Friday, December 24, 2004
Democrats will soon have to decide! Because right now, to fight the idea of putting private investments in Social Security, they are busy spinning two exactly opposite and contradictory arguments simultaneously. To wit:
#1) Promised benefits are so real, and so secure, that there's no need to do anything at all today to shore up Social Security for younger workers. The Social Security Trustees says there's a $10 trillion funding gap (current value) facing Social Security? Aw, what does that matter? Not only are promised Social Security benefits secure, they are a rock solid sure thing! E.g. ...
Promised benefits as a real and true obligation of the U.S. government can hardly get any more real than that.
"Out of all the possible problems to address in America, Social Security is probably not even in the top ten. It's solvent for at least the next 40 years, and possibly the next 50, even if we do absolutely nothing." [emphasis in original] Kevin Drum.
"... liberals need to drive home the message that 'There Is No Social Security Crisis' ... Social Security is healthy and successful ... The president and the Republicans in congress are trying to scare the American people to destroy the most successful program in American history .... Even if we make no changes and the president's pessimistic assumptions come true, future benefits will be even higher than benefits are today." [my emphasis] Matt Yglesias
But ... this creates a political problem for Democrats. Private accounts would today pre-fund benefits coming due in future decades, just like investments in a private company's pension plan pre-fund its future pension obligations.
However, the Democrats want to argue politically that pre-funding is just a big extra expense that will make the budget situation worse, impair the government's balance sheet and harm its credit standing. (The New York Times leads the way.)
Their problem when making this argument is the A-B-C rules of accounting: pre-funding a real future liability is not an expense. In fact, to the contrary, doing so by borrowing funds to be reinvested at a rate higher than the borrowing cost is routinely done to strengthen one's balance sheet and improve one's credit rating.
When General Motors recently did exactly this -- by borrowing $14 billion through a bond issuance to prefund its pension plan with investments that earn a higher rate than the rate it pays on the bonds -- it was praised, not condemned.
And all the millions of people who have taken out new low-rate home loans in recent years to pay off old higher-rate loans and consumer debt have done effectively the same thing -- taken on a new debt to fund an old, pre-existing debt at a favorable rate differential.
Have they all made themselves poorer by doing so? In the amount of the new debt they've taken on? Of course not. The only way one could claim such a thing is by claiming that their old, pre-existing debt ... wasn't real! They didn't really have to pay it, so funding it in advance was a cost with no benefit.
Sure, if General Motors doesn't have to pay its future pension obligations, then debt taken on today to finance them doesn't do so and is just an extra cost. And if you don't have to pay on your mortgage and credit cards in the future, then pre-funding them today at a favorable rate that you actually will pay is an extra expense that costs you money. Sure!
Which gets us to the second and opposite argument from #1 that the Democrats have just started spinning....
#2) The government has no obligation to pay promised Social Security benefits -- and Social Security's finances are so bad that it is obvious that it won't pay them all. Thus, pre-funding those benefits is a net expense -- a true additional cost we can't afford -- because otherwise the government isn't really going to pay them.
Am I the only blogger to note Krugman's curious recent description of Social Security's promised benefit schedule as: "nothing more than a suggestion to future Congresses"?
Hello?? Reading that I asked myself: is this the first public hint of a new spin coming?
Well, one didn't have to wait long for the full-fledged argument to arrive. A new position paper from the CBPP by Jason Furman, William G. Gale, and Peter R. Orszag, explicitly argues that -- contrary to the accounting rules that apply to General Motors and everyone else -- the government's pre-funding of its future liabilities should be considered a cost, an extra current expense.
Now many, including Nobelist Milton Friedman and Federal Reserve Chairman Alan Greenspan, have pointed out the simple fact that the unfinanced benefit promises of Social Security -- its $10 trillion dollar funding gap -- actually comprise an "implicit debt" of the U.S. government that is every bit as real as its existing "explicit debt" to the extent the government actually intends to pay those benefits.
Thus, the act of recognizing the implicit debt on the books by making it explicit has zero real effect on anything. It is just recognizing reality.
That's a simple enough idea. But Fruman, Gale, and Orszag reject it outright regarding Social Security, saying...
[Some argue that] borrowing to establish individual accounts would merely create "explicit debt" today (in the form of new Treasury bonds) in exchange for "implicit debt" that the federal government has already incurred (in the form of benefit promises to future Social Security beneficiaries that exceed the future revenues that Social Security will receive under current law). They argue that these two types of debt -- "implicit" debt and "explicit" debt -- are essentially the same, and that converting implicit debt to explicit debt thus is not an increase in overall debt and need not be included in the budget.But how are they different?
