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 The perceived reduction in the tax on labor would have been replaced by taxes on the broader economy.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.