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March 4, 2005



PAUL GIGOT: Welcome to THE JOURNAL EDITORIAL REPORT. President Bush returned from Europe and members of Congress returned from their recess -- and the fight was joined again this week on what to do about Social Security. Both Republicans and Democrats said most of their constituents were telling them the same thing recent polls have been reporting: most Americans still need to be convinced that changes in Social Security must be made soon. The White House announced that the president and members of his cabinet would blanket the country to generate support for changes. Democratic leaders in the Senate began a two-day tour of major cities, to generate opposition.

Everyone agrees on one set of facts: Fewer and fewer workers are paying into the system, and more and more people are taking money out of it. Especially with the baby boomers, more people will be reaching retirement age and living longer. Social Security will pay out more than it takes in from payroll taxes as early as 2018 -- 13 years from now.

Everyone also agrees that for workers 55 or older, nothing should change. But to prevent Social Security from going bankrupt over the next 40 or 50 years, President Bush says younger workers should have the option of investing a portion of their payroll taxes in private investment accounts. The president says he's open to other ideas. Some that have been suggested include: raising the retirement age, lowering benefits, raising taxes, stopping planned increases in benefits.

We'll get to the president's private investment plan later, but first we'll tackle the issue of how much change is needed. Here to try to make sense of all this are: Dan Henninger, a columnist and deputy editor of THE WALL STREET JOURNAL editorial board; Holman Jenkins, also a columnist and member of the board; and Ed Crane, president of the Cato Institute and a longtime advocate of changing the Social Security system.

Dan, can we at least all agree as a starting point that this is a problem that we're going to have to face as a society in our political system sooner or later?

DAN HENNINGER: I think we can all agree on it. I think most people do understand and do realize that the problem is basically about the birds and the bees. After World War II all these 20-year-olds had lots of babies, and they did so for about 15 years. And after that, 1960, people had fewer babies. We're now at the point where about 20 or more million people are over 70 years old. In 15 years, some 47 million people are going to be over 70 years, a virtual doubling of the number. There are going to be fewer workers to pay for all those retirees. And since what we have is a pay-as-you-go system, where the workers from one month to the next pay for the retirees, the current set-up just is not going to produce enough money unless it changes, to pay for those baby boomers.

PAUL GIGOT: So demography is destiny, and welcome to the program.

ED CRANE: Thank you, Paul. Good to be here.

PAUL GIGOT: What happens if we do nothing? What choices do we confront?

ED CRANE: Well, we're confronted right now with a 5.3 trillion dollar unfunded liability, if you -- some people say it's 3.7 trillion, but that's only because they count the 1.6 trillion in the trust fund as real assets, which it's not. I would commend people to look at page 337 of the 2000 ECONOMIC REPORT OF THE PRESIDENT, which was Clinton's last -- you know, a Democratic administration which made very clear there are no assets in the trust fund. So yes, at some point we have to figure out, once the cash flow turns negative in 2018, as you said, we're going to have to find the money somewhere and the way to do it primarily is by cutting spending. That's the way I view it. But you're either going to have to cut benefits, raise taxes, or borrow more money. And it's a large number.

PAUL GIGOT: Holman, that seems to be the choice that we'd have to confront, including either a major increase in taxes or perhaps a major cut in the political promises for future benefits.

HOLMAN JENKINS: Sooner or later, voters and their representatives are going to have to deal with this. A CBO statistic estimated in '98 was that it was going to take 11 trillion dollars of tax increases just to get you from 2030 to 2040. Ten years, 11 trillion dollars of additional taxes Americans would have to pay to meet the benefits of Social Security and Medicare.

If I was one of the people -- and I am -- who expected to be alive during those years, I would have no confidence in my fellow younger taxpayers to reach that deep in their pockets to keep me going.

PAUL GIGOT: Well, as the introduction said, for now -- at least until 2008 -- there is a rising level of excess Social Security taxes over benefits being paid out. In 2008, the size of that surplus starts to shrink until 2018. But between now and then, what happens to those current payroll taxes that people pay? Because there are a lot of people who still think, I believe, that there is a fund somewhere in some bank in West Virginia or the Treasury with their name on it building up assets. That isn't what happens.

