The debate about Social Security has started off on the wrong foot. To privatize or not to privatize should not be the main question. The problem with this administration is not that it wants private accounts, which have pluses as well as minuses. The problem is that it wants private accounts as an end in themselves, and so may lose sight of the Social Security issues that actually matter.
Why shouldn't private accounts be the central issue? Because none of their advantages is big enough to be decisive.
Consider the philosophical attraction of individual ownership. Owning your own retirement plan, like owning your own house, bolsters virtues such as responsibility and values such as freedom. But it's a mistake to weight this advantage too much, because private accounts will be intensely regulated. The contributions will be mandatory; the investment options will be restricted; and retiring account holders may be required to spend their savings on annuities. Individuals will "own" their accounts, but they won't exactly control them.
A second advantage in privatization is that it converts part of the current payroll tax into personal savings. Although the savings will be compulsory, many workers will feel as though they've had their taxes cut; work incentives will strengthen and the economy will grow. But this advantage should not be overemphasized either. The "tax cut" would be small, and would not affect the marginal rates of people earning more than the payroll tax cutoff of $87,900 a year, so the economic boost would be limited.
A third advantage is the possibility of higher national savings. Workers who get private retirement accounts may acquire a taste for thrift, and they may start putting aside more than they are forced to by the government. A higher savings rate means more capital, lower interest rates and so more investment and growth -- which in turn generates extra tax revenue to pay for the baby boomers' retirement. But this advantage isn't decisive either, because nobody knows whether a new savings culture would really take hold. Conceivably, some who currently save might stop if they acquired their own Social Security accounts. So savings might even diminish.
Finally, private accounts offer a way for the Social Security system to capture the returns from equities. Contrary to much anti-Bush chatter, holding equities is sensible for retirement plans -- that's why nearly all private ones invest in them. The long-term nature of retirement saving mitigates equities' risk, and the danger that stocks may crash the day before you retire can be managed by shifting gradually out of the market in the years before you quit working. But this risk management will happen consistently only if regulators control investment decisions. In other words, this fourth advantage can be realized only by giving up the philosophical satisfaction in permitting real "ownership."
Taken together, the four arguments for privatization amount to a weak case. There are some benefits to be gained, but there's also a risk that, if you blow up the current system, Congress will replace it with something irresponsible. What might "irresponsible" entail? Here's where Bush should listen to Democrats such as Gene Sperling, who set out sensible tests for any fix to Social Security.
The first test is that the funding gap in the current system should be plugged. This may sound obvious, but the leading proposal put forward by the president's Social Security commission used over $1 trillion in general tax revenue to pay for the nation's retirement (not counting the so-called "transition costs"). This sort of "solution" is a fraud. The premise of Social Security reform is that we need to avoid plundering the rest of the budget to pay for the boomers' retirement.
Second, the funding gap should be fixed equitably. It shouldn't be plugged entirely by cuts in benefits that hit the less well-off, especially since President Bush's first-term policies have been skewed in favor of the wealthy. So there needs to be some increase in revenue to balance the inevitable cuts in benefits. The payroll tax should be reformed so that income over $87,900 is not completely exempt.
Third, the opportunity to boost national savings should be seized aggressively. The United States is running a huge current account deficit and courting the possibility of a dollar crash because of its chronic lack of savings. One way to boost saving is to raise the cap on payroll taxes. But it can also be done by creating private Social Security accounts that are funded at least partly by mandating saving on top of payroll tax diversions.
There's nothing to stop Bush from endorsing these objectives: a real fix to the funding problem that isn't socially unfair and a serious effort to boost savings. Both objectives are consistent with Bush's policy of privatization; indeed, private accounts could help achieve them. But the signs so far are discouraging. Bush has said he rules out payroll tax hikes, and he's been silent on the savings question. He seems to want privatization as an end in itself -- which means he's likely to endorse a privatization that's not worth having.