Arnold Kling discusses Four Myths About Social Security. The first myth is that Social Security is a pension system. It’s not, of course; there’s no reserve accumulating interest in your name. That leads us to transition costs — and the Transition Cost Myth:
If Social Security were a pension, then the transition to private accounts would be simple. One day, at the stroke of a pen, the government would transfer the funds that had accumulated in your Social Security account into a personal private account, and the transition would be complete.
However, everyone who really understands Social Security knows that there are no funds accumulated in your Social Security account, or in anyone else’s. Since Social Security cannot stop paying benefits, particularly for people already retired, there is a “gap.” That is, if we reduce Social Security taxes on a young worker by $1000 in order to allow her to invest the money in her own account, then the government has to find another source for that $1000 in order to pay current retirees. Multiply this by hundreds of millions of taxpayers for a couple of decades.
In practice, the government would have to borrow hundreds of billions of dollars in order to fill this “gap.” Opponents of private accounts call this the “transition cost” and flaunt this cost as a barrier to privatization. Senator Kerry used the term “catastrophe” to describe the transition cost.
The transition cost is a myth. In economic terms, the transition cost is zero.
From an economic perspective, the transition exchanges an off-balance sheet obligation of the government for an equal-value on-balance sheet obligation. It makes government accounting more honest, without changing the underlying debt structure.
When your Social Security taxes are reduced by $1000, the government will reduce its obligations to pay you Social Security by an equivalent amount. That is what partial privatization means — you have to take that $1000 and invest it yourself, because the government is reducing its future payments to you.
The crux of the problem is that government accountants ignore future Social Security payments; they don’t count them as debt:
One way to eliminate the “transition cost” to partial privatization would be to first undertake a transition to better accounting. If the government were to put future Social Security obligations on its balance sheet as debt, then the accounting would be accurate. To borrow a locution from Warren Buffet, if promises to make Social Security payments are not a financial obligation of the government, then what are they? And if a financial obligation of the government is not debt, than what is it?
If unfunded liabilities to make future Social Security payments were counted as debt, then partial privatization would be nothing but a debt swap. The government would increase ordinary debt and reduce unfunded-liability debt by an equal amount. The transition cost would be zero.