There is no lockbox

Matthew Hoy
By Matthew Hoy on March 4, 2002

One of the advantages of living on the West Coast is that you can start reading the next day's Washington Post and New York Times at 9 p.m. It's not quite an afternoon paper, but it's close enough.

In tomorrow's New York Times, columnist and former Enron hack Paul "Line 47" Krugman assails any move to privatize any portion of Social Security. Krugman argues that Social Security is a social contract. Soon-retiring baby boomers have paid their dues to the system, so it is us Gen-Xers, among other, who have an obligation to pay up and shut up.

It's really a social contract: each generation pays taxes that support the previous generation's retirement, and expects to receive the same treatment from the next generation.

You may believe that Franklin Roosevelt should never have created this system in the first place. I disagree, but in any case Social Security exists, and older Americans have upheld their end of the bargain. In particular, baby boomers have spent their working years paying quite high payroll taxes, which were used mainly to support their elders, and only secondarily to help Social Security build up a financial reserve. And they expect to be supported in their turn.

Yes, baby boomers, and everyone else, has been paying quite high payroll taxes. When I got my first paycheck working at an Alpha Beta grocery store, I was amazed and alarmed by this FICA person who was taking my hard-earned dough. After all, I was the one who always ended up carrying out the 50-pound bags of salt out to customers' cars.

The second part of Krugman's claim, that payroll taxes have been going (if only "secondarily") to build up a financial reserve, is false. This guy is supposed to be an economics specialist? Listen, THERE IS NO LOCKBOX. None. Nada. The lockbox is a fiction created by presidential candidate Al Gore and, unfortunately, the GOP and President Bush bought into it.

Why there is no lockbox: Today the government collects more money from that "FICA" line on your pay stub than is needed to pay benefits to retirees. That surplus is then used to buy government bonds. When the bonds are bought, the money that was in Social Security goes into the government's main account. To make it look like something resembling basic accounting, Social Security ends up with Treasury notes, promises of future payment from the government. There is no real money in the "lockbox," just these IOUs -- with interest.

But what happens in a few years when all of the baby boomers have retired and the number of workers fulfilling this social contract drops from about 10 workers to 1 retiree to 2 workers for 1 retiree? Well, there obviously won't be enough money coming in each year to cover the benefits, so we've got to cash in some of those IOUs. Where does the money to pay those IOUs come from? The government's main pot of money. All of the sudden, there's no more money for education, federal parks, farm subsidies, foreign aid, environmental protection, interstate highways and the military.

Mr. Bush proposes to allow younger workers to place their payroll taxes in private accounts � in effect, to break this ongoing contract. But then what happens to older workers, who have already paid their dues?

There are only two possibilities. One is default: make room for the trillions diverted into private accounts by slashing the baby boomers' benefits. The other is to buy the baby boomers out � that is, to use money from other sources to replace the diverted funds.

Whether or not younger workers ever get the option of putting a portion of their FICA taxes in a personal retirement account, we will be faced with Krugman's two possibilities and one more. The third possibility is to raise already "quite high" payroll taxes. It's a simple demographics problem. Social Security can work just fine indefinitely if each new generation is significantly larger than the previous one. Unfortunately the Demographic Transition Model, something I learned in 9th grade geography, says that this doesn't occur in modern industrialized countries.

Private accounts won't "save" Social Security. On the contrary, they will create a financing crisis, requiring sharp benefit cuts, large infusions of money from unspecified outside sources, or both.

A financing crisis is already on its way, for the very reasons that I outlined above. Unlike the current Social Security system, a system of private accounts would not require ever-larger generations of workers. There would have to be a large outlay to pay current beneficiaries. But there's going to have to be a large outlay anyway, getting ever larger as average life expectancy increases and more and more people retire and fewer and fewer workers pay Social Security taxes.

Something is going to have to be done about Social Security eventually. The system is not financially viable as it is currently constructed. There are no good solutions, but partial privatization is probably the best one I've heard.

Krugman opened his column with a math problem.

If converting Social Security to a system of private retirement accounts is such a good idea, why can't advocates of that conversion try, just once, to make their case without insisting that 1+1=4?

Unfortunately for Krugman, he is insisting that 1+ (-2) = 3.

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