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POLITICAL PLAY | LAURENCE J. KOTLIKOFF

The end of Social Security?

Don't reform it, replace it

After a long campaign season of spin, smear, and slogan, we're finally having a serious debate over domestic policy. President Bush has set the agenda -- Social Security's privatization and tax reform. The president wants to cut Social Security's payroll tax and have workers invest their tax cut in stocks and bonds within private accounts. And he wants to replace the federal income tax with a tax on consumption.

Both proposals drive Democrats nuts. In their view, Social Security and the income tax are the only things keeping the elderly out of the poor house and the rich from gaining all the spoils. But Social Security is broke, and the income tax is a mess. So the Democrats must engage and stop treating these institutions like sacred cows.

In his quest to privatize Social Security, the president is poised to support one of three plans developed by his 2001 Commission to Strengthen Social Security. The plans differ in important ways, but each diverts payroll taxes to private accounts. Obviously, this limits Social Security's ability to meet its benefit obligations.

The trillion-dollar question is, thus, how to finance this tax cut, particularly given Social Security's dire financial position. As things now stand, Social Security doesn't need an immediate and permanent tax cut ranging, depending on the plan, from 16 to 33 percent. Instead, it needs an immediate and permanent 28 percent tax hike to cover its short- and long-term benefit commitments.

One way to make up for the loss in revenue from privatization as well as cover the existing revenue shortfall is dramatically but gradually to cut Social Security benefits. Such cuts are part of each of the commission's plans. The commission's report uses artful language to hide this fact. But the proposed cuts are huge. The second plan, for example, indexes the initial receipt of retirement benefits to prices, rather than wages, as is currently the case. Over time, this means that Social Security benefits would replace an ever smaller share of workers' pre-tax wages. In the long run, Social Security would protect those in abject poverty, but that's it.

Because they cut long-run benefits so deeply, the plans are actually fiscally quite conservative. But in the short run, their adoption would significantly raise the already massive federal deficit. This could drive up interest rates and trigger a recession.

Another concern is transactions costs. On a per person basis, the proposed accounts are small. Indeed, they're so modest as to suggest that the commission's real goal is eliminating not just the existing Social Security system, but compulsory saving in general. Take a household with $50,000 in income. The maximum annual contribution under all three plans would be only 2 percent or $1,000. This is hardly worthwhile when you consider how much Wall Street will charge to "help" workers keep track of and manage this money.   Continued...

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