from Follow the Money

The FT should have done better

January 8, 2005

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Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.

Usually, the FT -- including its oped page -- can be counted on to be the voice of moderate reason.

That’s why I was slightly disappointed by this line in today’s FT leader:

"Other critics argue that Mr. Bush has still to make a convincing case for a future Social Security deficit. They see false urgency, similar to the Administration’s presentation of the case for invading Iraq over weapons of mass destruction. The analogy understates the pressure on Social Security created by aging Baby Boomers."

I don’t think the facts support the FT’s final assertion. Social Security is projected to be able to pay full benefits until 2042 (Trustees) or 2052 (CBO), drawing on the resources from future payroll taxes, past payroll taxes that were saved and not spent (the Treasury bonds in the Trust Fund), and the miracle of compound interest on saved payroll tax revenues (i.e. interest on the bonds held by the Trust Fund).

The Baby Boom came about because soldiers returned home from World War 2 and got on with life. The leading edge of the "boom" is folks born between say 1945 and 1955. Social Security is perfectly well positioned to cover their retirement as is. Social Security even does pretty well for someone born in 1965 under the CBO’s assumptions.

I would agree that the Social Security faces problems covering all currently promised benefits after the Trust Fund is exhausted in 2042 or 2052, but then the FT should say "Social Security faces problems after the payroll tax surpluses now being set aside to cover the Baby Boom’s retirement are exhausted in 2042, or perhaps 2052."

Alternatively, the FT could have said "the analogy understates the pressures on the federal budget created by aging Baby Boomers." That would pick up the pressures created by paying for the baby boom’s health care, including the massive unfunded mandate created by the prescription drug bill.

And there is no doubt that paying for Social Security benefits also will place broader pressure on the federal government too. Social Security runs a $153 billion surplus right now, $64 from tax revenue in excess of spending, and $89 from saved interest. It lends that surplus to the rest of the government, reducing the overall deficit by equal amount. As the baby boom starts to retire, Social Security will be able to lend less to the government -- Social Security lending to the government is projected to peak as a percent of payroll in 2008. After 2018, Social Security will need to stop lending the interest it receives on its bonds back to the government, and start using its interest income to pay current benefits. And at some point, Social Security will need to start to redeem its bonds -- forcing the government to sell Treasury bonds into the market to pay back Social Security.

Fair is fair: if you borrow money, you have to repay it. And the rest of the government has borrowed a ton of money from Social Security -- even more than it has borrowed from Japan.

That’s why the single most important step toward retirement security for the Baby Boom is to fix the federal government’s overall finances. A bit more net private savings by middle income Americans would help too.

And while I am on the topic of Social Security, one thought:

Shouldn’t calculations of the expected benefits folks will receive from private accounts take into account the costs of the debt that has to be issued to finance private accounts? I realize it is a bit difficult, because the debt is paid out of general revenues, and estimating the share of future general government revenues that will be paid by different income groups is a bit hard. Taxes change. But in aggregate, if you borrow at 4.25% and invest the proceeds in an asset that earns 5% (net of fees), your aggregate return is 0.75%, not 5%. Someone will have to pay off the bonds issued to fund the "transition" costs.

Remember, that if partial privatization is not financed by raising current taxes or reducing current benefits, it is financed by debt. At least one generation gets an asset -- the private account -- and a liability -- the debt issued to fund the private account. If your private account does poorly, you could be left worse off: you still have to pay your share of the (now larger) national debt, after all.

And since there are no new savings in a debt financed privatization plan, there are not -- in aggregate -- more assets to go around. If the privatized what-used-to-be-social-security system now holds more equities, private pension funds and other investors have to be convinced to hold more government debt. It is just a big swap. The government debt that would be held in the Social Security Trust Fund is placed in the market, and some stocks and corporate bonds that would have been held privately are now held in the "privatized" what-used-to-be-social-security system. Society as a whole is not better off. If private accounts invested in equities do (comparatively) well, the folks who sold their equities to the private accounts in exchange for government bonds will end up doing (comparatively) poorly.

More on this later.

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