Social Security Reform: Mechanisms for Achieving True Pre-Funding

Thu, 17 Apr 2008 17:33:43 +0000

Yesterday, the Treasury released its fourth in a series of issue briefs on reforming Social Security. As the title indicates, this one was focused on making sure that Social Security surpluses are used to increase the ability of future generations of taxpayers to support the benefits claimed by future retirees. It uses the LMS plan as an illustration and emphasizes the constructive role that personal accounts can play in safeguarding Social Security funds for Social Security benefits.

Here's an excerpt of the discussion about pre-funding future benefits, with my emphasis added:

Pre-funding is an effective financing strategy provided that the near-term surplus revenues are safeguarded in a way that allows them to be used to pay for future benefits. The present Social Security system has its surpluses accumulate in the trust fund. These surpluses will increase the government’s capacity to pay benefi ts in the future only to the extent that they result in smaller amounts of public debt issuance than would occur if there were no surpluses. This is because reducing near-term public debt issuance would increase the government’s capacity to issue debt in the future to help pay benefits when the bonds in the trust fund are redeemed.

Many analysts believe that Social Security surpluses under the present system do not increase the government’s capacity to pay future Social Security benefits. Under this view, Social Security surpluses are offset in the rest of the federal budget by some combination of higher non-Social Security spending and/or lower non-Social Security taxes. To the extent that this is true, Social Security’s surpluses do not increase the government’s capacity to pay future Social Security benefits. The future benefit payments that would have been financed with public debt issuance had Social Security surpluses truly been saved must instead be financed with lower non-Social Security spending and/or higher non-Social Security taxes. In this case, the existence of the near-term Social Security surplus causes the non-Social Security budget to be more profligate, and the future Social Security cash deficit will require future non-Social Security budgets to have either higher taxes or lower spending than would have been the case had today’s surpluses resulted in true pre-funding. Under this scenario, an attempt to make Social Security fair to future generations by accumulating near-term surpluses in the trust fund would be undone by a non-Social Security policy that is less fair to future generations. Rather than resulting in resources that provide future benefits, running a Social Security surplus today would instead lead to more debt outside the trust fund that must be paid off by future generations, leaving them with no net gain.

The part I've highlighted is the reason why I favor an explicit target for the on-budget deficit. Read the whole thing.