In early summer last year, we published what we believed to be the state-of-the-art on the finances of the Social Security System. Its concluding paragraph tells us how little the state-of-the art has moved in eight months: “For all the potential of the high-growth option to begin resolving the Social Security problems that otherwise appear intractable, there should be no illusions. The pro-growth forces in Congress are stalled, stymied by a Hooverite austerity faction of the Republican party that believes its highest priority is to pay down the national debt...[We are] constantly told of the necessity of benefit cuts, retirement-age increases, and other measures to maintain the program as part of the long transition to a privatized system. In reality, this certitude could well become self-fulfilling. Just as the benefits of maintaining a high rate of growth compound over time, so do the costs of sub-optimal performance. Without further action soon, the current climate of robust wealth creation and above-average economic vigor is unlikely to be sustained long term. At some point, the growth required to overcome a period of mediocre economic performance and sustain financial viability of the system would be unattainable, making an austerity ‘solution’ inevitable.”
Without heroic feats of impossible policy change, the growth option we presented last July would put the economy on a productivity expansion track that would allow two workers to support one retiree in 2025, not the three workers required today. As a rough approximation, that simply would be consistent with a broad index of equity values increasing by 50% -- at a constant gold price. If the price of gold doubles in the next 20 years, for example, the Wilshire 5000, now at 12,000, would have to go to 36,000. But there’s more to it than that. Because the government has enriched the Social Security benefit formula to provide for increased real benefits in an expanding economy, and with the work force growing more slowly than it has in the last half century, there must be even greater increases in productivity. Think of it this way: If a given work force can produce a million loaves of bread, under the current projection, it has to be able to produce 1.5 million loaves by 2025 in order to support the growing retired population. It must produce another 500,000 loaves because the retirees are promised more bread in those years than they are getting now. The Wilshire 5000 would then have to go to 48,000. We of course use bread as a proxy for all consumer goods, including health-care services.
There’s really nothing wrong with that, as long as the government makes the changes in the tax and monetary structure of the economy so that efficiency sufficiently increases to meet those targets. Conceptually, Gross Domestic Product does not even need to increase over the next 20 years in order to meet most of the targets. As we pointed out last July, there are great numbers of people who labor today on the non-productive tasks that make up most of the inefficiencies we have embedded in our economy. In simplifying the tax structure and reducing the risks inherent in a floating dollar, these productive energies would be transformed into goods that people can use to satisfy their basic needs and wants. A tax lawyer who earns $300,000 a year guiding companies through the complexity of the tax codes would be able to earn $300,000 advising a new company that would spring out of the more efficient system on how to sell its product internationally. The income the lawyer reports to the government would be recorded as part of national output, but in the second example, the $300,000 would buy 300,000 loaves of bread from abroad. We do not need to be exact in the numbers we present here to make the argument that once you think in terms of the production of more useful goods and services with the same level of effort, you are creating the perpetual stream of wealth needed to take care of the aging population.
It of course is necessary for the government to have accounting procedures that keep track of pension debits and credits. Congress and the President, though, have gotten lost in this thicket of GDP statistics, actuarial tables, and trust fund accounts, with the outcome a debate that has not advanced the productivity track one iota. The President is determined to save Social Security before he alters the tax system. Out of fear that he will be able to defeat them politically by accusing them of “raiding Social Security,” Republicans have abandoned plans for passing even the 10% marginal tax rate cut this year. We are left with the vapid pledges of the GOP’s House-Senate “framework” agreement to “pay down more debt than the President,” and to “lock away every penny of the Social Security trust fund surpluses for our nation’s elderly.”
Nothing that now is being offered by either party would sustain Social Security’s financial footing by as much as a day beyond the point that ultimately will be determined by future economic conditions. By locking away the surpluses, not one extra loaf of bread will be produced in 2020. On its present course, the debate is more likely to significantly delay consideration of the steps required -- a delay that itself could in the end make considerably more difficult the task of ensuring that future retirement income needs do not become a drain on the nation’s resources. If the changing of the accounting ledgers do not change the risk structure of the economy in a way that produces more net “bread,” there is no point in going through the exercise. To give relief to those workers who are overpaying Social Security because it was overfunded in its last “fix” of 1983, the most reasonable method that does have a supply-side kick would allow workers to deduct their payroll tax from taxable income. At the margin, this increases the supply of labor. There also would be a kick if the payroll tax were reduced, but this mode would upset the President’s fiction regarding the need to save the surplus.
Were it not for the Republicans’ political timidity, in fact, this would be a golden opportunity for initiating a transition to private accounts as a mechanism for reducing the long-term burden of the government guarantee. Based on existing projections for surpluses in the system for the next five years, the effective payroll tax rate of 12.4% could be cut by at least two percentage points if the excess revenues were rebated in the form of personal accounts rather than dedicated to building trust fund assets. The short-sightedness of closing off this course will become even more clear next month when the trustees publish their annual report. It will show surpluses in the system growing even faster than earlier estimates due to higher-than-projected economic growth.
