Paying for change

December 16, 2004|By Robert Walker

WASHINGTON - President Bush will soon unveil a plan allowing younger workers to divert some portion of their Social Security payroll taxes into personalized retirement accounts. The unanswered $2 trillion question is, How will we finance the transition costs? Mr. Bush said categorically, "We will not raise payroll taxes to solve this problem."

That's a welcome relief to the great majority of working Americans who pay more in payroll than income taxes. But given that the White House also opposes benefit cuts for retirees and those nearing retirement, how long can the "no new payroll taxes" promise be kept?

Under the president's plan, workers opting for personalized retirement accounts will agree to reduce their future claims on Social Security, thus reducing future outlays. Looking out over the next 75 to 100 years, the drop-off in Social Security claims will more than pay for the short-term revenue loss without raising taxes.

But in the short run, there will be transition costs. With younger workers paying less into Social Security, there will be less money to pay for Social Security benefits. Instead of the Social Security trust fund reserves being exhausted in 2042, as now projected, the trust fund could run out of money sooner. How soon depends on how much money is diverted, but some experts anticipate that partial privatization could drain up to $2 trillion or more from the Social Security trust fund over the next couple of decades.

So how do we offset those losses? There are only three options:

Reducing Social Security benefits.

Raising taxes.

Borrowing money to make up the difference.

Cutting Social Security benefits could set off a firestorm of opposition. Raising taxes could make support for privatization evaporate if it required higher payroll taxes for low- and middle-income wage earners.

The White House has nixed both, which leaves the third option: borrowing. When asked about covering the transition costs by borrowing, White House spokesman Scott McClellan said last week, "That's what you're looking at doing as part of the transition to a better Social Security system."

Borrowing may be the path of least political resistance, particularly if Congress disguises the borrowing by pushing it "off budget." But it is not a long-term answer. Sooner or later, benefit reductions, tax increases or both will be needed to make up the deficit.

Also, the increased level of borrowing needed to finance partial privatization may not be sustainable. With current levels of federal borrowing, the dollar already is rapidly losing value. Further downward pressure on the dollar could force the Federal Reserve to spike interest rates and slow economic growth. If that happens, Congress will have to cut benefits and/or increase taxes in order to reduce borrowing.

When Congress is ultimately forced to pay for the transition costs, it would likely split the baby, spreading the pain between current retirees and today's workers, cutting benefits and raising payroll taxes.

So whether or not they occur on Mr. Bush's watch, payroll tax hikes tomorrow are a likely consequence of borrowing today. Yet even modest increases could make our economic problems worse.

Payroll taxes, a regressive tax on labor, are rising fast. Our reliance on them is already too high. Four years ago, they accounted for just 32 percent of total federal revenues. Today, they account for over 41 percent, almost as much as personal income taxes (42 percent).

Even at today's levels, payroll taxes discourage employers from hiring and people from working. With baby boomers starting to reach retirement age in 2011, the last thing the economy needs is fewer workers (and fewer taxpayers). It's already projected that there will be only 2.1 workers for every Social Security beneficiary by the year 2031.

Further reducing the number of workers will not help. Rather than force another round of payroll tax increases, we should develop alternative financing for Social Security and Medicare. A significant portion of Medicare is already financed by general revenues; we should find alternative revenues to help pay for Social Security.

For example, instead of taxing hiring when we urgently need more jobs, we could substitute taxes on energy and natural resources, which we urgently need to use more efficiently. That would encourage businesses to hire more American workers and use less foreign oil.

That's a more promising solution than relying on borrowing, which sooner or later would trigger payroll tax hikes, shrinking the number of workers and taxpayers needed to sustain Social Security.

Robert Walker is president of the nonpartisan Get America Working.

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