November 11, 2004

Funding Social Security: Carrots vs. Sticks

Kevin Drum asks:

The Washington Monthly: But here's my question: even if the equity premium really exists, does it matter? When we discuss Social Security, we usually talk in terms of money-related numbers: tax rates, benefit levels, investment returns, etc. This is useful because numbers can be added and subtracted and fed into formulas that spit out other numbers. Very handy.

But in the end it's not really about money. It's about the fact that at any given point in time, there are a certain number of workers who produce stuff, and a certain amount of this stuff is turned over to the nonworking elderly. It's true that the elderly use money to buy this stuff, but it doesn't really matter where the money comes from. All that matters is that they're hoovering up a certain percentage of the goods and services that workers create. As the number of elderly increases, this means that individual workers are forced to give up a larger and larger percentage of the stuff they create.

So suppose the whole thing works swimmingly. The government invests payroll taxes in the stock market and gets spectacular returns. This money is turned over to retirees. Result: tax rates stay low, but the elderly have as much money to spend as ever.

Which in turn means that workers are still forking over the same amount of goods and services as ever. So what's the difference? Who cares whether the money comes from tax payments or from government mandated investment income? One way or another, workers are still being forced to give up the same percentage of the stuff they produce to retirees. And it's stuff, not money, that ultimately matters.

And so, in the end, I don't get it. Even if the whole privatization scheme works, who cares?

There are two reasons to care. First, to the extent that any of these Clever Schemes are adopted and actually work, we boost national savings. We thus arrive at 2050 with a bigger pie to slice and divide between workers and retirees. That's probably a good thing.

Second, workers can be induced to moderate their consumption in order to make room for retirees' consumption in two ways. First, the stick: the government comes in and says, "We're taking your money." Second, the carrot: the elderly say, "We'll sell you these incredibly valuable stocks at a good price." Workers will be happier with the process if it's accomplished by carrots rather than sticks.

Posted by DeLong at November 11, 2004 08:53 AM | TrackBack
Comments

Brad DeLong wrote, "First, to the extent that any of these Clever Schemes are adopted and actually work, we boost national savings. ... Second, the carrot: the elderly say, 'We'll sell you these incredibly valuable stocks at a good price.' "

However, note this passage from William Bernstein's excellent _Efficient Frontier_ (at efficientfrontier.com):
"In short, the aggregate national investment return will be approximately the same no matter what the overall stock/bond mix of the capital markets. To the extent that debt tends to decrease agency conflicts, a small nod may go to an increase in the overall debt/equity ratio. If everybody issues/invests in stocks, then stock returns must fall to the aggregate return rate. Which may actually already have happened. If all of the nation’s pension funds and newly-privatized social security accounts shifted to stocks, they most decidedly would not obtain the historical 7%-8% real return."

(Click on my name for the link to the page with this quote...)

Posted by: liberal at November 11, 2004 09:06 AM

It seems to me that if the money put into personal accounts is diverted from the general fund which must borrow to replace this money, where is the increase in national savings? Didn't one of Bush's advisors want to borrow a bunch of money and invest in the stock market to lower the deficit? This seems like the same thing to me.

What happens to stock prices when high numbers of elderly are selling to pay for retirement and few young people are buying? Does not your gain disappear? How much of a discount of future benefits does a young worker have to forego to make the system cost less to the treasury?

Posted by: ted at November 11, 2004 09:10 AM

"Second, workers can be induced to moderate their consumption in order to make room for retirees' consumption in two ways. First, the stick: the government comes in and says, "We're taking your money." Second, the carrot: the elderly say, "We'll sell you these incredibly valuable stocks at a good price." Workers will be happier with the process if it's accomplished by carrots rather than sticks."

This is really the crux of the issue for Social Security. Does it make sense for the Government tax current payroll and or income to provide a guaranteed pension to the elderly and disabled, or should we rely exclusively on voluntary or forced savings to provide for those who cannot work? The advantage of SS is that a broad based tax can transfer a certain percentage of economic output without regard to such vagaries as labor share of output, stock market or bond yields let alone the individual risks involved in choosing amongst such options. Originally SS was envisioned as one part os a "three legged stool" for retirement, along with private pension and savings. Since the private defined benefit pension is going the way of the dodo the relative importance of the defined benefit from SS has grown.

