THE U.S. budget deficit is conservatively estimated at upwards of $350 billion this year, even including $150 billion in "surplus" Social Security payroll deductions that are counted as general revenues. In the face of record amounts of federal red ink, Congress is preparing to do just what one would expect: cut taxes. And despite the grim fiscal outlook, a number of legislative proposals to lower Social Security payroll taxes seem amply justified.
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Americans are more and more aware that Social Security contributions are not "invested" to finance future benefits; instead, they are used to disguise the true amount of borrowing necessary to fund the Administration's unprecedented spending spree. As the General Accounting Office stated last September: "The present situation, in which trust fund surpluses are combined with and partially offset a deficit in the general fund, means that the payroll tax is being used, not to make provision for future retirement benefits, but to pay for today's general operations of government."
Ernest "Fritz" Hollings, South Carolina Democrat who heads the Senate Commerce Committee, quantified the sleight-of-hand last April: "With the latest payroll tax increase on Jan. 1, surplus Social Security revenues are accumulating at the rate of $1 billion a week, rising to $2 billion a week in 1993, $3 billion a week in 1997, and $4 billion a week in 2000. At our current pace of stealing from the trust fund, we will have taken $500 billion from Social Security in five years' time -- the grandest larceny in history."
Several months later, a Senate majority, led by Daniel Patrick Moynihan, Democrat of New York, voted 54-45 to repeal boosts in Social Security contributions made during the 1980s. But the effort was rebuffed: Because the cut would have substantially reduced government revenues, 60 affirmative votes were needed for passage under the otherwise useless Congressional Budget Act.
In coming months, Congress again will weigh reducing Social Security payroll rates back to pre-1983 levels -- the amount necessary to fund current benefits. This time 'round, however, the feisty Moynihan, who already counts six committee chairmen among his co-sponsors, will easily prevail, especially since some largely overlooked additions to the 1991 budget law allow him victory with a simple majority of the vote. Yet merely cutting the payroll tax won't solve the problem. Indeed, it will make the massive liability already facing taxpayers in the 21st century ponderably worse.
Under current tax rates, rising Social Security revenues will expand government liabilities to the fund by fiscal year 1997 to $2 trillion (1990 dollars) and to $9 trillion by 2025. After that, the flow of funds will reverse as "baby boomers" retire and begin to draw benefits. Unless the government then runs an unprecedented general account surplus, the Treasury will be forced to refinance "investments" in its paper, loading an enormous burden on future workers and on the economy.
The demographic bulge represented by the baby boom underscores several flaws in the current Social Security system. First, it is not a pension fund at all, but rather a "Ponzi," or income redistribution, scheme that must ultimately be backed by general tax revenues. If the working population, and the economy, fail to grow enough to provide an ample economic base to fund benefits, either taxes must rise or benefits cut.
Because benefits are funded through marginal payroll taxes and employer contributions, the present arrangement stifles job creation and hinders overall economic growth. Indeed, each time Congress raises the payroll tax to "protect" future benefits, it further burdens the economy and makes eventual benefit payments after 2025 ever less likely.
Rolling back the payroll tax to pre-1983 levels would relieve the immediate negative economic impact of the hikes recommended by the Greenspan Commission, but leave the ultimate problem worse than under current law. Hence Congress should not cut the Social Security tax before deciding how to address more fundamental financial and moral questions.
Simply reducing the levy will leave young Americans entering the work force today with a grim choice in 30 years: Either repudiate benefits established by and for their aging parents, or endure indentured servitude under 20%-30% payroll levies to make good on the political contract that is Social Security.
Members of Congress who are willing to face unpleasant facts would do better to weigh more radical changes, moves that will reduce and ultimately eliminate the taxpaying public's future liability for most retirement costs. Some legislators, for example, propose changes in the law to slowly dismantle Social Security by allowing participants to invest a percentage of their contributions in Individual Retirement Accounts.
"Congress and the President should move now to begin the transformation of Social Security into vested, funded, worker-owned retirement accounts," so Rep. John Porter, Republican of Illinois, wrote last year in The Wall Street Journal. Under his plan, a growing percentage of each participant's payroll deduction over a period of decades would be channeled into a special individual retirement account, while the retiree's claim on Social Security would lessen proportionately.
Each American would own his or her account, held by a commercial bank or other trustee, and invested in federal and state obligations, time deposits, and high-grade stocks, bonds and mutual funds. "A substantial base of domestic savings and investment would be created," the Illinois Republican argues. "Every American worker, many of whom have never been able to save, would have a direct financial stake in the success of the U.S. economy."
The Porter proposal and similar schemes represent a good first step, but need to be taken further. Social Security should gradually be "transformed" into a system of individually based national savings, where the beneficiary may choose to have a separate account and control how the funds are invested. Under such a scheme, "competent adults," as commentator James Grant wrote on this page over a decade ago, "would be free to save and invest as they saw fit."
In addition, for those unable to take their finances in hand, the Social Security Administration (SSA) should be restructured as an independent agency, provided with public trustees appointed by the various state legislatures, and given full financial powers. It should also be authorized to pursue investment strategy that includes not only Treasury obligations, but other high-grade assets as well. A minimum retirement benefit, which was the original aim of Social Security, would be provided to the poor and indigent via an explicit government subsidy.
A combination of expanded IRAs and a renovated SSA would benefit both the economic and political health of the country. Higher yields generated by privately invested funds would produce bigger nest eggs for individuals and higher revenues for remaining SSA participants, an important point for the latter since current projections for Social Security's "solvency" labor under an assumed real return of 2%. Channeling a big percentage of savings flows into assets other than government debt also would furnish private industry with low-cost sources of investment capital.
"The amount of capital in the economy will not change," notes Joint Economic Committee economist Joe Cobb, "but benefits would be funded primarily by an infra-marginal source such as dividends and interest on private debt, instead of marginal sources like payroll or income taxes, both of which have a negative effect on growth."
Perhaps the most important effect of gradually eliminating the government's perverse role as "trustee" over Social Security would be to unmask the general fund deficit now hidden by payroll contributions and end the government's use of the SSA as a captive funding vehicle. For example, an independent SSA would compel the Treasury to actually pay interest on all its debt, instead of the convenient accounting fiction of just issuing more IOUs to the so-called trust fund. Also, publicly issued Treasury paper purchased by SSA would pay market rates rather than the bland "average yield" now accrued to nonmarketable Treasury paper held by SSA today.
One possible model for reforming Social Security is Chile. Latin America's only truly free-market economy adopted a social security program in 1924. When the system became a massive financial and social disaster decades later, the government embraced seemingly radical reforms. Today, Chileans pay a minimum of one fifth of their wages and salaries into privately administered, individual accounts. A state-sponsored "safety net" assures that poor citizens or workers with low lifetime salaries are guaranteed a minimum pension -- the only point in Chile's retirement system that requires a political decision.
On May 1, 1981, over 90% of Chileans chose the private option. A decade later, Chile's private pension funds total $5.6 billion, or 25% of GDP, and are a major factor in that nation's continued economic success.
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If Congress does choose to "mess with Social Security," it must do so while observing that many of its constituents view Social Security payroll contributions as a substitute for savings. For this and other reasons previously cited, Congress is morally bound not just to place such money out of its own reach, but also to take actions that will ensure the future safety and soundness of funds paid in trust today. Social Security must be transformed from a captive financing source for the Treasury, and a liability to future taxpayers, into real property and a foundation for economic growth.
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Christopher Whalen is senior vice president of Whalen Co. Inc., a Washington consulting firm, and a contributor to Barron's.