The Only Two Ways to Fix Social Security

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(January 2002)</U></A><B>   |   </b><A HREF="id238.htm" TARGET="_top" TITLE="Ephemerides (December 2001)"><U>Ephemerides (December 2001)</U></A><B>   |   </b><A HREF="id206.htm" TARGET="_top" TITLE="Ephemerides (November 2001)"><U>Ephemerides (November 2001)</U></A><B>   |   </b><A HREF="id132.htm" TARGET="_top" TITLE="Ephemerides (October 2001)"><U>Ephemerides (October 2001)</U></A><B>   |   </b><A HREF="id329.htm" TARGET="_top" TITLE="Scraps Archive"><U>Scraps Archive</U></A></div> <div> <IMG SRC="04107040.png" border=0 width="263" height="4" ALIGN="BOTTOM" HSPACE="0" VSPACE="0"></div> <div> The Only Two Ways to Fix Social Security</div> <div> Note: This piece was written in February 1999, shortly after the Clinton Administration announced its now-forgotten Social Security reform proposals. Debate on them was ephemeral, because Mr. Clinton quickly lost interest in the topic. The impending (as of the date of posting, 12/7/01) report of the Presidential commission on the future of Social Security may revive interest in how to deal with the system's long-term problems.</div> <div> What could be more "Clintonesque" than the President's plan to "save" Social Security?</div> <div> I put "save" in scare quotes, because the Administration's proposals to invest part of the Social Security trust fund in private securities and to create a new wealth transfer program for the benefit of 95 percent of the nation's voters are not simply bad responses to Social Security's long-term financing problems; they are no response at all. They will not affect the system's ability to meet its obligations any more than changing the color of your checks will alter your bank balance. What they <I>will</I> do is -</div> <div> <IMG BORDER="0" SRC="Symb075c00b700f000000000.png" HEIGHT="16" WIDTH="24" ALIGN="bottom" HSPACE="0" VSPACE="0">increase the economic power of the federal government in relation to the private sector, and</div> <div> <IMG BORDER="0" SRC="Symb075c00b700f000000000.png" HEIGHT="16" WIDTH="24" ALIGN="bottom" HSPACE="0" VSPACE="0">tax a narrow segment of society in order to provide a small new entitlement for everybody else.</div> <div> The essentials of Social Security financing are much less arcane than most people realize. The government levies a tax on the wages of active employees to provide the money for paying pensions to retired and disabled workers and their survivors. At present, this tax produces about $100 billion a year more revenue than is paid out in benefits. The government spends this surplus for other purposes. When the Treasury was operating at a deficit, excess Social Security taxes were used to pay the government's bills. Now, in the predictably ephemeral era of budget surpluses, they pay off government bondholders, who then reinvest elsewhere.</div> <div> The Treasury accounts for Social Security taxes used for non-Social Security purposes by issuing IOU's to the "Social Security trust fund". As many observers have pointed out, the trust fund is insubstantial, since its only assets are claims against the grantor of the trust. Whether the trust is real or illusory is, however, of little practical importance. Benefits under the present system are unrelated to any accumulation of assets, and, as we shall see, their economic cost unavoidably falls upon the current generation of active workers, no matter what intermediary mechanisms are used to disguise that reality.</div> <div> Due to the age distribution of the American work force, the ratio of active workers to Social Security recipients is declining. Consequently, benefits are catching up with taxes and will overtake them in about the year 2012. From that point forward (until some distant day when demographic waves generate a surplus again), the government will use other tax revenues to supplement Social Security taxes and keep benefit payments flowing. To account for this Social Security use of non-Social Security funds, it will cancel IOU's in the trust fund.</div> <div> Sometime in the early 2030's, there will be no IOU's left. To hear Mr. Clinton (and others) tell it, Social Security will then be "bankrupt" and a great crisis will ensue. The truth is slightly different. Instead of subsidizing Social Security with general revenues, the government will then have to - subsidize Social Security with general revenues. The illusory nature of the trust fund works both ways: Just as its assets do no good, its lack of assets does no harm.