Social Security Reform: MIA

Heard much about social security reform lately? I didn't think so.

This is unfortunate, because this is a problem that needs solving. The contours of the problem are obvious: sometime around 2040 (we don't need to argue over precise dates) the social security trust fund will run out of money, and there won't be anything there to pay benefits. 2040 - hey, make it 2050 if you want - isn't far off. Most workers age 30 and under can expect to be retiring then, and most workers 40 and under can still expect to be receiving benefits, along with lots of folks now in their 40s and 50s.

But wait: the problem is worse than that. For years the federal government has borrowed all of the trust fund surplus every year, in order to reduce or eliminate the federal deficit. All that is in the "trust fund," therefore, are IOUs from the government - government bonds. Sometime between 2015 and 2020, social security benefits paid each year will exceed social security taxes coming in. At that point, the government will have to turn to the trust fund. But all they will find there are IOUs. I have heard some people argue that this is fine - that the government is legally bound to redeem the bonds. How silly. The government has a certain amount of money. It doesn't really matter whether you say it is "social security" revenue or general revenue. If the government honors the social security IOUs, it can only do so by dramatically cutting spending elsewhere or by raising taxes other than social security taxes.

But wait: the problem is worse than that. Within the next 5 years, the social security annual surplus will begin to shrink. In other words, there will be less social security annual surplus to mask the deficit. Thus, either deficits will grow, or other government spending will have to be cut, or taxes raised. So where do you want to cut spending? And do you really think raising taxes is a good idea, and won't damage the economy?

What is the answer? President Bush put forward a very simple, practical solution. First, we protect all existing retirees and those near retirement. Next, we tell young workers - those with time to adjust - that their social security benefits are going to be reduced in the future. This hardly seems fair, but the alternative - significant tax increases - isn't fair either, and would do much more harm to the economy. So how do we make this a little more palatable? We allow these younger workers to divert some of their taxes to private accounts. In essence, they get a social security tax reduction - with the stipulation that they save their tax cut for retirement.

But how can this work? If we reduce their taxes, don't we merely offset the benefit reductions needed to bring the system into balance? No. The reason is because, social security taxes not being invested, the system gives young workers a rate of return of approximately 0%. (Some say a bit more, but others claim it is actually a negative number. Either way, it is palty - again, we don't need to quarrel over details). Thus, if private accounts can get a 5% annual return over one's working life - no trick to that, historically that is a very low number - then it works this way. The government cuts benefits by more than it cuts taxes, but the private savings accounts grow even faster - fast enough to more than offset the difference. Let me illustrate simply:

You pay $5/yr. taxes for 20 years, a total of $100.
The government then pays you $5.10/yr for 20 years, or $102.
That's the current system.

Now let's say that instead the government promises to pay you only $18/yr., or $90 over your 20 year retirement. But it will only charge you $19 a year, or $95 total, instead of $100. It seems like you are behind - your taxes are cut by $5, but your benefits by $12.
But suppose that over those 20 years, the $5 you save has grown to $10. Now, you will have a total of $105 over the course of your retirement. You are $3 ahead, and the government is $7 ahead. Simply because the returns in the private sector are better.

This is an eminently reasonable approach. It avoids the tough libertarian approach of complete privatization, or just cutting off current retirees, or even means-testing. It avoids economy-crippling tax increases. It requires some sacrifice by younger workers, but they are best able to adjust, and the sweetener of the tax cuts makes it likely that they will actually come out ahead. It solves the problem.

Unfortunately, the President has been stymied by a campaign of demgogery from the Democrats. They have refused to even discuss reform so long as one of the most obvious and practical alternatives - a limited use of private accounts, is on the table. In other words, the only solutions the Democrats are even willing to discuss are tax increases and benefit cuts - the most unpalatable solutions. Their other alternative is to do nothing, and to make ridiculous comments about how the trust fund IOUs really have value., and 2040 is a long way off (from the same people who complain that deficits are robbing our children).

This stubborn, head-in-the-sand approach explains why the Republican Party is slowly winning over the American center. For now, the Democrats seem to have killed social security reform, and they think this will help them at the ballot box in 2006. But it will not. Bush may not have convinced most Americans that his solution was the right one, but he did convince them that this is a problem that must be addressed. What I predict is that centrist voters will remember that Bush tried, and the Democrats offered nothing - not even a willingness to talk. And the center will keep moving to the GOP, cementing a new Republican majority.