ED CRANE: Well, the money is spent. The money is either paid to current retirees or goes to pay welfare to agribusinesses, or whatever the Congress wants to waste the money on. I think that's something the president needs to make more hay out of. The fact is that we have no right to the money we pay into Social Security. In 1960 the Supreme Court ruled in Fleming v. Nester that this is not a contractual arrangement. We have no property rights in the money we pay into it. It is totally a social program of Congress and what we give back is, in essence, up to 535 politicians. So it's a very insecure system. There are no private accounts, no individual accounts, right now.

PAUL GIGOT: What about, Dan, those who say, "2018, that's a long time. We can wait. Maybe the economy will grow more than we think. Maybe there'll be more immigrants. Maybe we'll have more kids. Something will happen. Let's not -- it's not urgent."

DAN HENNINGER: Well, if any of those things were true, such as if we would have more immigrants or we would be working longer, you might make an argument, because ultimately what you really need to keep the system going is more economic growth. And I think one of the problems with this debate is that people are acting as though the United States were an island, or as though it were still 1936, and we didn't have to worry about our position relative to the rest of the world. There are 20 countries, approximately, that have already privatized their pension system. One that is thinking and talking about doing it is India. Now if India, which is going to have tremendous growth rates over the next 40 years, starts getting those obligations off of the government's back, and we sit back and decide the solution is to raise taxes, retarding growth, we're going to get hurt. Our children are going to get hurt hard.

PAUL GIGOT: One of the points that Alan Greenspan, the Chairman of the Federal Reserve, made this week, is that if you're going to change the promises that politicians have made, better to start sooner rather than later, the way he put it. Because if you do that, you can phase in the thing gradually, reform gradually, and it makes less of any dramatic difference or burden any particular year.

ED CRANE: Well Paul, one of the things. I agree we have a financial crisis here. But it seems to me that even if you had solvency, even if the Social Security system, we didn't have the demographic problems that have created this deficit, the right thing to do is to create personal accounts, private accounts.

PAUL GIGOT: We're going to talk about that. I want to do that. Let's go to our taped piece now. Let's move on to discuss the president's proposals for the private investment accounts that Ed referred to, which he says would replace most of the Social Security system over a long period of years. Most people point to the system now being used in Chile, as the model for what the United States should have. So we sent correspondent Rick Carr to Chile to look at it.

RICK KARR: Politicians who are pushing for the partial privatization of Social Security say the future lies to the South.

PRESIDENT BUSH: Frankly, the Chilean model serves as a good example.

MAN: Look at the plans that have succeeded in Chile and ...

MAN: You can go to Chile. They would never go to our Social Security ...

RICK KARR: Fans of the privatized retirement system here in Chile say, "Why not try it in the U.S.?" Scrap Social Security, its bureaucracy, and its guaranteed payouts, and replace it with something more like our own personal accounts, where the money would be invested in the stock market. In the long run, they say, we'd make more money.

Chile privatized its system 24 years ago, when the military dictatorship of Augusto Pinochet imposed the reform. Jose Pinera was the architect of the plan. For years, he's been singing its praises in Washington. Pinera says the old Chilean system was pay-as-you-go, like Social Security in the U.S., and it was broken.

JOSE PINERA: People didn't have ownership of their money. The benefits of retirement depended on politics -- on whether the budget was in surplus or deficit, whether there was a crisis. How can you have a system of Social Security when really you are not secure about whether your benefit will be there?

The centerpiece of the Chilean plan is a group of six companies known as AFPs, in English, Administrators of Pension Funds. When young Chileans like environmental lawyer Cecilia Urbina enter the work force, they choose one of the firms to invest the 10 percent of their income that's withheld for their pensions.

By law, each of those companies offers five plans, much like mutual funds, which range from risky and potentially profitable to safe, but less sexy. Cecilia Urbina says it's a tough choice.

