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Social Security Snares & Delusions

From the January 17, 2005 issue: How not to squander political capital.

Jan 17, 2005, Vol. 10, No. 17 • By IRWIN M. STELZER
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It is, of course, also his responsibility to make clear just what his proposed solutions involve. A good beginning would be to abandon the argument that no cut in benefits is contemplated. That argument goes something like this. One reason the system is in financial difficulty is that (here and throughout I am sacrificing a bit of precision in favor of a great deal of clarity) the benefits of retirees are being increased more or less in line with the rise in wages. Reports are the president would change the escalator to the cost-of-living index. That alone, estimates Professor Olivia Mitchell of the University of Pennsylvania's Wharton School, "would fix the solvency problem without individual accounts. Indexing to inflation rather than wages will put it back on actuarial balance."

Now, it is possible to make a conceptual argument in favor of either of those escalators (such automatic increases are far superior to the old system where Congress raised benefits to win reelection). Escalate with wages, and you retain the standard of living of retirees relative to those of active workers. Escalate with inflation, and you retain the absolute standard of living of retirees. Surely a question on which reasonable men can differ.

What cannot be argued, at least not while maintaining credibility, is that a switch from a wage-based escalator to an inflation-based escalator does not result in a reduction in payments to retirees. It does, for the simple reason that in an economy in which productivity is increasing, wages will, over time, rise faster than inflation. That's why proponents of the president's plan argue that using a wage escalator places a far greater financial burden on the system than does the alternative. But if the current escalator is far more expensive than the proposed substitute, then the switch to an inflation index would reduce the benefits that would flow from retaining the wage indexation scheme. A change to a cost-of-living index would lower the cost of the system precisely because it lowers benefits--a good or at least necessary thing, perhaps, but a reduction by any other name remains a reduction. Meanwhile, payments into the system, being based on a tax on wages, would rise faster than benefits paid out, since wages should (one trusts) outpace inflation.

True, were we to switch escalators we would be imposing only a reduction in an increase, but it is a reduction in a promised increase, an increase that is now incorporated in what can be characterized as a social contract between active workers and retirees. That is not something conservatives should lightly contemplate.

In addition to reducing benefits, the proposal being mooted in the White House would allow some portion (one-third is the share recommended by the 2001 Presidential Commission on Social Security Reform) of the funds now being paid as taxes to support the Social Security system to be diverted into personal retirement accounts. The reasons given for this change, which polls suggest younger voters see as the only way they will ever collect any benefits, are two: It will help to create an "ownership society," weaning the individual from dependence on the state; and returns on the privately invested funds will in some economically meaningful sense be higher than those now being earned by the government on behalf of future beneficiaries. Neither reason withstands scrutiny.

No one is proposing to allow participants in the current system to invest even a part of their contribution in any way they might choose. After all, individuals might make the wrong choices, and find themselves less well-off than they would wish when the time comes to lay down their tools or attend their last important meeting. So the proposal now on the table would have the government limit investment options to stock-index mutual funds, bond funds, and cash--the resulting pool to be converted into annuities upon retirement. The theory of forced conversion into annuities, rather than allowing lump-sum withdrawals, seems to be that retirees and their money might otherwise soon be parted, a folly the government is honor-bound to prevent. So much for freeing citizens from the heavy hand of the state.