Bush May Be Borrowing Trouble With Social Security Plan

Just in case the prospect of a Social Security overhaul wasn’t complicated enough, get ready for a numbingly abstruse concept that may prove to be one of the pivotal points in the debate: the difference between implicit and explicit debt.

The underlying question is whether the Social Security program President Bush envisions would swell the national debt to dangerous levels, raising interest rates and burdening future generations with unsupportable debt-service payments. Critics say that’s the inevitable endpoint of Bush’s direction. His administration insists it can borrow big to restructure Social Security without adverse consequences.

The one point on which everyone now agrees is that Bush’s Social Security plan would require substantial federal borrowing for decades. Bush hasn’t endorsed a specific proposal, but he’s made clear that his central goal is to allow younger workers to divert part of their payroll taxes into individual accounts that they could invest in stocks or bonds.

The problem is that the payroll taxes from today’s workers fund the benefits of today’s retirees; if workers were allowed to divert part of their taxes into investment accounts, Washington would need to replace that money to continue providing benefits promised to seniors. Because Bush has indicated he doesn’t want to raise taxes, he is likely to propose borrowing most or all of that “transition” cost.

The amounts involved are daunting. Over the next decade, the federal government may need to borrow around $2 trillion to fund the individual account plan most favored by the Social Security commission that Bush appointed in 2001. For the decade after that, the bill would be even larger.

All of this would come while the national debt, after declining in the late 1990s, is soaring again. Recession, the cost of the Sept. 11 terrorist attacks, wars in Afghanistan and Iraq, and the price tag for Bush’s repeated tax cuts have sent the federal budget spiraling back into deficit -- and increased the federal debt held by the public from $3.4 trillion in 2001 to about $4.3 trillion now.

With large annual deficits already projected for the foreseeable future, skeptics fear that a plan to borrow as much as $200 billion a year more to fund private accounts could drive up interest rates as Washington elbows aside private borrowers.

But the White House insists those fears are misplaced. Officials are beginning to push the argument that this borrowing wouldn’t amount to new debt at all. Instead, they maintain, it would simply convert implicit future debt into explicit current debt.

What’s implicit debt? The administration uses the phrase to describe the long-term financing gap between the money Washington is raising for Social Security through the payroll tax and the cost of benefits promised to future retirees. The Social Security actuaries place that gap at $3.7 trillion over the next 75 years, and $10.4 trillion through, literally, infinity. Bush and his aides are highlighting the larger, scarier number.

The White House case is that financial markets are already considering these large unfunded future obligations when setting interest rates today. Their theory is that even if Washington adds trillions to the national debt to fund individual accounts, the markets won’t raise interest rates -- as long as the overall restructuring plan eliminates Social Security’s long-term financing gap.

The plan Bush is expected to endorse would close that long-term funding gap by significantly reducing the growth in guaranteed benefits for future retirees, relying on the returns from the individual accounts to compensate for part of the loss.

In essence, the administration is betting that the markets will stomach even large amounts of explicit new debt for a Social Security plan that reduces the so-called implicit debt of unfunded future obligations.

The administration says it is finding plenty of Wall Street support for that logic. But some financial traders consider it more wish than forecast. They believe the markets will weigh the reality of massive new federal borrowing more than the promise of long-term savings -- especially if the plan defers any benefit reductions far into the future, as seems possible.

“In an ideal world, the market would say, ‘Good, they’re doing something to fix Social Security,’ ” says Ethan Harris, chief U.S. economist for the investment firm Lehman Brothers. “But I think the market will focus almost exclusively on the increased deficit.”

If Harris is right, that would mean higher interest rates -- and bigger bills for mortgages and consumer loans.

Funding a Social Security overhaul on the government’s credit card raises other questions. With the dollar weakening, some critics warn that huge borrowing for Social Security would increase the risk that foreign creditors will balk at buying more U.S. debt.

“Can we say with certainty this will cause a collapse? No,” says Peter R. Orszag of the Brookings Institution, a nonpartisan think tank. “Can we say it entails risks it doesn’t make sense to be running? Yes.”

More federal debt would also mean bigger annual bills for debt service. Calculations from Orszag suggest that the borrowing for private accounts, layered onto the ongoing federal deficits, could saddle Washington with annual interest costs equal to more than 4% of the economy by 2030. That huge sum is about as much as Washington now pays to run Social Security itself. Such crushing interest expenses would leave future generations less money to fund other needs.

Faced with such arguments, the administration responds that failing to control the long-term cost of Social Security would also leave future generations scrambling to fund other priorities. That’s true; inaction could be expensive, too. But no one should pretend that adding trillions in debt to restructure Social Security wouldn’t also carry significant costs. The risks implicit in so much borrowing need an explicit role in the emerging Social Security debate.

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Ronald Brownstein’s column appears every Monday. See past Brownstein columns on The Times’ website at: latimes.com/brownstein.