CECILIA URBINA: [In Spanish w/English VO] I think that all this information sounds too complicated for the average consumer.

Once she makes a decision, Cecilia Urbina's pesos will join the billions in pension investment that have poured into Chile's stock and bond markets. All of that investment capital has funded new toll roads that operate at a profit, and thousands of mortgages. Pinera says privatizing Social Security has helped Chile's economy become the fastest moving in South America.

JOSE PINERA: This has increased the capital market. This has helped Chile to double its rate of growth.

RICK KARR: Looking at Chile's privatized pension system from the height of a few thousand feet, it's pretty clear that it's been good for the country's financial sector and for the economy as a whole. What's not so clear is whether it's been good for the majority of individual Chileans.

Return on investment has been good, an average of more than 10 percent a year. But it's been inconsistent. Some years, the plans lose money. And critics say Chileans pay too much in overhead -- fees, marketing costs, and profits. But supporters say the AFPs have lower overheads than most mutual funds.

SOUND UP: "Empanadas! Empanadas! Empanadas!"

RICK KARR: At Santiago's central produce market, Chile's system generates a lot of skepticism.

MAN SELLING ONIONS: [in Spanish with English VO] They've done nothing. All this government does is build roads. But you can't eat roads.

MAN SELLING CARROTS: [in Spanish with English VO] If you're not educated about it you basically rely on luck.

RICK KARR: Many Chileans say the private pensions do not pay as well as the old ones. Seventy-two year old gardener Aniseto Medina agrees. He still works because when he started drawing on his pension a few years ago, it paid only about a quarter of his old salary.

ANISETO MEDINA: [in Spanish with English VO] Clearly I consider the 70 thousand pesos I receive to be a paltry sum. You can't do anything with seventy thousand.

CECILIA URBINA: [in Spanish with English VO] I don't know how the system will work for the new generation.

RICK KARR: Lawyer Cecilia Urbina, who's just joining the system, says that unlike her parents and grandparents, who had the option of sticking with the old system or joining an AFP, her generation has to buy into the private system. All she can do, she says, is hope for the best.

Just how relevant is the Chilean system to the U.S.? Critics say its most important lesson is that it's expensive. Chile continues to pay pensions from its old system, at the same time that it's building up the new one. That transition has cost between two and five percent of gross domestic product every year for 24 years. Fabio Bertranou, of the U.N.'s international labor organization, says the transition won't be paid off for another 20 years.

FABIO BERTRANOU: If you don't have the instruments to finance the transition costs, I wouldn't recommend to go towards this type of reform.

RICK KARR: So it sounds like what you're saying is, if you're running a budget deficit don't even think about doing this.

FABIO BERTRANOU: Yeah, of course.

RICK KARR: Bertranou says Argentina looked at Chile, liked what it saw, and privatized social security, but failed to account for the costs. And that helped lead to an economic meltdown. But the architect of the Chilean plan, Jose Pinera, says the transition costs just do not matter.

JOSE PINERA: I believe passionately -- because I have seen it working -- that a system of personal retirement accounts is morally, economically, financially and politically superior to a system of entitlement where you depend on government, where it's very easy to go bankrupt because of demography, because of political manipulation.

RICK KARR: Ultimately, politicians on Capitol Hill will have to weigh the benefits of the Chilean system against its shortcomings, as they decide whether it fits the United States at all.

Reporting from Santiago, Chile for JOURNAL EDITORIAL REPORT, this is Rick Karr.

PAUL GIGOT: Ed, nobody's followed the Chilean experience more closely, no American certainly, than you have. What lessons do you think it has for the United States?

ED CRANE: Well, I mean, the announcer said, "But has it been good for the Chilean people?" It's earned 10 percent a year real for a quarter of a century. It's got to be good. And we know that from the fact that Chile's got the strongest economy in Latin America now. They need to get people who were in the underground economy in the real economy. But it's been a huge success.

