Saving Graces

The case for private retirement accounts does not depend on Social Security's bankruptcy


The loudest objections from Democrats during President Bush's State of the Union address came when he declared that if Congress fails to reform Social Security "the entire system" will be "exhausted and bankrupt" by 2042. They were right to object.

As the Democrats themselves are quick to point out, however, the case for the private investment accounts they vociferously oppose has nothing to do with the condition of Social Security in 2042. So their complaint about the president's description does not get them far.

What the Social Security Trustees' projections actually indicate is that the system's "trust fund" will be exhausted by 2042. But since this fund consists of IOUs from the Treasury, the relevant date is 2018, when benefits promised to retirees will start exceeding payroll taxes and the system will begin running a chronic annual deficit.

The point is not that the Treasury will refuse to pay off its bonds but that doing so will require lower spending, higher taxes, or more borrowing (which ultimately will mean higher taxes). In other words, Social Security's fiscal crisis begins in about a dozen years, so the focus on 2042 is misleading.

The Democrats nevertheless are correct that the system as a whole will not be bankrupt, since payroll taxes will still cover about three-quarters of benefits. They say the shortfall can be fixed with a few adjustments, a point Bush implicitly acknowledged when he said cutting benefits for wealthy retirees, raising the retirement age, discouraging early retirement, and indexing initial benefits to prices rather than wages are all "on the table."

One or more of these changes would suffice to bridge the gap between benefits and payroll taxes. So where do personal investment accounts come in?

To his credit, Bush made it clear they're a distinct issue. "As we fix Social Security," he said, "we also have the responsibility to make the system a better deal for younger workers. And the best way to reach that goal is through voluntary personal retirement accounts."

The Democrats object that allowing workers to put some of their payroll taxes in personal accounts will worsen Social Security's financial condition, since the diverted money would not be available to pay benefits for current retirees. Although much depends on the final details of the plan and the number of people who participate, the administration estimates that making up the difference would cost $754 billion during the next decade.

But this cost will be offset over the long term by lower demands on payroll taxes, as future retirees draw more on their own accounts and less on standard benefits. Another way of looking at it is that establishing private accounts simply makes explicit some of the system's existing liabilities. It may not reduce them, but neither does it raise them.

If workers eventually were permitted to put all of their payroll taxes (including the employer's share) in private accounts, Social Security would become completely self-financing. The transition costs would be higher, but so would the ultimate payoff.

The president's proposal is much more modest than that, although if the accounts prove popular they could pave the way for further privatization—the Democrats' greatest fear and the best argument in the plan's favor. Bush wants to let workers put up to 4 percent of their wages, about two-thirds of their payroll tax share, in regulated personal accounts. Initially the annual contribution would be limited to $1,000, just one-quarter of the current cap on IRA deposits.

The advantages of private accounts include better returns than the current system promises and the ability to leave any remaining balance to one's heirs. "Best of all," the president said, "the money in the account is yours, and the government can never take it away."

Although sold to the public as a pension system, Social Security is based on the forced transfer of resources between generations. It steals from the poor to give to the rich, and it substitutes dependence on a beneficent state for self-reliance and voluntary mutual aid. It may not be financially bankrupt, but it is morally so.

By contrast, private investment accounts represent genuine savings, as opposed to claims on other people's money. There is no getting around the fact that requiring people to save also involves the use of force, but this sort of paternalism seems preferable to the predation at the heart of the current system.