Against this benefit is the cost imposed by the tax burden which disadvantages US workers (payroll) and induces tax avoidance (income). On the other hand any system of forced savings and private accounts or private investment of SS funds faces serious administrative burdens and enormous potential for loss to fraud. Actually in is hard to see how the current income tax is much different from having the gov't take a fixed share of all companies, and we know how well that works out.

Finally there is the question of whether some change of this sort increases savings/ investment. It is not at all clear that this accomplishes anything except shuffling some paper, with higher deficits exactly balancing lower obligations (if they actually are lower). I find the argument that the gov't should arbitrage the equity premium by selling bonds and buying stock pretty questionable, if it is done on this scale, leaving alone the questions about impact on financial markets and asset allocation. While one could argue that this is a way to shift the burden of SS onto capital income (by reducing the real returns to equities they get a lesser share of national income) I am inclined to believe the primary impact would be a windfall to current shareholders and loss to bondholders (especially the SS trust fund) as interest rates rise. That seems a bit counterproductive. On top of those concerns there is the whole issue of whether modern economies really need to limit consumption to generate growth. The trend of modern economies is toward goods with high fixed and low or zero marginal costs. One can argue that growth is largely a function of tech capital expenditures which are demand driven and for which both the capital expenditure and the consumption take little from the stock of limited resources.

Posted by: economaniac at November 11, 2004 09:35 AM

It's not clear to me how buying stocks vs. treasury bonds makes a difference to the aggregate savings. It does shift the risk/reward ratio between future retirees and future workers. But in 30 to 40 years all work will be done by robots so who cares?

Posted by: Hacik at November 11, 2004 09:40 AM

Of course when considering any kind of scheme like this, one should always take Daniel Davies' Law into account, and conclude that even if it's a good idea in principle, it would be best to wait another 4 years before implementing it.

Posted by: Kuas at November 11, 2004 09:50 AM

Hey Professor: Paul Krugman doesn't think the SS "crisis" is much of a crisis from what I've read of his opinions in the popular press. Is Prof. Krugman wrong? Addled? So shrill that his analytical abilities have become stuck? I respect your opinion and I respect his opinion. Which planets are you on? Surely Krugman is not on an outboard rocket to the gamma quadrant?

Posted by: Cal at November 11, 2004 10:08 AM

Hey Professor: Paul Krugman doesn't think the SS "crisis" is much of a crisis from what I've read of his opinions in the popular press. Is Prof. Krugman wrong? Addled? So shrill that his analytical abilities have become stuck? I respect your opinion and I respect his opinion. Which planets are you on? Surely Krugman is not on an outboard rocket to the gamma quadrant?

Posted by: Cal at November 11, 2004 10:09 AM

There's a real risk of fallacious (and wishful) thinking, regarding "personal accounts" and and/or equity investment of Social Security funds. In the Keynesian model, there's no such thing as "saving" -- there's only spending (consumption or investment or govt expenditure).

If Brad's point regarding an increased national savings rate is that we could reduce our future obligations to China, Japan and other foreign holders of American debt, then he has a defensible point.

If the metaphor of a "bigger pie" is meant to convey the idea that boosting national savings is going to boost future productive output, that's a more doubtful proposition, to say the least. Investment, not saving, determines the future productive potential of the country; saving only determines how much of that future productive potential (net) is going to be obligated to foreigners.

Savings rates matter, of course. A very low savings rate gets us Argentina, but a very high savings rate is not necessarily a good thing; a very high savings rate gets us Japan.

There are two fallacies lurking here. One is the one "liberal" points out: that there's a free lunch to be had in equity returns, which can be garnered simply by transferring part of the accumulated trust fund from government securities into private equity securities. Not possible, says algebra; people who advocate such are liars or fools or both, says I.

The second fallacy is the idea that savings rates, per se, drive economic growth. Investment is what matters to future productive potential; what savings gets you is insurance. When a person at 30 buys a house with a 30 year mortgage, that's part of an implicit retirement plan. The "savings" associated with building equity in the home, gradually reduces the risks of increased housing costs. At 60, the homeowner has a high degree of assurance that he will have a place to live, which he can afford.

The Reagan-Bush redistribution of income away from the poor, and the working and middle classes, has increased the risks to which families are exposed, and "personal accounts" will just further increase the risks, as it further increases the redistribution of income and wealth to the richest 20 percent.

Bush proposals on social security will have everything to do with the distribution of income and risk.

To the extent that there is any impact on investment and economic growth, it will come because middle-class decision-makers, without adequate insurance, either become too conservative in their investment and other economic decision-making, or too desperate and prone to silly and wasteful choices (e.g. lottery tickets).

