Private Accounts Will Boost National Saving

December 23, 2004

In his most recent op-ed, Cato senior fellow and economist Alan Reynolds debunks some myths about personal retirement accounts that have been cropping up in major newspapers like the Washington Post. For example, a recent Post editorial claimed that shifting part of the payroll tax into private accounts would be 'savings-neutral,' as if there were no difference between paying taxes and owning stocks. In reality, workers with personal retirement accounts are investing their funds in stocks and bonds, thus creating new wealth.

Meanwhile, every Social Security reform plan that rejects private accounts can only leave future generations facing higher taxes and lower benefits. Social Security's insolvency could easily be "fixed" by raising the retirement age to 77, or perhaps 97, but today's young workers will still be forced to rely on the generosity of increasingly scarce young taxpayers in the future. Letting them build up a more reliable supply of retirement income during their peak earning years is the only workable solution to the Social Security crisis. Reynolds' op-ed follows:

December 23, 2004

"The Washington Post editorial page has taken to arguing with itself over the merits of Social Security privatization. 'How, exactly, would private accounts 'solve' the Social Security funding problem?' asked a Dec. 19 editorial. Mr. Bush doesn't say, and for good reason: In and of themselves, they don't.'

"On Aug. 15, however, a different editorial in the same paper answered this supposedly unanswerable question: 'Privatization could ... stimulate economic growth,' the editors explained, 'boosting tax revenues and so strengthening the nation's fiscal prospects. ... By converting the payroll tax into contributions to personal accounts, government could reduce the tax burden on workers, thereby boosting incentives.'

"Recent research by Edward Prescott, the newest Nobel Laureate in economics, strongly supports the editors' August answer to their December question. He shows that peoples' willingness to work full time for many years is quite responsive ("elastic") to marginal income and payroll tax rates.

"'The large labor supply elasticity,' Prescott explained, 'means that as populations age, promises of payments to the current and future old cannot be financed by increasing tax rates. These promises can be honored by reducing the effective marginal tax rate on labor and moving toward retirement systems with the property that benefits on margin increase proportionally to contributions. Requiring people to save for their retirement years is not a tax and does not reduce labor supply. My example establishes that reforms are possible that benefit the current young workers and future workers, while honoring promises made to the old. ... It is clear, given the high responsiveness of labor supply to marginal labor tax rates, that the potential gains are great.'

"Better work incentives are the biggest single benefit of privatization, in my view, but more effective savings and investment is another. On Dec. 21, however, another Washington Post editorial contradicted what the same paper wrote in August. 'Mr. Bush said yesterday that the creation of private accounts would boost national savings,' complained the editors. 'But ... the essence of privatization is that part of the payroll tax gets shifted into private accounts, a change that's savings-neutral.'

"By 'savings-neutral,' the editors mean there is not the slightest difference, so far as they can see, between paying taxes and owning stocks. Taxes, in this view, are identical to saving. Yet if a worker pays $5,000 a year in Social Security taxes, that money is not saved -- it goes directly to retirees, who spend it. Overtaxed worker Smith thus consumes $5,000 less, to be sure, but subsidized retiree Jones consumes $5,000 more. If Smith could use that $5,000 to buy stocks and bonds for his own retirement account, the funds would instead be made available for business and residential investment. "I dismembered this 'savings-neutral' fallacy in my column of Sept. 5, 2001, 'Would More Taxes Equal More Savings?' There is no need to explain it again, because The Washington Post already debunked itself on Aug. 15 by insisting, 'Private accounts would boost national savings. ... Privatization is a way of shifting the nation from a pay-go system to a pre-funded one. Savings would become more plentiful.'

"The December taxes-equal-savings editorial, by contrast, tried to replace such good economics with bad accounting. It quoted some bureaucrat's view that private accounts 'will not deal with the solvency and sustainability of the Social Security fund.'

"That remark just confirms that the so-called Social Security fund is insolvent and unsustainable. The next generation of workers is not about to tax itself into misery just because Social Security's current formula supposedly promises many more millions of people a 40 percent to 50 percent larger real benefit in the future than current retirees collect. This generation of politicians has no authority to compel the next two generations of workers to pay such unpayable bills, because the tax burden around 2040 will be determined democratically by voters at that time, not forced on them today.

"Meanwhile, every proposed solution to the 'Social Security funding gap' that eschews private accounts just promises to leave younger generations facing disappointing and delayed Social Security benefits and much higher taxes. And that, in turn, is why we need to get started on private accounts -- to give those now in their 20s and 30s some time to build bigger and more reliable sources of retirement income than simply relying on the unlikely generosity of increasingly scarce young taxpayers in the future.

"If the 'Social Security funding gap' was all that mattered, that could easily be fixed by raising the Social Security retirement age from 67 to 77, or perhaps 97. Such solutions pretend to 'fix the system' by putting young people in a fix. They try to dodge the unavoidable reality that during the next few decades, too many older people will be trying to retire at the expense of too few young taxpayers.

"The threat of increasingly punitive tax rates on future workers (or, even worse, trying to dump the burden on a few with high salaries) is not even part of a workable solution and is, in fact, the fundamental threat to future prosperity for workers and retirees alike. The Washington Post editors appeared close to understanding this in August, but have since reverted to dodging politically inconvenient realities under the pretense of accusing President Bush of doing the dodging."

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