that practiced by
any large financial institution. The treasury, in this case, operates as a cash management
device. As in a bank, the depositor’s money doesn’t sit idle for the subsequent use of the
depositor; it is put to work by the bank to make loans or to meet the other immediate cash
needs of the bank. The depositor’s account is credited, and when subsequently drawn upon,
the bank makes good using whatever funds it has available from the cash it has on hand.
12 Section 201(d) of the Social Security Act states that “Such investments may be made only
in interest-bearing obligations of the United States or in obligations guaranteed as to both
principal and interest by the United States.”
13 Section 201(d) allows the Secretary to purchase “interest-bearing obligations of the United
States or obligations guaranteed as to both principal and interest by the United States, on

Treasury Department issues and redeems special non-marketable securities directly
to and from the trust funds (what is basically an internal bookkeeping practice),
securities that bear an approximation of current market interest rates but whose14
principal does not fluctuate with changing market conditions. As such, the
investments of the trust funds merely mimic the market in federal securities – the
purpose being not to interfere with the market nor to advantage or disadvantage the
Social Security trust funds. As a practical matter, the trust funds represent an
authority to spend, operating more or less like a large checking account for the
recipient population as a whole – meaning that as long as there are federal securities
posted to them, the Treasury Department has “legal authority” and is required by law
to issue benefit checks to recipients.
Perhaps the most important distinction is that these trust fund investments do not
enhance an individual’s Social Security benefits. In fact, it is largely irrelevant to the
individual what the trust fund investments earn since the investments are not
earmarked for any single person. If the trust fund balances rise or fall more than
expected, it does not affect the level of individual Social Security payments. It is only
the individual’s earnings history, the benefit formula, and the related benefit
computation rules in the law that will affect the benefit amount. Except in a relatively
abstract sense, the individual has no stake in the investment outcome of the system
(obviously, there would be an effect if the system were unable to finance his or her
benefits because of an inadequate income stream).
A number of proposals have emerged over the past few years calling for a more
expansive investment policy. Among them is a plan proposed by President Clinton
that calls for investing a portion of the trust funds in the financial markets. The belief
is that an actively managed fund that took advantage of investment yields from stocks
and corporate bonds would raise the income of the Social Security trust funds. This
was part of the President’s January 1999 plan to credit the funds with a portion of the
projected federal budget surpluses, some $2.8 trillion worth over the next 15 years,
and use a portion of this amount to buy stocks. It was similarly reflected in his latest
plan (January of 2000) to credit the funds with the interest savings resulting from

13 (...continued)
original issue or at the market price, only where he determines that the purchase of such
other obligations is in the public interest.” The Treasury’s long-held view is that it will
obtain or issue marketable securities to the trust funds only if there is some reason of
overriding national policy. As a matter of practice, the Secretary of the treasury has made
such judgments sparingly and confined the acquisition of marketables for the trust funds to
meet a perceived need to stabilize a particular market (not the general market in federal
securities), most notably when prices were falling or in need of support.
14 The value of these securities upon issuance – i.e., their “par” value – never changes. They
are always recorded on the trust funds at their par value regardless of market conditions. As
such, they are referred to as “special issues.” The only thing that varies with market
conditions is the interest rates assigned to them. Section 201(d) of the Act states that these
bonds “shall bear interest at a rate equal to the average market yield (computed by the
managing trustee [the Secretary of the Treasury] on the basis of market quotations as of the
end of the calendar month next preceding the date of such issue) on all marketable interest-
bearing obligations of the United States then forming a part of the public debt which are not
due or callable until after the expiration of 4 years from the end of such month ...”

reduction of publicly-held federal debt engendered by his plan in the form of stocks.15
The same theme can be found in one of three alternative proposals suggested in a

1994-1996 Social Security Advisory Council report (the so-called “maintain benefits”

plan), which would have kept the system’s benefit structure essentially intact by
addressing most of the long-range problem with revenue increases (including an
eventual rise in the payroll tax) and minor benefit cuts. To close the remaining gap,
its proponents suggested that Congress consider authorizing investment of up to 40%16
of the Social Security trust funds in the stock market. It also is reflected in H.R. 633
and H.R. 990 (Bartlett), H.R. 871 (Markey), H.R. 1043 (Nadler), and H.R. 2717
(DeFazio) in the 106th Congress, H.R. 336 (Solomon) in the 105th Congress, and to
proposals of former Social Security commissioner, Robert Ball, and Brookings
Institution economists, Henry Aaron and Robert Reischauer. Most call for creation
of an independent or quasi-government board to manage the funds.
Foremost among the
Proponents of collectivearguments for a more expansive
investment argue that a moreinvestment policy is that it could
expansive trust fund investmentlessen the need for tax increasesor benefit cuts to restore the
policy could lessen the need forSocial Security system’s long-
eventual tax increases andrange solvency. Based on
spending cuts to shore up thehistorical average investmentreturns from stocks and
system.corporate bonds, the Office of
the Actuary of the Social
Security Administration has
consistently projected higher investment income from proposals that would invest a17
portion of the trust funds in the financial markets. With Congress having tried twice

15 His January 1999 plan called for crediting the trust funds with $2.8 trillion worth of $4.9
trillion in projected federal budget surpluses over the next 15 years, and using 21% of such
amounts to buy stocks ($.6 trillion). A revised plan he announced in June 1999 called for
crediting the funds with the interest savings resulting from using Social Security surpluses to
reduce publicly-held federal debt in the form of stocks until the stock portion of the overall
trust fund holdings reached 15%. In a draft bill sent to Congress on October 26, 1999,
subsequently introduced as H.R. 3165 (Gephardt), S. 1828 (Moynihan), and S. 1831
(Daschle), he dropped this part of the plan. The trust fund infusions were, instead, all to be
in the same form as today’s trust fund holdings, special non-marketable federal securities.
However, in his Budget for FY2001, he proposed partial stock investment again, in the same
form as his June 1999 plan. The new trust fund infusions would begin in FY2011. The
Social Security Administration’s actuaries estimated that they would range from $98.7 billion
in FY2011 to $204.9 billion in 2016 and thereafter (with all such infusions ending in 2050),
and that plan would extend the life of the system until 2054.
16 See Social Security Administration. Report of the 1994-1996 Advisory Council on Social
Security, Washington, January, 1997.
17 In making long-range projections of the impact of various Social Security reform plans
considered by the 1994-1996 Advisory Council, the Office of the Actuary relied on analysis
of Joel M. Dickson of the Vanguard Group, Inc., which indicated that the real yield on stock

in the past 25 years to shore up the system with incremental tax increases and benefit
constraints, the system’s defenders are somewhat wary of doing so again. While
acknowledging that some such actions may be necessary, from a political perspective,
they consider none of them good. The message such changes send is that “you again
need to pay more taxes for less benefits.”18 While the purpose – i.e., achieving
solvency – may have a “positive” ring, another round of tax increases or spending cuts
may be met with considerable doubt. Thus, to the extent the status quo can be
maintained by a showing of higher potential investment income, options are avoided
that could further sap public confidence.19
An underlying objective of this approach is to preserve the social nature of the
system, which its defenders view as setting it apart from other means of retirement
saving. From their perspective, it provides society with insurance against poverty.
No other system, with the exception of welfare programs, attempts to assure the
elderly as a group of a minimal retirement income. Unlike an employer pension plan,
Social Security provides lower wage earners with a greater return on their Social
Security taxes than it does for higher wage earners, and it pays extra benefits if a
worker has dependents, including a dependent spouse. While benefits are indirectly
related to the payment of “payroll” taxes, the “earned right” notion embedded in
Social Security is not complete – not exact. Supporters feel, however, that the flavor
it carries of being an “earned right” that is paid for has been a strong basis for the
public’s general support of the system. If taxes were to rise too much, they fear
public support could be eroded by perceptions that people were not getting their
moneys worth – that they are paying too much for too little return. Or conversely,

