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July 17, 2005
Mark Thoma on forced saving and Social Security
If you've been following this blog for the last few months, you know that Mark Thoma and I have engaged in a running discussion on Social Security. (PGL of Angry Bear commented on many of those posts, and others commented occasionally.)
And so, I bring you this recent dispatch from Thoma which I quote in part: (It's quite long, and I'm skipping over the part on insurance against poverty, a topic we have both covered-- Thoma here and me here).
A common solution to the moral hazard problem is deductibles and co-payments that cause individual to share in the cost of a negative outcome. Two proposed solutions to market failure in retirement savings markets have this deductible feature. The first is well-known, opt-out, add-on accounts. These tend to work better when the default outcome is very unattractive, and the difference between the outcome with active participation and the outcome with passive participation can be viewed as the deductible the individual pays for behaving in a manner leading to sub-optimal outcomes. The other is a money match program where the government matches, say dollar for dollar but the exact ratio could vary, money put into retirement savings accounts. In designing a system, I would implement a combination such as an opt-out add-on accounts with the amount matched in some ratio by the government (and capped) unless one of my really smart economic advisers convinced me some other program would work better.
The opt-out solution has the problem that short-run considerations may interfere with following the optimal long-run plan, and there is an argument for forced individual saving because of this. A family responding to the pressures of the moment may make decisions that, in retrospect, were not the best in the long-run, and forced saving overcomes the short-run temptations (IRAs have this feature). Forced retirement saving is not my preferred solution, but it needs to be mentioned, and, if the opt-out system appeared to allow sub-optimal behavior to emerge even with the incentives described above in place, I would consider dropping add-on accounts and adding forced retirement saving to the forced poverty insurance payment. That would result in a system resembling the current system in many ways. (emphasis mine)
All in all, it's a good post. In the part I'm not quoting, he has a little to say about how to design the poverty insurance aspect of Social Security. Of course, there are issues that are too much for one blog post, so there are no final answers here. But if you have forgotten the earlier discussion, this will refresh your memory.
In the part quoted above, Mark admits that add-on accounts may not be the optimal solution either. It doesn't totally overcome the incentive problem. He doesn't give forced savings a ringing endoresement, but says "Forced retirement saving is not my preferred solution, but it needs to be mentioned, and, if the opt-out system appeared to allow sub-optimal behavior to emerge even with the incentives described above in place, I would consider dropping add-on accounts and adding forced retirement saving to the forced poverty insurance payment."
First of all, forced retirement saving would (or at least could) look a lot like a system of private accounts much like the privatizers have been talking about. In fact, I should probably say "partial privatizers" since most of us who have advocated private accounts at one time or another have really been arguing for partial privatization. Partial privatization would effectively separate the poverty insurance from the retirement savings. The former could quite likely remain solvent in pay-as-you-go form while the latter becomes a system of "forced retirement savings."
Of course, I am assuming that the forced retirement savings go into an personal account. That would not look much like what we have now, so I have to differ with Mark a little bit, at least on the specifics of how I would implement the "forced savings." (Since he doesn't mention private accounts, I have to admit the possibility that he wants forced saving without private accounts--Mark, if you're reading this, please clarify.) Here's why. If we accept Mark's implication that the forced savings looks much like what we have now (without private accounts), then what is the point? One more way to divide up the FICA tax? Would a certain percentage go to a poverty insurance fund and a certain percentage go to a retirement fund? What sort of rate of return would it yield? If it resembled the rate of return the average person receives on their OASI contribution, there would be open revolt! You'd have people begging for private accounts so fast it would make your head spin.
Perhaps Mark would advocate funding the program by letting the government invest in other assets (i.e. stocks) rather than just government bonds--in effect, fully funding the retirement savings but not giving individuals private accounts (and control over the risk/expected return trade-off). He mentions this elsewhere in his post. But this has been suggested before and it went nowhere.
Honestly, I don't see how you sell a forced savings program without private accounts. My return from a forced savings program without private accounts is going to be determined by politics rather than the market.
On the other hand, partial privatization is really just forced savings with private accounts (and choice over your risk/expected return trade-off). At the risk of sounding like a broken record, I think that could be done quite effectively if it were phased in with younger workers first.
That said, Mark's post is a step in the right direction. He and I definitely agree that it would be better to separate the insurance from the retirement savings. The details are still left to be debated. I prefer the "forced saving" with private accounts over the add-on opt-out accounts. Whether I could reluctantly support the latter is something I'm currently pondering. Government matching money for retirement savings is worth exploring (Mark mentions this in his post as well).
The debate continues. The real question is whether any progress will be made in Washington this year. If the second half of the year is like the first, I doubt it.
UPDATE: Has Daniel Altman been reading our blogs?
Posted by William Polley at July 17, 2005 10:49 PM
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Comments
On the private accounts question, it has never been the participation in equity markets that has bothered me about the proposal. Instead, it is the shifting of risk unnecessarily to the individual. I see no reason, even with a forced saving program, for people to bear financial market risk, and hence economic risk individually. Instead, I prefer that the assets be pooled and held collectively so that all can receive the average return instead of having winners and losers, particulalry since it is not clear to me that with individual accounts the private market would offer assets with these characteristics to all who wished to participate (those with an aversion to risk which presumably captures a large share of the population).
The administration proposals did not, in my view, distinguish between the insurance and savings functions, and the very use of the word private and personal implied a desire to implement a system where, as I see it, individuals bear risk unnecessarily. In the long-run vision of the administration where accounts are purely personal recognition of the value of risk-pooling and problems with market failure seemed absent. Retirement savings shouldn't be a lottery for individuals and in the end I did not beleive that the goal of the administration was simply to address market failure in the retirement saving market by some kind of opt-out, add-on system. Carve out, and the more the better, is my recollection of the starting position. Even now, with only add-on ccounts under serious discussion, I see this more as an opening gambit rather than an end game in Washington.
Posted by: Mark Thoma at July 18, 2005 2:43 AM
If people actually received an "average return" and the share of payroll tax going to this forced savings plan was reasonable, that wouldn't be so bad. I do worry about this "average return" you speak of, however.
If this ends up being referred to as a "forced savings" plan, the rate of return better be competitive. That would require a system that looks quite different from what we have now (because it's not even close to being competitive with the private market as a savings vehicle).
Does the government guarantee a minimum rate of return? (moral hazard)
And who decides what is the right amount of your retirement savings to be held collectively to eliminate winners and losers?
Posted by: William Polley at July 18, 2005 6:24 PM