In my commentaries this week, I’ve discussed the transcendent importance to the economy and the markets of the potential for restructuring Social Security, to include individually managed private accounts. I’ve talked about some of the myths about Social Security, and I’ve shown how private accounts have worked for public retirement systems in other countries. Today I’m going to take on the most dangerous myth of all — the one that keeps us from reforming our broken Social Security system the way Chile did two decades ago.

I’m talking about the myth of “transition costs” — the myth that it is impossibly expensive to dig out from under the wreckage of today’s bankrupt system, and move to a more robust and sustainable system of private accounts. This myth is especially dangerous because it virtually concedes that moving to private accounts would be a good idea in principle — but, like other good ideas in principle, such as buying a Gulfstream V jet, it would just be too expensive.

The myth of transition costs goes something like this. If today’s workers paid their Social Security taxes into their own private accounts instead of into Social Security’s so-called Trust Fund, in less than five years there would be no money to pay benefits to people who are already retired, and older workers not yet retired but who have paid into the system all their lives. Those people somehow have to get paid — and that’s the cost of transition. Depending on who you listen to, the present value of that cost is anywhere from $4 trillion to $11 trillion.

Why do I say that’s a myth? What’s not factual about it? Actually, nothing — it is perfectly factual. What makes it a myth is that these costs are not “transition costs.” They are simply the value of the obligations of the system, whether there is a transition or not. These costs will have to get paid somehow, someday, by somebody.

To see why I say this, consider a simple thought experiment proposed by Nobel economics laureate Milton Friedman. Suppose that we repealed Social Security this very moment, and paid everyone a Treasury bond equal to the value of his claim on the system. That means you’d get a bond worth the present value of all the payments you can expect to get out of the system over your lifetime, minus the value of all the taxes that you’ll pay into the system. You hold the bonds, or sell them if you want — perhaps using them to create your own personal retirement plan. Friedman says, “The result would be a complete transition to a strictly private system, with every participant receiving exactly what the law promises.”

The perfect transition, right? Everyone has a government obligation equal to the value of the government obligation he has right now under the old system. Nobody’s entitlement changes, and the total value of the government’s obligation doesn’t change, either. There are no losers in the deal. Perfect. The system is now private. And what are the “transition costs”? Zero. Well, not literally zero. I guess it would cost something to print the bonds on fancy paper and mail them to everyone.

Of course, while it would truly cost nothing to privatize the system this way, it would feel as though the costs were enormous. That’s because sending out all those bonds would require that the massive obligations of Social Security be recognized on the balance sheet of the federal government — and right now, they are not.

By keeping these obligations off the books, we commit a collosal act of denial, an act of self-serving magical thinking, through which we choose not to recognize the realities of these obligations, these solemn promises. And then we rail against reforming the system because doing so would cause us to recognize these realities. We call that act of recognition, that act of honesty, that act of integrity… “transition costs.”

And in our denial, with every passing day, the costs of the existing system get higher and higher, as more and more people retire in relation to the smaller number entering the workforce. The sooner we face reality — the sooner we can stop these mounting costs. Let’s start by making a promise to ourselves right now — let’s stop calling them “transition costs.”

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