April 21, 2014

Another Wrong Turn on Social Security

Volume V, Number 6 -- May 19, 1999

The Social Security debate is once again veering off course--and this time Republicans are leading the way. Back in January, the President unveiled a plan that, without asking anyone to give anything up, would extend Social Security's solvency by twenty years. Now House Ways and Means Chairman Bill Archer says he can do better than that. His plan, with no more sacrifice, would save Social Security "not just for a limited number of years, but for all time."

In truth, there are only two roads to genuine reform, and a workable plan must pursue both. Reform must reduce Social Security's long-term burden by reducing its long-term cost. And it must make the remaining burden more bearable by increasing national savings, and hence the size of tomorrow's economic pie.

The Archer plan falls short on both counts. It makes no reductions in benefits. And it is questionable whether it would result in net new savings. As for the claimed extension of Social Security's solvency, this rests on little more than a risky game of financial arbitrage.

Ironically, these are much the same charges we have leveled against the President's plan. (See our alert of February 2, 1999). And indeed, both plans work the same way: They claim to shore up the status quo by crediting to Social Security trillions of dollars in future budget surpluses that may or may not materialize. True, the President would pump the surpluses directly into the Social Security trust funds, while Archer would channel them through personal accounts. But as we shall see, this is a distinction without much difference.

The public has a sense of what's at stake and is ready for real reform. Yet again and again, the plans political leaders offer turn out to be shell games.

A Peculiar Proposal

What exactly is the Archer plan? If you're a worker covered by Social Security, you'll get a personal retirement account, called a Social Security Guarantee Account. You won't make any direct contributions to the account. Instead, Treasury will each year deposit in it a sum equal to 2 percent of your taxable earnings. The deposits will be financed out of general revenues, not Social Security revenues, which will continue to be credited to the trust funds. You will be free to invest the money in your choice of qualified mutual funds, subject to the requirement that 60 percent of it be in stocks and 40 percent in corporate bonds. Upon retirement (or disability), the Social Security trust funds will collect all of your account balance. (Yes, that's right, 100 percent of it.) The trust funds will then send you a monthly check for your current-law Social Security benefit or the annuitized value of your personal account, whichever is greater.

To say the least, this is a peculiar proposal. For one thing, it leaves one wondering what Archer means by ownership. Assuming that all workers earn the average market rate of return, SSA's Office of the Actuary calculates that few if any will accumulate account balances that are larger than their current-law Social Security benefit--meaning that few if any will get to keep a single dime of their personally owned savings. At the same time, it creates a huge "moral hazard" problem. Since the only way that workers can hope to come out ahead is to hit the jackpot, they are invited to gamble on high-risk investments--and indeed, would be suckers not to. With government covering the downside, the only party that stands to lose is tomorrow's taxpayer.

This is a big flaw. But let's assume the plan's designers can minimize moral hazard by taking most choice away from workers. That still leaves a more fundamental problem: namely, that the plan does little to change the fiscal and economic bottom line.

An Unfunded Entitlement

Under current law, the Trustees project that Social Security will cost 18.2 percent of worker payroll by the year 2040, up from 10.8 percent today. What would the Archer plan do to reduce this cost growth? Precisely nothing: The only change it makes to benefits is to repeal the earnings test on working seniors, and this adds to cost. The total obligations for which future taxpayers will be liable under the Archer plan are therefore the same--or even slightly larger--than they are under current law.

So much for the first road to genuine reform. What about the second: Increasing national savings, and hence the size of tomorrow's economic pie?

At first glance, the Archer plan appears to do better here. After all, it takes 2 percent of payroll--money that Congress and the White House might otherwise divert to tax cuts or spending hikes--and deposits it into personal accounts invested in the real economy.

Yet the closer one looks, the less certain these savings are. First, it's questionable whether the money will really be off the table. We have often argued in these alerts that transferring budget surpluses from government to individuals is the only way to guarantee that they are actually saved. Because the money would become personal property, payable to workers or their heirs, Congress could not double-count it in the budget, as it does the existing Social Security trust funds. But are the Archer plan's Social Security Guarantee Accounts really personal property? Remember: Government makes all the contributions and retains a 100 percent claim on the assets. It sounds like it's government that owns the accounts--and if it does, what is to prevent Congress from borrowing against them?

Then there's the uncertainty of the surpluses on which the Archer plan depends. The official projections assume that current-law caps on discretionary spending will be honored--even though the caps call for deep real-dollar cuts that political leaders have no idea how to make. They assume that the growth in Medicare costs will be modest--despite the chorus of voices urging that Congress ease up on spending limits and expand coverage to include prescription drugs. They assume that the current expansion will keep chugging along. And, of course, they assume that Congress will not cut taxes. As we've recently shown, it wouldn't take anything so dramatic as a major recession or war to explode the projections. (See our alert of April 9, 1999.) If current expectations turn out to be even slightly optimistic, the budget could sink deep into deficit again by the end of the next decade.

But even if the future unfolds exactly as projected, the surpluses won't last forever. They will begin to narrow when Boomers start retiring a decade from now--and will vanish entirely during the 2020s. What happens then? The Archer plan doesn't say, so we will. Unless taxes are raised or spending is cut, Congress will have to fund the Social Security Guarantee Accounts by selling bonds to the public. In the end, all the Archer plan will have created is an unfunded entitlement.

This brings us to a further problem, which is that Social Security is already an unfunded entitlement--counting on trillions of dollars in budget authority unbacked by economic savings. Filling in the financing gap due to open up in 2014 when Social Security starts running cash deficits is a serious challenge that any serious reform must meet. But the Archer plan, like the Clinton plan, ignores the financing gap. It assumes that the trust funds can draw down all of the assets they are currently projected to accumulate, without ever accounting for the cost to the budget and the economy.

A Zero Sum Game

Archer has proposed a plan that does not cut benefits and that may not increase the future size of the economy. Nonetheless, he can claim that his plan would make Social Security permanently solvent with no hike (and maybe even a cut) in the future payroll tax rate.

How is this possible? By the only strategy that remains, which is to redistribute money from one group to another. In effect, the Archer plan proposes that government sell bonds to the public at a real rate of 3 percent, invest the money in stocks at 7 percent, and then use the profits to pay Social Security benefits. Archer thus wants government to raise revenue by playing the spread in financial markets. This sort of arbitrage is fraught with political and economic risks--which is perhaps why no government has ever engaged in it on a significant scale. But all that aside, it rests on an amazing proposition: that private investors will eagerly impoverish themselves by buying bonds and selling stocks (with no change in the yield spread) so that the government can enrich itself by doing the opposite. In other words, the Archer plan assumes that markets are irrational, an odd premise for conservatives to defend. Many reform plans rely in part on financial arbitrage. To lean on it as heavily as the Archer plan does, however, is a dicey and dangerous proposition.

Archer describes his plan as "meeting the President halfway." Actually, it's more than halfway. Stripped of the personal accounts fiction, his plan is almost indistinguishable from Clinton's. As even the conservative Heritage Foundation concludes, it "borrows the worst features of the Clinton plan and then adds some warts for good measure."

The public is weary of convoluted "reforms" that pretend to make fundamental choices, yet guarantee that everyone will continue to get everything they've been promised. If what our economy needs is new savings, the public wonders why the most talked-about plans deliver nothing but accounting games. It would be tragic if Americans grow so cynical that they pay no attention to the genuine reform efforts underway in both parties.¦

FACING FACTS AUTHORS: Neil Howe and Richard Jackson