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The Disastrous Deal of 1972

Mises Daily: Tuesday, December 07, 1999 by

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"There is no doubt that the real destroyer of the liberties of any people is he who spreads among them bounties, donations and largesse." Plutarch (a)

"Nothing could be more obsolete than to attempt to liberate mankind from poverty by political means; nothing could be more futile and dangerous." (Hannah Arendt) (b)

From its beginning in the mid 1930s, Social Security, the foundation program of the American welfare state, has been an inherently political system. Benefits and taxes have been determined by special interests. The program has been dominated by the needs of politicians to win elections. Social Security surpluses have been pillaged (1), diverted to other purposes, a form of political theft predicted by Senator Arthur Vandenberg back in the 1930s when the program was in its infancy. (2)

From the 1939 Social Security amendments that ended the pretense of Social Security as insurance (3)--a pretense that had been necessary to prevent the courts from striking it down (4)--to the decision to add disability insurance just in time for the 1956 elections, policies have been tailored without regard for future generations. The taxpayers of the future, who had no one to represent them, would pay the higher tax rates required to keep the political promises of today.

But it is not necessary to cite the works of critics of the system to document this political legerdemain. FDR conceded it. Speaking with a friend about Social Security payroll taxes, FDR said "those taxes were never a problem of economics. They are politics all the way through." (5) He boasted that the taxes would build political constituencies that would ensure that Social Security would go on forever and that "no damn politician" could ever scrape the system.

Despite FDR’s boast, there were politicians, in the first 35 years or so of Social Security’s existence, who thought the system was flawed and should be scrapped or radically changed. These critics included Governor Alf Landon in 1936, Rep. Carl Curtis in the 1950s and 1960s as well as Senator Barry Goldwater, who for one brief moment in the 1964 presidential campaign, suggested that Social Security should be made voluntary. But by the early 1970s, any serious discussion in Congress about alternatives to Social Security would be put off limits by a bi-partisan deal designed to re-elect politicians of both parties.

Crossing the Rubicon in 1972

After nearly 40 years of Social Security politics, a landmark decision was reached in the early 1970s, a decision to automatically increase Social Security benefits when inflation indices rose. That’s something that would happen a lot in the following decade as large loose monetary policies wrecked havoc with the American economy. The federal government’s critical entitlement decision set off a chain of events that would ensure that higher Social Security payments would hurt both taxpayers and beneficiaries. Both would be run over by double-digit inflation.

The 1972 decision on Social Security was little examined by economists and commentators at the time for its long-term consequences. But a few years later its consequences could not be ignored. That’s when the system all of sudden became so expensive that it threatened to implode.

Today one of the participants in the critical decision of 1972 concedes it "was the worst fiscal mistake" of the Nixon administration, (6) which is saying quite a lot since many economists blame Nixonomics for the disastrous policies that led to stagflation. Stagflation, by the way, was something Keynesians and those who believed in the Phillips Curve had said could not happen. Inflation could not happen at the same time as sluggish growth rates, they said.

Pete Peterson, then Secretary of Commerce in the administration of President Richard Nixon, is now very critical of the bi-partisan deal between a Republican president and a Democratic Congress that raised Social Security benefits by 20 percent in an election year--a common practice--but this time Congress and the president added a cost of living clause, something that had never happened before in the history of the system. Even though Nixon had originally proposed a five percent benefits raise, he embraced counter proposals by the Democrats that added 15 percent to his plan. Yet, when originally offered, the higher number was dismissed by Nixon aide John Ehrlichman. He said the 20 percent number was "a political ploy and cannot be considered seriously." (7)

But the 20 percent increase was serious--very serious especially for young and middle class wage earners in the 1970s, 80s and 90s who would find payroll taxes eventually ate up more of their pay than even the hated federal income tax. Payroll taxes would jump from 9.60 percent--divided between the employer and the employee--at the beginning of the 1970s to 15.30 today, an increase of just under 60 percent. And, as we will see later on, high payroll taxes, which hinder job creation, could rise another 60 percent over the next three decades. America might copy many of the social welfare states of Western Europe, where Social Security tax rates of around 30 percent are common. Along with those higher payroll taxes, most Western Europe economies have lower growth rates and higher unemployment rates than in the United States.

