Social Security system Summary

  • Last updated on November 10, 2022

The Social Security system imposes a heavy wage tax on most American workers, provides cash benefits and medical-expense reimbursements for most Americans at least sixty-two years of age, and is the source of unemployment compensation and some welfare payments to low-income families. As stakeholders in the system, businesses share the costs of public retirement pension and health insurance programs with the government and their employees.

Before the Great Depression, so few companies had private Pension plansRetirement planspension plans for their employees that only about 5 percent of the entire American workforce was covered. Moreover, most of the private pension plans in existence provided little or no protection and unspecified benefits. The Depression of the 1930’s caused many of those plans to collapse, so the New Deal administration of President Franklin D. Roosevelt created a vast system to provide pensions for the elderly, unemployment compensation for wage earners, and support for specified categories of public assistance. On August 14, 1935, President Franklin D. Roosevelt signed into law the federal Social Security Act of 1935Social Security Act.Social Security system

The Social Security Act required employers to pay excise taxes as a percentage of employees’ wages, with equal contributions paid by the employees themselves. The initial rate was 2 percent, half paid by workers and half paid by employers. Employers of eight or more employees also paid excise taxes of 1 percent in 1936 to be placed in an Unemployment Trust Fund. Workers paying the tax became eligible to receive pensions on their retirement at the age of sixty-five. Pension benefits were regarded as a right that workers earned by paying into the system. No means tests were imposed on pensioners. Railroads;pension plansA separate and parallel program for railroad workers was created by the Railroad Retirement Act of 1935.

Business Participation

The participation of business in the Social Security system and its influence on the provisions of the Social Security Act of 1935 have always been controversial. Three areas of business influence, albeit indirect and partial, on the law are notable.

First, business members of the Advisory Council to the Committee on Economic SecurityCommittee on Economic Security (CES), such as Marion Folsom of Eastman Kodak, brought with them commercial models of social welfare practices. New Dealers on the CES drew on private sector initiatives, and the work of most policy specialists spanned the public and private sectors. Even though the social insurance programs of the New Deal were government-sponsored and compulsory, they were more consistent with business thinking than they might have otherwise been. Second, concerns about business confidence during the Depression set broad constraints on the range of policy options considered, affecting the timing of initiatives, such as phasing in payroll taxes gradually over three years. Third, the southern wing of the Democratic coalition successfully fought for considerable decentralization of the Social Security system. Provisions governing the means-tested old-age assistance program were modified to enhance local administrative control and to exclude national standards on minimum benefits. Agricultural and domestic workers were dropped from the social insurance part of the system, thereby excluding three-fifths of African American workers.

Eventually, however, employers became stakeholders in the Social Security Act. They subsidized it over the years and designed their own retirement programs around it. Business sought to stabilize welfare-state spending and prevent new incursions (such as national health care) rather than roll back established programs.

After the New Deal

Business supported amendments to the Social Security Act in 1939 that added payments to spouses and minor children of retired workers and survivors’ benefits paid to families in cases of premature deaths of workers. During the 1940’s, business supported payroll tax freezes that kept old-age pensions small. It also supported granting old-age pensions to all elderly with work histories to prevent expansion of the means-tested old-age assistance programs.

By the 1950’s, Social Security with its emphasis on Old-age and Survivors Insurance (OASI; disability was added in 1956, making it Old-Age, Survivors, and Disability Insurance[Old Age, Survivors, and Disability Insurance]Old-Age, Survivors, and Disability Insurance, or OASDI) was a fixture in American society that garnered business support. This was the case even as payroll tax rates for OASI increased to 2.25 percent in 1959 and the rate of 0.25 percent was added for disability insurance in 1957 (a slightly higher rate was imposed on self-employed people).

