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April 04, 2005

Prefunding and Private Accounts

Andrew Samwick quotes Alex Tabarrok:

Vox Baby: Well, At Least He's Engaging: "So if we have an implicit debt of $10.4 trillion, and the real interest rate is 3 percent, then next year, the implicit debt will grow by 0.03*10.4 trillion = $312 billion, up to $10.7 trillion, if the assumptions underlying the projection stay the same. Why does this matter? Primarily, it matters because both the President and Senator Kerry have repeatedly stated (see the two speeches in Pennsylvania linked above) that they will not cut benefits for those at or near retirement age. (The Senator's statement may be even more encompassing, including benefits at any time in the future. I cannot tell for sure from his public statements.) This, in turn, means that each year that elapses without reform causes the burden of financing the unfunded obligations to be shifted away from one more birth cohort that crosses the threshold of being 'at or near retirement.' The more we wait, the larger the burden on future generations, and the higher that 3.5 percentage point surtax would have to climb."

And Andrew then comments himself:

The $10.4 trillion is about 90 percent of current GDP. In a later post, I made a rough calculation that if we waited until 2042 (the projected date of trust fund exhaustion), the implicit debt would grow (at the 3 percent real interest rate), to about $32 trillion, which would be about 141 percent of that year's (much larger GDP). So even if taxable payroll didn't fall as a share of GDP, the surtax applied in perpetuity would have to increase by a factor of 141/90, or from 3.5 to 5.5 percentage points.

The issue that Alex is pointing out is tax smoothing: for efficiency reasons, it is better to have a surtax rate that is steady at 3.5 percent rather than one that is 0 for 38 years and then jumps to 5.5 percent. The issue is, for me, less about tax smoothing and more about the intergenerational fairness of consigning future generations to pay higher payroll tax rates. We shouldn't be doing that--in Social Security, the General Fund, or Medicare.

The argument is that if you have a large lumpy liability waiting for you in the future, it's best to start saving for it now--to smooth out your tax rate.

This argument is correct, or rather would be correct were it not for one thing: the Bush administration. Remember: to the Bush administration the Social Security Trust Fund doesn't exist--"it's just a bunch of IOUs." Raise Social Security taxes now (or twenty years ago), and find a generation hence (or now) politicians like George W. Bush or Bill Frist or Dennis Hastert cutting income taxes and stating that there is no option but to default on the debt the general government owes to the Social Security Administration..

We simply cannot smooth out the taxes to pay for this forthcoming large lumpy liability--at least, not as long as we keep electing Republican politicians.

This is, I think, the principal reason that so many Republican economists are attached to private accounts. They imagine--think--hope--that private accounts will induce fiscal responsibility on the part of Republican High Politicians. When private accounts are implemented $200 billion a year of Social Security revenue will disappear from the government's books, and the enlarged magnitude of the budget deficit will then bring Bush, Frist, and Hastert to their senses. They will propose serious cutbacks in other entitlement spending programs. They will abandon their efforts to get expiring tax cuts extended. They will undergo a sea change, and all will be well.

I'm skeptical. But it is one of the two good arguments for private accounts that I have heard.

Posted by DeLong at April 4, 2005 06:50 PM