Charles Blahous on the End of Social Security Self-Financing

by Reihan Salam

At Economics 21, Charles Blahous discusses the findings of his new Mercatus Center report on the future of Social Security. Blahous outlines four possible futures for the Social Security program in his post:

1. Continuation. Social Security continues to receive substantial subsidies from the general fund while its historical ethic of self-financing is tacitly abandoned.

2. Recurrence. The current general revenue subsidies are allowed to terminate on schedule, but a precedent is established whereby lawmakers feel few inhibitions about resuming such subsidies whenever they believe other policy considerations warrant doing so.

3. Termination with Lasting Policy Effects. The general revenue subsidies terminate on their current schedule and are not revived, but public perceptions of Social Security’s role are significantly affected by awareness that benefit payments have been subsidized from the general fund.

4. Termination with No Lasting Policy Effects. The general revenue subsidies terminate on their current schedule, public awareness of the subsidies remains limited, and lawmakers henceforth treat the 2011–12 practice as a one-time exception to longstanding policy.

In Blahous’s view, the transformation of Social Security into an explicitly general-fund-financed program would make it far more likely that the program would be periodically altered. He outlines a number of reforms that might become more palatable, or indeed necessary, if Social Security abandons self-financing as one of its central organizing principles.

[T]he recent policy of cutting the Social Security payroll tax and financing the program from the general fund represents a fundamental departure from its longstanding financing basis and a philosophical break with the vision of FDR. The long-term policy implications are not yet clear. To the extent, however, that the current general-fund subsidies are either precedential or undermine perceptions of Social Security as an earned benefit, they could mean an end to political dynamics that historically have rendered Social Security unique, prompting renewed consideration of policy options traditionally applied only to what have been popularly thought of as welfare programs. 

This shift in the perception of Social Security could have salutary consequences, e.g., it might encourage high-earners to increase their retirement savings in light of the expectation that Social Security benefits would be more rigorously means-tested. Yet there are good reasons for those who are invested in FDR’s vision for the program to be concerned.

My own view is that Jed Graham’s Old-Age Risk-Sharing proposal is the best, most balanced model for Social Security reform:

Under Old-Age Risk-Sharing, a career-average earner ($42,000 in 2009) retiring after 2032 would face an upfront benefit cut of 20%, which would gradually unwind over 20 years to keep the safety net intact. However, thanks to enhanced incentives for delayed retirement, that worker could fully overcome this upfront cut and attain an extra measure of income security in very old age by working two years past the official retirement age.

A lower earner would face a 10% upfront cut that could be overcome with one extra year of work, while a high earner would need to work three extra years to overcome a 30% upfront benefit cut.

The surest way of tilting Social Security’s incentives toward delayed retirement (in a way that saves money) is by scaling back the incentives, i.e. benefits, for retiring early. The front-loaded benefit cuts prescribed in Old-Age Risk-Sharing would go further in this regard than the lifelong benefit cuts in the traditional menu of Social Security policy options. And because the cuts are front-loaded, the savings would accrue much faster.

Combining Old-Age Risk-Sharing with an increase in the official retirement age to 68 would save as much as hiking the retirement age to 70 on the same time table (50% of the 75-year cash-flow gap or 70% of the official shortfall that treats the trust fund as money in the bank). But Old-Age Risk-Sharing would yield a much more effective safety net: A worker claiming Social Security at 65 would enjoy a benefit that is 14% greater in very old age than if the retirement age were simply raised to 70. 

The basic principle undergirding reform efforts should be that we shouldn’t just cut benefits — rather, we should cut benefits from the relatively affluent while actually strengthening social protections for “the most precarious social groups,” as Silja Haeusermann has argued.

The Agenda

NRO’s domestic-policy blog, by Reihan Salam.