Personal Accounts Are No Cure-All
How conservatives should think about Social Security reform.


I don’t usually spend much time disagreeing with people I mostly agree with, but a column in National Review by the Cato Institute’s Michael Tanner — my old boss and an all-around great guy — presents a chance to talk about why Social Security reform has proved to be such a difficult task for those who believe in free markets and individual choice.

Here’s where I agree with Mike: “Given their large lead in current polls, it is perhaps understandable that Republicans don’t want to risk offending voters, particularly seniors, by wading back into the Social Security thicket. But they are making a mistake.” He’s right: If you run on nothing, you’ll receive a mandate to do just that. Voters need to hear a realistic discussion of how to fix Social Security and other entitlement programs.

But Mike also argues that conservatives shouldn’t give up on Social Security personal accounts: “By taking personal accounts off the table, Republicans may be boxing themselves into a very bad corner. There are, after all, only three options for Social Security reform: raise taxes, cut benefits, or switch to personal accounts.” These choices mimic those laid out by President Clinton in 1998, although at the time Clinton was arguing for investing in stocks through the Social Security trust fund, not personal accounts.

Here’s the problem: Personal accounts are a valid choice, and one I’ve supported in the past and continue to support. But accounts aren’t exclusive to tax increases or benefit cuts; they don’t, as I’ll explain, reduce the need for these other choices. One problem for the Bush administration’s reform drive in 2005 was that many congressional Republicans had bought into the idea that accounts reduce or eliminate the need for tax increases or benefit cuts. Finding out they don’t may have taken some wind out of their sails. Because of this, combined with some pretty shameless demagoguery from the left, Bush’s reform ideas didn’t even come up for a vote.

President Bush’s 2001 Commission to Strengthen Social Security (on which I was a staffer) wrote that once the program began to run payroll-tax deficits — something that happened this year — policymakers would face difficult choices to raise taxes, cut benefits, reduce other programs, or increase the budget deficit. All these claims are true.

Also true, however, is a statement the supercilious younger me made to one of my fellow staffers: With personal accounts, we face the same choices, only sooner. If workers invest part of their Social Security taxes in personal accounts, they could indeed earn higher returns and generate higher benefits without taking more risk. But diverting taxes to accounts leaves the program short of what is needed to pay benefits to today’s retirees. To cover these “transition costs,” we would need to generate new revenues for the program, either by raising taxes, cutting other programs, or borrowing.

But once transition costs are accounted for, the total rate of return on a personal-accounts-based program would be about the same as the current system. (If you’re willing to wade through some math, this paper by Olivia Mitchell, Stephen Zeldes, and John Geanakoplos is pretty much the canonical treatment.) Social Security’s overall rate of return stinks because (a) we paid early generations far more in benefits than they paid in taxes, meaning that later generations must make up the difference; and (b) we didn’t save the trust fund, meaning taxpayers must “repay” something that was supposed to have been an asset. These acts can’t be undone: We’re stuck with them.

Also unchanged would be the program’s financing shortfall, even assuming that account holders gave up a share of their traditional benefits. A pay-as-you-go program like Social Security is always in the hole, such that each generation honors the benefits of the preceding one while hoping their own claims will be honored by the following generation. No generation can break away from this cycle without either ponying up extra cash (tax increases) or defaulting on its promises (benefit cuts). Neither solution is costless.

Now, we could come out ahead if transition costs were funded by cutting other government spending, which at the margin certainly produces benefits below its costs. But we could reap those gains by cutting government spending in the absence of Social Security reform; in any case, few reform proposals have presented a credible way to ensure that non–Social Security outlays are reduced. The most likely path is simply increased debt.