Paralleling the argument over bean-counting, and the usual wrangling over who should bear what part of the burden, there was much jousting over the economic effects of a tax cut. People saw clearly enough that the acceptability of Social Security in the future would hinge upon economic growth in the interim, which in turn hinged upon investment. How, though, did the Social Security tax affect investment?
The New York Times (concurring with Moynihan’s opinion of Republican "thievery", but opposed to tax cuts) argued this way: "Future taxpayers won’t mind the tax burden [of supporting future retirees] if they feel well off. The best way to guarantee that is for the nation to invest in education and capital equipment." (Here again, they took some words out of my mouth. But they went on to say ...) "The big danger of Moynihan’s tax-cut proposal is that it threatens such investment. Tax cuts drive up the deficit, siphoning private savings away from productive investment." [12] Again, on the same theme: "For the economy to grow, the nation needs to invest in better machinery and in better workers. But such investments won’t happen if escalating Federal deficits continue to divert private savings." [13]
The joker in the argument is that it ignores the corresponding effect of taxes. How can the private sector invest what has been taxed from it, any more than what has been borrowed from it? Private investment (in things other than government bonds) is curtailed either way. How it affects total investment in productive, future-building activities depends on what the government does with the money. Government expenditures might or might not be "investments" in economic growth.
It’s true that there are some second-order effects, and these may be the cause of confusion. To the extent that government borrowing actually draws resources from the private sector, it is likely to bid up interest rates, until the private sector’s demand for investable funds is curtailed enough to clear the market. (This means only that the fall in private investment [14] will not match government borrowing dollar for dollar. The higher interest rates call forth additional saving, which goes to the government, along with some part of what would previously have been borrowed by the private sector.) On the other hand, if instead the government obtains the same resources by taxation, only a part of what it takes from the public was going to be invested anyhow; people do not save all of their money. The balance of effects is murky, but it’s fair to say that there’s no presumption in favor of taxation as against government borrowing; either way, private investment (in productive activities of the private sector) will fall.
A more substantial source of confusion, not widely understood, is that not all government "borrowing" is really borrowing. What the government "borrows" from the Federal Reserve System is not really loaned by the private sector. It’s commandeered by expansion of the money supply — "printing money", in effect. [15] To the extent that inflation stimulates the economy, this part of government "borrowing" does so; that’s why there’s a superficial impression that government deficits as such stimulate the economy. The stimulus, though, depends upon surprise; once the private sector has correctly estimated the future course of inflation, it builds its expectations into the interest rates at which it will loan money. Then the government must unexpectedly step up the pace of inflation. As it becomes harder and harder to catch anyone by surprise, the stimulatory effect of inflation becomes less and less. The "stagflation" of the late 1970’s showed the end of that game.
Taking the long view, government borrowing may threaten future retirees more than an increase in their payroll taxes today, but only because it’s a backdoor entrance to inflation. Nothing stands in the way of inflation but the stubborn insistence of a Federal Reserve chairman. Legislators and presidents alike are caught in an intolerable tug of war between voters’ demand for government services and voters’ resistance to taxation. It is a standing temptation to fudge a little: lean on the Federal Reserve to loosen up its reins upon the money supply. Then wages, prices, and the tax take all rise together. Seniors can be paid every cent that they were promised; it’s just that every cent they were promised won’t buy the living standard which the promise implied. Sure, it’s chiseling, but the mechanism is obscure, and the blame can readily be shifted to "greedy corporations" or "selfish unions".
Tying all this together, who was right? Would a cut in the Social Security tax have endangered the benefits of future retirees? Let us assume, as all the discussants did assume, that government "borrowing" is not turned into backdoor expansion of the money supply. (Monetary policy at the Federal Reserve was in fact non-inflationary at the time of the discussion. Were it to become otherwise, we would have to add that admonition to whatever else we might suggest, but it’s a separate discussion.) Assuming, then, that the alternative to taxation is true borrowing from the private sector, I think it’s pretty much of a wash. The discussants were distracted by a side issue; what they discussed was not nearly as important as what they mentioned only in passing. The manner in which the government extracts resources from the public to finance Social Security is not nearly so important as what it does with these resources.
If government expenditures out of Social Security receipts constitute investment, which will grow the economy to cover the future obligations, well and good. Otherwise, whether the money be taxed or borrowed, we’re in trouble. [16] How could we have lost sight of this?
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