17 (...continued)
(i.e., discounting inflation) averaged approximately 7% annually from 1900 to 1995. This
was greatly in excess of the projected 2.3% real annual yield assumed at that time for
continued trust fund investment in government bonds. Since that time, in analysis of
numerous alternative proposals, the actuaries have continued to project a higher yield on
stocks than government bonds, albeit projecting a higher real return on bonds in the latest
Social Security trustees’ report, i.e., 3% annually, than in 1995. Although there also has been
some recent debate about methodology and technical adjustments that might justify a projected
return on stocks of say 6% or 6.5% annually (see for instance, November 1999 Report of
Technical Panel on Assumptions and Methods of the Social Security Advisory Board), the
actuaries continue to reflect a substantial “premium” for investments in stock over the current
investment practices employed for the trust funds.
18 Major reform packages enacted in 1977, during the Carter Administration (P.L. 95-216),
and in 1983, during the Reagan Administration (P.L. 98-21), included various combinations
of tax increases and spending constraints, including payroll tax hikes, partial income taxation
of Social Security benefits, a revised benefit formula, phasing-in of higher ages for receipt for
full benefits, a delay in cost-of-living adjustments, and mandatory coverage of employees of
the federal government and non-profit organizations.
19 It should be understood that just because the actuaries project a higher return from stocks
and bonds, it does not necessarily mean that it is likely. The actuary’s basically are looking
at past performance of the markets for guidance in making projections. They are no more able
to project future returns than any other forecasters in the securities business. As stated in all
mutual fund prospectuses, past returns on investment are not a predictor of future
performance, and the future is as uncertain for the actuaries as it is for any other forecaster
of economic events.

if benefits were to fall significantly, the safety net features of the system would be
diminished. They fear that the result of turning Social Security into an individualized
system would be that the most economically vulnerable and unfortunate would be
forced to rely on welfare-type programs, and that welfare programs do not fare well
in the allocation of public resources. Ultimately, they fear a greater disparity of
wealth among the aged and disabled – an economic phenomena that already is
evolving in society as a whole as the very well off get richer while lower and middle
income segments see little or only modest economic improvement. While Social
Security may be an inefficient income-transfer program, they see it as a hedge against
rising income disparities and as an effective means of keeping a major segment of the
aged and disabled out of poverty without the trappings, denigration, and public
distaste of welfare programs.
In a political sense,
Arguing that if the markets canpromoting an expansive
be used to enhance the wealth ofinvestment policy takesadvantage of an idea that the
individuals, collective investmentsystem’s advocates would not
proponents ask “why can’t theyotherwise be expected to
be used to increase the return forpursue – i.e., they would notinstinctively seek to make use
the Social Security system?”of the financial markets.
Calling for such has been a
mantra of those seeking to
individualize or “privatize” Social Security. Proponents of an individualized account
system have argued for years for use of the investment potential of the markets to
power a system that does not rely on taxes and the government. The system’s
defenders attempt to co-opt the issue by arguing that if the markets can be used to
enhance the wealth of individuals, why can’t they be used to increase the return for
the Social Security system? In a sense, their approach is to share the advantages of
markets with the group as a whole.
They recognize that the public has misgivings about having the government
invest in private businesses and that policymakers have resisted such a practice, but
they contend that an effective means can be established to insulate the trust funds (and
therefore the nation’s businesses) from political influence and manipulation. They
advocate creation of a quasi-government investment board or entity to manage the
funds, similar to that used for the Federal Employees Thrift Savings Plan, with
perhaps the independence and stature of the Federal Reserve Board. To avoid
preference being shown for one industry or company over another, they recommend
the use of market index funds.20 They contend that state and local governments have
engaged in market investments on behalf of their pension systems for years without
adversely affecting the returns those funds earn nor exercising undue influence on the
businesses they invest in.

20 These are mutual funds or related financial instruments whose holdings represent the stock
of companies who make up one or another of the stock market’s composite indices, such as
the S&P 500. These funds attempt to mirror the performance of the particular index involved.

Much of the appeal of
Those pursuing marketindividual accounts emanates
from the dramatic gains seen
investment of the trust fundsover the past two decades in
contend that doing so dispersesstock indices such as the Dow
risks inherent in an individualizedJones Industrial average and the
Standard and Poor’s 500 (S&P
account system.500). Moreover, the
proliferation of 401(k) plans and
other employment-based
individual account arrangements has demonstrated the popularity and workability of
an individualized retirement savings system. However, individual accounts do put the
risk of adverse market performance on the individual, not the employer or the
government. The Social Security system’s defenders argue that the tendency to look
at averages of past market performance and deduce that individuals can achieve those
results indefinitely in the future oversimplifies the complexity of investing and
minimizes the effects of individual responses to risk and expanded choices. Markets
are volatile and do not always go up. Moreover, they don’t have a predictable pattern
and investors’ timing may be off. Simply stated, when they enter and exit the markets
is important. The Dow Jones Industrial average has risen 10-fold from 1983 to the
present, but it began and ended the preceding15-year period at the same level.
Individuals also may suffer from the choices they make (assuming individual stock
choices were to be permissible under a reform arrangement). Even within a generally
up-trending market, there are always sectors that do poorly. And studies of 401(k)
behavior show that a large number of people who participate have invested far too
conservatively, undercutting the potential of long-term compounding of market
returns and tax deferrals.
If annuitization is mandated, the value of the account will be fixed at the point
of retirement even if the account accumulation has been eroded by a temporary
downturn in the market. Critics also contend that the potential market returns that
individual account proponents cite ignore the potential costs of annuitization. Annuity
providers assume the risk of under-estimating longevity and changes in interest rates.
They, therefore, exact a price from annuity purchasers for assuming that risk as well
as for the administrative and marketing expenses they incur. Critics contend that
these costs can be large and significantly erode the “net” returns achievable through
individual investment accounts.
In contrast to these approaches, proponents of collective investment point out
that it not only shares the market’s gains but disperses its adversities. By protecting
the individual from volatility, Social Security takes an element of fear and uncertainty
out of retirement. A Social Security portfolio of marketable securities might drop
during an adverse period, but the amount of an individual’s benefits would be
unaffected. They contend that just like the gains, the losses would be absorbed by the
system as a whole.

