I also take the position that whether Social Security is privatized or not, Social Security or whatever replaces it needs to be properly funded. Social Security is a bit of a hybrid system, but still mostly a pay-as-you-go system. Current retirees are mostly paid with contributions from current workers. This is a major problem because of its effect on national saving, and thus on economic growth.
Because of the existence of Social Security, or for that matter any pension program, individuals feel the need to save less for retirement. Thus individuals contribute less to national saving simply because a program such as Social Security exists. This isn't a problem if the retirement program actually sets aside assets to fund future retiree claims. In this case, saving occurring within the retirement program offsets the reduction in saving by individuals.
Since the Social Security System has never been actuarially funded, it has had the
effect since its inception of reducing national saving, and hence economic growth.
Strong economic growth is essential in the next few decades in order to be adequately
prepared for the aging of the Baby Boomers, the generation born between 1946 and 1964.
For this reason, it is important that
Social Security or its replacement move in the direction of actuarial soundness
so that its effect on national
saving will be positive.
It's important to note that economists' projections are based upon a set of conditions. The implication is that if you change a particular condition, you can affect the growth rate. There is widespread consensus among economists, for example, that the rate of growth can be increased by increasing savings and investment. In another article, I argue that we should target a sustained rate of growth of 4 percent, and change the underlying conditions, if necessary, so that this growth rate is attained.
I personally believe that even without changing the underlying conditions, this economy has a very good chance of growing at a rate of 4 percent in the next twenty years. I base this belief upon two items: demographics and technology.
The Baby Boomers are in their peak savings years, and are preparing for retirement. In spite of the recent low personal saving rate numbers, the national saving rate, which is a combination of personal, business, and government saving, and the only number that is relevant, has risen considerably in the last few years, reaching 17.3 percent in the 3rd quarter of 1998, compared with 13.8 in the 4th quarter of 1992. Without policy changes whatsoever, I expect this number will continue to grow, at least for a decade.
My conclusion on technology's effect on the growth rate is born of my first-hand experience with computers and my perception of the potential this tool has for productivity improvements in virtually all parts of our economy. Many years of assimilating computer technology in the office passed before we saw much of a productivity boost. We are now seeing significant increases in productivity within the office. And, frankly, I think the best is yet to come.
At a four percent growth rate, the funding shortfall predicted by the Social Security administrators doesn't occur. The funding "crisis" simply disappears. This occurs because the salary and wage base upon which the payroll tax is levied is larger. Note that in April, 1997, the assumed threshold date when the funding shortfall would occur was 2029. Now, in April, 1999, just two years later, the date has been pushed back five years to 2034. This occurred for one reason: the economy grew at a faster rate of growth than expected in both 1997 and 1998.
Is there a crisis? The Social Security administrators state that after 2034, the Social Security System will be able to pay only 75 percent of defined benefits. It follows then that by increasing Social Security payroll taxes by 1/3 in 2034 (from 12.4 to 16.5), they would be able to pay 100 percent of defined benefits in the following years. This is not to suggest that raising of Social Security payroll taxes by 1/3 in 2034 is a desirable option, but rather to place this issue in perspective.
And this all assumes the economy grows at the conservative rates projected by the Social Security actuaries. A growth rate above these estimates will reduce and possibly eliminate the funding shortfall.
So, Social Security's funding shortfall is an issue we need to be
concerned with. However, it's certainly not a crisis situation. We
have time to study the issue, and make an intelligent choice about the
future of our national retirement system.
Why is this a problem? People as a rule act out of rational economic self-interest. If the Social Security contribution is perceived to be a tax rather than a set-aside for one's own retirement, the contribution portion of one's compensation ceases to be a motivation for one to work. One would then work only if the earnings after the Social Security contribution (including the employer's share) and all income taxes are deducted provide sufficient motivation.
Any kind of levy placed upon income will produce this disincentive to work, but Social Security contributions, which for many people represent a greater amount than they pay in income taxes, need not produce this effect. The key is in establishing individual property rights over the contributions and the returns they yield.
Martin Feldstein, a professor of economics at Harvard University, argues
in a January 1, 1997 article,
that taxes levied against income distort not just the quantity of work
but other aspects of it as well:
The link between contributions and benefits has been diluted in a number
of ways:
Further, the burden of helping low-wage earners is being borne equally by a worker that makes $70,000 and a worker that makes $200,000. To the extent that this redistributionist policy is needed or desirable, it should be handled within the framework of the general budget, because the general budget receives revenue through taxes from all manner and level of income.
Each existing retiree receives benefits as currently defined by the Social Security System.
Workers 55 and over continue to pay into the Social Security System, and will receive when they retire benefits as currently defined by the the Social Security System.
An interest-bearing note from the U.S. Government sufficient to cover the unfunded liability of existing retirees and workers 55 and older is created and transferred to the Social Security Trust Fund.
Each worker under 55 is assigned a private retirement account. An interest-bearing note from the U.S. Government is created and transferred to this account. The amount of the note is determined based upon the present-day value of the future Social Security benefits currently assigned to this worker. The worker thus immediately has a tangible financial value in this account, while the U.S. Government has incurred an equivalent debt. At an individual level, the retirement account is fully funded. The U.S. Government of course has now assumed the liability. How this is dealt with is discussed in the next section.
