TCS Daily


Investing in Alternatives

By Ramesh Ponnuru - January 31, 2005 12:00 AM

Last week, Senator Dianne Feinstein (D., Calif.) said that while she opposed creating personal investment accounts within Social Security, she was interested in creating such accounts outside the program. Carolyn Lochhead of the San Francisco Chronicle, who reported Feinstein's comments, noted that her position "is rapidly emerging as a potential Democratic alternative to President Bush's controversial plan to change the giant retirement program."

"The only thing I would consider -- and it needs to be thought out -- is private accounts in addition to Social Security," Feinstein said. "Because Social Security was never meant to be a full pension. It was meant to help. And I think anything government can do to encourage prudent investment by individuals, say within an indexed, limited fund of companies, maybe with some tax offsets to be able to do it, as an addition to Social Security, would be a good thing."

Rep. Benjamin Cardin (D., Md.), who is influential within his party on retirement issues, had already spoken similarly to Jonathan Weisman of the Washington Post. Wrote Weisman: "Democrats say they would accept personal investment accounts, but they will not accept diverting taxes now destined to Social Security beneficiaries to fund those accounts." He then quoted Cardin: "If the price of admission is the diversion of any money out of Social Security, we're not going to be a part of it."

The references to "diversion" recall the debate over school choice. There is, however, a difference. In the school-choice debate, many Democrats have decided that any governmental expenditure that goes to private or parochial schools is money that could have gone to public schools. Thus any such expenditure is automatically considered a "diversion" from public education.

The Democrats' failure to make this move in the case of retirement accounts would seem to undermine their opposition to accounts within Social Security. One popular Democratic line of attack on personal accounts holds that investment is like gambling. If that's so, then it hardly makes sense for the government to be encouraging it at all.

The Democrats' interest in promoting personal investment also opens up opportunities for conservatives -- opportunities that they might miss if they automatically reject the Democratic idea.

What the Democrats are discussing sounds like a revival of the Clinton-Gore idea of USA accounts. These accounts would be like 401(k)s -- but instead of employers matching workers' contributions, the government would match them with tax credits. Republican politicians and conservative and libertarian think tanks opposed the idea, and it didn't go anywhere.

The think tankers argued that merely setting up these accounts would not do anything directly to shrink Social Security's solvency problems. This is true. Of course, merely setting up accounts within Social Security wouldn't directly shrink its solvency problems either. To make the financing gap shrink, the Social Security accounts would have to be structured the right way: For example, it might be necessary for workers who chose to invest some of their payroll taxes to lose some of their traditional benefits in return. Perhaps you could devise some similar trade-off for non-payroll taxes -- so that you could set up a USA account and get the tax credit in return for giving up some of the traditional Social Security benefit. Or you could enact a bill that created accounts outside Social Security while also cutting future Social Security benefits.

But let's say we were thinking of setting up USA accounts without making any benefit cuts. There would still be a case for it.

Many Republicans support personal accounts within Social Security on the theory that it would tilt American politics rightward by expanding the new investor class. I believe that theory is true. But I also believe that USA accounts could have the same effect. They, too, would lead to an increase in the number of Americans who are building wealth in capital markets. Why wouldn't they, too, therefore pull American politics in a free-market direction? And if they do, then they would, indirectly, help to make Social Security more solvent -- because they would, over the long run, increase the constituency for a benefit-cutting reform.

It could be argued that handing out tax credits would make people dependent on the federal government. Certainly this seems to be the theory of some liberals who favor the idea. But this seems highly unlikely. In the first place, whatever conservatives may think, the recipients of these tax credits are going to experience them as tax cuts. As far as they are concerned, the accounts will simply be their property from the word go. Secondly, once the accounts accumulated enough money, voters' interest in the size of their market returns would be more important than their interest in the size of their tax credits. (If you have $15,000 in an account, you're more interested, that is, in getting a 10 percent return than in getting a $500 credit from Washington.) A continuing property interest would defeat the politics of redistribution.

USA accounts have less potential to expand the new investor class than personal accounts within Social Security have. In the case of USA accounts, you would have to put aside new money to become an investor. Social Security accounts would let you invest money that is already being taken from you -- no new saving would be required. On the other hand, the accounts would probably do more to expand the new investor class than liberalized IRAs would -- those, too, would require new saving, but there would be no tax-credit incentive.

It would be premature for Republicans to talk about any compromise with Democrats on the idea of accounts outside Social Security. But such accounts could make for a fallback position. The details would matter. If Democrats insist on raising the estate tax to offset the budget impact of the accounts, Republicans would probably have to say no. But there are circumstances under which the right answer would be yes. Democrats seem to be oddly insistent on the notion that payroll taxes have to go to the traditional Social Security program but other taxes can fund private investment accounts. Republicans shouldn't match this theology with an opposite one of their own.

The author is senior editor at National Review.

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