Originally published in THE WALL STREET JOURNAL
Monday, February 1, 1999
Clinton's Social Security Sham
By MARTIN FELDSTEIN
Board of Contributors
Although President Clintons Social Security proposal is terrible in itself and based on a remarkable accounting sham, it also contains and endorses the key building blocks of a very desirable Social Security reform -- creating individual accounts, using projected surpluses and investing in equities. The White House and the congressional leaders should now reshape the presidents plan to produce something that a majority in Congress can support and that can serve the nation well.
The most obvious fault of the Clinton plan is that it fails to "save Social Security". Even Mr. Clinton claims only that it would postpone bankruptcy to 2055 from 2032. After that, maintaining promised benefits would require raising the payroll tax rate to more than 18% from todays 12.4%. Without a tax increase, benefits would be cut by more than one-third.
Extending Social Security solvency to 2055 is based on a complex accounting sham so duplicitous that it is hard to believe. Heres how the trick works. Over the next 15 years, Social Security tax receipts and trust fund interest will exceed Social Security benefit payments by about $2.7 trillion. Under current law, this excess is automatically added to the trust fund. This $2.7 trillion Social Security surplus is the major source of the $4.5 trillion overall 15-year budget surplus. Under Mr. Clintons budget proposal, $1.7 trillion of this surplus is used to finance increased outlays for Medicare and defense and the presidents proposed universal saving accounts. However, the $2.7 trillion of net additions to the Social Security trust fund would keep the trust solvent until only about 2032 (or six years longer if funds are invested in the stock market). But thats no better than what we could expect without any plan at all.
To keep Social Security on track through 2055, the president arbitrarily transfers another $2.8 trillion--the remainder of the $4.5 trillion surplus--from the Treasury to the trust fund over the next 15 years. The president described this as equal to 62% of the projected budget surplus but it is not part of the surplus at all. The entire surplus is already spoken for by the new spending, the savings accounts and the automatic additions of Social Security surpluses to the trust fund. This $2.8 trillion is a completely new additional grant of money from the Treasury to the trust fund. The Treasury credits the Social Security account with $2.8 trillion and debits the governments general revenue account $2.8 trillion. This permits the trust fund to acquire $2.8 trillion in additional government bonds. Cashing in these bonds between 2032 and 2055 will pay for the projected benefits in those years. Magic!
The issue isnt just transferring money from general revenue to the trust fund. Its double-counting. The trust fund accumulates the $2.7 trillion of regular Social Security surpluses. The same $2.7 trillion is then counted again in the $4.5 trillion the president uses to finance his $2.8 trillion to Social Security. Thus the president raises the Social Security trust fund by $5.5 trillion while spending nearly $2 trillion on other things, all out of a total surplus of $4.5 trillion.
This amounts to the biggest and most creative budget sham Ive ever seen. If the government gave $2.8 trillion to private individuals, it would create $2.8 trillion of budget deficits, and the national debt would rise by $2.8 trillion. But since the Social Security trust fund is part of the government, this transfer of money (and the bonds that are bought with it) does not count as deficit or add to the national debt.
But when these bonds are used to finance benefits after 2032, they must be sold to the public. Selling the bonds will then add to the budget deficit and national debt unless there is a multitrillion dollar tax increase. Thus Mr. Clintons proposed sleight of hand commits us to massive future deficits or tax increases or both. And of course it does nothing to increase future real incomes to help pay for future benefits.
Even the ordinary trust-fund accumulation that results from the excess of Social Security tax receipts over benefits is likely to be just an accounting transaction that adds nothing to national saving and therefore does nothing to increase future national income. Heres why: Every dollar added to the Social Security trust fund is officially counted as an additional dollar of overall surplus in the unified government budget that guides congressional spending and tax decisions. Long experience shows us that when that unified budget is in surplus, Congress will soon find ways to spend those funds or give them back in tax cuts. The Social Security surpluses will just be balanced by deficits in the rest of the budget. The bonds bought with these Social Security surpluses will be financing these other government deficits. There will be no net increase in the government surplus and therefore no rise in national savings.
