Moment of Truth for Social Security

Ed Lorenzen
January 7, 2005  (modified 1/12/05 to correct a minor typographical error)

Centrists should be heartened by a memo from a senior White House official acknowledging that individual accounts are not a magic bullet that will solve the challenges facing Social Security on their own.  Instead, they must be coupled with other reforms to put Social Security on a sound financial footing. 

The memo suggests that the White House is not likely to follow the lead of the conservatives who argue that structural reforms to restrain the growth of Social Security are unnecessary.  This provides an opportunity for centrist legislators who are interested in advancing responsible Social Security reforms that put the system on a sound financial footing.

Outline:
Individual accounts can be an important component of a comprehensive reform plan, but they are not a magic bullet.
Social Security reformers should not promise too much.  
Moment of Truth.

The memo authored by Peter Wehner, Director of the White House Office of Strategic Initiatives, is essentially a pep talk for the President’s efforts on Social Security.  However, in the middle of the ideological cheerleading were two key paragraphs that signaled a welcome departure from the free lunch rhetoric being advocated by some conservatives.

 

You may know that there are a small number of conservatives who prefer to push
only for investment accounts and make no effort to adjust benefits -- therefore
making no effort to address this fundamental structural problem. In my
judgment, that's a bad idea. We simply cannot solve the Social Security problem
with Personal Retirement Accounts alone. If the goal is permanent solvency and
sustainability -- as we believe it should be -- then Personal Retirements
Accounts, for all their virtues, are insufficient to that task. And playing
"kick the can" is simply not the credo of this President. He wants to do what
needs to be done for genuine repair of Social Security.

If we duck our duty, it can have serious short-term economic consequences.
Here's why. If we borrow $1-2 trillion to cover transition costs for personal
savings accounts and make no changes to wage indexing, we will have borrowed
trillions and will still confront more than $10 trillion in unfunded
liabilities. This could easily cause an economic chain-reaction: the markets go
south, interest rates go up, and the economy stalls out. To ignore the
structural fiscal issues -- to wholly ignore the matter of the current system's
benefit formula -- would be irresponsible.  

 

The views expressed in those two paragraphs are clear indications that spade work done by so many fiscally responsible centrists to inform policy makers about the tough decisions involved in fixing Social Security is beginning to bear fruit.  In the first term the Bush administration rigidly followed the views of supply side advocates.  He implemented large tax cuts and ignored efforts by centrists to impose some fiscal discipline with “triggers” for tax cuts and restoring pay-as-you-go rules for all legislation which would increase the deficit through tax cuts or spending increases.  This memo suggests that there are at least some in the administration who will be sympathetic to the fiscal concerns of centrists in both parties in the Social Security reform debate.  This presents a tremendous opportunity that centrists should seize by actively engaging in the Social Security reform debate in support of fiscally responsible reforms.

 

Individual accounts can be an important component of a comprehensive reform plan, but they are not a magic bullet.  Centrists believe that personal accounts are not a magic bullet that will save Social Security, but coupled with progressive reforms to the benefit structure, they offer workers a much better deal than current law can afford.  This approach is exemplified in legislation authored by Senator Graham, as well as the Kolbe-Stenholm bill introduced in the 108^th Congress.

 

Individual accounts offer a more effective method to save current payroll taxes to pre-fund a portion of future benefits.   Past efforts to pre-fund Social Security's future liabilities via trust funds or other accounting mechanisms have failed to work in an economic sense, because Congress tends to spend the money in trust funds, or "off-budget" accounts, anyway.  In a sense, individual accounts are the ultimate lock-box, ensuring that current payroll taxes are truly saved for future retirement benefits.

 

Tough choices will be necessary to eliminate the deficit facing Social Security, regardless of whether individual accounts are included in a reform plan.  Including individual accounts in a reform plan does not require deeper benefit reductions than would otherwise be required, nor does it make such reductions unnecessary.  However, individual accounts can help make the task easier for policymakers and limit the impact on future beneficiaries.

The benefits from the higher returns earned by accounts could offset some of the reductions in promised benefits that will be necessary to restore solvency with or without individual accounts.  Analyses conducted by the independent Social Security Actuaries and the Congressional Research Service have found that reform plans which include individual accounts provide a better deal than plans which restore solvency through tax increases or benefit reductions alone. 

