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On a Wednesday morning in December, three dozen chief executives, economists and lobbyists filed into the Ronald Reagan building in the centre of Washington for an “economic summit” with President George W. Bush.

Mr Bush's last grand get-together with the captains of corporate America, two years ago in Waco, Texas, was dismissed as a political set-piece, a scripted opportunity for Republican industrialists to hail the work of the nation's chief executive.

In fact - although it may not have showed at the two-day summit - a fierce argument is brewing over some of the radical economic reforms that Mr Bush and his advisers seem determined to pursue after his re-election last month. The ambitions that the president is expected to lay out for his second term - an overhaul of Social Security and sweeping tax reform - together amount to a remaking of America's social contract.

Seventy years ago Franklin D. Roosevelt signed the Social Security Act of 1935 to establish a system of federal old-age benefits. Now the system that has endured since Roosevelt's New Deal is giving way to what Mr Bush calls "the responsibility era". The thrust of the White House's economic ideology is to shift responsibility from the state to the individual. Mr Bush's second term promises to be as controversial and ambitious on the home front as his first term was in its foreign policy.

"We are the party of freedom. We are the party that believes that freedom is the solution to a lot of different problems," says Ken Mehlman, chairman of the Republican party. "At home, we believe that more people will have prosperity if we have economic freedom."

Social Security reform is Mr Bush's highest priority. The oldest members of the "baby boom" generation will become eligible for Social Security benefits in 2008. Lower birth rates in later generations mean the number of workers per retiree is forecast to fall from more than three at present to two by 2040. This leaves the choice of increasing taxes to pay for the entitlement programmes or of cutting benefits.Mr Bush has ruled out tax increases, putting the burden squarely on benefit cuts, causing controversy even within the Republican party.

The introduction of personal accounts through which individuals can invest in stocks and bonds will be the cornerstone of Mr Bush's reform. Private accounts combined with reduced benefits as part of the traditional system, will gradually replace the government guarantee of old age security.

Martin Feldstein, the influential Republican economist who is seen as a potential replacement for Alan Greenspan as chairman of the Federal Reserve, has long advocated personal accounts, primarily as a way to increase national savings. However, Social Security reform also fits with the ideological goals of conservative thinkers who want to promote stock market investment and reduce the support role of government.

While Social Security is a popular programme, long-term funding shortfalls provide the spur for Mr Bush to propose partial privatisation. The Social Security Administration Trustees, who focus on the next 75 years, project that the pension system's funding shortfall has a net present value of $3,700bn - meaning $3,700bn would have to be invested today, at current interest rates, to fill the long-term funding gap. Going beyond 75 years and indefinitely into the future, the unfunded liability rises to $10,400bn.

But Peter Diamond, professor at the Massachusetts Institute of Technology and a leading authority on Social Security, who is co-author of the leading Democratic proposal on Social Security reform, says there has been a deliberate attempt to exaggerate the financial problems of the benefit programme. "The 'infinite horizon' model and the idea that we think we know anything about life expectancy a century from now is really silly. Seventy-five years is a stretch but at least it gets people thinking about the long term," he says. Even using the infinite horizon model, the unfunded liability is only 1.2 per cent of the present value of future gross domestic product.

Democrats object that allowing younger workers to divert part of their payroll taxes into personal accounts would undermine the system. Social Security would have to continue paying the current level of benefits to those in and close to retirement. A new funding gap would be created.

Mr Bush has not endorsed a specific plan. But the second of the three alternatives put forward by the 2001 Presidential Commission on Social Security Reform is widely seen as the leading proposal (see below). This would cut benefits and allow individuals to divert one-third of the 12.4 per cent payroll tax into their personal account.

Estimates by the Social Security Administration, the government agency that oversees the programme, suggest that over the first 10 years, the reform would have an impact of up to $2,000bn on government debt. Over the second decade it would cost a further $5,000bn. The savings from cutting benefits during the first 20 years would be less than $1,000bn.

Critics charge that, rather than raising national savings, the proposal would have a negative effect. Indeed, the White House's own forecasts, included in the 2004 Economic Report of the President, suggest that the commission's "Model 2" approach would have no positive impact on US government debt, compared with the existing system, for 60 years. In fact, it would make it worse (see charts). "It is like saying that a reform introduced at the end of world war two is now starting to have a positive effect," says Peter Orszag, a fellow at the Brookings Institution and co-author of the Democrat proposals on Social Security with Mr Diamond.