The commitment to colas and outdoing his opponents in expanding Social Security was part of Nixon’s Keynesian transformation. Vice President Hubert Humphrey, campaigning against Nixon in the 1968 presidential race, had pledged his backing for colas. So Nixon, in a close contest, also said that he was for colas. Nixon said that colas would "depolitize, to a certain extent, the Social Security system and give greater stability to what has become the cornerstone of our society’s social insurance system."(8) Nixon liked the Social Security hike so much that he tried to put a GOP logo on checks containing the announcement of colas.(9)

Social Security bi-partianship--a method of silencing the few critics of the system--was given a boost by the unprecedented. 1972 deal.This political bidding for votes was to be a disaster for the taxpayers. A few years after the 1972 deal the Social Security system, which had run surpluses in the 1960s, started to run up red ink. Taxes had to be increased again and again. Presidents Carter and Reagan, in approving separate "bi-partisan" payroll tax hike deals in the late 1970s and early 1980s, both announced that Social Security had been saved.

History has shown that Carter and Reagan, supposed ideological enemies, were both wrong. Automatic increases in entitlements--joyfully approved by both Republicans and Democrats in 1972--meant that tax increases couldn’t keep up with promises. After many tax hikes the system’s surpluses grew. But the surpluses didn’t grow at nearly the pace that will be needed to pay baby boomers, who will begin retiring around 2,012 and expecting the government to fund their retirement. And many baby boomers are under saving for retirement, no doubt, in part, because of the high payroll taxes that had to be raised many times to pay for the 1972 deal.

Even Nixon, years later, conceded the 1972 deal had been a mistake. He "regretted pegging benefits to the cost of living."(10) However, at the time, nary a peep was heard from the highly popular Nixon. Or Peterson. Or from the press, which generally applauded the bill. Or from the Republicans or Democrats, most of whom voted for the package (It passed in the House by 302-35 and in the Senate by a 82-4 vote).(11) Those few voting against higher Social Security benefits in an election year were risking political suicide.

No More Social Security Politics

Automatic Social Security payment increases meant the debate about entitlements was over. Social Security had become a secular religion that was beyond debate. The 1972 deal meant no more nasty votes on rate hikes. No more having to put up with a handful of maverick members of Congress who wanted to know how these things would be paid for; who questioned the ethics of election year increases or who wanted to closely examine what Social Security was becoming---the biggest entitlement---and what it would be for our grandchildren. Few were looking closely at what Social Security was.

Even the generic title for Social Security and other government welfare programs---entitlements---was misleading as we will see later on. No one was or is "entitled" to anything. There are no guarantees.

But in 1972 any possible substantial debate over Social Security was ended for a generation. Social Security, as so many lawmakers of both parties have said subsequently during budget debates, was "off the table." Thanks primarily to the presidential ambitions of key political players----Richard Nixon, seeking a huge re-election vote, Wilbur Mills, the most important Democrat in Congress, who was going to run an abortive campaign for the Democratic presidential nomination and Congressional barons such as Senate Finance Committee Chairman Russell Long----Social Security would not only have an unprecedented expansion, but its principles would be beyond debate.

Adding 100 percent cost of living increases (colas) was great politics. Both a Democratic Congress and a Republican president were easily re-elected. Nixon, who wanted the taxpayers to know that he had approved the increases, exploited its political value to the maximum. Senator George McGovern, a long-shot underdog presidential candidate running against Nixon who later would have to counter the political fallout from a disingenuous announcement by National Security Adviser Henry Kissinger a few days before the election that "peace was at hand" in Vietnam (it wasn’t), complained that Nixon was playing Social Security politics by taking credit for the hike.

The mailing notifying Social Security beneficiaries that payments were higher "implies that older people are indebted to Richard Nixon for the 20 percent increase…[That’s] very much like Scrooge trying to take credit for the spirit of Christmas," McGovern complained.(12)

The mailing went out just four weeks before the Nixon re-election landslide (Nixon carried 49 states. The hapless McGovern only won Massachusetts and the District of Columbia).

However, McGovern wasn’t above playing Social Security politics either. In the Senate, he had offered a bill containing the 20 percent increase and colas. Nixon outmaneuvered McGovern. The GOP could play Social Security politics as well as the Democrats.