Proponents of collective
Proponents of collectiveinvestment also argue that it is
investment contend that it haslikely to carry economies-of-
built in economies of scale notscale not achievable in anindividualized account system.
achievable under a system ofIn an individualized system,
individual accounts.millions of investors could
potentially make millions of
trades daily, each with some
form of transaction charge (i.e., broker commission). Under a collective approach,
stocks and bonds would be purchased in large blocks, presumably at a lower per unit
cost, by fund managers with more investment expertise than most individuals would
be expected to have. In effect, in a system of collective investment, society would
reap the benefits of the markets without much of the “transaction” costs that
individuals would incur. Supporters of individual accounts counter that the use of a
limited number of investment companies and investing only through market “index”
funds could mitigate such costs, but supporters of collective investment contend that
even these changes could not match the “institutional” savings inherent in a collective
approach. Less transaction costs would result not only from buying and selling in
large blocks, but from less trading and churning of the markets. Under an
individualized system, each account holder would have a stake in the outcome and
thus potentially would become a market player. As such, they would likely trigger
considerably more turnover of assets than if an equivalent amount of funds were
collectively invested. A manager, investing in a particular sector on behalf of the
Social Security trust funds, might buy 10 stocks a month. Individuals wanting to do
the same might collectively drive millions of “buy” orders and sell them sooner than
experienced stock managers, who would be expected to be more deliberative and
disciplined in their approach and longer term in perspective.
A collective approach also would avoid the creation of sales and marketing
costs, as well as employee (investor) educational expenses. In effect, society would
avoid a whole layer of business activity designed to attract and educate millions of
individual investors. Supporters of collective investment view these as “dead” costs,
as dollars that could be more effectively employed as investments if a single board or
quasi-governmental entity were responsible rather than millions of account holders
funneling money into the markets through numerous investment companies. In other
countries, where individualized systems were adopted, marketing expenses intended
to attract individual account holders to specific investment companies are alleged to
have detracted heavily from the potential returns. Moreover, educating the workforce
to become savvy investors would create an expensive societal overhead cost.
Someone would have to pay – the employer, the investment company, and perhaps
the government. If paid by the employer, less contributions would be made to the
individual’s account or some other aspect of employee compensation would be
reduced (i.e., be less than it otherwise would be). If paid by the investment company,
the return on investment would be eroded. If paid by the government, the tax burden
would be higher. There would be no free lunch. People would have to become
educated investors, and someone would have to pay for that education. Proponents
of collective investment contend that these costs are not minor – that they would put
a substantial drag on the “true” returns people would be able to achieve in an
individualized system.

An individualized system
Those wanting to strengthen thealso would be expected to add a
current system through collectivenew dimension of complexity to
investment feel that it avoids thepeople’s lives. The simplestmanifestation of this effect is in
inherent complexities andthe increased record keeping it
anxieties of growing individualwould dictate – for the
accounts.employer, employee, accountmanager, and the investment
company making the market
transactions. Even in an era of
advanced automation, more accounting also means more errors. At any stage of
human involvement, a mistake can be made. Errors are time consuming and
expensive to fix since corrections are not usually subject to automation. Social
Security now has a relatively low error rate. Simply stated, an individualized system
by definition requires more attention. Moreover, critics of an individualized system
contend that attentiveness to the process does not assure better outcomes. Too much
attention could lead to too much market churning. In an exaggerated sense,
individualized accounts could turn the nation’s workers into a “society of market
players” with all the potential trappings of obsessive attention to the vagaries of
market behavior. More choice also means more complexity in people’s lives, with the
likelihood of increased anxiety about and during retirement. In effect, there could be
psychological costs for society as a whole. In addition, while it is likely that people
generally would become better investors, they would be diverted to some undefined
extent from other potentially more productive facets of their lives.
Economists generally are
Some economists argue that aagreed that to the extent the
collective investment approachnation can save at a higher rate
potentially avoids or lessensin the coming years, thepotential demographic strains
savings “leakages” that wouldimposed by the baby boomers’
arise under an individualizedretirement and the gradual aging
of society could be more easily
system.accommodated. Some express
a cautious note about
converting Social Security into
an individualized system, pointing out that because a large number of people save
today on their own, creation of a new savings system might cause them to reduce the
savings they already do through other means. As people see their new accounts
grow, they might ask themselves why they need to save as much elsewhere, such as
in their 401(k)s or IRAs. To the extent they reduce those other savings, national
savings are less. Simply stated, critics of individual accounts contend that they are
likely to cause “leakages” in the nation’s savings system. They argue that collectively
investing a portion of the Social Security trust funds would have fewer such effects.
Individuals would not see the accumulation of wealth through new individual
accounts, and to the extent they do not see any obvious changes in their potential
Social Security benefits, they would be less inclined to alter their other savings
behavior. Hence, advocates of collectively investing a given sum of Social Security

dollars argue that doing so would have a greater positive economic impact on the
whole than the same amount invested in individual accounts.
Advocates of collective
Others contend that collectivelyinvestment contend that
investing through Social Securityindividualized accounts might
potentially avoids pressures tocreate other types of savings“leakages” as well – namely
make alternative use of moniesconsumption of the accumulated
intended for retirement.sums before retirement. Social
Security allows for the pre-
retirement payment of benefits
only for disability or death. The exclusivity of these non-retirement uses has held up
for 60 years. Critics of individualized accounts contend that the assets that would
build up in them – even if intended for retirement purposes – are likely to be eroded
by demands to make them available for other non-retirement purposes. They believe
that demands for early liquidation for a variety of life’s needs would become too
strong and eventually the political process would succumb. Other existing tax-
deferred savings vehicles (401(k)s and the like) already allow for loans and lump-sum
withdrawals to be made prior to retirement, even when sometimes subjected to
considerable penalty. IRAs can now be drawn down to purchase a house, finance the
cost of education, and cover extraordinary medical expenses.21 Critics of
individualized accounts argue that given the political pressures that are likely to
emerge, the expectation that new personal savings accounts would be a viable
replacement for Social Security retirement benefits may be illusory. They argue that
Social Security offers much greater assurance that funds collectively invested in the
markets will be preserved for retirement.
Defenders of the current
Defenders of the current systemsystem also argue that the
argue that it provides a morebeauty of Social Security is that
stable base of retirement incomeit provides a stable base ofretirement income for workers
for workers to build upon than anto build upon. They see it as a
individualized system would.form of societal guarantee.
While acknowledging that
Social Security does not provide
the degree of certainty of a contractually-prescribed benefit, they contend that the
economic factors that influence its financial viability are much less volatile than the
financial markets. People don’t suffer abrupt changes in their Social Security benefits
because interest rates change suddenly or the market rises or falls sharply. They argue
that Social Security allows people to better plan for retirement because it provides a
relatively predictable source of retirement income, i.e., at least in terms of the amount
of pre-retirement earnings it will replace.

21 The new “Roth”-type IRAs also can be annuitized at any age prior to retirement once
they’ve been held for 5 years.

Many proponents of individualized accounts contend that minimum guarantees,
investment limitations, and strong regulatory oversight can be employed to effectively
provide an equivalent amount of societal guarantees. Critics contend, however, that
the more this is done, the less the market returns would be, and the more the new
system would look like a reshuffled Social Security system; that it wouldn’t be better,
just different. They contend that the more proponents of an individualized system
attempt to achieve social ends, the more illusory their goal becomes.
Advocates of collective
Some argue that collectivelyinvestment also see a fiscal
investing in the name of Socialpolicy benefit to their approach.
Security carries a potentiallyUsing some or all of annualSocial Security surpluses for
larger fiscal policy benefit.investment in the markets
reduces the overall amount of
budget surpluses available to
federal policymakers for tax reductions or new spending programs. It has the same
(or similar) positive effect on the economy as reducing the amount of outstanding
federal debt, since money that would otherwise be used to pay off holders of
government debt would be invested directly in the markets. Debt reduction has been
a major theme of the current Administration and Congress. In theory, reducing the
portion of the federal debt held by the public frees up money in the financial markets
for savings and investment. When the holder of a government security is paid off, the
perception is that most of the proceeds are reinvested in private securities or
enterprises. This makes more capital available and dampens interest rates.
Ultimately, this influx of new capital could lead to a larger economy in the future, one
that might be better able to sustain the rise in projected government entitlement
expenditures when the baby boomers retire.
Proponents of collective investment contend that it is a more effective approach
to guaranteeing the use of budget surpluses for economic growth than trying to hold22
an elusive political consensus to reduce the government’s outstanding debt. While
the current Administration and Congress appear committed to making debt reduction
a priority use of budget surpluses, the politics of this issue could change. At some
future point, it may be difficult for a later President or Congress to fend off calls for
tax cuts or spending increases. A recession, for instance, might be a catalyst for tax
cuts; infrastructure or environmental needs or national calamities may pose the same

