As any casual observer of politics can tell you, America is engaged in a great debate over the future of Social Security. This debate breaks down into two distinct camps: One says Social Security is unsustainable in its present form and should therefore transform into a program that includes personal investment; another says don't worry, everything is fine, we don't need to do anything. Who is right?
The President's bipartisan Commission to Strengthen Social Security, the leading body in the reform camp, released a report this summer on Social Security's financial problems. In a nutshell the problem is demographics. Today's Social Security benefits are paid for by today's payroll taxes. As the nation's population ages – with people living longer and having fewer kids – the taxes we collect will at some point no longer be enough to cover all the benefits we are promising.
The question is when will it start to matter? Will it be in 2016 – just 15 years from today – when costs will first exceed tax collections (at the current rates) and we have to start redeeming the government bonds held by the Social Security trust fund? Or will it be 2038, when the trust fund runs out of bonds?
It depends on whether you believe the bonds held by the Trust Fund – IOUs from account in the U.S. Treasury to another – should be regarded as "real" or merely a bookkeeping slight-of-hand. Critics of the commission's report say these bonds are every bit as real as the bonds sold to the public – "They are backed by the full faith and credit of the federal government," they exclaim.
Even if you agree with that argument, what exactly does it mean? Simply that the government is legally obligated to redeem the bonds. But that doesn't change the fact that it must still come up with the money to do so. By 2016, when it'll be necessary to start redeeming the bonds, the trust fund will hold IOUs worth over $5 trillion – that's about $3 trillion more than the entire federal budget for this year.
Since the government doesn't save anything or generate any real wealth of its own, that means it must lower its obligations by reducing benefits, or increase its revenues by increasing payroll taxes or increase its future overall obligations (debt) by selling other bonds on the open market at unprecedented levels. Therefore proponents of the "do nothing plan" are really supporters of doing one or a combination of these three things.
That would be troublesome enough if coughing up the $5 trillion were the end of the matter – it's not. Paying the trust fund off only gets us to 2038. As long as the government continues to promise workers benefits upon retirement, the government will continue to need to raise payroll taxes or increase public debt again and again.
Opponents of investing the surplus money through personal retirement accounts claim that to do so would result in benefit cuts. Nonsense. Not reforming the system will lead to benefit cuts, not the other way around. It's true that the government's share or obligation for benefits will be reduced, but to say this means benefits will be cut is to ignore the fact that these personal retirement accounts will hold real money and will become part of an overall Social Security benefit package.
The transition to a privately funded system would be gradual, taking many years. But if we don't act now, when we have time on our side and the Social Security surplus to aid in the transition, our options will be limited and more painful.