Galveston

Galveston ‘Opt-Out’ Plan Not a Serious Proposal for Social Security

(click here for a pdf of this fact sheet with sources)
(click here for a 1-page pdf version of this fact sheet)

WATCH GINGRICH AND ROMNEY DEBATE THE GALVESTON PLAN: 1/16/2012

Several Republican presidential candidates have discussed the so-called ‘Galveston plan’ as a preferable replacement for the current Social Security system. Prior to 1984, states and localities were not required to participate in Social Security, and those that had opted in could later choose to opt out. Under current law, once these entities opt in, they can no longer opt out. In 1981, prior to the change in the law, three counties in Texas – Galveston, Matagorda, and Brazoria – opted out of Social Security, and established, as an alternative, defined contribution plans, in which 6.1% of workers’ salaries, together with employer contributions of an additional 7.8% were placed in private accounts. Under these plans, all known colloquially as the Galveston plan, retirement funds are invested in the private market. Individuals have some choice over how they receive benefits (but not how their funds are invested).

At the time these plans were created, it was claimed that this type of arrangement would generate higher overall returns for retirees. In reality, the vast majority of workers have fared worse than under traditional Social Security. Compared with Social Security, the Galveston plan disproportionally benefits high earners with many years of participation in the plan and no dependents, and exposes all retirees to risks arising from inflation and swings of the stock market. Moreover, because even plan participants can earn benefits under Social Security with 40 quarters of coverage in employment covered by Social Security, many plan participants gain Social Security’s cornerstone protection, even though covered by the Galveston for most of their work lives. For this and reasons described below, the Galveston plan is simply not a viable alternative to a national Social Security system.

· Social Security and the Galveston plan do not share the same goals: Social Security is wage insurance that provides basic protection against loss of income resulting from retirement, disability or death of a worker; it is not intended to be a wealth-maximizing vehicle. Social Security’s aims at providing a measure of economic security and a guarantee of lifetime benefits for workers that have contributed to the system. Though Social Security funds could be invested in equities, Congress has decided that those funds should be kept in the world’s safest and most reliable investment, U.S. Treasury bonds. In contrast, supporters of the Galveston plan see that plan as a way to build personal savings, and some view it as a means of “maximizing returns” in the market. Its funds are invested in fixed-rate marketable securities.

· Nearly everyone fares worse under the Galveston plan, with the possible exception of high earners with no dependents. In 1999, the Government Accountability Office (GAO) reviewed the performance benefits of both individual and spousal benefits under the Galveston Plan and Social Security across three earning levels – low, median, and high – for the previous twenty-four years. Across all three earnings categories, spousal benefits are higher under Social Security, and much higher for low and median earners. For individuals, low and median earners would receive higher benefits under Social Security. High-earning individuals are the only group that might fare better under the Galveston plan, while most others would lose critical protections currently offered through Social Security. A 2005 report presented by Senator Barbara Boxer with the assistance of the Congressional Research Service concludes that “Americans at every income level are clearly better off with Social Security’s guaranteed, inflation-protected benefit. The only exception is high income earners. And that is true only initially; over the course of retirement, even higher income earners are better off with Social Security.” It is noteworthy that no comprehensive studies have been conducted since the recession, which started in 2008. It is possible that even high income workers with no dependents retiring in the last few years have done worse than they would have under Social Security.

· Women and low-income workers are not well served by the plan. Since the Galveston Plan's retirement benefits are based on what workers accumulate in their accounts during their term of county employment, low-wage workers lose the benefit of the progressivity in the Social Security benefit formula which provides proportionately larger benefits to those working for many years at low wages. Women and others who are likely to be intermittent or short-term employees often earn cumulatively less and would also lose important Social Security coverage. Unlike the Galveston plan, their Social Security work history stays with them as they move from job to job. Moreover, the plan does not require spouses to select a joint survivor annuity. And, unlike Social Security, there are no spousal benefits and there are no guaranteed benefits for divorced spouses.