Mr Bush may pay little attention to such arguments. But one question is whether Wall Street's reaction to the prospect of thousands of billions of dollars of new government debt over the next 20 years might force him to listen. Since Mr Bush has said there should be no increase in payroll taxes to fund the transition, it is inevitable that government debt would increase.

In fact, while Social Security threatens to take up an increasing share of the government budget, Medicare, the government health insurance for the elderly, is a far larger problem. In the next 75 years, its financial shortfall is estimated to be four times as large as that of Social Security.

However, even Republican economists worry that the reform of Medicare during Mr Bush's first term set a bad precedent. Kent Smetters, professor at Pennsylvania university's Wharton business school and a Treasury official, estimates that the unfunded liability of the Medicare prescription drugs benefit signed by Mr Bush during his first term is $17,000bn using the "infinite horizon" model. "At a stroke of a pen, it created an unfunded liability that is 1.7 times as large as Social Security's," he says. Andrew Samwick, a professor at Dartmouth and co-author with Mr Feldstein of academic papers on Social Security, says the lesson from the Medicare drugs prescription bill is that reform proposals can end up creating more financial problems.

When the White House proposed the Medicare prescription drugs benefit, it included reform elements that would have cut costs, Mr Samwick says, but when it went to Capitol Hill the White House made clear that the prescription drugs benefit was the part that was really important. "We got all the sugar and no medicine," Mr Samwick says. "My biggest fear is that they are only doing this for the ownership society and not for solvency." This would mean introducing personal accounts but not the benefit cuts.

Social Security reform is likely to dominate Mr Bush's second term. But the president has also raised the possibility of sweeping reform of the tax system. While Mr Bush's priority is to make permanent the tax cuts passed during his first term, the White House will also appoint an advisory panel on tax reform, exciting those Republicans who have long campaigned for a flat tax or national sales tax that eliminates the long list of deductions in the current tax code.

Economists inside and close to the administration stress that incremental reforms, rather than a highly complicated and controversial effort to overhaul the current system, can give Mr Bush the results he wants.

Greg Mankiw, chairman of the Council of Economic Advisers, said in a speech this month that individual retirement accounts and 401(k) tax-favoured retirement savings vehicles - and the reductions in taxes on dividends and capital gains passed last year - have already helped to tilt the system away from taxes on savings towards a consumption tax.

Glenn Hubbard, another Republican economist touted as a future Federal Reserve chairman, says Mr Bush's first-term tax cuts provide the guide for the kind of reforms the president is likely to want in the second term, though Mr Bush has pledged that tax reform should have a neutral impact on overall government revenues. "The past is prologue. The president cares about reducing marginal rates and reducing the taxes on savings and investment," Mr Hubbard says.

A solution also needs to be found to the Alternative Minimum Tax, which is designed to prevent the wealthy from avoiding tax but threatens to embrace the middle classes, since the income levels to which it applies were not adjusted for inflation. Before considering anything more creative the administration must focus on plugging this hole.

Daniel Altman, a journalist and economist, argued in the recent book Neoconomy that a grand experiment is under way, inspired by the ideas of Mr Hubbard and like-minded economists. Reducing the burden of taxes on savings and investment, the theory says, will spur capital accumulation, advances in technology and long-term economic growth.

Moving from an income tax towards a consumption tax, however, puts more of the burden of taxes on wage-earners and less on those who derive more of their income from accumulated and inherited wealth - something that may prompt a political backlash.

How do Mr Bush's tax and Social Security plans square with the president's pledge to halve the US fiscal deficit over the next four years?

Few independent economists see the budget arithmetic as credible. Goldman Sachs, the investment bank, says it is more likely that the cumulative deficit over the next decade will be $5,000-$6,000bn, or 3-4 per cent of GDP, compared with 3.6 per cent in the financial year that ended in September.

Low long-term interest rates suggest Wall Street is not alarmed by the fiscal outlook. But the weakness of the dollar indicates at least some concern on the part of international investors, who are required to put up almost $2bn a day to cover the US's current account deficit.

