March 18, 2005,
The discussion over how to fix Social Security is filled with words that are getting too much attention. Privatization is one. Focus groups apparently don’t like that word, and supporters of private accounts have taken to using the words “personal accounts.” Why get so hung up on what you call it? The issue is whether individual ownership of Social Security savings is a good idea or not.
Crisis is another. Crisis is a relative term so there is no right or wrong here, but all serious policy experts believe Social Security has over-promised what it can deliver and that changes should be made sooner rather than later. Furthermore, arguing that the system is in crisis in no way strengthens the argument that accounts should be part of the solution, just as arguing there is no crisis does nothing to argue against accounts.
The current misplaced obsession is with the term “carve-out,” a term that has very questionable economic content. Opponents of account-based reform proposals have drawn a line in the sand over using existing payroll taxes to fund individual accounts, or “carving’ out accounts from Social Security. While many like the idea of “add-ons,” or layering an account on top of Social Security, they are vehemently opposed to diverting part of the payroll tax to fund the accounts. Many supporters of reform, on the other hand, are just as wed to the so-called carve-out method.
But the fight over the diversion of the payroll tax bypasses the issues that are actually at the heart of the debate.
Logically, one can think about Social Security reform as having two steps. First, a reform needs to restore balance. Second, a reform might alter the structure of the system to include private accounts. The real questions then, are: 1) Should we fix Social Security through tax increases or spending cuts? and 2) How much of the program should be in the form of traditional benefits and how much should be income generated from individual accounts?
To the first question one must determine the appropriate level of resources to devote to Social Security. Currently 11 percent of covered wages are devoted to paying benefits. This is projected to climb to over 19 percent. To honor benefits promises, we have to raise taxes. To contain the cost of the system from going beyond current levels, we will have to cut benefits from what has been promised. With few exceptions, those who prefer “carve-outs” want to devote fewer resources to Social Security, and those who prefer “add-ons” prefer more. However, this question is not determined by whether funds are diverted to pay for the accounts, but rather, how Social Security solvency is achieved.
Question two is also straightforward. Individually owned accounts shift part of the Social Security system from a defined benefits system, where participants receive a benefit based on a formula related to their contributions, to a defined contribution system, where benefits are based on contributions and the returns from investing. Supporters of private accounts believe that individuals will value the ownership and control over their money that the current defined-benefit system does not offer. Opponents prefer the communal, redistributional, and risk-sharing elements of the current system. So, figuring out how much of the program should be defined benefit vs. defined contribution is the second key question.
More often than not, these two questions get grouped together, greatly confusing the issues. One could easily construct a Social Security reform plan that used part of the existing payroll tax to finance individual accounts while closing the total Social Security deficit through other tax increases. So while accounts would be carved out, more resources in total would be devoted to Social Security.
Likewise, a plan could be constructed where accounts were added-on while the Social Security deficit was closed by price indexing benefits, or some other such benefit cut. Conceivably, both traditional benefits and total benefits could be lower under this scenario with add-on accounts than they would be under the carve-out reform.
Clearly, looking at the revenue stream for individual accounts in a vacuum does little good. Dollars are fungible and one cannot analyze the effects of creating accounts without also considering how Social Security would be balanced. It is completely legitimate to argue about the optimal level of benefits, and the extent to which they should be defined benefit vs. defined contribution, but whether the money should be carved, added, diverted, augmented, pasted, or cauterized, does little to further the discussion.