22 A unified budget surplus represents a surplus of governmental tax receipts taking virtually
all of the government’s many functions together, including Social Security and other programs
accounted for through federal trust funds. These surplus receipts don’t sit idle. In the absence
of legislative measures that would increase spending or reduce taxes, the excess money is
automatically used to reduce the debt – it happens as the Treasury Department pays off
holders of federal securities (public debt) when they mature and when it buys up outstanding
federal securities in the open markets as part of its debt management responsibilities. The
reader should note that the federal debt is comprised of two basic parts: debt held by the
public and debt held by governmental accounts such as the Social Security trust funds. When
policymakers discuss using budget surpluses to reduce the government’s debt, they are talking
about reducing the portion held by the public. This is the only portion that influences the
financial markets.

for new spending. Social Security is sometimes referred to as the third rail of
American politics – “touch it and you die.” Thus, proponents of collective investment
argue that if the law called for use of Social Security surpluses for investment in the
markets, the public could be expected to raise a clamor if someone wanted to use
them for some other purpose. The claim could be made that the budget surpluses
involved are excess Social Security dollars and are needed to make Social Security
investments. To use them in some other way would weaken the system. Thus, the
specter of misusing Social Security funds would emerge, raising a formidable
rhetorical obstacle against any attempt to use that portion of the budget surpluses for
some other purpose.23
Proponents of this
Some feel that investing part ofapproach also see a secondary
the trust funds in the marketsbenefit in the long range. In
provides the current system with aaddition to potentially increasingthe rate of return on the
protective financing cushion longsystem’s current holdings, they
range.perceive market investment of
some of its assets as giving it a
protective cushion – from the
perspective of an investment manager, the system would gain the benefit of
“diversification.” Although debt reduction may be a priority of federal policymakers
today, many uses have been proposed for newly emerging budget surpluses. In a
fiscal policy sense, collectively investing some or all of the portion attributable to
Social Security surpluses would provide a more secure store of assets for the system
in the long run. It would be different from simply crediting the trust funds with more
government securities and then attempting to use the cash for debt reduction. In the
latter case, while the money would be credited to the Social Security system, the
budget surpluses themselves could be used for something other than debt reduction,
namely tax reductions or new spending. Once enacted, those alternative uses might
be difficult to roll back. Under this scenario, the government would have created
other long-run fiscal pressures (less revenue or more spending on other activities) and
potentially higher interest costs from not having used the money for debt reduction.
Thus, when the Social Security system needed to draw on its reserves of government
securities to help meet its future benefit obligations, there would be other fiscal

23 Under official budget scoring rules, the Congressional Budget Office (CBO) estimates there
will be unified budget surplus of $176 billion in FY2000. Of that amount, $153 billion is
attributable to Social Security. The remaining $23 billion is attributable to the rest of the
government’s activities. This latter figure, however, reflects the effect of making $67 billion
in “intra-governmental” payments to the Social Security trust funds representing interest and
other internal credits from the government to the trust funds. As internal payments, they
create no real governmental outlays, but for accounting purposes they show up as receipts to
the trust funds and outlays to the rest of the budget. If these internal payments are ignored,
the portion of the estimated budget surplus due exclusively to excess Social Security tax
receipts is only $86 billion. Using the former scoring approach, CBO estimates that $2.3
trillion of its projected $3.2 trillion in cumulative unified budget surpluses over the next 10
years would be attributable to Social Security. Using the latter scoring approach, $1 trillion
would be attributable to Social Security. [Derived from CBO’s The Budget and Economic
Outlook, January 2000, and other unpublished CBO estimates].

pressures on the government from decisions made today to commit budget surpluses
to things other than debt reduction. Proponents of investing a portion of the next 15
years of Social Security surpluses in the market argue that it has the dual benefit of
(1) making less of the looming budget surpluses available for new spending and tax
cuts, and (2) giving the trust funds non-governmental assets to liquidate (i.e., an
alternative source of financing) when it no longer has enough incoming receipts to
cover its benefit commitments.
The Case for Individualized Accounts
Proponents of creating a system of individualized accounts see the current Social
Security system as a dinosaur – a relic of the depression era. While the system has
had its detractors since its inception, today’s proponents of an alternative non-
governmental approach are benefitting from a sizeable degree of public discontent and
apprehension about the current system’s long-run viability as well as an
unprecedented run up in the stock market over the past two decades.24 They also
have been buoyed by reforms undertaken by other nations, a number of which had
social insurance programs that pre-date the U.S. system. These countries have not
only acceded to changing public sentiment about how to prepare for old age but have
looked to reform of their governmental systems as a tool of economic stimulus and
advancement.25 They contend that people will save for old age on their own provided
the right savings incentives or mandates, the use of payroll deductions and direct
deposit, strict governmental oversight of the investment institutions involved, and
appropriate limitations on the pre-retirement draw down of assets. This, they
contend, has been amply demonstrated by the proliferation and popularity of 401(k)
and related tax-deferred, individually-based savings plans in the United States.
They argue that society no longer needs a “big government” tax and transfer
system. They concede that 65 years ago the nation’s employers and financial
institutions may not have been capable of launching and maintaining a national
retirement system with the reach that Social Security had at its inception. However,
they contend that with the subsequent advancements in technology, the widespread
automation of record keeping, the massive improvement in communications, and the
growth and evolving sophistication of the nation’s banking and investment

24 Representative of this sentiment, reflected in many opinion polls over the past couple of
decades, is one conducted by Gallup in May 1999 for USA Today, where 64% of “currently
working” respondents stated that they did not think the Social Security system would have the
money available to pay their expected retirement benefits. A Gallup poll done in June 1999
found that 58% of the respondents felt the system needed major reforms or to be “totally
overhauled.” Only 13% said “it was fine the way it is.”
25 Among them are Great Britain and Chile, whose reforms set examples for a number of other
countries around the world. A somewhat controversial but widely disseminated 1994 World
Bank report brought considerable attention to a shifting international climate toward
governmental pensions and promoted the notion that a privately managed mandatory savings
system should be a fundamental component of evolving international strategies for providing
citizens with old age security, particularly in the context of “avoiding many of the growth
inhibiting problems associated with a dominant public pillar” (see Averting the Old Age
Crisis, The World Bank, Oxford University Press, 1994).

institutions, the framework for an individualized non-governmental system has
become possible.
They stress that the issue they are raising is not about whether people need to
save for retirement, death, or disability – they accept the necessity of having a national
mandate and structure to do so – but more about how. Even those who propose a
voluntary personal account system argue that it would be voluntary only in the sense
of substituting for a person’s Social Security participation – not whether the person
should be able to opt out of both.
They view the anti-poverty role the government now plays as excessive. While
agreeing that there is still very much a need for a government-run safety net program,
they consider the dimensions of the current system too large. They contend that there
is no need to transfer $500 billion annually of workers’ incomes to the elderly to deal
with an aged poverty rate that is currently under 11%, a rate as low or lower than that
of the other age group of the population – and that the cost of alternative government
run anti-poverty efforts could be considerably less.26 While it is alleged that Social
Security keeps 41% of the elderly out of poverty, they argue that the same or greater
percentage could be kept out of poverty through a mandatory, employment-based,
non-governmental system. They argue that the current system crowds out other
means of retirement savings in two ways: by imposing too large a tax burden and by
creating too much reliance on governmental income during retirement. They contend
that an individualized system is the only way to truly advance-fund future retirement
claims, not only making them more secure than under a governmental tax and transfer
system but augmenting future economic growth with a more politically resistant
savings mechanism.
They don’t refute the idea that people like Social Security today, but contend
that its acceptability does not emanate from it being an inherently better system. They
contend that it’s hard for people to question the worthiness of something that has
evolved into being such a substantial part of current retirees’ well being. They view
the statistics of how many people depend on Social Security as the problem, not a
measure of its success, contending that average workers today put so much into the
system, they haven’t got enough left over to save in a more productive fashion. If
people could put some or all of their Social Security taxes elsewhere, they argue that
Social Security would be a far less important source of future retirement income – and
that would happen by choice.
The wide-range of ideas that proponents of an individualized system are pursuing
reflects an entirely new way of looking at alterations to Social Security. Unlike past
attempts to shore up the system, it is not about changing the system’s benefit rules or
making modest changes in its revenues or other sources of financing. These
traditional approaches are not central to the newer thinking of proponents of
individualized accounts. They want to take the debate further, to what they describe
as “looking outside the box.” What the current Social Security system would look
like when altered is secondary and almost irrelevant under some plans. What virtually