Posted by: Bruce Wilder at November 11, 2004 10:16 AM

economaniac:

Is there any evidence that the payroll "induces tax avoidance (income)"?

Common sense tells me that with the taxable income capped at 80 some odd thousand - this is extremely unlikely.

Posted by: Armando at November 11, 2004 10:17 AM

I'm not an economist but...

Might it not be possible, in principle, that additional money put into equities markets (instead of government debt) means additional capital investment, means additional productivity growth, means more wealth to spread around, come 2050 (or whenever...)? (In Kevin's terms, the higher the productivity of the 2050 workforce, the easier time they have supporting the non-workers.) Could this be a source of the "equity premium"?

Posted by: Alex R at November 11, 2004 10:24 AM

I think this is the most important economic discussion over the next four years.

Kevin is correct that the Administrations proposal as it is currently communicated doesn't do us any good. As Ted points out we are just moving funds from one pocket to the other.

Brad points out that the hidden assumption behind this is that it raises national savings, and I agree that this assumption is necessary for us to increase output. However, what the public doesn't understand is that this assumption requires that we decrease consumption. Instead they just think there is some sort of magic in the stock market.

If you take the step to realize that the real issue is cutting consumption, then privitizing looks like an inefficient way to do that. In the end the problem is that the US doesn't save enough, and this proposal doesn't do much to change that directly.

BTW, I was thinking of how the gov't does its accounting. If we were to divert, say, a third of the social security funding to private accounts I don't think this would change the reported deficit. Wouldn't the reported deficit remain the same, but the Treasury would borrow from the public instead of the trust fund?

Posted by: Keith at November 11, 2004 10:31 AM

"One way or another, workers are still being forced to give up the same percentage of the stuff they produce to retirees. And it's stuff, not money, that ultimately matters."

Two problems with he above. If we do nothing, then future workers will be giving up more "stuff", than current workers do. Currently, approximately, for every $1,000 of benefit paid, three workers each pay $333 tax. But, in 70 years it will be two workers paying $500 each. Huge difference.

Second, if we have investment in a GLOBAL portfolio (stocks and/or bonds), we can increase the size of the workforce producing "stuff" for us. We cannot tax those foreign workers, though.

Posted by: Patrick R. Sullivan at November 11, 2004 10:34 AM

Professor DeLong, I respectfully must ask just which planet you are on at this time? Surely it cannot be the planet earth, the one where people seem to keep expecting -- for reasons which elude me -- to see actual competence from this administration. Iraq? Hello! Fiscal policy? Hello! Environmental policy? Hello!!!

I encourage you and others to take a long hard look at an article Ron Suskind wrote for Slate back in February of this year: The Free Lunch Bunch (URL http://www.slate.com/id/2096337)

*************

An excerpt:

During the 2000 campaign, candidate George W. Bush seemed particularly confident about his ability to pay for Social Security reform. Despite independent estimates that creating the kind of "voluntarily" private accounts he envisioned could cost more than $1 trillion, Bush consistently took the position that he could reform Social Security for free, without undermining promises to baby boomers anticipating retirement over the next several decades.

Why was Bush so sure of himself? According to documents unearthed yesterday from the trove of 19,000 files given to me by former Treasury Secretary Paul O'Neill, and a bit of additional probing, candidate Bush and later President Bush believed in the "Lindsey Plan." These documents show us what the president thought about Social Security reform at the only moment over the past three years—the fall of 2001—when he was fully engaged with this issue.

Larry Lindsey, Bush's tutor on economics during the campaign and later chairman of the White House's National Economic Council, devised a scheme based on creative accounting principles. Essentially, it proposed that the government would issue substantial new debt to sustain old-style benefits. This debt would be serviced and paid down by confiscating revenues from the higher returns from those opting for new-style personal accounts.

For the first nine months of the administration, this was called the "free-lunch" plan—a painless way to convert to a blended, private-accounts model. Inside of the Treasury Department and the Council of Economic Advisers, however, officials were befuddled by it. Lindsey seemed to have never called upon analysts inside the Social Security Administration to run the traps on his idea. Treasury and CEA did—and the numbers didn't even come close to working out. But that didn't stop Lindsey, or the president, from believing in and promoting the "free-lunch" plan. These two memos (URL: http://thepriceofloyalty.ronsuskind.com/thebushfiles/archives/000083.html) on RonSuskind.com, which have never before been released, show what Bush and others in the White House were actually thinking about Social Security reform.

