Reform without cost

President Bush’s plan to allow individuals to invest their Social Security taxes in private investments, in return for surrendering commensurate future benefits, addresses the fundamental flaws of Social Security; a “pay as you go” Ponzi scheme that relies on unrealistic demographics and is thus doomed to implosion.

However, the president’s plan creates a huge cash flow deficit, the “transition costs” and leaves future retirement benefits open to market risk, two shortcomings on which liberal demagogues, led by the likes of the AARP, already capitalize.

The president can make moot all this opposition and expand his program from partial to full privatization by simply requiring that, in the short term at least, all private investments be restricted to TIPS; price-indexed Treasury bonds.

Opposition to Social Security reform is based on the “Trojan Horse” that the current system is secure and can be easily “fixed” without fundamental reform. But Social Security is a misnomer: It is not secure and doomed to financial implosion. It relies on the ratio of workers-to-beneficiaries for solvency; a 40-1 ratio at the program’s genesis in the 1930s, but due to longer lifespans and lower fertility rates this ratio is shrinking from 3-to-1 today to 2-to-1 in the coming decades. Your second grader can do the math; while it once took only 2.5 cents of taxes to support a dollar of benefits it will soon take 50 cents to maintain benefits; and that is a formula for socioeconomic Armageddon.

As a result of this doomed “pay-as-you go” scheme, the system has already accumulated more than $10 trillion of unfunded promises due to retirees over the next 70 years.

Neither side wants to admit it, but Social Security must break its promises or raise taxes to fund this liability. The costs can be addressed rationally and without considerable pain, but only if the basic program is first reformed to stop the bleeding.

The most immediate problem with the president’s plan is that the more it diverts Social Security taxes from the Trust Fund to private investment the greater are the taxes, debt or benefit reductions necessary to fund the cash deficit.

The TIPS plan has no such cost because no cash leaves the government until benefits are paid, as already promised, years later. There are no “transition costs.”

The TIPS plan also moots the claim private investment is risky. While fallacious, the claim is still politically devastating.

In reality, both theory and empiricism demonstrate private equities deliver higher returns over any intermediate or long-term planning horizon, but that does not keep the AARP from raising the threat private investors will lose their fortunes only to return to the government till for a double dip.

Nevertheless, the president should focus on the most important principals: creating a true savings plan based on private ownership and not lose the opportunity for reform. Because the TIPS plan restricts investment to inflation-adjusted government-guaranteed bonds, investor risk is eliminated. In fact, the TIPS program is more secure than Social Security.

After all, the Supreme Court has allowed Congress to expropriate promised Social Security benefits from retirees, which several Democrat-led Congresses have done via higher taxes and later retirement ages. But no Congress has ever defaulted on Treasury bonds, a point trumpeted by the AARP.

What about the $10 trillion deficit already accumulated? Reform freezes this loss, which any plan (reform or status quo) must address. It took 70 years of New Deal schemes to create the deficit, but by spreading the pain over different programs over the next 70 years it can be ended without significant pain.

Possible solutions include an across-the-board 1 percent increase in income tax rates, a 1 percent payroll tax, or a 1 percent tax on payments from Social Security.

It would be more efficient to spread the burden among the three solutions; a meager one-third-point increase in income taxes, a half-point increase in payroll taxes and a half-point increase in taxes on Social Security benefits. Harmless? No. But reform must not fall victim to the Trojan Horse that this cost is somehow “avoidable” if we keep the status quo, which would mean these costs will increase over time.

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