</div> <div> Social Security's "looming crisis", then, has nothing to do with the "assets" of the Social Security trust fund. Its nub is the need to make up the eventual deficiency in payroll tax collections, a task that will have to be accomplished through some combination of -</div> <div> <IMG BORDER="0" SRC="Symb075c00b700f000000000.png" HEIGHT="16" WIDTH="24" ALIGN="bottom" HSPACE="0" VSPACE="0">reducing payments to Social Security recipients,</div> <div> <IMG BORDER="0" SRC="Symb075c00b700f000000000.png" HEIGHT="16" WIDTH="24" ALIGN="bottom" HSPACE="0" VSPACE="0">increasing payroll taxes earmarked for Social Security,</div> <div> <IMG BORDER="0" SRC="Symb075c00b700f000000000.png" HEIGHT="16" WIDTH="24" ALIGN="bottom" HSPACE="0" VSPACE="0">increasing other taxes,</div> <div> <IMG BORDER="0" SRC="Symb075c00b700f000000000.png" HEIGHT="16" WIDTH="24" ALIGN="bottom" HSPACE="0" VSPACE="0">cutting other spending,</div> <div> <IMG BORDER="0" SRC="Symb075c00b700f000000000.png" HEIGHT="16" WIDTH="24" ALIGN="bottom" HSPACE="0" VSPACE="0">borrowing money, or</div> <div> <IMG BORDER="0" SRC="Symb075c00b700f000000000.png" HEIGHT="16" WIDTH="24" ALIGN="bottom" HSPACE="0" VSPACE="0">liquidating government assets.</div> <div> How painful will these measures be? At the worst point, about 2035, Social Security taxes are projected to cover about 70 percent of benefits. If that coverage ratio existed today, Social Security would need a subsidy of about $120 billion a year. Finding that sum would not be pleasant, but America would not be at the gates of Armageddon. Absent any changes in taxes or expenditures, the federal budget would slip from a modest surplus to a modest deficit amounting to less than one percent of Gross Domestic Product.</div> <div> So <I>this</I> is our nation's most pressing worry, for the alleviation of which the federal budget surplus must be preserved like a sacred treasure. Happy the land that is free to make the fiscal conundrums of its grandchildren into its number one priority.</div> <div> Still, one should not belittle the importance of avoiding unnecessary burdens on future generations, so let us look at Mr. Clinton's remedy and see to what extent it would actually help.</div> <div> The Clinton Scheme has three parts.</div> <div> Part One: The government will take the bulk of the excess Social Security taxes, use them to pay off government bondholders and issue IOU's to the Social Security trust fund. That is what happens now, of course. The proposed change is that the trust fund would also receive some additional IOU's. Through mechanisms whose details are unimportant, some bonds retired through the use of non-Social Security taxes would reappear as assets of the trust fund. The sole effect is that the trust fund's stock of IOU's would last longer. But, as has already been observed, the depletion of trust fund assets is an event without any economic effects. Postponing it will have no bearing whatsoever on the country's ability to afford its Social Security promises.</div> <div> Part Two: The balance of Social Security's excess revenue will be used to buy nongovernmental securities in lieu of retiring debt. Hence, the government's assets and liabilities will each be larger than would result from following current policies, and the government will make investment decisions that would otherwise have been made by the holders of repaid bonds.</div> <div> Part Three: Taxpayers will be given a new savings option: a type of individual retirement account to which the government, as well as the individual himself, will make contributions. Needless to say, the "wealthy" will not receive this benefit and will, in effect, subsidize the benefits provided to everybody else. The new accounts will not affect Social Security entitlements and will leave the system no better or worse off than before.</div> <div> What impact will these proposals, if adopted, have when Social Security's cash flow turns negative a decade and a half from now?</div> <div> The six options for curing the deficiency will not have changed. The only differences from the <I>status quo </I>scenario are these: First, the government will have a handy pool of assets (the private securities that the Social Security trust fund has purchased over the years) available for liquidation, accompanied by a higher debt (and thus lower borrowing capacity). Second, some individuals will have larger retirement savings to supplement their Social Security benefits. Third, the economy will be larger (if the government's investment acumen exceeds that of private investors) or smaller (if, as is not inconceivable, it does not).