The Coming Collapse of Socialist Security

By DAVID MOON, Moon Capital Management
November 21, 2004

As a part of his second term agenda, President Bush promises to reform Social Security, transforming a portion of what is currently a pay-as-you-go system to something more like a savings plan. Philosophically, I agree with this idea. (Poorly done, however, this type of private retirement account could be little more than another overly regulated, highly restrictive government boondoggle.) Although I agree with the idea, there are plenty of legitimate reasons why a person might oppose such a change to the current system. The enormous cost of such a change, however, is not one of these good reasons.

During the presidential campaign, John Kerry warned that the partial privatization of Social Security would cost an additional $2 trillion in transitional costs. (Someone would have to continue to pay current retiree benefits while workers diverted some of their current payroll taxes into private accounts. This would either come from increased taxes, higher deficits or reduced benefits.) Arguing against this kind of change in the system, the AFL/CIO website says Social Security 'privatization would cost a bundle.' So what?

Like the old Midas Muffler ads, you can pay me now or you can pay me later.

If reform opponents are going to worry about the high cost of change, they ought to also worry about the high cost of doing nothing. Without changes to the current system, the Social Security trustees estimate that future benefits will have to be cut 32 percent. We are going to have to cut Social Security benefits, increase taxes, reduce eligibility or some combination of the three.

In 1994, Argentina began offering its citizens the right to partially opt out of its Social Security system, allowing taxpayers to direct some payroll taxes to private investment accounts. Over the next nine years, Argentineans diverted $100 billion a year from Social Security and placed the money in private savings accounts. The problem, however, was that the government needed that money to pay the benefits of the people who were already retired. The Argentina deficit soared, as did interest rates, placing a terrible drag on the economy. While the outcome wasn't pleasant, maintaining the status quo would have been worse. The problem was the accrual of years of future pension benefits, without a planned funding mechanism to pay those benefits. Like Argentina, the longer we wait in the U.S., the worse it will be.

There are plenty of legitimate reasons to oppose any modification to the current Social Security system: any change is unsettling, particularly to current and prospective retirees; the devil known is more comfortable to many people; changing the system in mid-stream prompts questions of fairness to people who've paid into a system for years and expect the program to continue.

Those arguments are fundamentally different, however, than opposing change because it will cost too much. We have a catastrophe coming in the Social Security system. Dealing with that catastrophe is like much of life: doing the right thing is often difficult and costly. But continuing to do the wrong thing will be even more expensive.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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