William J. Polley: Social Security Archives

September 25, 2007

Another run at Social Security reform?

Andrew Samwick informs us of the Treasury Department's series of issue briefs on Social Security reform. The first one is already up on the Treasury website.

He is pleased to see that the Treasury issue brief points out that:

Delay reduces the options for distributing the financial burden of reform across generations because delay exempts additional generations from sharing in the financial consequences of reform.

Samwick said something similar in the early days of his blog (October 2004).

...each year that elapses without reform causes the burden of financing the unfunded obligations to be shifted away from one more birth cohort that crosses the threshold of being "at or near retirement." The more we wait, the larger the burden on future generations...

I couldn't agree more. My comment in Feburary 2005, when talk of reform hit its peak was similar.

The more gradual the transition, the more the transition cost can be spread out. The sooner we start, the more gradual we can afford to be.

Now to be sure, I'm not one of those who thinks the system is in imminent danger. However, the fact that the system is on solid ground for a number of years to come reinforces the idea that any reform can be gradual. If we start now with a cautious and reasoned plan, the result will be better than if we wait another ten years and need to consider something less gradual.

As I put it in my first post on the subject:

Could the right sort of adjustment/modification/reform of Social Security in the next few years make future retired persons better off? Almost without question, yes.

Is Social Security on the verge of becoming the nation's biggest fiscal problem if it's not fixed in this presidential term of office? Definitely no.

...

But I also concede that you can't just take any old privatization scheme off the shelf and say that it will be a Pareto improvement.

I think that still sums up my thoughts on the matter.

Posted by William Polley at 11:16 PM | Comments (14) | TrackBack

April 23, 2007

Social Security report released

The Social Security Board of Trustees Annual Report is on the web. Have at it.

Posted by William Polley at 04:54 PM | Comments (0) | TrackBack

October 17, 2006

Watching the odometer turn

Remember when you were a kid and you couldn't wait to see the odometer in the family car turn over to some multiple of 10,000. Of course in today's cars the odometers are digital, so it's about as exciting as seeing your digital watch tick past midnight. Those old odometers looked like they really had to work to turn that last digit.

And so it is with the U.S. population clock which, as I write this, stands at 299,998,288. You can check the current number for yourself by going to the Census Bureau web site. In the morning, the big three-oh-oh (million) will have been reached. The Census Bureau's clock, like my odometer, is digital. The addition, be it by birth or by immigration, will arrive seemingly effortlessly. I think that is a good analogy. We're not running out of room in this country by any stretch of the imagination. Our society and economy will absorb the 300,000,000th person as readily as the 299,999,999th. And by 2050, we'll be adding number 400,000,000--a fact which causes Joel Kotkin to opine in the Wall Street Journal:

Unless there is some sort of cultural revolution, most people, particularly families, are likely to continue migrating to places where they can acquire a spot of land and a little privacy. And despite the much ballyhooed "return to the city" by aging boomers, most experts suggest that most are either staying in the suburbs or moving to towns farther out in the hinterland. At least 30% of Americans, according to surveys by the National Association of Realtors and the Fannie Mae Foundation, express the desire to move to the country or a small environment, far more than live there now. The scale of this dispersion depends largely on urban governance. If cities cannot, due to economic or regulatory constraints, provide sufficient job opportunities, people and businesses naturally will flee elsewhere. Other factors, such as preserving family-friendly neighborhoods and stamping out a nascent resurgence in crime, will also be critical.

Yes, we will find room for number 400,000,000 too. There is room for a few of you out here. Sorry, no "for sale" signs on my block. The few that were available this summer have long since been sold. Unlike some places, the real estate market here seems to be approximately in equilibrium. Growth is proceeding sensibly. I still have to get used to the sight of a new apartment complex a mile or two south of us. More room for the next hundred million Americans.

So rejoice at this milestone. Malthus was wrong. We're not doomed by population growth. While a growing country has always presented certain challenges, it has been our innovative responses to those challenges that have made this country what it is. And it's a reason that people keep coming.

To the 300,000,000th American: Welcome! We're glad you're here.

Posted by William Polley at 01:19 AM | Comments (0) | TrackBack

July 28, 2006

Social Security sense and nonsense

First the nonsense. Mark Thoma quotes a Financial Times piece by Rep. Jim Kolbe. For the sake of brevity, the last line from Kolbe says it all.

Far more people would confront the need to rein in entitlements if they understood how they are putting our foreign aid budget in a straitjacket.

By entitlements, Kolbe is speaking broadly to include Social Security, Medicare, etc. To which Mark responds,

I don't have time to deal with this properly, so hopefully comments or other bloggers can put this into it's proper place, but the amount of foreign aid we give relative to the size of the budget, spending on the war, and so on, is miniscule, low among developed countries on a per capita basis (this says 27 billion in 2004).

Indeed. When I read Mark's post, I couldn't help but wonder just how I would properly deal with such a statement. Foreign aid is often smaller than the forecast error in the budget. True, foreign aid would be one among many programs fighting it out for the remaining funds if there were broad cuts in discretionary programs. But my assessment of the situation is that there is a substantial enough lobby to prevent any serious reduction in aid. There are other, larger, more promising targets for the budget axe. Now, might there be some political reason for setting up a false tradeoff between foreign aid and Social Security? Of course. One doesn't have to be all that cynical to see that. There are always political reasons for framing the rhetoric of budget priorities. So take that and see where you end up.

By the way, I'm no huge fan of the current system of foreign aid. What we do spend is often used less than effectively. That doesn't change my opinion of Kolbe's odd comparison.

So that's the nonsense. PGL at Angry Bear chimes in as well, and in a comment to that post he offers up some sense about Social Security. For context, the comments at AB went in the direction of the "trust fund" as often happens when Social Security is the topic. PGL writes,

On this no trust fund argument, consider this analogy. A 53-year old worker has accumulated funds in a private retirement account to which he'll continue to add savings draw from his salry for the next 12 years. In 2018 he retires and wishes to draw funds from his account from 2019 onwards. Imagine his reaction if he were told that his account weren't really there. That's the rightwing argument. Something tells me that this 53-year old would not accept it in the least.

That is a nice illustration to make the point that the trust fund represents a commitment to play by the rules of the game (but see below). And that is precisely how I see the trust fund. It is an accounting device that represents the promise to follow the law as currently written. The accounting device (whether a ledger sheet or a file cabinet full of bonds) is not the important thing. The promise is. As I said a year-and-a-half ago:

We need to be careful about what we mean when we discuss (or imply the possibility of) default lest we fall into rhetorical traps. The "worthless IOU" argument is itself worthless. There are undoubtedly other cases where it has been used to get the attention of the reader and then been cast aside when it has served its purpose.

My opinion on that has not changed.

To elaborate briefly on PGL's point, the government wouldn't tell the holder of a private account that his account no longer exists. Rather, they could allow inflation to eat its purchasing power away, or they could raise the taxes on investment income. The rules of the game can be changed in many ways--some ways are easier and/or more visible than others, and that should not be forgotten. But the basic thrust of his comment is on the mark.

