Duncan Black thinks about Social Security privatization:
Posted by DeLong at November 9, 2004 09:54 AM | TrackBackEschaton: Privatization, Not Reform: First, oh media, please call it what it is. It's not "reform," it's "partial privatization." Or, at least, that's what we assume it is. There isn't actually a proposal on the desk, and nor was there one during the campaign.
But, in any case, the mutual funds are already squealing about the fact that administrative costs on low-dollar accounts would be high and non-profitable. Lovely.NEW YORK (Reuters) - The bonanza many believe President Bush has handed the mutual fund industry with his plans to reform Social Security may be a mirage, industry leaders say.
How workers will be allowed to invest some of their payroll taxes in the stock market is far from clear, but there is a presumption it will be windfall for an industry that manages the nest eggs of about 95 million Americans.
The administrative costs for managing accounts that for the most part will hold less than $1,000 in the first year suggests mutual fund companies could easily lose money for at least several years, industry experts said.Assuming the magic "2%" proposal is what happens, although something "bolder" could be in the works, someone earning $40,000 per year is going to be putting just $800 per year into one of these accounts.
But, more generally, this could be the most important domestic economic policy debate of our generation. And, it's going to be a lot more complicated than simply "should workers be allowed to divert 2 percentage points of payroll taxes into private accounts." While I hold my position that this is a universally bad idea, just how bad it is will depend on the details. And, there will be lots and lots and lots and lots of details. Sadly, our media will not be up to the job of informing people just what those details are.Eschaton: More Social Security: As I've written before, my opposition to a forced savings plan [note to Democrats: "forced savings" has a nice ring to it, and is in fact what such a plan would be.] is largely due to the fact that it opens the door for Fund firms, one way or another, to loot the US Treasury and to loot these mandatory accounts. Conservative trolls like to write "Oh, but if you lose all your money it's all your fault!" which, after I get a good laugh at how stupid they are, depresses the hell out of me. First, investments are not deterministic. They are risky. People who do well in the market like to believe they're "smart investors." Maybe they are. But, most of them just got lucky. Being a "smart investor" means that you know more than the market does, something which can't exist if we believe the markets are efficient, as our conservative trolls usually do.
Who knows what kind of investment options would be available for people? Why could you, say, invest in a publicly traded company and not your brother's new pizza joint. But, aside from the risk issue - the bigger one is the fact that firms will find big and small ways to skim from accounts. This latest SEC investigationgives us another way they can do so:The Securities and Exchange Commission is investigating about a dozen brokerage firms - including Morgan Stanley, Merrill Lynch, Ameritrade, Charles Schwab and E*Trade Financial - on suspicion that they failed to secure the best available price for stocks they were trading for their customers, according to people who have been briefed on the inquiry.
At issue is the way the companies executed trades of Nasdaq-listed securities when the markets opened in the morning, a period of intense trading activity resulting from the backlog of orders since the market's close the previous day.
After examining trading data from the last four years, the investigation found evidence that trades were often processed in ways that favored the firms over their clients, these people said.
Securing the best price is one of the industry's critical obligations to investors. If the investigators' suspicions are confirmed, these practices are not likely to add up to significant costs for individual investors - the difference would be pennies a share traded - but in total they could represent substantial amounts of money for the brokers.
Eschaton: Even More Forced Savings: Of course, another concern is that at some point the "forced savings" plan will cease to be that, or at least become more "flexible." Pressure will exist to start letting people borrow against their equity, or to withdraw early for reasons-other-than-retirement (medical bills, tuition, first downpayment, etc...) as currently exists with all the other tax free savings vehicles. And, yes, here's where the personal responsibility crowd gets to scream "well, if you don't save for your retirement then tough titties!" But, it's one thing to expect able-bodied individuals to pick themselves up off their feet after bad luck and bad decisions have left them pennyless. It's another to expect not so able-bodied 75 years olds (and their spouses) to do the same. The fundamental question is how do you deal with the prospect of millions of destitute seniors? We answered that question long ago - Social Security...