26 The poverty rate reported using census data for 1998 for persons age 65 and older was

10.5%. For persons of all ages it was 12.7%.

all of them have in common is that the current system would be smaller, and perhaps
eventually phased out entirely.
It is only at that juncture, however, that there is commonality, for the ideas range
from a massive, nearly immediate overhaul to a gradual transformation taking a half
century or more to complete. No single idea best reflects what advocates desire. For
some, participation in a new individualized system would be voluntary; for others it
would be mandatory. Some would keep a large remnant of the current system, either
as a matter of principle to keep some continuity of a government supported safety net
or simply to reflect the eventual lack of resources that the current system is projected
to face. Others see the current system being phased out completely – some would do
it quickly; others contemplate a long transition. Some provide considerable freedom
of investment choices, while others confine them to very regimented choices managed
by a limited number of investment companies. Finally, some involve carving out
resources for the new accounts from existing Social Security taxes while others would
use additional wage withholding or, alternatively, general government resources, i.e.,
budget surpluses.
In its most modest form, the creation of an individualized account system would
be done without altering Social Security. This approach, reflected in a number of
recent bills would require that future budget surpluses be used to set up personal
accounts with market investment options for people currently paying Social Security
taxes. The expressed view is that Social Security will eventually have to be
constrained, and the creation of these accounts could help fill the benefit gap in the
future. 27
At the other end of the spectrum are proposals that would rapidly transform
Social Security into a new individualized system. H.R. 249 (Sanford) and H.R. 874
(Porter) of the 106th Congress would allow workers to divert 8 and 10 percentage
points, respectively, of the current 10.6% OASI tax rate (i.e., the employee/employer
combined rate) into new personal accounts. These are often referred to as “carve
out” plans since the income for the new accounts would come from the existing Social
Security tax base. An 8 percentage point diversion would represent a redirection of
75% of OASI taxes; a 10 percentage point diversion would represent a redirection of
94%. Under H.R. 249, workers who opt for the new system would receive Social
Security benefits equivalent to what they would have received had they turned age 62
and retired in the year 2000 and a minimum annual annuity from their personal

27 They include S. 263 of the 106th Congress (Roth) and H.R. 3456 (Kasich) and S. 2369
(Roth) of the 105th Congress. Although not presented in the context that benefits would
eventually need to be constrained, the President’s January 1999 reform plan included a similar
approach allocating a portion of the then projected budget surpluses to new personal accounts
supplemented by a worker’s own contributions and a government match. The new accounts
were to be targeted toward low and moderate income workers. The Administration has since
given mixed signals as to how the proposal was to be viewed. Although there was some initial
expression that these accounts were to be viewed as part of a Social Security reform plan, and
thereby as supplements to Social Security benefits, Administration officials subsequently
stated that the proposed accounts were to be viewed as free standing savings instruments
designed to fill gaps in the nation’s private pension system. The context for presentation was
changed, not the reality of their being supplements to Social Security.

accounts.28 S. 1103 of the 106th Congress (Rod Grams) and H.R. 3683 (Sessions) of
the 105th Congress would similarly allow workers to opt for a new system altogether.
Like H.R. 874, S. 1103 would allow them to divert 10 percentage points of the OASI
tax rate into new accounts. Workers age 30 and older would receive “recognition”
bonds for past Social Security taxes.29 H.R. 3683 would allow workers to divert
6.2% of pay — the employee share of the tax — into new accounts. Employers
would continue to pay their share of the tax to the old system for 15 years, after
which they would contribute to the worker’s personal account. The worker’s Social
Security coverage would decline by 20% per year until all protections were forfeited
in the 5th year.
Among more gradual approaches is one proposed by five of the 13-member

1994-1996 Social Security Advisory Council (the “personal security account” plan),

which called for redesigning the system by gradually replacing its retirement benefits
with flat-rate governmental benefits based on length of service and private personal
savings accounts funded with 5 percentage points of the OASI tax rate. Another is
found in H.R. 3206 (Nick Smith) of the 106th Congress, which would allow workers
to put 2.5 percentage points of the OASI rate into new personal accounts for the next
25 years, 2.75 percentage points for the period from 2026 to 2038, and an amount
thereafter based on the yearly excess of aggregate Social Security revenue over
expenditures. At retirement, each participant’s Social Security benefits would be
reduced by the amount of a hypothetical annuity derived from their accounts.30
Examples of partial approaches include one proposed by two members of the
1994-1996 Advisory Council on Social Security (including the chairman of the
Council, and referred to as the “individual account” plan), which would have required
workers to contribute an extra 1.6% of their pay to new personal accounts to make
up for Social Security benefit cuts the plan called for to restore the system’s long-
range solvency. Another “add on” type plan (i.e., funded with monies other than
Social Security taxes) suggested by economists Martin Feldstein and Andrew
Samwick would create personal accounts funded with federal budget surpluses

28 For those remaining in the old system, H.R. 249 would gradually raise the full benefit age
to 70, alter the basic benefit formula to produce lower benefits, reduce annual COLAs and
spousal benefits, and extend Social Security coverage to newly hired state and local
government workers. Under H.R. 874, workers opting for the new system would receive
Social Security benefits (through so-called “recognition” bonds) based on their employment
record before they joined and a minimum annuity from their new personal accounts. For those
remaining in the old system, the bill would gradually raise the full benefit age to 70 and alter
the basic benefit formula to produce lower benefits.
29 Those choosing the new system could opt back into the old one within 10 years upon
repayment of the taxes and any recognition bonds received.
30 The bill includes numerous other major constraints to the current Social Security system
that would greatly reduce its expenditures and make room for even larger long-range
diversions of the tax for personal accounts. According to estimates prepared by the Social
Security actuaries, the cost of the existing system would drop to a level equal to 27% of its
current size in 2074. Memorandum from Stephen C. Goss, Deputy Chief Actuary, SSA,
“Estimated Long-Range OASDI Financial Effect of Social Security Solvency Act of 1999"
Proposed by Representative Nick Smith, November 3, 1999.

allocated to workers at a rate equal to 2% of their pay. Withdrawals from the
accounts would cause a partial reduction in the worker’s eventual Social Security
benefits; i.e., for every $1 withdrawn, $.75 in benefits would be forfeited. In this way,
the build up of the accounts would lead to an eventual reduction in the existing
system’s cost while enhancing future retirees’ income. A related approach suggested
by Representatives Archer and Shaw calls for partial funding of Social Security with
withdrawals from the accounts.31 Upon entitlement to Social Security, an amount
equal to a “life annuity” would be transferred monthly from each worker’s account
to the Social Security system, and the higher of current law Social Security benefits
or the life annuity would be paid. The new accounts would be managed by a select
number of investment companies through portfolios containing a 60/40% split of
equities and corporate bonds.
A plan suggested by Senator Phil Gramm incorporates both “add on” and “carve
out” features. It would allow workers to divert three percentage points of their Social
Security tax rate into new personal accounts with the government guaranteeing a
higher retirement income than would be payable from Social Security alone. The
guarantee would apply when a retiree’s Social Security benefits plus an annuity from
the new accounts are less than 120% of current law Social Security benefits. An
additional 2% of workers’ pay also would be contributed to the new accounts by the
government (from budget surpluses), and the annuities from such would be used
entirely to offset the cost of a worker’s eventual Social Security benefits.
Various other partial approaches, using straight “carve outs,” are reflected in S.

