November 1, 2012

Limiting Social Security's Drag on Economic Growth

Removing Disincentives to Personal Savings and Labor Force Participation
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Despite the lack of action, most policymakers understand the urgency of the federal entitlement crisis, and specifically, of the need to reform the largest entitlements—Medicare, Social Security and Medicaid—to constrain cost growth. Less frequently discussed, however, is the importance of reforming these programs in a way that ensures their future operation doesn’t unnecessarily constrain broader economic growth, labor participation and savings.

A new Mercatus Center at George Mason University study finds that pro-economic growth entitlement reform must not only rein in unsustainable cost growth, but also remove the barriers to labor force participation and disincentives to personal savings currently embedded in the largest entitlement programs generally, and the Social Security program in particular.  

Below is a brief summary. To read “Limiting Social Security’s Drag on Economic Growth: Program Reforms to Facilitate Labor and Savings Formation” and learn more about its authors, please click here


Entitlement Reform Must Constrain Costs, Correct Economic Disincentives

  • The primary driver of unsustainable federal spending growth is federal entitlement spending. Without effective reform, the largest entitlement programs cannot continue to function effectively. Their unchecked growth will require an insupportable burden of federal taxation and indebtedness that limits the nation’s potential for economic growth.
  • Economically sustainable entitlement reform must focus on 1) reining in unsustainable program costs; and 2) correcting economic disincentives currently embedded in the programs—Social Security being a key case in point.

No ‘Fix’ to Entitlement Crisis Without Meaningful Spending Reform

  • Attempting to fund currently projected entitlement spending growth through increased borrowing or increased taxes would be an ineffective and economically crippling approach to reform. 
  • The Congressional Budget Office estimates that federal tax rates would have to more than double to address currently projected spending increases. 
  • A Harvard study of other nations’ fiscal adjustments shows that attempts to close deficits with tax increases, rather than spending reductions, were far less successful, and more likely to lead to recession. 
  • Relying on borrowing to fund entitlement programs is shortsighted and would severely harm the economy in the long run.  
  • International studies find that high levels of government debt relative to GDP significantly cut economic growth rates. 
  • Social Security must be reformed to remain solvent. Further delaying reform threatens to severely limit our ability to sustain the program without drastic benefit cuts, massive tax increases, or some combination of the two.
  • Social Security’s reform must focus on reining in program costs; funding shortfalls cannot be closed mainly by raising taxes as the level of taxes required would have devastating economic effects. 
  • Even taking the perspective of those who might prefer to raise taxes substantially rather than to cut significantly into entitlement cost growth, relying on tax increases alone would represent an ineffective and economically crippling approach to this policy challenge.

Economically Sustainable Social Security Reform Promotes Work, Savings 

  • Several design features of Social Security undercut our national economic growth potential. These include disincentives for work, savings, investment and caring for dependent children. 
  • To ensure Social Security is economically sustainable in the future, these flaws must be corrected as a part of comprehensive reform to control costs. 
  • Various reforms to encourage work—such as adequately compensating those in early- and middle-age who extend their working years—would benefit both Social Security’s specific financing and general economic growth. 
  • Studies of other nations show that increased levels of personal savings and investment (including private accounts) have led to increased economic growth.
  • In recognition of the extent to which both Social Security finances and general economic growth depend on future growth of the working population, the authors also explore a fertility-neutral payroll tax system to finance Social Security as an alternative to the current system of compensating parents through the income tax code. 

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