Last week I debated New York Times columnist Paul Krugman at the National Press Club on the future of Social Security. This was about as much fun as trying to eat corn on the cob with braces.
Krugman is the leader of the opposition to personal investment accounts. He argues, and most liberals agree with him, that the Social Security system is not facing a financial crisis and that minor tweaks to the system will pull it out of the red for at least the next 50 years. A recent USA Today poll seems to suggest that the public agrees with Krugman on this point. A minority of voters believe there is a “crisis.” But it’s also true that more than two-thirds of respondents agree the system is in bad shape financially and needs to be shored up. The public is not nearly as delusional on this point as Krugman and his congressional disciples are.
Krugman tries to turn the tables on those like President Bush who support personal investment options by maintaining that this option is what would cause a real financial crisis. He points to a huge amount of borrowing necessary to fund these accounts.
Krugman is referring to the so-called “transition costs” of Social Security reform. A transition cost is the price you have to pay to get from point A to point B. Establishing personal accounts will require about $2 trillion in government borrowing over the next 15 years. But once the accounts are in place, the government saves about $10 trillion in future obligations. Any private business with large pension obligations would sign on to such a refinancing plan in a heartbeat. The debt restructuring would substantially improve the firm’s balance sheet and its stock price would rise — reflecting improved long-term finances even though its current cash flow would be reduced.
Why doesn’t Congress make this rational financial decision? Part of the answer is that government isn’t run like a business. In fact, Uncle Sam doesn’t use a balance sheet at all. When the feds promise to pay in the future (as with impending Social Security and Medicare obligations to baby boomers) those payments might as well be invisible to policymakers — they never show up in the accounting books. Another problem is that massive unfunded liabilities don’t have to be dealt with for at least a decade, and most members of Congress are incapable of thinking more than one week ahead.
Fortunately, Dr. John Templeton, the Pennsylvania-based philanthropist and public-policy entrepreneur, has devised a disarmingly simple way to blow through this government accounting smoke screen. The “Templeton Curve,” shown below, depicts two financial futures for Social Security. The first is the “do nothing” scenario in which we pretend the program is in fine shape and that only minor tinkering will be required when baby boomers retire. Politicians who buy into this fairy tale also tend to believe that Social Security tax receipts are all safely stashed away in Al Gore’s giant, mythical “lock box.” As we can see from the chart, if we choose the “do nothing” option, the program runs surpluses for another dozen years, hits the fiscal quicksand in 2018, and sinks deeper into debt in every succeeding year.
The second option, on the polar opposite side of the debate, would be to create large personal investment accounts now, borrow to pay for them, and let future workers draw their retirement incomes from these accounts rather than from conventional Social Security. Because of the higher rates of return in the private equity markets, workers would be substantially better off financially under this option. But the Templeton Curve shows why the government also comes out way ahead. Yes, it’s true that the personal investment account option, as proposed in Congress by Sen. John Sununu and Rep. Paul Ryan, requires lots of borrowing in the near term. But those debts then turn to surpluses, which get larger in every succeeding year. Starting in 2015, the returns from personal retirement accounts begin to cancel out benefit requirements for Social Security. By 2040 nearly 40 percent of future obligations would be wiped clean. By 2050 two-thirds of the government’s liabilities would be erased.
As such, the two paths produce diametrically opposite financial futures: The do-nothing approach yields deficits forever and the private investment option produces surpluses forever. Hmmm, this seems like a tough choice.
The Templeton Curve teaches us that the short-term costs of Social Security reform are trivial relative to the long-term gains. The sooner we adopt the personal investment option, the better off our children’s, and their children’s, and their children’s children’s financial futures will be. Perhaps the personal account option should be called the “children’s defense fund.”
–Stephen Moore is president of the Free Enterprise Fund and a senior fellow at the Cato Institute.