Sunday, December 05, 2004

Nonsense and Sense about Social Security

E.J. Dionne Jr., writing in The Washington Post on November 30, opined that

...President Bush carries a heavy burden in trying to sell the country on his plan to carve private accounts out of Social Security. Bush has been pushing privatization since he first ran for the presidency in 2000. But he keeps changing his explanation of how the program will be paid for and what its effect on the deficit will be....

Dionne goes on in that vein throughout his column, using what seems to be a discrepancy between what Bush said four years ago and what he and his aides are saying now to play "gotcha." Worse than that, however, Dionne -- who is a Washington insider of sorts -- spends much of his column spreading confusion about Social Security; for example:

The big cost of privatization comes from allowing individuals to keep a share of the Social Security taxes they now pay into the system and use it for private investment accounts. This reduces the amount of money available to pay current beneficiaries. Since Bush has promised the retired and those near retirement that their benefits won't be cut, he needs to find cash somewhere. The only options are to raid the rest of the budget, to raise taxes or to borrow big time....

[During the 2000 presidential campaign] Gore...challenged Bush on his numbers. "He has promised a trillion dollars out of the Social Security trust fund for young working adults to invest and save on their own, but he's promised seniors that their Social Security benefits will not be cut and he's promised the same trillion dollars to them," Gore said at that third presidential debate. "Which one of those promises will you keep and which will you break, Governor?"

...Bush is about to offer an easy answer to Gore's challenge: More borrowing....

...Last week The Post's Jonathan Weisman reported that Republicans were considering moving the costs of social security reform "off-budget" so that, on paper at least, they wouldn't inflate the deficit. And Joshua B. Bolten, the director of the White House's Office of Management and Budget, let the cat out of the bag over the weekend in an interview with Richard W. Stevenson of the New York Times. "The president does support personal accounts, which need not add over all to the cost of the program but could in the short run require additional borrowing to finance the transition," Bolten said. "I believe there's a strong case that this approach not only makes sense as a matter of savings policy, but is also fiscally prudent."

A huge new borrowing -- "from hundreds of billions to trillions of dollars over a decade," as Stevenson notes -- is suddenly "fiscally prudent" in the administration's eyes....

Dionne betrays such stupendous misunderstanding of the issue that the only way to deal with his ignorance is to explain the whole megillah, step-by-step:

1. The cost of Social Security is the cost of the benefits paid out, not the payroll taxes or borrowing required to finance those benefits. There are two basic issues: how much to pay in benefits and how to finance those benefits.

2. Assuming, for the moment, that benefits will be paid to future retirees (today's workers) in accordance with the present formula for computing benefits -- which today's workers believe is a "promise" they have been made -- something must "give" when payroll taxes no longer cover benefits, beginning in 2018.*

3. No matter how you slice it, someone will pay for those future benefits. The question is: who and when? There are three conventional ways to do it:

  • Raise future workers' payroll taxes by enough to cover benefits.
  • Borrow enough to cover benefits, thus shifting the immediate burden from future workers to willing lenders, who are also the "future generations" that "bear the burden" of the debt. The cost of borrowing (i.e., interest) raises the cost of the program a bit, but interest is also income to those who lend money to the government. In other words, borrowing -- on balance -- doesn't create a burden, it merely shifts it, voluntarily.**
  • Raise taxes and borrow, in combination.

4. There's an "unconventional" way to deal with the looming deficit in Social Security: invest payroll taxes in real assets (i.e., stocks, corporate bonds, mortgages). Why? Because money invested in real assets yields a real return that's far higher than the "return" today's workers will receive on their payroll taxes. (See, for example, figure 2 in this paper.) There are three ways to "privatize" Social Security by investing in real assets:

  • Abolish Social Security and make individuals responsible for their retirement (perhaps with a minimal "safety net" funded by general taxation).
  • Let the government do it, through a "blind trust" run by an independent agency.
  • Let individuals do it, through mandatory private accounts.

5. I assume that the first option is off the table, for now, even though Social Security (like so many other government programs and activities) is unconstitutional. Given the large sums of money involved, the second and third options would yield about the same result, on average. I'll continue by outlining the third option, which is the proposal that has drawn the ire of E.J. Dionne and so many other anti-privatization leftists.

6. Workers would invest some (or all) of their payroll taxes in real assets (private accounts). Those same workers would agree to receive lower Social Security benefits when they retire. (The precise tradeoff would depend on the age at which a worker opens a private account and how much the worker has already paid into Social Security. Workers who are over a certain age -- say 50 or 55 -- when privatization begins wouldn't be allowed to drop out, but would receive the Social Security benefits they expect to receive.) That leads to a series of questions and answers:

  • Q: What happens when the shift of payroll taxes to private accounts results in a deficit, that is, when payroll tax receipts are less than benefit payments? A: The government borrows to make up the difference. (See the discussion of borrowing in point 3 and the second footnote, below.)
  • Q: What happens to the money invested in private accounts? A: It would belong to the workers who invested it. They'd receive smaller payments from "regular" Social Security, but those smaller payments would be more than made up by the income they'd receive from their private accounts.
  • Q: When does it all end? A: It would depend on how much workers are allowed to invest in private accounts and how much those private accounts earn. If workers were allowed to invest all of their payroll taxes in private accounts, and if all workers elected to do so, Social Security -- as we know it -- would wither away. Every worker would have his or her own source of retirement income. That income come from earnings on real assets, not from taxes paid by those who are then working. And that income would exceed what the retiree would have received in Social Security benefits -- even for private accounts invested "safely" in high-grade corporate bonds or mortgage-backed securities.
In sum, whether or not Bush is telling the same "story" now that he told four years ago, there is no shell game of the kind suggested by Dionne, and Gore before him. Dionne (and Gore) are simply unable to grasp the notion that by diverting payroll taxes to real investments, with real returns, no one would be made worse off, and many would be better off. They're hung up on the borrowing that must take place in the initial stage of privatization, and they overlook the return on that borrowing, namely, higher income for future retirees and lower payroll taxes on future workers. And the threat of borrowing, as I have explained, is a bogeyman, which the economically illiterate use to scare the economically illiterate.

* As I've explained here, here, and here, the so-called Social Security trust fund, which won't be exhausted (on paper) until 2042, is just a myth.

** If you're still bothered by the prospect of borrowing, read my post on "Curing Debt Hysteria in One Easy Lesson."