Social Security and Budgets

There have been recent discussions about Bush’s proposed budget (see here or here for instance.)

There seems to be some major freaking out about the transition cost of Bush’s Social Security Plan. But as Arnold Kling points out, the transition cost is not a new government liability. It is simply moving an off-book debt onto the audit books where it belongs:

In fact, the cost of privatization is zero.

Look at it this way. There has been a brouhaha over accounting for stock options in private companies. Companies deny that options are an expense. But as Warren Buffett puts it, "If stock options are not compensation, then what are they? And if compensation is not an expense, then what is it?"

The promises to future Social Security recipients are to the government what stock options are to private companies--off-the-books costs. You could say, "If promised Social Security payments are not obligations of the U.S. government, then what are they? If an obligation of the U.S. government is not debt, then what is it?"

If we decided tomorrow to recognize Social Security promises as obligations, then this would be a huge "cost" in accounting terms, but no change in economic terms. That is what the "cost" of privatization is all about.

This seems correct to me. Take 4 age cohorts: A=0-20, B=21-40, C=41-65, D= 66+. Right now we have a cost of retirement in Social Security for all of them. We pay as we go. Under a privatization plan we pay for D with current accounts just as before. I presume we would phase C into an intermediate system. Part of their Social Security will be paid under the current system, part of it under the new system. The total extra cost over their lifetime is zero because they were going to be paid Social Security anyway. Cohorts A and B are entirely in the new system. Total extra cost is still zero, but unless the economy completely tanks for decades (in which case there was going to be other problems in paying Social Security) they will have a much higher return on their 'investment' into the fund. That means either that they will have more money for retirement, or the government can lower the mandatory contribution amount which functions the same way as a tax.

But none of this is an extra 'cost'.

Now my prefered solution would be to make Social Security a real safety net program instead of a huge citizenship program. If you are of retirement age and are poor, the government provides assistance. The middle class and rich ought to provide for their own retirement. We obviously can't implement that immediately, but we could warn people in their 40s not to expect Social Security unless they are poor. This is something we could easily afford. But in any case it is important to remember that identifying a liability is not at all the same as creating a new cost.

Posted by Sebastian Holsclaw at September 22, 2004 4:25 AM