/End Excerpt

*****************

Got it? These people plan to set up private accounts and pay for transition costs by confiscating excess returns (that is to say returns higher than needed to pay for basic guaranteed benefits) from the people who own them. There seems to be no mention of what happens if pie-in-the-sky doesn't materialize and returns lag (as many market watchers expect for the next ten years or so) or even crash.

Stop expecting reality-based competence from these people. It isn't there and it isn't coming any time soon.

Posted by: Roman Berry at November 11, 2004 10:36 AM

OK, so this is shamefully off-topic (shoot me), but since the future of Social Security does involve making choices...

While avoiding a rain storm today I ducked into a used bookstore and emerged the proud owner of Heap, Hollis, Lyons, Sudgen and Weale's "The Theory of Choice: a critical guide". I'm only a psychologist, so this book should teach me a lot, but I have been unable to find any on-line (or other) reviews of it, so if there were any things I should watch out for, I don't know them.

And, man, am I naive. I didn't know really anything about this subject (as it turns out). I didn't even really know about the problems with lexicographic choice models...

Posted by: Jonathan King at November 11, 2004 10:43 AM

armando:

I was referring to classical "dead weight" arguments about the economic costs of taxation. The payroll tax distorts production away from using US labor and so has negative efficiency and distributional effects on American workers. The income tax is more complicated, but seems to generate inefficiencies primarily through tax avoidance.

Posted by: economaniac at November 11, 2004 10:54 AM

Patrick,
As you may have noticed people on this blog are often frustrated with a perceived lack of good communication from the Administration on a variety of topics. I find myself in their camp when discussing privitization. Since you often appear to defend the Administrtions actions, I thought that I might pose some questions to you in the hopes that you would be able to explain some elements more thoroughly. As a springboard for discussion, allow me to ask a couple of questions about your post.

You start by quoting Kevin Drum as he ponders how the Administrations proposal would accomplish anything. You issue two critiques. In the first you indicate that we have a problem with social security and that we need to do something. I think we all agree with that, but I don't understand how that is a counterpoint to Kevin's thought that the Administrations proposal might be ineffective. Am I misunderstanding your post?

Your second point centers on investing outside the US, and I think there is some merit to this point provided that we don't artificially force jobs overseas by subsidizing production there. Do you know if the "overseas investment" element is part of the Administrations plan, or is this your point of view?

Lastly, I think an important point remains unclear to me. How does the government pay for the shortfall that we will have in the next few years as we divert funds away from retirees to private investment accounts? Will this be borrowed?

Posted by: Keith at November 11, 2004 11:25 AM

The answer to the Social Security deficit problem is explained on my blog:

http://laglux.blogspot.com/

We need to reintergrate the Social Security Fund into the economy. Check out my blog, as you might find some interesting things there. lgl

Posted by: lgl at November 11, 2004 11:26 AM

Why not make this easy? Remove the salary cap($87K) on SS for all cash compensation by a company, then consolidate all the other various retirement instruments into one account. 401ks, 403bs, IRAs and the like are just saving accounts written into the tax code. We already contribute and allocate these to private investments. Make a small portion manditory and the rest voluntary.

You could even roll the college account into this(512?), start one for you kids. The only 2 ways to remove money other that retirement would be a home downpayment(equity only) or college tuition. The college would only be a loan required to be repaid to the account.

Posted by: RC at November 11, 2004 11:56 AM

OK, if people start saving more and spending less, what happens to the consumer economy? Every time "consumer confidence" slips, it's reported as a disaster.

Posted by: Zizka at November 11, 2004 11:59 AM

OK, if people start saving more and spending less, what happens to the consumer economy? Every time "consumer confidence" slips, it's reported as a disaster.

Posted by: Zizka at November 11, 2004 12:06 PM

Okay, some points:

1) Encouraging savings only matters if there is a shortage of investment capital that is holding back advances in production and productivity. There is not. There is a shortage of consumptive capacity to consume the enormous amount of goods and services that the economy can generate. Thus the whole notion that "encouraging savings is good" is an absurdity in today's economical conditions. The only good that savings can accomplish in a time of overinvestment and overproduction is to smooth out the fluctuations in national income by allowing savings to be drawn down in bad economic times and built back up in good economic times. But we're using credit cards to do basically the same thing (run up debts in bad economic times, pay off debts in good economic times).

