Going off the (third) rails

Mar 4th 2005
From The Economist Global Agenda

Social Security is too expensive, says Alan Greenspan. But reforming it may be too politically costly, fear the Republicans

ALAN GREENSPAN is just a year or so from retiring as chairman of the Federal Reserve, but he shows a striking lack of solidarity with those of his countrymen also reaching the twilight of their careers. In 2008, the first of America's baby-boomer generation will turn 62, the age at which many can start claiming the state pension benefits, known as Social Security, to which they are entitled. But the state, Mr Greenspan fears, has made promises to future retirees that it cannot keep. In his testimony before the House of Representatives budget committee on Wednesday March 2nd, he said that Social Security—not to mention Medicare, which provides state-subsidised health care for the elderly—will probably need “significant structural adjustments”—Greenspan-speak for cuts.

The American government is already living beyond its means, of course. This year, it is running a budget deficit equivalent to 3.5% of GDP. Economic growth should narrow the deficit somewhat, of course. Mr Greenspan described the expansion as “reasonably good”, and jobs figures released on Friday showed firms hiring with new confidence: 262,000 workers were added to the payrolls of non-farm businesses in February, up from the 132,000 added the month before. But despite the robust recovery, the government’s books will not improve substantially in the coming years unless “major deficit-reducing actions are taken”, said the Fed chairman.

Only last month, of course, President George Bush proposed a budget for the coming fiscal year that was supposedly full of big deficit-reducing actions. The budget was indeed tough on “discretionary” spending—expenditures that Congress can adjust each year. But discretionary spending accounts for less than 20% of total federal outlays, and spending is only one side of the government’s balance sheet. Federal tax revenues have fallen from 20.8% of GDP in 2000 to an expected 16.8% in 2005. Almost half of this drop-off in revenues is due to Mr Bush’s tax cuts, which he proposes to make permanent.

Mr Greenspan thinks that America’s budget-setting process is broken. To fix it, he wants Congress to resurrect the so-called “pay-go” rules, which were in force during the 1990s. These strictures forced Congress to offset tax cuts with matching cuts in spending, and to pay for spending hikes with higher taxes. America, says Mr Greenspan, needs a “commonly agreed-upon standard for determining whether the nation was living within its fiscal means.”
America's fiscal means will be stretched to breaking point in the decades ahead by its aging population, the Fed chairman said. At present, every beneficiary of Social Security is supported by 3.25 workers. By 2030, there will be only about two workers to support every beneficiary. As a result, if everything else remains equal, the real burden of supporting retirees will increase by over 60% for each worker.

At the moment, the state is the conduit through which Social Security transfers resources between generations: it levies a payroll tax on the 3.25 workers and sends a benefit cheque to the retiree. This wholesale reliance on the state strikes many conservatives in the United States, not least Mr Bush, as outmoded. The president proposes allowing workers to invest a portion of their payroll taxes in financial assets of their choosing (or chosen from a menu of relatively safe assets determined by the government). When workers retire, they can draw on the accumulated savings in these accounts.

In economic terms, the difference between the current Social Security scheme and a new partially privatised scheme is not that stark. Both a benefit cheque and a financial asset, such as a share certificate, are claims on the output of the working generation. In other words, private accounts merely offer a different way of transferring resources from workers to retirees. They do not in and of themselves increase the resources available.

To claim that private accounts will ease the demographic burden, one must argue that they will raise national saving. Mr Greenspan supports private accounts on precisely these grounds. He thinks the public are more prudent than politicians: they will save more in their private accounts than the Social Security system can. As he points out, when Social Security is in surplus—that is, when the funds flowing into it from payroll taxes exceed the benefits flowing out—politicians cannot resist the temptation to dip into this surplus and spend it. Private accounts, on the other hand, would be off-limits.

Saving might also be encouraged by reform of America's tax code, Mr Greenspan believes. The day after testifying to Congress, he offered his two cents' worth to the president's advisory panel on the subject. The current federal tax burden falls on income from work and investment, largely sparing consumption: America has no federal value-added tax, for example. Many economists believe this imbalance discourages saving. If you spend your wages as soon as you get them, the Feds tax them only once, but if you squirrel them away, you also have to pay tax on the interest income you earn. Americans might be more thrifty, economists argue, if their savings were better sheltered from tax and the fiscal burden fell more heavily on consumption. Mr Greenspan, it is safe to say, sees merit in these theoretical arguments, though he cautioned against embracing them with too much unworldly purism.

An emperor with no clothes?

In theory, a reform of the tax code and an overhaul of Social Security could complement each other. But it would take a brave president to fight on both fronts simultaneously. A month ago, it seemed clear that Social Security would take priority. Mr Bush was on the march, up and down the country, talking of a pensions crisis that must be averted. But his campaign, Napoleonic in ambition, may already be heading into its Russian winter.

In a New York Times/CBS News survey of public opinion, released on Thursday, no fewer than 63% of respondents said they were “uneasy” about Mr Bush’s ability to make the right decisions on Social Security. A small majority, 51%, thought that letting individuals invest some of their payroll taxes in their own private retirement accounts was a “bad idea”. When the other shoe dropped, their disapproval grew: an additional 18% disliked the thought of diverting payroll taxes if it meant cutting guaranteed retirement benefits by up to a third—the essential twin-step of Mr Bush’s approach thus far.

“Panic” might not be too strong a word to describe the Republican reaction to these developments. Some conservatives, who see Social Security reform as the defining struggle of their era, are panicked that the battle may never be joined. Other Republicans who were never keen on reform in the first place are panicked that Mr Bush will push it regardless of the opposition. The backlash, they fear, could hit their party across the board at next year’s mid-term elections. The “third rail” of American politics, as Social Security reform was once known, still has plenty of potential to shock those who touch it.

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