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Social Security assessments still poles apart

First in a series of occasional articles examining the economic and political stakes involved in Social Security reform.

In the growing national debate over Social Security, it is sometimes hard to believe the two sides are arguing about the same program.

President Bush has made Social Security reform the centerpiece of his second-term agenda and will unveil details of his plan for private investment accounts within the next month. The president's proposal may clarify the debate, but it won't end the squabbling.

Defenders of the current system and proponents of private accounts disagree over just about everything, from the role government should play in guaranteeing that Americans have at least a modest income after they retire to the risks of allowing people to invest Social Security funds in the stock market.

The split extends to the most basic questions: How serious are Social Security's financial woes? Does the system need an injection of $3.7 trillion? Or $10.4 trillion? Will a crisis develop in 2018, 2042, or never?

Everyone agrees that the aging of the baby boom generation eventually will strain the system's finances. After that, the consensus breaks down.

Those who want to preserve Social Security, a group that includes most Democrats, say that any shortfall can easily be made up with fairly modest tax hikes and benefit cuts and that the day of reckoning is decades away.

"This doesn't strike me as a difficult problem to solve," said Alicia Munnell, director of the Center for Retirement Research at Boston College.

The other side, a group that includes supporters of private accounts and those who want to keep the government from going into deep debt to meet its obligations to future retirees, says Social Security is in big trouble. By 2018, they say, Social Security taxes will fail to cover the cost of paying benefits.

"This is a serious problem that will only get worse," said David John, a research fellow at the conservative Heritage Foundation in Washington.

In a memo leaked to the press last week, Peter Wehner, a policy adviser to President Bush, used even starker language. "The current system is headed for an iceberg," wrote Wehner.

Unlike pension plans, IRAs, and 401(k)s, Social Security is not an individual retirement savings plan. It is essentially a pay-as-you-go program in which the payroll taxes contributed by the current generation of workers and employers are used to pay the benefits of retirees.

In 1983, a set of Social Security reforms, recommended by a commission headed by Alan Greenspan, now the chairman of the Federal Reserve Board, changed the system somewhat. Anticipating the strains the baby boomers -- with fewer workers supporting more retirees -- would place on Social Security, the Greenspan Commission concluded that Social Security had to build a big surplus to help it pay benefits further in the future. Until then, Social Security ran fairly close to break even. The Greenspan solution was to have Social Security collect more in taxes than it needed and save the balance for a rainy day.

Since 1984, Social Security has run a surplus each year and -- at least on paper -- its trust fund has a balance of $1.5 trillion in government bonds. Each year, the trustees of Social Security, a group that includes several Cabinet officers, issue a report on the finances of the system.

Last spring, the trustees concluded that Social Security taxes would be large enough to cover all obligations until 2018 without having to dip into the trust fund. Between 2018 and 2042, however, Social Security would need to draw down its trust fund to keep paying full benefits. In 2042, the trust fund would be exhausted.

Between 2042 and 2078, the trustees said, the cash coming into the system would only be enough to pay retirees about 70 percent of their promised benefits.

That gap -- the difference between 70 percent and 100 percent -- is known as the Social Security shortfall. Last spring, the trustees said an immediate injection of $3.7 trillion would plug the gap.

"Anytime you go out 75 years the dollar figures are going to look huge," said Peter Diamond, an MIT economics professor and co-author of the book "Saving Social Security." Diamond argues that over the long term the $3.7 trillion figure is not as overwhelming as it appears.

At the moment, workers and their employers pay a combined Social Security tax equal to 12.4 percent of wages up to a ceiling of $90,000. If that tax were bumped up by 1.9 percentage points -- roughly a 1 percentage point hike on both workers and employers -- the 75-year gap would be closed, says Diamond. The increase would amount to a tax hike of about $760 a year on a typical worker earning $40,000, with the burden split between worker and employer.

The same shortfall could be made up by an immediate benefit cut of 13 percent, which would translate to a reduction of roughly $1,850 a year in benefits to an average retiree.

Social Security's critics, however, aren't buying the notion that the program can be repaired with such small nips and tucks. Specifically, they dispute the notion that the assets of the trust fund will be available to pay future benefits. For them, the trust fund is more fiction than fact.

They argue that while Social Security has been running a surplus, the extra money has not been saved. Instead, it has been lent to the rest of the federal government to pay for everything from medical care to defense. The federal budget, excluding Social Security, has been running annual deficits for most of the past 20 years. In exchange for the loans it made, the Social Security system received a special class of government bonds from the Treasury, a kind of intra-governmental I.O.U. When the time comes -- presumably after 2018 -- Social Security is supposed to cash in its bonds and use the money to pay benefits.

But where will the Treasury get that money? According to Michael Tanner, a policy analyst who wants to see major changes in the system, the answer is simple: Washington will have to raise taxes or cut other spending.

"The trust fund may have some value for accountants and politicians, but it doesn't have much value in reality," said Tanner, who runs the Social Security project at the Cato Institute, a Washington think tank that has long advocated private accounts.

In 2000, President Clinton's Office of Management and Budget made a similar point. "These [trust fund] balances are available to finance future payment . . . only in a bookkeeping sense," the OMB wrote in a report. "They do not consist of real economic assets that can be drawn down in the future to pay benefits. Instead they are claims on the Treasury, that when redeemed, will have to be financed by raising taxes, borrowing from the public, or reducing benefits or other expenditures."

David John from Heritage estimates that by 2023 the government will have to come up with roughly $100 billion a year in today's dollars to cover annual cash deficits. By 2033, those annual deficits will reach $300 billion.

"The question is: What sacrifices will our kids and grandkids have to make to pay back the money in the trust fund?" said John.

Social Security's defenders counter that when the time comes the government will make good on its commitments, even if that means raising taxes, cutting benefits, or both.

Still, some economists believe any of the Social Security reforms currently being discussed are only postponing the day of reckoning. Laurence Kotlikoff is in that camp. Kotlikoff, an economics professor at Boston University and the author of a book called "The Coming Generational Storm," says that even if Congress tomorrow approved a 75-year fix of Social Security, the solution wouldn't last long. Within a few years, deficits would be forecast and Americans would be back worrying about passing on financial burdens.

Kotlikoff says the system could be fixed permanently for roughly $10.4 trillion, which could be done with an immediate hike in the payroll tax of 3.5 percentage points or a $1,400 tax hike for that typical worker earning $40,000. But many specialists, regardless of where they stand on private accounts, say that projections into the distant future amount to little more than guesses, and that relying on them to evaluate Social Security makes no sense.

No matter how it is cast, the coming debate promises to be polarized. Bush and the Republicans want to build an "ownership society" based on the principle that individuals, not the government, should bear the risks and rewards of retirement savings. The Democrats see Social Security as the bedrock program of the New Deal, which established the idea that the government has a vital role to play in guaranteeing economic security for the elderly.

About the only thing the two sides agree on is this: The longer politicians wait to come up with a Social Security fix, the more expensive and painful that solution will need to be.

Charles Stein can be reached at stein@globe.com.

Social Security Series
 JAN. 14: Poles apart
 JAN. 30: Bush: 'Unfair'
 FEB. 2: Stocks carry risk
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