Social Security’s Privatization
The U.S. Social Security System faces a grave long-term financial crisis the full dimension of which is not well known. Paying out benefits on an ongoing basis requires an immediate and permanent increase of roughly 50 percent in the OASDI payroll tax rate. The President and Congress are now embarked in a national debate about how to save Social Security. They are considering options that include cutting benefits, raising the payroll tax, and privatizing all or part of the system by allowing people to contribute to individual accounts. A key set of issues in this debate is how any policy, including maintaining the status quo, will affect the macro economy as well as rich and poor members of current and future generations read only.
The key finding of my joint research with Smetters and Walliser is that privatizing Social Security can produce a significant long-run improvement in the economy’s capital stock and level of per capita output, but that the transitions to such an improved economy are quite long and that how one finances the transition will determine the duration of the transition as well as the economy’s final resting place. Consumption-tax financed privatizations of Social Security produce the fastest transitions and are most efficient.
In addition to eliminating a distortionary payroll tax, a consumption tax entails an implicit one-time wealth tax (in taxing retirees when they spend their wealth on consumption) which is non distortionary. In forcing the elderly to contribute toward paying off the liabilities of the old system, the consumption tax also redistributes from older spenders to younger savers. This promotes national saving. In contrast to consumption-tax finance, income tax finance entails highly distortionary tax rates in the short run that dramatically slows down the transition.
Another of our findings is that using deficit finance to limit the imposition of higher marginal income tax rates as one is paying off Social Security’s accrued liabilities makes the economy’s short run look better and its long run look worse. Indeed, sufficient reliance on deficit finance will leave the economy in a worse position in the long run than the one at which it started. We’ve also learned that Social Security’s privatization is remarkably progressive with respect to its impact on the lifetime rich and poor alive in the long run. The lifetime poor enjoy a larger improvement in their well being than do the lifetime rich because a larger fraction of their labor earnings would otherwise be subject to payroll taxation.