"Time is Not Our Friend"

Tuesday, March 29, 2011

Ryan Streeter, ConservativeHome USA: What does every voter in America need to understand about the Social Security shortfall and why it has gotten to this point?

Charles Blahous: If there is one thing every voter needs to better understand, particularly every taxpayer—and even more particularly, every fiscally conservative taxpayer—it’s that further delay in repairing Social Security inevitably means bigger tax increases down the line. This is partially because of demographics and partially because of the wage-indexed benefit formula, but it’s also because we have a pretty firm bipartisan consensus—from the most conservative members of Congress to the most liberal—not to cut benefits for those already receiving them.

This means that with each passing year, we have millions of additional baby boomers on the rolls whose benefits are politically inviolate. It’s then too late to pre-fund those benefits, and they’re not open to renegotiation; they can only be financed by raising tax revenue. The deck is thus really stacked against those who worry about the growth of taxpayer burdens. It’s not so simple as saying, “I don’t like this particular Social Security deal—let’s come back in four or five years and strike a better one.” Four or five years later, we’re on the hook for much bigger tax burdens. Time is not our friend here.

Now, that’s the main thing. But there are other issues that need to be better understood. One is that the crafters of the 1983 Social Security reforms never intended to build up a big trust fund, nor did they believe that doing so would effectively fund future benefits; we’ve had a failure of national memory on this point. Also, if we act now, future benefits don’t need to decline in real terms. But again, that’s only if we act soon. We’d benefit from broader understanding of all these points.

Streeter: You favor reforming Social Security to fix the shortfall by moving toward a defined-contribution approach. Can you explain what this would mean for a middle-income family of four, where the parents are between forty and forty-five years old?

“High-income Americans should prepare themselves to either depend less on Social Security or contribute more to it.”

Blahous: I should clarify. In my ideal world, I would favor a “partial” defined-contribution approach. Sticking wholly with pay-as-you-go defined-benefit financing is the path of least resistance in the short term, but the hardest on younger generations. Alternatively, immediate transition to a fully funded system would be great for future generations, but murder on the transition generation, because they would have to pre-fund all their own future benefits while also paying pretty much the entirety of older generations’ benefits.

A partial defined-contribution system is the fairest middle ground between these extremes. The parents who are forty to forty-five would put aside a little income in a savings account so that their benefits aren’t paid entirely by taxing the next generation. They couldn’t spend that money, nor could the government spend it for them on additional services.

Meanwhile, the growth of their taxpayer-financed benefits would be scaled back. The kids would benefit enormously because they would be excused from some of the mounting tax burdens under pay-go defined-benefit financing. In sum, partial pre-funding means that today’s working generations put aside a little savings in order to head off the mounting tax burdens now facing their kids.

Streeter: When it comes to fixing Social Security, how would you weigh the importance of raising the retirement age, instituting private accounts, and constraining Social Security spending growth?

Blahous: Constraining Social Security spending growth is the highest priority from the standpoint of program finances, whether it’s done by changing the benefit formula or adjusting the retirement age. The math is pretty simple: taxpayer costs go up because we have an aging society in which people receive benefits for a lot longer, and because we are paying them higher real benefits each year, even in per-capita terms. You have to deal with both if you want to avoid a large rise in taxpayer burdens.

Of these items, I’d (perhaps surprisingly) rank the accounts last. They’re important for arresting the decline in the money’s worth treatment of younger generations, but all they can do is to arrest that decline—no matter what, younger generations still will get lower returns than earlier ones, because of the enormous cost to them of financing trillions in unfunded benefits over the next few decades. We can only limit the overall negative hit if we contain the growth of costs, whether that’s done in the benefit formula or through the retirement age.

“Four or five years later, we’re on the hook for much bigger tax burdens.”

Streeter: Let’s say Congress enacted the perfect Social Security reform bill tomorrow. Which part of the American population would be most negatively affected, and what can they do to prepare themselves?

Blahous: No question on this one: high-income Americans. Every single plan will hit them disproportionately. Plans from the right do it by constraining the growth of their benefits; plans from the left would raise their taxes. But both sides of the aisle are trying to protect people on the low-income end, which means people on the high-income end will pay the price of getting to solvency. So high-income Americans should prepare themselves to either depend less on Social Security or contribute more to it.

They can also provide a signal to legislators indicating what they really care about. The left believes that high-income Americans will withdraw their political support if their benefit growth is constrained; the right believes that high-income Americans are more worried about their tax burdens. High-income Americans could actually help legislators resolve this argument if they clearly conveyed to their own congressional offices whether they would be more perturbed by higher taxes or slower benefit growth.

“Partial pre-funding means that today’s working generations put aside a little savings in order to head off the mounting tax burdens now facing their kids.”

Streeter: If you were a newly elected member of Congress and you had promised voters you would do something about America’s entitlement crisis, what would you do upon arriving in your office?

Blahous: First, contain any immediate damage. Any spending increases that haven’t gone into effect (some of which were recently legislated in the health care bill) need to be stopped before there is a dependency on them. It’s very hard to slow down spending once people already depend on it. The logical place to start is with spending that hasn’t become entrenched.

Second, signal a willingness to work on a Social Security deal that contains cost growth, possibly including a close look at the fiscal commission’s recommendations.

Third, reassess the federal government’s myriad actions that fuel health care cost inflation, including everything from government-subsidized insurance to ages of eligibility to tax preferences for compensation in the form of health benefits.