Rising tax rates during the 1930’s and 1940’s spurred employers to create private pension plans–the second tier of the Social Security system–as tax shelters. Wage-and-price controls encouraged employers to provide benefits in lieu of additional wages. The Revenue Act of 1942Revenue Act of 1942 sanctioned the business practice of “integration,” that is, restructuring private pension plans to take OASI into account. Increases in OASI coverage and benefits offset costs of integrated plans and spread the costs of the plan to employers who had initially been excluded from the system. In 1949, the Ford Motor Company;pension plansFord Motor Company agreed to finance pensions of $100 per month to workers retiring at the age of sixty-five who had thirty years of service with the company. However, because the company’s pension was integrated with OASI, Ford only had to finance part of the $100 pensions. Ford’s program set the pattern for American industry. By the late 1950’s, more than half of all unionized employees in the United States were covered by integrated plans. By 1974, 46.5 percent of all persons in the private workforce participated in employer-sponsored pension plans.

Early Retirement Programs

In 1964, the first private pension early retirement provisions appeared in the automotive industry, allowing workers to retire with reduced benefits at the age of sixty if they had at least ten years of service and at the age of fifty-five if they had at least thirty years of service. The key was “supplemental” benefits, an additional benefit paid until workers were eligible for OASDI at the age of sixty-two. During the 1973-1974 and 1981-1982 recessions, employers added “sweeteners” to the usual early retirement benefits. These Early retirement incentive programsearly retirement incentive programs (ERIPs) extended retirement opportunities to otherwise ineligible workers when companies needed to downsize their workforces. With oil prices declining in 1986, for example, the Exxon Corporation offered immediate retirement to employees aged fifty and up who had more than fifteen years of service.

Enactment of the Employee Retirement Income Security Act of 1974Employee Retirement Income Security Act (ERISA) of 1974 protected employee pension benefit rights and set standards for tax-exempt status and funding levels for pension plans. For many businesses this meant increasing their plan contributions in short order and many did. The percentage of large firms with plans having accrual values at least as great as the values of their liabilities increased from 25 percent in 1978 to 84 percent in 1987.

Defined Contribution Plans

ERISA accelerated a shift away from traditional defined benefit plans to defined contribution plans. In defined benefit pension plans, employers make pretax contributions into a pension fund for all participants. Workers are automatically enrolled, face no direct investment risk, and automatically receive payments based on wages and years of service for the rest of their lives after retirement. The Pension Benefit Guaranty CorporationPension Benefit Guaranty Corporation (PBGC) guarantees the benefits within limits and charges insurance premiums intended to cover the plans’ anticipated costs. In defined contribution plans–like the popular 401(k) retirement plans[Four o one k] 401(k) authorized in 1978–workers own their own financial accounts that build value over time. Benefits are not insured, so employers do not pay insurance premiums.

A 1936 poster urges Americans to apply for Social Security cards.

(AP/Wide World Photos)

Of benefit plans started before 1941, 10.4 percent were defined contribution, rising to 77.8 percent by 1987. By 1995, nearly 90 percent of all plans (623,912 of 693,404) were defined contribution plans and the number of participants in those plans was nearly double that of those in defined benefits plans (42.7 million vs. 23.5 million). The growth of 401(k) plans was so substantial after 1984 that by the turn of the twenty-first century, they accounted for 44 percent of defined contribution plans and for about three-fourths of active participants, contributions, and assets in those plans.

Throughout the 1990’s, defined contribution plans moved toward cash benefit plans, the first created by Bank of America in 1985, and to a lesser extent to pension equity plans. These hybrid plans were like traditional defined benefit plans in that the employer contributed funds into a general fund for all employees, owned the assets, made the investment choices, and bore the investment risk. Benefits were also guaranteed within PBGC limitations. Like defined contribution plans, however, cash benefit and pension annuity accruals depended on annual pay credits and annual interest credits, with employees bearing the market risk. Cash benefit plan benefits were a function of annual pay over the employee’s entire career with the employer; annuity plan benefits were based on a percentage of final average earnings for each year of service under the plan. In 2005, approximately 25 percent of all workers covered by defined benefit plans had a cash balance plan, up from 4 percent in 1996-1997, and they had about 28.8 percent of all defined benefit assets.