In fact, there was no philosophical disagreement over expanding the program, merely a disagreement over who was going to get the political credit. The 1972 deal meant American politics’ two major parties were the Big Government party and the Bigger Government party.

A Few Cassandras

Still, a few in Congress thought something was wrong when administration experts said the raise and colas were actuarially sound. The experts based their projections on the expectation that wages would have the sane dynamic growth over the next decade as they had in the previous decade. These projections came just as real wages would stagnate.

"I will not dwell on the question of whether the experts…are entitled to our confidence," said Representative Barber Conable. "I say only that we in the Congress are not entitled to the confidence of the American people if we allow ourselves to be stampeded into this vote."(13)

Representative John Byrnes complained that a 20 percent increase would inevitably mean higher taxes. He said no testimony had been taken by Mills’ Ways and Means Committee on how the deal would be financed. "Some may call what we’re doing here cute politics. I call it irresponsibility."(14)

The deal was a decision that needlessly cost the taxpayers billions of dollars because the benefits formula overweighted inflation though a system of double indexing. That meant the system was paying out too much and the trust fund started to be depleted at an alarming rate.

From 1975, when the cola increases went into effect, until 1981, the trust fund, which includes funds for Medicare, dropped from $55 billion to $40 billion, a decrease of some 27 percent.(15). The trust fund, by the spring of 1977, had only eight months of payments left. Wrote William Simon, who was Secretary of Treasury in the mid 1970s, "at the rate of depletion the trust funds would be depleted by early 1980s. The unfounded liabilities of Social Security add up to more than $4 trillion."(16)

But the system would not be allowed to fail. The workers would be required to "save" it. Payroll taxes were raised, but it was not enough. Another bi-partisan deal was on the horizon in 1983, which would again "save" the system by raising the rates some more.

Mills’ Metamorphosis

Wilbur Mills had originally opposed the addition of colas in the 1960s. He initially thought that colas--as well as other automatic spending programs--would take power away from Congress. He asked, "Is Congress going to get any credit for future adjustments in benefits, or are we going to...let the Secretary of HEW (Health, Education and Welfare) get all the credit."(17)

Mills ultimately changed because the cola issue was politics. And, after strong efforts by the AARP, an organization that was and remains instrumental to the presidential hopes of many candidates, Mills reversed himself.(18)

Some have suggested the AARP was not the key element in Mills’ volte face. Rather, they might have used FDR’s "politics all the way through" phrase to explain the change. Fellow Democrat Russell Long, chairman of the Senate Finance Committee, said Mills and his other Democratic colleagues backed colas because they were not going to be outflanked by a Republican administration.

Long said "one reason Chairman Mills came out and advocated this is that the President was likely to advocate it any day." "If there is going to be a parade, I think I would rather be at the front of the parade rather than the tail end," Long said. (19) Interestingly, Health, Education and Welfare Secretary Elliot Richardson admitted that Nixon and Congress were in a bidding war over Social Security benefits. (20)

The success of the Nixon-Mills entitlement deal set a dangerous precedent. Both major presidential candidates, despite their supposed philosophical differences, were in basic agreement about the expansion of the welfare state. The major parties would no longer argue about automatically expanding Social Security benefits. And both parties---when they would start encountering deficits that would threaten to drown the system in red ink---would get together and jointly agree to let more tax increases go through on a "non-partisan basis."

Social Security politics ended at the Potomac. Just as both parties accepted the foreign policies of the cold war, so, also, did they accept the basic assumptions of the welfare state, which were no longer up for debate. By the 1980s, Ronald Reagan, the supposed enemy of big government, would say of Social Security that it "has proven to be one of the most successful and popular (federal) programs."(21)

The 1972 Social Security Deal in History

The remarkable thing about the 1972 episode is that few pols and other elites thought anything remarkable was happening at the time. The cola package was seen as an "incremental" expansion of Social Security. But, as a few commentators have subsequently said, this was a massive expansion disguised as incrementalism.