And that brings us back full circle to the Kolbe article about "entitlements" in general and the trade-offs that they imply for present and future Congresses. Entitlements are, in effect, promises. People assumed that those promises would be kept when they made decisions such as how much to save for retirement. Just remember that when people plan how much to contribute to their private retirement funds, they are also making assumptions about future tax rates and inflation rates. However, I'm not sure that we treat those assumptions like promises--we know that tax rates and inflation rates are too fluid to project out 30 years. That is a distinction worth remembering.

Posted by William Polley at 01:13 AM | Comments (1) | TrackBack

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 10:49 PM | Comments (2) | TrackBack

June 24, 2005

Another Social Security proposal I don't like

With apologies to Brad DeLong, I think this deserves a "Why, oh why..." sort of intro.

Here's the Washington Post article about DeMint's proposal for private accounts. They catch on to the flaw.

Key Republican lawmakers, scrambling to keep President Bush's Social Security proposals afloat, plan next week to embrace an idea that many have avoided thus far: funding personal retirement accounts with surplus revenue that now pays for other government programs.

There's a reason they avoided it. It's a bad idea.

The strategy is controversial because it would create new budget problems. Either the diverted money would have to be replaced with new taxes, or Congress would have to slash programs now funded by Social Security's excess payroll taxes.

and...

Aides close to Graham, Santorum and DeMint said their proposal will not preclude broader initiatives, including several that have been floating for months. "It is not a comprehensive reform," one aide said. "It is sort of a first step toward gaining momentum." A Graham aide said the senator still thinks Congress must trim benefits and raise taxes to safeguard Social Security's future.

Another GOP staffer familiar with Tuesday's scheduled event said the participants will acknowledge that redirecting surplus Social Security funds will create budget problems elsewhere.

"No one is going to find a magic bullet," the staffer said. "There's going to be real pain at some point."

Among other things, the proposal would be horribly confusing to implement. Are they proposing to divide up whatever the Social Security surplus turns out to be in a given year among millions of private accounts for people? And these accounts just hold government bonds? The surplus is set to shrink, you know. So over time, the additions to the private accounts shrinks? At least Al Gore's proposal was more practical. This one just seems odd to me. The only thing I can possibly come up with is that they figure that they will add-on or carve-out more contributions for the private accounts later. But if that isn't spelled out at the beginning, it could lead to trouble down the road. Do you raise payroll taxes down the road to pay for low income taxes today?

If they want a "lockbox" as a commitment mechanism, that's one thing. But the addition of private accounts would be needlessly costly added to a plan like this. It doesn't make any sense. There are better ways. It seems like they are trying to blend Gore's lockbox with a minimal sort of private account. The result would be more costly and confusing than either Gore's lockbox or a straight-up diversion of some percentage of the payroll tax to private accounts.

I like the principle of private accounts--I really do. But when something like this comes out of left field ("right" field?), it seems to indicate that there is not a well thought out strategy here. DeMint has this plan, Bennett has another, there are already House and Senate bills (imperfect as they are) languishing in limbo.

Socialsecuritychoice.org is already spinning this as free lunch. They don't use those words, but they also don't acknowledge the costs. Not acknowledging the costs constitutes "spin" from my point of view.

Mark Thoma is disgusted with it too, as is PGL (Angry Bear). Thoma goes to great lengths to smack it down, which is really unnecessary. "No free lunch" says it all. The rest is commentary.

UPDATE: It's worse than I thought. (h/t Mark Thoma)

Posted by William Polley at 12:36 AM | Comments (2) | TrackBack

June 23, 2005

Are private accounts for Social Security DOA?

Probably. Today's NY Times editorializes thusly:

Rather than accept defeat and consider alternatives, Mr. Bush is becoming even more feckless as public and political opposition mounts. On Tuesday, in a lame ploy to draw the Democrats to the table, he gave tepid approval to a proposal by Robert Bennett, the stalwart conservative senator from Utah, to restore the system's solvency in a way that would not include private accounts - all the while saying that he was not prepared to give up private accounts.

Let me interject to say that I too thought that the "tepid approval" of Bennett's plan together with the continued push for private accounts was weird to say the least. I wonder what Mr. Bennett makes of it.

Mr. Bennett's plan includes drastic and unnecessarily large cuts in Social Security benefits, but at least he is being straightforward in offering a plan that addresses the real problem Americans want solved. A group of four Republican representatives have meanwhile offered a proposal that would, in effect, abandon efforts to restore solvency in order to resuscitate those doomed, unwanted, unwise private accounts.

Enough is enough. Mr. Bush must either put forth a complete plan - including details of the risks, benefit cuts and borrowing costs that privatization would entail - or abandon his quest. Anything other than that is wasting his own and, by extension, the American people's time.

It's getting harder and harder for me to imagine a world in which private accounts become part of Social Security before the end of this presidential term of office. If you've been following the blog for a while, you know that I've been supportive of the general idea of private accounts (see here, for example) but not at all bashful about criticizing various proposals that have been floated (see here and here, for example). As the discussion evolved, I came to see Social Security as a very good income insurance program and a lousy retirement investment. The real questions are how much income insurance is optimal and how progressive it should be. I became frustrated with the notion of "rate of return" as applied to Social Security (see the comments to this post). To the extent that Social Security is insurance, the term "rate of return" is awkward to say the least. Because Social Security is partly (mostly?) insurance, any calculated rate of return to the average participant is sure to be dominated by the return to TIPS--probably even dominated by the return on passbook savings accounts. So many people would be better off with private accounts, but if that comes at the expense of the social insurance, it's not an unambigously good thing.

All the while, President Bush kept talking about IOUs and file cabinets. In fact, he did it again on Wednesday. Ugh. It's like the movie Groundhog Day. Same thing over and over again. Even for a supporter of private accounts it's getting old.

And it's not working. Republicans are distancing themselves from private accounts (e.g. Bennett). The polls don't look good for private accounts. Midterm elections will be coming up quickly before anything can get passed. Even Andrew Samwick is losing hope. After testifying before Congress, he notes,

It is not clear that we accomplished much through this hearing. I got no indication from the Representatives that they would be looking to get a bipartisan bill through their Committee. I hope that I'm wrong.

I'm afraid he's probably right.

A few years ago (2001 to be exact), I put the number 2008 on the whiteboard in my office. When people asked about it, I said that's the next time that Social Security reform will be seriously debated. At the start of this year, I feared that I would turn out to be wrong. Well, I was wrong if you're talking about the blogosphere, but if we're talking about any serious chance of anything really happening in the halls of congress I still have a chance. It will only happen if a Democratic candidate engages by endorsing something like Brad DeLong's idea, (not Al Gore's "lockbox").

Not that I would mind having either or both candidates in 2008 touting some version of a plan to increase national (and personal) savings. I think private accounts, if done right, would work. But it is nearly impossible to imagine a world in which politicians could come together to do it right. The last 6 months have been very discouraging in that regard. Doing it right means phasing in private accounts (and the carve-outs) very slowly with younger workers. Since younger workers don't vote in large numbers, what appears to me to be the sensible way to do it economically ends up being political suicide.

It is with much disappointment that I say this. I have lost hope that a Social Security reform plan that is anything close to optimal will be politically acceptable, and I won't throw my support behind plans that are flawed. If that means no private accounts because the demographic who would benefit from them doesn't vote, then so be it. It's a miserable conclusion if there ever was one, but I fear it is so. Time to look for a second best solution for 2008. Enterprising Republicans and Democrats seeking the White House should get to work on it now.