The political conundrum flows from the almost universally misunderstood function of the system’s “trust fund.” Both Clinton and the Republicans say they want to bolster so-called trust fund assets, fostering the impression that this would build up reserves that could be drawn down to help pay future benefits. In reality, the trust fund does no such thing. It is simply a bookkeeping device that records the payroll tax revenues in excess of current benefits that the Social Security Administration receives and is required by law to transfer to the Treasury Department. The trust fund “assets” are the IOUs that the system gets back from Treasury. They represent the government’s obligation to fund future benefits from general fund revenues. The Clinton Social Security “plan” significantly one-ups the Republicans in mischaracterizing the utility of trust fund balances. It would credit the fund with more than double the $2.3 trillion in surpluses projected over the next 15 years and claims the accrued interest on the additional assets would keep the system “solvent” for 23 years beyond the fund’s current drop-dead date of 2032. This is an accounting mirage that the administration has been permitted to put forward as realistic due to widespread ignorance that the trust fund does not represent real economic assets.
Incredibly, the Clinton Administration’s own fiscal 2000 budget proposal acknowledges that the trust fund plays no part in actually financing future benefits: “These funds are not set up to be pension funds, like the funds of private pension plans....Instead, they are claims on the Treasury, that, when redeemed, will have to be financed by raising taxes, borrowing from the public, or reducing benefits or other expenditures. The existence of large trust fund balances, therefore, does not, by itself, make it easier for the government to pay benefits.” In other words, the President presents himself as the savior of the retirement system in order to prevent Republicans from cutting tax rates, while the responsible officials in his administration readily concede they are doing nothing to solve the problem.
The rhetoric of both sides also obscures the fact that the size of payroll tax surpluses has no relation to whether the excess revenues are spent, used to retire debt, or to support income tax cuts. Public perceptions that Congress faces a meaningful choice of whether to “save” the surpluses or “squander” them in new spending or tax cuts are entirely without foundation. Surplus-generated trust fund assets have been building for a number of years even as the excess revenue has co-mingled with the general fund and been spent as part of current budget outlays. None of the proposals of either party would alter this mechanism. Thus, the Republican decision to “lock away” the Social Security surplus and forgo a major tax cut until the general fund moves into surplus in another two to three years only has relevance as a political matter; it is immaterial to disposition of the payroll tax surplus.
In addition, the Republican proclamation that it is walling off the Social Security surplus to “pay down the debt” amounts to a bookkeeping fiction. The Treasury’s net indebtedness would not be reduced by a dime as result of plans to use $1.8 trillion in Social Security surpluses over the next decade to absorb publicly held debt. That sum would be equally balanced by growth in trust fund obligations. In essence, the Republicans are making an argument for paying down the publicly held debt now in order to build it back up later.That congressional GOP leaders believe they have little choice but to acquiesce in this delusion or face being pilloried by Clinton and the Democrats for “wasting” the Social Security surplus on “tax cuts for the rich” speaks volumes to the party’s current aimlessness. Admittedly, part of the dilemma is that since so few of its own members actually comprehend the system’s arcane accounting conventions, there is little faith on Capitol Hill that the party would survive the inevitable partisan PR war without sustaining even deeper wounds. Then, there is the “problem” of the economy’s current robust health, which is perceived as sapping the arguments for deep cuts in marginal tax rates.
This is the crux of the issue, as the sustained gains in productivity and real wages required to keep the retirement system on sound footing will not be possible without tax policy changes that improve the marginal after-tax returns to capital and labor. Delaying the reforms for even a few years could prove costly, as the burdens to the system of every year of slower-than-potential growth compound over time. Worse yet, the economy’s present run of “above-trend” growth is highly unlikely to endure without tax policies that continue to provide fresh incentives for more productive deployment of human, physical and financial capital. We have been pointing out for more than two years that the “bottom of the economy” has not been as healthy as the top seems to be. In her excellent “Market Watch” column in Sunday’s NYTimes business section, Gretchen Morgenson notes the work done by Salomon Smith Barney analysts, which points out that the great bulk of growth in market capitalization in the past two years has been among firms at the top of the economic pyramid. It is because of the heightened risks around the world due to the dollar monetary deflation that this split level exists, as capital that flows into our market is being exchanged for today’s equivalent of the “nifty fifty” equity issues of the early 1970s.
Given the political realities, the best we can hope for now is a tax cut along the lines of an expanded Roth IRA or the Coverdell-Torricelli “Family Savings Act,” which does form capital from the bottom of the economy. To get to the basic restructuring needed for the long haul, it now seems certain we will have to go through the 2000 presidential elections and come out with a Republican President or a Republican Congress with backbone.