Milton Friedman on Social Security
By Arnold Kling
My choice for last week’s comment of the week generated a lot of comments! It refers to this article by Milton Friedman, who describes a conceptual scheme for transitioning out of Social Security. Based on the comments, I can tell that people are challenged by Friedman’s idea. Let me try to explain it.
Suppose that I reach retirement age today. How much is in my Social Security account?
Nothing. All I have is a promise from the government to pay benefits.
Now, suppose that instead of a promise to pay benefits, the government gives me cash equal to the present value of the promised benefits. The present value can be calculated using the formulas that life insurance companies use to convert cash to annuities. In fact, I could take my cash, walk into a life insurance company, and purchase an annuity. Thus, I would go from a government program to a private program with the same characteristics.
If the government gives me cash instead of promises, then it has successfully transitioned me out of Social Security. To find the cash, however, it has to borrow money. This debt can be repaid immediately by raising taxes now, or it can be repaid with taxes collected over a long period of time. Those taxes could be payroll taxes, or they could be other revenues such as income taxes.
(For younger workers, a cash-out transition also can work. However, the younger worker’s expected Social Security benefits are out in the future, so the present value has to be adjusted. Furthermore, as we abolish Social Security, the younger worker’s one-time cash payment should be reduced by the present value of the payroll taxes that the worker will no longer be paying.)
The day that the government cashes everyone out of the Social Security system, the debt on its balance sheet will balloon, because the debt that funds the cash payments counts as debt, but the promises of future benefits are not accounted for. This is a matter of sloppy bookkeeping in the present system.
If you were to count future Social Security liabilities on the balance sheet, then a cash-out program would leave total government liabilities unchanged. To a first approximation, the only difference between Milton Friedman’s cash-out plan and the current Social Security system is that the bookkeeping of Friedman’s program is transparent, while the bookkeeping for Social Security is opaque.
Note that Friedman’s cash-out concept should not be confused with any “privatization plans” that have been placed on the table in the past few years. Privatization plans often are misleadingly presented as if they were solutions to the long-term Social Security budget problem, which they continue to hide. Instead, Friedman’s approach would put the long-term budget problem out in plain view.
Friedman’s approach is simply a shift in timing. Instead of an annuity, you receive a one-time cash payment. It relates to privatization in the sense that if you cash everyone out of the system today, then the government can choose to get out of the tax-and-transfer business with future workers. However, as a matter of theory, the government could stay in the tax-and-transfer business by making new cash payments to people as they enter the labor force. As a matter of practice, the foolishness of this would be transparent.
For Discussion. Democratic economists, including Brad DeLong, “bang their heads against the wall” trying to make it clear that the country needs fiscal discipline because of the long-term outlook for Social Security. Should they support Friedman’s idea as a way of making the liabilities in the entitlement programs more transparent?