SOCIAL SECURITY

SOCIAL SECURITY. The social security system in the United States was established on 14 August 1935, when President Franklin D. Roosevelt signed the Social Security Act. The act created a range of government programs, including unemployment insurance and federal welfare grants, but the term "social security" generally designates Old Age, Survivors, and Disability Insurance (OASDI) and related federal programs run by the Social Security Administration. In the second half of the twentieth century, social security grew to become the most expensive federal government program, directly touching the life of almost every American. It enjoyed widespread popularity for several decades, but by the end of the century worries about its future and concerns about its effects on the economy greatly diminished its popularity and led policy makers to consider major changes in its operation.

Before Social Security

Social security is primarily designed to provide income for the elderly by taxing the workforce. Before the establishment of social security, workers pursued a range of strategies to prepare themselves and their spouses for old age—relying primarily on the market and the family. The historians Carole Haber and Brian Gratton have shown that in the late nineteenth and early twentieth centuries, average annual household incomes of those sixty and over were only modestly lower than those in their forties and fifties and were rising over time along with overall economic growth. Most men continued to work into old age, but many were able to retire. The labor force participation rate of men aged sixty-five and over was about 76 percent to 78 percent between 1850 and 1880; thus the retirement rate was 22 percent to 24 percent. The retirement rate rose to 35 percent in 1900 and 42 percent in 1930. Social critics worried that elderly workers were adversely affected by industrialization and that many were becoming unemployable and were being thrown onto the "industrial scrap heap." Research by economic historians has shown that this was probably not the case, as increasing retirement rates were driven by rising incomes. The earnings of their children were an important component of the elderly's income during this period. Surveys from 1889–1890 and 1917–1919 show that children's wages provided about one-third of total income in households headed by those sixty and over. In addition, saving for old age was an important strategy, and nearly 30 percent of elderly households took in boarders. Nearly one million

people received Civil War pensions in the 1890s and first decade of the 1900s, declining to about 600,000 by 1920. They covered over half of elderly native-born Northern males and made up 42 percent of the federal budget at their peak. However, by 1930 only about 10 percent of workers were covered by pensions, especially government workers and long-term employees of large corporations such as railroads.

Many of the elderly lived in poverty, especially widows and those who had low earnings before reaching old age. A traditional response was for a poor widow to move in with the family of an adult child. As a last resort, the indigent elderly could move into an almshouse or poor-house run by a charity or local government. Conditions in these institutions were often harsh and moving there was generally considered to be a deep humiliation. Fear of being consigned to the poorhouse haunted many, but no more than 2 percent of the elderly lived there in the nineteenth and early twentieth centuries.

In 1889 Germany, under Chancellor Otto Bismarck, adopted the first modern social insurance plan, in which workers were taxed to provide money for an old-age fund. Many European countries followed suit, including France (1910), the Netherlands (1913), Italy (1919), and Britain (1925), as did many Latin American nations. The first federal old-age pension bill was introduced into the U.S. Congress in 1909, and Theodore Roosevelt's Progressive Party made old-age insurance part of its platform in 1912, but very little progress was made toward this goal until the Great Depression struck the American economy. The depression caused massive unemployment, forced many employers to cancel pension promises, wiped out the savings of some older people, and squeezed many families who supported their elderly parents. Calls for assistance for the elderly and for a system that would encourage retirement, opening up jobs for younger workers, abounded. As the depression continued, more and more state governments provided reliefpayments to the elderly poor, but most observers considered these to be grossly inadequate.

