Bush Social Security Revolution?

The Social Security Act was the signature accomplishment of Franklin Roosevelt's newly created American welfare state in 1935. It switched the American ethos from individual and community reliance to national government responsibility for personal security and welfare. Its early and apparently costless success provided the legitimacy for all of the expert-directed federal social programs that have followed to this very day. Yet, today, it and its entire supporting apparatus stand near bankruptcy.

President George W. Bush has now raised a challenge to the whole justification of this historic substitution of bureaucratic for personal responsibility for the general welfare by proposing an "opportunity society" instead. In the Oval Office on December 9, 2004, sitting with the Trustees of Social Security and Medicare, he faced the nation and told it there was an enormous unfunded liability of $11 trillion that threatened to sink America's economy, and asked, "Does the country have the will to address this problem?" He answered himself by replying, "I think it must."

"There is a recognition among the experts that we have a problem, and the problem is America is getting older, and that there are fewer to pay into the system to support a baby boomer generation which is about to retire," Mr. Bush continued. "We have a responsibility to solve problems before they become acute," he pledged. "We will not raise payroll taxes to solve this problem," and assured seniors that there would be no change for those in retirement or near retirement who want to stay with Social Security as it exists today. The president concluded, "I will not prejudge any solution" at this time but will await a report from his Trustees, headed by Treasury Secretary John Snow, before making his recommendations to Congress and the country.

While most conservatives have focused upon his important pledge not to increase payroll taxes, the more significant statement was the promise to "solve problems before they become acute," for the real danger comes from the enormous unfunded liability in entitlements that could wreck the whole economy, as the table from the Trustees demonstrates (where OASDI represents Social Security and HI is Medicare):

As we reported earlier, the leaders of Japan and China (and it does not even matter if they were correct if they believed so) tied this coming bankruptcy to the current decline of the dollar in meetings with the president at the recent Pacific Rim summit, and he promised to deal seriously with the fiscal deficit when he returned to Washington, which he is now proposing to do. The danger as this proceeds, as Ross Perot warned, is the details. It is a cautionary tale that last year's Medicare drug reform started with a positive proposal from the president, one that would not have increased costs over the long run, but ended with an additional unfunded liability of $16 trillion that made the whole entitlement problem worse.

The Trustees would do well to consider a masterful proposal incorporated in a bill co-sponsored by Sen. John Sununu and Rep. Paul Ryan that meets all of the general ideas advanced by President Bush:

(1) Out of the 12.4% deducted for the payroll tax, workers could choose (not be forced) to shift to personally owned individual retirement accounts: 10% of the tax on the first $10,000 in wages would be invested each year, plus 5% of the tax on any income above that amount. These new accounts would be owned by the worker rather than by the government.
(2) The average individual investment would be 6.4 %, roughly the amount of the present employee contribution, invested in approved private mutual fund-like instruments modeled on the Federal Employee Thrift Retirement System. For new workers, the contributions would be large enough that all retirement benefits would be paid by the accounts and none would come from the government accounts, eliminating this government obligation. Those who were already working but choose to add private accounts would receive part of their benefits from the present system and part from the accounts, with all workers guaranteed at least as much as existing Social Security benefits would provide.
(3) For those in the present system who choose not to participate, the benefits would remain the same, as would survivors and disability benefits for all, supported by the other 6% of the payroll tax for the later.
(4) To pay for transition costs (a) the growth of federal government spending would be capped at 1% per year for 8 years and then continued at that rate until all debt was paid, (b) revenue to the federal government would be increased as a result of the higher investment return from the private accounts (the present value of which is estimated by Martin Feldstein to be $10-$20 trillion), and (c) the short term Social Security surpluses until 2018 would pay all additional costs plus funds from selling existing Social Security bonds to the Treasury (as the law envisions).
(5) Once the transition costs have been paid entirely, the remaining funds generated by the reforms would automatically trigger an actuarial reduction of the payroll tax (which the Chief Actuary estimates would eventually result in a payroll tax of only 4%, equally shared by employee and employer), primarily to support survivors and disabled benefits, since most workers would have shifted to private accounts by then.

Under this plan, Social Security would achieve permanent and growing surpluses by 2030, instead of going into the red starting in 2018. A trillion dollars in additional bonds would have been issued to pay for transition costs but this is much more than offset by $16 trillion invested in the personal accounts by then. Some object that the bonds that would have to be issued to meet the transition costs would increase indebtedness and further undermine the dollar but most of these obligations already exist as promises to retirees. We already owe the $11 trillion only we do not list it (that is why it is called "unfunded"). Unless someone is seriously proposing to eliminate the obligations, all transferring them into bonds does is to recognize the debt formally, which is an additional plus for honesty. Any earlier payments from cashing the bonds merely advance the date of the obligations not increase them and, over the long run, all obligations will be paid or transferred to the individual accounts.

