Monday, November 01, 2004

Kevin Muphy on Social Security

Kevin Murphy is one of the smartest people I met at Chicago. And that's really saying something. He has a post up on social security that I think is worth reading. His main points:
1) Privatization in and of itself does nothing to alleviate Social Security's impending fiscal imbalance or improve Social Security's rate of return.
2) So long as Privatization also reduces the stream of promised benefits by the amount of reduced taxes, it has no effect on the solvency of the Trust Fund; it reduces inflow to the Trust Fund to the same degree it reduces outflow from the Trust Fund.

Key conclusions:
The analysis here demonstrates that Social Security privatization is unlikely to improve solvency.

A broader question is exactly why solvency is an issue. According to conventional wisdom, solvency matters because exhaustion of the Trust Fund will mean Social Security is bankrupt.

It is merely an accounting fiction, however, that only Social Security taxes can be used to pay Social Security benefits. So the impending exhaustion means simply that at some point before Trust Fund exhaustion, Congress must either use other taxes to pay Social Security benefits, or cut benefits, or raise the Social Security tax rate.

The real issue, therefore, is that under current policy the U.S. is committed to spending a large and growing share of GDP on transfers to the elderly. This requires either increased tax revenues or decreased spending on other programs.

Society must therefore choose between two options. The first is to honor the existing liabilities of Social Security and accept the necessary taxation or lower expenditure on other programs. The second is to reduce the existing liabilities. There is no third option; privatization does not provide a free lunch.


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