Social Security: How Much Longer Can It Last? Interviews with Peter Ferrara and Maggie Kuhn

Peter J. Ferrara is a youthful New York lawyer who specializes in corporate litigation — when he isn’t busy pursuing one of his many interests, like economics, journalism and scholarship. As an undergraduate at Harvard, he majored in economics; and he has since put in time as a research assistant at a Boston-based consulting firm where he worked with Arthur Laffer and others on techniques of measuring the impact of various tax cuts. While still an undergraduate—and later, during his years at Harvard Law School, as well—he wrote editorials for the Harvard Crimson and served on its executive board, edited the national newsletter of the New York-based Center for Libertarian Studies, and worked as an assistant producer of a Boston radio program. Today, in addition to his law practice, he is a regular participant in the annual Libertarian Scholars Conference and is also an associate scholar of the Cato Institute, the libertarian-leaning San Francisco think tank which has just published Ferrara’s first book, an encyclopedic study of the Social Security system, its defects and the prospects for reform, entitled Social Security: The Inherent Contradiction.

With the impending collapse of the Social Security system apparently just over the horizon, the time seems ripe for such a book. And if initial reaction may be considered indicative of what lies ahead, Ferrara’s study seems likely to wield considerable influence in the next few critical years of public policy debate on the Social Security question. University of Chicago economist Sam Peltzman has written, for example, that Social Security: The Inherent Contradiction “will have to be read by anyone who wants to know how Social Security became the biggest tax program we have and why it is rapidly creating the most important economic problem for the next generation. This book manages to get the important points across in an eminently readable style. It should have a wide audience.”

Ferrara seemed to us at LR to be the ideal person to address the question of what lies ahead for Social Security. So we contacted him at the end of a long workday in his Manhattan office and posed the question.

LR: How much longer does the Social Security system have? How soon will the situation become so bad that whoever is in power in Washington will no longer be able to evade the fact that something obviously has to be done?

Ferrara: I think that is coming up very quickly, by the mid 1980s at the latest. You have, in regard to Social Security financing, two problems. You have a long term problem that’s due to demographic changes, and you have a short term problem that’s due to the performance of the economy.

When you have stagflation you have benefits increasing, because benefits are tied to inflation. But you also have wages falling, because recession is discouraging employment. The result is that the taxes being generated by the system are declining at the same time that its benefit expenditures are increasing. And with expenditures increasing and revenues falling, I think at this point one more sharp recession is just going to finish the system.

LR: Will that recession come during the next four years?

Ferrara: I think so. Judging from history, we get at least one recession per presidential administration. If Reagan manages to avoid a recession during the entire four years I think it will be a miracle.

LR: What will Reagan do to solve the crisis when it comes?

Ferrara: I think he’ll turn to general revenue financing. I think he’ll just throw in the towel on financing Social Security solely with the payroll tax. He’ll go towards subsidizing the program and making up the deficits with general revenues.

LR: And where will he get the general revenues? From tax increases?

Ferrara: Well, that’s interesting. If Reagan follows the program that he has announced, Social Security may well end up being financed by decreases in other expenditures or by a slowing down of the increases in other expenditures. If Reagan is actually going to go through with his Kemp-Roth tax cuts and everything else in his economic program, then he is going to have to come up with the money to bail out Social Security by restraining growth in other expenditures.

LR: You’ve recently published an exhaustive analysis of the Social Security system under the title Social Security: The Inherent Contradiction. What is the inherent contradiction?

Ferrara: The inherent contradiction is that the system pursues both welfare objectives and insurance objectives. And those two objectives are inherently contradictory, inherently irreconcilable. So it should come as no surprise that the result is you have both bad welfare and bad insurance.

LR: What makes these two objectives inherently contradictory?

Ferrara: Well, in a welfare program, benefit amounts are based solely on the amount of need and are unrelated to any amount that might have been paid in the past. In an insurance program, benefits are related solely to the amount that was paid in in the past and are not based on the amount of need. Now, Social Security is financed by a payroll tax, because it’s thought of as an insurance program. They figure they’re charging everyone a similar amount for basic service. But the welfare portion of the system gets financed this way as well, and that makes for a bad welfare program. You don’t finance a welfare program that’s supposed to benefit poor people with a regressive tax which hurts poor people; that’s counter productive.

On the other hand you have the earnings test, which denies elderly people benefits if they continue to work past the age of 65. That’s included in the program because they figure people who are working don’t need the benefits. But it makes Social Security a bad insurance program, because even if you pay tax money into the program you can be told that you are not getting your benefits. They can say, “well, you just don’t need them.”