"As far as I know," writes Peterson, "our domestic economic staff never seriously analyzed the cost of the future cola increases."(22) Nixon, by the way, didn’t even think the deal was important enough to mention. In Nixon’s some 1,100 page memoir, there is not one mention of Social Security. Given the historic importance of this deal, it is remarkable that Nixon saw no need to discuss his election year deal.

But the significance of the bi-partisan Social Security agreement of 1972 cannot be ignored, understated or exaggerated.

"Few citizens or politicians knew the damage that had been done to Social Security in 1972," wrote former Senate Finance Committee staffer and Social Security commentator Carolyn Weaver. "In one fell swoop the new indexing provisions converted a system characterized by ad hoc growth to one of automatic and uncontrolled growth…"(23)

It meant that, because of over promising, those receiving benefits in the 1970s would receive a better deal than those in the next generation. Each succeeding generation of recipients would get shortchanged. Each future generation would receive less and each generation of taxpayers would have higher payroll taxes. It was, is and remains a pyramid scheme. These conclusions were tacitly acknowledged some twenty years later by a government commission investigating the skyrocketing costs of entitlements.

"Our current entitlement system is based on a huge generational injustice. On average, today’s retired Americans will receive huge windfalls that far exceed the value of their prior contributions. On average, Baby Boomers will be lucky to break even---and even that will be only possible by condemning still younger generations to unthinkable tax hikes," according to the commission.(24a).

A separate study by the Congressional Research Service found more "generational injustice." The payback period for the average worker who retired in 1960 was 1.1 years. By 1980, it was 2.8 years. And, for those retiring over the next 30 years, the payback period will be between 12.9 and 18.3 years!(24b).

The same study showed Social Security’s guardians were and are poor money managers. The study would show real returns for average taxpayers on Social Security taxes will plummet to about 1.5 percent over the next two decades.(25) The real returns of the stock market over the past 75 years---in bad times and good—have been about ten percent a year,(26) although superior money managers usually perform a lot better than that.

Who Needs Congress?

Mills had been originally right in opposing colas. They did take away power from Congress and allowed administrative agencies such as Social Security---it would become so big that in the 1990s it would merit its own cabinet level department---to make vital decisions on spending. Social Security decisions and legislation are often so complex that few members of Congress can understand what is happening.

Thanks to the Mills/Nixon deal, more and more of the federal budget would be spent without any decision by Congress. The Kerrey-Danforth entitlement commission took notice.

In 1973, just as the colas were going to be phased in, mandatory spending took up 45 percent of the federal budget, according to the commission. Most of it (38%) was from so-called entitlements. Ten years later, mandatory spending was 56.3 percent of the federal budget and entitlements were 45.2 percent. By 1993, the numbers were 61.4 percent and 47.3 percent, respectively. And, by the year 2,003, mandatory spending is projected to take up 72 percent of the federal budget, with 58.2 percent going to entitlements.(27) At this pace, Congress’ role in social spending may become as inconsequential as whether modern presidents wage war or not!

The Mills/Nixon deal was still being paid for long after the pols had been elected and the major participants in the deal had gone to their graves. Do young people paying high payroll taxes today know who Wilbur Mills was? Or Russell Long? Or that Richard Nixon’s controversies involved more than Watergate? One might paraphrase John Maynard Keynes and say that we’re all the prisoners of long-dead politicians whose names we have long forgotten. These forgotten pols ensured that Congress was no longer needed.

Entitlements would grow at an accelerated pace and regardless of whether a supposedly anti-big government Congress was elected or not. For decades after the Mills/Nixon deal anyone who dared to challenge Social Security was a "candidate for a frontal lobotomy," according to Republican Jack Kemp.(28)

The Future of Social Security

It is important to study the history of this system as Americans debate how to "save" this system, a system, many historically illiterate Americans seem to forget, that has been "saved" almost as many times as some of the characters in Sinclair Lewis’s timeless novel of evangelism, "Elmer Gantry."

Today, the same Pete Peterson who admits the 1972 accord was a dreadful political deal, calls for the continuation of the Social Security system in a modified form, with taxpayers allowed to control some of their "contributions." He writes admiringly of the Singapore Social Security system in which citizens are required to pay into a central account.