This argument is seriously flawed, however. The two types of debt are decidedly not the same, and converting implicit debt into explicit debt could worsen the nation's fiscal outlook and would reduce the government's fiscal flexibility...
... "implicit debt" associated with future Social Security benefit promises does not have to be financed in financial markets in coming decades ...One decade, singular. Starting around 2016 benefits will be financed by the financial markets in a big way, as Congress will have to start raising the funds -- through additional taxes or more borrowing -- needed to redeem $5 trillion of bonds in the Social Security trust fund. That's compared to a national debt compiled all throughout US history of $4.4 trillion as of today. And this will be occurring just as Congress will have to raise even much more than that to finance Medicare.
Indeed, this is a major argument for pre-funding Social Security benefits with real economic investments today -- to reduce the need to raise funds for them 20 and more years from now when the nation will be in an unprecedented fiscal vise. As has been noted in more detail previously.
.... and might not have to be financed even after that, because the implicit debt could, and likely would, be reduced through future policy changes... [my emphasis]Yes, it was, by significantly cutting benefits. Taxes were increased too by a closely matching amount, so the funding gap then was closed 50% by cutting benefits and 50% with tax hikes. But the economy was healthy then, and there was ample room to raise taxes.
In 1983, Social Security faced a large implicit debt; benefits would soon exceed the revenues to pay them and would continue to do so indefinitely. Congress and the President acted -- they changed Social Security benefits and taxes and did so without borrowing new money -- and the implicit debt was substantially reduced.
In 2030, as Congress is in the midst of raising $5 trillion of new taxes to pay Social Security benefits and much more than that in additional taxes to finance Medicare at the same time, where will be the room to cut the ever rising implicit debt -- it grows every year -- by raising taxes??
The same is likely to occur with regard to future unfunded Social Security promises..."Likely" to the degree of being a sure thing.
Once explicit debt is incurred, by contrast, and Treasury bonds are issued, the government is stuck with the debt...The point!
Fruman, Gale, and Orszag -- and Krugman -- are making a clear and outright statement that they don't want the government to become "stuck with the debt" of owing promised Social Security benefits! That would increase their real cost, because under the status quo after the cost of financing them hits the financial markets around 2016 it is "likely to occur" that Congress will reduce them.
While if the implicit Social Security debt is made explicit through privatization, Congress will actually be "stuck" with meeting its promises!
So it seems in the coming debate Democrats have a choice of taking one of these two positions as their argument against privately-owned investments in Social Security...
A) "There's no need to shore up Social Security with privatization because payment of future benefits is already a rock solid certain sure thing!"
OK -- but in this case they can't argue that pre-funding those benefits is any kind of "cost." To the contrary, if those benefit obligations are real and will be met, then, as per Friedman and Greenspan, making the implicit debt they represent explicit in the form of government bonds makes no cost difference. And prefunding them with real economic investments, as per General Motors, is beneficial. Even more so for the U.S. than GM, in light of the chance to alleviate the U.S.'s coming fiscal crunch of the 2030s.
B) "Borrowing to pre-fund promised Social Security benefits, making the implicit Social Security debt explicit, will only add to the fiscal debt of the U.S., and so worsen the government's fiscal position during the foreseeable fiscal crisis of a generation from now."
OK -- but then they have to admit they are planning, intending and expecting to not pay a goodly share of the Social Security benefits promised for after 2016. Because the only way that making an implicit promise explicit increases its cost is if you are expecting not to keep it as long as it is merely implicit -- but find yourself stuck with it when it becomes explicit.
So the Democrats have a choice. Which will they choose?
Personally, as a matter of intellectual honesty, I'd certainly choose B. Whenever somebody tells me they are sure that Social Security benefits will come through the great fiscal crunch of the 2020s and 2030s unchanged, because they are fully secured by all that bond debt that the government owes to itself in that trust fund, I'm tempted to offer to sell them a bridge and some magic beans I own.
But I think most Democrats are going to have a hard time buying into B. They've spent generations making election year hay out of accusing Republicans of trying to cut Social Security benefits. Now, with Republicans moving to make Social Security obligations explicit, and to give workers property rights in them, the Democrats are supposed to respond with: "No, that's fiscally irresponsible! You all know that your benefits will have to be cut after 2016. You've all known that all along, of course, right?" I don't see it.
I won't take it seriously until I see Krugman & Co. get Ted Kennedy, Nancy Pelosi, and Harry Reid to stand up on the podium and say it out loud: "You all know we can't afford to increase the cost of your Social Security benefits by making an explicit promise to pay them. Oh, c'mon! Then we'd actually have to..."
Yes ... and I'll want to see Kevin Drum and Matt Yglesias signing on board with this argument too.