GWB's Plan For Social Security Woulnd't Have Worked

Given that it has been 15 years since George W Bush proposed to save Social Security, someone will reflect on what might have been even though none of his ideas on reform created any traction in Congress. But what if they had?

 
High school reunions have taught me one thing: The older we get the faster we were. Someone is going to tell you that it was an opportunity missed, and every year the genius lost will get bigger.

The president laid out his framework for broad based reforms for Social Security in the State Of The Union in 2005. That proposal would:

• Allow workers to invest a small portion of their Social Security taxes in individual accounts.
• Reduce the benefit formulas to factor in Social Security to reflect earnings from individual accounts
• Create a guarantee for those people born before 1950 for the benefits promised by the system
• Provide direct subsidies from the general fund to the system to fulfill the promises made by the system.

The obvious question that someone should have asked was: Mr. President, would it not be easier to leave payroll taxes alone, and simply create additional benefit models within Social Security that track stock portfolios funded with funds borrowed in the public markets?

You get the same economic outcome with half of the paperwork. The only real difference is that the president's plan sounds like he is fixing Social Security whereas my plan sounds like we are opening a hedge fund.

Bush’s plan would have changed how we pay for Social Security. The perceived reduction in the tax on labor would have been replaced by taxes on the broader economy. Payroll taxes would remain at 12.4 percent, and over time additional taxes would have been required to pay for subsidies from the general revenue to replace revenue diverted to private accounts.

This structure changes who pays the taxes rather than the amount. In 2005, the projected cost to make Social Security solvent was an increase in payroll taxes of 1.89 percent. By waiting to back fill the tax base with subsidies from the general fund, the nation would face an effective equivalent of a 20 percent payroll tax in 2030. Essentially, Bush’s grand idea was that our children will pay the taxes that we would not.

From an economic prospective, personal accounts do not create any incremental wealth. Any increase in investment capital created by personal accounts would be offset dollar for dollar by increased government borrowing from the public markets. The only wealth created within a privatized Social Security program would depend upon the success of the "central administrator" as an investor.

These investment returns are the lynchpin to the entire plan because Social Security uses the earnings of the personal account as an offset for benefits of the retiree. Supporters in general expected the central administrator to be a very good investor earning 7 percent real returns, well above the rates earned by the government securities held by the Social Security Trust Fund.

Is 7 percent real a reasonable expectation? No. That expectation is well above the historic average of the 45-year rolling real return of the S&P 500, which has varied between 4.5 percent and 8 percent over the last 80 years. There are going to be working careers in which workers are lucky to get 5 percent.

Unfortunately, these historic averages generally overstate the potential of system wide earnings because the individual captures the winnings, and Social Security absorbs the losses. The people who win, pass their winnings onto their kin. The people who lose are picked-up by Social Security. Losers are the average investors who outlive their personal account.

Proponents of personal accounts also ignore the fact that wages and market are run together. This relationship means that worker’s highest earnings statistically buy the market peaks, while missing the buying opportunity at the market at the bottom. In 2009 when the market bottomed, the U-6 measure of employment registered more than 17 percent. U-6 did not break the 16 percent level until the market had doubled in value. Wages are weakest when workers should be buying the most.

To offset the uncertainty of the markets and the transition to a modern program, Bush wanted to create a guarantee of benefits for people born before 1950. Social Security benefits - even today - are not guaranteed. Because of the shift to general revenue subsidies, the cost of this guarantee would be absorbed almost entirely by future taxpayers who couldn’t vote in 2005.

Bush professed his worry that doing nothing would mean that our children and grandchildren would have to borrow $13.9 trillion. Ironically enough, his proposal introduces the guarantee for Social Security benefits that would ensure future generations would have to borrow the $13.9 trillion.

The Bush reform would not fix Social Security. It switched which pockets would pay for the program, resulting in an even larger system. It expanded the revenue reach of the system, and created guarantees for current voters that came directly at the expense of future voters. The entire plan was nothing more than an elaborate way to kick the can from generation to generation.

What would our children have gotten for the $13.9 trillion bail-out? They would get the privilege to save for their own retirement.

Social Security : From Thomas Jefferson to Francis Underwood

While many have tried, few writers have proven in writing as effective as Thomas Jefferson at criticizing Social Security. 

In a 1798 letter, Jefferson, who died more than a century before Social Security reached the public’s conscience, laid out one of the most compelling arguments ever written against the program as it exists today. It was wasn't a rant about the size of government or a philosophical look at fairness and the rights of man. He said that "intergenerational contacts" were not valid, and likely would not be honored.

Specifically, he wrote a letter to Madison that dealt with the consequences of enabling one generation to lay debts upon another. In sum, he predicted that eventually a generation would, “eat up the usufruct [the right to enjoy the use and advantages of another's property short of the destruction of its substance] of the lands for several generations to come.”

That sounds a lot like Social Security, which has a shortfall of more than $40 trillion. That figure means that the program’s remedy would require nearly double the nation's GDP or “the usufruct of the lands.” At this point, our politicians are struggling to explain this breathtaking financial gap and to propose a way to fill it. 

How did we get here? 

We nominally cling to the notion that the money was misused or that unforeseen demographic shifts have somehow complicated the best laid politics of mice and men. In other words, hidden hobgoblins menaced the system far beyond the control of our current politicians, whose main complaint is there is no way to push these costs out to even further generations.

Jefferson said nothing about demographics or financial malfeasance. He said that the public council–Congress–would place the self-interest of re-election over the long-term interests of the general public. In just this fashion, Congress ‘expanded’ Social Security for decades without any consideration for how to pay for it, because voters love benefits, but hate the costs. In other words, Congress was giving dollars to voters for dimes, while leaving the balance left to a future generations through the Social Security system.

The Path to Crisis

The Social Security system sold dollars for dimes for decades, and we wonder how such a concept could possibly fail. Over decades, Congress larded benefits upon an ever-widening number of voters in an ever-increasing balance of checks.  They added benefits for spouses, children, ex-spouses, COLAs, and survivors without providing an incremental source of revenue to pay for the bills. Mind you, Congress now wants to give away more based on the idea that future generations will contribute more to Social Security.

The pathway for the approaching crisis was created in 1983 with short-sighted legislation, which was made necessary by an imminent crisis created by even earlier lapses in legislative judgement. For 80 years, Congress has created deals in which their children will pay the taxes that voters won’t and accept the benefit cuts that no one would even discuss. As a result, it is not possible to kick the can down the road anymore.

The crisis coming in Social Security will manifest Jefferson’s “lands holden in tail.” In 1983, law makers protected those who were 45 and older from the consequence of the dollars for dimes math of the system. By 2005, we nominally talked about protecting those 55 and older. Now someone turning 72 this year expects to out live full benefits defined in current law.

Jefferson’s letter serves as a somber presage for politicians promising to keep Social Security’s promises to seniors. He reasoned that “the earth belongs in usufruct to the living; that the dead have neither powers nor rights over it.” In other words, today’s workers cannot be bound by the promises of a past Congress, much less the promises of past promises.

Clearly, we are not there yet, but Jefferson’s reasoning implies that one day a politician will emerge who will serve the new generation. At some point, younger Americans will elect a Francis Underwood, who in turn will tell seniors, “We owe you nothing.”

And Thomas Jefferson would not only agree, but say, I told you so.