April 17, 2014

The Great Train Robbery


The Railroad Retirement and Survivors' Improvement Act of 2001, which has been passed by the House and enjoys widespread support in the Senate, claims to put the program on a sounder financial footing.

It does nothing of the kind. The Act undermines Railroad Retirement's financial balance by increasing benefits and by cutting earmarked taxes. A novel provision that permits the investment of trust-fund assets in private securities is supposed to offset the cost. But the provision as structured is a shell game and is unlikely to result in genuine savings. Worse, it sets a terrible precedent for Social Security reform.

A Dangerous Gamble

Let's start with some facts. The Act would lower the full-benefit eligibility age for Railroad Retirement, a government pension program covering career railroad workers, from 62 to 60. It would also speed up vesting, increase survivors' benefits, and cut payroll tax rates.

All this generosity might lead one to suppose that Railroad Retirement is running large cash surpluses. In fact, railroads are a graying industry in which retirees outnumber workers three to one, and this gives rise to large cash deficits. Last year, earmarked taxes covered only 62 percent of the program's cost. The remainder was paid for by interest on the Railroad Retirement trust fund -- that is, by general revenue -- and by transfers from Social Security, whose full-benefit eligibility age, by the way, is being raised from 65 to 67.

On paper, the new investment provision would offset some of the additional cost. According to the CBO, 80 percent of Railroad Retirement's current trust-fund balance, or $15.3 billion, would be invested in private securities instead of Treasury bonds. To manage the investments, the Act would set up an independent board with Trustees appointed by industry and labor.

There's just one problem: The Railroad Retirement trust fund, like the Social Security trust fund, has already been spent. To invest trust-fund assets in private securities, Congress will have to come up with new cash. And this will force Railroad Retirement to compete with other priorities -- which, with budget surpluses evaporating, is the last thing the Act's backers want.

So we arrive at the shell game. To hide the proposal's cost, the money invested in private securities would not be counted as an outlay and so would not reduce the budget surplus. In other words, the Act allows Congress to double-count the money invested in corporate stocks and bonds just as it now double-counts the money invested in Treasury bonds. Thus can Congress continue to spend what it pretends to save.

True, Railroad Retirement may earn a higher return by investing in private securities. But this is mere arbitrage. If it made sense for governments to play the spread between stocks and bonds, it would make sense entirely apart from pension reform. Governments would issue trillions of dollars in debt, invest the proceeds in stock market indexes, then refund the effortless profit to taxpayers. But this is a dangerous fiscal gamble -- which is why no government has ever engaged in it.

An Important Lesson

Some critics of the Act worry that the board will be unable to prevent Congress from injecting politics into its investment decisions. But almost no one points out the much bigger problem -- namely, that the board will be investing borrowed money.

There's an important lesson here for Social Security reform. One school of thought maintains that new institutional arrangements similar to those proposed in the Act can ensure that Social Security's trust-fund surpluses are genuinely saved. The Concord Coalition has long cautioned that such arrangements provide no guarantee. So long as government owns the money, it will be difficult -- maybe impossible -- to prevent Congress from double-counting and spending it.

The Railroad Retirement Act shows that the concern is justified. Not only is Congress robbing the train, it is doing so before the train even leaves the station.