The Third Rail of Politics Switches Sides
By Michael Barone

The time for fixing Social Security is here. The content of the reform is fairly clear—individual investment accounts to replace part of the government benefits financed by the payroll tax, later retirement ages, adjusted cost of living increases. The details are important and need to be worked out carefully, but the political and macroeconomic stars are in order. The only question is whether the political actors have the necessary skill and will.

The conventional wisdom has long been that Social Security is the third rail of American politics: touch it and you die. Political events from the 1940s through the 1980s provided plenty of support for this rule. But very recently things have changed, and now the third rail has shifted to the other side of the tracks. While as late as 1992 it was politically risky to propose any changes in Social Security, it is now politically risky not to propose fixes.

This shift was caused by two key changes, neither caused by government, and neither much noticed by most politicians. The first change was demographic, and the key year was 1993—the first year in which Americans turning 65 had not served in World War II. Daniel Patrick Moynihan, born in 1927, served in the war; Walter Mondale, born in 1928, did not. This was critical, because the bedrock of support for the existing Social Security system is the G.I. generation, which grew up in the Depression, served in World War II, and then went on (against everyone’s expectations) to build prosperous post-war America. Greed is always a strong motive for political activism, but even stronger is a sense of moral entitlement, and the G.I. generation has a powerful sense of moral entitlement to Social Security and, since 1965, Medicare. These Americans felt they had been dealt a poor hand, played it well, and passed on a very much better one to the next generation. To threaten to take away the smallest portion of Social Security benefits was to arouse their undying wrath. Congressmen faced the outrage of so-called notch babies (G.I.-generation members born in 1917 and after) for years after Congress took away the higher-than-inflation cost of living adjustment which had been unwittingly written into the 1972 Social Security increase package.

Economically, the Social Security system was an amazingly good deal for the G.I.ers. Senator Alan Simpson used to tell complaining elders that the value of the payroll taxes they had paid during their earning years was only a small fraction of the total they would receive from their monthly checks. They paid him no heed. After all that they had been through and all they had accomplished, they felt entitled to anything they could get. If younger Americans had to pay much higher payroll taxes than they had had to pay, that was just fine. The 1972 increases were their great triumph, the product of a bidding war between Wilbur Mills and Richard Nixon, an alcoholic and a crook both running for President. Together they produced the doubled cost of living adjustment that overadjusted benefits for inflation just as America was about to enter the most inflationary decade of the twentieth century. It can be argued that this law and the unanticipated steep increase in Medicare spending were—more than the Reagan tax cuts or defense increases—the real cause of the 1983-93 budget deficits.

But every day, the G.I. generation becomes smaller. Today about one-quarter of Americans over 65 are younger than the G.I.s. These new post-G.I. elderly are from what William Strauss and Neal Howe, in Generations, call the Silent Generation. They do not remember much about the Depression; they did not serve in World War II; the escalator of post-war prosperity was already moving up when they stepped on. They do not have the sense of moral entitlement to Social Security benefits that the G.I.s have.

Meanwhile, the younger generations—baby boomers and Gen Xers—have come to realize that they are on the losing end of a Ponzi scheme. Their payroll taxes are high, and there is no way they are going to receive Social Security benefits comparable to their "contributions." If you ask a group of twentysomethings what they expect to get from Social Security, they laugh. They intuitively understand, without knowing the figures, that the ratio of workers to retirees is falling toward 2 to 1, and that the payroll tax will have to become even more steep than it is now in order to support current Social Security payments. As a matter of fact, the Congressional Budget Office estimates the Social Security tax will have to jump from 12 percent to 18 percent over the next 30 years.

The twentysomethings know there is an alternative to that heavy blow. Which brings us to the second great change that makes Social Security reform foreseeable in the 1990s: the boom in investment. Pollster Peter Hart, in a survey for the National Association of Securities Dealers, reports that stock ownership has zoomed from 21 percent of adults in 1990 to 43 percent in early 1997. An nbc/Wall Street Journal survey conducted later in 1997 by Hart and Robert Teeter showed that 51 percent of respondents said they owned at least $5,000 in common stock or mutual funds, either individually or through a retirement savings program.

We are well on our way to becoming an investor nation. Americans have long had an interest in stocks through their pension plans; increasingly, those interests are direct, as employers shift from defined-benefit plans (in which a centralized entity does the investing and promises a specific pension) to defined-contribution plans (in which the employee invests his pension directly and the eventual returns depend on his own choices). In the 1970s and ’80s, most individuals had the bulk of their wealth in residential housing; by 1997, most individuals have more wealth in stocks than houses.

