Social Security, considered to be the nations bulwark for ensuring secure retirements, is in urgent need of repair. Fed Chairman Alan Greenspan again emphasized the urgent need for Social Security reform this week. President Bush will likely make Social Security reform a campaign issue in the fall election and, if re-elected, a major priority during his second term.
There is likely to be stiff opposition, however, to reform proposals that correct Social Securitys financial imbalance but that also appear to create short-term deficits. Last Monday, House Democrats, in fact, sent a letter to Mr. Bush lamenting the creation of new deficits found in the presidents economic reports recent analysis of personal accounts that could be used as part of reforming Social Security.
Social Securitys future financial shortfalls are so large that even when they are discounted in value to recognize interest costs they add up to a large total. According to the 2003 Social Security trustees report, Social Security currently faces a financial shortfall of $10.5 trillion in present value, equal to about 100 percent of GDP. Each year that passes without a reform makes that shortfall larger, and it increases the cost of fixing the program’s finances hence the need for immediate corrective measures.
The economic report of the president promotes the case for Social Security reform by devoting an entire chapter to assessing the systems financial status and exploring the feasibility of a personal accounts option. Although the report pushes for reform, the clear message from the numbers presented is that reform will first worsen the governments budget for several decades before improving it. This is ironic in light of the large recent budget deficits. It is also incorrect. Indeed, the case for Social Security reform is even stronger than suggested by the administration.
As its primary example of a potential Social Security reform, the economic report considers reform Model 2, taken from the presidents recent Social Security Commission. Whereas Social Security benefits are currently scheduled to grow with inflation plus worker productivity, Model 2 proposes to limit benefit growth to no more than inflation. Model 2s reform would also allow people to redirect some of their payroll taxes into personal accounts in exchange for a smaller future Social Security benefit. The future retirement benefit of a worker who selects a personal account, therefore, would come from his personal account plus a reduced benefit from the Social Security System. Allowing workers to redirect a portion of payroll taxes away from the existing system, however, incurs additional debt to pay for the benefits of current retirees. The economic report projects that adopting Model 2 would increase the nations debt level during the next several decades by 23.6 percent of GDP by 2036.
In explaining the consequences of reform, it is important to emphasize that this debt is not being created by the reform: It already exists. Yet it is not properly counted under current budget conventions, including those used by the economic report. The problem with the reports deficit and debt projections is that these measures only show what has happened in the past: They do not show how Social Securitys future unfunded costs would be reduced under Model 2s reform.
In fact, the adoption of Model 2 would likely eliminate the entire current $10.5 trillion imbalance not eventually but immediately. The reason is simple: Containing the growth of Social Security benefits to no more than the inflation rate eliminates the large shortfalls mentioned earlier. While we are not endorsing Model 2, it would improve the budget outlook and help capital markets and it would do so today, not eventually.
To its credit, the economic report acknowledges that the initial deficits created by Social Security reform do not pose an additional burden on the economy. Instead the report argues that the appearance of deficits could potentially undermine the political case for reform. But that is only true to the extent that policymakers continue to focus on flawed budget measures, including deficits and debt, that do not include future net costs.
In contrast, the $10.5 trillion present value calculation made by the trustees includes all future costs net of dedicated revenues. If the focus were instead redirected toward this number, then the political case and economic case for reform would be the same and very strong.
Jagadeesh Gokhale, former senior economic adviser to the Cleveland Federal Reserve Bank, is a senior fellow at the Cato Institute. Kent Smetters is a professor at the Wharton School and a member of the National Bureau of Economic Research.