The other elements of Mr. Clintons plan are both bad economics and bad politics. His plan to turn the government into the nations largest shareholder deserves the widespread condemnation it has received. Despite administration promises to follow a passive investment strategy like holding the Wiltshire 5000 portfolio, the temptation for the government to become an active investor with a political agenda would be irresistible.
An investment policy that excludes companies that make certain products (cigarettes, handguns, etc.), or that pollute the environment, or that invest heavily abroad ("taking jobs away from American workers") would greatly extend the governments influence over the economy as well as hurt the portfolios rate of return. Government share ownership would bring voting rights and therefore the power to change management, block mergers and otherwise interfere in corporate affairs.
It is not surprising that key political leaders and Fed Chairman Alan Greenspan have sharply criticized this policy of government share ownership. Sen. Daniel Patrick Moynihan, the ranking Democrat on the Senate Finance Committee, had previously announced his opposition to such government share ownership. All the key House and Senate Republicans, whose support would be needed to pass Social Security legislation, have also made their opposition clear.
The $500 billion Clinton plan to subsidize new individual saving accounts makes no sense when those accounts are kept completely separate from the Social Security program. Why use scarce budget dollars to create these accounts when the funds could be used instead to protect the solvency of Social Security? Why a voluntary program in which those with the lowest incomes are least likely to participate? Why a plan in which the administrative costs of collecting small individual deposits would erode much of their return?
Bad as all this is, the Clinton proposal has put on the table with full White House endorsement the key ingredients--using the budget surplus, investing in equities and creating individual accounts--of a desirable plan. Heres how such a plan would work:
The government would continue to collect the 12.4% payroll tax and use those funds to finance traditional Social Security benefits. The government would also use the budget surpluses to finance deposits of 2% of each individuals earnings (up to the Social Security maximum, now $72,600) in a new Personal Retirement Account. The individual would designate a fund manager (a bank or mutual fund) and the specific approved mutual funds into which the money is to be invested. At retirement age, the accumulated PRA balance would finance a variable annuity
invested in a mixture of stock and bond mutual funds. Each retiree would receive a combination of traditional tax-financed Social Security benefits and PRA annuities, with a government guarantee that the combination is at least as large as the benefits projected for that individual in current law.
Such a plan, which is similar to legislation proposed by Senators Phil Gramm (R., Texas) and Pete Domenici R., N.M.) and to the plan that I put forward last year on this page, corrects each of the flaws in the presidents plan.
First, it actually saves Social Security. The combination of the PRA annuities and Social Security benefits financed by the current 12.4% payroll tax would exceed the benefits promised in current law. This would be a permanent fix that, based on current economic and demographic projections, would never require a tax increase or benefit cut.
Second, there would be no accounting sham with its implication of multitrillion dollar future budget deficits or tax increases.
Third, the government would not be a shareholder. The investments in the stock market would belong to individuals, just as they do in individual retirement accounts and 401(k) plans today.
Fourth, the funds that go into the PRAs would be outside the federal budget and therefore wouldnt tempt Congress to spend more money.
Fifth, since the government would send money directly to fund managers for the individual accounts, there would be no administrative cost of collecting funds from individuals and no risk that low-income individuals would fail to participate. For anyone who does not select a fund manager, the government would create an account with a private manager or with an entity like the Federal Thrift Saving Plan.
All of this could be financed at a cost that would be less than the president proposes for Social Security. Over the next 15 years, the cost of depositing 2% of payroll would be less than $2 trillion. By 2030 the program would be self-funding: The accumulated PRA investments would generate enough extra corporate tax revenue to finance the governments PRA deposits. Indeed, after 2030, there would be extra revenue that could be used to cut other taxes or to finance new spending. The extra corporate tax revenue also means that even if the budget surplus is exhausted by 2015, the annual funding gap between then and 2030 would be equal to only about 0.25% of GDP.
Republicans and Democrats in Congress, recognizing the egregious shortcomings of the presidents plan, should now sit down with administration officials and use the building blocks Mr. Clinton has endorsed to save Social Security.
Mr. Feldstein, former chairman of the presidents Council of Economic Advisers, is a professor of economics at Harvard.