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The 4 Historical Misunderstandings About Social Security

This article was delivered as a talk to members of Congress in mid-May. It was one of a number of talks being sponsored by the American Historical Association as part of the National History Center's Congressional Breakfast Seminar Series.

Everyone concedes that Social Security is important. Senator Robert Dole once said that it overwhelmed all domestic priorities.

It is important in part because it is so large. It started from scratch in 1935 and grew to be a program that collected money from 154 million people and paid more than $470 billion to 47 million people in 2003.

And it is important because it comes bundled with so many features. It is a program for people of all ages because it includes survivors benefits, which started in 1939, disability benefits, which started in 1956, and it is closely tied to Medicare which started in 1965. And it has built-in protection against inflation, since benefit levels rise with the CPI. It is also an important anti-poverty program, because of these features and also because it has a benefit formula that is tilted in favor of lower-income workers.

For such a large, diverse, and apparently popular program, it has been the subject of a number of historical misunderstandings.

Historical Misunderstandings

In the first place, the program was not always large, popular, or the third rail of politics.

When it was created in 1935, it was not particularly popular. That is because it covered only industrial and commercial workers on regular payrolls or about half of the labor force. So if you were a congressman from rural Texas in a district with farmers and a few businessmen who owned their own fertilizer or tractor stores, then essentially no one in your district was paying into Social Security or expecting to receive benefits.

If you were a congressmen from Chicago, most of the people in your district were likely to participate in Social Security. But they faced a hard road. They were expected to pay Social Security taxes beginning in January 1937 but not to receive Social Security benefits until 1942. That meant five years of paying in without getting anything back at a time when no one had ever gotten anything back from the program, except for lump sum death benefits.

And it meant that money was being taken out of circulation in the midst of a deflationary depression to pay for Social Security taxes, helping to create the so-called Roosevelt recession in 1937.

It is not surprising then that many congressmen, Republicans and Democrats, wanted to vote against Social Security in 1935. But they didn’t for two reasons. One was that Social Security was a priority item for the Roosevelt administration in 1935 and FDR was very popular and still in his first term. The other was that the bill was actually an omnibus bill that came bundled with many items, other than old-age insurance. Most of these items were federal grants that would bring money into many congressional districts. Hence, congressmen voted for the bill in order to get those other benefits.

Between 1935 and 1950, old age assistance—welfare payments to the elderly who could prove they were poor that were administered by the states with federal matching grants—reached more people and paid higher benefits than did Social Security. Congress rescinded Social Security tax increases in the forties and actually decreased the range of covered occupations.

In the second place, Social Security has not been antithetical to the development of private accounts.

In 1935 an issue arose in which Senator Clark of Missouri proposed that employers who already offered pensions to their employees which were as good as or better than Social Security could opt out of the program. His amendment passed the Senate but was removed in conference after a great deal of discussion. So unlike workers compensation an employer could not self-insure for Social Security.

But, contrary to what you might expect, private accounts actually grew after the passage of Social Security. The program provided a base for private pensions on which companies could build. Social Security made people security conscious. The passage of survivors benefits did not thwart but rather aided the life insurance business. When large pension programs started in the automobile, steel and other industries at the end of the forties, that actually provided the impetus for the expansion of Social Security in 1950 that, for the first time, brought the program to parity with welfare. And, of course, health insurance became a largely private endeavor, despite the Social Security Act and even Medicare created a market for what were called Medi-gap policies.

In the third place, the issue of Social Security surpluses has come up before in the history of Social Security.

At first, large surpluses arose in the Social Security accounts because many people were paying and almost no one was receiving benefits. Such surpluses have always been controversial, because people wonder about where their money is going. If it is spent on current items, how can it later be used to pay Social Security benefits? As journalist Mark Sullivan wrote, money collected in Social Security taxes “may be spent for any legal purpose under the sun and in practice they are now being used to help the Government’s current bills.” He wrote in the 1930s but could as easily be writing today.

Members of Congress reacted to large Social Security surpluses by spending them and by reducing tax rates. They spent it through starting regular benefits early and by providing family and survivors benefits. They reduced taxes by not allowing the tax increases scheduled in the law to go into effect.

Eventually, surpluses were reduced and something like a reasonable contingency reserve was established. This system operated between 1950 and 1972, the years in which Social Security enjoyed the most success. Something called the level wage hypothesis provided the dynamic for benefit increases in 1952, 1954, 1958, 1965, and 1967. The official predictions would call for wages to remain level. When in fact they rose, that provided an unexpected surplus that Congress could spend on raising benefit levels without raising taxes.

