Problems with proposed social security reform

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[published in Harrisonburg, Virginia Daily News-Record, January 20, 2005]

I support several of President Bush’s economic proposals: tort reform for medical malpractice suits, and in principle increased free international trade, increased use of market mechanisms for environmental protection, and tax simplification. However, President Bush’s proposal for social security reform is unnecessary and dangerous to the economic health of our country. The system is not broke and does not need to be “fixed.”
The Social Security Administration (SSA) forecasts a rising ratio of retirees to workers over the next several decades, forecasting that around 2018 the system will begin taking in less in taxes than it pays out in benefits, thus cashing in bonds accumulated for decades. These bonds will be cashed by 2042, thus the “bankrupting” the system. President Bush proposes to switch some social security taxes of younger workers into private accounts and to reduce their future guaranteed benefits.
The DNR editorial page recently supported this, citing programs in other countries. However, Chile’s program has serious problems and is not working as advertised, and Britain is moving away from its program due to its inadequacies. Sweden has much higher pensions and a much better fiscal situation to make a transition than does the US. There are many problems with President Bush’s proposal.
First, the SSA forecasts the US economic growth rate to slow soon to 1.8% annually. It is around 4%, and has averaged between 3 and 4% for a long time. A more reasonable projection would be for this to continue, for which the SSA projects that 2018 never arrives. With no changes in promised benefits the SSA will run surpluses forever, no changes needed at all, no crisis, not even a problem.
Second involves the private accounts proposal, with the stock market forecast to rise annually at 7.8% per year forever. However, if economic growth decelerates we should expect stock market growth to slow down much more. We had a mild recession in 2001 and the economy is now growing above its historical rate. However, all stock market indices remain below their March, 2000 peaks, the NASDAQ below half that peak, even though President Bush pushed through tax cuts favoring stock market investment. We hear that the stock market has always increased over periods at least 20 years long. But many people die less than 20 years after they retire, possibly facing negative returns. The Dow-Jones hit 1000 in July, 1966, not reached again until the end of 1982. The Nikkei in Japan remains below half its level of more than 15 years ago. The impending retirement of baby boomers may worsen this as their stock market investment for retirement ran up stocks in the 1990s. As they retire, they will start selling stocks, putting downward pressure on the market (price-earnings ratios remain above historical averages).
Third, even if the official forecast proves correct there will be no “crisis” in 2042. Future recipients would still receive more than 70% of the projected benefits without any other revenues. This sounds bad, but these would exceed the current level of benefits. The 25 year olds that President Bush is appealing to would do better than retirees today, even if the system were “bankrupt.”
Finally there are transition costs. President Bush has promised that those 55 or above would not have their benefits cut. To achieve this while diverting tax revenues into private accounts for younger workers would require borrowing around $2 trillion over the next 30 years. In 75 years the balance would look better, assuming 7.8% stock market growth rate with a 1.8% economic growth rate. But financial markets do not look that far off; 30 years is far off, with few financial securities having even that long a maturity. This implies a $100-200 billion increase in the annual federal budget deficit for years to come.
The most serious potential problem facing the US economy is a possible hard crash of the US dollar. Such an increase in US government borrowing, over 40% of which is coming from China and Japan, could spook the financial markets into a massive run on the dollar, potentially tanking the entire world economy. President Bush’s proposal to resolve a nonexistent crisis could provoke a very real crisis instead.
J. Barkley Rosser, Jr.

Professor of Economics

James Madison University

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