Jose Pinera is a colleague of mine, likes to talk about how people take their passbooks out and show it to him, and show how much money they have. They have a sense of control over their own lives. It has been an unequivocal success in Chile.

PAUL GIGOT: And it's been tried elsewhere in the world, too. More and more of the world, as Dan suggested earlier, are moving to these kinds of systems.

ED CRANE: We had a conference in China three years ago. The labor minister there is a big fan of Jose Pinera's and they were trying to install in China a Chilean-like system.

PAUL GIGOT: Let's talk about this issue of ownership, because that seems to be the nub of the debate. And you made the point earlier that you think that the current payroll taxes are not yours, according to the Supreme Court case Nester v. Fleming. There's no ownership, there's no property right. Do you really think the politicians, now or in the future, are going to repudiate the promises they've made?

ED CRANE: Why wouldn't they? They've done it in the past. Every time they raise the retirement age, or cut the benefits, increase taxes -- of course, they're going to be forced to. And that is why it's so important to have a system, like Sam Johnson's bill in Congress, that would allow not only private accounts but provide what they did in Chile, so-called "recognition bonds" so that everything you paid into the system, you'd get in a deep discount zero coupon bond that would be yours and you owned, and that the politicians couldn't take away from you. So yeah, there's a real -- people should be concerned that the politicians are going to renege on their promises. And that's why private accounts are such a good solution.

PAUL GIGOT: Holman, what are some of the other advantages of this kind of system, personal investment accounts?

HOLMAN JENKINS: Well, you don't know what your life expectancy is, so you can pass it on to your children if you get struck down by some terrible disease at age 64. There's also, you have the choice of how to draw it down. If you, in the first years of retirement, want to go wild and have a big vacation, do a world tour, you can spend the money at that rate and then live off the remainder at a more leisurely and relaxed kind of level of consumption. You have lots more options.

PAUL GIGOT: Right now, of course, if you die as a single person when you're 64 and you've been paying in for 40 years --

HOLMAN JENKINS: The system loves you.

PAUL GIGOT: -- because it keeps all the money, and you don't get anything, and you can't it on to your children.

ED CRANE: The money goes "poof." And even if you're married, the spouse's benefits disappear if your benefits are higher than his or hers. And then once the surviving spouse passes away, the money is all gone. And where's the compassion in that? Where's the justice in that kind of system?

PAUL GIGOT: Let's address some of the objections that have been raised to this kind of idea. One is that it's a risky scheme. You can't put the money in the "stock market casino" because some people would simply be irresponsible, and put money in the penny stocks in Denver, and there won't be any money left for their retirement. Dan, what's your response to that?

DAN HENNINGER: My response to that is, so what exactly are you saying? Once you say that, you have to default to the status quo. The status quo results in two alternatives: one, raising taxes to pay for the system going forward; or cutting benefits. I don't think anybody disagrees with that. The Democrats say, well, we can raise taxes two percentage points and that will fund the system. You're talking about a situation where the payroll tax could go from 12 percent over the next 40 years, up to 18 percent. That is surely going to retard growth in this country.

PAUL GIGOT: Won't the funds also be invested in presumably relatively low-cost --

ED CRANE: There will be a limited number of mutual funds that you can invest in. You know, people have made the same argument about "too risky" in 1983 when the Greenspan commission was meeting, and they didn't even consider personal accounts. The stock market today is eight times higher than it was at the peak in 1983. And so the same people who wring their hands -- with some justification -- over the growth wealth gap in America, refuse to let middle- and lower-income people have an opportunity to accumulate wealth, which they could have done in '83. It'd have been tremendous.

HOLMAN JENKINS: Anybody can learn to invest safely. It's not that hard. No one has bothered to teach them. But if you presented them with this money and said, "You're going to have to look out for yourself in 40 years," they'll learn.

DAN HENNINGER: And you know, most interestingly, federal workers basically have this system. The thrift savings system gives federal workers four or five indexed accounts in which they can put their money. It's run through the government. The administrative costs are very low. But I suspect most people would be startled to realize that federal workers have a system that private sector workers don't have access to.

