December 17, 2004,
In November, the American people faced a clear choice on Social Security. George W. Bush proposed creating voluntary personal retirement accounts and permanently fixing Social Security’s finances. By contrast, John Kerry committed to preserve the current program, charging that the Bush plan would cut Social Security benefits. The voters rejected the status quo and endorsed Social Security reform.
Personal accounts offer the best solution to strengthen Social Security. However, much of the congressional debate on Social Security reform will center on how to finance the trillions of dollars in forgone payroll-tax revenue that would be directed to personal accounts. The Bush administration has already ruled out raising payroll taxes and has signaled that increased government borrowing will be part of the solution. As Joshua B. Bolten, the president’s budget chief, recently put it, increased borrowing “is merely bringing forward obligations that the U.S. government now has. If markets see our political process moving toward a solution to that, I think markets will be greatly comforted.”
The president’s bipartisan Social Security Reform Commission, chaired by the late Sen. Daniel P. Moynihan, called for personal accounts allowing contributions of 2 to 4 percent of payroll taxes. Free-market conservatives are pushing for 6 percent accounts proposed in legislation sponsored by Rep. Paul Ryan (Wisc.) and Sen. John Sununu (N.H.). However, the transition to large personal accounts could exceed the $1 trillion to $2 trillion often cited by the media.
Supply-siders will correctly argue that large budget deficits do not necessarily lead to higher interest rates. But at some point, government borrowing that significantly exceeds $2 trillion is bound to have some negative psychological impact on the financial markets. I am of the view that the markets will tolerate increased levels of near-term debt so long as reasonable and credible budget restraints are enacted that put Social Security into permanent solvency.
Policy-makers should consider additional actions to control spending. The Ryan-Sununu Social Security reform bill calls for a spending control cap of 3.6 percent annually for the next 8 years to finance the transition. The Bipartisan Social Security Commission proposed linking the growth of future Social Security benefits to inflation instead of to wage growth. In 1972, first-year benefits were indexed to inflation because economists believed that wage growth would always exceed inflation. But with the onset of “stagflation” in the 1970s, Congress in 1977 decided to link benefits to wage growth because inflation indexing was proving to be too expensive.
In today’s low-inflation economy, price-indexing benefits for future retirees would maintain the purchasing power of today’s Social Security benefits, but would limit the increase in benefits to eight-fold over the next 75 years instead of eighteen-fold under wage indexing, producing budget savings of $10 trillion. Alternatively, price indexing could be structured to apply to high-income workers, while preserving wage indexing for low-income workers and widowed spouses. Or perhaps future benefits could be linked to the lesser of inflation or wage growth.
To be sure, many Democrats will reflexively charge that price indexing will “cut” benefits for seniors. However, President Bush has explicitly pledged to protect benefits for both today’s retirees and near-retirees. Secondly, only in Washington would slowing the rate of increase in overall benefits from eighteen-fold to eight-fold be considered a “cut.” Finally, the politics of Social Security have dramatically changed: Today’s young workers would gladly give up all of their future Social Security benefits for the chance to invest part of their payroll taxes in an account that they would own and control.
Policy-makers must keep in mind that the goal should never be simply to “save” Social Security or any other program. Rather the objective should be to provide reasonably secure retirement opportunities for workers, opportunities better than the status quo offers, since workers will own assets that the government can never take away. Achieving that objective will require a transition that may involve borrowing or other actions that will spark opposition. But as Don Luskin of NRO Financial and TrendMacrolytics told me: “Many times in the past the American public has accepted an appropriate mixture of ice cream and spinach on Social Security. This will be no different.”
In the end, any speculative criticism of the transition to a better system should be judged against one certainty the status quo on Social Security is not an option.