Defined Benefit vs. Defined Contribution:
Let's see where President Bush is right, viz. his Social Security proposal, and where he is wrong. He is right that the system is in trouble. The dimensions of the problem and the expected insolvency date are debatable, but there is no doubt that the system has a structural problem. You cannot run a pay-as-you-go system indefinitely if the number of contributors (workers) is constantly declining and the number of beneficiaries (retirees) is constantly increasing. At some point, the system will
crash. His basic approach, to allow workers to use a portion of their payroll taxes to set up Personal Retirement Accounts, would probably be a benefit to workers who took advantage of the opportunity. More important, it makes sense to move the system away from a "defined benefit" approach to a "defined contribution" approach. This is what is happening in the corporate world, precisely because the "defined benefit" programs are by definition long-term liabilities, and they have had a tendency to grow beyond the organization's ability to keep up with the funding. As a result, corporations have been moving to "defined contribution" plans (like 401Ks) that have the twin advantages of incurring no long-term liability for the company and of giving workers control of their funds. This approach actually adds security, both for the organization and for the workers. The government is in exactly the same position, looking ahead to liabilities it will not be able to pay. Where the President is wrong is that he is presenting the right type of solution without a plan to pay for the transitional costs. These Personal Retirement Accounts can be looked at as a zero sum game (reduced liability pays for reduced income) only if you take the long view, the very long view. In the short and middle term, the proposal will leech money out of the system, move the insolvency date forward, and increase the likelihood that somewhere down the road, sooner now rather than later, retirees will get their benefits cut. For that reason, the older generation is absolutely right to be leery about the proposal. What the President needs to do is present a plan for paying the transitional costs, and we think the plan needs to share the pain. The wealthy should pay more (through a complicated formula combining a slight increase in the income ceiling for payroll taxes and a diminishment in the proportion of their contributions returned back to them as benefits); retirees should contribute with a small cut in the COLA increases; working people, including near retirees, should contribute by having the retirement age increased on a pro-rated basis; and all workers and employers should contribute with a small increase in payroll taxes. No one group should bear the complete burden. If this is done fairly but substantially, people will feel more comfortable transitioning to a defined contribution approach, which can and should in this case be bolder and more dramatic. Wile E.