The Chief Actuary estimates that workers would accumulate $7.8 trillion in today's dollars in their accounts as early as 2020. If the economic growth rate is higher than his estimated 1.6% (which is low historically), returns will be even higher. Since individual accounts are easily the better deal for workers, over time virtually all benefits would be paid out of real market investments rather than government redistribution, and this alone would reduce government spending by an incredible 5% of wealth (GDP). The overall national government spending cap would reduce it by an additional 1.5% for the staggering total of 6.5% of GDP less government spending. Not only is a bankruptcy disaster averted but the lower national spending will reorient economic and social activity to more effective private and local hands, finally after a seventy year reversion returning America to the course the Founders envisioned.

Rep. Sam Johnson has likewise introduced a bill based on a similar private account solution that would also eventually eliminate the unfunded liabilities of Social Security. While current retirees would continue receiving existing benefits, this plan would immediately end the present retirement system for those working and present them with "recognition bonds" representing the value of the benefits they have earned to date under it. All workers would then contribute the same 6.2% of the payroll tax into their own personal account and start accumulating investment returns in it. Instead of guaranteeing no less than existing benefits as under Ryan-Sununu, workers would be guaranteed at least 120% of the poverty level as a return. The most significant difference is that the benefits formula for future retirees would be based upon the consumer price index rather than the wage index, saving $1 trillion or so relative to the alternative plan. The problem is this provision could be exploited by opponents as "reducing benefits," even though it only applies to retirees in the far future. The Johnson bill does not cap general federal spending but those close to him suggest he might be willing to add such a provision.

Sununu-Ryan or even Johnson with a spending cap represent the type of comprehensive social security reform that conservatives have been dreaming about since the revival of their movement in the 1960s. As Ronald Reagan put it, "We're not cutting the budget simply for the sake of sounder financial management. This is only a first step toward returning power to the States and communities, only a first step toward reordering the relationship between citizen and government. We can make government again responsive to the people by cutting its size and scope and thereby ensuring that its legitimate functions are performed efficiently and justly." If political conditions permit, the spending cap could be reduced even more to further advance this vision.

The danger is what happens to the Ryan-Sununu proposal, even with presidential endorsement, once it is introduced into the Congressional sausage factory. Unlike the president's Medicare drug proposal, this time President Bush must follow the details and not allow the proposal to turn to the Democrat alternative, which is to add 2 or 3% accounts on top of the existing system. That would simply guarantee Social Security would start hemorrhaging obligations as early as 2018 that would have to be met by enormous increases in taxes, doubling them or more, hyper-inflation or drastically reduced benefits -- or all three.

In an attempt to attract some Democrat support for meeting the transition costs, Sen. Lindsey Graham has suggested a compromise to establish personal accounts as a means to satisfy conservative desires but to increase the payroll tax on higher income earners to court liberal support. While this might be politically clever in terms of legislative politics, it will be unpopular at the grassroots, especially in the GOP red states. President Bush has opposed any increased payroll tax. Moreover, if that is Sen. Graham's opening bid, the Democrats will surely raise the stakes.

Our guess is that liberals would call for eliminating the cap on the payroll tax entirely. If conservative Graham can raise taxable income to $200,000, why would liberals not eliminate the payroll tax cap completely, going after the millionaires and billionaires? In 1999, a Heritage Foundation study found that eliminating the existing cap altogether for those earning more than $87,900 would raise the top marginal federal tax rate to 54.9%, reduce the income of 23.4 million families by $9,000 the first year alone, reduce the number of jobs by 219,000, result in $34 billion less in saving, and increase taxes by almost a half trillion dollars over five years. Most important, the largest tax ever would not prevent Social Security bankruptcy, pushing back insolvency by only six years.

Given the close divide of political sentiment in Congress, it is unlikely that real reform of Social Security can pass over the next few years. Democrats will not allow it and they have the votes to stop it, especially in the Senate. In light of this reality, conservatives should refuse the honey trap of going through a bruising battle for reform that could not solve the crisis. At one point, the White House was supposedly only considering investing 2% of the payroll tax in private accounts. That would allow the Democrats to demagogue the issue without having accounts large enough to prevent insolvency. The GOP would receive the full political damage but gain nothing, or even end up making matters worse, as with the prescription drug bill (especially if the accounts are mandated on top of present obligations). On the other hand, it is essential that these issues be raised now and that conservatives have a sound proposal to offer in the debate. The Sununu-Ryan bill especially serves that purpose.

The staggering magnitude of the approaching social security crisis, and specific proposals to meet and solve it, must be debated before the political climate can be created to force the difficult decisions necessary to avert it. Rep. Ryan and Sen. Sununu have developed a plan that truly solves the problem and assists conservatives' longer-term goal of reviving the idea of limited government in the U.S. If it takes to 2008 or even longer, it is better to promote a principled solution that will actually avert the crisis rather than play the old Washington shell game. For, sooner or later, the people will realize the seriousness of the problem and they will then punish those who refused to avert the crisis and reward those who had the courage to offer fair and effective solutions.

Donald Devine, Editor, was Director of the U.S. Office of Personnel Management in President Ronald Reagan's first term. He was instrumental in reforming the second-largest retirement system covering Federal retirees to eliminate its unfunded liability, and was a member of the 1981 Reagan Administration executive working group that proposed earlier Social Security reform.

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