The operative meme on this needs to change from "retirement" to "insurance." Conservatives basically want to roll back Social Security to a time when, well, it didn't exist. My (admittedly limited understanding) of the history of Social Security is that it was not meant to be a retirement program. It was meant to be an insurance program to keep old people from going homeless.
Posted by: Derek Scruggs at November 9, 2004 10:23 AMPardon me, but I may have been threadburied, and this is important.
Operative fields of knowledge in re the SS privatization question:
1) Asset-class returns, sources of and prospects for
2) Behavioral finance
3) How the financial-services industry makes money
For one-stop shopping, look for a capable synthetic thinker. Please take a few hours of your time to meet Bill Bernstein, if you have not had the pleasure. He is an excellent citizen.
http://www.efficientfrontier.com/ef/102/index102.htm
A degree of SS privatization might be a good idea if:
either
1) U.S. stocks will return significantly more than fixed-income instruments over the long term--a questionable proposition at this time.
or
2) The investments of SS funds are made globally so as to represent all the world's economic growth and reduce the potentially deleterious effects of individual market misvaluations on investor returns.
and
3) Administrative and asset management fees are appropriate to the scale of the funds invested--i.e. cheaper than any institution pays now.
4) Individuals are allowed no control over their investments whatsoever. The drag on investor returns from poor decision-making is preposterously large, thanks in part to the miserable job our educational system does in teaching basic economic, financial, and investment concepts, and this ignorance mostly ends up falling right to Wall Street's bottom line.
W's people, I am quite sure, are great believers in the U.S. stock market, would scoff at the idea of investing American tax dollars in overseas equity markets, would favor "healthy competition" among asset managers rather than using the government's bargaining power to get better prices from a single big index shop, and trust (at least publicly--who knows what they are chuckling about in Karl Rove's conference room right now) in the ability of individuals to make their own investment decisions.
The red states would concur.
My advice for blue people under 55, if SS privatization happens: invest a significant portion of your income in emerging-market stocks and bonds + international small-cap stocks (and pound the table at your neighborhood ETF provider--Barclays, Vanguard--for them to get vehicles out there that enable you to do this inexpensively) and assume that you will get no more than 50% of your parents' SS benefits when you retire. Save and hedge.
For red people: man proposes, God disposes.
NM
"We already answered that question: Social Security".
Except that we _didn't_ answer the question, we said "for now, let's do this". If SS didn't have a $10,000,000,000,000.00 accounts deficit, we wouldn't need to be having this discussion...
Posted by: john at November 9, 2004 11:03 AMdeficit? I am sure they system takes in more than it pays out. You must be confusing bush blowing the surplus on tax cuts for the rich and a stupid crusade to conquer the Muslims.
Posted by: me at November 9, 2004 11:15 AMdeficit? I am sure they system takes in more than it pays out. You must be confusing bush blowing the surplus on tax cuts for the rich and a stupid crusade to conquer the Muslims.
Posted by: me at November 9, 2004 11:22 AM"My (admittedly limited understanding) of the history of Social Security is that it was not meant to be a retirement program. It was meant to be an insurance program to keep old people from going homeless."
-----
Nope, that's quite backwards.
FDR established SS as a defined benefit pension plan, and *insisted* that it be fully-funded and actuarially sound so it would *not* be a burden on future generations. Everybody got a positive return, about 3% real (slightly more for lowest wage incomes and more for higher) based on what they contributed.
FDR *so* insisted on full funding -- and that SS create no burden on the future -- that when the drafters tried to pass a program with partial unfunded benefits in it by him he literally threw it in his office trash, to make his point. He later vetoed the first legislation that proposed major unfunded benefits.
It's rather ironic, but the "insurance" terminology re SS was introduced by FDR himself to get across the point that it was *actuarially sound* -- i.e., funded *just as a private insurance company* would fund a pension plan, with advance contributions earning a market return (that on T-bonds) on an actuarially sound basis.
