Prefunding and Private Accounts

Andrew Samwick quotes Alex Tabarrok:

Vox Baby: Well, At Least He's Engaging: "So if we have an implicit debt of $10.4 trillion, and the real interest rate is 3 percent, then next year, the implicit debt will grow by 0.03*10.4 trillion = $312 billion, up to $10.7 trillion, if the assumptions underlying the projection stay the same. Why does this matter? Primarily, it matters because both the President and Senator Kerry have repeatedly stated (see the two speeches in Pennsylvania linked above) that they will not cut benefits for those at or near retirement age. (The Senator's statement may be even more encompassing, including benefits at any time in the future. I cannot tell for sure from his public statements.) This, in turn, means that each year that elapses without reform causes the burden of financing the unfunded obligations to be shifted away from one more birth cohort that crosses the threshold of being 'at or near retirement.' The more we wait, the larger the burden on future generations, and the higher that 3.5 percentage point surtax would have to climb."

And Andrew then comments himself:

The $10.4 trillion is about 90 percent of current GDP. In a later post, I made a rough calculation that if we waited until 2042 (the projected date of trust fund exhaustion), the implicit debt would grow (at the 3 percent real interest rate), to about $32 trillion, which would be about 141 percent of that year's (much larger GDP). So even if taxable payroll didn't fall as a share of GDP, the surtax applied in perpetuity would have to increase by a factor of 141/90, or from 3.5 to 5.5 percentage points.

The issue that Alex is pointing out is tax smoothing: for efficiency reasons, it is better to have a surtax rate that is steady at 3.5 percent rather than one that is 0 for 38 years and then jumps to 5.5 percent. The issue is, for me, less about tax smoothing and more about the intergenerational fairness of consigning future generations to pay higher payroll tax rates. We shouldn't be doing that--in Social Security, the General Fund, or Medicare.

The argument is that if you have a large lumpy liability waiting for you in the future, it's best to start saving for it now--to smooth out your tax rate.

This argument is correct, or rather would be correct were it not for one thing: the Bush administration. Remember: to the Bush administration the Social Security Trust Fund doesn't exist--"it's just a bunch of IOUs." Raise Social Security taxes now (or twenty years ago), and find a generation hence (or now) politicians like George W. Bush or Bill Frist or Dennis Hastert cutting income taxes and stating that there is no option but to default on the debt the general government owes to the Social Security Administration..

We simply cannot smooth out the taxes to pay for this forthcoming large lumpy liability--at least, not as long as we keep electing Republican politicians.

This is, I think, the principal reason that so many Republican economists are attached to private accounts. They imagine--think--hope--that private accounts will induce fiscal responsibility on the part of Republican High Politicians. When private accounts are implemented $200 billion a year of Social Security revenue will disappear from the government's books, and the enlarged magnitude of the budget deficit will then bring Bush, Frist, and Hastert to their senses. They will propose serious cutbacks in other entitlement spending programs. They will abandon their efforts to get expiring tax cuts extended. They will undergo a sea change, and all will be well.

I'm skeptical. But it is one of the two good arguments for private accounts that I have heard.

Comments

[jm]

" and find a generation hence (or now) politicians like George W. Bush or Bill Frist or Dennis Hastert cutting income taxes and stating that there is no option but to default on the debt the general government owes to the Social Security Administration."

The convenient thing about private accounts is that, unlike with the public Trust Fund, there will be no need for anyone to explicitly default on them if future workers are not so productive as to have enough surplus income to buy the stocks from the retirees at prices high enough to give the retirees a decent living. The default will be accomplished smoothly and automatically by falling stock prices.

[wkwillis]

Ditto house prices. Persuade people to pay three hundred thousand dollars for a fifty thousand dollar house and then screw them when they retire and no one has the money or need to buy their house. It's a much simpler way to transfer money to politically connected real estate developers.

[P O'Neill]

Wasn't this tax smoothing the essential logic of the Greenspan commission Trust Fund? And we all know where that got us over the last four years. But it's also interesting that the whole SS debate seems to have arrived back at the point where Al Gore tried to get it 4.5 years ago. Dare anyone say the word "lockbox"? The pundits laughed and laughed when Gore said it.

[Lee A. Arnold]

Republican economists think (imagine? hope?) that it is a "good argument" that some new sense of crisis will shake politicians out of immorality and intellectual corruption?

I think it's more likely that the transition cost will be off the books, and the "brightening future" will enable the Republicans to proclaim fiscal breathing-room, to do whatever they want--to borrow and spend some more. They've already effected a redistribution upward through the payroll-to-income tax transfer; they are using this missing money to gin-up a trustfund crisis when there are three or four other more pressing and indeed disastrous fiscal problems.

Why will rewarding these deceits by giving them what they want, change their behavior?

[mrkmyr]

How about Alex and Cato just promote viewing the budget numbers excluding the SS trust fund? Sounds a lot easier.

I really don't see how a bigger number would affect these people. They are, at best, willfully ignorent of the numbers they are currently presented.

[Chad]

That's the logic, but Bush said the difference would just be financed. Hence, why do it when we can get the debt "in house" and have control over when it is repaid? If we can't get deficit spending reduced,then at least maintain control over whether we have to spend the money.