Federal Reserve Chairman Alan Greenspan recently drew criticism (notably from Democrats) with his comments on Social Security. When presenting his ideas on how to contain the U.S. budget deficit, Greenspan agreed with President Bush that increasing taxes is not the best way to do so. The controversy arose, however, when Greenspan proposed that the government scale back Social Security and Medicare benefits.
Senator John Edwards called Greenspan’s comments “an outrage” and went on to say that the current tax cuts are on unearned wealth as opposed to Social Security benefits, which Edwards claimed are earned by “working people.” Edwards’ claim that the upper-end of the income spectrum is unearned should be seen as the real outrage. Top income earners not only work extremely hard for what they make, but also subsidize low or no-income earners through their higher tax contributions. The Social Security system currently collects payroll taxes of roughly 7.65% (from both employees and employers) and instead of placing this money aside in some sort of “trust,” it is used to subsidize the federal budget and pay current Social Security benefits.
Several Democratic leaders responded to Greenspan’s comments by saying that raising taxes is the best way to reduce the budget deficit, but raising taxes could in fact lower total tax revenue. In his address to the House Budget Committee, Greenspan noted that raising taxes by enough to solve the deficit would “pose significant risks to economic growth and the revenue base.” Greenspan went on to say that the risk to economic growth is high enough to justify spending cuts rather than tax increases to curtail the deficit. Total tax revenue ultimately depends on the state of the economy, and the recent tax cuts need to remain permanent to help ensure sustainable economic growth. Nearly all economists will agree that large, long-term budget deficits are undesirable because of the crowding out effect on interest rates (among other factors), but in the case of a tax increase, the cure would be worse than the disease.
Greenspan and most independent analysts agree that even if taxes had not been cut recently, there would still be a huge budget shortfall to cover ballooning costs of Social Security and Medicare when baby boomers begin retiring. One way Greenspan suggests slowing the growth of Social Security costs is through changing the way benefit increases are calculated. Currently benefits are pegged to the consumer price index (CPI), but Greenspan proposed pegging benefits to the chained CPI. The chained CPI more accurately reflects changes in the cost of living because it takes into consideration changes in consumption as the aggregate price level changes. For example, if the cost of coffee suddenly doubles, people will probably drink less coffee and drink more tea, but this is not reflected in the basket of goods used to calculate CPI, thus overstating the impact of price increases. Since 2001, the normal CPI shows inflation averaging 2.1%, but the chained CPI comes in at 1.8%. Greenspan also proposed linking the retirement age for both Social Security and Medicare to increases in life expectancy.
Another possible solution is to divert some of the current Social Security contributions to private savings accounts; however, this would significantly increase the national debt over the next 30 years, according to White House economists. This option would reduce the burden to pay for future benefits, but in the short run the Treasury would not be subsidized by payroll tax contributions as it is today. As long as the Treasury’s shortfall was handled via spending cuts rather than tax increases, allowing private Social Security accounts is perhaps the best long-term solution to the growing retirement problem. Regardless of which solution (if any) is chosen, politicians need to take a long-term outlook, much like Mr. Greenspan has, and not bow to pressure from misinformed elderly voters and people who have no understanding of economics.
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