Social Security: Red Ink's Benefits

Michael Mandel As I wrote in a previous piece, the national Democratic Party has been captured by anti-budget-deficit activists for the past 20 years (see BW Online, 11/15/04, "Faith, Hope, and Progress"). From Walter Mondale's promise to raise taxes in 1984 to John Kerry's attacks on the deficit in 2004, a central thesis of the Democratic economic platform has been that Republican tax cuts can cause budget deficits, budget deficits are bad, vote for us.

This position has been a disaster on several levels. Politically, the anti-deficit argument has garnered little support, producing only one Democratic President, and a string of congressional losses. Economically, little evidence shows that big budget deficits have impeded U.S. economic growth, the strongest among all major industrial countries over the last two decades. And because an anti-deficit stance makes it harder to fund social programs, it's tough to understand how opposing the budget deficit makes the poor and minorities, the ostensible Democratic base, better off.

THREE FIXES. Now, President George W. Bush is pushing for Social Security reform, and the Democrats are about to shoot themselves -- and their constituents -- in the foot again. They're attacking Bush's proposal for private accounts because it requires borrowing $1 trillion to $2 trillion. That's just stupid.

If the Democrats really cared about poor and working-class retirees, they should be doing the exact opposite -- pushing to borrow a much bigger sum, enough to put the whole Social Security program on a financially sound basis. (Arnold Kling, an economist who has worked with the Federal Reserve Board and Freddie Mac, makes a similar point in a piece he recently wrote.)

Let me lay out my reasoning. The Social Security system has a funding problem, but it's not an enormous one. According to the latest report from the Social Security Trustees, the difference between the revenues from the Social Security payroll tax and projected benefit payments is less than 2% of taxable payrolls for the next 75 years (see page 2 of the report).

The funding gap can be fixed in only three ways. First, the Social Security payroll tax can be increased. Second, benefits can be cut. Third, the government can borrow to fill the gap and draw on general revenues to pay back the debt. Any of these can put the program on a sound financial footing, with or without privatizing Social Security accounts.

ROUNDING ERROR. From the perspective of future Social Security recipients, the first two options are less than desirable. Higher payroll taxes hurt the poor more than the rich, since the levy applies only to wage income below a certain amount. And nobody likes benefit cuts.

In many ways, the best-case scenario for future retirees is for the government to simply borrow the money to fill the gap. That has the advantage of drawing mainly on income tax, which is much more progressive than the payroll tax since the former has no cap and hits capital gains and interest income as well as wages.

In present-value dollars, it would take $3.7 trillion in total borrowing to fill the gap, according to the Social Security Trustees. That sounds like a lot, but it's really not. It's the equivalent of only 0.7% of gross domestic product summed over the next 75 years. On the scale of the U.S. economy, the Social Security gap is like a rounding error.

MAKE A DEAL. So if the problem is so small, why hasn't it been solved yet? The answer is simple: Politics, politics, politics. Ideologically, the Republicans weren't interested in borrowing to save the current system, and the Democrats didn't want to be pilloried as big borrowers.

Bush's privatization push creates an opportunity to escape the political dilemma. The Republicans want to privatize at least part of the system. To fund the move, they have to be willing to borrow some money. However, $1 trillionto $2 trillion in borrowing isn't enough to fill the whole funding gap of $3.7 trillion. The remainder will come, in one way or another, from benefit cuts.

Instead of attacking the borrowing plans, the Democrats should make a deal: They should indicate their willingness to vote for private accounts -- but only if the Bush Administration increases the amount of borrowing enough to provide a real and guaranteed retirement safety net for at least the poorest half of Americans, even if the returns on the private accounts happen to fall short.

COMPROMISE NOW. That would be a win-win solution. The Republicans would get private accounts, the Democrats would put the Social Security system on solid ground, and needy future retirees could be certain that they'll receive their money.

That compromise may eventually come to pass. But at least for now, the Democratic Party still seems to be tied to its anti-deficit message in the Social Security arena. That's wrong economically, wrong politically, and wrong for the values that the party has historically stood for. Mandel is BusinessWeek's chief economist

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