Posted by William Polley at 12:39 PM | Comments (0) | TrackBack

May 15, 2005

Some numbers on Social Security

Most of you probably have heard most of what is in this article before if you've been following the debate. But in case you haven't...

Beware the Easy Fix for Social Security (NY Times)

Posted by William Polley at 01:36 AM | Comments (1) | TrackBack

May 11, 2005

"I" is for insurance, continued

First, I don't know if "Jane Galt" read my post on Social Security as insurance, but she comes to a similar conclusion.

What's the best solution, then? I'd say we're converging on it: a system of minimal government insurance for those who have been unlucky, in life or investments, combined with a regulated forced savings plan to make sure that those who aren't unlucky aren't tempted to free-ride on society, and incentives to employers to encourage additional savings among employees. This won't make anyone ideologically happy. But it seems like the least intrusive, most fair, most economically sound possibility.

Your ideological happiness (or lack thereof), I'd say, rides on how minimal the insurance. Hence, Mark Thoma writes in a comment to my post:

I agree entirely and have noted before that the question of whether a person views the current system as just insurance or insurance plus savings depends upon their (normative) view of the level of support that ought to be insured, the minimum acceptable level of societal support. Much of the argument you hear is needless because it is really an argument over this difference and there is no right answer.

Yup.

So now, Winterspeak asks (also in my comments section):

So what risk are we left with -- the risk that the retiree has not saved enough before he retired? I don't see how this is a risk. The retiree 1) chose when to retire and 2) saved throughout his life. This is not a risk, this is a bad choice.

Not to mention the bad choice of leaving all your retirement in the stock market too long.

I am supportive of (and understand) forced savings so ppl don't make the bad choice I've detailed above. But I cannot see the insurance aspect so social security. I don't understand why insurance against unexpected poverty should be limited to old people.

One crucial reason for a different sort of program to insure against old age poverty is that most of us are of a sensibility that makes us uncomfortable making senior citizens work to pull themselves out of poverty. For younger people, we have unemployment insurance and TANF, both of which have limits which induce young people to get back into the workforce. I think there is good reason for something different for those over a pre-defined, socially acceptable age.

As for the distinction between risk and a bad choice, I'd offer the following. Too much risk is sometimes the result of a "bad choice." In a free society, some people will make what I would consider to be bad choices and take on too much risk. Some will lose. Yet, I am uncomfortable watching them be reduced to poverty (when they have less of an opportunity to pull themselves out). So I like the idea of a safety net. But I also understand moral hazard, so I know that a safety net that is too generous will just encourage folks to make bad choices (take on too much risk, let it ride on the stock market too long, etc.).

Hence, the problem simply boils down to how generous we want that safety net to be. That is an appropriate question for society to consider through the political system. (And a question on which economists can and should offer sound theory and evidence.) Or, as Mark says (in a comment to my post),

You can argue anywhere from an absolute bare subsistence level to a fairly generous level of support, but there is no correct answer as to what is fair that we will all agree upon other than that a floor exists. And I suspect there are a few who would even argue against a minimal level of support.

And while we're at it, let's consider another source of risk that could bite a lot of people in the next few decades--the demise of the corporate pension system. I would be remiss if I didn't mention this:

Unions Threaten to Strike After Pension Default at United

This is the tip of the iceberg. There is also the more subtle pension shaving due to reductions in health benefits for retirees in a number of companies. Did the workers in these situations make a bad decision? The fact is, corporations may no longer be the appropriate vehicle for bearing this sort of risk.

Back to "Jane":

The defined benefit corporate pension plan has been, for a long time, the holy grail of liberals. It was lavish and safe. It is also dying. Not that it was ever that prevalent in the first place, mind you; liberals who lionize the Golden Days of the fifties and sixties seem to believe that everyone worked for either IBM or GM, when in fact most jobs, just like today, were with small businesses.

But the corporate pension was certainly *more* prevalent. Unfortunately, time has revealed its cracks; companies aren't very good vehicles for managing this sort of risk. Time is the biggest one; pensions require companies to plan over time horizons that span 30 or 40 years. That was fine in the cozy, protected, and highly regulated environment of the 50s and 60s, but when the market changed, the pension promises couldn't. This is what (among other things) is dragging down the major airlines; I expect that within the next decade we will also see Ford and GM default on their pension promises.

She goes on to say that there are problems with having the government provide this insurance as well (which I take it is why she argues for "minimal" government insurance). All of this leading up to her conclusion I quoted at the top of this post.

If we could get broad agreement on a coherent system that provides incentives for saving, together with an open and honest debate about the appropriate level of social insurance, that would be ideal.

Posted by William Polley at 11:51 PM | Comments (3) | TrackBack

May 04, 2005

The I in OASI is for "Insurance"

A couple days ago I said,

And what, you ask, do I think the real debate is (or should be)?

I'll have some thoughts on that later. It's probably not what you think I'm going to say.

Social Security benefits are progressive--benefitting lower income workers with higher replacement rates. The system is widely touted as Insurance against poverty in Old Age or in the case where a spouse or dependents Survive the main breadwinner. OASI=Old Age and Survivor's Insurance.

However, benefits are at least marginally tied to your lifetime wage profile--like a defined contribution plan or a forced savings program. So what is it? Insurance or forced savings? Brad DeLong and Mark Thoma emphasize the insurance aspect. Actually, they take particular objection to those who call it welfare. Most assuredly, Social Security is not welfare, so we've got no argument there. Angry Bear comes closer to a direct comparison of the insurance vs. savings question. He says,

...all of the privatization plans I've seen discussed would replace Social Security with a defined contribution style system in which the more a person makes, and the luckier that person is, the more that person will have at retirement, and vice-versa. The insurance function of pooling and attenuating risk is totally removed; or, more accurately, reversed.

So I think it is useful to think of a Social Security program like ours as having an insurance component to prevent poverty and indexed benefits as a political appeasement to those who are less likely to need the insurance.

Where do you draw that line? What is the appropriate level of insurance? Can you have private accounts (add-on or carve-out) and maintain the insurance aspect? How do we get from where we are to where we want to be?

This is the discussion that we aren't having, but should have. It doesn't matter where you stand on trust funds or private accounts to discuss the appropriate level of social insurance. If we could get a handle on that question, then we could make progress on the rest of it. The consequences of this question run deep. If you believe that the insurance portion of the system should be enhanced above what it is now, then private accounts are a non-starter. If you want to allow people to self-insure more than they do now, then you would likely think that private accounts are a vehicle for them to choose their level of risk. This is a normative question. This is a matter of your view on how much risk is acceptable in a person's lifetime consumption profile, how replacement rates should vary with lifetime income, etc.

Trust funds are a distraction when you look at the problem this way. All these posts about the trust fund are arguing over minutia--how real are the assets, how shortsighted the credit market is for not recognizing that the trust fund has been raided, and so on. The bonds are real. The promise to pay benefits will be kept (subject to modifications by Congress, but the modifications are not likely to be severe). The trust fund is being used by both sides as a rhetorical device to advance their point of view by quibbling over the value of a bond. These matters, while interesting, are nothing compared to a frank discussion of the role of Social Security as insurance and the appropriateness of having the government run a pension program whether it's with private accounts or not. This discussion would not take place in a vacuum, but would necessarily take place in the context of the overall tax and spending environment at the macro (government finance) and micro (overall tax progressivity and the effect on households) levels.