Each new worker is assigned a private retirement account, with an initial balance of zero.
Contributions from workers converted to private accounts and the employer's matching share are now transferred to the worker's private retirement account.
Investment options within the private accounts are initially rather limited, but become more flexible as the account value relative to the amount needed for a minimum benefit level grows. High-risk investments are forbidden until sufficient funds have been set aside to fund the minimum benefit level.
Withdrawals are not allowed before retirement. At 62 or later, an inflation-adjusted annuity is purchased with the assets of the retirement account. The retiree then receives a monthly payment, based upon the size of the annuity purchased. It will probably be necessary to have a U.S. Government agency sell and administer these inflation-adjusted annuities.
If a retired worker returns to work, contributions are again placed in his or her private account. Annuitization can then take place at any time, and would be merged with the original annuity to increase the amount of the monthly benefit.
Accounts accrue tax free. Withdrawals are taxed as ordinary income.
Total U.S. Government debt will increase from approximately $5 trillion to approximately $14 trillion. Note that while it appears the U.S. Government is taking on additional debt, the reality is that it is simply acknowledging an implicit debt that already exists. That is, it is simply placing a dollar amount on the current unfunded liability that exists in the Social Security System. If the transaction had been completed at the end of 1998, national debt as a percentage of the size of our economy ($8.5 trillion) would have been 164.7% (14 / 8.5).
Assuming a 2 percent economic growth rate, a 2 percent inflation rate,
a 5 percent interest rate, and a pre-transaction general budget surplus
of $100 billion in 1999, one would expect the following state of affairs
at the end of 1999:
Also, remember that even as the federal government adds $350 billion of debt, approximately $250 billion that formerly would have been deposited in the Social Security Trust Fund will have been deposited in workers' private accounts. In addition, workers' accounts will have been credited with approximately $200 billion in interest.
Note that I deliberately used conservative numbers. The current estimate on general fund surpluses for the next decade, while slightly lower in 1999, average about $170 billion per year. I also used the 2 percent growth rate.
This arrangement funds the Social Security System and the private accounts such that they are actuarially sound. Of course, it doesn't create any wealth. It just adds to the national debt. The advantage though is that it's an explicit acknowledgement of the liability. It emphasizes the importance of maintaining existing U.S. Government revenues. In other words, a tax cut is obviously not appropriate.
It is very likely that as the economy grows the budget deficit will
narrow. This is especially likely if the economy grows at a rate
greater than 2 per cent per year. If the budget deficit does not
narrow, spending cuts or tax increases will be necessary.
However, two aspects to this program should cause national saving over the long term to be greater than it would otherwise be. First, by transferring $9 trillion in the form of notes from the U.S. Government to private accounts and the Social Security Trust Fund, the unbooked implicit retirement debt of the Social Security System will be made explicit. That is, the obligation will be officially recognized and recorded. While the private retirement accounts and the Social Security Trust Fund will be made actuarially sound, the U.S. Government will incur an additional $9 trillion in debt. Because of interest on this additional debt, the unified budget will be in the red to the tune of approximately $350 billion the first year. This will constrain the temptation for the federal government to increase spending or to reduce taxes, either one of which would almost surely reduce national saving. Depending upon progress towards balancing the budget, it may even create pressures to reduce government spending or increase taxes, either one of which would increase national saving.
Secondly, for workers converted to private accounts, since there will be a direct link between contributions made and benefits ultimately received, distortions in labor supply will be reduced. This will increase economic efficiency, and hence the economic growth rate. With increased economic growth government revenues will be larger than they otherwise would be, thus increasing national saving.
I have deliberately not used the argument that private accounts would be partially invested in higher yielding assets, such as common stocks, and hence would generate greater returns and hence increased national savings. Although there are some legitimate concerns about the Social Security Trust Fund investing in common stocks, since theoretically the Social Security Trust Fund could have the same mix of common stocks as the private accounts collectively, the higher return argument doesn't by itself support the argument for privatization.
Robert Reischauer and Henry Aaron, in the book Countdown to Reform, advance an argument worthy of note. They raise the possibility that individuals will see the value in their private accounts rising, and will feel wealthier, and will therefore save less than they would have when they were enrolled in the Social Security System. I find the argument less than compelling, because individuals will not have access to the money, and will only receive the money as monthly benefit payments when they retire. If this trend were noted, however, it would be necessary to increase contribution rates to the private accounts in order to maintain the national saving rate.
The unfunded liability in the Social Security System will be financed by the general fund rather than solely by contributions from current and future workers. This is fairer to current and future workers whose contributions will flow directly to their own private accounts. They will still contribute to the payment of the unfunded liability, but through the income tax system, which levies taxes against all type and level of income, rather than through contributions to the Social Security System.
Existing and future retirees will feel secure knowing that the nation's retirement system is actuarially sound. Pressures that had been placed on the Social Security System will now be placed on the general budget.
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