But the most important contradiction in Social Security is that the simultaneous pursuit of welfare and insurance objectives leads inevitably to a pay-as-you-go system, which means that the money that is paid through taxes is not saved in investments but is immediately paid out to current beneficiaries in the form of benefits. In a pure insurance system the money you pay in is saved and invested and then that is used to pay your own benefits later on. But in the early years of Social Security, there was pressure to provide benefits to people who were elderly at that time, but who had of course not paid taxes in the past and were therefore not entitled to benefits. So instead of saving the first money paid into the system, the new Social Security bureaucrats immediately paid it back out, because they wanted to perform that welfare function. So the pay-as-you-go nature of the program is a direct result of the pursuit of welfare objectives in addition to insurance objectives. And when you have a pay-as-you-go system, when you pay out the money immediately as it comes in, that leaves you vulnerable to short range economic trends. It leaves you vulnerable, for example, to this stagflation problem where benefits are rising while revenues are declining. It also leaves you vulnerable to long term problems, because since you’re totally dependent on the current work force for your benefits, if the number of working younger people declines in comparison with the number of older people, then in a pay-as-you-go system you’re going to have a natural financing problem. You’re going to have to keep raising taxes to make up for the decline in the population. The current financing problems of Social Security are all due to this pay-as-you-go method of financing.

LR: Then why not keep the mandatory Social Security system, but really put it on an insurance basis, and simultaneously create a completely separate agency to administer the welfare programs?

Ferrara: Well, that would go part of the way. That’s the proposal advanced by Professor Martin Feldstein of Harvard University, Chairman of the National Bureau of Economic Research. He would like to separate out the welfare and insurance elements of the program, because he recognizes they are inherently contradictory. This was also recognized by the Brookings Institution in a 1968 book by Joseph Peachman, Henry Aaron, and Michael Taussig titled Social Security: Perspectives for Reform. The Brookings study recognized the conflict in objectives, but Feldstein went a step further and recognized that there was a problem in the pay-as-you-go nature of the system. He therefore advocated fully funding the insurance element of Social Security by having the government save these enormous trust funds. I go a step farther than Feldstein. I say once you agree that the pay-as-you-go system is no good, then there’s no reason you shouldn’t entirely privatize the insurance function. If you have the government save and invest this enormous trust fund, the government is going to own 40 percent of all the assets in the entire private economy. That’s a way of nationalizing half the country. It would be far preferable to have private institutions doing the investment.

LR: But some people would be improvident and wouldn’t avail themselves of private savings accounts and pension plans if they weren’t mandatory.

Ferrara: That argument is based on a theory that the government has to protect people from their own short-sightedness. And on that theory the government should also prescribe people’s diets and tell people that they have to listen to classical records and that they have to drink good dry French wines. I don’t buy that approach. But if people found that a stumbling block to acceptance of this reform, then we could merely continue to require people to buy one form or another of private alternative insurance, just as we now require them to buy auto insurance. In other words you could say to them, “You will have to pay these Social Security taxes unless you use the money to buy a private alternative that would be invested. If you do, then you will be exempt from

“the Social Security taxes.” This would allow people to save and invest their money in alternative private retirement funds. What I would suggest is IRA-type accounts with more wide-ranging tax exemptions. I don’t believe the government should be taxing money that people are trying to set aside for their retirement. This plan would privatize the entire system, yet would get you around the objection that people won’t save on their own. You simply require them to have some sort of alternative. I would rather have a free system. But I think this middle ground where you have a privatized system with a requirement that you participate is far preferable to what we have today.

LR: What does the historical record show? In the ‘20s and early ‘30s, before passage of the original Social Security Act, elderly people had to rely either on what they had saved or on private pensions or on the charity of younger friends and relatives. What percentage of them were improvident?

Ferrara: Well, of course, people didn’t live as long in the past, and they weren’t as wealthy in the past, so they didn’t tend to retire long before their life expectancy had run out. The reason people are able to retire earlier today is because we are so much more wealthy that we can set aside enough money earlier in our lives to live out the last 20 percent of our lives without working at all. They just weren’t rich enough 100 years ago to do that. They had to keep on working until near the very end. Also, because they didn’t live as long, those who were considered elderly weren’t as debilitated and incapable of working as many of today’s elderly. So if they didn’t save for their old age they ajust didn’t retire. They continued to work. If you haven’t saved for your retirement then you don’t retire—just as if you haven’t saved to buy a car then you don’t buy a car.

LR: But many able older workers are forced to retire.

Ferrara: I think the compulsory retirement system in this country was caused by Social Security. If you go back to the 1920s, you find there was no compulsory retirement at age 65 then. It was because Social Security set a national norm in retirement that everything else was structured accordingly. And the earnings test which says you can’t get your money back unless you retire—I think that tends to cause people to retire at age 65 as well. I think without Social Security people today would be retiring at a later age than 65, probably in their late 60s, closer to the age of 70.

