6:39 a.m. Monday 7/15/96
Dr. Stein is right, privatizing some or all of the Social Security retirement program is the idea that is attracting all the attention. In my view, this is not because privatization appears painless, but because the status quo–and tinkering reforms to it–are so unappealing to many working-aged Americans. Public opinion polls reveal growing skepticism among workers that the government will meet its long-term benefit obligations. Also the relationship between taxes paid and benefits received under Social Security is becoming much more unfavorable. Whereas earlier generations enjoyed double-digit rates of return on their taxes, younger workers are projected to receive only 1 or 2 percent on average, net of inflation, which is well below the real return to private capital investment. Two-earner couples, single people, and high-wage workers will fare even worse. Conventional fixes for Social Security–cuts in future benefits or increases in taxes to close deficits that have a way of reemerging–will only reduce the return on workers’ taxes, while doing little to enhance benefit security.
Little wonder there is interest in privatization, which would involve moving toward a system of personal investment accounts in which workers taxes are saved and invested for the future rather than being siphoned off to pay current benefits–or to fund other government activities. Similar to an IRA or 401k plan, workers would own their accounts and the interest thereon, and they would decide how best to invest their taxes. These accounts would be managed by private financial institutions.
Individual workers and the economy as a whole both stand to gain from a system built on real capital investment. Our complex and low-yielding system of income transfers would be replaced by a set of straightforward, fully-funded retirement accounts.
There are no free lunches, though. If we are to move to a system of personal accounts, while at the same time meeting benefits to current retirees and older workers, there is a big cost of transitioning from where we are to where we would like to be. This cost stems from Social Security’s big unfunded liability. Workers must perceive the gains to personal accounts (the higher potential interest earnings, higher potential national saving and economic growth, and decreased political risk) as being large enough that they are willing to help finance the transition–as well as to bear some new investment risk.
There is also the question of what to do about workers who accumulate very low balances: leave the problem to the poverty-relief program for the elderly, provide a set of government-financed minimum guarantees, or maintain a streamlined program to supplement personal accounts with a low basic benefit. Each option has a cost.
7:01 a.m. Monday 7/15/96
[For my opening statement I’ve imagined a key meeting between congressional leaders and the president’s top economic advisors as they craft the final version of their bipartisan Social Security reform bill in, say, mid-1999.]
Powerful Senate and House committee chairmen huddle with the secretary of the Treasury and chief of staff late into the night. They’ve split the difference over most issues already, but they’re hung up over government-directed privatization.
One senator wants to know what will happen to the interest rate the government will have to pay on its debt if the following occurs: the government starts to buy private assets–such as stocks–with FICA taxes, leaving private investors to buy billions in government bonds that previously had been absorbed by Social Security surpluses.
The participants stare blankly at each other, since no one had thought of this one before, and it sounds important. They break for pizza.
After dinner, the chief of staff casually asks how this version of privatization will affect “total investment in the nation.”
No one knows for sure, but this question provokes a torrent of others: “With government-controlled investment of the Social Security surpluses, meaning literally tens of billions of dollars up for grabs each year, how would the government determine which stocks to buy? Would we create an independent commission?” one chairman asks. “Would its goal be to target our investments into socially responsible companies, or to maximize returns?” asks another. “Will the biggest employers in my district benefit from this?” asks a third.
A senator suggests investments be handled exclusively by an index fund. Sounds great, say a couple, but the Treasury secretary chimes in: “Which index? Could it include American companies doing the bulk of their business abroad? What would happen if the top executives at a large, profitable company included in the index were convicted of felonies? Or the company began selling a consumer product found to be toxic? Would that company be excluded from the index? If so, by what means? If not, how would the government justify supporting wrongdoing with Americans’ retirement dollars?”
Overwhelmed by practical considerations, the participants adjourn for the night and decide that if there is to be any private component to Social Security, the investment will have to be made by individuals, not the government. But no one’s sure how to implement that either. …
8:48 a.m. Monday 7/15/96
A lot of nonsense has been uttered lately about Social Security and repeated with such frequency that flat falsehoods have come to be taken as obvious truth. Thinking straight about Social Security requires that one recognize four basic points.
1) There is no Social Security CRISIS. Social Security is in surplus over the next 30 years. The total increase in the cost of Social Security from today until the time the last baby-boomer has retired in 2035 is projected to be 1.8 percent of gross domestic product, less than the decline in the defense budget between 1990 and 1996.
2) Social Security does face a long-term DEFICIT of about 14 percent of projected outlays, measured over the 75-year horizon generally used to determine long-run financial balance. Modest changes in the current system can close that deficit. But it is very important that those changes by made now so that working-age Americans have time to adjust to those changes. These changes should entail some reduction in benefits payable to new retirees in the manner Herb Stein suggested in his opening comment.
3) There is a real financing crisis outside Social Security. The combined cost of Medicare and Medicaid is projected to rise about four times more than the cost of Social Security over the next four decades. Action to bring those costs under control is imperative.
4) Privatization of Social Security, touted as a panacea for the problems of social Security, by itself, does nothing to help future generations bear the projected increased cost of pensions for the elderly and disabled. As Herb Stein’s introduction suggested, every dollar diverted from social security to a privatized system requires the federal government to borrow an additional dollar from private capital markets. That adds nothing to private capital formation and does precisely nothing for economic growth. It does give future retirees access to private market rates of return (and to private market risk and uncertainty). But if higher returns are the goal, they can be achieved at much lower administrative cost and at much lower risk to individual investors by authorizing the Social Security trust funds to invest part of their reserves in a broad index of private market securities.
The dirty secret of privatization is that it works only if accompanied by a sizable tax increase. The tax increase reduces consumption and leads to added saving and capital formation. One variant of this tax increase, supported by a minority of the current Advisory Council on Social Security, will last about seventy years. With truly breathtaking nerve, its supporters call it a “transition” tax. Once again, if the nation is prepared to increase taxes and use the added revenue to cut the federal deficit, scrapping social security, a program that tens of millions depend on, is not necessary. Exactly the same gains in national saving and investment can be achieved by modestly reducing benefits, modestly raising the payroll tax, or some combination of the two. This course will build the trust fund, raise national saving, and increase future production from which the cost of consumption by tomorrow’s disabled and retirees must come.
2:19 p.m. Monday 7/15/96
Perhaps we could dispose of some semantic questions first. Henry Aaron says that there is no Social Security CRISIS now. But he thinks something should be done, starting now. Is he saying that if we don’t do something in the meantime there will be a CRISIS in 30 years? Or is he saying that even then the problem could be dealt with by moderate measures? Carolyn Weaver gives a much more worrisome picture. Is there something real between this apparent difference of estimates or is this just a difference of language?
Carolyn Weaver says the magic words, “There are no free lunches.” But then she rather cryptically says that workers must be “willing to help finance the transition.” Is this a delicate way of saying that higher taxes are necessary? If so what is doing the heavy lifting in solving the problem–the tax increase or the privatization?
Later we should get to Richard Thau’s skeptical parable, and ask him what, if anything, he proposes to do.