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Better Use for Tax Cuts

September 08, 2002|MAYA MacGUINEAS | Maya MacGuineas is a senior fellow at the New America Foundation, a nonpartisan think tank.

WASHINGTON — While Democrats disliked President Bush's trillion-dollar-plus tax cut from the beginning, the dramatic deterioration in the federal budget outlook has given them new ammunition for assaulting the final, most expensive phase of the cut. With deficits forecast for the next three years, holding off the rest of the tax cut, as Democrats are suggesting, seems eminently sensible. But there's a catch. Democrats aren't invoking fiscal restraint as their cause. Rather, they want to spend the money generated by curtailing the tax cut on education and prescription drugs for seniors. Since a purpose of running a budget surplus is to increase savings, the Democratic proposal seems as fiscally irresponsible as plowing ahead with the tax cut. But the idea of postponing the final phase of the tax cut provides the underpinnings for what could be a fiscally responsible and economically beneficial compromise.

As gloomy as the current budget projections are, they pale in comparison with the deficits that will emerge when baby boomers retire. Yet the question of how to reform Social Security has created a divide even larger than the one produced by the debate over cutting taxes versus government spending. Republicans want to set up individual investment accounts but ignore the fact that the loss of budget surpluses makes funding the accounts next to impossible. Democrats have been content to attack Republican plans and provide no alternatives, though doing nothing is not an option.

Enter the compromise. Diverting the balance of the Bush tax cuts into personal retirement accounts would not only resolve the dispute on short-term budget priorities, it would also contribute a solution to the retirement issue.

For starters, the diversion would accomplish an objective that both Democrats and Republicans share: putting resources aside today to help reduce the burden of paying for Social Security benefits in the future. This was the original purpose of the lockbox, an approach that quickly failed because government lockboxes are easy to pick.

Part of the appeal of the GOP's private accounts is that the funds could not be used for other purposes, thus providing a far more secure lockbox. But the problem with most private-account plans is that they don't specify the source of the money. As Democrats have pointed out, using Social Security payroll taxes to fund the accounts could weaken the system's ability to pay traditional benefits, not to mention further undermine the overall budget.

But if Congress were to hold off implementing the rest of the Bush tax cut, it would free more than enough money to start building individual accounts for younger workers while the rest of the Social Security program continued to pay benefits as promised. It's an approach with clear bipartisan appeal.

For Republicans, diverting the tax cut to private accounts would not be a tax increase as such, since the money would remain the private property of workers. For Democrats, the plan would commit more resources to Social Security, reducing the level of benefit cuts that would otherwise occur.

Perhaps most important, saving the money in private accounts is the only use that would be as beneficial to the economy as paying down the debt. The increase in savings would supply more investment capital and keep interest rates in check, contributing to economic growth.

Certainly, the timing of an individual investment account proposal might strike many as odd, given the recent stock market implosion. But while there are plenty of lessons to be learned from the market meltdown, avoiding saving for retirement should not be one of them. Nobody expects the market decline to last for decades, the time horizon of retirement investment. Since investing the accounts as part of Social Security would go hand in hand with regulations ensuring that workers invest only in well-diversified funds, risk would be contained.

That said, creating private accounts alone will not save Social Security. As all politicians know, but few are willing to acknowledge, other reforms--raising the payroll tax cap, increasing the retirement age or slowing the growth of benefits--will be necessary. A primary benefit of private accounts is that they will provide a second source of retirement funds to help compensate for these changes.

Certainly, since taxpayers and Social Security participants are one and the same, using the tax cut to fund individual investment accounts would seem to be in the best interests of the public at large.

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