America's Fiscal Constitution (39 page)

By early 1950 Doughton, Mills, and Myers had developed a plan for Social Security reform that satisfied critics in both parties. Some liberals such as Henry A. Wallace, disliked the regressive nature of Social Security payroll taxes, which were assessed at a flat percentage rate up to a wage ceiling. Insurance executive Albert Linton, one of the leading Republican voices on federal pension programs since the mid-1930s, feared the loss of control over a program administered apart from annual appropriations. Linton had persuaded some Republicans to back a plan for a flat, standard pension for all older Americans. No mainstream federal elected official supported the abolition of a federal pension system or a return to locally funded poorhouses. Similarly, no one entertained the notion of borrowing to pay for the retirement expenses of the growing population of seniors, a form of financing that would be utilized by Congress in legislation enacted in 2003 and 2010.

The cost of the Cold War and the interests of the business community undergirded the new consensus on Social Security. Congress needed every dollar of revenues from income taxes to balance Cold War budgets. A contributory pension system financed with payroll taxes prevented income tax revenues from being consumed by the rising cost of old-age assistance grants. By the late 1940s, even business organizations and labor unions that had opposed federal pensions in 1935 appreciated how portable pension benefits could be integrated into a system of employer-based retirement benefits.

A pension system based on employees’ contributions was a conservative alternative to welfare. If an older American had paid into a fund while employed, Mills said their pensions were not a form of receiving “something . . . for nothing.”
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It did not seem unfair that benefit formulas provided a higher return for those contributing workers who lived longer or earned less. After all, most Americans had some form of life insurance, and the relationship between total premiums paid and the benefit received varied greatly among families. In late 1949, the House—by a vote of 333 to 14—passed the legislation amending the Social Security Act. Only two senators voted against the Senate version in 1950, and President Truman signed it into law just weeks after the North Korean invasion.
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The act increased the minimum monthly benefit by 77 percent to offset the impact of inflation since 1935.
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Congress raised payroll taxes to 3 percent of wages and the ceiling on wages subject to the payroll tax. Most American workers, including self-employed Americans, were included in the Social Security system. The act almost immediately relieved pressure for higher public assistance grants; in 1951, for the first time, more seniors received Social Security pension payments than checks for public assistance.

By separating the Social Security trust fund—officially referred to as the Old Age and Survivors Trust Fund—from the rest of the budget, Congress avoided the problems inherent in combining actuarial and traditional budget accounting. A unified annual budget that counted pension fund revenues without an accrual of future liabilities would have been misleading, while one that attempted to do so would have been difficult for non-experts to comprehend or reconcile with cash accounts. Though the trust fund did not build up a cash reserve to the extent originally envisioned in 1935, the trustees reported on its annual actuarial balance. Their reports rested on a conservative “flat wage” assumption, which produced a steady cushion of reserves so long as wages grew steadily over time. In essence,
Robert Myers compared the value of future payments at existing benefit levels with the value of future revenues from payroll contributions based on the assumption of no increase over existing wage levels. Mills and Meyers realized that this assumption would result in an actual surplus so long as the level of wages and salaries continued to grow. This method gave Congress a margin of error when deciding the levels of benefits and corresponding tax rates.

The Social Security Act Amendments of 1950 also authorized federal matching grants that states could use to reimburse medical expenses for patients unable to pay, a critical feature of the plan sponsored by Senator Taft as an alternative to proposals for national medical insurance. The cost of the program, the precursor to modern Medicaid, would rise sixfold, to over half a billion dollars, during the next decade.
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Oscar Ewing, a skilled lawyer and political confidante of Truman who led the agency overseeing the Social Security system, looked for an affordable alternative for expanding health insurance. Leonard Pink, who headed New York’s nonprofit Blue Cross program, recommended that the federal government administer an insurance pool that could reimburse hospitals for up to sixty days of care for older Americans. Blue Cross and other insurers offered employer-based hospital insurance, and retired Americans did not qualify as part of an employee group. Private insurers, Pink said, would find it hard to estimate medical costs in a pool for retirees. Ewing convinced Truman to embrace Pink’s idea. The plan made little immediate headway because of the cost of the Korean War and the preference of medical associations for state grants. It began to gain momentum as hospital costs soared in the late 1950s.

After passage of the Social Security Act Amendments of 1950, elected officials in both political parties almost universally accepted the concept of federal old-age pensions. Dwight Eisenhower, the first Republican president elected since Herbert Hoover, called for an expansion of Social Security pensions during his 1953 inaugural address. He characterized worker-supported pensions as a form of self-reliance and “domestic security.”
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His administration rejected the US Chamber of Commerce’s proposed plan for the federal government to guarantee a flat minimum pension to all retirees, regardless of whether they had contributed payroll taxes. Instead, in 1954 Congress passed—with only eight dissenting votes—a bill expanding coverage and payroll taxation to many agricultural and public sector workers.