In the fourth place, Social Security has faced previous crises and surmounted them.

The first crisis was the battle with welfare that threatened to make Social Security irrelevant. Solved in 1950 with coverage extension and benefit increases.

The second crisis was that the growth of the economy in the fifties and sixties threatened to make Social Security benefits fall far below the standard of living. Solved in 1972 by changing the actuarial assumptions and indexing Social Security to the rate of inflation.

The third crisis came with the slow down of the seventies. The program was tied to employment, which determined how many people were paying in and to inflation which determined the amount of money being paid out. Stagflation thus posed a crisis. Congress reacted by raising Social Security taxes in 1977. But the second oil shock of the decade posed further problems. Congress reacted by creating the 1983 amendments.

The 1983 amendments were remarkable. In the past, Social Security policy was made by the Social Security Administration and the tax committees in Congress, with some input from organized labor and business organizations like the National Association of Manufacturers. It was a closely held enterprise, with bureaucrats in SSA designing legislation and even writing congressional reports, and legislation being formulated in the House Ways and Means Committee and debated under a closed rule.

But in the seventies that system broke down. Ways and Means began to get subcommittees, including a subcommittee on Social Security. The president became more involved as Social Security became an important national issue. SSA itself became a much less cohesive bureaucracy. Two people essentially ran SSA between 1937 and 1973. But after that Social Security commissioners came and went with rapidity.

So in 1981 there was a new exercise. President Reagan, the Speaker of the House, and the Majority Leader in the Senate all cooperated in naming people to a Social Security commission, which included powerful members of Congress and representatives of the key interest groups. These people bargained over the amount of money that was needed to keep Social Security solvent. Then the group dissolved into confidential private negotiations between White House staffers, such as James Baker, and key Democrats, such as Senator Moynihan. The Republicans agreed not to challenge the basic design of Social Security. No private accounts, in other words. The Democrats agreed to make cuts in Social Security. The two sides negotiated with a score card that showed how much money would be saved by doing a particular thing. In the end, they agreed to a six month delay in the cost of living adjustment and other changes that assured Social Security’s solvency.

The Present Controversy

If that happened in 1983, what has caused the present problem? It is not the retirement of the baby boom. We have known about that for a long time and it has already been factored in. Instead, the problem has to do with actuarial assumptions related to real wage rates in the future and disability rates in the future. There is an irony here because the 1983 amendments had helped to create a large surplus in the program, so people are talking about a long-run deficit at a time when there was a short-term surplus.

So far, we have not seen a repeat of 1982, with people calmly taking out score cards and making political bargains over how to restore long-term solvency to the program.

In part, the program has suffered from its success. Sold as an insurance program, people now point to the low returns that generation x and yers will get on their Social Security taxes. The trust fund makes the long-term deficit visible. No one is talking about a long-term deficit in the education programs for example. So, as part of an ambitious second term agenda, President Bush has decided to take on what David Stockman has called the fortress of the welfare state. He would like to convert the program into one that deflects a portion of Social Security taxes into private accounts.

There are two parts to this campaign. One is to convince America that Social Security is going bankrupt. If that is the case, then its chief beneficial attribute—its defined benefits—are not going to be worth much. Two is to say that, if that is the case, then the only way out of the dilemma is to let workers invest in private accounts which because of their high rates of interest will make up the shortfall.

But of course that represents a fundamental change in Social Security.

There are problems associated with it. Second term initiatives often fail, as in the court packing plan in 1936.

It is a costly proposal, because the president has already said that people who are older than 55 will keep their benefits. So there has to be enough money in the system to take care of them and also to allow people to start investing in private accounts. So it will be a more expensive proposition than simply fixing the system we already have in the style of 1983.

On the other hand, private pensions have changed. What were once plans to pay guaranteed benefits to people have now become defined contribution plans. This reflects a world in which people change jobs frequently and in essence carry their retirement plan around with them. The president’s Social Security reform would make Social Security more compatible with this sort of arrangement.

I don’t know what will happen. But I do know as a historian that presidential social welfare initiatives almost always have consequences. President Nixon tried to pass major welfare reform and failed but we did come away with a major new welfare program, in the form of Supplemental Security Income. President Clinton tried to pass national health insurance and failed but we did come away with major expansions in Medicaid and major reforms of Medicare. So, in a similar sense, I know that the president’s proposals will have consequences. I think it is fair to say that history teaches me that, just as it does that Senator Dole was right when he said that Social Security overwhelms all domestic priorities.