Continued from the last post.
Question #5: Would privatization be a free lunch? (See numerous posts at Angry Bear) Economists are trained to be very skeptical of free lunch claims. It's hard to answer yes to that question. However, if it were reworded: are the opportunities for some small efficiency gains? That asks about the same thing but sounds better. (Ok, ok, I'll quit being evasive.) Not much of a free lunch--not to the extent that some claim. Some efficiency gains might be possible, mostly for the very young. This has a lot to do with how people's portfolios will change if there was privatization. It also has to do with Ricardian Equivalence. Here's what I said in January. I was responding to PGL of Angry Bear:
PGL writes that if people already have balanced portfolios, including the bonds implicit in the Trust Fund and their 401(k)s and they suddenly receive the Trust Fund, they will not buy stocks. The implication is that they would buy bonds, effectively replacing the bonds in the Trust Fund and keeping their risk/return ratio the same.
Our logic is pretty much the same. If Social Security was fully funded, I would absolutely 100% agree. But it's not. So I don't. Not 100% anyway. I have to ask myself this question. Suppose the government gave me a $1000 refund on my FICA tax for this year and offered me two options. 1) Give it back to Social Security and forget the whole thing ever happened or 2) buy a $1000 government bond (TIPS, so I don't have to worry about inflation) and keep rolling it over until I retire.
I choose door number 2. In a heartbeat. In other words, I don't think that the bonds implicit in the Trust Fund are the same as a bond in my hand (or my private account). If I did think that they were the same, I wouldn't care--option 1 and option 2 would be equivalent. (UPDATE/CLARIFICATION: It's not by a wide margin that I choose door number 2, but I would choose it. The implication that has for PGL's comment is that while I don't agree 100%, I think he's close. Close enough that there should be more discussion on this point.)
Another reason I'd choose door number 2 that I didn't mention is that I would just like to own the bond myself. Once I own those bonds, would I sell some to buy stocks? I would if my portfolio was previously at a boundary--if I had no stocks and was borrowing constrained. I make the same point in these comments.
No large scale free lunches, but some small scale efficiency gains for mostly young workers. The wealthy and the over-40 set would probably be unaffected. In other words, Ricardian Equivalence would be a good first order approximation. Barro and Becker would be right as a first order approximation.
Question #6: Should private accounts be carved out or added on? I think a carve out would be better if it was done right (sensible assumptions about equity growth, less Draconian cuts). It would also be worse if it was done badly (use your imagination). To have any value, an add-on would have to accomplish something that the present array of 401(k)s and IRAs does not. If it encourages young people to save, it would be better than nothing.
Question #7: What is the significance of 2041? I'll be 69 years old. That's about it.
In other words, the date the trust fund is exhausted is a moving target. (Wasn't it just 2042?) If productivity growth stays healthy and other good things happen, that date will be pushed back. It has been pushed back before. But by the same token, it won't be pushed back to infinity. Since initial benefits are indexed to wage growth, it is harder for productivity gains to push that date back than if initial benefits were indexed to price growth. (See my response to the question on whether or not there is a crisis--it's not a crisis, and 2041 isn't set in stone.)
Closing thoughts: A reasoned debate is still possible. My rationale for these posts is to summarize where I've been and collect my thoughts in one place for my own reference (and yours if you're still listening) as we go into the serious debates on this issue over the summer. If you're still with me after these two posts, you can decide for yourself where I am on the ideological spectrum--I've been called all kinds of things. But I endeavor to be honest. I try to be as consistent as I can be. I love a good discussion of economics, both theory and policy. This has been, and promises to continue to be, both enjoyable and enlightening. As I look back, I haven't changed my position much, but discussions with you, my readers, have refined them.
Thanks to everyone with whom I have discussed these issues through e-mail or blog comments. I look forward to more. Have at it.
Two thoughts on this set of queries: (a) a gradual approach would be preferred because it would spread the pain across all living generations - including the currently retired - but Bush has ruled that out; and (b) the lack of prefunding does exist but how does that make the case for privatization? Someone has to ante up the difference. Now if you are endorsing a return on the estate tax so Paris Hilton et al. antes this up - GREAT!
