Editore"s Note
Tilting at Windmills

Email Newsletter icon, E-mail Newsletter icon, Email List icon, E-mail List icon Sign up for Free News & Updates

January 13, 2005
By: Kevin Drum

SOCIAL SECURITY: A CONVERSATION....One of the drawbacks of the blog format is that it's fundamentally a collection of snippets. This makes it almost impossible to divine a blogger's actual position on a complex subject like Social Security unless you're willing to search through the archives and figure it out from individual posts.

But I've posted enough snippets on Social Security over the past couple of months that it's probably time to put them together so everyone knows more or less where I stand at the moment. I've constructed it as a dialog, and it's below the fold so you can skip it if you're not interested.

Imaginary Interlocutor: What are your nonnegotiable starting points?

Me: Simple. Social Security must be:

  • Universal. Everyone pays in, everyone gets benefits. It is not merely "welfare for old people" a phrase usually uttered with a contemptuous shrug.

  • Risk free. A reasonable benefit level should be guaranteed by the federal government, because it's the government that has the resources to spread risk most widely. There are plenty of appropriate places for risk in our society, but retirement isn't one of them.

These are goals. I'm open to just about any means of achieving these goals.

To meet those goals Social Security has to be solvent. What should we do about that?

Nothing. We have plenty of bigger fish to fry right now.

Nothing? As in zilch? Zero? Nada?

Yep. A decade ago the Social Security trustees forecast that the trust fund would be exhausted in 2029. Today they've moved the date out to 2042 you can see the details here. The Congressional Budget Office thinks it's good until 2053. And if you use slightly less pessimistic economic projections than these guys do something a lot of economists think we should it's good until at least 2060 or 2070.

In other words, Social Security is in good shape for at least 40 years and maybe more like 60 or 70 years. So our best bet is to leave it alone and revisit the subject in another decade or so.

But even if the problem is that far off, aren't we better off doing something now instead of waiting?

I don't think so. If we were talking about 20 or 30 years, I'd agree. But at some point it just stops making sense to plan too far into the future our economic forecasts are too uncertain to allow us to make reasonable choices. A decade from now we'll know a lot more about the real trajectory of the economy, and there will still be plenty of time to act if the news is bad.

Really, though, we start running into problems in 2018, don't we? That's not so far off. At that point we start redeeming the bonds in the trust fund and we have to raise income taxes to pay them off.

Sure although the 2018 date is iffy too. More to the point, though, that increase in income taxes was all part of the 1983 Social Security reform proposed by Alan Greenspan and approved by Ronald Reagan. Basically, the bargain was this: lower and middle class workers would overpay payroll taxes for a few decades, and following that the well off would overpay income taxes for a few decades. The required increase in income taxes is fairly modest, and like it or not, we can't renege on that deal now anyway. More details are here, if you're interested.

OK, but suppose the trustees are right about the 2042 date and the trust fund really is going to become insolvent then? What would you do?

I'd rather not get into that.

You have to.

Oh, all right. If the trustees are right, then we need to implement some combination of benefit cuts and tax increases to stabilize the system. The normal retirement age has already been increased to 67, and I'm not crazy about raising it further I think there are less painful alternatives. I'd probably do the following two things:

  • Currently, initial Social Security benefits are increased each year in line with wage growth. For a middle income earner, the initial benefit is kept equal to about 40% of pre-retirement wages.

    After that initial benefit is calculated, annual cost-of-living increases are calculated using the Consumer Price Index. However, many economists believe the CPI overstates actual inflation, which means benefits are probably being increased more than they should be. We could eliminate half the estimated shortfall in the trust fund by reducing the cost-of-living increase to about half a percentage point less than the CPI.

    This is a very small reduction, and it's also a fair reduction since it could take effect immediately. Thus, it would affect both current retirees and future retirees equally.

  • To make up the other half of the shortfall I'd raise the cap on payroll taxes. Today, only income up to $90,000 is subject to payroll tax.

    I'm not sure what the exact numbers on this should be, but my guess is that the cap would need to be increased to about $200,000 or so. This should be done gradually starting in about ten years.

