Originally published in THE WALL STREET JOURNAL

Tuesday, February 10, 1998

Let's Really Save Social Security


Board of Contributors

"Despite Mr. Clinton's rhetoric, all his budget 'reserves' for Social Security is what's left after other spending and tax cuts chew up the projected budget surpluses."

President Clinton highlighted Social Security in the resounding rhetoric of his State of the Union address--and again in a speech yesterday--but completely ignored it in the budget proposals he then presented to Congress. Despite the president's calls to use the projected budget surpluses to "save Social Security first", there is nothing in his budget to improve Social Security's finances or to enhance future retirement incomes.

Mr. Clinton's inaction notwithstanding, the projected budget surpluses do provide an unprecedented opportunity to improve the financial outlook for Social Security and, at the same time, to supplement future Social Security benefits with investment-based pension income. Before I describe that possibility in more detail, let's look more closely at what Mr. Clinton said and what his words might have meant.

Careful Words

In the State of the Union address; the president said: "If we balance the budget for next year, it is projected that we will have a sizable surplus in the years immediately afterward.. I propose that we reserve 100% of the surplus--that's every penny of any surplus--until we have taken all the measures necessary to strengthen the Social Security system for the 21st century" What does that mean? Mr. Clinton often chooses his words very carefully, so we must read those words with equal care.

Lets begin with the "surplus" itself. The Congressional Budget Office now projects that the overall federal budget will be essentially in balance for the next two years (annual budget deficits of $2 billion and $3 billion) and will then shift to a decade of surpluses that by 2006 will exceed $100 billion a year, equal to more than 1% of projected gross domestic product.

Contrary to the impression of his language, Mr. Clinton does not propose to devote these projected surpluses to Social Security. He only suggests that "any surplus" that remains after whatever new spending and tax cutting occurs should be "reserved". In short, he makes no commitment to do anything for Social Security. Despite his rhetoric, all that Social Security gets is what's left after other spending and tax cuts chew up the projected budget surpluses. In reality, saving Social Security comes last.

The president's budget calls for a wide range of new spending programs in health, education, child care, the environment and transportation that would cause total spending to exceed, by $40 billion over the next four years, the budget caps that were the essence of the 1990 budget agreement and that are the basis of the CBO's forecast of the future budget surpluses. That $40 billion would be half of the CBO's total projected surplus for the next four years. In addition to these explicit new spending plans, the president has several spending initiatives dressed up as targeted tax reductions (e.g., "a school construction tax cut to help communities").

By an amazing feat of inside-the-Beltway logic, Mr. Clinton claims that this jump in spending would be consistent with his proposal to "reserve 100% of the surplus" for Social Security. The trick is his plan to introduce new taxes on cigarette smokers, high-income individuals and corporations. Since those taxes have not yet been enacted, they are not reflected in the projected budget surpluses. Mr. Clinton can therefore propose to spend those future tax dollars while technically claiming that he is not spending any of "the surplus"! Of course, those who are as concerned about the future of Social Security as Mr. Clinton claims to be might wonder why he wouldn't "reserve" the additional tax revenues as well as the existing projected surpluses.

It also takes a highly nuanced construction of language to reconcile Mr. Clinton's big new spending plans with his call in the State of the Union to "approve only those priorities that can actually be accomplished without adding a dime to the deficit". In truth, every one of his new spending proposals would add to the deficit. But combined with enough new taxes, there need be no increase in the deficit. That is the nature of tax-and-spend budgeting. But if the Republican-controlled Congress rejects Mr. Clinton's tax increases, the popular spending plans that he proposes would cut into the projected surpluses.

Yet if there are some surpluses left, what might Mr. Clinton mean by his proposal to "reserve 100% of the surplus"? The word "reserve" has no particular meaning in the budget process. Money can be appropriated, spent or added to trust funds, but it cannot be "reserved". And Mr. Clinton doesn't even say that it should be reserved "for Social Security" or for anything else in particular. Just "reserved". Senior administration officials have subsequently testified that it doesn't mean putting the money in the Social Security Trust Fund. It turns out that "reserving" this money has nothing at all to do with Social Security.

In short, Mr. Clinton talked eloquently about the Social Security problem but offered no proposal to do anything about it. The projected budget surpluses are clearly vulnerable to a combination of special-interest spending programs and populist tax cuts. And the Social Security program continues to head toward a deficit that will require a massive tax increase or drastic cuts in benefits.

There is a simple and direct solution: a legislated commitment now to use the projected surpluses to finance Personal Retirement Accounts for every working person. The projected surpluses are large enough to permit the government to put 2% of each individual's wages (on earnings up to the $68,400 Social Security maximum) each year in such an account to be invested in stocks and bonds. There are a variety of ways in which such accounts could be established and financed; I offered one way, based on personal income-tax credits, on this page in November.

If the budget surpluses projected for the next decade are used in this way, funding such accounts would not reduce the money going into the Social Security Trust Fund and would not cause a budget deficit. Committing future budget surpluses now to individual investments in stocks and bonds would guarantee that they add to national saving instead of being dissipated in new government spending.

A system of accounts based on 2% of earnings would accumulate some very significant totals, providing the only way in which many low- and middle-income households might ever accumulate some personal wealth. Based on the historical average return on a portfolio of stocks and bonds (5.5% a year before personal taxes), a couple that earns $60,000 a year (in 1998 dollars) and contributes 2% of that each year from age 30 to 65 would accumulate $125,000 at age 65, enough to finance a $10,000-a-year annuity for 20 years. In the aggregate, such annuity payments would equal 17% of the Social Security benefits implied for the year 2030 in current law and 40% of the benefits implied for 2050.

That has important implications for the long-term solvency of the Social Security system. Following a suggestion of Sen. Phil Gramm (R., Texas), the Personal Retirement Account-funded annuities could be "integrated" explicitly with Social Security benefits so that traditional Social Security benefits are reduced by a dollar for every two dollars that individuals receive from their Personal Retirement Accounts. That would leave individuals with more retirement income while reducing the payroll-tax increases that would otherwise be needed to finance future benefits.

Clear Opportunity

There are many changes that can be made to help Social Security weather the surge in benefit outlays when the baby boomers begin to retire, about a decade from now. The four regional forums on overhauling Social Security that Mr. Clinton announced yesterday, as well as the bipartisan summit he says he plans to call a year from now, can grapple with those tough choices.

But the projected budget surpluses now provide the clear opportunity for a simple legislative action that would help all working people, raise national saving and contain the rise in future payroll taxes. With the president's support, this can be done quickly, before the opportunity to do so is destroyed by the pressures that will otherwise dissipate the projected surpluses. A bipartisan effort could actually turn Mr. Clinton's rhetoric into a serious plan to save Social Security and protect future retirement incomes.

Mr. Feldstein, a former chairman of the President's Council of Economic Advisers, is a professor of economics of Harvard University.