On May 2, President Bush announced the appointment of a bipartisan, 16-member panel to study the Social Security system and recommend ways to ensure that the system returns to fiscal soundness. The President’s Commission to Strengthen Social Security has already produced an interim report that describes the challenges facing the system, and by the end of the fall it expects to produce a final report with specific recommendations. Those recommendations must follow a set of guidelines outlined by the President. Among his charges: Social Security payroll taxes must not be increased; the government must not invest Social Security money in the stock market; and reforms must include individually controlled, voluntary personal retirement accounts that will augment Social Security.

One of the commission’s members is Olivia S. Mitchell, professor of insurance and risk management at Wharton. Knowledge at Wharton talked with Mitchell, a Democrat, about the panel’s work and about criticism that has been leveled at the panel. For example, Rep. Richard Gephardt (D-Mo.), the House minority leader, has called for creation of a new commission because he says the current panel is made up of people who are predisposed to supporting Bush’s plan to partially privatize the system. Others have criticized the panel for trying to frighten Americans into thinking that the system is in worse shape than it is. The Commission is co-chaired by Sen. Daniel Patrick Moynihan, a Democrat, and Richard Parsons from AOL-Time Warner, a Republican.

Knowledge at Wharton: The commission has been subjected to criticism in the last couple of weeks. How do you respond?

Mitchell: It’s basically simple math. In 2016, because of the retirement of the baby boomers, there won’t be enough revenue coming in from the payroll tax alone to pay promised Social Security benefits. There’s nothing partisan about it. We never said that retirees today are at risk. We never said people would have their benefits cut today. We’re not trying to scaremonger. We’re simply saying: We have 15 years. Let’s get started. Let’s make sure the system is working when that day arrives.

Most of the opposition to reform has been of the head-in-the-sand variety. But anybody who says “simply stay the course” is implicitly telling us that 15 years from now there will be no problem. That’s irresponsible. We need to make hard choices before problems arise. As you know, people have said that Social Security has always been a third-rail issue – touch it and you die politically. It’s fortunate that none of the members of the commission are current politicians because that allows us to take a harder – and clearer – look at things.

Knowledge at Wharton: What will happen if nothing is done to reform the system?

Mitchell: Let’s look at history. Social Security basically operates as a pay-as-you-go system. Workers pay taxes today and retirees receive that money in benefits today. Now, as long as there were lots of baby-boomer workers and a vibrant economy, it was possible to sustain that pay-as-you-go system. You could tax workers, and because there were a lot of them in relation to the number of retirees, the tax wasn’t very large. In the early 1980s, however, it became clear that the legislated tax was not high enough to pay retirees. In fact, in 1983 the system was only about three months away from running out of money completely. A commission headed by Alan Greenspan was formed, taxes were boosted and benefits were cut somewhat, the retirement age was delayed and other reforms were instituted. Cash-flow solvency was restored.

At that time, taxes were raised above what the system needed to pay benefits. So we ended up with a surplus; the system had more money than it needed to pay retirees. The Social Security Administration then took the surplus to the U.S. Treasury whereupon Treasury issued Social Security a series of IOUs. These are the special-issue Social Security trust-fund bonds that have been in the news of late. Once the money was given to the Treasury, the government began using the money for other purposes.

The situation we face now is that projected taxes will move along at a steady rate but prospective Social Security benefits will spike up because of the retirement of millions of baby boomers. Those two lines are forecasted to cross in 2016. At that point, payroll-tax revenue alone will not be enough to pay benefits. Then the Social Security Administration will have to go to Treasury and start redeeming these special bonds. Once the bonds start to be redeemed, the rest of the government will no longer be able to use Social Security surpluses to pay for general expenses. Then, cash flow is going to have to go the other way. The part of the government budget outside Social Security will have to begin covering Social Security promises. At that point, hard choices will have to be made. Either other government spending will have to go down, taxes will have to be raised, or the government could borrow money by issuing new debt that would have to be repaid in the future.

Knowledge at Wharton: What are some of the most difficult issues the commission is dealing with?

