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Simple Rules for Social Security Reform

by Edward H. Crane

This article appeared on Cato.org on September 21, 2004.

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Now stumping on the campaign trail, President Bush is renewing his call for fundamental Social Security reform through giving younger workers the option to privately invest part of their Social Security taxes in individual accounts. It's a bold stand — the proverbial "big idea" that can help define a campaign or a second-term agenda.

And it's a stand that draws a bright contrast between candidate Bush and challenger John Kerry, who says that he believes Social Security needs nothing more than a "tweak," and "little jots and jags here and there." Kerry has yet to tell us what those jots and jags are or how they'll shore up the troubled program, but he has made it clear that he opposes any proposal to allow individual investment accounts.

In grabbing onto "the third rail of American politics" by talking about fundamental changes to Social Security, President Bush is actually taking less of a political risk than commonly believed. Public opinion polls consistently show that voters across the political spectrum and in virtually every demographic understand the need for Social Security reform and support private investment accounts. Still, the president can expect a torrent of criticism from Sen. Kerry and the "do nothing" seniors lobbies, as well as resistance from the timid congressional leadership of his own party.

Whether the president can use the issue successfully depends on how he presents it to the American public. As the campaign progresses this fall, here are a few things that President Bush, Sen. Kerry and American voters should keep in mind:

• Reform Can't Wait

  In less than 15 years, Social Security will begin running a deficit, spending more on benefits than it will take in through taxes. Overall, Social Security faces unfunded liabilities of more than $26 trillion in constant 2004 dollars. That will require much more than a tweak to fix. And, the longer we wait to fix it, the worse the problem becomes. In fact, every two-year election cycle that we wait costs an additional $320 billion.

  Moreover, Social Security is not just a fiscal problem. Most American workers pay more in Social security taxes than they do in federal income taxes. That money comes out of their next paychecks and goes to Washington where it is not set aside in a personal account, but spent immediately. Those workers need action today, not in 2018 or whenever the politicians can work up the courage to act.

• Solvency Is Not Enough

  The goal of Social Security reform should be to provide workers with the best possible retirement option, not simply to find ways to preserve the current Social Security system. After all, if solvency were the only goal, that could be accomplished with tax increases or benefit cuts, no matter how bad a deal that provided younger workers. A successful Social Security reform will not only result in a solvent system, but it will also improve Social Security's rate of return, provide better retirement benefits and treat women, minorities and low-income workers more fairly.

• Size Matters

  Many proposals for Social Security reform would allow workers to invest only a small portion of their payroll taxes while relying on the existing Social Security system for the majority of their retirement benefits. This is a mistake, in terms of both substance and politics.

  The underlying economic premise of individual accounts is to take advantage of the higher returns available from private investment, using what Einstein called "the most powerful force in the universe" — compound interest. Small accounts fail to take full advantage of the compounding dynamic and will not allow low- and middle-income workers to accumulate meaningful, real wealth or achieve other objectives of reform. Individual accounts should be as large as feasible, ideally at least half of payroll taxes. There are several proposals for this in Congress now, including one by Rep. Sam Johnson (R-Tex.), based on work by the Cato Institute.

• There Is No Free Lunch

  Individual accounts will create a better, fairer and more secure retirement system, but they cannot create miracles. They will provide higher retirement benefits than Social Security can pay, but they will not make everyone into millionaires. They will help solve Social Security's financial crisis and save taxpayers trillions of dollars over the long run, but there is no free lunch. Reforming Social Security will create short-term costs that will require tough choices by the president and Congress. President Bush should not pretend otherwise. One way to cover those costs, which would also be smart politics, would be to end corporate welfare and use the freed-up federal dollars to cover a significant portion of Social Security reform's transition costs.

  It's important to remember that financing that transition is a one-time event that serves to reduce the government's future liabilities. The transition moves the government's need for additional revenue forward in time but — depending on the transition's ultimate design — it would not increase the amount of spending necessary. In effect, it is a case of "pay a little now or pay a lot later."

• Ownership Is the Key

  One of the central organizing themes of President Bush's reelection campaign is "The Ownership Society" — giving citizens more individual control over health care, retirement, home ownership and Social Security. Ownership is particularly critical in the debate over Social Security. Most Americans are not aware that the Supreme Court has ruled that we have no property right in our payroll tax. Social Security was judged a social program of Congress and what you get back at retirement is, under the current system, entirely up to 535 politicians. That makes Social Security without reform very difficult to defend.

  As Jose Pinera, the architect of Chile's hugely successful Social Security reform, puts it, "We all know the Social Security system is broke, but the fiscal problems are small compared to the culture of dependency the system fosters. There is no human dream stronger than the dream of having something to call your own."

In 2000, George W. Bush became the first major party presidential candidate since Barry Goldwater to campaign in favor of Social Security reform based on private accounts, and he won. In the 2002 congressional elections, pro-reform candidates won every race where Social Security was a major issue. The American people are clearly ready for a candidate who will speak to them openly and honestly about Social Security. George W. Bush now the chance to be that candidate.