America's Economy Headed for Crisis, Part 2

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Former Colorado Governor Richard Lamm presented his unique view of the fiscal problems associated with the federal budget in Prairie Fire's August issue. The following month, the comptroller general of the United States, David Walker, presented an overview of the public meetings throughout the United States that he and his associates have been conducting. In October, we began a three-part series explaining how one group, The Concord Coalition, proposes to solve three distinct problem areas: the federal deficit (presented last month), the Social Security system (presented this month) and Medicare dilemma (coming in December). By Robert Bixby, J. Robert Kerrey, Peter G. Peterson, Warren B. Rudman We believe that Social Security reform plans should meet three fundamental objectives—ensuring Social Security’s long-term fiscal sustainability, raising national saving rates and improving the system’s generational equity: *Long-term fiscal sustainability. The first goal of reform should be to close Social Security’s financing gap over the lifetimes of our children and beyond. The only way to do so without burdening tomorrow’s workers and taxpayers is to reduce Social Security’s long-term cost. *Increased national saving. As America ages, the economy will inevitably have to transfer a rising share of real resources from workers to retirees. This burden can be made more bearable by increasing the size of tomorrow’s economy. The surest way to do this is by raising national saving rates and hence, ultimately, productivity growth. Without new saving, reform is a zero-sum game. *Generational equity. As currently structured, Social Security benefits offer each new generation of workers declining value on their contributions. Reform must not exacerbate—and ideally should improve—the generational inequity underlying the current system.

Paths to avoid

Candidates tempted to take the path of least resistance may rely on criteria that minimize the size of the problem or on options that merely shift and conceal the cost. Here are a few examples of such shortsighted approaches. Trust-fund accounting. The traditional method of measuring Social Security’s future is the 75-year actuarial balance of its trust funds. By this measure, Social Security is said to be “solvent” until 2041. That may sound reassuring, but all it really means is that the government owes itself a great deal of money. Trust-fund accounting obscures the magnitude and timing of Social Security’s financing gap by assuming that trust-fund surpluses accumulated in prior years can be drawn down to defray deficits incurred in future years. However, the trust funds are bookkeeping devices, not a mechanism for savings. The special-issue U.S. Treasury bonds they contain represent a promise from one arm of government (Treasury) to satisfy claims held by another arm of government (Social Security). They do not indicate how these claims will be satisfied or whether real resources are being set aside to match future obligations. Thus, their existence does not, alone, ease the burden of paying future benefits. The real test of fiscal sustainability is whether reform closes Social Security’s long-term gap between outlays and dedicated tax revenues. Reliance on new debt. Paying for promised benefits or financing private account options by issuing new debt defeats the objective of increased savings. To the extent that reform relies on debt financing, it will not boost net savings and may result in a decline. Without new savings, any gain for the Social Security system must come at the expense of the rest of the budget, the economy and future generations. When we resort to borrowing, we are ultimately increasing taxes for our kids. Reliance on outside financing. Ideally, reform should achieve all necessary fiscal savings within the Social Security system itself. Unrelated tax increases and spending cuts may never be enacted, or if enacted, may at any point be neutralized by other measures.