President Clinton says Social Security can be saved merely by giving the government more authority over the system’s assets, which has been exactly the problem throughout its history: The government--or rather pols serving special interests--played with the assets. Sometimes presidents use these trust funds to pay off political debts or to mislead people as to the nation’s economic condition.

Say two commentators "Social Security is not a trust fund. Congress uses the reserves built up in Social Security to mask the real size of the federal budget deficit."(29).

Still, the president actually thought--for a while--that the solution to the system’s problem was just let the government invest some of the system’s revenues in the stock market and the system will be saved, an idea that Vandenberg, 62 years ago, said would "amount to socialism."(30)

Advocates of the Clinton plan seem to think that the same government that squandered billions of dollars over the years, the same government that raised Social Security taxes 24 times over the past 62 years--under both Republicans and Democrats who both played, play and will continue to find new ways to play Social Security politics--will be an excellent money manager.

But if I told you the same adviser who had stolen or misallocated your money for almost 65 years now had a new plan what would be your reaction? Most people, I believe, would want to fire the adviser and maybe even sue him for good measure. They would want to know why no one had launched an investigation. Someone might ask a consumer advocate such as Ralph Nader to charge into the mess if it was a private business that had caused the problem.(31)

The problem of 1972 is the problem of 1956, the problem of 1935 and the same problem of today. Political control of the retirement assets of millions of Americans means their money can be stolen or misallocated as soon as the next election or the next bi-partisan accord. There is every indication that, whatever political solution is imposed, it will be done with utter disregard for future generations. Fetuses don’t vote.

"I’m not going to spend a lot of political capital solving some other guy’s problem in the year 2,010,"(32) said a candid official in the Reagan administration who was asked about the future problems of Social Security and other entitlements. The problem is basic and can not be fixed with another reform commission: The original Social Security Act is open-ended, giving the government unlimited authority over the system, its assets and its promises.(33) Nothing is guaranteed. And the courts have held Congress and the administration are within their rights to take away anything contained in the Social Security Act.(34)

The problems of Social Security mean history tragically or farcically repeats itself time and again. Looking at the past, one may view what will happen in the future if this system is continued: Either taxes must be raised again or benefits cut again.(35) Or probably, as the system continues its inevitable mismanagement and decline, both.

No amount of tinkering can change human nature--the nature of unscrupulous people of all political stripes who want to win elections and are not very particular about abusing their power to tax. James Madison, in Federalist 10, wrote of the taxing power that "there is, perhaps, no legislative act in which greater opportunity and temptation are given to a predominant party to trample on the rules of justice."(36)

In 1972, Nixon, Mills and most of Congress, serving the special interests of a "predominant party" and representing the demands of those who expected greater entitlements, "trampled" on the rights of those who would have to pay for them. The bill for this mischief continues to grow and will be assessed against future generations as long as Social Security survives.

Notes

a) "The Big Lie. What Every Boomer Should Know About Social Security and Medicare" by A. Haeworth Robertson, p67 (Retirement Policy Institute, Washington, D.C., 1997

b) "On Revolution," by Hannah Arendt, (New York, Viking Press, 1971), p107.

1) Attending a Securities Industry Association conference in Florida in the early 1990s, I heard economist Douglas Bernheim of Stanford University, who has studied the problem of low savings rates for Merrill Lynch, describe the problem of the Social Security trust fund. "The history of the Social Security system is that, whenever there have been big surpluses, Congress can’t resist using them." (Author’s notes)

2) "Social Security After 50: Successes and Failures," Edward D. Berkowitz, editor, (Greenwood Press, New York, 1987) pp 60-61. Also see "The Private Papers of Arthur Landenberg," Arthur H. Landenberg, Jr. (Houghton Mifflin Company, Boston, 1952).

3) "When in 1935 the United States introduced the (Social Security) scheme, the term 'insurance' was retained---by a stroke of promotional genius---simply to make it more palatable. From the beginning it had little to do with insurance and has since lost whatever resemblance to insurance it may have ever have had." From F.A Hayek’s , The Constitution of Liberty, pp 288-289, (University of Chicago Press, 1960)

4) See "Louis D. Brandeis, Felix Frankfurther and the New Deal" by Nelson L. Dawson.

