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Want to Fix the Economy? Start With Social Security.

This article is a contribution to 'Is There Anything That Can Be Done? A TNR Symposium On The Economy'. Click here to read other contributions to the series.

With millions of Americans out of work, a mounting federal debt, and the national economy at risk of a renewed recession, no one seems to be thinking about the Social Security system at the moment. But they should be. Fixing Social Security—that is to say, restoring the program’s actuarial balance—would serve our economic needs in a number of ways. It would help with our long-term fiscal problems without damaging our short-run outcomes; moreover, it would be a lasting commitment, not a seeming fix that might be undone. Most importantly, it’s something that our existing political system might actually accomplish.

In contrast to fixing Social Security, addressing now the budgetary elephant in the room, healthcare costs, has little to recommend it. We don't sufficiently understand how to make health care work better. We do understand how to shift costs from the federal government, but that does not address the root of the problem. We have a healthcare cost problem not only for the federal budget, but also for state and local budgets, for businesses and for individuals. In short, we have a system that doesn't work well. While there are some changes we should make now, learning how to fix it thoroughly is going to take experimentation, evaluation, and repeated corrections. Not to mention the fact that we have a history of some of the cost-lowering legislation in the health care sector getting canceled later. Tax reform has a similar history of some backtracking; a number of the important 1986 tax reforms have already been rolled back.

Social Security, by contrast, is both easy to understand, and already has a history of significant, positive, lasting reforms. The program’s design is simple: it’s essentially money in and money out. Everybody who looks at it understands how it works. We also can estimate, with fairly good accuracy, what sort of behavioral changes—and cost savings—would be produced by changes in the program’s parameters.

Moreover, restoring Social Security’s actuarial balance makes eminent macroeconomic sense. It would have a significant effect on the debt held by the public in the long run, without harming the economy in the short run.For example, the reform that Peter Orszag and I proposed in our book Saving Social Security would have reduced debt held by the public by 25 percent of GDP within 45 years of its enactment.  

It’s encouraging, as well, that there’s a pretty good track record for Social Security reform. The last major reform of Social Security came in 1983, and it looks likely to have given us 50 years of ability to pay scheduled benefits. None of its major provisions have been rolled-back, not even the controversial increase in the age for full benefits from 65 to 67. In fact, Social Security has a long history of addressing future concerns with sustainable policies: Future payroll tax rate increases were incorporated into the program from the very beginning. While these increases were sometimes delayed and sometimes accelerated, they were never canceled. Even now there’s largely a consensus on how to approach fixing Social Security: Everyone agrees that we should phase changes in slowly, thereby having no negative short-run effects. In short, if we fix Social Security, we are very unlikely to undo it.

And with the system’s trust fund reserves projected to run out in 2036, pretty much everyone agrees that we do have a Social Security problem, and would have one even if we didn't have a debt or overall deficit problem. Starting in 2036, the payroll tax revenue will continue to flow in but will be enough to pay only three-quarters of scheduled benefits. With no legislated change, benefits would need to be cut by a quarter.

In some ways the current political climate makes this an especially good time to try fixing Social Security. Fixing Social Security involves some combination of raising taxes and lowering benefits, both of which are very hard to legislate until the public feels it’s facing an imminent crisis. Heightened concerns among many Americans about the long-run debt held by the public should help cultivate acceptance for changes in Social Security.

One issue that has held up reform is the dispute between Republicans and Democrats over whether to use existing payroll tax revenues for individual savings accounts. I suspect that idea is no longer much in play—not least because diverting payroll tax revenues from Social Security’s existing trust fund to individual accounts with diversified portfolios would add to public debt. The reason for that is simple: Instead of the trust fund using payroll tax revenues for the purchase of government debt, some revenue would instead go to individual purchases of stocks and corporate bonds, resulting in more debt that gets sold to the public and so more risk of a negative bond market reaction and a greater cost if one does happen. For example, the proposal from the Bush administration would have added 19 percent to the debt to GDP ratio by 2050. And some proposals would have had massive increases—the proposal by Congressman Paul Ryan and then-Senator John Sununu would have added more than 90 percent to the debt to GDP ratio by 2050.

The hard issue is what mix to have between additional revenues and decreased benefits. To get the 1983 Social Security reform, President Reagan and Speaker of the House Tip O'Neill agreed that the mix would be 50/50, and they set up a committee to work out the details. Congress stayed fairly close to that balance, if not exactly on it. Finding an acceptable mix remains a serious problem and policymakers will need to find a mechanism for addressing it.

The base-closing commissions remain a prime example of Congress partially tying its own hands in order to get an improved result, an example that lot of analysts now want to use. Following that example, a Social Security commission’s report (with a sufficient majority) would receive special congressional rules requiring an up-or-down vote and disallowing the use of a filibuster. To make this work Congress should legislate instructions to the commission requiring a particular balance between direct revenue increases and benefit cuts. (Any increase in the maximum earnings subject to tax or coverage of state and local workers would increase both revenues and benefits and should be treated as a separate category). Unlike much of the legislation discussed in Washington, the public should be able to relatively easily follow the Social Security debate, and what it would mean to refuse all revenue increases or to refuse all benefit cuts for the program. Neither position is politically viable for a plan to rescue Social Security and polls have repeatedly shown that the public wants a balanced Social Security reform.

Social Security reform--with its large contribution to the long-run debt problem—should not be seen as exclusive, but combined with the sort of large infrastructure program that could stimulate the economy. As with Social Security, there is wide agreement that we have major infrastructure needs throughout the country, and fixing now what we would otherwise need to fix later would not really add to the long-run debt level. In fact, current infrastructure spending would have a lower real cost by drawing in part on otherwise idle labor and capital as well as having a multiplier effect on unemployment.

But while reforms to Social Security would ideally be combined with this kind of fiscal stimulus, at a time of rising polarization, policymakers should at least address those problems that we know we can fix. Social Security is the place to start.

Peter Diamond is a Professor Emeritus at MIT and a co-recipient of the 2010 Nobel Prize in Economics. He first consulted to U. S. Congress about Social Security reform in 1974 and has remained active in Social Security analysis here and abroad ever since.