</div> <div> None of these background changes will alter either how much money will be needed to supplement payroll taxes or when it will have to be provided. Nor will the Clinton Scheme give future policymakers an easy way out. The plan takes it for granted that the Social Security trust fund will meet its obligations by selling accumulated investments, but that course of action, which would put downward pressure on the stock market, is not likely to be very attractive.</div> <div> If selling shares does prove to be politically acceptable, nothing guarantees that the proceeds of sale will redound to the benefit of Social Security recipients. State and local governments not infrequently dip into funded pension plans for their employees (despite federal laws aimed at discouraging such practices). A Social Security trust fund invested in stocks is no more immune to such decisions. A trillion or so dollars of hard assets will simply be a trillion dollar "rainy day fund", and politicians have always been able to find pessimistic weather forecasts. Little could be easier than selling stock to meet "urgent needs" and compensating the Social Security trust fund with yet more IOU's.</div> <div> The Clinton Scheme will not, then, furnish any additional resources for meeting Social Security promises. It will leave the post-Baby Boom generation with exactly the same problems and exactly the same set of choices for dealing with them. There are, in fact, only two actions that we can take today to make those future decisions less painful:</div> <div> The first is to cut back the promises that Social Security has made to the Baby Boomers. That strategy is the essence of all serious privatization proposals: The government commits to less in exchange for offering workers enhanced opportunities to save on their own. The Clinton Scheme will probably be called "privatization" in some quarters, but it is really a wealth transfer: A large share of the "savings" accounts will be funded by shifting money from higher bracket to lower bracket taxpayers, and the whole will be layered onto the present Social Security structure, without affecting its system of entitlements. That sort of "privatization" is non-serious.  Real substitution of private accounts for government promises is, on the other hand, so antithetical to liberal core beliefs that resistance will be ferocious.</div> <div> The second way to make life easier for our children and grandchildren is to hand down to them a larger, more vibrant economy, on which the burden of financing Social Security will fall less heavily. How that can be done is, naturally, a controversial topic, but it is surely noteworthy that very few economists of Left, Right or Center advocate a combination of large government budget surpluses and high federal taxes as the ideal recipe for economic growth. That is, nevertheless, the path toward which the President's new budget points America, with the fillip of substituting governmental for private investment judgment to a not insignificant degree.</div> <div> Letters of Comment: Arnold Kling (<A HREF="id26_fixing_social_security.htm" TARGET="_top" TITLE="Letters of Comment"><U>1/23/02</U></A>); George F. Vaughan (<A HREF="id26_fixing_social_security_1.htm" TARGET="_top" TITLE="Letters of Comment"><U>3/31/02</U></A>); Jim Welford (<A HREF="id26_another_idea_for_fixing_social_security.htm" TARGET="_top" TITLE="Letters of Comment"><U>11/15/03</U></A>)</div> <div> [<A HREF="id26_instant_loc_form.htm" TARGET="_top" TITLE="Letters of Comment"><U>To comment, click here.</U></A>]</div> <div> <A HREF="#_________home" TITLE="The Only Two Ways to Fix Social Security"><U><B><Return to Top of Page></b></U></A></div> <div> <B>  <script type="text/javascript" language="JavaScript">var site="sm8Stromata";var g_frames=true;</script> <script type="text/javascript" language="JavaScript1.2" src="http://sm8.sitemeter.com/js/counter.js?site=sm8Stromata"> </script> <noscript> <a href="http://sm8.sitemeter.com/stats.asp?site=sm8Stromata" target="_top"> <img src="http://sm8.sitemeter.com/meter.asp?site=sm8Stromata" alt="Site Meter" border=0></a> </noscript>    </b></div> </td> </tr></table></body>