Wherever he is today, whenever he hears his own "insurance" terminology used to argue exactly the opposite -- that SS *doesn't* have to funded -- he must pop a wheelie.
That was all the SS Act of 1935, put together under FDRs own hand.
SS's conversion into the paygo program we have today started with the Act of 1939 -- when liberals said, "why should people wait to receive benefits when all this payroll tax money is coming in now? let's up benefits!" ... and conservatives said "if all this tax money comes in the liberals will just spend it, so let's cut taxes!" ... and they compromised by doing *both*.
Sound familiar?
FDR vetoed that move too at first, but he was overriden, and as he had WWII to fight he wasn't going to spend political capital fighting that.
The full conversion to out paygo happened over the next couple decades. The really big cash winners (in dollar, not % terms) over the amount of contriutions they put in were middle class folk who retired in the 1970s. Of course, SS was bankrupt by 1980 and had to be "saved" by the Greenspan commission, reworked into what it is today.
Contrary to so much popular myth, SS didn't save anyone in the Depression from poverty with a "backward transfer". FDR's own SS plan in the Act of '35 wasn't going to pay anyone full benefits for 30+ years -- 1970! By the time the big unfunded backward transfers were legislated, the Depression was long gone.
None of this history is ever repeated by defenders of the status quo who somehow imagine they are "defending FDR's social security". For some reason. ;-)
FDR famously described the SS plan he had enacted as "actuarially sound and out of the Treasury forever".
The idea that it would be bankrupted by 1980 -- and then after being reworked, after only another 20 years, young workers would face getting back 25% to 40% less than they put in it, absent trillions of dollars of general revenue sbsidies going into it, would have given him another stroke.
I have written on other Web sites that the only way to save the SS Fund is to turn it into a private banking system--possibly through purchase of existing private banks for Treasuries in the surplus. The only way to save the SS Fund is to intergrate the Fund in the economic performance of the Economy--something which cannot be done with private accounts. Why? Because Mutual Funds are already complaining they cannot make money off of $14 per $800 per year per account. Just like it costs more than $2 per account per year with modern computer programs. The fact remains We need to maintain central accountability. lgl
Posted by: lgl at November 9, 2004 11:34 AMSo long as SS "privatization" is limited to 2% and made voluntary, I can't feel too concerned about the people who elect to take the leap. The relevant question is, "Who will do it and what will their income levels be?" I suspect the better educated and/or those with higher incomes will actually do it.
Posted by: Lawrence at November 9, 2004 12:06 PMThere will likely be private accounts established for Social Security, because the President and a Republican Congress will wish it so. But, there is no crisis for Social Security and the idea that the program is in danger, that our benefits are in danger, is completely absurd.
Change Social Security, but do so honestly. A litany of foolish and fooled reporters and columnists are continually telling us that there is a Social security crisis. Rubbish!
Posted by: anne at November 9, 2004 12:28 PM"While I hold my position that this is a universally bad idea..."
Sweden is in the universe and has already done this. Shall we examine the terrible price it's paid?
Sweden -- a country too far to the right on SS reform for the US Democratic Party.
Brad DeLong writes:
"benefits for those of us half a generation or more from retirement -- say, in their early 50s, or younger -- must be cut by proportionately more: 40 percent or so."
GAO writes that 'government ends' around 2045 when entitlement spending pushes just the *interst* on the national debt to a portion of GDP larger than the entire government today.
http://www.gao.gov/new.items/d01385t.pdf
The Comptroller General of the US describes the US fiscal situation this way:
"'We start with a haircut,' he said, thumbing through the pages that show federal spending starting to explode as Baby Boomers reach retirement. 'The next page is a scalping, and then we go to decapitation and finally disembodiment.'"
http://story.news.yahoo.com/news?tmpl=story&cid=2027&e=1&u=/chitribts/usfacesominousfiscalpicturewithhugedeficit
So ... we are in a situation where today's SS participants face a 40% cut in benefits while the nation goes bankrupt.