Debating the progressive price indexing of the Pozen plan is a start. Brad DeLong's piece in Slate is a good opening salvo. In it, he implicitly acknowledges the political reasons for less draconian cuts.

Pozen's proposal caps the maximum Social Security retirement benefit at roughly $22,500 dollars a year (adjusted for inflation). Bush's private-accounts plan—which would allow people to contribute 4 percent of their wages—makes retirees repay the taxes they diverted into private accounts out of their standard Social Security benefit. Medicare premiums are already deducted from your Social Security check. Deduct the claw-back for the private-accounts diversion as well, and by late in this century the odds are that—at least for the upper middle class—the standard Social Security check would be zero. Social Security would no longer be a universal program: It would be a program in which the half of America that is richer and more powerful and more likely to vote sees large chunks of its money going in and nothing coming out. (emphasis mine)

Appeasement for those less likely to need insurance might be a political necessity to keep the program viable. This has always been a standard argument against means testing.

I say again, this is the right discussion to have.

I, for one, would approach such a discussion with an open mind.

Posted by William Polley at 11:37 PM | Comments (12) | TrackBack

May 02, 2005

The rhetoric of Social Security

Let's look at what the President said in his news conference.

We're saying, you ought to have the right to set up a personal saving account so you can earn a better rate of return on your own money than the government can.

And it's that difference between the rate of return, between what the government gets on your money and what a conservative mix of bonds and stocks can get on your money that will make an enormous difference, and a person being able to build his or her own nest egg that the government cannot spend.

Now, it's very important for our fellow citizens to understand there is not a bank account here in Washington, D.C., where we take your payroll taxes and hold it for you and then give it back to you when you retire. Our system here is called pay-as-you-go. You pay into the system through your payroll taxes, and the government spends it. It spends the money on the current retirees, and with the money left over, it funds other government programs. And all that's left behind is file cabinets full of IOUs. (emphasis mine)

What's wrong with the italicized part? If you said that what the government "gets" on your money is irrelevant, you're a winner. Why did he say it this way? No clue. Rhetorical flourish maybe. Maybe he thinks it sounds good to put the idea in people's minds that individuals can do better than the government. Sounds nice, but it's both irrelevant and technically wrong.

Hence PGL at Angry Bear writes:

So if I own a Treasury bond, that is a real asset but it is not a real asset when a Trust Fund owns a Treasury bond. And suppose I recently purchased a bond paying a 4.8% nominal return. Bush is saying this is somehow a better return than the Trust Fund gets – even though its bond also pays a nominal return equal to 4.8%.

Good catch, my friend. That is what Bush appears to be saying. And you're also correct to point out that it can't possibly be right.

But it's also irrelevant. Why? You could set the nominal interest on those non-traded bonds to be anything you want. It has no impact on the benefits that retired people will receive (a point I made here). The interest on the bonds does not figure into the benefit formula for an individual. Higher interest on the bonds would just mean that the general fund has to pony up more cash when the bonds come due--restoring "solvency" at the stroke of a pen by making it explicitly a general fund problem. It's irrelevant to the discussion of private accounts!

To the individual, it matters not "what the government gets" but "what the government gives" (the benefit formula).

So, PGL calls out Don Luskin for saying

Younger workers should have the option of putting a portion of their payroll taxes into a voluntary personal account which will allow them to build a nest egg that belongs to them. This money will give workers an opportunity to receive a higher rate of return than the current Social Security System can provide. (emphasis mine)

But to be fair, this is really just a paraphrase of the Moynihan-Parson's Commission (2001, p.38).

The river of lousy rhetoric runs deep indeed. Let's get it right. The pro-privatization side is doing a terrible job of explaining itself and it plays right into the hands of the opposition. It's a shame, because this just bogs down the real debate.

And what, you ask, do I think the real debate is (or should be)?

I'll have some thoughts on that later. It's probably not what you think I'm going to say.

Posted by William Polley at 12:45 AM | Comments (5) | TrackBack

April 30, 2005

Random thoughts on Social Security (Part II)

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.)

Final point: The more gradual the change to the Social Security system, the better. The sooner we start, the more gradual we can afford to be.

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.

Posted by William Polley at 01:25 AM | Comments (13) | TrackBack

April 29, 2005

Random thoughts on Social Security

It was a pretty interesting week for Social Security blogging. See Angry Bear (pgl), macroblog (David Altig), and Economist's View (Mark Thoma) just to name a few. I figured I'd put down some thoughts--sort of in the form of an interview with myself. Some of it is retrospective. Let's start with the basic question.

Question #1: Is Social Security in crisis? No crisis, but we could do better.Here's what I said in January.

Could the right sort of adjustment/modification/reform of Social Security in the next few years make future retired persons better off? Almost without question, yes.

Is Social Security on the verge of becoming the nation's biggest fiscal problem if it's not fixed in this presidential term of office? Definitely no.

No change in my opinion there.

Question #2: Are the bonds in the trust fund worthless IOUs? No. However, I do not have a claim to those bonds other than through my participation in the Social Security system. The payout I will receive when I retire will be determined by the SSA's formula rather than by the return on those bonds. The bonds represent the government's commitment to fund our retirement based on that formula.

I don't like photo-ops with file cabinets, and I'm not crazy about comments like this from President Bush's press conference:

Now, it's very important for our fellow citizens to understand there is not a bank account here in Washington, D.C., where we take your payroll taxes and hold it for you and then give it back to you when you retire. Our system here is called pay-as-you-go. You pay into the system through your payroll taxes, and the government spends it. It spends the money on the current retirees, and with the money left over, it funds other government programs. And all that's left behind is file cabinets full of IOUs.

The reason I don't like that rhetoric is that it downplays the government's commitment to funding the retirement of the next generation. Some would say that it's tantamount to threatening default. You be the judge of that. I'm pretty sure Bush is not actually threatening default (he'll be long out of office by the time it would happen anyway). It's just not the way I would say it. The political and moral commitment cannot be understated. But a political and moral commitment is not a claim to a specific quantity of bonds.

And here's what I said about it once before. (Feb. 21)

We need to be careful about what we mean when we discuss (or imply the possibility of) default lest we fall into rhetorical traps. The "worthless IOU" argument is itself worthless. There are undoubtedly other cases where it has been used to get the attention of the reader and then been cast aside when it has served its purpose.

That characterizes my current sentiment as well. So far so good.

Question #3: Would privatization solve the solvency problem? Nope. Might privatization make a marginal contribution towards achieving solvency? This depends crucially on the assumptions one makes concerning growth of the stock market and how much the traditional defined-benefits can be reduced as a result. Assume a high enough growth in the stock market and it does contribute towards solvency. I don't buy the upper range of those claims. With reasonable assumptions, the contribution is likely to be small.

However, I don't think that this is a reason to reject partial privatization out of hand. If you want to reject privatization, do so on the merits. Judge privatization by what it would do, not by what it would not do.