LR: Or they might quit the full time jobs which they have worked for many years and go into some other field, something more along the lines of a hobby, in which they could work part-time and earn less money, and supplement their incomes with a private pension plan that would pay them whether they were working or not.

Ferrara: Yes. They would be more likely to phase gradually into retirement. Today, people are expected to drop out immediately upon reaching a certain age. I don’t think that’s good for people, and I don’t think it’s what people would want to do normally on their own.

The Gray Panther as Reaganite

Maggie Kuhn is an energetic, dedicated political activist who will be 76 years old this summer. Eleven years ago, when she turned 65, she was forced to retire from her job as Associate Secretary at the United Presbyterian Office of Church and Society. She didn’t want to quit. It was a matter of mandatory retirement. So then and there she became an activist. She got together with five of her friends and founded the Gray Panthers, an organization which has since become by far the best known of the various lobbies and public interest groups devoted to the cause of what might be called Elderly Liberation.

How do the self-proclaimed representatives of the aged feel about the Social Security crisis? To find out, LR contacted Maggie Kuhn by telephone. To be honest, we weren’t sure what to expect. We knew the Gray Panthers were not libertarians: to cite only one example, they’re avid advocates of compulsory national health insurance. But neither were we expecting their founder and most famous spokeswoman to come out on the telephone for essentially the same plan to save Social Security which policy analyst Peter Ferrara believes will be adopted in the next few years by Ronald Reagan—funding the program out of general revenues and getting the needed revenues by cutting back on other programs.

Of course, Maggie Kuhn’s idea of what should be cut back differs radically from Reagan’s, as you’ll see in a moment. But we were struck by the fundamental similarity of approach between the two—and by the unimaginative nature of Kuhn’s reaction to Libertarian Ed Clark’s very different ideas on the same subject. Some extracts from our conversation follow.

LR: How much longer can the Social Security system last without some kind of fundamental change?

Kuhn: Well, I don’t take such a dismal view of it as some people do. I believe that there have been profound changes in the past 30 years since it was enacted, and that more changes are going to be needed. But the Social Security system is the one instrumentality that benefits people of all ages, and it would be a disaster to our country if it were to go under. I can’t believe it will. I think that there ought to be a lot of discussion, very, very probing intelligent discussion of the system. And I think we should, out of that discussion, be able to come up with a formula for paying into the system from general revenues.

LR: Were you satisfied with the kind of discussion of Social Security that Jimmy Carter and Ronald Reagan engaged in during the 1980 campaign?

Kuhn: No. I thought it was very superficial and it didn’t really get at the real question.

LR: One of the minor party candidates in the campaign made a proposal on Social Security which was quite different from anything either Carter or Reagan was saying about it. This was Ed Clark, the Libertarian Party candidate for President, who proposed that for those workers now under 40 the Social Security system simply be discontinued and that an amount of money equal to the amount those workers would otherwise have been contributing to Social Security each month be given back to them in the form of a tax credit—that is, if they put the same amount of money into a private savings account they could write it off directly on their income tax. Clark also proposed that, for those who are between 40 and 65 and have already put many years of payments into the system and want to go ahead and collect their benefits, the system could be made optional. For those already receiving Social Security, there would be no change. And the result, according to Clark, would be that we would get out from under the enormous debt that the system is accumulating, and out from under the developing problem of the birth rate. In the future there are going to be a great many more older people than there are younger people, and the tax burden on the young could be enormous if we had a pay-as-you-go Social Security system. But if tax incentives were created to make it possible for people to put the money that they would have been paying in the form of taxes into banks and other kinds of investments to provide for their own old age, there would be no less money—perhaps even more money—available to them upon retirement. How does that idea strike you?

Kuhn: Well, human beings being human, I wonder whether this would really happen, whether people would really behave in that manner. Some would. But one of the benefits of the Social Security system as it was devised and has been operating is that it is virtually universal in its coverage. Whether you’re provident or improvident, you at least have some security at hand.

LR: But Grey Panther literature says that older people who have been improvident and so have to rely entirely on Social Security are really not being provided for very well, because the rate of inflation has eaten up the value of their Social Security checks.

Kuhn: Well, that’s true. There isn’t any plan at the present time that guarantees against poverty as long as we’ve got the inflation that we’ve got.

LR: And who do you think is mainly responsible for the inflation?

Kuhn: I think one of the big inflationary causes is the defense budget, the bloated defense budget. We’re putting billions into goods that are never going to be consumed—we hope—and adding to the national debt on that account, and using our technology and scarce materials for things that are calculated for human destruction rather than for enhancement of human life. Until we reduce the inflationary aspects of the defense budget and begin to get back to some new national priorities, the inflationary spiral is going to go up and up.