Commentary: A Better Way to Use All That Dough

Big budget surpluses and a weakening economy--it seems like there could be no better time for a tax cut. But there's a better way to use much, if not all, of the $1.6 trillion in projected surpluses that the Bush Administration wants to plow into income tax reductions. The alternative: Put the money into Social Security where it can be used to bolster the system's long-term solvency, while easing the burden of the onerous payroll tax that funds the system.

Right now the Social Security trust funds are expected to run out of money in 2037, when today's 40-year-olds are in their prime retirement years. But transferring $1.6 trillion of surpluses--the expected size of Bush's tax cuts over the next decade--into the Social Security system could stave off insolvency for years beyond that date.

"UNIQUE OPPORTUNITY." Moving a portion of the surpluses might even solve the Social Security funding conundrum permanently if the trust funds were allowed to invest in private stocks and bonds. Because such investments pay a higher return than the government bonds that the Social Security trust funds now hold, it would be possible to maintain benefits while cutting payroll taxes almost in half by mid-century. This is "a unique opportunity" to solve the looming Social Security crisis, says Nobel laureate Franco Modigliani of MIT, a leading advocate of such a transfer.

Other economists are now proposing similar ways to use the surplus to shore up Social Security. In a forthcoming book, Henry J. Aaron of the Brookings Institution and Robert D. Reischauer, former director of the Congressional Budget Office, call for crediting roughly the same amount of general revenue as the Bush tax cut to the Social Security trusts between now and 2023. By itself, such a transfer would eliminate half of the Social Security shortfall. Additionally, Aaron and Reischauer would slightly trim benefits, while allowing the trust funds to invest a small fraction of their assets into a "balanced portfolio of common stocks." The combination would "sustain Social Security indefinitely," argues Aaron.

To be sure, many economists, including Federal Reserve Chairman Alan Greenspan, object to the federal government investing in public stock and bond markets. Their fear is that investment decisions will be made for political rather than economic reasons. But such interference "could easily" be avoided with use of an independent investment board, says Alicia H. Munnell, director of the Center for Retirement Research at Boston College and a former member of the Clinton Council of Economic Advisers. In fact, she says the government's ability to do this has already been demonstrated by the federal Thrift Savings Plan, which has established "a highly efficient stock index fund."

In the end, if government investment in the stock market proves politically unacceptable, budget surpluses could still be used to fund a system of personal retirement accounts that supplement the existing Social Security program. The investment decisions would then be under each individual taxpayer's control. Indeed, such a transfer of money might be the best way to fund the transition to private retirement accounts, a long-time objective of some conservatives. Without such accounts to provide a nest egg, Social Security would be nearly impossible to phase out.

If the surpluses were to be set aside for the Social Security system, that would also help serve another purpose: Easing the burdensome payroll taxes now paid by workers and businesses to fund Social Security and Medicare. Such a cut would help many Americans more than an income tax reduction, since three-quarters of families pay more in Social Security payroll taxes than income taxes.

Moreover, cutting the payroll tax would give a bigger boost to the economy, because more of it would go to poorer families. They typically save less of their income than the wealthy. Says economist William G. Gale of the Brookings Institution: "The biggest bang for the buck comes from a stimulus that gets money into the hands of consumers who will spend it."

RELUCTANT. Economists have been reluctant to tinker with the payroll tax, because any cut would affect Social Security's long-term solvency. That's why some tax experts now propose using the surplus to give workers an income tax credit for a portion of payroll taxes paid. One version of such a credit is offered by Robert S. McIntyre, director of the liberal Citizens for Tax Justice. It would give each worker a refundable tax credit of up to $350. That would absorb about $48 billion--just under half of the $106 billion non-Social Security, non-Medicare budget surplus that the Congressional Budget Office projects for the coming fiscal year. If the size of this cut were doubled, then the stimulus would be almost exactly the size that many economists say is now appropriate.

So far, there are no solid congressional proposals to direct surpluses to the Social Security problem. But some lawmakers, including Senate Democratic Leader Tom Daschle (D-S.D.), have mentioned setting aside part of the surplus for this purpose. What's more, the payroll tax credit has been cited by leading members of Congress, including Senator Joseph I. Lieberman (D-Conn.).

Nevertheless, the likelihood of such proposals becoming law is remote. Most Democrats have jumped on the tax-cutting bandwagon. Still, politicians would do well to focus on the ease with which huge budget surpluses could help fix Social Security's supposedly intractable problems. Bush's $1.6 trillion tax cut will only make it more difficult to address the looming national retirement crisis. Many economists believe that a far better long-term use for the surpluses would be to shore up Social Security. Until that occurs, many Americans will remain worried about their retirement--and rightly so.

By Charles J. Whalen

Whalen covers the economy from New York.

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