April 27, 2005

Tell me something I don't know

Headline (NY Times): Survey Finds Many Have Poor Grasp of Basic Economics

You guessed it. This is not simply a story about the need to improve economics education and basic financial literacy.

Their implied conclusion: Many don't have the skills to cope with an ownership society.

...there was confusion about the purpose of mutual funds, with some students stating that they provided higher returns than individual stocks, and others stating that they guaranteed a steadier income. Only 15 percent of students understood that the purpose of mutual funds was to provide diversification.

Mr. [Alan] Krueger, who contributes a column for the business section of The New York Times, said these findings were disturbing, given the big increase in the number of households that hold stocks and mutual funds.

"Many Americans are potentially open to scams because they don't understand the purpose of the financial markets," he said yesterday.

I agree that's disturbing. But they did not report how adults did on that question (or adult owners of mutual funds). The millions of adults who actually own mutual funds probably understand their purpose a little better than that.

Other analysts said they thought that the findings added to a growing body of evidence that the typical American is poorly equipped to take advantage of what proponents call the ownership society: a future in which individuals are free to invest their own retirement money, rather than having to accept the returns offered by the Social Security program or a group retirement program at work, like a pension plan. Many surveys have shown the public has doubts about the Social Security program, with young people, in particular, confident that they could do better by investing on their own.

Yet even their concern is poorly informed, according to the Employee Benefits Research Institute, a nonpartisan research organization that is financed by companies and labor unions. The institute's own research showed that fewer than 20 percent of workers thought that Social Security would be their primary source of income in retirement, even though Social Security is currently the primary income source for more than two-thirds of retirees.

I don't doubt the validity of these statistics (and I agree that some people are probably deluding themselves), but I do want to give this some additional thought. Is it realistic in the current environment with 401(k) plans, IRAs and so on, to expect that the number of future retirees (current workers in the survey) whose primary income source will be Social Security will equal the portion of current retirees who rely so heavily on Social Security? I don't think so. Now, do I think there will be as massive a shift as the survey implies? Of course not. Would a shift be a good thing? I think so. This story just doesn't give me enough information to say any more than this--it may not be as bad as it seems.

I'll bet I know what people said on this one.

Even though the Social Security Administration sends all participating workers individual annual statements, the institute found that only 18 percent of Americans know at what age they will be eligible to retire with full benefits.

I'm sure a lot of them said 65, but if they are under 44 years old it's 67. As retirement nears, they'll get the message. This question worries me less than some of the others.

The article concludes:

The purpose of the National Council on Economic Education is to raise the public's understanding of the economy. It created a basic standard for high school level financial literacy in 1997 and conducted its first survey in 1999. The economic literacy of both students and adults has improved since then, but only slightly.

Talk about burying the lede. No details on just how much it has improved. I'll try to research that for you and report what I find. We can clearly do better, and I think we also have to remember that if the stakes were higher and a partial privatization ever came to pass, I think we would. After all, if people didn't have to make choices about the allocation of scarce resources because they were all made for us, I (and many of you, my economist readers) would be out of a job.

Our job is to present these concepts and issues in our courses, discuss them on our blogs, and work with the MSM to get the message out.

The fact that so many people do participate in 401(k) plans, contribute to Roth IRAs, and so on, is very encouraging indeed. Rather than wringing our hands, let's redouble our efforts.

N.B. Even if privatization does not happen, I do not shrink from anything I say in this post. Economic and financial literacy is more important than this single issue.

UPDATE: Don at Cafe Hayek has much more.

Posted by William Polley at 01:27 PM | Comments (14) | TrackBack

April 18, 2005

Another blogger considers the "trust fund"

Jane Galt questions the value of the Social Security trust fund.

Upon even a moment's reflection, it's obvious that the trust fund does not exist in the way that its proponents are claiming -- as a guarantee of benefits -- because the bonds are not obligations to Social Security beneficiaries. They are obligations to the Social Security Administration. (emphasis in original)

She continues:

Let's say it's 2018, and Congress is running out of money, as the Social Security system stops paying money into the government coffers, and starts taking it out. Congress cuts benefits to the point where Social Security taxes are once again a net contributor to federal revenue. Have we violated the trust fund? Nope. Congress is still paying the interest on those bonds; it's just that the interest they pay is immediately lent back to the federal government. Congress could knock benefits to zero, and keep recording interest payments into the trust fund for all eternity, without violating anything except its constituents expectations.

Now, is this likely? Probably not, because the political cost would be high. But the point is that the continuation of benefits depends on the political cost of offending a highly motivated interest group, not the existance of this trust fund. And the effect on the government of continuing those benefits--forcing it to raise taxes, cut other spending, or borrow money to pay for them--is exactly the same whether or not the payments are recorded on the books as "interest on bonds" or "contribution from general revenue". (emphasis mine)

That last part is what tells me that she understands the concept of the trust fund. I gather, however, that she is just a little less optimistic than I am about the government's willingness and/or ability to make good on their past promises.

But that's ok. That's where the discussion should be focused. In order for any progress to be made on this issue, we all must agree that the generational contract is what is important and that contract has nothing to do with how many bonds are in the SSA's file cabinet. If you happen to interpret the part of my sentence in italics as meaning that the trust fund consists of "worthless IOUs," that is your interpretation. I would, however, say that they are no more or less valuable than the IOUs (T-bills) that the government issues to the public. They are not worthless in that sense. They will be paid to the SSA and not repudiated. But their connection to actual benefits paid is a political, not an accounting, relationship.

To put it another way, those who will retire between 2018 and 2042 should consider this question. How do you think of the government's promise to pay you Social Security benefits?

a) a promise of a stream of income related by a formula taking into account the earnings over my lifetime, indexed by the growth of wages, and once I start earning it, adjusted for increases in the cost of living.

b) a claim to a share of the bonds in the trust fund.

Just because the answer is (a) that doesn't mean that the trust fund is worthless. If we can't agree on that, I don't think we're going to get very far. This sort of thing doesn't help.

Unfortunately, it is easier (for both sides) to politicize the trust fund than it is to discuss the generational contract. It's inevitable (for reasons that economists on both sides understand quite well, I think), but it's very unfortunate just the same.

Posted by William Polley at 11:47 AM | Comments (7) | TrackBack

March 18, 2005

Rome wasn't built in a day, and neither is an ownership society

The title of this NY Times article is, "When It Comes to Managing Retirement, Many People Simply Can't."

I'll admit it, the headline made me read the article. Score one for the Times. But there's a lot more in that article than just that one-liner. A more accurate title would be, "Some People Enter Retirement With Too Little In Their Private Accounts; Reasons Vary." You now see why I'm an economics professor and not a headline writer.

One very important reason mentioned in the article was that some people start saving too late in their working years. 401(k)s and IRAs are a relatively new invention. Two people mentioned in the article saved for only 17 years. A 22 year old college grad could save for more than 40 years if they start right after they get their first job. This is a pretty good argument for making private accounts a part of Social Security (whether they are a carve out or an add on is less relevant to my point here than just getting 22 year olds to do it automatically and steadily--let's save the carve out/add on argument for another day). Saving for retirement must begin early. Rome wasn't built in a day. I would expect that as time goes on and later generations of workers (who have had 401(k)s for a longer period of time) retire, the results will improve.

