Phasing Out Social Security

Matthew Yglesias explicates the Bush Social Security plan in lucid prose. It would probably be best just to read his post, but I will try to summarize the main points here.

The Bush plan involves three phases:

1. Default on the General Fund's debt to the Social Security Trust Fund.

2. Benefit cuts.

3. Allow workers to divert 1/3 of their payroll taxes into a "personal," formerly known as "private," account.

Let's take each of these phases in turn. It will turn out that there are at least two ways to describe them, i.e., two equivalent ways though they may have a different rhetorical effect. These alternative descriptions were the source of some controversy regarding Jonathan Weisman's Washington Post article. See Brad DeLong for an extensive account of that matter, but I will try to give the gist of it here along with the main points of the Bush plan.

So the first phase is to default on the General Fund's debt to the Social Security Trust Fund. A little background is in order here. The Social Security Trust Fund was created in the early 1980s by Alan Greenspan et al. as a means of dealing with the retirement of baby boomers thirty years later. Essentially, the plan was to have workers pay in more than their fair share for the next twenty years so that there would be a Trust Fund from which to draw benefits once the income of payroll taxes decreased after their retirement. At that point, the upper income levels would have to pick up the slack after years of low payments. (Part of the reason for this plan was supply-side economics: allow the wealthy to invest their funds during the rocky years of the early 1980s, and collect their share later when the economy would presumably be booming.)

At this point, the fact is that all of the extra money coming into the Social Security Trust Fund has actually been "borrowed" by the U.S. government and spent as part of the General Fund. The Social Security Trust Fund really amounts to U.S. Treasury promisory notes. As Josh Marshall notes, the question we need to be asking is whether the U.S. government plans to default on these promisory notes. Marshall writes:

The Social Security Trust Fund now has accumulated roughly $1.8 trillion worth of US Treasury bonds. That total debt of the United States government is, if memory serves, just over $7 trillion. US Treasury bonds are owned by Americans, foreigners, individuals, pension funds, everybody under the sun. Most of the president's personal wealth appears to be tied up in them. They're universally considered to be the safest investment in the world. George W. Bush is the President of the United States. So the question is to him. Are the Treasury notes in the Social Security Trust Fund backed by the full faith and credit of the United States every bit as much as the bonds everyone else owns?

It seems clear from the rest of the "plan" we are hearing that the President can have nothing else in mind but defaulting on these Treasury notes, and all of the references to 2018 as a moment of crisis would indicate this because that is the date at which these notes would begin to be redeemed. There is no reason to describe that year with words of caution and trepidation unless it marks the ominous moment of failure to redeem these promisory notes. Of course, the possibility of defaulting on this debt looks like a gold mine with which to rescue the General Fund from its current state of massive deficit. This way the tax cuts can justifiably be made permanent, reform of the A.M.T. can go forward, and the enormous cost of the Iraq War can be afforded. So that's phase one: default on the General Fund's debt to the Social Security Trust Fund.

Phase two is a set of benefit cuts. The only problem with defaulting on the Social Security Trust Fund is that there will not be nearly enough money coming in from payroll taxes to pay the current benefits. Thus, benefits will have to be cut in order to balance the cash flow. How much exactly is hard to predict, but by 30% or more does not seem out of the question.

Phase three is a program of optional savings accounts. A citizen can opt to divert one-third of her or his payroll taxes into a private account. This account will then accrue interest according to the whims of the market and its vehicle of investment. Meanwhile, the government will still have to pay benefits to the nation's seniors and so will make up for the loss of this revenue by borrowing the money at a 3 percent interest rate. When this citizen retires, her or his benefits will have to be cut one more time, in addition to what was cut in phase two for everyone across the board. That is, upon retirement anyone with a private account will have her or his benefits cut by the amount that was diverted into a private account over the years plus 3 percent interest. Assuming my account earns 3 percent interest, I come out even. Any higher earnings are my extra savings, but anything lower and I simply lose. That's the risk of the market.

Another way to describe phase three is to say that the government is loaning me the money for my private account in the first place. When I retire, I pay back the loan with 3 percent interest and keep any profits above that. Phase three under this second description is identical to the phase three under the first description. In the former description, citizens who choose private accounts get two cuts in benefits, while the latter description makes their accounts an elaborate government loan rather than a truly personal account.

In the end, unless you are very wealthy to begin with, the cuts in benefits in phase two will do the most damage, and the potential earnings in phase three--earnings that rise above the rate of 3 percent of one's (fairly small) private account--could never outstrip those losses. For the very wealthy, such tax-free accounts could provide another kind of tax shelter for their assets, but for most people such savings would be minimal compared to the diminished earnings caused in phase two.