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Reaching for the Wrong Remedy

by Peter Ferrara

This essay appeared in the May 2, 2000 Washington Times.

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Still another bad idea now circulating in Washington is that the problems of Social Security can be solved simply by running a budget surplus and paying down the national debt.

The argument runs like this. Running a surplus and paying down the debt will increase national savings, which will increase investment. This in turn will increase productivity and economic growth, producing a higher future GDP when the Baby Boom retires.

The argument already breaks down here, however, for the notion that running a budget surplus is a sound economic growth strategy is wretchedly fallacious. Even putting Keynesian economics aside, which Washington does whenever it doesn't justify bigger government, the higher than necessary tax rates producing the surplus will most likely do far more to harm economic growth than any reduction in debt will help it. Indeed, if taxes on capital are too high, any increase in national savings will go to investment overseas rather than in the United States, producing higher economic growth there rather than here.

But let us continue by assuming that sustained long-term budget surpluses would produce higher economic growth and GDP. What then? Just exactly how does this solve the problems of Social Security?

Higher productivity would produce higher wages, which would produce more payroll tax revenue at fixed tax rates. But this alone won't nearly close the program's long-term financing gap, and no one claims it would. Indeed, the government's projections of Social Security's future already assume higher wage growth than we have had over the last 30 years.

Most budget surplus advocates are really just arguing that with higher GDP the higher tax rates that would be necessary to close Social Security's financing gap won't be so painful. Workers at the time would still be richer than today after the higher taxes.

But those higher tax rates will still be economically counterproductive, and losing more of their earnings will still be mightily resisted by workers and employers. Trying to make higher tax rates more palatable is not a solution to Social Security's long-term financing crisis. Those higher tax rates are the crisis.

Others argue that by paying down the national debt now we can cover Social Security's long-term deficits by issuing new debt later. But if paying down the national debt is supposed to have all these wonderful economic effects, then running it up later with large new deficits would surely be economically harmful. Moreover, after the Baby Boom retires, huge Social Security deficits will continue indefinitely. How much debt do these doubletalkers expect to issue?

The same people wail that issuing any debt to finance the transition to personal accounts would be so awful. But that would require far less debt than trying to cover Social Security's long-term gaps by issuing bonds. And when the economic benefits of the transition to personal accounts kick in, any debt issued to help finance the transition can be paid off with the resulting surplus.

But there is another, far greater difficulty with the national debt paydown solution to Social Security. That supposed solution does nothing to address the biggest problem with the program, which is really what is driving the movement for reform. Social Security's biggest problem is that even if all its promised benefits are somehow paid, those benefits are now a woefully poor deal in return for the huge taxes workers and their employers are already paying.

Multiple studies from multiple sources show workers would receive 2, 3, 4 times and more the benefits promised by Social Security by investing through personal accounts instead and earning just standard or even below-average long-term investment returns. Moreover, the studies show this is true for all workers of all income levels, family combinations, and racial and ethnic backgrounds.

The personal accounts would produce these higher benefits not because the private sector would make better investments than Social Security. They result because Social Security makes no real investments at all. Social Security is simply a tax and redistribution scheme where almost all taxes paid today are immediately paid out to current beneficiaries on a pay-as-you-go basis. The private, invested system, by contrast, pours it funds into real, private, capital investment that produces new income and wealth. That increased income and wealth is what finances the far higher returns and benefits of the private system.

Paying down the national debt is not going to do anything to make Social Security a better deal for working people or give them more control and freedom of choice over their own money. And that is why it is just a smokescreen and not a solution.