Consider this:

Ms. [Annika] Sunden [of Stockholm University and Boston College's retirement studies center] and Alicia Munnell, director of the Boston College retirement studies center, estimated that a worker making the minimum ideal contribution of 6 percent of wages to a 401(k) plan, with a company match of a further 3 percent, could do better than with a traditional pension.

If the account achieved a 4.6 percent annual return on top of inflation, the assumption adopted by President Bush based on historical returns, a worker retiring at 62 after 30 years of savings and a final salary of $52,650 would amass more than $350,000. This could provide annuity income for the rest of the person's life of roughly $31,000 a year, higher than the $26,500 such a worker would get from a typical defined-contribution pension.

Disciplined saving is a good thing. But...

In 2001, the most recent year for which comprehensive figures are available, the Federal Reserve's survey of consumer finances found that the median savings in a 55-to-64-year-old American's 401(k) or individual retirement account added up to $42,000, less than one-eighth the amount needed at 62 to achieve the retirement income estimated by Ms. Munnell and Ms. Sunden.

$42,000 is not much of a retirement nest egg. Obviously people are starting late and not saving enough. I think we've pretty much established that now. Towards the end, the article says,

Fewer than 10 percent of eligible workers contribute the maximum amount to their 401(k), and about a quarter contribute nothing at all. Many younger workers empty their 401(k) accounts when they change jobs - postponing saving for retirement.

Low savings are not the only problem. After they retire, workers must manage their savings, a task often complicated by unexpected expenses.

It's hard to imagine something worse than cashing out your 401(k) when switching jobs. If you have to use it as a cushion to tide you over to the next job (if you really must), then at least put back what you don't spend when you take a new job. The article ends with an account of how difficult retirement planning can be:

When Robert Stacy took an early retirement package from U S West more than six years ago, at 53, he had a traditional pension. But he took only half as an annuity, worth $900 a month, and the other half as a lump sum. His total savings at the time, including his 401(k) and the proceeds from the sale of his house, added up to almost $600,000.

The Stacys expected this money would be enough to roam through the country carefree in their new R.V. But six years later, the stash is down to $400,000. And the couple is facing higher health expenses since Qwest, which took over U S West in 2000, started charging hefty premiums on its retirees' health plans. So the Stacys, too, decided to take up jobs in retirement. "If I had to choose again," Mr. Stacy said, "I would have taken it all as an annuity."

Maybe so. But nothing here suggests that Mr. Stacy didn't understand his options. This seemed like a strange way to end the article.

Anyway, if the intent of the piece is to scare people away from private accounts for Social Security, it doesn't deliver the goods. The whole idea of private accounts should be to get younger workers used to saving and taking ownership of their retirement funds. Judging individual retirement accounts by the fact that most people haven't been contributing to them for very long strengthens my contention that starting young is the most important thing. An ownership society will take generations to build, but every day we wait just puts it off further.

The private accounts being discussed for Social Security would not (to my knowledge) allow workers to cash them out when changing jobs like a 401(k). That's one more problem eliminated.

Furthermore, the Hagel bill (S. 540) specifies that the private accounts be converted to an annuity on retirement. You won't have the same regret about your Social Security private accounts that Mr. Stacy did about his pension. Still another problem solved.

(Another nice thing about S. 540 compared to H.R. 530 is that the eligibility age is lower--45. I'd argue for even lower, but at least this is moving in the right direction.)

The Times article could certainly be interpreted as an attempt to show the perils of relying on private accounts for retirement (especially if you only read the headline). On the contrary, it makes an effective argument that disciplined saving over one's working life is very important. It also makes the point that once retirement hits, those savings should not be left to chance. Neither of these points is controversial.

Advocates of private accounts need to start making these very uncontroversial points.

Posted by William Polley at 02:32 AM | Comments (3) | TrackBack

March 14, 2005

Other trust funds (continued)

Thanks to a comment from Calculated Risk (by way of Movie Guy), I looked at some publications on the other trust funds. This is an interesting one that came up in the search.

I didn't find any long term projections but did find some history and some clarifications on how they are handled. There really are a lot of them, fortunately most are extremely small in the grand scheme of the budget. Even the larger pension plans are small compared to Social Security (and let's not even talk about Medicare). Plus, I suspect the demographics are different. Military pensions, for example, would have income/outgo profiles that respond to the demographics of the military rather than the demographics of the work force in general (which is the problem for Social Security).

One other thing I noticed while reading the publication is that the 1999 balance of the Civil Service Retirement and Disability Fund was around 6 times its 1999 revenue. Compared to Social Security where the 1999 trust fund balance was not even twice its 1999 revenue. I have my theory on why this is the case.

All in all interesting, but still nothing that worries me greatly.

Posted by William Polley at 12:50 AM | Comments (1) | TrackBack

March 11, 2005

Other trust funds

Calculated Risk makes a good point. There are other trust funds, like the Civil Service Retirement System, will face demographic problems similar to that faced by Social Security. Acutally, I haven't seen long term demographic projections for these funds, though I assume such projections exist. These other funds are "on-budget," which means that you should be able to find the short term projectons in the budget (something to do this weekend).

Granted, the magnitude of the problem will be much smaller, so I am confident that this can be handled. Also, I would be interested in hearing the details of how these trust funds work. Civil service pensions would seem to more closely resemble employer managed pensions than a general Social Security system. I would think that the administrative details would be a little different.

So, while this doesn't particularly trouble me, it is a good point. Most of all, it highlights the problem of lumping every thing into one "unified" budget. I like the idea of generational accounting for Social Security and separating it (and perhaps the other trust funds) from the general fund.

Posted by William Polley at 02:02 PM | Comments (3) | TrackBack

March 08, 2005

Dead Parrot vs. Angry Bear, "starving the beast," and just who has been raiding the trust fund?

Dead Parrot vs. Angry Bear. Quite a mental image, isn't it? Anyway, lots of stuff to address, and I can't figure out where to break it into two posts. So here goes...

If you haven't been following it, today's participants in the Social Security free-for-all have been PGL of Angry Bear and Victor of Dead Parrot Society. They cover a lot of ground, and I'm not going to trace through it all. Today, I will cover just one aspect of their posts. This is a long post, but I have a couple of tidbits for you that I think are worth reading.

One observation I have is that the debate on the econoblogs is moving towards more general issues of government financing. Not that I have a problem with that. Might be a good thing.

PGL and Victor are arguing over whether increases or decreases in specific taxes affect the overall trend in spending. This is sometimes called the "starve the beast" theory. Cut taxes and spending will fall. Obviously it's not that simple in reality. It certainly hasn't been the case this time around. But the discussion then turns to the experiences of the 1980s and 1990s.

So, was the Social Security surplus that big of a deal during the Reagan administration? Nope. Not at all. You can say that Reagan raided the lockbox if you want, but at the time, the lockbox was the government equivalent of petty cash. Year to year fluctuations in the on-budget deficit were larger than the Social Security surplus. No evidence of "raiding the lockbox" yet, not in any meaningful sense. (Ah, but read on!)

The Bush (41) years were different. The size of the off-budget surplus (mostly Social Security) stayed relatively constant. Meanwhile the deficit took off. Looking at the numbers, you can't make a convincing case that Bush (41) was looking to the trust fund as a contemporaneous source of revenue. I suppose he could have been forward looking, but I'll leave that for you to decide.