Establishment of the Program

On 29 June 1934 Franklin Roosevelt created the Committee on Economic Security (CES), chaired by Secretary of Labor Frances Perkins and led by Executive Staff Director Edwin Witte, a University of Wisconsin economics professor, to study social insurance and recommend legislation. Roosevelt and Congress were faced with a growing call to provide large pensions to the elderly. Most prominent were the "Share Our Wealth" plan of the Louisiana senator Huey P. Long and especially the retired physician Francis Townsend's plan, which called for a pension of$200 per month for those sixty and over—an amount that was more than one-third of per capita annual income—on the condition that recipients not be employed and that they spend their pensions within thirty days. Instead the CES recommended and Congress adopted (by 372 to 33 in the House and 77 to 6 in the Senate) a plan that gave much more modest immediate aid to the elderly through the Old Age Assistance program and created a more permanent system, Old Age Insurance. Old Age Assistance was a joint federal-state venture with the federal government matching state expenditures on a one-to-one basis up to a specified maximum per recipient (originally $15 per month). It allowed states to establish their own eligibility criteria and benefits levels. Meanwhile, the Old Age Insurance system began to tax workers and promised benefits when they reached age sixty-five that were tied to the amount of taxes they had paid, much like a private-sector annuity. This lag between payments and promised benefits made it difficult for future legislation to repeal the social security system. Franklin Roosevelt recognized this, explaining "We put those payroll contributions there so as to give the contributors a legal, moral, and political right to collect their pensions. … With those taxes in there, no damn politician can ever scrap my social security program." Alf Landon, the Republicans' unsuccessful 1936 presidential candidate, criticized the Social Security Act as unjust, unworkable, stupidly drafted, and wastefully financed, but Gallup polls showed that voters overwhelmingly approved of it, with 73 percent approving the social security tax on their wages. In late 1936, the federal government began assigning social security account numbers, taking applications at post offices. On 1 January 1937 workers began paying social security taxes and acquiring credits toward old-age benefits. The Supreme Court upheld social security's constitutionality in Helvering v. Davis on 24 May 1937. However, the 7 to 2 ruling made it clear that social security taxes are simply taxes like any other, and individuals have no legal right to any benefit based on paying them.

Initially over 9 million workers, including agricultural workers, domestic servants, and government employees, were excluded from the social security system, as were railroad workers, who had their own retirement fund established by federal law in 1934. It was originally planned to begin paying monthly pensions to retirees in 1942, but the Social Security Amendments of 1939 brought this forward to 1940, and on 31 January 1940 Ida May Fuller, a retired legal secretary from Vermont, became the first recipient of a monthly benefit check. The 1939 amendments also added a program to provide dependents' and survivors' benefits—akin to private-sector life insurance—and the program was renamed Old Age and Survivors Insurance (OASI). The acceleration and expansion of social security benefits was driven by the political popularity of spending social security's amassed pool of savings rather than letting it accumulate, especially in light of the "Roosevelt Recession" that struck the economy in 1937. As OASI switched from a fully funded system to a pay-as-you-go system, it became even more difficult to undo the system. Simultaneously, it abandoned the principle of tying benefits exclusively to payments and added a number of redistributive elements, such as providing additional benefits to elderly recipients who were married. With its mix of insurance principles and redistribution, social security carefully straddled the political boundary between stressing self-reliance and welfare.

Expanding Coverage and Benefits

Over the course of the next few decades, as the economy grew rapidly, social security continued to expand, covering more and more workers and adding new benefits. As Andrew Achenbaum observes, "as long as the number of new and current contributors far exceeded the number of beneficiaries, legislators could liberalize existing provisions, expand coverage, and increase benefits—and still point to huge surpluses in the trust funds" (Social Security, p. 3). In 1940, 43.5 percent of the labor force was covered by social security's insurance program. This rose to 55 percent in 1949. In 1950 farm and domestic laborers were added to the system. A few years later most of the self-employed were added, as well as military personnel, and coverage reached 78 percent in 1955. Subsequent expansion of occupational coverage pushed this figure to 85 percent by 1968. September 1950 also saw the first across-the-board increase in social security benefits, by a dramatic 77 percent, and Old Age and Survivors Insurance benefit payments became larger than Old Age Assistance payments for the first time. Subsequent benefits increases were often passed just before elections, as they were in September of 1952,1954, and 1972. Social security's replacement rate—measured as the OASI benefit in the first twelve months of retirement as percentage of employment income in the preceding twelve months—was 39 percent for the average one-earner couple in 1940. Due to inflation, this fell to 23.5 percent before the 1950 benefits increase and then rose to 52 percent in 1955, 58 percent in 1975, and 62 percent in 1995. In 1956 the Social Security Act was amended to provide monthly benefits to permanently and totally disabled workers aged fifty to sixty-four and for disabled children of retired or deceased workers. Old Age, Survivors and Disability Insurance (OASDI) became the system's new name. In 1961 men were allowed to take early retirement at age sixty-two (with lower benefits) for the first time. In 1965 health insurance was added to the social insurance umbrella, with the establishment of Medicare, although the Social Security Administration did not run this program. In 1972 amendments were adopted that expanded benefits considerably, eased earnings restrictions on nonretired workers and began to automatically adjust future benefits for the impact of inflation. In addition, the state-based supplemental payments to the needy, blind, and disabled elderly were federalized as the Supplemental Security Income (SSI) program, administered by the Social Security Administration. By 1972 every major idea of the 1935 Committee on Economic Security had been enacted, coverage had become nearly universal, and older Americans had a deep sense of "entitwlement" to their social security benefits. The growth of social security can be seen in tables 1 and 2. (The SSI columns' figures before 1980 are for its predecessor programs: Old Age Assistance, Aid to the Blind, and Aid to Permanently and Totally Disabled.

