September 16, 2004

September 16, 2004 | Commentary on Federal Budget

Improving Social Security: Pay A Lot Now or Even More Later


In his acceptance speech at the Republican National Convention, President Bush revived several initiatives from his first presidential campaign. Not the least of them: a pledge to "fix" Social Security by letting younger workers invest some of their payroll taxes in personal retirement accounts.


Opponents of modernizing the Depression-era system quickly jumped on the proposal as too costly. But such criticisms are penny wise and pound foolish.


Trying to keep the ailing system going for another generation will wind up costing taxpayers far, far more than making reforms today. Demographic realities -- the increasing longevity of Americans and the looming mass retirements of the baby boomers -- make it impossible to maintain the current system indefinitely.


Fifty years ago, the ratio of workers to retirees was 16 to 1. Those days are long gone. Today only 3.3 workers pay into the system for every person drawing benefits. By the time today's new workers are ready to retire, the ratio will have shrunk even further, to just 2 to 1.


While President Bush would maintain the current benefit system for those at or near retirement age, he wants to give younger workers an option: to invest some of their payroll taxes into a personal retirement account -- an account that will earn interest and belong to them.


What makes this approach expensive is the need to continue paying full benefits to those remaining completely in the current system while younger workers send part of their money (that would otherwise help pay current benefits) into personal accounts. In other words, these so-called "transition costs" come from changing the program's cash flow.


Admittedly, these reforms are costly. The Social Security Administration has analyzed a number of Social Security plans similar to that outlined by the president. Its estimates of transition costs incurred by these plans run as high as $2 trillion over the first 10 years, and from $7 trillion to $8 trillion total before the transition is completed in mid-century.


Critics of personal accounts stress the transition costs while ignoring the costs of not making the transition. Newsday columnist Marie Coco dismissed the president's plan as "a jumbo mortgage, taken out against the nation's future." The analogy is off because that mortgage has already been taken out.


The latest report by the Social Security Trustees pegs the system's unfunded obligation at $27 trillion, making transition costs pale in comparison. Simply doing nothing and maintaining the status quo will cost three to four times as much as transitioning to a personal-account system that provides retirees will own, control and can pass on to their heirs.


To argue that high transition costs should put the whammy on reform efforts is to argue that a family should not refinance their home mortgage because of points, fees and other transaction costs -- even though the family could save tens of thousands of dollars over the long run due to the lower interest rates won in the deal.


One reason Social Security is such a fiscal mess today is because it is financed on a pay-as-you-go basis without any recognition of the $27 trillion IOU it has promised future retirees.


Congress easily ignores the cost of these promises because it writes the budget the same way -- considering only one year's tax revenues and one year's expenses. Congress does not consider the long-term obligations created by entitlement programs such as Social Security and Medicare that will be paid past an arbitrary five- or 10-year window. This, too, must change for Congress to address the federal government's finances in an honest, responsible way.


And lawmakers don't have the luxury of time to dither over whether or not to act. Whoever is elected president this November will preside over the retirement of the first of the baby boom generation on January 1, 2008. In 2009, Social Security's surplus will stop growing, beginning the fast decline into a sea of red ink.

The longer Congress waits to fix Social Security, the more expensive and painful the fix -- and the transition -- will be.

Alison Acosta Fraser is director of the Roe Institute for Economic Policy Studies at The Heritage Foundation (heritage.org).

About the Author

Alison Acosta Fraser Senior Fellow and Director of Government Finance Programs
Domestic and Economic Policy

Related Issues: Federal Budget

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