While I am utterly cynical about this administration and the 'real' motives behind the proposed reform, I too can see some attraction in door 2, as you have direct ownership. A caveat though:
You would pay the administration costs of holding the bonds in a private account. Are these not likely to be somewhat higher than letting the govt do it? (orczag/diamond argue yes, I believe). So perhaps its not free.
RJW,
If Social Security actually gave me the return on those bonds they hold "for me," I would agree. It doesn't, so I don't.
PGL,
I think if you were gradual enough you wouldn't have to impact the current retired generation. Yes, you have to pay the freight (in Dave Altig's words) for the current and about-to-be retired, but if you phased in any changes gradually enough I am quite confident that current workers could pay that freight. However, every day we wait makes it more difficult to do it my way. I'm becoming resigned to the fact that it won't be done as gradually as I want. I would like privatization only if it were done right--which I think is economically possible (though maybe not politically possible).
I really didn't like the House version of the current privatization bill, and I'm not crazy about the Senate version. I hope we get some quality discussion on the Pozen plan.
I'm as steadfast as ever on the concept of partial privatization, but I'm mindful of the fact that the actual proposal might be less attractive to me than my "ideal."
As for trying to bait me into a discussion of the estate tax, I'll take the bait. This may surprise you, but I'm generally in favor of the estate tax as we have always known it. My main concern would be for family farms, but the horror stories are out of proportion. Repealing the estate tax might actually hurt family farms and benefit the "city folks" who own farmland and also benefit from farm subsidies.
Since you opened the door, I think your post a couple weeks ago painted a little too rosy of a picture of the average midwestern family farm. (Saying that "the kids will have to survive on a mere $9.5 million per year" was a little gratutitous, IMHO. It didn't exactly work that way among my friends who grew up on family farms.) However, one does not have to paint that extreme a picture to agree that the horror stories are overblown.
But let's keep the two issues separate as much as we can. I don't want to make the estate tax a means of funding Social Security reform. I think framing it that way would be a mistake.
I'm curious about your post William.
If you mean that in practice the implicit return to your payments (the 2% number quoted around so much?) will be less than if you put it into conventional t bills, then there is a flaw in the argument.
The fact is that the first generation that benefitted from the system did so at low personal cost - they derived significant net benefits and imposed a drag factor on later contributors that lowers returns to payments in.
But this is purely an artefact of the way the system was set up, and the fact that this involved a significant redistributive transfer.
To put it another way - its not legitimate to compare the return on a brand new private system starting from scratch with the implicit return you get in the current system, as the starting points are different.
But this is a pretty obvious point, so I guess you had something else in mind.
Suppose that your contributions were higher. So they holds more bonds in trust. Do they not pay the market return on those additional marginal bonds? Is here some cross subsidisation of general spending by paying below market returns?
I'm not au fait on the mechanics of how the system is actually managed on a day to day basis, so perhaps this is what you were geting at?
I hope this debate on SS ends soon. I’m sick of it.
SS is a subsistence level support program for seniors and the disabled, most of whom would otherwise be impoverished. There is no reason to expand it to private accounts. We already have 401Ks, IRAs, SEPs, etc. There is no reason for the govt to become more involved in private accounts.
Excess SS contributions into the trust fund have been squandered and the trust fund is owed almost 2 trillion $. This amount is rising rapidly as it is accumulating interest as well as principal. The govt will flood the market with bonds to raise money to pay back the fund when SS needs the money to pay benefits to boomers. This will cause interest rates to skyrocket, as Greenspan has said, and the govt will find it difficult to raise funds for its bloated budget.
With a few tweaks now and then, SS can easily remain solvent. The problem will be paying back the trust fund between 2018 and 2042 or so. This is really what the politicians are worried about. Our federal govt will itself be destitute.
RJW,
This is what I'm talking about.
http://www.sf.frb.org/images/pdfcharts/el99-34.pdf
This and other sources put the rate of return at under 2% and getting worse for workers just coming into the system. Honestly, I don't care about myself as much as for an 18 year old just starting out. It's too late for me.
But suppose we are generous and say that Social Security will pay 2% on our contributions. Would the real return on TIPS pay more than 2% over the long run? At today's rates, just barely. But today's rates are below historical averages by any measure. I'd take the bet, even taking a few basis points off for administrative costs.