As defined contribution plans became more popular, the idea of partially Privatization;Social Securityprivatizing OASDI as a way to ensure the solvency of its trust fund for future generations was considered during the presidential administrations of Bill Clinton and George W. Bush. Although such plans were not adopted, the financial sector of the business community stood to gain from administering the individual accounts that would have been established. The prospect of making defined benefit payments to retired workers for the remainder of their lives was troublesome for the federal government and employers alike. Lacking the taxing power of government, many businesses took steps to minimize future obligations to retired workers.

Between 2004 and 2006, seventeen large financially healthy companies “froze” their defined benefits plans, closing them either to new employees (for example, Alcoa and Nissan N.A. in 2006, Lockheed Martin Corp. in 2005, and Motorola in 2004), new and some existing employees (for example, Verizon Communications and Sprint Nextel in 2005), or new employees and all existing employees (for example, Coca-Cola Bottling Company Consolidated and IBM Corporation in 2006, Sears Holdings Corporation in 2005, and Circuit City Stores in 2004). More than 400,000 persons were affected by the freezes and well in excess of one million workers had 401(k) defined contribution plans instead of defined benefit plans. This shift enabled employers to reduce required contributions from 7 to 8 percent of payrolls to the 3 percent employer match. Employers were also driven to reduce total compensation burdens by rising health care costs, which had increased from 2.4 percent of total compensation in 1970 to 8.4 percent in 2006, the lion’s share of which was due not to Medicare contributions but to the cost of group health care, 2 percent in 1970 and 7.2 percent in 2006. Finally, the shift to defined contributions reduced employer risks (economic, demographic, or legislative) associated with funding requirements sufficient to cover future employee benefits.

Further Reading
  • Berkowitz, Edward, and Kim McQuaid. Creating the Welfare State: The Political Economy of Twentieth-Century Reform. New York: Praeger, 1980. Argues for an enhanced role of business in passage of the Social Security Act.
  • Colin, Gordon. “Why No National Health Insurance in the U.S.? The Limits of Social Provision in War and Peace, 1941-1948.” Journal of Policy History 9 (July, 1997): 277-310. Shows how business and economic interests limited further expansion of the Social Security Act of 1935 by preventing passage of national health insurance.
  • Derthick, Martha. Policymaking for Social Security. Washington, D.C.: Brookings Institution, 1979. Detailed account of factors conducive to expansion of the Social Security Act.
  • Gale, William G., John B. Shoven, and Mark J. Warshawsky, eds. The Evolving Pension System: Trends, Effects, and Proposals for Reform. Washington, D.C.: Brookings Institution, 2005. Examines trends of private retirement pensions.
  • Gordon, Colin. “New Deal, Old Deck: Business and the Origins of Social Security, 1920-1935.” Politics & Society 19 (June, 1991): 165-207. Argues for a modest indirect role of business in the origins of Social Security.
  • Hacker, Jacob J., and Paul Pierson. “Business Power and Social Policy: Employers and the Formation of the American Welfare State.” Politics & Society 30 (June, 2002): 277-325. Argues for a more restricted role of business in passage of the Social Security Act.
  • Schieber, Sylvester J., and John B. Shoven. The Real Deal: The History and Future of Social Security. New Haven, Conn.: Yale University Press, 1999. Shows how business acts as stakeholders in the Social Security system.
  • Swenson, Peter A. Capitalists Against Markets: The Making of Labor Markets and Welfare States in the United States and Sweden. New York: Oxford University Press, 2002. Highlights employer support for development of the welfare state.

Ford Motor Company

Government spending

Great Depression

Personal income tax

Medicare and Medicaid

New Deal programs

Pension and retirement plans

U.S. Presidency

Privatization

Recession of 1937-1938

Taxation

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