Civic Elite Bet Social Security Loophole Loot

While the debate over Social Security’s future rages in Washington, New York City is quietly engaged in an experiment with private retirement programs more radical than anything George W. Bush has ever suggested.

Here’s how it works: A participant pays no Social Security tax and can expect no Social Security benefits. Every penny of the employee’s retirement savings is lodged in 401(k)-style stock and bond investments.

The New York City program, which replaces Social Security entirely, goes much further than the “personal accounts” that President Bush has been pushing, which would be only a partial substitute for Social Security. New York’s program has existed for more than a decade without attention or controversy, despite offering a useful counterpoint to the deeply polarized national debate. It is available to about 20,000 city government managers, political appointees and elected officials, although relatively few take advantage of it.

Mr. Bush’s proposal to overhaul Social Security has been blocked by a united front of Senate Democrats, with New York’s Hillary Clinton recently denouncing the plan as a “risky privatization plan.”

Here in Mrs. Clinton’s back yard, however, the experiment with private accounts is hidden in plain sight at City Hall. The experimental subjects include four Democrats in the firmly anti-privatization City Council, including Brooklyn’s David Yassky and Oliver Koppell of the Bronx. Many other participants are younger political appointees like Robert Capano, until recently an aide to Brooklyn Borough President Marty Markowitz.

When Mr. Capano took a job with Mr. Markowitz’s predecessor, Howard Golden, in 1999 at a salary of about $38,000, he jumped at the chance to get into the booming stock market of the time.

“I liked the idea of managing my own money,” he said. “The money I would have been putting in Social Security, I was putting in deferred compensation.”

Mr. Capano, now 31, talked to a knowledgeable uncle, then decided to spread his money among four of the seven available funds.

“I fooled around with it a little bit-I put 50 percent into an equity index fund, 25 percent into a small-cap equity fund, 15 percent into a mid-cap fund and 10 percent into bonds,” he recalled.

After four years in government, his nest egg had risen to $26,000.

“Anything that gives people options and choices to manage their money, I’m for,” said Mr. Capano, a Republican. “That’s not just lip service for me-I took advantage of it.”

The City Council Democrats–who said they oppose the privatization of Social Security on a national scale–were less sanguine about the program they’d chosen, and said they plan to rely largely on Social Security and other savings in retirement.

Mr. Yassky said that between the SocialSecurity tax he’d paid in previous jobs, and the tax he will pay in the future, he expects to receive the maximum Social Security benefit despite not paying in during his time in the City Council.

“It’s a free ride.” he said, adding that he wouldn’t criticize a plan that effectively increased the income of New York City workers in his position. “The federal government is so unfair to New York in so many other ways, when there’s something that is a disproportionate benefit to New York, I’m not going to get too outraged about it.”

City Councilman Oliver Koppell, a Democrat from the Bronx and former New York State Attorney General, discovered the program’s existence after taking a look at his pay stub one recent afternoon. “They’re not even taking Social Security out,” he noted.

He said he hadn’t realized that he was, in fact, enrolled in a private alternative to Social Security “I don’t believe in these private plans,” he said. “For some people, the option may make sense, but I’m willing to forgo the option for the general good.”

Some city workers enrolled in the private plans declined to speak about them on the record, wanting to keep themselves out of the bitter Social Security debate. City Council officials said four Council members don’t pay Social Security, but declined to give their names. But with all three Republicans reporting that they are grudgingly enrolled in the federal program, the four members with private accounts must be Democrats. In interviews with most of the 51 Council members only Mr. Koppell and Mr. Yassky attested to participate in.

The quiet existence of the New York City option-which apparently hasn’t led to an outbreak of poverty among retired city employees-could dispel some of the nightmare scenarios painted by opponents of Mr. Bush’s plan. They depict private retirement accounts as a fast track to pre–New Deal destitution for the elderly. But the New York program also illustrates a major drawback for the Bush plan: Americans aren’t terribly interested in managing their own retirement savings. Not many city employees have chosen the private option. Although no city agency knew precisely how many employees choose not to pay into Social Security, the number is a small fraction of the 20,000 eligible.

And even among those who use it, few are actually buying into the notion of a market-based retirement. Some, like Mr. Koppell, a prosperous lawyer in private practice, have savings and other pensions that they can rely on in retirement. Many others opt into the private program temporarily, then use their savings to buy into New York City’s generous employee retirement system, with its full health-care benefits.

“The pension is just a very good deal,” said E.J. McMahon, a scholar at the conservative Manhattan Institute who has argued, as has Mr. Bloomberg, that city and state pensions are too expensive for taxpayers.

New York City’s private retirement alternative exists through a narrow gap in federal, state and local regulations intended to put every American in the Social Security program. Under state law, all participants in the city’s generous public pension plans are obliged to enroll in Social Security-except for “pure provisional” employees, as some managers and political appointees are known.

