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A Fix for Social Security?

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By Sebastian Mallaby
Monday, November 27, 2006

The next six months could be a productive time for economic policy. After a wasted 2005-06 cycle, in which the Bush administration approached entitlement reform too confidently and Democrats refused to talk, both sides may return to the table. The administration, now led by a practical Treasury secretary with the heft to sideline ideologues, may be willing to make concessions. The Democrats, faced with the challenge of living up to their unexpectedly clear election victory, may decide it's time to make policy rather than just block it.

The most interesting debate will revolve around retirement. This will start with a rerun of the Social Security argument of 2005; but it could easily blossom into a discussion about the inequality and income volatility that's grown with globalization.

Top administration officials have already signaled that they want to return to the question of Social Security. They no longer regard "privatization" -- the diversion of payroll taxes into personal accounts -- as the starting point for negotiation. The solvency of Social Security, not a desire to promote an "ownership society," is their main concern.

A solvency fix will involve some cuts in future benefits. Democrats won't love this, but there are ways to do it progressively. During the 2005 debate, President Bush endorsed an idea that would inflict no cuts whatsoever on low-income workers and would allow the value of middle-class retirees' benefits to rise, albeit less quickly than now scheduled. Because this formula (devised by a Democrat named Robert Pozen) spreads the burden fairly, Democrats who worry about rising inequality should be open to it.

The solvency fix will also require increases in revenue. Again, during the last Social Security debate Bush left open the possibility of doing this in an extremely progressive way -- by lifting the cap on the payroll tax, which currently exempts income above $90,000. This reform would raise revenue exclusively from the richest 6 percent of taxpayers. It's hard to see how Democrats could object to that.

The next question is where to put the extra revenue: into the notional Social Security trust fund or into personal accounts. The administration will prefer private accounts, partly because it would like a face-saving link to the president's 2005 proposal but also because personal accounts provide a way of walling the revenue off from the general budget and so reduce the government's tendency to spend it. Meanwhile, Democrats will prefer to put the money into the trust fund. They reason that any personal account created as part of a reform that cuts Social Security benefits is headed the wrong way: toward replacing the security of the traditional guaranteed benefit with the uncertainty of 401(k)-type investments.

Judging from the hints flying around Washington, the administration sees how to bridge this divide. Democrats may be allergic to personal Social Security accounts, but they are enthusiastic about other ideas for personal retirement accounts that just don't have "Social Security" in the title. For example, Gene Sperling, a former Clinton adviser, has called for a "Universal 401(k)" that would extend the benefits of 401(k) saving to workers whose companies don't offer such accounts. In Sperling's vision, everyone would get the chance to contribute to an account and receive a government contribution as a match, with the most generous match going to low-income workers. To pay for this program, the government could prune the existing $150 billion patchwork of tax breaks for saving. This patchwork is extraordinarily, scandalously regressive: 90 percent of the tax breaks go to the richest 40 percent of taxpayers.

Sperling is motivated by a desire to help low-income people. As he writes in his book, "The Pro-Growth Progressive," 85 percent of workers in the bottom fifth of the labor force have no access to a company 401(k), nor do 75 percent of Hispanic workers or 60 percent of black workers. Globalization, which has boosted the volatility of family incomes, makes it especially important to help workers build assets that can cushion them against job loss, illness or the financial fallout from divorce. Although the Universal 401(k) would be primarily aimed at retirement security, there could be limited earlier withdrawals at times of misfortune.

So while Republicans have been pushing personal retirement accounts as part of an entitlement fix, Democrats have been pushing personal retirement accounts because they worry about worker insecurity. By enlarging the debate so that it's about savings in the era of globalization rather than just Social Security, negotiators can conjure up the common ground that was missing during the 2005 train wreck. Personal accounts need not be merely the alternative to the traditional Social Security benefit. They can simultaneously be the alternative to the nation's outrageously regressive system of tax breaks for saving and a way to help ordinary people build nest eggs. When personal accounts become both of these things, perhaps Republicans and Democrats alike will back them.

smallaby@washpost.com


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