588 (Bunning), H.R. 250 and H.R. 251 (Sanford), S. 21 (Moynihan/Kerrey), H.R.

1793 (Kolbe and Stenholm), and S. 1383 (Gregg and Breaux) – all of the 106th

Congress. All include either voluntary or mandatory partial diversions of Social
Security taxes into personal accounts as well as other constraints on Social Security
benefits to reduce the system’s long-range cost.32

31 Instead of the offset occurring with Social Security benefits, it would affect the annuities
paid from the personal accounts. The account balances of deceased recipients would be used
to finance Social Security benefits of any eligible survivors or would otherwise revert to the
Social Security trust funds. The balances of workers who die before entitlement with no
eligible survivors would become part of the worker’s estate.
32 S. 588 (Bunning) would allow workers initially to divert 2.5% of their OASDI taxes into
new personal accounts with the diversion amount rising to up to 50% over 20 years. Retirees
would be required to draw down at least 75% of their personal account accumulations in the
form of an annuity or other monthly payment based on their life expectancy and to take a 50%
reduction in their Social Security benefits. H.R. 250 and H.R. 251 (Sanford) would
mandatorily divert one percentage point of the OASI tax rate into new personal accounts (for
those under age 55 upon enactment) managed by the Treasury in the same manner as the
federal workers’ Thrift Savings Plan (with the same investment options) or by banking
institutions. Future Social Security benefits would be scaled down to take account of the
growth of the accounts. S. 21 (Moynihan/Kerrey) would put the current system on a pay-as-
you-go basis by immediately reducing the tax rate by 1 percentage point each on workers and
their employers, and then raising it later in tandem with the system’s future cost. Workers
would be given the option of using the initial tax cut to create new personal accounts. If they
did, their employers would have to match their contributions. H.R. 1793 (Kolbe and

Perhaps the foremost
Proponents of a moreargument made by proponents
individualized system argue thatof individual accounts is that
personal accounts have thethey have the potential to growmuch larger retirement incomes
potential to outgrow the value offor people than the current
future Social Security benefits.Social Security system. There
isn’t much debate about the
market’s averages
outperforming Social Security in recent years. While as a social insurance system, the
potential rates of return vary considerably for people of different incomes and marital
status (the tilted benefit formula favors low-wage earners and the provision of a
“dependent” spouse’s benefits favors one-earner couples), estimates by SSA’s
actuaries in 1996 suggest that for people born the following year, with subsequent
careers of average earnings, the real return on their Social Security contributions
would be only 1% or so; for low-earning workers, it would be around 2%; and for
high wage earners, it would be zero or negative (i.e., they would not get back the
value of their contributions).33 They acknowledge that left to their own devices,
people don’t achieve a rate of return equal to stock market averages – even
experienced portfolio managers have a difficult time doing so and most don’t – but
they argue that with the emergence of index funds, limitations on switching, and
mandated withdrawal, annuitization, and liquidation schedules, many of the protective
features of Social Security can be replicated while still allowing people to achieve a
larger retirement income from their private accounts than from Social Security. They
contend that even if people earned only a long-bond rate of return on their assets –
now projected to be 3% annually in real terms – most would outperform their
projected Social Security return.34

32 (...continued)
Stenholm) would mandatorily divert 2 percentage points of the tax rate into new personal
accounts (for those under age 55 upon enactment). S. 1383 (Gregg and Breaux) calls for a
similar diversion, with some or all of the annuities from these accounts causing a reduction
in the worker’s eventual Social Security benefits.
33 These figures represent approximate “unisex” returns for full career workers (the figures
are slightly lower for men than women). A low-wage earner is assumed to be someone always
earnings 45% of the average wage; a high-wage earner is assumed to be someone always
earning at least the maximum level taxable for Social Security purposes. Those with shorter
careers would have higher returns. They also would be higher for two-earner couples
(because of the provision of potential survivor benefits) and for workers with dependent
spouses (although the vast majority of future retirees will receive benefits in their own right,
not as dependents). See Report of the 1994-1996 Advisory Council on Social Security, v. 1,
appendix II, Washington, January 1997.
34 Commentators often mistakenly describe the rate of return that the trust funds are expected
to earn as the rate of return that workers can expect to receive on their Social Security
contributions. They are different. The trust fund rate of return does not effect the
computation of a worker’s benefits. As previously explained, Social Security is not a defined
contribution system where the value of one’s benefits is based on the amount and growth of
what one contributes. The real trust fund rate of return projected at the time that the above

Fundamentally, proponents of an individual account system feel it would correct
what they see as Social Security’s contradictory mix of insurance and social welfare
goals — that its benefits are not based strictly on a person’s contributions as a
personal account would be, yet because it is not means-tested, many of its social
benefits go to well-to-do recipients. Hence, they view it as wasteful as a welfare
program, and a “poor performer” as a pension system.
Proponents of
Proponents of individualizedindividualized accounts also
accounts also contend that theircontend that their approach
approach would deal morewould deal more effectivelywith the public’s uncertainty
effectively with the public’sabout their retirement security
uncertainty about their retirementthan investing the Social
security than investing the SocialSecurity trust funds in themarkets or adopting a
Security trust funds in thetraditional set of Social Security
markets.fixes (raising revenue or
constraining benefits). They
contend that the public really
gives off mixed messages about Social Security. While on the one hand, the public
says Social Security should be protected and preserved, a significant segment says
that it is skeptical of the system and doesn’t trust its potential to meet its long-run
promises. They contend that the people who are least distrustful of Social Security
are those now receiving it; it is in their self interest to feel so. Nonetheless, opinion
polls repeatedly suggest that there is considerable public skepticism at all ages, and
that it is most pronounced among younger workers. The system’s critics contend that
younger people are not secure and don’t feel good about the program. Many
complain about having to pay more in Social Security taxes than income taxes, and
in their view, the injustice is only compounded by expectations that they won’t get
their money’s worth. Proponents of individualized accounts say that younger workers
frequently see advantages in saving through 401(k)s and other deferred compensation
arrangements. Although Social Security’s defenders say it may be illusory to view
one’s 401(k) as more secure than Social Security, its critics contend that there is a
tangible feeling of worth from direct ownership of one’s individual savings account35
– a feeling not present under Social Security. They argue that recognizing this is
fundamental in addressing the public’s apprehensions about retirement – and that
creation of individual accounts better addresses a desire to have a greater feeling of
control over one’s economic destiny.

34 (...continued)
worker rates-of-return estimates were done was 2.3%; in the latest trustees’ report (March

2000), it is 3%.

35 In the aforementioned May 1999 Gallup poll, some 60% of currently employed respondents
reported that they had an employer sponsored pension plan. In contrast to their reported
apprehension that the Social Security system would not be able to pay the benefits they
expected, 73% said their pension plans would have the money to pay their pension benefits.