A couple other points. The file I link to in this comment only deals with OASI, not the disability insurance. This is your rate of return on the 10.7% that goes to the retirement portion of Social Security. This is the right comparison.
And I am well aware that the Social Security benefit system is progressive--this is as it should be. So I wouldn't want full privatization, but partial privatization. Leave a partial pay-as-you-go system to provide progressive benefits to low income retirees.
Preserve the insurance; scale back the pay-as-you-go pension system. Why should this be regarded as impossible?
The FRBSF Weekly Letter from which those charts came is here.
http://www.sf.frb.org/econrsrch/wklyltr/wklyltr99/el99-34.html
william - thx for the coming back on my post - I appreciate that - a couple of remarks:
- surely the 2% return is below market because of the intergenerational drag factor I mentioned in my previous post. it's a historical artefact no?
- to put it another way, surely the 2% return does not apply to marginal changes in contributions. And for purposes of comparing rates of return, should we not look at the marginal return, and not the average ?
- so suppose people cut their contributions and invest privately. to finance this government debt goes up by the same as the reduced contributions (ceterus paribus). the individual gain from the private account is thus offset by the fact that their future taxes will be higher (to cover the higher govt debt)
- and the relevant interest rate comparison here is then the return on private accounts versus the marginal cost of additional govt borrowing. (which are pretty much the same if individuals stock their private accounts with t bills - less any differences in admin costs etc etc)
of course - tax incidence affects might affect the individual outcomes. And people might choose to go for riskier assets with potentially higher returns. And they have direct ownership with private accounts.
so - not that i'm arguing against private accounts ( i see the case , and i think that there is a pretty good argument for part privatisation). I just want to be clear on the economics.
I'm not sure - do we disagree on something in the economics here?
an afterthought - suppose the gubmint does not pay a market return on contributions, but pays below market so as to keep current taxes lower or spending higher,
- then this is also neutral if the taxpayers use the proceeds from their lower taxes to save more (definitely not the case right now it seems, which is a worry).
- it's not neutral if the net effect is higher govt spending not lower taxes. then it's much more complicated
rjw,
You ask about marginal vs average rate of return. Yes, I've been using an average. Marginal is a bit tricky to define here. Are you suggesting that if you earned an extra $10 so that you could contribute an extra dollar to Social Security you would earn 2% or more on that extra dollar? Since benefits are progressive, I don't think you're going to get a higher marginal return than average return. If anything, wouldn't it be lower?
Is it generational? Partly. If you turned 18 in 1983, that's too bad (you're paying higher taxes throughout your working life). In other words, it's not necessarily an artifact of the way the system was started (your point) but also how it has evolved.
Let us not forget that the rate of return to Social Security is subject to political risk. (If taxes go up, the rate of return goes down.)
You say, "of course - tax incidence affects might affect the individual outcomes."
Of course, and that is a big part of my point. More to come.
thx again.
yes - what I'm saying is that the extra dollar contributed to the system at the margin earns more than 2% - that basically it earns the rate on govt debt (as it effectively reduces the outstanding volume) . that is the essence I think of what I was getting at above.
But the redistributional effects of the system (leaving aside , for the sake or argument, the generational drag factor) could lower the return on marginal contributions for some individuals. But won't others then get higher returns relative to their contributions - (a cross subsidy)
On evolution - yes - history basically I guess. And on the political risk - agreed - a good part of the case for a private component I think.
On incidence. Lots to say, I guess.
Cheers
Return to the Social Security system (market return) need not coincide with the return to the average representative of any one generation. That's the bottom line.
Yeah, that's pretty much it. There is some intergenerational drag and there is some redistribution. The average person born in the last few years could do better, at least according to the source I cite.
Yes, the marginal (and average) return is higher for low income workers. This is as it should be. Government provided social insurance is a good thing. Government run pay-as-you-go pensions are tempting targets for presidents and Congresses as we have seen, and end up being a lot of trouble.
Keep the insurance and scale back the pension. In a perfect world, I think this would be the best idea. However it's not a perfect world and there are arguments to be made on both sides. These decisions are made in the political arena, not a blackboard in an economics class.