· Substantial inflation risks appear with the Galveston plan. Inflation significantly erodes Galveston’s retirement, disability, and survivor’s benefits since the plan does not include annuities that are indexed to inflation. A Pension Research Council report noted that Galveston plan benefits could lose 46 percent of their purchasing power after 20 years, with yearly inflation averaging three percent. This threatens the purchasing power of benefits for seniors as time passes, when the adequacy of benefits is most important.

· Under the Galveston plan, workers do not control how their funds are invested. Many advocates of the Galveston model tout the fact that participants would have more autonomy over their retirement decisions. In fact, workers have no control over how their funds are invested; those decisions are made at the county level. Moreover, far from being able to ‘opt-out’ of the system, participation in the Galveston plan is mandatory.

· The Galveston plan’s options for claiming benefits means that some retirees could outlive their benefits, something that cannot occur under Social Security. Proponents of the Galveston plan point to the multiple ways one can claim benefits as a measure of the system’s flexibility. Retirees can withdraw their accrued benefits in several ways: a lump sum, for life (with smaller benefits), a fixed annuity for a certain number of years, or an annuity for life with a guaranteed number of years. Since Galveston benefits do not rise with inflation, many participants elect to take smaller monthly benefits up front to allow for larger benefits down the road, a choice Social Security recipients do not need to make. They can also withdraw their funds for certain unforeseen emergencies (e.g. illness, casualty loss). Because people often underestimate their future needs or find it hard to resist up-front payouts, many Galveston participants elect for shorter-term disbursements, leaving many extremely vulnerable and without support in their old age. This flexibility undermines the concept of retirement income security. Social Security beneficiaries need not worry about their individual accounts running out, since the program guarantees fixed, inflation-protected benefits for life.

· Under the Galveston plan, workers are subject to fluctuations of the stock market. Even though Galveston funds are invested conservatively, they still carry substantially more risk to workers and their families than traditional Social Security. One study has shown that a typical worker with a partial private Social Security account retiring in 2008 would actually have seen a negative net annual rate of return from his investments because of the recession – and lost $26,000 through the market. Market-based plans leave retirees vulnerable to the winds of economic fortunes at the time they retire; by contrast, Social Security provides benefits that are protected from both inflation and economic downturns.

· The Galveston plan offers better disability protection for some, while leaving some worse off. Under the plan, disabled workers are entitled to 60 percent of their wages at the time of disability, up to $5,000 a month, plus the value of their individual account. This means that the initial benefits for most categories of workers would be higher under the plan than Social Security. However, the redistributive benefit tilt doesn't apply to low-income workers as it does with Social Security’s formula, and benefits for all persons with disabilities are not protected against inflation. Also, unlike Social Security, the Galveston plan offers no additional benefits for disabled workers with dependents.

· The two plans’ options for survivors’ benefits are mixed, but the Galveston plan does not factor in a deceased worker’s dependents. Under Galveston, the life insurance benefit triples the worker's salary (with a maximum benefit of $150,000 and a minimum benefit of $50,000), and the balance of a worker's retirement account can be passed on, regardless of whether the worker has dependents. Single workers without dependents tend to fare well. But lost is the assurance of sustained family protection for families with very young children, especially those with low and moderate incomes. Also, since the Galveston benefit is based on the worker’s salary, and since younger workers tend to have lower salaries on average, workers under age 60 have lower benefits than Social Security would provide.

· Converting Social Security to the Galveston model would be prohibitively costly, requiring huge transfers from general revenues or large cuts in benefits, or both. Social Security is primarily a pay-as-you-go system, meaning that for the most part, current income paid-in to the program through FICA payroll tax contributions is used to fund benefits in the same year. The security of one generation’s retirement depends directly on the next. The Galveston plan cannot be expanded to a national scale without simultaneously paying for 54 million Americans who currently depend on Social Security, at an annual cost of $738 billion in 2011, and millions more who are nearing their retirement years. These enormous transition costs would place tremendous strain on the rest of the economy, and would be difficult to pass in the current political environment. The Galveston plan would allow workers and their employers to divert all of their FICA taxes into private accounts, forcing either the government to support current seniors at enormous expense to the General Fund, or to completely break its promise to them.

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