Mitchell: One of the concerns about having individual accounts within the Social Security system is how the money will be collected. Ideally the contributions will be gathered with a minimum of overhead and leakage. Another question involves how the money will be invested. An appealing aspect of individual accounts is that people have control over how the money will be allocated between stocks and bonds. On the other hand, you don’t want people to fall prey to unscrupulous brokers or a brother-in-law suggesting they should invest in hot new stocks. There will have to be some regulation around the investment options.

Another challenge is how the accounts will be administered. One idea is to offer a plain-vanilla program with three accounts: a stock index fund, a bond index fund and a government-security fund. This is the type of plan that government employees already have in place. A fairly restrictive set of choices might be required initially since many people are not particularly educated or sophisticated about investing. Another issue is how people gain access to the money. With 401(k) plans, the law allows people to take out loans against their accounts and to take lump-sum cashouts. Both of those would be very problematic in Social Security. If you let people take a lump sum at retirement, what happens if they blow it? All of these are design issues that we have to look at.

A number of individual-account proposals have been put forward and there seem to be many good ideas out there. I suspect that in the next couple of months we’ll take a look at a range of proposals, maybe do some adapting or melding of proposals so commissioners will be able to agree on a plan or a set of plan design options.

Knowledge at Wharton: The stock market has been flat for a long time now and technology stocks have taken a pounding since last year. Has this caused a decline in support for having individual accounts within Social Security?

Mitchell: People talk about the decline in tech stocks as a reason not to have individual accounts. But if you use an individual Social Security account as a way to invest in an index fund, a basket of stocks, then the decline in tech stocks would not matter as much. So I don’t find that argument persuasive. There are ways to put structure into a system that includes individual accounts so that the most worrisome concerns can be mitigated.

I came back from Japan a couple of weeks ago where the new government just announced legislation permitting 401(k) plans. This is interesting because the stock market there has been in the doldrums for a decade. Nonetheless, Japanese people want an opportunity to choose where their savings go. The German government is also moving toward allowing people to have defined contribution plans. Sweden has done the same thing. These countries make an interesting counterpoint to those that oppose individual accounts here. It’s not like individual accounts solve all the problems Social Security faces, but they are a step in the right direction.

Knowledge at Wharton: What’s next for the commission?

Mitchell: We’re supposed to finish our work by late fall. We have scheduled several meetings over the next few months. We will hold public hearings in September to get input on how to think about designing individual accounts and how to reform the system as a whole. Virtually everybody on the commission agrees that these individual accounts will not involve complete privatization of Social Security; in fact initially they may be quite small. We will also be looking at how to redesign the remaining portion of Social Security so it will have safety-net protections. For example, the current system does not provide that a retiree will get benefits that will at least provide a minimum poverty line income. Also, if someone is married to a worker for fewer than 10 years, he or she wouldn’t be entitled to any spouse or widow benefits when the worker dies. So there are huge holes in the safety net and we need to address those.

Another concern is that the Social Security system today needs administrative support no matter what new system emerges. They’re working with old computers and old record-keeping technology. There’s been under-investment in the system over the last 40 years, and while productivity has remained strong in the agency, it can’t go on forever.

As an educator, I believe that it is important to inform the American public as to what the problems are with Social Security and what its potential solutions are. Some press has been negative but other coverage has been positive. Looking down the road, it is clear we won’t satisfy everyone. Of course change never happens overnight. The pension legislation that completely reformed American’s private pension system took 10 years in the making. I can’t predict how long this will take but I do have a long horizon. Reforming Social Security is challenging and complicated. The program touches just about everyone in the country, all through their lives. That’s why it’s so important to vet the options thoroughly and get everybody involved in the discussion.

Knowledge at Wharton: Are you confident that major progress will be made in reforming Social Security?

Mitchell: I do think that more people are getting involved in the debate than ever before. There’s certainly more learning going on. Six or seven years ago the debate was quite different: For instance, when I worked with the Social Security Advisory Council in 1994, nobody was talking about individual accounts. So today there is a different level of interest and discourse than just a few years ago. Today, too, public opinion surveys tell us that people are very interested in individual accounts. Many, especially the young, like the thought of being able to invest for their retirement. I believe there’s been a sea change in the public perception of Social Security. But that doesn’t mean a reform plan will be easy to develop or get passed by Congress.