The tax increases of the early '90s were perfectly timed (for everyone except Bush 41). The recovery was well underway by the time they really started to bite. Revenue growth outpaced spending growth. The on budget deficit fell for 8 years (becoming a surplus for 2 of those years). Meanwhile, the off budget surplus took off for demographic reasons that have very little to do with what was taking place "on budget." So, did Clinton raid the lockbox? No more (or less) in substance than Reagan or Bush (41). There was, however, a more subtle raid taking place--one that continued into Bush (43) as the following question makes clear.

What was the peak surplus at the end of the last cycle? 236 billion or 86 billion? If you say 236 billion, you're guilty of raiding the trust fund. (The off budget surplus was 150 billion in 2000.) The trust fund was getting huge just in time to make our already pretty good deficit fighting effort look even better. But the two have very little to do with each other. So who can blame the Democrats for touting hundreds of billions of dollars of surpluses? I certainly don't! (And don't say they didn't make those claims and rhetorically raid the trust fund--the proof is here. Furthermore, Gore wouldn't have made the lockbox such a big deal in his campaign if they hadn't already noticed that their hands were in it.) The current administration has simply continued on this path. In fact, the off budget surplus hasn't grown much since Bush (43) took office. The on budget deficit has. Like father, like son.

The punch line is that there really isn't much connection between the growth of the trust fund and the changes in trends in taxes or spending, at least not contemporaneously. That explains my reasoning for being skeptical of the "starve the beast" theory as well as my skepticism over any cause and effect connection between the tax increases in the early '90s and the fact that the economy boomed and government's share of GDP fell during the Clinton administration. There you have it--I'm an equal opportunity skeptic.

So, I don't mind making this debate at least partly about government financing in general. The general fund deficit is a big problem worth talking about independently of Social Security. I happen to think that if Social Security reform is done correctly, it won't make the general fund problem much better or worse. So let's do Social Security reform correctly and tackle the general fund problem separately.

PGL often claims that the payroll tax increases were to prefund the baby boomers' retirements (and thus he contends that claiming that we are still essentially pay-as-you-go is equivalent to saying Reagan lied in 1983). The first part is true, at least rhetorically. The trust fund is a meaningful promise to pay--fully funded politically and morally (but not in a strict accounting sense). Because of this, your mileage may vary on the conclusion he draws. However, it's interesting that the first time this issue came up was in 1985, just as Social Security was being taken off budget. Reagan wanted a one year freeze on cost of living adjustments to Social Security. This would save $6 billion in FY1986. Imagine! He wanted to raid it for $6 billion and make the $200 billion dollar deficit look $6 billion smaller! I don't know what Reagan was thinking, but I think it's plausible to think that he either thought that in 20 years we would solve this problem or that we wouldn't be talking about such huge amounts being at stake. Again, you are free to make up your own mind. (By the way, this information is from the May 14, 1985 New York Times. If you have Lexis-Nexis, do a search for the headline "Two kinds of deficits" from that day's paper. It's an article worth printing and saving if you have access. I'd excerpt from it if this wasn't so long already. Maybe another day. To boil it down to whether the Times writer thought that Reagan was lying--his answer would have been a firm yes... and no.)

All historical data in this post are from the 2005 Economic Report of the President, Table B78.

Ok, that's enough for today. As always, your comments are welcome.

UPDATE: PGL responds. Also, take note of a comment by CalculatedRisk.

Posted by William Polley at 10:28 PM | Comments (6) | TrackBack

March 07, 2005

What will privatization do to national saving?

Let's start with a quote from macroblog.

I won't even bother to link to previous posts, but if there was ever a policy-driven transaction without consequences for national saving, it would have to be issuing explicit debt for already promised benefit payments. (OK, I lied -- here's the link.)

In the same spirit, here are links to a couple of my previous posts. I think Altig's comment above makes excellent sense as a first approximation. In other words, in a perfect world or a simplified model it should hold. The extent to which it doesn't hold exactly would, in my estimation, have to do with market imperfections and other "real world" problems. So when Brad DeLong says,

My position is that we really don't know what the impact of having the Treasury sell $4.5 trillion more of government bonds and then having individuals invest that $4.5 trillion in their private Social Security accounts will be. I would bet that there's at least a 50-50 chance that it will be a wash as far as national savings is concerned. I would also bet that there's at least a 20% chance that it will shrink national savings significantly--that people will regard their private accounts as relatively close substitutes for their 401(k)s and other assets, and so reduce the amounts they commit to funding their other retirement savings.

I have to give him credit for honesty. DeLong also says,

What I object to are assertions that people know that the effect on national saving will be a wash. They don't know this. What I object to are assertions that worriers--like me and Alan Greenspan--should "stop railing about the budget impact [of the Bush Social Security plan]. The... increase in the budget deficit won't place a new burden on future generations." There's reason to hope that this is the case, and I think it is better than a 50-50 bet. But as Uncle Alan said, it's important to go slowly: if it is a big mistake, we need to find that out in time to stop it.

I also said this more than a month ago.

Back to the issue of what happens to national saving, here's why I think there might be some ambiguity. Let's go back to macroblog again.

I have already conceded that the trust fund should be treated as a meaningful promise to pay future benefits.

Me too. Of course, there are various ways to shave the amount that we have to pay (like raising the retirement age or changing the indexing formula, to give two examples). One possible problem for Ricardian Equivalence is financial market uncertainty about whether and how much we'll shave that amount. If privatization changes those expectations, RE will not hold exactly.

Another possible problem would be if privatization had a very different generational effect compared to waiting until 2042 and the generations react in systematically different ways. This is a serious research question, not something you can answer off the top of your head.

I'm not sure how much either of these would impact national saving, but it's worth talking about.

Once again, the more gradual the transition, the better the chance for success. The sooner we start, the more gradual we can afford to be.

H.R. 530 is not gradual. If this ends up being the plan for consideration, I'll be as worried as Greenspan and DeLong.

Posted by William Polley at 12:50 AM | Comments (0) | TrackBack

February 24, 2005

Actuarial assumptions and my beef with H.R. 530

Today's best Social Security analysis is by Arnold Kling. By the way, if you don't read his blog, you should.

The memorandum to which he refers is can be found at the SSA website.

He gets it right. At issue is the rate at which a worker trades off benefits when he or she contributes to a private account. If I'm reading it as he does, it appears that this proposal shaves the benefits by 3%, which means the private accounts have to return at least that much for the worker to break even. His problem with that is that 3% is too high. Alas, it looks like this is, as he says, "dictated by the Social Security actuaries."

I have to agree with Kling that 3% makes the system look more solvent, but might bias people against private accounts (or lead to inflated claims about the returns on those accounts--something which also appears to be happening).

Kling says,

"Actuarial scoring" of Social Security and the reform proposals is a menace. The assumptions used in scoring are rigid and misleading. If you want to be in a position to evaluate Social Security reform objectively and accurately, the first thing you have to do is throw out the actuarial analysis. Pay no attention to the "trust fund," the "solvency" of the system, or other noise generated by the actuaries.

