Social Security Means a Strong Economy

Working in the shadows of the Iraq crisis, the president’s economic team has produced an ambitious agenda to strengthen the American economy. Both proponents and opponents have discussed at length the tax proposals announced by President Bush. However, other proposals deserve attention as well, especially the president’s approach to savings and his continued commitment to reforming the nation’s Social Security system.

Simply put, the administration understands the importance of savings for the future of the U.S. economy. From an economic perspective, savings are critical to economic growth; savings supply the pool of resources necessary to invest in the future. Savings do not disappear from the economy; individuals invest these resources or banks lend them out to expand economic activity. Unfortunately, the savings rate in the United States is among the lowest in the developed world, due perhaps to a tax code that is biased against savings and investment—double taxation of dividends, the capital gains tax, and so forth. The president recognized this shortfall in savings and his proposals to establish lifetime savings accounts and retirement savings accounts are an attempt to eliminate the current tax code’s unfairness toward saving.

These proposals would establish two new vehicles for saving—two new vehicles for ensuring the productive capacity to meet future needs. Between the two, individuals would be able to save up to $15,000 a year in accounts where earnings would not be taxed, nor would withdrawals. The president also plans to extend this approach to reforming the ailing Social Security system. In particular, while ensuring retirees and near retirees do not lose any benefits, President Bush wants to offer younger workers greater choices and more control over their retirements. When President Bush delivered his State of the Union, he noted, “As we continue to work together to keep Social Security sound and reliable, we must offer the younger workers a chance to invest in retirement accounts that they will control and they will own.”

To understand the importance of the proposed reform, it must be remembered that Social Security was originally established as a “pay-as-you go” system, which means that whatever today’s workers pay into Social Security is immediately spent to meet the needs of today’s retirees. Anything remaining goes into a “trust fund” that ultimately finds its way to the U.S. Treasury where it is spent in exchange for an I.O.U. to the trust fund. In other words, the 12.4 percent taken paid by employees and employers goes primarily to current consumption, either by Social Security recipients or the federal government. No resources are available to invest in the capacity to provide for future generations. Even worse, the system has created long-term liabilities that will require either tax increases or benefit reductions when the I.O.U.s come due.

In a strong economy with a growing pool of employees, this system had the resources available to meet the needs of all recipients. However, demographics are stacked against the current system, as an expanding pool of retirees will soon overwhelm the shrinking pool of employees paying into the system. The problem is becoming acute; By the year 2030 there will be 34 million new retirees. While there were at least five workers for every one retiree in 1960, today there are roughly three, and by the middle of this century, there will be only two workers for every retiree. The shift has a significant impact on the viability of the current Social Security program. By the year 2017, the system will be paying out more than it collects in taxes, which means the program will have to begin drawing on general revenues to remain viable; the fund will be exhausted completely in 2041.

Under the current system, the bleak financial outlook can only be resolved in two ways, increased taxes on those still working, or decreased benefits for recipients. In the past, both methods have been used. Taxes have been raised over 20 times since the program has been introduced, and benefits are subject to change with no notice. For example, the retirement age can be changed, benefits can be taxed, and so forth. And the program offers nothing for individuals to pass on to their families—all benefits cease at death. Moreover, the courts have made it quite clear that, unlike an investment, individuals who contributed to social security have no claim over the benefits they receive; the government has full authority to modify benefits at will.

The president proposed a plan that breaks the cycle of dependency on a failing program by offering younger workers a way out. Specifically, the president is calling for a program that allows individuals to invest a percentage of what they pay in social security taxes into a private account that they would own. Not only does this provide individuals with a secure source of income that can be passed on to their heirs, it also has the potential to increase the productive capacity of the economy, which means future generations will have additional resources to expand economic output, which is the only way future generations will be able to meet the needs of their society.

Coupled with sensible economic reforms, social security reform offers the opportunity to increase national savings that will allow the necessary investments to strengthen the economy. As the Congressional Budget Office noted, sound economic policies are critical for meeting the social security needs of future generations: “Tax increases that impede business investment, personal savings, and work effort may impair productivity. Conversely, constraining government expenditures that add to consumption; adopting policies that advance productive technology and investment in human capital; eliminating regulations that inhibit productivity; and adopting tax measures that encourage investment, personal savings, and work effort are the types of policies that are likely to have the greatest chance of spurring growth.” (CBO, p. 4)

Like the president’s economic agenda, the goal of the social security proposal is to strengthen the program’s long-run viability. This year’s budget acknowledges that the system is currently on an unsustainable path and delaying reform only increases the economic costs facing future generations. The bottom line is that the U.S. economy must expand to generate the resources to meet future needs. President Bush has outlined a plan to improve the long run economic forecast. He has also re-affirmed his commitment to Social Security reform that includes personal retirement accounts. As the debate over domestic economic policy moves forward, it will be important to remember that Social Security reform is just as critical to the long run economic health of the nation as the tax cuts that currently dominate discussions of economic policy.