Sunday, December 05, 2004

Social Security reform: The simple reason why it's better to borrow to close the funding gap now rather than later.

Future US government budget deficits as projected by GAO:

[From Figure 3, (.pdf) * ]


There's been much to-do recently about the pending Social Security reform proposal -- particularly about the "extra debt" that will have to be incurred to fund private accounts while closing Social Security's funding gap.

It's bad to incur additional borrowing, it will hurt the nation's credit standing, argues the NY Times (in an editorial that in all its economic astuteness matches the Times' recent one that claimed the labor force is growing both larger and smaller simultaneously.)

Folks like Max Sawicky and Dean Baker ask why we should borrow now to close the funding gap when we can put off doing so for so many years, until so much later, notes Andrew Samwick, who answers with his own good reasons why we should.

But here's the simplest reason why we should: Due to the unfunded liabilities of Social Security, Medicare, and Medicaid, the US government's deficits are set to explode starting about a decade from now. And borrowing then, as we will have to do if the status quo remains in place, will be one whole lot harder than borrowing now.

The General Accounting Office in 2001 projected the government's future financial position based on then-current law and economic projections. The result was that the annual fiscal deficit would reach 20% of GDP -- the size of the entire federal government today -- around the year 2045. After that GAO ended what was supposed to be a 75-year projection, saying 'government will end', projections beyond there are implausible.

A graph charting these projected deficits is at the top of this post.

So now, considering that graph, here's a simple question for the NY Times, Dean Baker, Max Sawicky, et. al., to answer:

If you are going to have to borrow to finance Social Security, and you are, would you rather do it now or in 2040? The NY Times thinks borrowing at today's deficit level will harm the nation's credit standing -- what does it imagine borrowing at 2035's deficit level will do??

Not that we can expect the US to actually run a fiscal deficit of 20% of GDP 30-odd years from now. That, being impossible, will be avoided -- but the only way it can be avoided is through a fiscal collision such as this nation has never seen before, which is sure to result in tax increases and benefit cutbacks for retirees that everyone will hate, to go along with the largest possible deficits that are sustainable.

Now, even if borrowing today doesn't actually reduce the total necessary borrowing cost at current value needed to sustain Social Security, but only moves borrowing forward in time to when it is easier to do, it provides a substantial fiscal benefit by helping alleviate the fiscal crunch of the future -- and thus also helps preserve retiree benefits.

And, of course, if market investments provide a higher return than government bonds -- and over 30+ years they'd better or we'll have bigger problems to worry about -- then borrowing today can indeed provide a substantial net reduction in total borrowing cost at current value, and larger benefits to Social Security participants too, compared to the status quo, since one dollar borrowed today can avert the need to tax or borrow multiple dollars in the future, as illustrated previously in more detail.

By the way, don't think that we won't have to borrow to finance Social Security during the next 40 years because we have the Social Security trust fund to finance it for us. Every single dollar of Social Security benefits "financed" by the trust fund must in fact be financed by a dollar more either added to the national debt through borrowing or collected through taxes. So as soon as Social Security starts tapping the trust fund, it starts driving up the national debt and driving us towards the future fiscal crisis.

But every dollar borrowed today that is saved and invested in real economic assets so that it enables the government to avoid borrowing or taxing one or more dollars in the future helps alleviate the future fiscal crisis -- and avoid future retiree benefit cutbacks too.

And that's the simple reason why it's better to borrow to close the funding gap now rather than later.

*fn: The GAO report used year 2000, pre-recession, pre-9/11, pre-Bush tax cut, and pre-Medicare drug benefit economic projections that anticipated the government would still be running a surplus today -- instead of the current deficit level marked by the X, which has arrived about 20 years ahead of schedule. This makes everything in this post even more so.