Echoes of 'Read My Lips' Haunt Bush and Paulson

Jan. 31 (Bloomberg) — A legacy is something Treasury secretaries think about a lot. After all, they have often already completed careers on Wall Street or in a corporate boardroom when they come to the job — Henry Paulson and Robert Rubin of Goldman Sachs Group Inc., Paul O'Neill of Alcoa Inc.

Usually, the secretaries think that such a legacy involves halting some kind of crisis. Paulson, for example, seems to believe his contribution will be a fix that ends a crisis confronting Social Security. There is, what's more, general agreement that some sort of tax increase is necessary to provide that fix. Many Republicans even are willing to be polite and go along with an increase, if only to protect the party's reputation.

The trouble with all these premises is that they aren't accurate. Social Security does have large shortfalls in future years, but it isn't in crisis. The mechanism that generates those shortfalls can be altered so that they narrow to nothing. And getting that to happen only requires suspending partisan hysteria and addressing a rather techie problem matter-of-factly.

At issue is the formula used to calculate pensions. Now, base pensions correlate to the average real wage. Every year that wage moves up, so do pensions. This includes an increase above and beyond inflation, which means that even if siblings have identical careers, the younger sibling will get a better pension than the older.

The solution therefore is simply to index base pensions to inflation, so that everyone gets what his forerunners did, but not more. Worn out by decades of dire warnings about Social Security's future, many Americans don't even expect Social Security to be around when they retire. They would accept such a modest change if it were presented to them in context.

Asking Too Much

But that's probably too much to ask of our political parties — Democrats who want to blame the rich, and Republicans who often care more about spending than about preserving tax cuts. Democrats are especially concerned with keeping the real wage increase for lower-earning households, for whom Social Security is the largest tax.

So there is another solution, one put forward by Robert Pozen, former vice chairman of Fidelity Investments and a member of President Bush's Social Security Commission. Pozen would keep the old benefits formula for lower earners, give middle-earners a base pension indexed partly to real-wage rises and partly to inflation, and index higher earners' pension to inflation alone. Pozen calls this progressive indexation, for obvious reasons. This milder proposal removes more than half of Social Security's shortfall.

A Third Way

Yet a third way to end the false emergency is to combine progressive indexation with other steps, such as raising the retirement age again or changing the formula by which inflation is calculated for Social Security purposes.

Read my lips: none of these steps requires any kind of tax increase.

Instead of shouting this reality from the rooftops, Paulson is going around talking about opening doors and making friends with Democrats. What he means by this is considering a Social Security fix that would lift the cap on the payroll tax.

If he is interested in his legacy, Paulson might note that the current picture of a Treasury secretary negotiating while the White House stands firm is strikingly similar to another one, from the time of the current President's father.

George H.W. Bush made his "read my lips, no new taxes" pledge in the presidential election campaign of 1988. Then came trouble in the Middle East, the Gulf War and the widening deficit.

Under Siege

The Treasury secretary doing the negotiation then was Nicholas Brady. Brady cared a lot about his legacy, too. He and colleagues holed up with John Sununu, the White House chief of staff, and Richard Darman, the director of the Office of Management and Budget, at Andrews Air Force Base.

The "read my lips" pledge didn't survive the siege. When the men emerged, it was to present a reversal of the Reagan tax cuts, pulling the top rate into the thirties from Reagan's 28 percent. Brady's name — and Darman's for that matter — was mud with conservatives ever after. Bush paid the price when he lost his campaign for re-election. And Bush's tax increase was a smaller marginal rate boost than lifting the Social Security cap would be.

To add tax insult to tax injury the economic growth of the 1990s made their sacrifice seem unnecessary. The Republicans' concession merely set up a winning shot for one of Brady's successors, Rubin — the capital-gains rate cut later in the decade.

These are all things Paulson and colleagues might like to consider as they begin meetings. So too might the rest of the country, especially those who care about sustaining the record of growth set recently. There is definitely a door here — but no need to open it.

(Amity Shlaes, a visiting senior fellow at the Council on Foreign Relations, is a Bloomberg News columnist. The views expressed here are her own.)

© Copyright 2007 Bloomberg

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