Most employees can choose to join the city pension system, which takes a 3 percent bite out of their paychecks, and Social Security, whose main portion takes out another 6.2 percent. Or they can simply pay Social Security without considering other retirement options.

All city employees can also direct some of their salary into a deferred compensation plan known by its tax-code number as a “457,” the public-sector equivalent of a 401(k). But unlike the majority of city workers-who are forced into Social Security-if the provisionals direct 7.5 percent or more of their salary into the 457 plan, they are, under Internal Revenue Service rules, permitted to opt out of Social Security. While the plans are not popular among elected officials, however, they can be attractive to young appointees who don’t expect to spend their careers in government and may not be around long enough to qualify for pensions. Elizabeth Lynam, for example, opted into one for her brief stint in the city’s Office of Management and Budget, then cashed it out-paying taxes-when she left for a job at the nonprofit Citizens Budget Commission. She’d already paid some Social Security in other jobs and made the calculation.

“It’s a tradeoff in terms of ‘Well, O.K., where does Social Security have me recorded versus what’s the benefit of having a portable pension?'” she said.

New Deal Vestige

The system that Ms. Lynam, Mr. Capano, Mr. Yassky and other city workers took advantage of is an odd vestige of the 1935 creation of Social Security. At the time, the program only covered about half of all American workers, excluding some, like farm workers, because they were hard to find. State and municipal employees were left out because the Roosevelt administration feared the Supreme Court would strike down a measure that included those workers.

“It had to do with federalism and the lingering belief that state governments are separate and sovereign, and thus that the federal government had no right to tax either them or their employees,” said Martha Derthick, a historian of Social Security at the University of Virginia.

In the 1950’s, the federal government began bringing government workers into the program, making a separate deal with each state to apply Social Security tax to some or all of its workers. In 1957, the New York State Legislature voted to require workers who joined the pension system to join Social Security as well. But groups of government workers from California to New York remained uncovered, and local governments could withdraw from Social Security until after President Ronald Reagan signed legislation closing that door in 1983.

Through the 1980’s, that segment of “provisional” city workers remained free from Social Security and from any obligation to save for their own retirement.

“It used to be a recruiting tool in a place like the Law Department,” said Paul Rephin, a senior official in the city’s Law Department. “We used to tell people, ‘You don’t have to pay [Social Security] if you want to come work with us.'”

Finally, in 1991, Congress passed legislation that closed many of the remaining gaps in the Social Security program. It also established the requirement that the few employees remaining outside the system pay at least 7.5 percent of their income into the private retirement plans, making the city’s option less easily available.

Holdouts remain, however. Only one system similar to New York’s private plan has gotten much attention: the privatized retirement system of Galveston County, Texas, which opted out of Social Security in the early 1980’s. Conservatives have touted the plan as a model, in which civil servants earn better returns in the stock market than they would under Social Security. Liberals point to cases of workers who pulled cash out of their accounts early under a “hardship” clause and were left with very little.

And a 1999 study from the General Accounting Office gave some ammunition to both camps, showing that high- and middle-income workers prospered under the private system, while poorer workers lost out-a consequence of Social Security’s moderately redistributive formula.

New York’s plan has some of the same lessons. Experts say it’s a better deal for high-income workers, but that most city workers would wind up with more money in retirement in the purely private plan.

“Somebody who did this for 20 or 25 [years], assuming they invested 50 percent in bonds and 50 percent in stock, would be doing better [than they would in Social Security] from a pure retirement point of view,” said Joel Frank, a financial advisor to the city’s civil servants who writes a column on the subject in The Chief, the civil-service newspaper. But he noted that the private plan leaves out two elements of Social Security: disability insurance and survivor benefits. (The fourth piece of Social Security taxation, Medicare, is mandatory for all workers.)

But the New York experiment is likely to remain a small and difficult to read venture as long as it competes with one of the nation’s great pension systems-the New York City Employee Retirement System, or NYCERs-which offers not just pensions nearly equivalent to a retiree’s old salary, but also full medical coverage for people who have spent 10 years in the system.

And so, as it stands, the city’s experiment teaches only one clear lesson: public employees overwhelmingly prefer a generous public pension system to private accounts. Even ideologically committed conservatives often buy back into the pension system, seeing it for the great deal it is. Mr. Capano, the Brooklyn Republican, finally decided that the public pension was a better deal.

But even after buying back in to the pension program, which cost about $10,000, Mr. Capano decided to keep about $16,000 in his private account when he left government earlier this year. He says he plans to leave it there until his retirement. And he remains a partisan of the private system.

“If the choice is available to civil servants, I don’t see why it shouldn’t be available to everyone,” he said.