Some contend that building an individual account component into the current
system could actually strengthen its image, even if the system’s taxes were raised and
benefits constrained to address its eventual insolvency. The long-run outlook is for
a continuing decline of the rates of return the system will afford. Raising taxes or
constraining expenditures to deal with its insolvency will only worsen those returns.
By incorporating a new individual account feature into the system, one that takes
advantage of the present period of surpluses, the shrinkage in the system’s returns
could be mitigated by the more favorable market returns earned by the new accounts,
as well as giving worker’s a periodic measure of increasing net worth. The perception
is that growing retirement savings accounts could restore credibility in the entire
system. 36
Perhaps the foremost
Perhaps the foremost argumentargument against collective
made for an individualized systeminvestment is that it directly or
over collective investment is thatindirectly makes the governmenta market investor, and given the
it avoids the issues of governmentsums of money involved,
intrusion in the nation’spotentially a principal
businesses.stockholder and thus owner ofmany of the nation’s businesses.
Since the program’s inception
this has been the fundamental impediment to market investment of Social Security
funds – i.e., the fear of government intrusion into private enterprise.
The problem with government ownership of stocks is the potential for politics,
rather than the workings of a competitive free market, to determine the course of
much of the nation’s business. It steps across fundamental boundaries between the
roles of government and private enterprise. The fear is of the political manipulation
– of pressure being imposed on businesses to behave in a manner that serves the best
interest of a political leader, a political party, or ideological or vested interests other
than those whose assets are at stake. In the context of Social Security, the concern
is that political opportunity would take the place of serving the best interests of
workers and future recipients. It probably would not be blatant; in fact, most
proposals attempt to guard against such. However, critics are concerned that with
the trust funds being a public enterprise, whose charter is granted by law, there are
inherent pressures on policymakers that over time would blur any initial commitment
to keep public and private policy interests separate. They argue, for instance, that
there would be an inevitable clash between achieving maximum investment returns

36 An idea of this type was put forth by former Social Security Commissioner Robert M. Ball
in May 1998. Long an ardent supporter of the current system, he proposed creation of a
voluntary “add on” component (workers would be able to contribute 2% of their pay, over and
above their Social Security taxes, toward an individual account) as part of a more extensive
reform plan that also called for collective investment of the trust funds. Mr. Ball stated that
in addition to having people receive annual statements of their potential Social Security
benefits (i.e., the traditional type), they would be given statements of “the amounts
accumulating in the individual’s supplemental savings plan.” He viewed the new accounts as
“logical add ons to a refinanced and fully dependable Social Security system.” [From
unpublished plan description prepared by Mr. Ball]

and the holding of “socially acceptable” investments. With a private fund, the fund
manager is required to put the best interest of the fund participants first. Whether
companies sell politically incorrect products, i.e., potential carcinogens, or fall into
public disfavor as polluters, alleged monopolists, international opportunists, or for
having poor labor practices, are less relevant factors in addressing whether a pension
plan should acquire their stock. When the pension plan is the Social Security trust
funds, however, there is a clear “public” interest in the investments of the funds.
Why, some might ask, should the trust funds own tobacco stocks, or that of
companies who “export” manufacturing jobs, gouge consumers, or sell products that
harm the environment? Even if a stock index were used, why, it might be asked, not
exclude them from the index? Critics of collective investment contend that there is
no end to where the line can be drawn between public and private interests. They
claim that there are clear examples of such behavior among state and local
government pension plans that have invested in the markets.37 Generally, they argue
that an individualized system is the only way to avoid most of the issues of
government intrusion into private enterprise, particularly if investment discretion rests
with the individual.
Proponents of an
Those who are apprehensiveindividualized system feel
about collective investmentstrongly that no body created
believe that no governmentalfor the purpose of conductingcollective investment can be
investment process could trulytruly insulated from political
insulate business from politicalinfluence. Ultimately a federal would dictate the creationof any investment board or
governing body, and the law
that made it can be changed.
Whatever the process, appointments have to be made. They allege that how they are
made and why they are made cannot really be shielded from partisan or other related
political influences. They acknowledge that an investment body could be created with
safeguards (bipartisan representation, rules mandating that the “best interests” of the
covered workers be served, the use of index funds, guidelines for selection of
investment companies, SEC oversight, etc.), but contend that any such body would
be independent in name only. Over time, there would be erosion because there would
not be enough individual self interest to truly guard against it. In most instances,
individuals would not see nor could they be shown direct harm from any alleged
political decision – their benefits would not be impacted per se. Proponents of
individualized accounts contend that concern about such a decision would not be
nearly as large as if an investment body were directly responsible for one’s personal
wealth and well being.

37 For a discussion of these issues among state and local government plans and a sampling of
examples, see CRS Report RL30218, State and Local Pension Plans: Economically
Targeted Investments and Social Responsibility Screening, by Celinda Franco, Edward
Rappaport, and James Storey, May 25, 1999.

Critics of an individualized system contend that whether policymakers want to
create a new individualized system or opt for market investment of the trust funds, the
action to do so could only occur through enactment of a law. They contend that just
as Congress would have to create a board to undertake market investment of the trust
funds, it would have to set up an entity of some sort to oversee an individualized
account system. Thus, they argue that there really is no difference in the potential
political influence that could be exerted under either approach. Proponents of
individualized accounts counter, however, that there is a fundamental difference
stemming from the fact that the money in the trust funds does not belong to any single
individual, whereas the money in an individual account does. They argue that
individuals would more readily react to a political decision affecting their personal
accounts than one affecting a trust fund arrangement having no direct bearing on their
benefits. Simply put, they contend that people are more apt to object to something
that directly alters their own personal net worth. As evidence of this, they point out
that no change has been made in the now 13-year old stock index fund (the “C” fund)
of the Federal Employees Thrift Savings Plan, which is an individualized savings
arrangement for federal workers similar to a private sector 401(k) plan.
They also contend that fear
Advocates of personal accountsof the market’s volatility is
contend that fear of the market isoverblown. They argue that
overblown and that ultimatepeople participating in 401(k)sand like arrangements have
pension risk is not confined togenerally learned to accept the
market’s fluctuations – that they
have learned to contend with the
volatility or have opted for less
risky investments, e.g., bonds. They argue that a large share of the public owns stock,
has seen the market’s occasional wild gyrations, and have learned not to panic at each
turn. “Buy and hold,” diversification, and “averaging in” are understood to be
effective investment concepts, and mutual funds, portfolio management, and money
markets are modern phenomena that operate today with considerable success in
mitigating the “risks” of total loss.
They argue that defenders of Social Security use periodic stock market declines
to attempt to instill “fear” of moving Social Security to an individualized system and
to intensify the perception that Social Security as it stands is more secure. They argue
that time is a proven remedy for market drops – once “fallen” does not mean that the
equity values will never return; and after 30 or 40 years of building an account, a
retiree will not suddenly need to spend all of his or her “depressed” assets when the
downturn occurs. Most of the account accumulation will not be needed for current
consumption and will have time to recover its value.
They further contend that Social Security has its own set of risks, foremost being
the demographic risk associated with not having enough workers in the future to pay
the taxes needed to make good on the promised benefits. They point out that Social
Security’s benefit package has been unilaterally changed in the past – the “full” benefit
age has been raised from 65 to 67, the benefit formula has been altered to reduce its
generosity, and COLAs have been delayed – and can be changed again by some future
Congress. Thus, they argue, Social Security is subject to its own set of unique

