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Why the Left Should Favor Social Security Privatization (and the Right Should Oppose It)

By Arnold Kling - December 10, 2004 12:00 AM

"For Social Security is a government program that works, a demonstration that a modest amount of taxing and spending can make people's lives better and more secure. And that's why the right wants to destroy it."
-- Paul Krugman

The debate over Social Security privatization is starting to remind me of my favorite Winnie-the-Pooh story, In Which Piglet Meets a Heffalump. At one point in the story, Pooh and Piglet are discussing the best bait to use in a trap for a Heffalump (author A. A. Milne's deliberate mispronunciation of elephant). Pooh, who likes honey, starts arguing for honey as bait. Meanwhile Piglet, who likes acorns, starts arguing for acorns. Suddenly, each of them realizes that he is arguing against his own interest: if acorns are chosen for the trap, then Piglet will have to supply them; whereas if honey is chosen for the trap, then Pooh will have to supply it. So the argument ends, with Piglet giving in first.

I think something similar would happen if the Left and the Right were to think through the consequences of Social Security privatization. Krugman and others on the Left would suddenly realize that they are in favor of it, and conservatives might decide that they should be against it.

Income Taxes vs. Payroll Taxes

For the Left, the Achilles heel of Social Security is the regressive payroll tax that is used to fund it. Social Security taxes soak up a much larger share of the income of the average worker than of the affluent. Income taxes, on the other hand, have become increasingly progressive. For example, the tax policy center found that in 2000 the percentage of income soaked up by the two taxes was as follows:

Income Class

Payroll Tax

Income Tax

lowest fifth

6.7

-2.4

second fifth

8.7

0.8

third fifth

9.8

5.6

fourth fifth

9.3

7.8

highest fifth

6.7

13.7

top 5 percent

4.1

16.9

top 1 percent

2.1

20.2

As the table shows, the burden of the payroll tax falls as you reach the top of the income distribution, while the burden of the income tax rises sharply for the highest earners. Furthermore, because wealth and age are positively correlated, the recipients of Social Security taxes are, on average, relatively well-to-do. In terms of pure income distribution, Social Security steals from the average-to-poor and gives to the rich. Yet this is Krugman's idea of "a government program that works"!

To be fair, Krugman and other economists on the Left would like to see Social Security paid for in part by "general revenues," meaning income taxes. If that were done, it would serve to reduce the regressivity of Social Security.

The Impact of Privatization

Privatization, as Krugman and everyone else realizes, would create a near-term cash shortfall for Social Security. This is what others refer to as the transition cost, and what I call Social Security's worn-out roof.

As I pointed out, if the government borrows the funds to finance the transition to privatization, the generational burden is the same as the status quo: the burden of paying for Social Security's currently unfunded liability is passed along to future taxpayers.

However, there is one important difference between keeping Social Security as it is and switching to privatization. Under the current system, Social Security's liabilities will continue to be funded by payroll taxes. However, under privatization, the transitional debt would be repaid using -- guess what? General revenues! In other words, privatization is a vehicle for changing Social Security's medium-term funding mechanism from payroll taxes to income taxes. It is exactly what the Left presumably wants, and what the Right presumably opposes.

Bring Back Social Security!

Why are the two sides of the Social Security debate so confused? I think it is because they are basing their views of Social Security on the context of the 1930's when it was enacted rather than on the context as it stands today.

Today, we refer to Social Security as an "entitlement." In the 1930's, however, that was not the case. It was thought of as social insurance. The difference is significant.

In the 1930's, relatively few people lived significantly past the retirement age of 65. In those days, it would have been foolhardy to save enough to last until you were 80. But if everyone contributed to a collective pool, then we could insure that the few who lived long past retirement would not be destitute.

Since the 1930's, longevity has increased by more than a decade. However, the Social Security retirement age has been raised only a few years. As a result, Social Security no longer represents insurance for the unusually long-lived. It is now an "entitlement" for everyone.

Back when it was insurance, Social Security's tax burden was low, and the benefits clearly flowed to people in need. Today, the tax burden is high, and benefits go mostly to people who had the means, if not the incentive, to save to provide for themselves.

I would like to see us bring back the Social Security of the 1930's. Actually, the benefit increases that have been enacted since then strike me as humane. But I would like to bring back the principle of insurance, by raising the retirement age to account for the increase in longevity, and by indexing the retirement age to longevity going forward. Raising the retirement age would increase the portion of retirement funded by personal saving and reduce the portion that needs to be funded by taxes.

Head in a Jar

The climax of the Winnie-the-Pooh story finds Pooh at the bottom of the Heffalump trap with his head stuck inside a honey jar. He is furiously banging his head against the wall of the trap, trying to escape the jar. Somehow, that image seems to fit Paul Krugman in his opposition to Social Security reform.


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