Conclusion:
"there is no crisis for Social Security and the idea that the program is in danger, that our benefits are in danger, is completely absurd."
Posted by: Jim Glass at November 9, 2004 12:59 PMFebruary 5, 2004
Some lessons from Sweden on the pros and cons of privatizing Social Security.
By Alan B. Krueger - New York Times
'YOUNGER workers,' President Bush said in his State of the Union address, 'should have the opportunity to build a nest egg by saving part of their Social Security taxes in a personal retirement account.'
According to former Treasury Secretary Paul H. O'Neill, the president believes that the reason he was elected was his bold -- some would say risky -- stance on replacing part of Social Security with personal accounts. If the president holds onto office in November and his party continues to hold Congress, the creation of some sort of personal retirement accounts as part of Social Security seems likely.
Although it is impossible to know what form such accounts might take, in 2000 Sweden instituted a system of personal accounts that holds many lessons for any country seeking to reform its retirement system.
Sweden now has a blended system, an approach Mr. Bush apparently favors. Employers and employees contribute a combined 16 percent of payroll toward a 'pay as you go' retirement system like Social Security, and an additional 2.5 percent toward individual retirement accounts. Those born after 1954 are fully in the new system, while older workers are phased in.
The reform process began in 1991, when a center-right coalition came to power. At the time, Sweden's generous retirement system was expected to exhaust its 'buffer' funds in about 20 years, a more dire situation than what now confronts the United States; Social Security will not exhaust its trust fund until 2042, according to the latest projections.
To address its problems, Sweden set up a committee with representatives from all parties in Parliament. Because the reforms were expected to last for decades, there was pressure to devise a plan with broad support, said Annika Sunden, an expert on pensions at Stockholm University. There was agreement back in 1994 that reform would include individual accounts, so beginning in 1995 the government began tucking away 2.5 percent of payroll for employees to invest once the system was set up.
Personal investment accounts were not established until 2000, with a bewildering array of funds to choose from. Some 456 funds participated initially, and the number has since grown to around 600. Most funds invested in stocks, with a quarter primarily in Swedish stocks. Workers could choose up to five funds.
Anyone who did not choose a fund was automatically assigned to the default fund, which was set up by the government. The default fund must invest 80 to 90 percent of its assets in stocks.
A central pension agency records all the accounts and fund values. The agency also ran an ad campaign to discourage people from going into the default fund.
Nonetheless, a new study by Henrik Cronqvist and Richard Thaler of the University of Chicago finds that a third of Swedish workers did not make an active choice when the system started in 2000, and were therefore assigned to the default fund. Since 2000, fully 92 percent of new enrollees have not made a choice and have been added to the default fund.
Apparently, the large number of funds to chose from paralyzed many individuals from making a choice. This has also been the experience of many 401(k) plans that have a default option in the United States: the default option, whatever it may be, is chosen by a high proportion of investors. People are also reluctant to switch once they are in a fund, a tendency that the economists William Samuelson and Richard Zeckhauser have called status quo bias.
Another bias that Mr. Cronqvist and Mr. Thaler documented is home bias, a tendency to pick funds composed of Swedish companies, as opposed to a diversified portfolio of companies from around the world. Nearly half the money actively invested was in Swedish stocks. The default fund, by contrast, was better diversified: only 17 percent was in Swedish stocks.
They also found that people tended to pick funds in sectors that had done well recently, and to pick funds with low fees. The average fee for active choosers was 77 basis points, or 0.77 percent of the funds invested. For the default fund it was just 16 basis points. Chile's mandatory savings plan provides another point of comparison. Fund management fees were much lower in Sweden than administrative costs in Chile's plan, probably because the central pension agency orchestrated rebates and advertised the fee rates.
OK folks, please explain this to me:
SS is currently running a surplus. This means that of the SS payroll tax that I pay, some percentage of it goes to pay for benefits to current retirees, and some percentage goes into the general federal revenue stream to pay for Bush's war and corporate tax cuts and whatever else he is "spending his political capital" on. For argument's sake, let's say that 80% of my payroll tax goes towards current retirees and 20% goes into the general revenue stream.
