Liberal Dogma On Social Security Redux

From The CATO Institute:


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Liberal Dogma on Social Security Redux

Posted by Jagadeesh Gokhale



Liberal posturing on Social Security reform continues unabated – betraying nervousness that Obama’s Deficit Reduction Commission will recommend Social Security benefit cuts.



Left-wing voices also continue to repeat the mantra that introducing private Social Security accounts would be a bad idea. Ronald Brownstein’s recent recent column in the National Journal is a case in point. However, Brownstein’s readers may come away thinking that he believes breaking promises is a good idea.



Brownstein concedes that “Social Security indeed faces a long-term imbalance between expected revenue and promised benefits.” I consider this to be progress — at least relative to the erstwhile “there’s nothing wrong and nothing to fix” mantra adopted by liberal adherents of the status quo on Social Security.



Notice Brownstein’s use of the term “promised benefits.” A promise implies a commitment and obligation to make good on future benefit payments. But the solution that Mr. Brownstein points to is as follows:



Instead [of private accounts], Obama argued, the two parties could emulate the Reagan model and arrive at a sensible solution… [T]he program’s long-term shortfall could be eliminated just by trimming benefits for the top half of earners [JG note: breaking the Social Security benefit promise here], linking the retirement age to lengthening life spans [JG note: breaking the promise here too], and imposing a partial payroll tax on earnings above $250,000 [JG note: that is, promise more benefits by expanding the definition of covered earnings and increasing payroll taxes on high earners].”



But all that the last element may achieve is to stave of the program’s insolvency for a few more years.



My comment: Please don’t drag Reagan into this “solution.” The 1983 reforms were implemented under the gun, at a time when there was no way out of Social Security’s imminent revenue shortfall. If President Reagan had enjoyed the luxury of a couple more years to plan changes to Social Security, he would have adopted a different approach, and be much better off today. According to broad market indexes such as the S&P 500, total returns averaged well above 10 percent per year during the 1980s and 90s – so, well above inflation. (The first decade of the 2000s yielded a negative 1 percent return.)



Finally, Brownstein writes:



[T]he gap between the system’s revenues and obligations, relatively speaking, isn’t that daunting–less than 1 percent of the economy’s expected output over the next 75 years.



Does Mr. Brownstein really appreciate how large that is? In present value terms, the Social Security actuaries report that the present value of Social Security’s shortfall over the next 75-years equals $5.4 trillion. That’s one-third of current annual GDP. In other words we have to devote that sum to earning interest each year for 75 years to cover Social Security’s financial gap.



Alternatively, since payrolls equal only one-half of national output, it means that payroll taxes would have to increase by an average of about 2.0 percent per year if they are levied over all wage earners. However, the tax increase is to be levied only on those earning $250,000 or more. There are about 3 million U.S. taxpayers with incomes above $250,000, with average income of about $500,000. (I’m rounding up based on information for 2006 available here.) That makes a tax base of $1.5 trillion. (Actually, this is likely to be too large because I’m counting total income, not taxable income, which would be much smaller.) Raising the equivalent amount of revenues from these high earners (who face the highest marginal income tax rates already and are likely to alter their work effort in response to still higher taxes) would imply increasing their average tax rates by almost 11 percentage points. Of course, because some of the adjustment will be through benefit cuts and indexing the retirement age to increasing longevity, the tax increases that must be levied on high earners would be smaller.



But are those benefit cuts politically realistic? Americans already face a normal retirement age of 66, and it is scheduled to increase to 67 in little more than a decade. Extrapolating from the French response to increasing their pensionable age from just 60 to 62, Americans’ would probably end up opening a third war front to resist further increases in Social Security’s retirement ages — a “generational war” here at home.



So where do we go from here? One answer may be to first introduce “add-on” personal accounts using the 2.0 percentage points of payrolls – the amount required to plug Social Security’s current shortfall. This would not be a “tax” as the funds would be invested in personal accounts – and it would enable low earners an opportunity to partake in the long-term wealth creation mechanism that they have heretofore been unable to exploit. As I have argued here, if this amount is effectively saved and invested – by insuring that the government does not borrow and spend those savings — it would create space for a “carve-out” addition to the “add on” personal accounts, increasing retirement wealth even more. Finally, with the stock markets relatively stable and current P/E ratios of broad market indexes close to historical averages, now would be the right time to begin such a reform program for Social Security.



Would liberal policymakers and analysts take on this approach? No prizes for guessing the answer.



Jagadeesh Gokhale • October 22, 2010 @ 5:49 pm