 

Social Security reformers should not promise too much.  The transition costs of reform should be addressed responsibly, not waved off as inconsequential.  Large unfunded transition costs would defeat one of the primary purposes of Social Security reform, which is to protect future generations from undue tax burdens.

 

Social Security reform could spark increases in national savings if the funding for personal accounts is at least partially "paid for" with tax increases or spending cuts, and if workers believe the funds in their Social Security accounts represent a replacement for benefit cuts and therefore do not adjust their outside levels of savings.

 

Some proponents of Social Security private accounts insist that because private investments will have a high rate of return, the accounts are essentially "free money," creating national wealth that would not otherwise have been created.  This position is advanced by the same anti-tax groups who brought us unfunded supply-side and business oriented tax cuts.  A motivating belief in these proposals is that very large federal deficits will not significantly hurt the economy.  

An economist's maxim is "beware the free lunch," and Social Security calculations that sound too good to be true are usually based on the tenuous assumption that Social Security reform will dramatically increase national savings and investment, and raise the national tolerance for risk.  Proponents of Social Security accounts should not depend on such "leverage" in their calculations of the likely impact of reforms.

 

Plans that suggest it is possible to save Social Security without any pain actually have tremendous hidden costs that will require “sneak attack” pain.  They will drain the federal budget and U.S. economy of resources that are needed for other government programs and ultimately result in higher tax burdens and lower national savings.

 

The proposal developed by anti-tax activist Peter Ferrara in late 2003 best exemplifies this approach:  very large accounts coupled with guarantees that retirees would receive benefits at least equal to those promised under current law.  However, the transition costs of this proposal would be enormous.  The proposal would actually increase Social Security costs to almost 8 percent of GDP before it started saving money, and the savings would come only after 4 decades.

 

Social Security benefits are predicted to rise from about 4.3 percent of GDP at the end of this decade to 6.1 percent of GDP in 2030.  Therefore, the primary reason for reforming Social Security is that its costs would otherwise raise government spending by about 2 percentage points of GDP. The only way to reduce Social Security costs is to reduce them.  Benefit guarantees that claim all retirees will get the currently promised benefits and more are unhelpful exaggerations, or would lock in future taxpayers to even great liabilities than the current promises imply.  Reform proposals must control the growth of these costs to credibly solve the budget problem.

Moment of truth.  We are at a moment of truth in the Social Security debate that will play out over the next few weeks: will the administration move forward with a fiscally responsible plan that honestly addresses the financial challenges facing Social Security or will it take the free lunch route advocated by some conservatives?  If Mr. Wehner's views are shared by the President and his senior advisers, this question may be resolved in a manner that is consistent with centrist principles.  Centrist legislators should seize this opportunity to influence the debate to ensure that we seriously address the fiscal challenges facing Social Security in a responsible manner.


Links:

Upcoming Event:  Is Social Security's Financial Future In Jeopardy?  Three Perspectives, Similar Conclusions  Please join Centrists.Org and The Alliance for Worker Retirement Security on January 21^st as Steve Goss, Chief Actuary of the Social Security Administrat-ion, Doug Holtz-Eakin, Director of CBO, & Dave Walker, Comptroller General of the United States , discuss their respective estimates and perspectives of the size and nature of financial challenges facing Social Security.

Centrists.Org The Kolbe-Stenholm Social Security Plan (February 14, 2004)

Centrists.Org Unfunded Transition Costs of the Ferrara Social Security Proposal (December 2, 2004)

Centrists.Org The Fourth Entitlement:  Interest (December 1, 2003)

Centrists.Org A Preliminary Analysis of Sen. Graham's Social Security Proposal (November 18, 2003) 

Full text of the Wehner Memo (January 3, 2005)

Centrists.Org Issue Summary:  Social Security

Centrists.Org Long-Term Baseline Homepage (Revised June 3, 2004)

Centrists.Org Where Will the Deficit Go From Here?  New Long-Term Budget Projections (June 3, 2004)

Centrists.Org Testimony: Comparing Social Security Reform Proposals (Jeff Lemieux, for the Senate Special Committee on Aging, June 15, 2004)