“Transition Costs” of Partially Privatizing Social Security

by | Jan 14, 2005

There’s a lot of discussion in the media about the “transition costs” of partially privatizing Social Security. These “transition costs” are estimated to be $1 trillion to $2 trillion. The specter of this amount of expenditure is–second only to altruism–the major weapon the left has to use against privatization. But in reality, there are no […]

There’s a lot of discussion in the media about the “transition costs” of partially privatizing Social Security. These “transition costs” are estimated to be $1 trillion to $2 trillion. The specter of this amount of expenditure is–second only to altruism–the major weapon the left has to use against privatization.

But in reality, there are no costs whatsoever to privatizing Social Security.

A “cost” is an amount of money that has to be spent in order to acquire a value. But what is the situation in regard to privatizing Social Security? Essentially, under the present system, the government promises to pay people over some age, such as 65, a pension. (I don’t know if the applicable age is still 65–and I don’t really care–but let’s assume it’s 65.)

The amount of this pension is in some vague way based on the amount of Social Security taxes they and their employers have paid. But that part is not important to my point. The fact is that Social Security is welfare for the retired, paid by the money the government takes out of the economy now.

As I understand the semi-privatization plan, people below some age (55 has been mentioned) are going to be offered a chance to reduce their Social Security taxes–maybe by as much as half–if they agree to correspondingly reduce the amount of the welfare they will receive after age 65.

Where, then, are the costs? Well, the notion is that the tax break for the young will mean the government has less revenue with which to pay the old. So what?

Let’s say that the plan goes into effect on New Year’s Day. Due to the tax break for the young, the government will seize from them X fewer dollars during 2005. But, since the government is not cutting Social Security for those over 65, the government has a revenue-shortfall of X.

Okay, but where’s the “cost”? With or without the privatization, the government still has to pay out the same amount to the same people. There simply is no new expenditure. It’s just that the same old expenditure now has to be financed in some other way. The same X dollars will be paid out whether or not there is privatization. The total drain on the private sector will be the same.

What then does semi-privatization accomplish? In the first year, nothing. But in later years, the government is committed to paying out less and less in welfare to those over 65.

Let me try to concretize this further, because the “transition costs” bogey is such a vaunted “obstacle” to privatization.

First we take the case of the present system. Let’s make up some easy round numbers for illustration. Suppose the government is slated to pay out $100 billion during 2005 for Social Security. And suppose that the revenue from current Social Security taxes is $300 billion. The extra $200 billion above what is needed for paying Social Security to those over 65 goes into the general revenue and is doled out as loot to various pressure groups.

Under the present system, in other words, the government drains $300 billion out of the economy and pays $100 billion to those over 65 and $200 billion to others.

Now take the most extreme case of privatization. Assume that full privatization is instituted for those under age 55, beginning January 1. Whamo! The government’s revenue drops a lot, because only people in the age bracket 55–65 are paying any Social Security taxes. Say that the government takes in from these people only $50 billion in Social Security taxes. That’s a drop in revenue of $250 billion ($300 billion–$50 billion). How will it make up this $250 billion shortfall?

Ideally, it wouldn’t make up all of the shortfall. Ideally, it would honor its commitment to pay $100 billion to those slated to get Social Security, but would cut spending by $200 billion response to the drop of $250 billion of its revenue drop. That would mean it takes only $100 billion out of the economy instead of the $300 billion it did in 2004, with zero cuts in Social Security payout. What a bonanza for the economy!

Unfortunately, spending cuts are not in the cards. But my point is unaffected. If the government continues to spend the same amount, it takes the same amount out of the economy. President Bush has said, “No new taxes,” so the $250 billion shortfall would be financed by one of the other two means of government looting: borrowing or inflation.

The net result is: without privatization, the government drains the economy of $300 billion; with radical privatization, the government drains the economy of $300 billion.

The only difference, in the short term, is the means by which the blood-letting is accomplished: without privatization it’s done by Social Security taxes; with privatization it’s done by lower Social Security taxes and higher borrowing and/or inflation. There are no “transition costs” in this picture.

But that’s only in the short term. What privatization would accomplish is the reduction in welfare for the aged as those who opted out of the system reach age 66. Eventually, with full privatization, there would be no one left alive to be owed Social Security payments.

There are further details, some of which cut one way and some of which cut the other way. But these are just details. For instance, under the current system, a person who dies before reaching age 66 represents a net gain for government revenue, but under privatization, the early death of a person who has opted out of the system leaves revenue unaffected. On the other hand, the prospect of a declining Social Security liability 10 years in the future would be anticipated by the market and start having some immediate positive effects.

But these are details that don’t affect the principle.

The principle is that a shortfall in government revenue is not a cost.

In fact, the exact opposite is true: government revenue is the cost, the cost borne by those whose production supplies that revenue.

Since no one, alas, is proposing overall spending cuts, the near-term cost of privatization would be as high as the cost of the present system. But no higher: there are no “transition costs.”

Dr. Binswanger, a longtime associate of Ayn Rand, is an professor of philosophy at the Objectivist Academic Center of the Ayn Rand Institute. He is the author of How We Know: Epistemology on an Objectivist Foundation and is the creator of The Ayn Rand Lexicon: Objectivism from A to Z. Dr. Binswanger blogs at HBLetter.com (HBL)--an email list for Objectivists for discussing philosophic and cultural issues. A free trial is available at: HBLetter.com.

The views expressed above represent those of the author and do not necessarily represent the views of the editors and publishers of Capitalism Magazine. Capitalism Magazine sometimes publishes articles we disagree with because we think the article provides information, or a contrasting point of view, that may be of value to our readers.

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