Good (and Not Good) Reasons to Overhaul Social Security

Posted February 1, 2005 at 4:53pm

The Republican Congressional retreat last weekend at the Greenbrier resort in West Virginia resulted in a renewed, if nervous, commitment to forge ahead full-bore on Social Security. That is the topic of the day, but not before I note for the record the startling change in media coverage of Congressional party retreats from the 1980s and 1990s. [IMGCAP(1)]

Back then, Democrats regularly used the Greenbrier for their retreats, until they were forced, after the federal pay raise in 1989, to move to more Spartan locations under a barrage of criticism from journalists for cavorting at the “posh” resort. Other adjectives used were “palatial,” “swank,” “exclusive” and “glamorous.” How the world has changed: It would probably take a retreat at Versailles nowadays to get press attention for overreach.

Back to Social Security. There are three possible reasons for the president to make sweeping changes to Social Security, his top domestic priority. First and most frequently stated is fixing the program’s fiscal imbalance — that is, making sure, for a very long period of time, that income will equal or exceed outlays.

A second reason is to use Social Security as a wedge to expand the size of the investor class, ultimately leading to every American having a share of the market and a piece of the action.

A third reason is to leverage such significant changes in Social Security — the centerpiece of the social welfare state — that it becomes a watershed in demolishing that state, moving instead to a system in which the government offers no guarantees or safety nets, and in which the risks are born by, and the rewards accrue to, individual citizens, rather than the government.

Let me emphasize that these goals are not mutually exclusive. But let me equally stress that if the primary goal of the president were ameliorating the future fiscal problem, there is little reason to make individual private (oops, “personal”) accounts the centerpiece of the solution.

Why? First, individual personal accounts, on their own, do nothing to deal with the fiscal problem, or at least nothing positive. They do not increase inflows into the Social Security reserve or reduce future outlays. All they do is take a sizable slice of the current revenue stream out of the system’s coffers. That money is now being used for two purposes: paying current Social Security beneficiaries and financing much of the deficit that exists for the rest of the federal budget.

The money diverted into personal accounts — $1 trillion, $2 trillion, take your pick for a 10- to 20-year projection — will increase savings and investment in the United States. But the federal government will have to go to the markets to borrow an equivalent amount to pay the current beneficiaries and finance the other deficits.

Any way you look at it, that will add a big sum of money to annual deficits and the cumulative federal debt, even if you call it, in Pennsylvania Republican Sen. Rick Santorum’s felicitous phrasing, “preborrowing.” A sharp increase in federal borrowing will, in turn, probably affect interest rates and the reaction of non-Americans to the desirability of buying dollars. This could mean a drop in the value of the dollar.

Those shortcomings might be worth bearing to “save” the Social Security system. But, again, these personal accounts don’t do that. They can serve that purpose only if they are twinned either with a corresponding increase in other taxes or with cuts in future Social Security outlays, or some combination thereof.

Many Republicans, such as Sen. Lindsey Graham (S.C.), understand this. Many do not, or at least don’t even want to think or talk about it. Frankly, only a combination makes fiscal sense. Tax increases will be necessary over the next decade or more to reduce or eliminate the large drop in revenues from the personal accounts. Then, once the personal accounts begin to produce healthy rates of return for the individuals who have them, Americans can look to their accounts when they retire, and the benefits they would otherwise get from Social Security could presumably be shaved back to save the system. Such reductions would keep Social Security from growing too steeply as a share of the budget and GDP, yet still give workers a benefit equal to or greater than what they would have expected without reform.

That combination might be workable. But it is one of many options, and a very unwieldy one, to save a system that needs serious change but is not in crisis.

If the goal is to raise more revenue so benefits can continue apace, why not just have the system invest in a broader range of instruments, including stock index funds? Why not consider a combination of raising retirement ages, reducing the benefits for early retirement, making modest changes in benefit formulas, making the system more progressive through salary cap increases on payroll taxes and adjustments in benefits? Even better, why not look at ways of eradicating the payroll tax, a terrible, regressive tax on jobs that is especially burdensome in a global economy, and replacing it with a more efficient and fair tax?

And why not focus on a tougher and more delicate problem: all three major entitlement programs are soon going to grow logarithmically, reaching 20 percent or more of GDP and 80 percent of the federal budget by 2040 unless their growth is restrained. This should not be acceptable to conservatives, who can’t be anxious to see a federal government exceeding 25 percent or even 30 percent of GDP, or to liberals who will see Social Security, Medicare and Medicaid, like giant tapeworms, crowd out everything else in government, with Medicare the biggest tapeworm of all.

If anything, a huge partisan debate on personal or private Social Security accounts puts off the more urgent and difficult discussion of how to reduce the rate of growth of Medicare. It doesn’t solve the program’s more serious fiscal imbalance, and it moves us further away from the kind of broad bipartisan cover needed to make necessary, painful choices in entitlements.

So let’s turn to reason two. No question, the goal of a universal investor class is a good one. But is the Social Security system a necessary place, or even the best place, to enlist in that goal? If it is, why not do it in a broad bipartisan way, by having personal investment accounts on top of Social Security, implementing expanded 401(k) accounts with tax credits for poorer workers, including refundable ones for those working but only paying payroll taxes. An even better way would be through KidSave, the widely acclaimed program introduced some years ago by then-Sen. Bob Kerrey (D-Neb.) and co-sponsored by a remarkable group of Congressional luminaries including Sens. Daniel Patrick Moynihan (D-N.Y.), Joe Lieberman (D-Conn.), John Breaux (D-La.), Chuck Grassley (R-Iowa) and Santorum.

Under KidSave, the federal government would deposit $1,000 into an individual, tax-deferred account, managed by the federal government using a limited universe of index funds, for every child born in America, then supplement it with $500 annually for the child’s first five years. That would mean that accounts would be worth more than $3,500, not counting appreciation, for everybody at age 5.

With 4 million kids born each year in America, the initial cost would be $4 billion, with later costs easily manageable in a $2 trillion-plus annual budget. By retirement age, through the miracle of compound interest, each participant would have a large nest egg, amounting to hundreds of thousands of dollars in today’s terms.

To make the investor class approach more workable, why not turn those investment choices over to the individuals at age 21? There are many other ways to tweak these KidSave accounts. One of the most innovative and interesting ways has been put forward by the impressive new group ThirdWay, but the basic point is that they provide an affordable and noncontroversial way to expand the investor class to all.

That leaves us with the third reason, which is the real reason that personal accounts within Social Security have become such an article of faith among conservatives.

Former Speaker Newt Gingrich (R-Ga.) and others argue that it would be political suicide for Republicans to tie personal accounts in Social Security either to tax increases or benefit cuts, saying instead that the accounts should stand on their own. Hearing this, it becomes obvious that the supporters’ central goal is neither to eliminate the long-term Social Security shortfall nor to simply expand the investor class, but rather to transform government by eliminating the remnants of the New Deal and Great Society.

A focus on reasons one and two could conceivably result in a broad bipartisan compromise — modest, long-range changes in retirement age, benefit formulas and the tax base, along with add-on individual retirement accounts for all, some system-wide investment of Social Security revenues in stock index funds, and a version of KidSave. Ideally, as well, that compromise would begin to look at Medicare and Medicaid, especially its largest component, long-term care for the elderly. A focus on reason three will not lead to any of the above.

For these reasons, I applaud Ways and Means Chairman Bill Thomas (R-Calif.) for trying to put Social Security into a broader context, moving the debate away from a monomaniacal focus on personal accounts. I hope his comments spur a new dialogue. I am not optimistic.

Norman Ornstein is a resident scholar at the American Enterprise Institute.