The Department of the Treasury today released its fourth issue brief on Social Security reform, entitled "Mechanisms for Achieving True Pre-Funding." This excerpt summarizes their argument pretty well:
Any reform of Social Security that makes the system permanently solvent and that seeks to maintain contributions and benefits at some stable fraction of people’s wages while working must accumulate resources in the near term when there are relatively more workers (that is, when the old age dependency rate is relatively low) so as to help finance benefit payments in later years when there are relatively more retirees (that is, when the old-age dependency rate is relatively high). This accumulation of resources is known as “pre-funding,” and is accomplished by having current revenues exceed expenditures and by safeguarding the resulting surpluses so that they provide resources with which to fund future benefits. If instead no attempt is made to pre-fund future benefits, then it will be necessary in a solvent system to reduce benefits for the cohorts of retirees that are relatively large and/or to require higher contributions from the later, relatively small cohorts of workers who are paying for the retirement benefits of the earlier cohorts. Either outcome would be viewed as unfair by most people because it causes the net value of Social Security to vary across birth cohorts depending on their size.The brief explores pre-funding issues in great detail. I recommend it.
Significantly, the Treasury brief examines pre-funding using the Liebman-MacGuineas-Samwick reform plan as a model. In theory, any plan with pre-funding -- either via personal retirement accounts or trust fund investment -- could be used. Unlike almost all other plans, however, the LMS plan is almost totally self-financed. That is, it does not utilized transfers of general tax revenue to finance the "transition" to personal retirement accounts.
Being self-financing allows for much greater confidence that a reform plan actually will accomplish pre-funding. If transition costs are financed with general revenues, which in effect means that much of the cost will likely be borrowed, it is very difficult to determine how the financing burdens are distributed over generations. Given that pre-funding is all about distributing financing burdens over generations, self-financing plans have a strong advantage in this regard.
Update: Also see posts from Andrew Samwick and Angry Bear.