Business leaders have said that fiscal deficit reduction should be the priority in Mr Bush's second term. Republicans in Congress have also warned that an increase in payroll taxes will be required as part of Social Security reform - something the White House has said is not up for discussion. Republicans in Congress are already eyeing the 2006 mid-term elections, adding to their wariness about tampering with the highly popular Social Security system. Proponents of reform want at least some Democratic support.

The volume of legislative traffic in Congress could clog the process. And, to appropriate Donald Rumsfeld's phrase, there are "unknown unknowns". The need to appoint a new Supreme Court justice could paralyse Washington by sparking a battle in America's continuing culture wars; the deteriorating situation in Iraq could yet weaken the president; a terrorist attack may, as it did in the first term, derail the domestic agenda.

But Mr Bush is at least being sweeping in his ambitions.

IN SURPLUS FOR NOW, BUT HEADED FOR DEFICIT AFTER 2018: AMERICA’S SOCIAL SECURITY SAFETY NET EXPLAINED

WHAT IS SOCIAL SECURITY? Social Security is the US public pension system. As well as retirement income, it provides disability benefits and survivor benefits when a family’s primary wage-earner dies. It is funded by the payroll tax, levied at 12.4 per cent on the first $87,900 of an individual’s employment earnings. Social Security gives the average worker a retirement benefit equivalent to 42 per cent of wages and is the primary source of income for two-thirds of retired households.

IS THE SYSTEM IN GOOD SHAPE? Social Security takes more in payroll tax contributions than it pays out in benefits, holding the difference in Treasury bonds in the Social Security trust fund(see next question). But the retirement of the “baby boom” generation will turn this surplus into a deficit after 2018. According to the Social Security Trustees, the trust fund will be exhausted by 2040 if there are no other changes in policy. The funding shortfall over the next 75 years is equivalent to 1.9 per cent of taxable income over the period. “Governments can raise taxes, cut benefits and print money,” says Douglas Holtz-Eakin, director of the non-partisan Congressional Budget Office. “Talking about the pending bankruptcy of Social Security is misplaced. The real point is whether funding Social Security should come first and the rest of the budget should be secondary.”

WHAT IS THE SOCIAL SECURITY TRUST FUND? In 1983 a commission on Social Security chaired by Alan Greenspan, now chairman of the Federal Reserve, increased the payroll tax above the level required to pay current benefits. This built up a trust fund, providing an element of pre-funding for the future retirement of the baby boomers. The evidence suggests the trust fund had a positive impact on national savings during the 1980s and 1990s, yet over the past four years the government has run a unified budget deficit.

WHAT IS THE LEADING WHITE HOUSE PROPOSAL FOR REFORM? President George W. Bush has not endorsed a specific approach beyond saying that Social Security reform should introduce private accounts and should not increase the payroll tax. The 2001 Presidential Commission on Social Security reform’s “Model 2” plan is widely seen as the White House’s favoured approach. It would fix the long-term funding shortfall by changing the way that benefits are calculated after 2008, indexing contributions to past inflation rather than wages. The benefits replacement ratio would fall from 42 per cent to about 22 per cent of an average worker’s wages over the next 40 years. Individuals could choose to divert 4 per cent of their payroll tax into private accounts. Their future traditional Social Security benefits would be further reduced to take this into account. The Commission’s report can be found at www.csss.gov.

WHICH CONGRESSIONAL INITIATIVE COMES CLOSEST? Lindsey Graham, Republican senator from South Carolina, has a proposal that is very close to Model 2. But Mr Graham, along with other Congressional Republicans, has said maximum taxable earnings subject to the payroll tax should be increased to help meet the transition costs.

WILL PEOPLE GET BETTER RETURNS OVER TIME INVESTING IN THE STOCK MARKET? Historically, stocks have outperformed bonds - but not in every decade. The difference in long-term returns is called the equity risk premium. Financial theory says that, adjusted for risk, the return on different assets must be the same.

WHAT DO THE DEMOCRATS THINK? John Kerry, the Democratic presidential candidate, accused Mr Bush of wanting to undermine the system. Democrats say the first priority should be to restore discipline to the federal budget, so the public finances are in better shape as the baby boomers retire. They say there will be little positive impact on national savings from introducing personal accounts for several decades and that the transition costs of moving to private accounts will only weaken Social Security in the meantime. A combination of modest benefit cuts and tax increases, they argue, would shore up Social Security for the long term. They also argue that Republican plans overlook the costs of disability and survivor benefits.

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