Social Security pensions, like pensions for veterans, incorporated a historic ideal of reformers in both parties: benefits should be earned and distributed based on formulas rather than discretionary decisions subject to patronage politics or ethnic discrimination. In 2001 President George W. Bush’s chief economic advisor explained why payroll taxes were unlike other taxes: “When I pay another dollar for Social Security tax, I buy an explicit, legislated amount of benefits. . . . It is purely a private good.”
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George W. Bush himself, in his second inaugural address, referred to the Social Security Act as an expression of “economic independence.”
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Like the acceptance of a global leadership role, the commitment to maintaining a minimum standard of dignity for older citizens became part of the American “way of life.” This promise reflected changes in culture rather than ideology. By the 1950s, more Americans had moved away from their families, and more women worked outside the home. A portable national pension allowed women, who frequently cared for aging relatives, to balance other responsibilities at work and with children. Between 1950 and 2000, females accounted for 60 percent of the growth in the workforce, while the birth rate soared during the Baby Boom from 1945 to 1965.
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In 1957 the United States set its all-time record for births: 4.3 million babies joined a population of 172 million.
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Retired Americans lived longer. The average remaining life expectancy of thirty-year-old male workers rose from 38.86 years in 1945 to 46.87 years in 2010.
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In 1950 people over the age of sixty-five represented 8 percent of the population, an increase from 3 percent in 1900.
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By 2010, 13 percent of the population exceeded age sixty-five.
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With the retirement of Baby Boomers, Americans over sixty-five are expected to constitute a fifth of the population by 2030.

Social Security pension benefits have always remained at modest levels in relation to average working incomes. In June 2013 the average beneficiary received $1,158 a month, and for most elderly Americans, the Social Security pension remained their largest source of income.
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Until 2010 the federal government never incurred long-term debt to pay for Social Security benefits.

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Federal Reserve Chairman Marriner Eccles had supported the Treasury’s insistence on low interest rates during World War II. After the war he
fought to regain the central bank’s control of monetary policy. A monetary policy capable of sustaining growth without inflationary pressures on interest rates would be critical, Eccles believed, in managing postwar debt, just as it had been after the Civil War. Though Truman replaced Eccles with Thomas McCabe as head of the Federal Reserve, Eccles continued to serve on the board and enlisted a majority of its members, including the new chairman, in support of his position.

Truman’s Treasury Department insisted that the nation’s central bank continue its support of low interest rates even after the war’s end. Since income tax rates were considered to have reached their practical limit, any spike in interest rates would require corresponding cuts in military and other types of spending in order to balance the budget. For example, if the interest rate on federal debt had averaged 5.2 percent rather than the actual 2.2 percent in 1947, the extra cost would have exceeded half the amount of the nation’s military spending. Growing private sector loan demand could exert upward pressure on interest rates without continued support by the Federal Reserve. Eccles and other Federal Reserve officials realized that unlimited monetary expansion could spark inflation. Yet Eccles was repeatedly rebuffed by the Treasury when he attempted to negotiate an agreement recognizing the Federal Reserve’s independence. The concept of an autonomous Federal Reserve had not yet become part of the nation’s unwritten constitution.

The Federal Reserve unilaterally broke the impasse on August 18, 1950, when it decided to raise interest rates on short-term debt without the Treasury’s permission. Many members of Congress and the administration, including Truman personally, failed to corral the Fed.
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The Federal Reserve felt even greater urgency to curb inflation when consumer prices spiked in early 1950, after Chinese intervention in Korea threatened to prolong the war indefinitely. Eccles explained to Congress that “as long as the Federal Reserve is required to buy government securities . . . for the purpose of defending a fixed pattern of interest rates established by the Treasury, it must stand ready to increase bank reserves in unlimited amounts.” He condemned that requirement as an “engine of inflation.”
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On March 3, 1951, the Federal Reserve and Treasury announced that they had “reached full accord with respect to debt-management and monetary policies” for the common goal of assuring “the successful financing of the Government’s requirements and, at the same time, to minimize monetization of the public debt.”
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The Federal Reserve agreed to credit
to the Treasury any interest on its investments in federal debt and thereby avoid future tension over whether the central bank profited from its open market operations. The 1951 agreement, frequently referred to as the Accord, concluded a 160-year national struggle to define the power of federal elected officials, the Treasury, and financial market participants over monetary policy, even after the great compromise of 1913 that created a Federal Reserve, an organ of the executive branch during the crises of two world wars and much of the Great Depression.

Within days of the Accord, the Federal Reserve’s Open Market Committee allowed interest rates on five-year notes to climb. President Truman promptly replaced Federal Reserve Board Chairman Thomas McCabe with William McChesney Martin, an assistant treasury secretary and former Wall Street prodigy who had once served as president of the New York Stock Exchange. Martin had negotiated the Accord on behalf of the Treasury, but, to Truman’s dismay, he defended the Federal Reserve’s independence after becoming chairman. Interest rates on Treasury debt rose slowly during the 1950s, from 2.27 percent in 1950 to 2.51 percent in 1956 to 3.25 percent in 1960.
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During his nineteen years as chairman, Martin used his keen intellect and political skills to define the modern role of the Federal Reserve. The Federal Reserve’s role as guardian of the currency gave it great influence on financial markets, a power that it sometimes used to reinforce traditional limits on debt.

The independent Federal Reserve became a virtual fourth branch of government, with power over the money supply. Money, which principally consists of electronic ledger entries in a modern economy, performs several functions. It serves as a medium of exchange, which an economy needs in sufficient quantity to facilitate standardized pricing and settlement of amounts owed. Money is also a means of storing wealth. The Federal Reserve, like most central banks, tries to maintain the level of money to serve effectively as both a medium of exchange and a store of value. At times these functions may conflict, like when an excessive supply of money reduces its usefulness as a store of value and constricts savings. An inadequate supply of money, in turn, can result in deflation, which puts a premium on money as a store of value and reduces the willingness to spend and invest. Since adequate investment requires both saving and lending or investing, either deflation or inflation can destabilize the investment and consumption needed to fuel economic growth. Central bankers are principally concerned with managing the money supply at a level that
supports the dual objectives of stable prices and economic growth that fosters employment.