Now assume that Bush's proposal takes effect and approx 20% of my SS payroll tax is diverted into a private account with my name on it while the other 80% continues to pay for current retirees as before. In order to for this to happen I agree up front to accept reduced benefits down the road because my private account will make up the difference.
So what is the overall effect? Seems to me that immediate effect of the proposal would be that SS tax revenues will no longer be available to fund other government programs such as Bush's war and corporate tax cuts because the so-called SS "surplus" will disappear overnight to be replaced by millions of private accounts that the government will be unable to touch. This is assuming that the amount of SS taxes that are diverted into private accounts is similar to the current amount of SS surplus.
Now as for the long-term effects. At some point in the future the program with or without private accounts will be running a deficit and federal revenues will need to be used to cover the shortfall. When this happens, all those billions of SS IOUs will start getting paid back. And eventually all the IOUs will get paid back and then some other means of covering the shortfall will need to be used, either an increase in SS taxes, some federal subsidy from other sources, or a cut in benefits, or a combination.
This is all going to happen whether or not SS is partially privatized, although the date at which the threshold is reached may be different depending upon how much benefits are cut for those who opted for private accounts and other details of the program.
So in fiscal terms, why is this a bad idea? Seems like all we are really doing is taking the current SS surplus and dedicating it to private accounts so that the money is no longer available to be spent for extraneous things. Unless I'm missing something, it seems to me that forcing Congress to keep its hands of the SS surplus is a good idea. Because with this current Congress, I sure as hell don't trust them to spend the money wisely.
Posted by: Kent at November 9, 2004 02:10 PMEschaton writes: "there will be lots and lots and lots and lots of details. Sadly, our media will not be up to the job of informing people just what those details are."
That's just patently ridiculous: blaming the media for future failures of policy is already something out of the Republican playbook. But more to the point, for a decade or more, most newspapers and newsweeklies have featured extensive investor advice, and it is usually the most easily understood, cautious and thorough of any info available on investing. TV like MSNBC is shoddy, true, but, c'mon, blaming the media for, (1) the public's difficulty in understanding complex investment instruments and risks, and (2) the investment industry's deliberately making it all complex so investors can get screwed.
Atrios, we're all bummed about Kerry's loss, but c'mon, get over it. Bush won, not the media.
There is a problem with Social Security, but it's not the one being talked about directly.
Here is the problem: a fully funded system (like a private pension plan) is a means for one person to smooth consumption over his lifetime. It means that the government has huge amounts of money on hand. What will it do with it? It could also invest it in the private markets: that's the trust-fund solution. That solution has the problem that it is very likely that the governments investing decisions and voting of shares will be driven by motives other than profit maximization; we already see this happening with state pension funds. Alternatively, it can spend it now, and promise to repay it out of future revenues: that's the current system. That solution has the problem of being, in effect, a pay-as-you-go system taken in terms of taxes as a whole.
A pay-as-you-go system is NOT a way of enabling a person to smooth consumption over his lifetime; rather, it smoothes consumption over the current population. This method of funding has the problem of depending on demographics. The total production of the people working must cover the total consumption; if there are few workers relative to retirees, the tax burden on the workers will go up. THIS is the real problem with today's social security system: as life expectancy has gone up, and birth-rates have gone down, the worker:retiree ratio has gone down greatly.
Private accounts would automatically adjust to life expectancies; this is the real benefit. However, losing the insurance is a real loss. Given the political will, government-run systems could also adapt to life expectancies by raising the retirement age (and making retirements at other ages actuarially equivalent by adjusting benefits.) Changing retirement age gradually, but sharply, would be my preferred solution. My proposal would be to increase retirement age 1 year for every year of age under 60, and then to index it to life expectancy in such a way that the proportion of one's life spent working would be constant (thus adjusting the retirement age automatically in future.)
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