They certainly are rigid. And it's true that the solvency or lack thereof depends on those rigid assumptions. I'd be more comfortable with a lower number, but that means that private accounts would have to be introduced much more gradually (to satisfy anyone's definition of actuarially sound). Of course, that wouldn't bother me one bit.

Oh, and one more thing. The proposal in the memo, which apparently is now going by the name of H.R. 530, lets anyone under age 55 start a private account. Read it!

I give you David Altig and Jagadeesh Gokhale's idea from back in 1996, nine years ago. (Yes, the David Altig of macroblog.)

Calculations using the current distributions of Social Security benefits by age and sex (assuming a 1.8 percent internal rate of return on the contributions of those included in the present system, and an 8 percent return on investments in private capital markets) suggest that 42 is the appropriate cutoff age. With this as the dividing line, 18 percent of the contributions of those age 42 and younger would be sufficient to provide those age 43 and older with benefits at least equal to those received under the current system. For younger workers, future benefits may be greater than those offered by the current system, because their contributions will reap the higher private rate of return for an even longer period.

Having dithered for nine years, I'd say the appropriate cutoff is at a younger age now. And this paragraph from the same 1996 article is delicious in its irony.

For an individual starting from scratch, the rate of return from a funded system will clearly exceed that of the unfunded scheme. However, if the cutoff age below which individuals are shifted to the privatized system is too high (say, 55), some workers would not have enough remaining years to exploit the increased private returns, leaving them worse off than before.

I don't know whether to laugh or cry.

Posted by William Polley at 04:26 PM | Comments (0) | TrackBack

February 23, 2005

How not to reform Social Security

Via the Club for Growth:

U.S. Rep. Martin Sabo (D-MN) announced this week that he will introduce a bill in Congress that he says will "guarantee Social Security solvency through 2080" by increasing the interest rate on Treasury bonds in the Social Security trust fund.

PGL at Angry Bear responds first. I'm going to take a different approach though. Rather than make this another post about what I think the trust fund is or is not (I've been pretty clear about that in the last few weeks), I'm just going to explain why I think this idea is not a good one.

My complaint is simple. Even if we keep the current Social Security system, I would just ask that the system's income and outgo be balanced in the long run. Right now, that's where the infamous 2018 and 2042 dates come into play. The plus side of the ledger wins until 2018, then the negative side of the ledger wins for many years into the future--hitting a zero balance in 2042. PGL often comments that the Republicans want to raid the trust fund or that Reagan lied in 1983. I respond as follows. If we raise taxes (or borrow less!) from 2018 to 2042 to pay back the bonds in the trust fund, then David Ricardo, for one, would not call Reagan a liar.

(The fact that many people reading this will find the previous sentence unrealistic is a political issue, not an economic one.)

The problem is that the world does not end in 2042. Beyond that year, the system goes negative and would probably stay negative for a long time, forcing the general fund to subsidize Social Security, perhaps indefinitely (unless there is another baby boom). I think we can all agree that the pay-as-you-go system is not in long run balance when the long run is taken to be past 2042. That would bother me. At that point, I would want us to raise the retirement age, raise payroll taxes, or cut benefits. Of course, I really would prefer that we never get to that point in the first place. That's why I support doing something now, while there is a lot of time to do something gradually.

Anyway, back to Rep. Sabo's plan. His plan would simply shift the financing from the pay-as-you-go Social Security system to the general fund... until (at least) 2080. He's talking about doing exactly what I would try to avoid... for 40 years. This is more than just a counterpoint to the "raiding the trust fund" argument. This would institutionalize a long run imbalance in the pay-as-you-go Social Security system--a long period of deficit without a corresponding surplus. In my rank ordering of approaches to the Social Security issue, this ranks right below doing nothing.

Posted by William Polley at 07:35 PM | Comments (2) | TrackBack

February 21, 2005

What does it mean to default? (Part II: The rhetoric of default)

The discussion that started at Angry Bear and macroblog (not to mention the others that have piled on) got me thinking.

We use this word "default" a lot in these debates over the appropriate way to pay for war, pay to restructure Social Security, and otherwise finance our debts. When most people hear the word "default," they probably think of firms which have gone out of business without paying off its debts. Bonds from companies that face this kind of risk carry the adjective "junk" due to the fact that you may not see any return if the firm goes under. Perhaps some people relate default to third-world debt crises. But are the third-world debt crises or the kind of default that results from a firm going out of business appropriate models for the U.S. economy?

I don't think so.

(*I can hear the shuffling of feet and clearing of throats out there in blogland*)

Let me explain. The part of Krauthammer's piece that had everyone in an uproar was the part about the IOUs in the trust fund being worthless. OK, he doesn't say "worthless," he says,

These pieces of paper might be useful for rolling cigars. They will not fund your retirement.

Whatever. This is the rhetoric of default. This is the (overly) dramatic statement of how bad things are. This is the heart of the "worthless IOU" argument.

But it doesn't fly. Krauthammer himself follows with,

To cover retiree benefits, the government will have to exhaust all of its FICA tax revenue and come up with the rest -- by borrowing on the world market, raising taxes or cutting other government programs. (emphasis mine)

And in so doing, he reveals that this is a General Fund problem. The worthless IOU argument was just a distraction. Whether he meant it to be a distraction or not, I can't say. It's an easy trap to fall into, but I'm sure that some writers have set the trap deliberately.

The real problem is not some theoretical point in the future when the U.S. repudiates its debt. Not likely to happen. What we need to be on guard against is the prospect of the insidious default that is caused by inflation (if the Fed becomes complicit in the borrowing and becomes the buyer of last resort for the IOUs). Another version of default was pointed out by Dave and I will repeat the two paragraphs that make the point extremely well.

Suppose I hold a Treasury security. That, of course, is a payment the government owes to me, and I have every expectation that it will be made. But if, for some reason, there has been a miscalculation, a change in economic circumstances, a change in policy, the government may find that it has to raise my taxes to obtain the revenues to honor those payments. In doing so, it has effectively reduced the return on that security. Distortionary price effects aside -- granted, a major qualification -- why should it matter to me how it happens? Lower my social security benefits, raise my income taxes, whatever. It all amounts to a haircut on that Treasury payment to me.

Because the distributional aspects of these things can matter, blanket haircuts are probably a pretty bad idea -- foreigners, for example, finance a good chunk of our collective borrowing, and they aren't likely to appreciate the opportunity to finance our fiscal imbalances on an ongoing basis. Changes in tax and transfer policies are the way we go because they can be targeted (which gets us to positive versus normative questions, which I'll address below.) But the basic economic distinction is one without a difference.

Precisely.

Bottom line: We need to be careful about what we mean when we discuss (or imply the possibility of) default lest we fall into rhetorical traps. The "worthless IOU" argument is itself worthless. There are undoubtedly other cases where it has been used to get the attention of the reader and then been cast aside when it has served its purpose. Better to be upfront about the more likely (and just as troubling) consequences of too much spending, if that's the point you would like to make.

Krauthammer's argument does not require the "worthless IOU" concept and would be better off without it. And I think we should keep the discussion of Social Security reform honest by refraining from using that argument unless you are willing to apply it to the General Fund problem as well. I am not. I'm more inclined towards Dave's comments noted above.

Posted by William Polley at 11:38 PM | Comments (0) |

William J. Polley

Comments and observations on economics and whatever else catches my eye