Repeat after me: “There are no transition costs to reforming social security. There are no transition costs to reforming social security. …”
Pundits on both sides of the aisle are referring to the huge “transition costs” of going from the system we have now, to one where a portion of your payroll taxes go into private accounts. The argument is as follows: If you let young workers put 1/3 of their Social Security payroll taxes (4% of their salaries below the earnings cap) into private accounts, as Bush will propose, where are we going to get the money to pay current retirees? Won’t we have to borrow it? (Yes.) The sum of all that accumulated borrowing until these young workers retire is what is usually referred to as the transition cost of going from our current system to Bush’s reformed system, and this is a huge number.
But these aren’t real costs at all. If you need to retool a factory to produce minivans instead of golf carts, those are real costs. But SS transition “costs” are just artifacts of bad accounting.
The problem with the way government accounting works is that unlike every company in America with regard to pension promises, Social Security promises don’t “count” as government debt. But suppose they did, as they should. Next, consider two workers, worker A who agrees to have 1/3 of his payroll taxes go into a private account, in return for giving up 1/3 of his benefits, and worker B who opts not to have a private account, and thus keeps all of his benefits.
Every year worker B works, all of his payroll taxes go to pay current retirees, but his promised benefits go up as well, increasing government debt if these promises are counted as they should be. On the other hand, every year worker A works, 2/3 of this payroll taxes go to pay current retirees, but his promised benefits go up only 2/3 as much as the first worker since he has given up 1/3 of his benefits. So properly accounted government debt, so far, only goes up 2/3 as much for worker A. Now add in that we have to borrow 1/3 of worker A's payroll taxes to pay current retirees (since 1/3 of his taxes are going into his account instead of to pay current retirees) and government debt increases by the same amount for both workers. But again, official government debt only goes up for worker A since for some crazy reason we don’t count Social Security promises as debt.
So far this argument only says there is no cost to reform. Is there a benefit? The basic idea is that the option to have this private account is worth something. Thus young workers should be willing to have their benefits cut somewhat in return for the right to have these accounts. Thus there is a chance for a win-win here.
Finally, there is a big macroeconomic gain from private accounts. I don’t consider my 401k deductions to be a tax on my income. While it’s true I don’t get this money in my paycheck, I see my account increase. If my employer where to stop matching contributions, I would consider this a pay cut, even though my take home pay would remain the same. On the other hand, I see my Social Security deductions as simply a tax. The macroeconomic gain then is to turn the 12% Social Security tax into an 8% Social Security tax. This encourages work. Another win-win.
UPDATE: Although it predates it, this post answers Professor Bainbridge's question 2