Social Security Must Be Reformed

As the White House has increased its support for strengthening Social Security, opponents have introduced another reason why reform should not take place: the budget is in deficit.

The surplus has been squandered by last year's tax cuts, they argue, therefore the administration's objective of fixing Social Security must be put on hold. Stated a bit differently, if the president would only raise taxes we could address Social Security's financial problems forthwith. This political logic attempts to put the president into a box of his own making.

Others think that reform should not wait, because the sooner it happens the less expensive it will be. In their recent Annual Report, the Trustees of the Social Security system argued that Social Security "deficits projected for the longer run should be addressed in a timely way to allow for a gradual phasing in of any necessary changes and to provide advance notice so that workers can adjust their plans to take account of those changes. The sooner adjustments are made, the smaller and less abrupt they will have to be."

The argument to postpone reform because of the current budget deficit is entertaining theater in which Washington's thespians of all ideological persuasions can play their assigned roles. But it has very little to do with the substance of Social Security's financial challenges.

The main reason that Social Security is in trouble is demographic: people are living longer and families are having fewer children. The combination of these two realities shrinks the number of workers relative to retirees eligible for Social Security benefits. In 1950 there were 16 workers paying taxes for each retiree. Today there are 3.4 workers and in 2030 there will be only two.

Given Social Security's pay-as-you-go financing, it is axiomatic that promised benefits can be delivered only if taxes are continuously raised. Indeed, as the relative number of workers declined over the last five decades, the maximum payroll tax increased about 1200 percent even after adjusting for inflation. Without reform, the future holds the same.

Tax increases, or benefit cuts for that matter, approach the Social Security financial challenge in strictly cash flow terms. Neither reverses increasing life expectancy or below-replacement birth rates. Both are a financial patch. But as the relative number of workers falls, tax increases ultimately hit a political wall. At some point people sense that their taxes provide them little security relative to what they could have by saving and investing a like amount of their resources in wealth producing assets. We may now be facing the wall.

At this stage politicians look for alternative solutions. Invariably, they move to where their constituents already are. In our case, as has been true in so many other countries, they begin to consider saving and investing in professionally managed diversified portfolios of stocks and bonds. They contemplate promoting substantive reform.

Such reform takes time to complete. In fact, it takes decades. And it may, depending on its design, require resources beyond the payroll tax. But if thoughtfully constructed, the system will be funded and sound at the end of reform. Continuing to pay Social Security's promised benefits solely through ever increasing payroll taxes requires even greater resources, and the system is never stable.

If reform is put off, as opponents suggest it should be, the demographic time clock still ticks. The window of opportunity slowly shuts. The ultimate costs rise.

From this perspective, whether the current budget is currently in surplus or deficit matters little. The cost of not reforming the system will not go away. The White House fully understands this. That is why President Bush is not deterred from arguing his case that we must address Social Security's financial realities irrespective of whether we are fighting terrorism, dealing with an economic downturn or facing a temporary budget deficit. He is absolutely correct.

Opponents of reform actually see the logic of this argument as well. That is why over the past few years they have changed their position and accepted many, although not all, of the reformists' points.

In just seven years the conventional wisdom on how to deal with Social Security's future has changed dramatically. Most students of the issue, proponents and opponents of reform alike, realize that time is working against us. They understand the Trustees' admonition of "the sooner the better." But it will take considerable political leadership to bring all parties to the table to keep Social Security's promises. And as has been the case in other countries, the leadership must come from the top.

George W. Bush campaigned for the presidency on Social Security reform. As he promised he would, he established a commission to report to him on how best to strengthen the system. Now, he has accumulated an extraordinary amount of political capital, and he has the opportunity to aggressively spend it on Social Security reform, one of our country's most challenging domestic financial issues. The budget deficit should not stand in his way.

William G. Shipman is Chairman of Carriage Oaks Partners LLC and co-chair of the Cato Institute Project on Social Security Privatization.