January 25, 2005

I. O. ME:

A Hamiltonian solution to Social Security's bankruptcy (Jack Kemp, January 24, 2005, Townhall)

According the Social Security trustees, by 2042, Social Security's debt obligation to beneficiaries will exceed its claim on the U.S. Treasury. The solution to Social Security's insolvency is not to repudiate the debt incurred when the government misappropriated workers' payroll tax contributions by using them to pay current retirees' benefits rather than allowing workers to invest the money to pre-fund their own retirement. The solution is not to cut Social Security benefits from what is promised to what is "payable." And the solution is not to raise taxes or to increase the retirement age.

The solution is to refinance the federal government's debt obligation to workers and retirees. As a new report from the Institute for Policy Innovation by Lawrence Hunter points out, the most rational way to do that would be to allow workers to save half of the payroll tax contributions in personal retirement accounts through which they could invest in real assets. To the extent that creates a cash-flow shortage, Congress could have workers lend the federal government whatever funds are needed to pay all current Social Security benefits. In exchange for the loan, the federal government would deposit into the taxpayer's personal-retirement-accounts inflation-protected, interest-bearing long-term federal bonds backed by the full faith and credit of the United States with no restrictions on the right of the account holder to resell the bonds in secondary bond markets.

Refinancing the Social Security liability in this way would not cause a short-term shock to the bond market or create upward pressure on interest rates because the government would simply issue new bonds to refinance an old debt obligation as Hamilton did. Nor would this approach threaten financial markets over the long run since the future financial obligation represented by the Social Security liability is already reflected in the current price of federal bonds, and any new forays outside retirement accounts into financial markets would be relatively small compared to the size of the economy.

Since new federal bonds issued to personal retirement accounts would simply refinance an already existing liability, no net increase in federal indebtedness results. There are no "transition costs" involved. Refinancing the Social Security liability through new-issue federal bonds would not entail new debt; in fact, it would make it possible to pay off debt and leave Social Security financially sound in perpetuity. To paraphrase Hamilton, debt incurred to refinance Social Security would be to us a "national blessing" as we create a truly democratic, capitalistic shareholder society.

Especially as we transition to accounts, folks are going to want U.S. bonds.

Posted by Orrin Judd at January 25, 2005 6:11 AM

The sheer obfuscation in the Social Security debate drives me bonkers. It is a pay-as-we-go system, in which current tax receipts are used to pay current recipients. In order to hide this fact, the government solemnly writes itself checks that it promises itself to pay. Then, depending on the context, it can be defended as a pay-as-we-go system or as a funded vested system. The truth is that, in 2018, the government will stop collecting FICA taxes sufficient to cover Social Security payments and will have to find the money somewhere else. The only solutions are to cut other spending, raise taxes or borrow. Guess which of the three definitely won't be used. There is a crisis coming, and it's coming tomorrow.

Posted by: David Cohen at January 25, 2005 9:10 AM

Clearly, this is incomlete. Despite what he says, the old benefit formulas cannot hold up. We must trasition from a defined benefit plan to a defined contribution plan.

Posted by: Robert Schwartz at January 26, 2005 1:43 AM