demographic and political risks. Moreover, while the stock market may be more
volatile than the economic factors that effect Social Security, over time Social
Security’s finances can be adversely effected by business stagnation and deteriorating
economic trends. High inflation and unemployment triggered a rapid erosion of the
system’s trust fund balances in the mid 1970s and early 1980s forcing Congress to
address both near and long-term problems with revenue increases and benefit
constraints. Proponents of individualized accounts contend that no system, public or
private, can optimally anticipate all the risks that may eventually alter its benefit
streams. They argue that the biggest “risk” in the current debate is that fear and
complacency about how to save Social Security will cause the nation to miss an
opportunity to build larger and more secure retirement incomes for future retirees.
Proponents of
Some argue that individualizedindividualized accounts also
accounts offer a more secure waybelieve that it is a more effective
of earmarking budget surplusesapproach to guaranteeing theuse of the emerging budget
for economic growth.surpluses for economic growth
than using them to build larger
Social Security trust funds.
Regardless of whether budget surpluses were used to buy stock for the Social
Security trust funds or used as a means to reduce publicly held debt, the ultimate
disposition of the surpluses rests not with the taxpayers whose money creates them,
but with federal policymakers. In other words, individuals would not have a direct
say in how the money is used. Proponents of individualized accounts contend that
there is a big difference in the political sustainability of earmarking money for a
government trust fund (or for debt reduction) than earmarking it for individuals’
personal accounts. If future federal policymakers decide that budget surpluses should
be used to expand or create new programs or benefits, no one individual taxpayer can
say that money is being taken from his or her account. The impact is not discernible
on an individual level. However, if policymakers wanted to forego depositing money
into an individual’s personal account so that some other use could be made of it, there
would be complaints by many of those affected. While proponents acknowledge that
in theory the law can be changed in either case – i.e., to reduce the amounts
earmarked for the Social Security trust funds or for individual accounts – they
contend that altering the rules for personal accounts would be much harder. A
decision by policymakers today to invest part of budget surpluses in stock for the
Social Security system could be superceded by policymakers in 2002 or 2004 or at
any later time who decide to spend the money instead. There might be heated rhetoric
– i.e., Social Security was being “touched” – but there would be no direct economic
impact that individuals could see. Changing the rules so that less of the budget
surpluses would go to individual accounts, on the other hand, would be direct and
highly visible. Each individual having an account could be shown how much less they
would get. Hence, proponents of individualized accounts argue that these accounts
are a more politically secure way of ensuring the use of budget surpluses for
increasing capital and economic growth.

Proponents of an
Proponents of individualizedindividualized system further
accounts contend that it is a “realargue that market investment of
fix” in contrast to collectivethe trust funds is merely apalliative. In contrast to
market investment of the trustenacting tax increases or
funds.spending reductions that
redefine the parameters and
value of the system, collective
investment would not really alter the system. Its effectiveness as a remedy to the
system’s financial woes relies directly on favorable market performance. In order to
have any positive effect, the trust funds’ new investments would have to out-perform
government bonds – a return equal to that of bonds would be about the same as
current law. Timing also is a factor – if the market does not produce a “premium”
over bonds early enough in the 75-year projection period, there would not be the
“extra” build up of reserves needed to sustain the system beyond its projected
insolvency point (2037). Early capital growth in the system is necessary to get the
benefit of compounding.
They further point out that if all that collective investment does is help bring the
system into balance, there would be no room for a mis-estimate, and future Social
Security benefits could be threatened. In effect, critics argue that if the market is risky
for individuals in terms of rendering a reasonable retirement income from personal
accounts, it is equally risky for the existing system as a whole in terms of achieving
financial solvency. If the market doesn’t perform but the impact is confined to
individual accounts, the Social Security system is not threatened as it would be if it
also relied on market performance. They charge that the only reason the system’s
proponents are advocating collective investment is to avoid having to take the “hard
medicine” of raising taxes or constraining the system’s future benefits.
They argue that it would be
Proponents of individualizedbetter to enact the necessary
accounts further argue that itconstraints to the system and
would be better to enact thebuffer them with the creation ofan individualized account
constraints needed to restore thesystem. In this way, they
current system’s long-rangebelieve that the system’s
solvency and buffer them with thesolvency would be betterassured, and even if the market
creation of an individualizeddid not perform well, individuals
account system.would still be building
“something” on their own to
buffer any future Social Security
cuts. They contend that it would be easier to enact the constraints today and allow
for their gradual implementation than to wait until insolvency is imminent. They
speculate that if the projections upon which the benefit reductions were based proved
to be pessimistic, there would be room to raise benefits in the future; politically, it
would be easier to raise them then than to cut them once again.

The financing concept
In contrast to the creation ofbehind collective investment is
individualized accounts, somethat the building of larger trust
fear that building a larger trustfunds than under current lawwill provide needed resources to
fund could become an irresistibledraw on when the system’s
source of future spending.income no longer is sufficient to
meet its expenditures. In
theory, its purpose is to advance
fund more of the resources that will be needed in the future. While not different in an
economic sense from advance funding future retirement incomes through individual
accounts, there is a large difference in who controls the disposition of the funds.
Proponents of individual accounts argue that an individual controls the ultimate use
of the money that is drawn from them. Third parties, i.e., federal policymakers,
control the disposition of the Social Security trust funds. If an individual account
were to grow larger than expected, the individual would decide what to do with the
extra money – i.e., spend it or save it; the money is theirs. In contrast, greater-than-
anticipated success with trust fund investments, in their view, would lead to a larger
trust fund balance providing future politicians with welcome surpluses to spend. For
instance, to the extent the economy did better than expected or demographic
conditions improved, a larger trust fund might provide funds for a general expansion
of the program. Even though an individual’s taxes helped create the surplus, that
person would have no direct say on how it was used. Proponents of an individualized
system contend that it is very hard for lawmakers to resist the many complaints and
inequities raised about Social Security, and point out that the urge to fix them is
evident in the many bills routinely introduced to address a myriad of issues created by
the system’s current structure and benefit rules.
They contend that pay-as-you-go financing of the current system gives it a
needed discipline. By its nature, pay-as-you-go requires careful scrutiny of possible
new benefits. As such, it creates a needed firewall between politically popular ideas
and good public policy. When they clash, policymakers can always argue that taxes
would have to be raised or the system’s financing would be threatened if every “great
new idea” were enacted. In effect, it tests policymakers’ resolve.
They further argue that a government doesn’t need to advance fund a mandatory
pension system when it can alter the system’s benefits or financing arrangements
unilaterally. This “right” of the federal government was long ago tested in the
courts.38 Recognizing this flexibility early on, the notion that the system would be
financed on a pay-as-you-go basis was decided with passage of amendments in 1939
– the year before it began paying benefits – and in the years since, as long as its future
income and outgo were estimated to be in reasonable balance, its trustees have

38 In the case of Fleming v. Nestor (363 U.S. 603, 1960), the Supreme Court took the position
that a worker’s interest in Social Security was not contractual and “cannot be soundly
analogized to that of a holder of an annuity, whose rights to benefits are bottomed on his
contractual premium payments ... To engraft upon the ... program a concept of accrued
property rights would deprive it of the flexibility and boldness in adjustment to ever-
changing conditions which it demands ...”

declared the system to be financially sound. Critics of collective investment accept
the justification for a contingency reserve – to assure the Treasury Department does
not have to return to Congress every year or frequently to obtain the right to pay
benefits. They see it, however, only as reserve of “spending authority,” not a reserve
of real resources from which funds are actually drawn to pay benefits. Why invest a
reserve in the markets that is needed only as a “contingent” authority to write checks?
The money ultimately comes from the government’s authority to tax under the
Constitution. They contend that a reserve for more than contingencies is simply an
“invitation” to spend for benefit increases.