Immediately after his reelection, George W. Bush placed restoring solvency to Social Security high on his second-term priority list. During the 2000 campaign, then-candidate Bush announced principles that he felt should guide Social Security modifications. He also promised to appoint a commission to design changes consistent with those principles. This is exactly what he did. The commission duly submitted its report, which Bush unceremoniously shelved. In his first term, Bush emphasized tax cuts and added a drug benefit to Medicare. Now, for better or worse, it is Social Security’s turn.

As is well known, Social Security faces a long-term deficit. Contrary to popular belief, however, this deficit is neither imminent nor large. The system is now running cash flow surpluses of more than $150 billion, which are projected to increase until 2008. Outlays are not projected to outstrip tax revenues until 2018 (total revenues, including interest, not until 2028). The deficit measured over 75 years is just 0.6 percent of gross domestic product. By comparison, the tax cuts enacted during Bush’s first term come to 2 percent of GDP.

Though modest in size, the deficit merits attention soon to avoid large, abrupt changes later. Congress is loath to implement benefit cuts abruptly for the compelling reason that workers need time to adjust their savings and retirement decisions to cutbacks in the nation’s most important retirement program. If Congress defers action, large and abrupt benefit cuts or tax increases would become necessary to preserve solvency.

Bush intends to do much more than restore solvency. He wants to cut back the traditional system, replacing it, in whole or in part, with individual accounts financed by payroll taxes diverted from Social Security. Privatization advocates emphasize that individuals investing in private stocks and bonds can earn higher returns than the Social Security trust fund earns investing in government bonds. They play down the heightened risks private account holders will bear from fluctuations in asset prices.

Privatization plans restore solvency to Social Security by eventually cutting traditional Social Security benefits more than they cut revenues. They project that pensions based on private accounts would eventually offset cuts in traditional benefits. Under such plans, the federal government can come out ahead, but only after several decades. Under the current system, money taken from the paychecks of working Americans funds the benefits paid to retired Americans. If, as Bush proposes, payments into the system are diverted to private accounts, who will pay the benefits of current retirees? This is the euphemistically named—but formidable—transition problem. If taxes are diverted from the traditional system into private accounts now, but benefits are cut only much later, the problem becomes how to cover a growing deficit in the interim.

CATASTROPHIC VICTORY
Surpluses in Social Security or the rest of the budget could help fill in the gap. Such surpluses exist today, but, as noted, they are not projected to last long. The rest of the budget is running enormous deficits right now—about $600 billion annually, excluding temporary cash-flow surpluses in federally managed retirement programs. Under plausible assumptions, current budget deficits outside government-managed retirement accounts will grow to more than $1 trillion a year by 2014. Diverting tax revenues from Social Security to fund individual accounts simply widens the gap.

When Bush took office in 2001, he actually had a grand opportunity to address the transition problem. At that time, official forecasts indicated that the federal budget would run surpluses for decades. Even then, critics pointed out that official projections were overly optimistic and neglected the possibility of unexpected bad economic news. Events rapidly validated the budget skeptics’ concerns.

What is now clear is that Bush made a momentous choice when he made large tax cuts his number one domestic priority. He doubtless anticipated that early successes on taxes would advance other items on his agenda. The United States then had sufficient revenues either to fund tax cuts or to deal with the transition problem, but not both. Since then, events intervened. Budget prospects turned from favorable to dismal. Dealing with the transition problem became something that the nation could no longer afford. Former Treasury Secretary Robert Rubin has warned that if projected deficits come to pass, financial panic could ensue. Confidence in the U.S. dollar could evaporate, disrupting financial markets and drastically inflating interest rates.

Diverting payroll taxes into individual accounts now would deepen that fiscal imbalance and heighten that threat to long-term economic stability. Bush may use the momentum from his reelection to push Social Security privatization, but if he does so and wins, this may turn out to be the latest example of “catastrophic victory."

Henry J. Aaron is a senior fellow in economic studies at the Brookings Institution in Washington.