Table 1

Table 2

These programs are not part of social security's insurance system.)

Operating Procedures

Before examining social security's evolution in the twentieth century's last quarter, it will be valuable to explain its operating procedures. The insurance portions of social security (retirement, survivors, and disability benefits) have always been paid for by a payroll tax. Initially, the tax was 2 percent of the first $3,000 earned by employees (the "earnings base"). The tax is automatically deducted from payroll and is officially evenly split between the employer and the employee. However, most economists believe that the tax is effectively paid completely by the employee, whose pay would rise by the entire amount of the tax if it did not exist. The tax rate rose to 3 percent in 1950, 6 percent in 1960, 8.4 percent in 1970, 10.16 percent in 1980, and 12.4 percent in 1990 and 2000. The earnings base was also gradually increased, generally much faster than the inflation rate, reaching $4,800 in 1960, $25,900 in 1980, and $76,200 in 2000.

Social security retirement benefits are calculated in several steps. First the worker's Average Indexed Monthly Earnings (AIME) are calculated. Under the procedures adopted in the 1970s, all earnings on which a worker paid social security taxes up until the year he or she turned sixty are "wage indexed" to compensate for past inflation and real wage growth. To accomplish this, each year's wage is multiplied by an "indexing factor" that equals the ratio of the average national wage in the year the worker turns sixty to the average national wage in the year to be indexed. From this set of earnings, the worker's thirty-five best years are selected, added together and divided by 420 (the number of months in thirty-five years). This amount is the AIME. The second step determines the worker's Primary Insurance Amount (PIA) by applying a progressive formula to the AIME to calculate the monthly benefit that the person would receive if he or she retired at the "normal" retirement age. (The normal retirement age was sixty-five from the beginning of the social security system until 2003, when it begins gradually increasing to age sixty-seven by 2025.) The progressive formula has been selected so that low-earning workers receive payments that are disproportionately higher—compared to the taxes that have been paid in—than for high-earning workers. For example, in 2001 the Primary Insurance Amount was 90 percent of the first $561 of the retiree's AIME, 32 percent of the AIME over $561 and up to $3381, and 15 percent of Average Indexed Monthly Earnings above $3381. Adjustments are made to the retiree's Primary Insurance Amount, which is reduced for those taking early retirement and can be increased by as much as 50 percent if the retiree has a spouse who had little or no earnings. Finally, the monthly benefit check is adjusted annually for changes in the cost of living. The adjustment is determined by the rate of inflation in the Consumer Price Index (CPI). Most economists believe that the CPI overstates inflation, so this means that the retiree's monthly benefit buys more over time.

One of social security's initial purposes was to reduce unemployment by inducing older workers to retire. Throughout its history, social security has had a retirement earnings test. The 1935 Social Security Act prohibited any payment when income was earned in "regular employment." In 1939 "regular employment" was defined as earning more than $15 per month—about 25 percent of the minimum wage. The economist Donald Parsons estimates that this earnings test increased the retirement rate for men sixty-five and over by about six percentage points in 1940. In 1950, the income threshold was raised to $50, and the retirement test was eliminated for those age seventy-five and older. In 1960, for the first time, earnings over the exempt amount did not produce total loss of benefits; instead, for income in a certain range, benefits were reduced $1 for every $2 in earnings. In 1990, this rate was cut to $1 for every $3 in earnings for workers above the normal age of retirement. In 2000, as unemployment reached its lowest rate in over thirty years, both houses of Congress unanimously voted to eliminate the retirement earnings test for workers above social security's normal retirement age.

