You’ve said that Social Security has been running on the federal government’s credit card for years. What do you mean?

The program carries a very substantial legacy debt from the promises it’s made to past workers and current retirees. Every year, the size of that debt grows by hundreds of billions of dollars, so while the trust fund appears to be growing each year and running a surplus, the system’s mounting liabilities are in fact outpacing its accumulation of assets.

You’ve suggested that the system’s obligations are underrepresented by the government’s accounting methods. Can you explain?

One of the problems with the current accounting system is that it doesn’t reflect all of the program’s liabilities. If the Social Security program were obligated to use the same methods of accrual accounting used by most private companies, it would show losses of $300 or $400 billion a year instead of a cash flow surplus of $150 billion. The accounting method changes the system’s apparent performance on the order of half a trillion dollars—a very big difference. Not only are the unfunded obligations growing, but they’re growing much faster than the economy. So, the overhang becomes much larger with each passing year.

Why are the program’s liabilities growing so quickly?

For many years, participants enjoyed benefits that were much higher than the payroll taxes paid on their behalf. This left us with a legacy debt of some $14 trillion. On top of that, current workers accrue additional entitlements under the Social Security Act each year. In the late 1970s, Congress established a generous indexation formula for these benefits that makes them grow faster than the cost of living. Current workers continue to accrue their retirement benefits under that generous formula, even though the system will not be able to shoulder this level of retirement benefits.

Are the Democrats correct to argue that there isn’t a crisis?

They’re right and they’re wrong. In terms of liquidity, the system’s problems are fairly remote. The trust fund is not projected to run out of cash until 2042, though it will have to start redeeming its treasury bond reserves within another decade or so. But if one looks at the trust fund’s balance sheet, the picture is much bleaker. While the trust fund has $1.5 trillion in reserves, the present value of its statutory obligations is in the range of $15 trillion—10 times greater. In other words, the trust fund has unfunded obligations on the order of $13.5 trillion, and that figure is growing by several hundred billion dollars a year. Where I come from, that counts as a fiscal crisis.

What do you think of individual accounts for Social Security?

In terms of improving solvency, individual accounts are pretty much a wash. Under most individual account proposals, when individuals choose to direct some of their payroll taxes to individual accounts, there is an offsetting reduction in the amount of their traditional Social Security benefit that roughly equals the amount of the redirected payroll taxes. So, in and of themselves, individual accounts don’t do much to address the system’s solvency problems. What individual accounts do offer is the possibility of revisiting the structure of Social Security benefits and other features of the program. In combination with creating individual accounts, Congress might be able to do some things to address the solvency issue. The value of the idea of individual accounts is that it allows you to make other adjustments to the system not possible in their absence.

What kinds of adjustments?

There are only two ways to correct the solvency problems: increase revenues or reduce benefits. These changes can be accomplished in many ways. On the revenue side, you can raise the payroll tax rate, raise the tax base to make more income qualify or earmark revenue from other sources. On the benefit side, you can change indexation formulas, raise the retirement age, make adjustments in benefits based on life expectancy or reduce some benefits for certain participants, like the wealthy.

What about investing some of the system’s assets in the stock market?

That’s another way to try to increase the system’s revenues. Historically, stocks have experienced higher returns than the government bonds in which the trust fund now invests its reserves. Of course, equity investments would expose the trust fund to greater risk, so in thinking about those greater returns, you have to factor in this volatility. But the main concern about letting the trust funds get into the stock market is whether this arrangement would lead the federal government and politicians to become excessively entwined in the private market. Of course, one could ask the same question about individual accounts—would the government be too directly involved in the stock market for comfort if most Social Security individual accounts were invested in equities?

Are there other problems in having individual accounts?

The two chief concerns are risks and costs. Individual accounts would expose participants to investment risk and also, potentially, mortality risk—the risk of outliving your retirement savings. Costs could also be a serious problem. If one leaves it to individuals to find investment houses IRA style, it would be quite expensive for individuals. That’s particularly true in the initial years when accounts will be small, and it’s hard to find cost-effective money management. Another thing to worry about: There could be as great a variation in administrative costs for different participants as there would be variation in investment performance.

How can you address that?

Concerns over risks and costs weigh in favor of a more centralized management structure, with the government offering a relatively limited number of investment options and negotiating low-cost administrative structures for participating workers. I’ve served on academic panels that have explored different ways of dealing with these issues, and most experts agree that it is possible to mitigate investment risks and minimize administrative costs with carefully constructed regulations. Of course, those who champion individual accounts for libertarian reasons tend to resist the kinds of regulatory controls needed to limit risks and keep costs down. So it’s not clear whether, if Congress were ultimately to adopt an individual account program, it would impose regulatory controls as stringent as I would recommend.

Is a solution politically feasible? Or will resistance from seniors make it impossible?

The fate of Social Security reform is uncertain. Clearly, the Bush administration is putting a lot of effort behind this initiative, but the opposition is also strong and well-organized. My only prediction is that, if we don’t address Social Security reform and other retiree entitlements in the next few years, it will get progressively more difficult to correct our fiscal problems in the future. Massive and highly painful adjustments in benefits or taxes would be necessary if we wait until the baby boomers are largely retired and counting on retirement benefits of the types currently promised. The difficulty of making relatively modest adjustments now pales in comparison to what we are going to face a decade or two down the road. If we wait too much longer, we risk genuine intergenerational warfare and blood in the streets.