Private Accounts Would Substantially Increase Federal Debt and Interest Payments

Summary

All of the major proposals to replace a portion of Social Security with private accounts would require large increases in federal borrowing for many decades.  This increased borrowing is not necessary to restore Social Security solvency.   Instead, the increased borrowing would be needed to finance the creation of the private accounts, which by themselves would not do anything to restore solvency, and under some circumstances would worsen solvency.

Some plans with private accounts, like the President’s, would shrink the solvency gap by reducing Social Security benefits (over and above the benefit reductions that are designed to compensate for the loss of payroll taxes diverted to private accounts).  These benefit reductions would partially offset the increased borrowing that would result from the private accounts.  Even when these benefit reductions are taken into account, however, all of the proposed plans that include private accounts would substantially increase the federal debt and the interest payments on the debt.  For instance:

• The President’s plan would create $17.7 trillion in additional debt by 2050. ^[1]  This additional debt would be equal to 19.3 percent of the Gross Domestic Product in 2050.  By comparison, the total federal debt currently equals 38 percent of GDP.  Thus, by 2050, the President’s plan would require more than half as much borrowing as the federal government has undertaken for all purposes in its first 216 years.  In 2050, the interest on the additional debt created by the President’s plan would be equivalent to $133 billion in today’s economy, or more than the federal government will spend this year on all education, veterans’ health care, science, conservation, pollution control, and job training programs combined.
• The plan proposed by Robert Pozen, an investment company official who served on the President’s Social Security Commission, would create $3.5 trillion in additional debt (equal to 3.8 percent of GDP) by 2050.  Interest on that additional debt in 2050 would be equivalent to $29 billion in today’s economy.
• The plan proposed by Senator Lindsey Graham (R-SC) in 2003 would create $19.1 trillion in additional debt (equal to 20.8 percent of GDP) by 2050.  Interest on that additional debt in 2050 would be equivalent to $145 billion in today’s economy.
• The plan proposed by Senator Chuck Hagel (R-NE) would create $24.2 trillion in additional debt (equal to 26.5 percent of GDP) by 2050.  Interest on that additional debt in 2050 would be equivalent to $182 billion in today’s economy.
• The plan proposed by Senator John Sununu (R-NH) and Representative Paul Ryan (R-WI) would create $85.8 trillion in additional debt (equal to 93.7 percent of GDP) by 2050.^[2]  Interest on that additional debt in 2050 would be equivalent to $635 billion in today’s economy.

These estimates and comparable estimates for other Social Security plans are shown in the table on page 5.

Why do these private accounts plans create additional debt?  Currently, all payroll taxes paid into Social Security are used by the federal government.  These taxes are used to the full extent needed to pay Social Security benefits to current beneficiaries.  The Social Security trust funds loan any revenues not needed for this purpose to the Treasury and receive Treasury bonds in return.  Since total federal revenues — including Social Security taxes — are now less than total federal expenditures, the government runs a deficit each year.  Thus, the funds borrowed from Social Security are used to help cover these deficits.  (If the rest of the budget were balanced, the Treasury would use the revenues borrowed from Social Security to pay down the federal debt.)

Creation of a system of private accounts would not change the amount of revenue coming into the federal government, but it would increase government spending, because the federal government would be making regular payments into the private accounts.  These payments would represent new government spending.  This increase in spending, unaccompanied by an increase in revenues, would widen annual deficits.  The federal government would have to borrow more to cover these larger deficits, and that added borrowing would increase both the national debt and the cost of interest payments on the debt.  (If the budget outside of Social Security were balanced and the Treasury were using the payroll taxes borrowed from Social Security to pay down the debt, diverting those revenues to private accounts would still result in higher levels of debt than would occur if the taxes were not diverted).

Proponents of private accounts dismiss the increased borrowing and interest costs caused by private accounts as “transition costs,” since the cost of establishing the accounts would eventually be offset by reductions in Social Security benefits for workers who opened a private account.^[3]  However, the additional debt created by President’s plan would continue growing as a share of GDP until 2044, when it would peak at 20.5 percent of GDP, and would remain as high as 10.6 percent of GDP in 2061.  A problem that will not begin to recede for four decades is difficult to dismiss as simply a “transition cost.”

Moreover, the eventual reduction in the debt incurred in order to fund private accounts would depend on future reductions in Social Security benefits being carried out as planned.  It is by no means certain this would happen, especially if the securities held by private accounts earned less than proponents predict and pressure consequently grew for the offsetting benefit reductions to be scaled back.

The added interest payments during the several-decades-long “transition” period would place more pressure on the federal budget, which already faces growing shortfalls in coming decades because of demographic pressures, rising health care costs, and tax cuts.  These additional interest payments would make it harder to maintain important federal programs and avoid unsustainable deficits.  In addition, the increase in federal debt that resulted from a private accounts plan could contribute to or exacerbate a fiscal crisis that some experts fear may be triggered at some point by continuing high federal deficits. 

It is important to note that Social Security reform plans exist that restore solvency and do not increase debt and interest payments.  A plan proposed by economists Peter Diamond of MIT and Peter Orszag of the Brookings Institution that does not include private accounts would restore solvency and reduce federal debt in every year; by 2050, this plan would reduce debt by $23.7 trillion (or 25.9 percent of GDP) and reduce interest payments by $1.3 trillion (or 1.4 percent of GDP).

Changes in Debt and Interest Resulting from Proposed Social Security Plans

The table on the next page shows the increases in federal debt, and the interest payments on that additional debt, that would result from the private account plans discussed above and from several additional plans.  (See Appendix A for a description of the plans included in the table and Appendix B for the methodology used to determine the estimates, which include adjustments to make all estimates consistent with the assumptions of the 2005 report of the Social Security Trustees and with the assumption that private account plans would start in 2009, as the President has proposed).

The table also shows the reductions in federal debt and interest payments that would result from two plans that do not include private accounts.  Finally, the table shows the percentage reduction in the 75-year Social Security shortfall that each plan would achieve, excluding the effects of transfers from the rest of the government.^[4]

Read the remainder of this analysis.