Peter Diamond, professor of economics, emeritus, Massachusetts Institute of Technology and recipient of the 2010 Nobel Prize in economics, answers the big question of how to fix Social Security. Can we save Social Security? Yes, Social Security can be fixed. There’s a long-term deficit problem, but it’s far from a crisis yet. Projections show the trust fund will run out of money by 2033. At that point everyone’s benefits would have to be cut by 25% if nothing is done. But it won’t go to zero — there would still be enough money to pay remaining benefits for years to come. Still, this is a great time to fix Social Security precisely because we might do better if there isn’t a crisis. Yet many Americans view the deficits as a crisis. Surveys show that people think Social Security won’t be there when they retire. Sure, many people say that. But it’s not consistent. Those surveys also often ask, “Thinking about your own retirement, where do you think the money will come from?” The same people who say Social Security won’t be there commonly include it in their expected retirement income. So what fixes need to be made? We need to make Social Security financially sustainable. There’s a straightforward, nonradical way to do it. In 2004 [former director of the White House Office of Management and Budget] Peter Orszag and I proposed balancing modest and gradual reductions in benefits with a modest and gradual increase in the Social Security payroll tax — 2.8 percentage points over 70 years on top of the current 12.4% paid by employers and employees. Initially, the increase would be only about $25. The full tax, about $1,000, would be reached in 60 years. Your plan is nearly 10 years old. Would it still work? Yes, but the deficits have grown about 40% over the last decade, so fixes would have to be larger and kick in more quickly. [The Social Security Administration said this year that immediately raising the payroll tax 2.66 percentage points could repair the program.] One of the few reforms proposed by President Obama is to use a different measure for cost-of-living increases, called chained CPI. This measure, which takes into account consumers’ ability to buy cheaper versions of costly items, results in smaller benefit increases. What do you think? It’s bad economics and bad politics. Under this plan, the chained CPI would also be used to set federal income tax brackets [which are now based on the headline Consumer Price Index]. So it’s both an income tax increase, because people would be pushed into higher brackets more quickly, and a Social Security cut, because benefits would increase more slowly. Let me start with the terrible economics. Since the benefits grow more slowly year after year, the impact is biggest for those who are oldest. So the elderly would suffer most. Is this who we particularly want to hit? Heavens, no. Proponents recognize this, because they often say, “Oh, but we’ll offset some of it when you hit 85.” Terrible way to do it. As for the bad politics, we have a long-standing tradition that Social Security financing is not part of the regular budget process. Rather, as it is funded by dedicated tax revenue, changes to financing are made separately. That way we have a secure system people can rely on for the long term. And the proposal to switch both Social Security and tax brackets to chained CPI would be a real break with tradition. It would be a quid pro quo between cutting Social Security and raising income tax revenue. It would be an unfortunate precedent — using Social Security as a bargaining chip in annual budget negotiations. That would be bad for the country. You’re very familiar with today’s political gridlock, which kept you off the Federal Reserve Board after your 2010 nomination. How might Washington reach a deal fixing Social Security? Right now it’s pretty hopeless. But that’s not unusual. Washington typically postpones fixing the program until a crisis is imminent. Obama faces difficult gridlock, so it wouldn’t be easy, but undertaking Social Security reform would be a great legacy — one that’s less controversial than health care. Next to Social Security, 401(k)s have become the national retirement savings plan. But they don’t provide the same security as defined-benefit plans. The defined-benefit plan, as it operated in the U.S. labor market, was never as good as lots of people thought it was. It was hard for firms to fully fund. And how much you get from a DB plan depends on mobility — when you come to the employer and how long you stay. Many of the formulas make little sense. The President has proposed a cap on the total amount held in tax-advantaged retirement accounts. What’s your view? It’s clear that there can be gaming of the system; we’ve seen some of it in reports of hedge fund accumulations that are just enormous. A tax break that extends to too much savings is just a weakening of the taxation of capital income. So, yes, we want to limit the tax breaks. What else can the government do to improve the retirement system? I look to the Thrift Savings Plan for federal civil servants as a model. The TSP doesn’t have many choices, but they’re great, and the costs are low. You can also easily turn your savings into income with an annuity. The government could make the TSP available to everybody, or it could set up a parallel plan as an IRA or 401(k) option. Other IRA and 401(k) providers wouldn’t be happy about that. You will get screams from the financial firms. They don’t like competing with the government, especially if the government’s plan is subsidized — say, by getting a break on administrative expenses. But this can be done on a fair-competition basis. The question is, Can the government just do this better than you can? Often the answer is yes. Private industry won’t disappear. There will be competition for the government. And the government will have to be doing it well.