The Tree of Tax Hikes and Social Security Privatization

Mark Thoma views Jagadeesh Gokhale as Adam viewed the Snake in that old garden--you know, the one that was the source of four rivers: the Pishon,the Gihon, the Tigris, and the Euphrates. Only Jagadeesh is offering Mark a pomegranate containing not knowledge of good and evil but instead a linked package of tax hikes and private Social Security accounts:

Economist's View: Everything Old is Still Old: This National Review Online commentary urges Republican leaders to reconsider their opposition to tax increases as part of the solution to growing entitlements. The idea is to trade concessions on taxes for the creation of personal Social Security accounts with the hope that, once the door has been opened slightly, salesmanship can open it further and allow conservatives to reach their goal of privatizing Social Security. Beware of compromise in sheep's clothing:

Entitlement-Reform Realities A little conservative compromise will go a long way as we attempt to revamp today's safety-net system, by Jagadeesh Gokhale, NRO: Some conservatives are apoplectic about the prospect of abandoning the "no-tax-hike" pledge as part of entitlement reforms.... Unfortunately, the political and economic arithmetic of entitlement shortfalls does not permit them much hope; remaining wedded to high principles and shunning compromise will only worsen their choices.... Liberals' programs have been in operation for decades and are now supported by a large bloc of voters, making it especially difficult for conservatives to challenge or modify them.... [L]iberals are viewed as having no new ideas... because most of their ideas are already in operation.

Liberals are in a peculiar bind. Entitlement shortfalls are growing larger and threatening to undo their legacy.... That presents an opportunity for conservatives to revamp today's safety-net system by introducing their own market-oriented framework, with personal Social Security accounts as the crown jewel. Unfortunately, worsening entitlement shortfalls also make adopting personal accounts more difficult each year. The closer baby boomers come to retirement age, the less likely they are to acquiesce....

Could conservatives do better by agreeing to accept some of the taxes in exchange for removing the cake earlier and replacing a part of future tax increases with personal accounts? The answer of the high priests is "no," which is puzzling given that their choices would only worsen over time.

What are the strategic tradeoffs? Three items seem relevant: First, resolving the entitlement shortfall by paring scheduled benefit growth is becoming less feasible.... [I]ntransigence on compromise will make higher taxes more, not less, likely.... Second... personal Social Security accounts do not yet exist and thus cannot compete with the existing system to demonstrate their superiority.... Third, if personal accounts were introduced and proved successful... they would carry strong momentum for expansion as more groups clamored for access to personal accounts. So any arguments that the advantages of introducing personal accounts are not worthy of a few early concessions on taxes appear far from credible....

Mark Thoma wants to turn down the pomegranate:

First, there is nothing that necessitates linking tax changes to personal accounts - no such linkage was made when taxes were cut. This is nothing more than a strategy for attaining personal accounts, it is not a solution to the entitlement problem...

True, but private accounts as an add-on would be a fine thing for Social Security. Americans need to save more, both individually and collectively. Hence greater "contributions" now and in the future are attractive. And where should those contributions go? The poorer half of Americans have no long position in the stock market. Given that the S&P currently carries a real earnings yield of 6%, that is a scandal and an outrage. Almost all of the richer half of Americans' long positions in the stock market yield them S&P - 2.5% per year, given their mutual fund fees, brokerage fund fees, and the price pressure the herd exerts against itself as it churns its portfolios. That is at least a semi-outrage.

My ex-student Konstantin Magin has long argued that the projected equity premium makes policies to boost investments by Americans in the stock market a winner, and has recently pointed out to me that the magnitude of long-run mean-reversion implied by current estimates of return predictability makes long-run passive investments in the stock market the closest to a sure thing of anything except running your own online poker site.

Now it is possible to make Social Security private accounts a bad deal for everyone. And it is surely the case that the Bush White House's track record is such that only an idiot would sign on to any proposal designed and implemented by the Bush White House.

But if we were offered a slightly different pomegranate. If, say, we were offered a pomegranate that consisted of: (a) contribution increases, (b) well-designed, low-fee private accounts, (c) Treasury Secretary-to-be Paulson with the baton to make the detailed decisions and set the tradeoffs, (d) advised by an Assistant Secretary for Social Security Reform named Jagadeesh Gokhale, who (e) promised to retain enough social insurance in the system to preserve a substantial defined benefit component--then yes, I would eat that pomegranate. And I would advise Mark Thoma to eat it too.