When Alan Greenspan was in Minneapolis recently, he weighed in on the current debate about Social Security. It was unfortunate, he said, that so many of the reform proposals were nothing more than accounting gimmicks that did nothing to ensure that the nation would be able to grow its economy with a proportionally smaller work force when baby boomers retire.
His remark cut to the heart of the Social Security problems we’re facing. Unfortunately, it rang hollow.
Here’s why: In a previous public-service incarnation, Greenspan was responsible for setting up the shell game that we call Social Security Trust Funds. He headed a select commission on Social Security from 1981 to 1983 at the request of President Ronald Reagan.
Its mandate was to come up with proposals to solidify Social Security funding, taking into account considerations such as the demographic bulge caused by high birth rates from the end of World War II into the early 1960s.
The commission’s response was to recommend higher rates of payroll taxes and conversion of Social Security’s trust funds from a simple checking account–payroll taxes in, survivors’ and retirement checks out–to some sort of pension investment fund. Baby boomers would pay higher FICA rates during their working life, accumulating large balances that could then be drawn down during their retirement.
The problem is that these measures didn’t increase national savings or national investment in new productive machines and infrastructure. So, as Greenspan now tacitly admits, they were largely accounting gimmicks.
The Greenspan commission, Congress and successive administrations all fell victim to an error in logic called the fallacy of composition. That is the mistake of assuming that what is true for an individual must therefore be true for a larger group.
The textbook example is standing up to see better at a basketball game. If one person stands up, she will see better; therefore if everyone stands up everyone will see better, right? Wrong.
With Social Security trust funds, the error is that U.S. government bonds are the safest investment any person can make. Historically there is no risk of default on interest or loss of principal; therefore, they are the safest investment for the nation’s retirement fund. Wrong.
Taking money from one pigeonhole in the U.S. treasury and putting in another pigeonhole does not create any additional wealth or any additional goods and services to meet the needs of baby boomers when they retire. It would only do so if it somehow increased the U.S. savings rate. If the higher FICA taxes reduced households’ current consumption without increasing government spending, that might have occurred.
But the creations of “trust funds” with large balances did the opposite.
It gave successive Congresses and administrations an opportunity to hide the size of true federal deficits by using positive balances in the Social Security accounts to offset large negative balances in general funds.
Moreover, it confused virtually every member of the public about Social Security financing.
Surveys show that people don’t want Social Security funds invested in private stocks or bonds. They want something safe, like government bonds. But they don’t want the government to “spend” that money. That’s an impossibility.
Now the media are rife with reports about how everything in Social Security was just hunky-dory except that Congress or the president “spent the money.” The trust funds were never anything more than a claim on future tax revenues, but most people don’t understand that.
Putting Social Security flows “on budget” did give a truer picture of the federal government’s actual net borrowings in any fiscal year. That is something like the Public Sector Borrowing Requirement tabulated by the British and some other foreign governments. But that feature, of use to economists, is enormously confusing to the general public, the media and, apparently, to many politicians.
One alternative would have been to invest excess Social Security receipts in private-sector stock, bond and real estate markets. But that would have constituted “privatization,” with all its with all its fears for many. And Greenspan was a cautious middle-of-the-roader who understood his mandate was to appear to do something positive without rocking the boat.
The commission also could have recommended a gradual reduction in real benefits, which had been increased by about 40 percent a decade earlier. A benefit reduction was no more politically palatable in 1983 than now, so the Commission recommended higher FICA and a budgetary smoke screen. To be fair, they didn’t know that Congress and three presidents would play fiscal chicken and quintuple the national debt by the end of the century.
But the Greenspan commission “reforms” slapped a Band-Aid over real problems and delayed true reform for another two decades.
Now the chairman decries lack of attention to fundamental problems of low savings and investment and excess attention paid to accounting gimmickry. True, but he would have served his country better by raising those issues more clearly 16 years ago.
© 1999 Edward Lotterman
Chanarambie Consulting, Inc.