Social Security, Political Insecurity

Towards the end of last week's Democratic presidential debate, Barack Obama and Hillary Clinton had this exchange (which I've edited a bit):

SEN. OBAMA: ...I've been very specific about saying that we should not privatize; we should protect benefits. I don't think the best way to approach this is to raise the retirement age. But what we can do is adjust the cap on the payroll tax. Right now anybody who's making $97,000 or less, you pay payroll tax on 100 percent of your income. Warren Buffet, who made $46 million last year, pays on a fraction of 1 percent of his income. And if we make that small adjustment, we can potentially close that gap and we can make sure Social Security is there....

SEN. CLINTON: ....I think we have to have a bipartisan commission. I do not want to fix the problems of Social Security on the backs of middle class families and seniors. (Applause.) If you lift the cap completely, that is a $1 trillion tax increase. I don't think we need to do that...

MR. BLITZER: All right. So Senator -- so you're not ready to accept that raising of the cap on that, but I know that Senator Obama wants to respond to you.

SEN. OBAMA: I will be very brief on this because, Hillary, I've heard you say this is a trillion dollar tax cut on the middle class by adjusting the cap. Understand that only 6 percent of Americans make more than $97,000 -- (cheers, applause) -- so 6 percent is not the middle class -- it's the upper class.

As Senator Clinton pointed out, of course, he meant to say "increase." Paul Krugman, among others, has been very critical of Obama's willingness to raise the cap on income subject to social security contributions. Krugman's argument is that the idea of "crisis" in social security is greatly exaggerated, and the incorrect, but widespread, perception that social security is in financial danger has been politically exploited by those who want to replace the system with private accounts.

This chart from the report of the social security and medicare trustees shows the projected costs for social security (blue line) and medicare (red line) as a share of GDP.

The social security trust fund, which holds government bonds (i.e. the government is borrowing money from social security), is not projected to run out of money until 2041. Contrary to popular belief, social security is in pretty good financial shape. The real "entitlement problem" is with medicare, and this is driven by projected increases in the cost of health care. Therefore, the much more more urgent policy challenge is to find ways to reduce the growth in health care costs.

Although the shortfall in social security is modest, getting more money in the trust fund now would ease the future problems. Since the cap for social security taxes is a regressive feature, raising it would have the effect of making the tax code more progressive. Moreover, Obama's tax increase (and that is, indeed, what it is) would increase net national savings (private savings less the amount borrowed by the government). Currently, this is far too low to finance domestic investment, which means that we have to borrow from abroad, hence the large current account deficit. So, while Krugman's absolutely right that there is no social security crisis, Obama's idea has some economic policy merit. I have no idea whether Krugman's correct about the politics, though I suspect the failure of the Bush administration's push for private accounts, combined with disillusionment with the stock market, has shut the door on privatization for the near future, so he may be fighting the last war.

For more, check out this analysis by Times columnist Tom Redburn. Also, Financial Times columnist Clive Crook makes an interesting argument that the Democrats should embrace more radical social security reform.