Saturday, November 20, 2004

Social Security -- Myth and Reality

Not only is Social Security unconstitutional, but -- as I said here -- "Social Security is merely a transfer-payment Ponzi scheme that's going to begin claiming victims in about 14 years, when benefits begin to outrun taxes. "

What about the Social Security trust fund, which is supposed to last another 38 years? As I pointed out here, the trust fund is mythical. I quoted two members of the President's Commission to Strengthen Social Security -- Olivia S. Mitchell, a Democrat, and Thomas R. Saving, a Republican -- who reiterated the commission's view of the trust fund in a July 2001 Washington Post op-ed piece:
...When Social Security ran annual surpluses in the past, it enabled other parts of government to spend more. The trust fund measures how much the government has borrowed from Social Security over the years, just as your credit card balance indicates how much you have borrowed. The only way to get the money to pay off your credit balance is to earn more, spend less or take out a loan. Likewise, the only way for the government to redeem trust fund IOUs is to raise taxes, cut spending or borrow....

We are surprised that this perspective on the trust fund is controversial. The commission's interim report quotes credible sources -- the Congressional Budget Office, the General Accounting Office and the Congressional Research Service -- supporting the view that the trust fund is an asset to Social Security but a liability to the rest of the government. The Clinton administration's fiscal year 2000 budget indicated a similar perspective:

"These [trust fund] balances are available to finance future benefit payments and other Trust Fund expenditures -- but only in a bookkeeping sense. . . . They do not consist of real economic assets that can be drawn down in the future to fund benefits. Instead, they are claims on the Treasury that, when redeemed, will have to be financed by raising taxes, borrowing from the public, or reducing benefits or other expenditures. The existence of large Trust Fund balances, therefore, does not, by itself, have any impact on the Government's ability to pay benefits."...

[T]he nation has only three ways to redeem trust fund bonds: raising taxes, cutting spending or increasing government borrowing. If there is some alternative source of funds, no one has yet suggested it....
Nevertheless, the trust fund has some true believers, among them Paul Krugman, who in July 2001 made this effort to rebut the commission's position:
The Social Security system has been running surpluses since 1983, when the payroll tax was increased in order to build up a trust fund out of which future benefits could be paid. These surpluses could have been invested in stocks or corporate bonds, but it seemed safer and less problematic to buy U.S. government debt instead. The system now has $1.2 trillion in its rapidly growing trust fund. But the commission says that the government bonds in that trust fund aren't real assets....

Every dollar that the Social Security system puts in government bonds — as opposed to investing in other assets, such as corporate bonds — is a dollar that the federal government doesn't have to borrow from other sources. If the Social Security trust fund hadn't used its accumulated surpluses to buy $1.2 trillion in government bonds, the government would have had to borrow those funds elsewhere. And instead of crediting the trust fund with $65 billion in interest this year, the government would have had to cough up at least that much extra in actual, cash interest payments to private bondholders. So the trust fund makes a real contribution to the federal budget. Doesn't that make it a real asset?...
No. Here's why: As Krugman admits, the government didn't invest Social Security surpluses in stocks and corporate bonds, it squandered the surpluses. Did the surpluses enable the government to borrow less from other sources, or did the surpluses simply enable the government to spend more money without raising taxes from other sources? We'll never know, but I suspect the latter; that is, the surpluses simply fed Washington's big-spending addiction. No matter how you slice it, the government didn't invest in real assets. Ergo, the trust fund is nothing more than a big IOU.

To come at it another way, consider the following thought experiment: Suppose the government is collecting $700 billion in Social Security taxes and spending $500 billion of that on benefits and program administration. Suppose, further, that Social Security is the government's only program; it collects no other taxes and has no other outlays. The government can do four things with its $200 billion surplus:
  • simply make a bookkeeping entry to record the surplus (without doing anything else)
  • increase benefits by $200 billion
  • cut taxes by $200 billion
  • invest the $200 billion in real assets (e.g., stocks and corporate bonds)
What are economic effects of the four policy options?

Making a bookkeeping entry -- and doing nothing else -- would mean that the government has chosen to increase taxes without increasing spending by the same amount. That would soon lead to a reduction in national income and employment; in the longer run it would reduce economic growth by reducing the flow of saving that underwrites capital investment.

Increasing benefits (spending the surplus) would -- in the short run -- leave the economy roughly in the status quo, with some shifts in the level of consumption and saving because of the redistribution of income from workers to retirees. But the economy would suffer in the longer run because future retirees would expect -- and probably get -- the same higher benefits as their predecessors. Because the retiree-to-worker ratio is rising, the average future worker would face a higher tax burden, thus reducing incentives to work and invest.

Cutting taxes to the level of benefits would boost the economy in the short run, by increasing incentives to work and invest. But actuarial reality would set in, as the retiree-to-worker ratio rises, and the average future worker would face a higher tax burden, thus reducing incentives to work and invest.

Investing in real assets would shift resources from consumption to investment -- for as long as there are surpluses -- with beneficial long-run economic effects and roughly neutral short-run effects. However, even with real assets, the trust fund would someday be exhausted without imposing some combination of tax increases and benefit reductions (including further increases in the retirement age). Then, we'd be right back where we started.

Here's the bottom line: The trust fund is mythical and cannot be salvaged. Social Security is a drag on the economy, no matter how it's packaged. Complete privatization (i.e., abolition) of Social Security is the only economically sensible option:
  • It would increase incentives to work and invest, thus boosting employment in the short run and economic growth in the long run.
  • Armed with greater prosperity, we could do a better job (privately and publicly) of helping the aged, their survivors, and the disabled who are truly in need.
But that's an economic perspective which won't survive political scrutiny (not yet, anyway).

Perhaps the easiest way, politically, to "fix" Social Security would be to allow benefits to slide gradually to a level that can be supported by the current tax formula. Additionally, the benefit formula might be skewed even further in favor of low-income workers. Given ample notice, higher-income workers would increase their rate of saving, thus underwriting beneficial, growth-generating capital investments.

Call it partial, back-door privatization. But it would be better than the more likely alternative, which is to transfer an ever-larger chunk of the economy from those who produce to those who don't. There's a formula for economic disaster.