When it comes to Social Security, it's all rocks and hard places. Over the next 75 years, the unfunded liabilities of our most important...

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When it comes to Social Security, it’s all rocks and hard places.

Over the next 75 years, the unfunded liabilities of our most important social program are estimated at $3.7 trillion. That figure assumes the $1.5 trillion in U.S. Treasury obligations in the Social Security retirement trust fund can be redeemed for cash when promised benefits exceed payroll-tax collections.
This means our government would need $5.3 trillion in cash, on hand today, plus all expected payroll-tax collections to fulfill the promises that have been renewed by Republicans and Democrats alike for decades.

If the trust-fund IOUs can be redeemed, our annual Social Security letter tells us, benefits are safe until 2042. After that, they must be reduced by 27 percent.

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If the trust-fund IOUs can’t be redeemed, which no politician will discuss, the benefit cuts would have to start earlier — perhaps as early as 2013.

This is a real problem.

The Democrats want to deal with it in the traditional manner of politicians: denial. They intend to tinker their way through the largest demographic change in American history. It simply won’t work.

And now we know what the Republicans want to do, at least if they follow the leadership of President Bush. They’ll reassure voting seniors and consign millions of our children and grandchildren to the poverty that seniors fear by putting the entire burden on our descendants, cutting their future benefits.

Bush wants to tax those too young to pay attention, those too young to vote and those yet to be born.

I believe there is a better way to deal with this problem. So does Laurence Kotlikoff, the economist with whom I co-authored “The Coming Generational Storm” (MIT Press, $28). Our plan isn’t without pain. But it spreads the burden fairly. Here is what we suggest in our book:

Step 1:
Recognize the unfunded liabilities as real obligations. While the technicians worry about floating more Treasury debt for transitions and related machinations, the promises of Social Security are as real as U.S. Treasury bonds.

Step 2:
Institute a national sales tax on all consumption. This tax would be dedicated to paying the Social Security benefits promised and accrued to today’s workers and retirees.

Because consumption accounts for 70 percent of gross domestic product, a sales tax is the broadest possible base, so the tax would be much smaller than the payroll tax. Seniors would pay the tax. So would workers. But it would be in proportion to their means.

Step 3:
Kill the payroll tax. Replace it with a compulsory program of real private accounts so that every worker would build substantial assets. We call this the Personal Security System. This can be done without enriching the mutual-fund industry, as some fear.

We are not alone in this idea. In a recent article, Edward Prescott, winner of the 2004 Nobel Prize in economics, suggests that Social Security be “reconstructed,” not reformed, with 100 percent private accounts.

As workers approach retirement, they would have the option of converting all or part of their accumulated assets into inflation-protected life annuities. With large-scale competitive purchases, annuitants would get a better deal than private-purchase annuitants get.

Removing the payroll tax would take a major burden off employers and employees. It would cut the marginal tax on labor. It would make us more competitive in global markets. It would encourage employers to hire.

It would be a New Deal for the 21st century.

Questions about personal finance and investments may be sent to Scott Burns at The Dallas Morning News, P.O. Box 655237, Dallas, TX 75265; by fax at 214-977-8776; or by e-mail at scott@scottburns.com. Questions of general interest will be answered in future columns.