Different River

”You can never step in the same river twice.” –Heraclitus

March 3, 2005

Social Security Privatization

Filed under: — Different River @ 4:34 pm

I’ve been debating whether or not to add my voice to the din about Social Security reform/privatization/crisis-management. On the one hand, lots of “prominent” people (politicians, “journalists,” etc.) are saying a lot of dumb things, showing they don’t get it. On the other hand, lots of economists more famous (and often better qualified) than I are saying the right things. And if no one is listening to them why would I think anyone would listen to me?

In the meantime, here’s an excellent point, made in different ways by Lawrence H. White of the University of Missouri-St. Louis and Ed Prescott of Arizona State and the Minneapolis Fed (and the 2004 Nobel Prize winner in economics):

If done right, there are no “transition costs” to switching to private accounts.

Lawrence White:

I’ve been making the point that letting people opt out of Social Security is “self-financing” if done right. Letting Ms. Smith move $100 of her payroll taxes into her own savings plan is a break-even proposition for the federal government if she also signs away just enough future benefits to retire the debt that the government incurs replacing her $100. (Because Ms. Smith’s payroll taxes are used to pay current retirees, the government needs replacement cash to continue paying current retirees). Namely, Smith signs away her claim to future payment of $100 plus interest, with the real interest rate she “pays” set equal to the Treasury’s real borrowing rate. The transitional debt then requires for no additional taxes or benefit cuts. Opponents of Social Security reform who cite “trillions of dollars of borrowing costs” as a fiscal irreponsibility are being frightened by a phantom: there is no additional cost to taxpayers.

Here’s another way to make the same point, courtesy of 2004 Nobel laureate Ed Prescott. The debt incurred to replace Ms. Smith’s payroll taxes, because it matches the cut in the government’s obligation to pay her future benefits, does not even represent new debt. It merely swaps one debt for another. Instead of owing Ms. Smith $100 plus interest, the government owes a bondholder exactly the same amount.

“There are no transition costs,” Prescott said at the Cato Institute Feb, 9. “Re-labeling debt is not a cost.”

Prescott added that the federal government is being less than honest when it calls the money it has borrowed from current FICA taxpayers to pay retired workers’ benefits an asset rather than a liability.

“Firms are required to list pension fund liabilities,” Prescott stressed. “I think the federal government should as well.”

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