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John Adams Blog

The blog of The Antient and Honourable John Adams Society, Minnesota's Conservative Debating Society www.johnadamssociety.org

Wednesday, February 09, 2005

Transition Costs

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.

Blogger Sloanasaurus said...

I agree with your argument. But the critics who point out the alrge transition costs are basing their argument on the fact that future workers after 2042 will not receive 100% of the promised benefits. Instead future workers will only receive 73% - 65%. Based on this assumption, there is no contingent debt out there to assume in the computation because the future shortfall will not be made up.

This argument is of course a bunch of crap because no current critic is going to admit that they plan to cut the benefits and not provide these benefits in the future. Thus a critic who argues that there are transition costs must also be arguing that they will cut benefits in the future. In accounting lingo Congress should admit that a reserve needs to be assumed for the shortfall after 2042 and increase the nationaal debt. Then you could charge the current transition costs to that reserve.

I think this is what you mean...correct?

I have an alternative idea on restruction SSI. I will post later.

9:48 AM, February 10, 2005  
Blogger Harsh Pencil said...


I don't think we agree. I mean there are no transition costs period regardless of whether after 2042 we cut benefits or not. How one labels and accounts for future promises and whether one partially breaks future promises (by paying only a portion of benefits) are completely separate things. The supposed transition costs come completely from the fact that Bush's reform moves liabilities from a category that doesn't "count" (Social Security promises) to a category that "counts" (government bonds). This is true whether we assume we are going to pay full benefits after 2042 or only partial benefits after 2042.

Those who are saying there is no crises are right on one dimension. If we simply assume that we are going to cut benefits by whatever level is necessary to make inflows equal outflows when the system runs out of money, then Social Security will never become broke. But at this point one would have to question using the word "Security" in the name of the program.

10:19 AM, February 10, 2005  
Blogger Sloanasaurus said...

It seems that we agree...

If one were to argue that no change is going to be made to the Social Security System and that starting in 2042 retirees will receive 75% of their benefits then the transition costs indeed are an additional expense. Further, I agree that the transaition costs are a misnomer because no one can honestly argue that we will just stary paying people only 75% starting in 2042.

In a sense the "transition cost" argument is a straw man because critics leave out the fact that the same cost if not more will be required to make up for the short fall. Thus, an honest critic of transition costs would have to admit that benefits would be cut but for the transition costs (leaving taxes aside of course).

11:25 AM, February 10, 2005  

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