PAUL GIGOT: All right, we've got to take on at least a complicated issue technically, this transition cost argument, Ed, where people are saying that if you're going to take money out and invest it, current benefits, and give it into retirement accounts that will build up assets, it's not there to pay for the benefits so you're going to have to borrow, and you're going to have to pay for this transition. And people say, well, you're going to have to build up too much debt and it will raise interest rates. What's your response to that?

ED CRANE: Well, what is too much debt? I mean, we have world capital markets. The money is there. It's not that much money in terms of the total capital markets in the world. But the debt is already there. The actuary of the Social Security system, Mr. Goss, has done studies of all the privatization plans. They all save money in the long run. Now, they do move some of the debt up earlier, but they actually save trillions of dollars in terms of the total debt that the system has.

PAUL GIGOT: Do you have to cut benefits at all to make this happen as well? To make the math work?

ED CRANE: No, this is another area where I disagree with the way the Bush administration presents this. It's not benefit cuts. It's simply a change in the nature of the benefit. There are going to be benefit increases with private plans, it's just going to be more of a mix of your own assets with the government's assets.

HOLMAN JENKINS: Somebody should also point out that you go in this direction and you reduce the drag on labor markets and on investment returns. You're going to get more growth between now and then. You're actually going to come out better. This can be a win/win if done properly.

PAUL GIGOT: All right, with everything we've said, why is the administration having a hard time selling this politically -- which it seems to. I mean, if you look at the polls, the voters aren't convinced yet, Dan. What's going on?

DAN HENNINGER: Well, I think it's been poorly explained to them. I think it's also true that the president has been, in fact, emphasizing the solvency of this system. You get into the sort of these green eyeshade issues that are impossible to ignore, certainly. But that he has not been emphasizing enough the ownership side of it, and the fact that people -- I think people believe that Social Security exists like the Bill of Rights or a Supreme Court decision, that it's set in concrete: I have that money come to me when I retire. That is not true. It's like the Welfare system. They can change it any time they want to.

PAUL GIGOT: Ed, as you mentioned, Bill Clinton was on the verge of trying to do something about Social Security.

ED CRANE: Before Monica came along, right.

PAUL GIGOT: That's right, before impeachment took everything off the agenda. Bob Kerrey, Patrick Moynihan, a lot of Democrats were in favor of this in the late nineties. Bob Kerrey said one of the great advantages of this is if we take care of this entitlement problem we'll have more money to spend on things like health care and education and so on. Not maybe things you would savor, but things the Democrats savor. It wouldn't crowd out the federal --

ED CRANE: It's a Democratic issue.

PAUL GIGOT: Why are they so opposed?

ED CRANE: Well, for ideological reasons, I guess. But the beneficiaries of private Social Security accounts are primarily the poor, blacks, women, union workers, blue collar workers -- who all favor it, by the way. I'd love to see Barack Obama, who I knew could be --

PAUL GIGOT: Senator from Illinois.

ED CRANE: Senator from Illinois. He could be Nixon going to China. Very smart guy. And he was asked on one of the talk shows what he thought about this, and he said, "I have an open mind." But if you get some Democratic leadership in there -- Harold Ford in the House is in favor of these ideas. I think it should be a Democratic party issue.

PAUL GIGOT: All right. Very briefly, just I want to go around the table. Is Congress going to pass a Social Security reform in the next two years that includes these personal retirement accounts?

ED CRANE: They will if the president changes his tactics away from solvency and toward ownership and inheritability.


DAN HENNINGER: I think the chances are slight, because Democrats haven't come up with an alternative that will give them a piece of the action. As a result, they'll default to total opposition.


HOLMAN JENKINS: They'll give a different name. It'll be the same thing, and we'll say, "We will give you a tax cut if you save the money." That simple.

PAUL GIGOT: Interesting. I'm pessimistic about this one. I think the Democrats are just not going to let it happen. This debate has to percolate a little longer. All right, thanks everybody. Next subject.