Friday, December 03, 2004

A False Start on Social Security

The New York Times
December 3, 2004

A False Start on Social Security

Even before the debate has truly begun over the centerpiece of President Bush's second-term domestic agenda - creating private retirement accounts within Social Security - White House and Congressional budget leaders have been floating the idea that it won't require a major increase in the federal budget deficit. This is dangerously misguided. Unwilling to raise taxes, Congress and the administration will have to borrow well over $1 trillion to turn the president's wish into reality.

For a country that already needs to borrow $2 billion a day just to stay afloat, that gargantuan price tag for privatization is one reason it's a bad idea. It is far from the only reason, and arguably not even the main one. Yesterday, for instance, the president's top economist said privatization would very likely lead to major benefit cuts, which could be devastating for people who lost money in their private accounts. For now, however, the cost issue is moving to center stage in Washington. It is imperative to refute the suggestion that private accounts would somehow, magically, pay for themselves.

The issue is how to pay full benefits to people at or near retirement if Social Security money starts going into private accounts. Since current wage earners cover the benefits for current retirees, every dollar workers invest elsewhere has to be replaced. This is the so-called transition cost, estimated at $1 trillion to $5 trillion.

To convince the public that those costs won't matter, privatization advocates are concocting a ruse something like this: Borrow, say, $2 trillion today to establish private accounts, with the expectation that they'll generate such tremendous personal savings that the government will be able to cut future Social Security benefits by an even larger amount and use the savings to erase the debt, plus interest, some 40 years down the line. By this sleight of hand, the money borrowed is not new debt, and there's no need to count it toward the deficit.

Remember how Enron used off-the-books maneuvers to pretend it had no debt? Remember how well that worked out?

For privatization advocates who have been stumped by how to pay for the transition to private accounts, this ploy has significant political advantages: creating the illusion that Social Security privatization entails no cost would bolster the case for privatization for an unwitting public. It would also give political cover to legislators and other policy makers who want to be on the president's team but may otherwise balk at the huge deficits that come with playing along.

What accounting gimmickry won't do - and this is crucial - is fool America's lenders, like the central banks of China and Japan, and other participants in the financial markets. Whether it's recorded on the nation's books or not, ever more government borrowing will, sooner or later, reduce lenders' appetite for Treasury debt, forcing up interest rates as the government scrambles to attract the money it needs.

This is not a distant and theoretical danger. Last month, Alan Greenspan, the Fed chairman, flatly stated that America's lenders would eventually tire of financing our deficits. Underscoring his comments, the yield on the benchmark 10-year Treasury note hit a four-month high this week, as the ever-weaker dollar continued to lure investors away from dollar-based debt.

The immense additional borrowing envisaged by privatization advocates would accelerate and intensify these disturbing trends, precisely the opposite of what the government should be doing. Trying to hide the borrowing would create the impression - an accurate one, as it turns out - that our government is fiscally irresponsible. The global financial community would respond by upping the pressure because lenders demand tougher terms from feckless borrowers.

Privatization advocates will tell you that the cost of creating private accounts today must be compared with the cost of doing nothing to reform Social Security. This is specious. First, no reasonable person is suggesting that nothing be done. The proper comparison is between a plan to borrow trillions and a plan to phase in slowly a modest package of tax increases and benefit cuts that would preserve the current system's essential protections without borrowing or dubious accounting.

Second, borrowing to finance the transition to private accounts could very well cost more than doing nothing. If private accounts didn't perform as well as their proponents hope - and the proponents are by and large a very optimistic bunch - the government might need to take on even more debt decades hence to rescue the old people who ended up without adequate retirement income.

Solid accounting must underlie Social Security reform. Once that's in place, let the debate begin.