Of course there is no guarantee that the current bull market will continue forever or that the gains investors have made in the 1990s are locked in. But over time, the stock market grows faster than incomes, as the investing public has come to understand. Harvard economist Martin Feldstein notes that while funds raised by the payroll tax have historically risen at about two percent a year, stocks rise by five to six percent a year over the long run. (This is a conservative estimate: Feldstein’s average covers the years 1926-94, which means he includes the ’20s stock market crash and the Depression, while leaving out the doubling of the market since the Republicans won control of the House in 1994.) It is increasingly becoming plain to Americans that they would do well to look more to stocks for a greater part of their post-retirement income and less to the payroll tax.

Some may doubt that voters make such long-range calculations. But there is increasing evidence that the economic factor most important to American voters is not short-term income but long-term wealth. The large majority of Americans do accumulate significant wealth, in the hundreds of thousands of dollars, over their lifetimes, as Federal Reserve data show. Journalists miss this because they focus on the aggregate figures for all Americans—which are skewed by the negative net worths young people typically have—rather than on the figures for people around the relevant age of 60, when wealth accumulation maximizes.

Voters of the G.I. generation were sensitive to small fluctuations in income. They remembered the 1930s, when a layoff was often the prelude to years of unemployment and economic ruin. But voters growing up in the age of credit cards and vast job growth, the America of the last 30 years, know that they can survive a period of temporary income loss. They are more concerned with how they are faring in their lifetime project of accumulating wealth.

T focus on wealth rather than income helps to explain the otherwise puzzling responses of voters to economic events in the 1990s. The relatively small income losses of the 1990-91 recession are not enough to explain how George Bush fell from 53 percent of the vote in 1988 to 37 percent in 1992. But a look at where his greatest losses occurred tells the story: they were in New Hampshire and southern California, which also suffered the nation’s biggest drops in housing values. Voters spurned him because they lost wealth and he didn’t seem to be doing anything about it. As for 1994, the old political formulas based on macroeconomic indicators suggested the Democrats should have lost about a dozen House seats. Instead they lost 52, in part because their big government programs threatened wealth accumulation. And how to explain the current euphoric feeling about the direction of the nation, and Bill Clinton’s high job ratings, amidst deepening political scandal? Income growth is lower than the peaks of the Reagan years, so that’s not it. But look at the stock market, and the vast increases in wealth it has given millions of Americans—there’s the source.

A final bit of evidence: the fizzling of the Medicare issue in the 1996 campaign, when Democrats hammered away at Republican "cuts" in Medicare (actually, the Republicans called for lower increases than projected). For months journalists reported, accurately, that these attacks were hurting Republicans. But at the beginning of October the Republicans counterattacked, and as Peter Hart has noted, the Democrats’ Medicare advantage disappeared by the middle of the month. The Republican response—that Medicare was going broke, that Republicans were just proposing smaller increases, and that they had a "lockbox" to guarantee the savings went to Medicare—went mostly unreported, and even many Republicans still believed they had lost votes on the issue. But the exit polls tell another story. In a country with a vanishing G.I. generation and two younger generations skeptical that they will receive much from Medicare or Social Security, the Medicare issue was a wash. You could almost see the third rail flipping over.

So we now have an electorate ready for Social Security reform. Only a few politicians have stepped forward though, the first being junior Republicans like South Carolina’s Mark Sanford and Michigan’s Nick Smith. Then in January 1998 came Bill Clinton’s opportunistic ploy to outflank tax cut proposals by calling for budget surpluses to be plowed into Social Security. That put the issue into play. Then in March, Senator Daniel Patrick Moynihan (D-N.Y.) came forward with his own plan for cutting payroll taxes and allowing taxpayers to start personal investment accounts to supplement Social Security benefits. Moynihan wouldn’t make the investment accounts mandatory, and he would raise the amount of income on which payroll taxes would be due—features the Republican Social Security reformers oppose. But the direction of movement is apparent. Suddenly American politicians are moving toward a system similar to those already working in Chile and Britain.

Will they get there any time soon? That is by no means clear. We have a President elected with 49 percent of the vote and beset by scandal, whose fellow Democrats in Congress may not be ready to follow him in this direction. We have a Republican House majority elected with 49 percent of the vote and still spooked by the public’s adverse reaction to their stand in the 1995-96 budget showdown. Neither side may have the strength and confidence necessary to move ahead. Which would be unfortunate, because suddenly the money to pay for the costs of transition is at hand, in the form of a budget surplus.

In any case, the politicians don’t have the excuse for hesitation that they had in the 1980s, when they claimed the public would not accept significant changes. Today, Social Security reform would merely reflect transformations in our citizenry. The generational shifts and investment boom of the ’90s have changed the American people from beneficiaries worried about yearly income and relying on centralized experts running a welfare state to investors embarked on a lifetime project of accumulating wealth and relying on their own decisions in the marketplace. Social Security reform would transform a system that is lagging behind the people to one that works in tandem with their deepest priorities and principles.

Michael Barone, senior staff editor for Reader’s Digest, is a regular contributor to The American Enterprise.

THE AMERICAN ENTERPRISE, MAY/JUNE 1998