The Death of Social Security

Debating Bush's plan for private retirement accounts.

James K. Glassman & Tyler Cowen from the April 2005 issue

(Page 3 of 6)

Whether we like it or not, government would come to be seen as offering an implicit guarantee for these accounts. If the stock market were to stay low for 10 or 15 years, retirees would demand that government supplement their returns. Government would feel pressure to cough up additional revenue exactly when the budget would be in the tightest squeeze. The result would be higher taxes in times of recession, exactly the opposite of what is appropriate. (It is true that government does not end up guaranteeing current IRAs, but that is only because we already have Social Security as a backstop.)

The private accounts would function as a kind of forced saving, as Glassman admits. But how much can government really force people to save through this kind of mechanism?

You can make people lock up funds in an account, but they can respond by borrowing more on their credit cards, taking out a bigger mortgage, and in general investing less in their future. The net increase in savings will be much less than the mandated increase. So the government will control more of our lives but without making our old age much safer. In essence we would see substitution from privately initiated saving to government-controlled saving. Is this really a step in the direction of liberty and responsibility?

And what will happen to the efficiency of private capital markets? Glassman already has admitted that investment choices will be "restricted." By whom? According to what standards? Will the government use these regulations to punish unpopular companies? How about companies that (supposedly) break the law? How about companies that supported the other political party? The proposal invites a politicization of investment decisions.

The Glassman proposal also would raise your taxes. Keep in mind that Social Security, whether we like it or not, is structured as a pay-as-you-go system. That means current taxpayers fund current retirees. If we allow current taxpayers to divert funds into private accounts, how do we fund the (constant) benefits to current retirees? It has to be either taxes or borrowing, and the latter means future taxes. Depending on how many people wish to switch to the private accounts, the size of this tax increase could run to the trillions.

In fairness to Glassman's proposal, it can be argued that these taxes would have been coming anyway. When subsequent generations of the elderly retire, we must pay taxes to fund their benefits. So arguably the Glassman reform is simply taking an implicit future liability and making it explicit in the present.

Unfortunately, the reality is grimmer than such logic would suggest. In theory it would work if government raised our taxes today, and then cut our taxes tomorrow as future retirees relied more on their personal accounts. But is that how governments operate? How often do they cut taxes just out of generosity? More likely they would keep the higher levels of taxation (and/or borrowing) in place. The plan would lead to a permanently larger role for government.

Whatever the problems with Glassman's idea, you might object, isn't the current system even worse? The correct comparison is not with the status quo but rather with caps on benefit increases. Those caps would bring fiscal stability to the system without requiring tax increases. Over time Social Security taxes could be cut. Individual saving would be encouraged. We could reap the higher returns available on private investment. At the same time we would not be breaking promises to current or near-term retirees. Even long-term retirees would receive a level of benefits at least as high as today.

And consider how benefit caps would operate in the long term. As benefits are held constant in real terms and the economy grows, the relative size of the Social Security program will shrink. Over time Social Security will become very small, in real terms, relative to the economy as a whole. This requires some patience, but it is the best recipe for privatization we have available. And it does not require additional regulation of savings or investment.

Glassman asks, "Can Americans handle this much freedom?" I think they are ready to handle more liberty than he is proposing.

Proceed With Caution

James K. Glassman

Tyler Cowen would reform Social Security by capping benefits, thus forcing people to save more on their own through existing private mechanisms, including IRAs, 401(k)s and taxable mutual funds, stocks, and bonds.

I am not sure what Cowen means by "caps." The implication is that he would stop increasing benefits, period. If inflation runs 3 percent annually, that would mean that in 24 years retirees would have half the purchasing power from their Social Security payments as retirees today.

Slowing the rise in benefits is part of my own proposal as well. I want to boost payouts to retirees each year according to the consumer price index, not according to the annual rise in wages.