Social Security Choice Paper No. 35

Social Security Status Quo versus Reform: What’s the Tradeoff?

Executive Summary

The debate on Social Security reform has moved rapidly. Not too long ago, it was focused on whether the Social Security Trust Fund’s holdings of Treasury obligations—now totaling $1.7 trillion—implies that future benefits are secure. Recent studies suggest that, for each dollar of payroll tax surpluses made available to the federal government, federal consumption spending increases by much more than a dollar and the emergence of Social Security surpluses may have reduced, rather than increased, net domestic saving and investment. Because that implies smaller aggregate output and a smaller tax base, using the trust fund to pay future benefits will require higher non–Social Security taxes or deeper cuts in non–Social Security spending.

The value of the Social Security Trust Fund is minor compared to the accrued excess benefits of past and current generations of retirees and workers. Currently, those benefits amount to $13.7 trillion. The federal government’s apparent failure to conserve Social Security’s surpluses and the poor prospective returns that the program provides current and future participants have prompted proposals for introducing personal Social Security accounts. Critics of personal accounts assert that the additional explicit debt (“transition costs”) needed to continue paying current benefits would likely give rise to negative reactions from financial markets, which would make personal accounts prohibitively expensive.

That criticism ignores several facts: The administration’s latest proposals to gradually introduce personal accounts beginning in 2009 would, if enacted, cause a relatively small increase in federal debt—$273 billion measured in present value as of 2005—during the decade after 2009. The increase in explicit debt would be matched by an equal or greater injection of funds in private markets. The associated future reduction in federal obligations could potentially improve the government’s financial position. And a carefully crafted system of personal accounts would improve labor market incentives, making the economy better positioned to fulfill the needs of an aging population.

Options for Social Security reform must be weighed against the proper alternative—the financial implications of postponing policy adjustments. The program’s massive financial shortfall implies an annual interest cost accrual of more than $700 billion—far exceeding growth in the economy’s capacity. If changes to Social Security policies are delayed, runaway growth in Social Security’s financial short-fall is likely to ensure higher tax rates and more adverse reactions by financial markets in the future.

Read the Full Social Security Choice Paper

Jagadeesh Gokhale is a senior fellow at the Cato Institute and coauthor ofFiscal and Generational Imbalances.