Comparing taxes paid to benefits received, it is possible to calculate the rate of return on a worker's social security "investment," just as one would for a private investment. Such calculations show that social security's rate of return was very high for the first population cohorts covered by the system. Rates of return for those reaching sixty-five in 1950 averaged about 20 percent. By 1965 returns fell to about 10 percent and they continued this downward trend because tax rates had increased and retirees had now been taxed for all or most of their working lives. Inflation-adjusted average rates of return from OASI are given in table 3, which shows that lower-income workers have higher rates of return. Single males' average

Table 3

rates of return are lower than for single females because women live longer than men and therefore collect more benefits. Studies also show that blacks have lower rates of return due to their lower life expectancies. The table shows that rates of return are projected to continue declining—assuming that taxes and benefit formulas are unchanged.

Problems and Changes

By the mid-1970s, it was becoming clear that the mature social security system could not continue to finance all the benefits it had promised. In 1975, for the first time since 1959, social security ran a deficit, spending more on benefits than it collected in taxes. Deficits occurred again in 1976 and 1977 and were projected to continue, exhausting the Social Security Trust Fund—U.S. government debt owned by the social security system—by the early 1980s. In response, Congress substantially increased social security taxes, and benefits were scaled back by reducing spousal benefits and amending the indexing procedure. President Carter, signing the bill into law, predicted that these moves would make the system sound for decades to come. He was wrong. By 1981 worries about funding shortfalls reappeared and the Reagan administration proposed additional cuts in benefits, including scaling back the cost-of-living inflation adjustment and reducing early retirement benefits. The powerful senior citizens' lobby greeted these proposals with a withering wave of protests and the Senate immediately rejected them, but polls showed that two-thirds of the public were "not too confident" or "not at all confident" in the system. To defuse the issue, the president and Congress appointed the bipartisan National Commission on Social Security Reform, chaired by Alan Greenspan, to make recommendations to solve social security's financing crisis. In 1983, after intense political bickering, Congress accepted the Greenspan commission's proposals to further increase taxes, begin taxing the benefits of higher-income retirees, and gradually increase the normal retirement age from sixty-five to sixty-seven. Taxes were expected to greatly exceed expenditures so that the system's trust fund could be built up in anticipation of the retirement of "baby boomers" born between the end of World War II and the early 1960s. The bill was signed amid predictions that the funding problem was solved for generations to come, and the Social Security Trust Fund, which had never exceeded $40 billion before 1983, began to grow. It reached $214 billion in 1990 and $931 billion in 2000.

Unfortunately, this nest egg did not appear to be large enough given demographic trends and somewhat pessimistic projections of economic growth. By 1993, social security's board of trustees projected that OASDI would begin running deficits around 2015. Social security's spending would then exceed income by an everincreasing margin, and the board expected the trust fund to be exhausted by about 2035. The number of OASDI beneficiaries per one hundred covered workers, which had been 6.1 in 1950 and 26.6 in 1990, was expected to climb to 42.7 by 2030—there would be only a little more than two workers paying for every beneficiary as the population aged and life expectancies increased. In light of these pessimistic predictions, the 1994–1996 Social Security Advisory Council released its report in early 1997. Unable to achieve consensus, the council offered three options. The "Maintain Benefits" option (supported by six of the thirteen council members) proposed to essentially maintain the historical structure of social security by increasing taxes and slightly reducing benefits. However, the other two options broke with tradition. The "Personal Security Accounts" option (supported by five members) advocated a partial privatization of social security, proposing to divert nearly half of the social security tax into mandatory personal retirement accounts, allowing individuals to put their own social security funds into the stock market. The "Individual Accounts" option (supported by two members) was in between the other two, proposing that social security payroll taxes be increased, but that this money be put into government-run individual retirement accounts.