Realistic reform strategies

There is no one right answer to Social Security reform. However, adjusting the program for Americans’ increasing longevity and constraining the growing value of its scheduled monthly benefits are the two most logical steps for constraining growth in the program’s cost. Personal accounts would help improve generational equity and improve savings — if the accounts are fully funded and mandatory. Longevity adjustments. Raising the age at which retirees are eligible for full benefits (now 66 and scheduled to go up to 67 by 2025) makes good sense for several reasons: *Longevity is increasing steadily, and longer life spans mean longer, and more costly, lifetime benefits. *Older Americans are generally healthier than in the past and can work more years, especially as jobs have become less physically demanding. *In coming decades, the pool of working-age Americans will virtually stop growing, depriving our nation of this engine of economic growth. Raising the full-benefit-eligibility age could help augment the labor force by encouraging older people to remain at work for a few more years. Some proposals would raise the full-benefit age in the future. Others would set up an automatic provision, referred to as “longevity indexing,” but that would have the full-benefit or initial age rise periodically if longevity continues to rise. As a practical matter, these options should be combined. Raising the eligibility age to a higher fixed target may balance the system for a while. But without longevity indexing, the system will again drift out of balance. Price indexing. Another good option would be to index initial benefits to the growth in prices for commonly used goods and services, as measured by the Consumer Price Index. (See Endnote 1) This reform has two advantages: It is simple, and it creates large savings. According to the most recent estimate by the Social Security program’s actuaries, moving to price indexing would more than close the program’s projected gap. Assuming this change took effect in 2012, the actuaries estimate that the system’s annual shortfall would peak in 2032 at 2.33 percent of taxable payroll. By 2055, the system would show a positive balance, and by 2080, it would be running a surplus equal to 2.23 percent of taxable payroll. Under the rules by which Social Security operates today, it is virtually impossible to close its deficit by increasing national productivity. True, higher productivity would result in higher wages and thereby boost payroll tax revenue. But higher wages also would result in higher benefits that would largely cancel out the gain. With price indexing, however, benefits would shrink indefinitely relative to taxable payroll and gross domestic product (GDP)—and the faster wages grow, the more benefits would shrink as a share of the economy. This dynamic, of course, means that retirees would receive smaller benefits, relative to the waves of the working population. To the extent that Social Security is viewed as a type of “safety-net” program, this does not pose a public policy problem. To the extent that Social Security is viewed as an income-replacement program, it does. For this reason, price indexing makes the most sense as part of an overall reform that also incorporates funded benefits like personal accounts. On one hand, the price-indexed pay-as-you-go benefit would ensure that the purchasing power of benefits would remain the same for each new generation of retirees. On the other, the funded benefits would help ensure that the relative living standard of retirees is not eroded. Another approach, called “progressive price indexing” would mitigate the effects of reform on low- and moderately low-income workers by wage indexing benefits for the lowest third of benefits (as under current law), phasing in an element of price indexing for the middle third, and fully price indexing benefits for the top third. This would generate program savings from moderate- and high-income workers but protect lower-income workers. According to the Social Security actuaries, this reform would close roughly 80 percent of the cash deficit by 2080. While this change alone would not be enough to close the system’s financing gap, Congress should give it serious consideration as part of an overall reform plan. It would substantially improve the system’s fiscal sustainability while preserving all promised benefits for those who rely on them most. Tax options. Raising the payroll tax to meet benefit obligations would be neither economically sound nor generationally equitable. The burden would fall most heavily on lower- and middle-income workers and on future generations. A popular alternative to an across-the-board increase is to make more of the earnings of higher-income workers taxable, by raising the cap on taxable wages. Currently, the Social Security payroll tax (12.4 percent) is levied on wages up to $97,500. Raising this cap would bring in more money, but as a means of assuring the program’s sustainability, it would be considerably less effective than its proponents allege. It would provide only a few more years of positive cash flow to the system and, unless the link between taxable earnings and benefits were to be eliminated, it would add to the system’s long-term cost, by providing higher benefits to those who need them least. Certainly, raising taxes in some form would be more fiscally responsible than unlimited borrowing. It may also be a necessary component in any plan that is capable of winning broad bipartisan support. But before resorting to this option, policy makers must carefully weight the magnitude of the looming demands that Social Security and health-care entitlements will place on the income of future workers and the economy overall. Levying higher taxes to meet rising costs could hinder an economy that will also have to cope with near-stagnant workforce growth. Moreover, a Social Security tax increase now would simply be used to support other governmental operations and perhaps would even encourage higher government spending, while pretending that we are “shoring up” the trust fund. In short, increasing Social Security revenues today will not reduce the program’s future burden unless a mechanism is in place to ensure that the extra money generates increased personal saving and a larger future economy. Personal accounts. One way that higher Social Security contributions could generate new saving would be if they were used to create personally owned accounts within the Social Security system. This reform could increase saving by providing a more reliable method of pre-funding promised benefits than government trust funds can ensure. The funds would be beyond the reach of government, and Congress could not double-count personal account assets in the federal budget. In other words, they would provide a “lockbox” no politician could pick. However, the money to establish personal accounts must come from somewhere. To the extent that the source of funding is additional government borrowing, no new savings for the economy will result, because the increase in government borrowing would cancel it out. Moreover, personal accounts alone do nothing to close the existing gap between dedicated revenues and promised benefits. In any true transition to a funded system, workers will have to pay more, retirees will have to receive less, or both. Reform plans that do not face up to this transition cost will not result in new net saving or a larger economy. It thus makes sense to use the “add-on” approach to personal accounts, meaning that they should be funded from additional worker contributions. These contributions would be personally owned saving, and so would not function as a “tax increase.” They would increase national and personal savings rather than increase the size of government. Such accounts should be a mandatory part of the system. The government has a legitimate interest in seeing that people do not under-save during their working lives and become reliant on the safety net in retirement.

Endnote

1. Under current law, initial benefit awards are indexed not to prices but to wages—that is, the wage history on which benefits are based is updated at the time of retirement to reflect the rise in the economy’s overall wage level over the course of the beneficiary’s working career. Related: America's Economy: Headed for Crisis, Part 1 America's Economy: Headed for Crisis, Part 3

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