5) "The Age of Roosevelt," Vol 2, The Coming of the New Deal," by Arthur Schlesinger, Jr., (Houghlin Mifflin, Boston, 1962), pp 308-309.

6)The comment comes from Pete Peterson’s "Will America Grows Up Before It Grows Old. How the Coming Social Security Crisis Threatens You, Your Family and Your Country," pp 98-100, (Random House, New York, 1996)

7) See "Policymaking for Social Security," by Martha Derthick, p360, (Washington, Brookings Institute, 1979)

8) "Nixon Reconsidered" by Joan Hoff, p135, (Basic Books, New York, 1994)

9) See "The AARP: America’s Most Powerful Lobby," by Charles R. Morris, p78, (Times Books, New York, 1996)

10) See Nixon’s comment that he "regretted" supporting "the pegging of Social Security to the cost of living" in Hoff, p 135.

11) Derthick, p362

12) "Promises to Keep. Saving Social Security’s Dream," p 58, by Marshall N. Carter and William G. Shipman, (Regnery, Washington, D.C., 1996)

13) Congressional Record (June 30, 1972), p 23734

14) Ibid, p 23732-33

15) The figures are from "Social Security. What Every Taxpayer Should Know," p78, by A. Haeworth Robertson, (Washington, D.C., Retirement Policy Institute, 1992). Robertson is a former actuary of the Social Security system. A critic of the system, he has called it "The Big Lie."

16) "A Time for Truth," by William Simon, pp 204-205, (Readers Digest Press, New York, 1978)

17) "The Crisis in Social Security. Economic and Political Origins," by Carolyn Weaver, p 162, (Durham, North Carolina, Duke University Press, 1982).

18) Derthick, p 358.

19) Derthick, page 359. Also see, page 346 for Richardson’s admission.

20) Ibid.

21) From "Social Security after 50: Successes and Failures," Edward Berkowitz, editor, p11, (Greenwood Press, New York, 1987)

22) Peterson, pp98-100.

23) Weaver, p170.

24) "The Bipartisan Commission on Entitlement and Tax Reform," (Washington, D.C., Government Printing Office, 1995), p55.

25) See Carolyn Weaver’s article on Social Security on p 299 of "The Fortune Encyclopedia of Economics," David Henderson, editor, (Warner Books, New York, 1993).

26) The compound rate of return of U.S. stocks between 1926-1993 was 10.2 percent, according to Ibbotson Associates, Chicago.

27) Bipartisan Commission on Entitlement and Tax Reform," p 10.

28) "Social Insecurity," by Dorcas Hardy, p 16, (Villard Books, New York, 1991)

29) From "The Fifteen Biggest Lies in Politics," p 148, by Major Garrett and Timothy J. Penny, (New York, St. Martin’s Press, 1998).

30) "The Private Papers of Arthur Vandenberg."

31) Interestingly enough, this is precisely what Helen P. Rogers, a certified financial planner, asked Nader to do at the back of her useful little book, "Social Security. An Idea Whose Time Has Passed," (Wellington Books, Carmel, California, 1985). On January 8, 1986, she wrote Nader that "If you are indeed a Champion of the Consumer you must raise you voice in protest over the bundle of inequities the Social Security system has become." To my knowledge, Nader has never responded to her request.

32) The official was Reagan’s OMB chief, David Stockman. Berkowitz, p 15.

33) Representative Carl Curtis, a Republican House member in the 1950s who was a critic of Social Security, often cited Section 1104 of the original Social Security Act, which said that Congress reserves "the right to alter, amend or repeal any provision of this act." From "Social Welfare in the United States," Poyntz Tyler, p. 55, (H.W. Wilson, Bronx, New York, 1955)

34) The story of Fleming vs. Nestor--in which a former Communist was denied his Social Security after "contributing" for many years and the U.S Supreme Court upheld the government--has been detailed in many places. See "The Social Security Fraud" by Abraham Ellis, pp 169-171, (Irvington-on-Hudson, New York, FEE, 1996)

35) That warning came from Senator Robert Kerrey. See "Wall Street Journal" of June 19, page 22. "Senators Air Beefs at Summers hearing.

36) "The Federalist Papers," Clinton Rossiter, editor, p80, (New York, The New American Library of Literature, 1961).