There's no such thing as a free lunch. That has long been the response of conservatives when liberals have proposed policies that seemingly offer vast benefits at little cost. And, it applies to Social Security reform as much as to any other issue.
Individual accounts are the key to any Social Security reform. They will build retirement assets today, to avert a rising tax burden on workers tomorrow. They will give workers ownership and control over their retirement funds. They will allow middle- and low-income workers to accumulate real, inheritable wealth — many for the first time in their lives. They will treat women, minorities and young people more fairly. And, because of the higher return to capital investment, they will help reduce Social Security's nearly $12 trillion unfunded liability. But they are not a magic bullet. They cannot, all by themselves, dig us out of the enormous hole that Social Security is in.
Currently, the formula for determining your initial Social Security benefits is adjusted to reflect national wage growth. Because wages generally grow faster than prices, each year's retirees receive higher benefits (after adjusting for inflation) than those retiring the year before. An average-wage worker retiring in 2055 will receive benefits over 50 percent higher than an average worker retiring today, even after adjusting for inflation. The White House is reportedly considering changing the formula so that it is adjusted by prices or inflation instead. This means that future retirees would receive the same initial benefits as retirees in 2011 (when price indexing would begin), even adjusted for inflation. But they would not receive benefit increases above inflation.
Unfortunately, a small group of conservatives has attacked President Bush for facing this reality. Most recently, Peter Ferrara of the Institute for Policy Innovation called the president's proposal, "the biggest reduction in Social Security benefits in world history."
Setting aside the fact that only in Washington is the reduction in the rate of increase considered a cut, he might just as well have called it "the largest reduction in government spending in world history." Instead, Mr. Ferrara backs a plan that would permanently guarantee all future promised Social Security benefits in perpetuity. Mr. Ferrara's plan relies on large influxes of corporate taxes and permanent general revenue subsidies equal to about 1.2 percent of GDP, not just to make the transition to a system of individual accounts, but to provide for ever-rising Social Security benefits. His proposal is, by far, the most expensive of all the major Social Security reform plans being considered.
Mr. Ferrara has long been a hero in the movement for Social Security reform. He has written a number of studies for the Cato Institute, and he and I co-authored a book together on the subject. His current intransigence sullies his legacy.
Today, Mr. Ferrara condemns proposals to price index future benefits. Yet, in a reform proposal written for Cato in 1998, Mr. Ferrara advocated both price indexing future traditional benefits and increasing the normal retirement age to 70, saying "the benefit changes are justified to bring the system's expenditures in line with steady-state, long-run revenues." In that same proposal, Mr. Ferrara also rejected government guarantees for personal account holders, calling them "counterproductive and unnecessary." However, Mr. Ferrara's current proposal now includes a generous guarantee against market risk. While the SSA scores this guarantee at a modest cost, the head of the Congressional Budget Office indicated his office will use market-based financial tools to analyze guarantees, resulting in far higher estimated costs.
And all this for what? To finance an ever-larger Social Security program paying ever-higher benefits, on into perpetuity.
Mr. Ferrara proposes to pay for his proposal through large reductions in government spending, equal to about 10 percent of all non-Social Security federal spending, or almost one-quarter of all spending other than Social Security, defense, interest, Medicare and Medicaid. While I would welcome such cuts, Mr. Ferrara unwisely does not make the plan's general revenue transfers contingent on the spending cuts actually taking place. Without such spending cuts, his benefit guarantees would force massive new borrowing or increased taxes.
Indeed, it is this fear of new taxes that has made the Ferrara plan the only individual account proposal that the business community has refused to endorse. But even if the spending cuts are possible, shouldn't reductions in government spending be offset by future tax cuts? Instead the Ferrara plan uses all these reductions to finance higher Social Security benefits.
In tackling the "third rail of American politics," Mr. Bush will face the full fury of the left. He is not helped by attacks from a small group of would-be reformers seeking a free lunch.