Transition Costs

TRANSITION COSTS….Very roughly, Social Security is a “pay as you go” program. That is, workers pay payroll taxes, and those tax dollars are immediately transferred to retirees. If taxes are reduced, there’s not enough money to pay current retirees.

This is the “transition cost” problem. If a portion of payroll taxes is diverted to private accounts, as President Bush is proposing, there’s less money available to pay current retirees. This shortfall will remain a problem until private accounts are fully funded, a transition period of (probably) around 30 years or so.

Brad DeLong notes today that it seems likely this transition cost will be funded not by raising taxes in some way, but simply by increasing the deficit. But how will Bush get away with this, given the very considerable federal deficit (and related trade deficit) problems we already have, problems that are getting increasing attention even from prominent conservatives?

I’m not sure, but I want to throw out a wild guess. As some people know and lots of people don’t, Social Security is only roughly pay as you go. In fact, right now payroll taxes exceed payouts to retirees by about $150 billion per year. This extra money is used to buy treasury bonds, which are piled up in a trust fund designed to be used in the future when taxes no longer exceed payouts.

Now, George Bush is known for liking “big” ideas. So here’s a big idea: let’s stop filling up the trust fund. This gives us $150 billion a year to fund the transition without raising taxes and without affecting benefits for current retirees.

What’s the downside? First, it means the trust fund will run out of money sooner. Right now it’s good until 2042, but if we stop filling it up it’s probably only solvent until 2030 or so. For Bush, though, that’s a minor roadblock. He’ll just claim that by then private accounts will be so bulging with cash that we won’t need the trust fund anymore.

Second, it means the federal deficit will go up. Right now, that $150 billion stays inside the government, turning a $600 billion deficit into a $450 billion deficit. But if that money is used to fund private accounts, our $600 billion deficit will genuinely become a $600 billion deficit.

But I’m not sure Bush will care about that either. My guess is that he’ll argue that he isn’t really increasing the deficit at all. He’s just getting rid of some fuzzy accounting and ensuring that Social Security money is really being used for Social Security, not for funding other parts of government. Hell, he might even start quoting Al Gore about putting payroll taxes in a lockbox.

Needless to say, this is all speculation. But I hope somebody is thinking about how to fight this just in case it turns out to be his plan. Remember, George Bush has a penchant for making proposals that are more dramatic than anyone thought he’d dare, and this would certainly qualify. It’s at least worth thinking about.