Leading economists, including the former Council of Economic Advisors chairman Martin Feldstein, began to advocate a transition to a completely privatized social security system. They argued that social security had slowed economic growth by reducing the national savings rate, reasoning that if social security did not exist workers would have saved more for their retirements and this savings would have boosted the investment rate, increasing the nation's capital stock. Because social security is mostly a pay-as-you-go system, however, the money was never saved and any money in the trust fund was lent to the government rather than invested. Feldstein estimated that this effect probably had reduced national income by about 6 percent and that social security taxes further reduced national income by curbing work incentives. Privatization advocates pointed out that inflation-adjusted long-run stock market returns have been about 7 or 8 percent per year—much higher than the returns earned and promised by social security. Privatization would essentially be a forced savings plan, but its critics warned that many individuals were not competent to make their own investment decisions, that the stock market was very volatile, that privatization allowed no room for redistribution, and that privatized plans would have much higher administrative costs than the social security system. Privatization's fans pointed to the success of Chile, which in 1981 replaced its failing pay-as-you-go retirement system with a privately managed mandatory savings program. Chileans earned impressive returns in their new system, which was soon imitated around the world. Amid these developments and a booming stock market, politicians began to advocate similar plans. President Bill Clinton floated the idea of investing surplus social security funds in the stock market, and in his campaign for the presidency in 2000 George W. Bush advocated reforming social security so that it would offer private savings accounts.

Many have seen social security as the most successful government program in American history. It has been credited with bringing true security to American workers, reducing the fear of poverty in old age, allowing more of the elderly to retire and giving them the resources to live independently. Others see it as a flawed system, an inter-generational transfer mechanism that has benefited the earliest cohorts of retirees, but which promises too little to the current and future generations, explaining most of the elderly's rising retirement, income, and independence as extensions of historical trends caused by continued economic growth. By the early twenty-first century, social security had become the subject of an intense political argument.

BIBLIOGRAPHY

Achenbaum, W. Andrew. Social Security: Visions and Revisions. New York: Cambridge University Press, 1986.

Berkowitz, Edward D., ed. Social Security after Fifty: Successes and Failures. New York: Greenwood Press, 1987.

Berkowitz, Edward D., and Kim McQuaid. Creating the Welfare State: The Political Economy of Twentieth-Century Reform. Lawrence: University Press of Kansas, 1992.

Costa, Dora L. The Evolution of Retirement: An American Economic History, 1880–1990. Chicago: University of Chicago Press, 1998.

Feldstein, Martin. "The Missing Piece in Policy Analysis: Social Security Reform." American Economic Review 86, no. 2 (1996): 1–14.

Ferrara, Peter J., and Michael Tanner. A New Deal for Social Security. Washington, D.C.: Cato Institute, 1998.

Haber, Carole, and Brian Gratton. Old Age and the Search for Security: An American Social History. Bloomington: Indiana University Press, 1994.

Lubove, Roy. The Struggle for Social Security, 1900–1935. Cambridge, Mass.: Harvard University Press, 1968.

Myers, Robert J. Social Security. 3d ed. Homewood, Ill.: Irwin, 1985.

Nash, Gerald D., Noel H. Pugach, and Richard Tomasson, eds. Social Security: The First Half-Century. Albuquerque: University of New Mexico Press, 1988.

Parsons, Donald O. "Male Retirement Behavior in the United States, 1930–1950." Journal of Economic History 51 (1991): 657–674.

Quadagno, Jill. The Transformation of Old Age Security: Class and Politics in the American Welfare State. Chicago: University of Chicago Press, 1988.

Rejda, George E. Social Insurance and Economic Security. 6th ed. Upper Saddle River, N.J.: Prentice Hall, 1999.

Rubinow, Isaac M. The Quest for Security. New York: Henry Holt, 1934.

Social Security Administration, Social Security Online: History Page. http://www.ssa.gov/history/

Steuerle, C. Eugene, and Jon M. Bakija. Retooling Social Security for the Twenty-first Century: Right and Wrong Approaches to Reform. Washington, D.C.: Urban Institute Press, 1994.

Weaver, Carolyn. "On the Lack of a Political Market for Compulsory Old-Age Insurance Prior to the Great Depression." Explorations in Economic History 20, no. 3 (1983): 294–328.

———. The Crisis in Social Security: Economic and Political Origins. Durham, N.C.: Duke University Press, 1982.

RobertWhaples

See alsoMedicare and Medicaid ; New Deal ; Retirement ; Retirement Plans ; Welfare System ; andvol. 9:The New American Poverty .