Other ideas are here if you want to put together your own rescue plan. The table on page 25 is a handy quick reference.

Why wait ten years to start increasing taxes? Why not do it now?

I don't see the point in raising taxes right now. Social Security is already overfunded at the moment, and increased payroll taxes would just go straight into the general fund. The general fund certainly needs more money, but I'd prefer that it come from some other source instead of through the backdoor of increased payroll taxes.

How about private accounts? What's wrong with that?

In principle, nothing. Private accounts invested in stocks would probably have pretty good returns and would also increase national savings. Those are both good things, but only if the accounts are honestly funded.

Honestly funded?

Yeah. If we just increase the deficit and use borrowed money to fund private accounts, it won't work. That's George Bush's plan. But borrowing money to invest in the stock market won't do a thing for national savings: the savings in the private accounts are offset by dissaving in the form of increased federal deficits. What's more, the high returns become kind of a mirage too. Unless private accounts boost economic growth, high returns just become a way of shifting money around. Someone gets more, but someone else gets less. I don't really see the point.

So how would a good private account plan work?

First, it would be funded by a tax increase. For the sake of discussion, let's say three additional percentage points in the payroll tax. Since this doesn't increase the deficit, the private accounts really would increase national savings. That in turn would probably help economic growth.

Second, projections of long-term returns from private accounts need to be calculated honestly. You can't assume slow economic growth when you're projecting Social Security's future demise and then turn around and assume high economic growth when you're projecting returns from private accounts. As Dean Baker explains here, an honest plan needs to be based on real stock returns of 5% and total portfolio returns of about 3.5%.

Third, any private account plan needs to have some kind of safety net. What if your investment does poorly? What if you live to a hundred and run out of money?

How do you solve the safety net problem?

The most interesting idea I've heard so far came from Phil Longman in Fortune last month. The idea is simple: raise the retirement age to, say, 72. After that, normal Social Security kicks in and everyone is covered no matter how long they live. Your private account would cover you between age 67 and age 72.

This is fairly clever because it limits the downside risk. If your investments do poorly, you might have to put off retirement for a year or two, but that's all. It's bad, but not catastrophic. (Of course, if your investments do well, you can retire early.) What's more, you know exactly how long your private account needs to last: five years.

Any other thoughts?

Sure, but they're mostly just doodles. For example, there's no law that says Social Security has to be funded solely through payroll taxes. Medicare is funded partly through payroll taxes and partly from the general fund, for example. Maybe OAS (the retirement potion of Social Security) should continue to be funded through payroll taxes and DI (the disability portion of Social Security) should be funded from the general fund. That wouldn't reduce the cost of Social Security, of course, but it would put the system on a more solid financial footing.

I've heard ideas for other funding sources too: an energy tax, for example, or the estate tax. I'm not sure how much sense these ideas make, and I'm not sure how stable they are as funding sources, but they're interesting possibilities. They also sound like political nonstarters, though.

Any final thoughts?

Yeah: Social Security is not in crisis, no matter how many times George Bush says it is. The trust fund has gotten a lot stronger over the past decade, and our best bet is to wait and see if it continues to get stronger yet.

If it doesn't, there are simple and fairly painless remedies available. Conversely, private accounts strike me as little more than a desperate desire for a free lunch although they might be worth trying if they were implemented by paying for them honestly. George Bush, however, has no such intention, and would instead combine huge benefit cuts and massive borrowing with increased risk and an implied contempt for the very idea that the federal government should guarantee our elderly a dignified retirement.

In the meantime, we have bigger problems to worry about: Iraq, defense transformation, Medicare and rising healthcare costs in general, the growing federal budget deficit, and the skyrocketing trade deficit, just to name a few. Social Security "reform" is little more than a smokescreen to avoid dealing with harder problems that George Bush doesn't have any easy answers for.

Kevin Drum 1:55 PM Permalink | Trackbacks

Bookmark and Share
 
Comments




 

 

Read Jonathan Rowe remembrance and articles
Email Newsletter icon, E-mail Newsletter icon, Email List icon, E-mail List icon Sign up for Free News & Updates

Advertise in WM



buy from Amazon and
support the Monthly