2) Moving some Social Security savings from the government bond market to the stock market does not increase the amount of savings. Presumably, a lesser demand for bonds will result in an increased interest rate on the bonds in order to sell them all, causing other people who have money in the stock market to move said money into bonds. All you're doing is changing WHO is holding the bonds -- not the total number of bonds outstanding -- and increasing the amount of money that the population must be taxed in order to pay the interest on the bonds.

3) Given current productivity gains, a smaller number of people will be able to sustain a larger number of retirees than anybody could previously have envisioned. It is looking increasingly unlikely that there will be any problem meeting the basic needs of the Baby Boomer retirees. In addition, we have the option of bringing in guest workers from other countries to fill positions where we just need bodies. We're already doing that with Mexicans, albeit unofficially.

Frankly, I'm not seeing anything that needs "fixing", or any benefit from investing the Social Security fund in securities rather than bonds.

Badtux the "take from one basket, put into another, still got same number of eggs" Penguin

Posted by: BadTux at November 11, 2004 12:23 PM

BadTux writes “moving some Social Security savings from the government bond market to the stock market does not increase the amount of savings.” But as Brad DeLong notes, savings can increase with the same movement of savings from government bonds to stocks.

Either view can be correct although historically, the return on stocks has been higher than for bonds (see Stocks for the Long Run by Siegel). If this continues to be the case, then savings will increase by moving from bonds to stocks. Savings is not just comprised of the total amount saved, but also the return on savings. If you save $1,000 and your return is 5%, then you have $1,050 after a year – with a 10% return the value of your savings is $1,100.

Higher levels of savings finance a greater level of business investment since there is equality between savings and investment in the macroeconomy. Higher levels of investment increase worker productivity, non-inflationary long run economic growth and incomes.

Partial Social Security privatization allowing a shift of savings into the stock market does reduce the amount of money used to purchase government treasuries and finance the federal deficits. This implies that we will need an even higher inflow of foreign money to purchase the Treasury debt. This will be the case even with a higher return on savings in the stock market since most of that money will remain in the stock market rather than migrate to bonds.

Posted by: Jay at November 11, 2004 02:47 PM

"You start by quoting Kevin Drum as he ponders how the Administrations proposal would accomplish anything."

That's not what Kevin Drum did. He asked a general question about how pensioners are provider for. Not one about the specific Bush proposal.

At any rate, the Bush idea is merely a starting point to get the debate started.

Posted by: Patrick R. Sullivan at November 11, 2004 03:56 PM

This does not concern me, "I am in the boat",but what happens to those people who have their money for retirement in a company that tanks? Sally Ann?

Posted by: Big Al at November 11, 2004 04:45 PM

I'm with Big Al. I'm not following the economics very well (and if that's a preview of our side of the SS debate, we're going to get creamed.)

My worry is that we're going to give people control of their money and a large portion of them are going to make bad decisions or get ripped off. So then we'll either have to create a safety net for the folks who fall through the holes in the safety net or let 'em die.

I figure that the people who really need SS are not generally well prepared for making investment decisions and, further, that most of the people whose need for SS is less have other investments/savings.

Put bluntly, I get the feeling that this is just the next opportunity for Bush's predatory cronies to get rich off the backs of working people.

Unless someone convinces me that privatization will reliably put a lot more money in the system, I say the hell with it.

Posted by: Dave Hollander at November 11, 2004 05:59 PM

The remarks about rates of return dropping if everybody went via investments are spot on. Another thing missing from this discussion is the genuine insurance side of things. That isn't just the financial risk that could be smoothed out via pooling, but the personal worry of outliving one's savings.

I believe we (in any country) can get the best of both worlds by phasing in a system whereby the middle aged got tax breaks allowing them to fund the first part of retirement, while the insurance side cuts in for older ages funded from the younger groups (with the cutoffs gradually opening out over time). This not only avoids flooding the investment pool and clears up the outliving one's savings problem, it means that the self funding window only has to cover a shorter time span. Unmanaged funds typically have financial risk that grows at a faster exponential rate than the returns do, which makes long term management precarious; it's that sort of managing financial risk that really needs to be insured against.

I have an article on this topic at my publications page, http://member.netlink.com.au/~peterl/publicns.html

Posted by: P.M.Lawrence at November 11, 2004 07:54 PM

I have two big doubts about the practicality of funding American retirement out of the capital markets.

1. Will the bond and stock markets continue to function as capital markets once the geezers are tapping them for a trillion dollars a year? Will prices reflect "real" values when more money than the market can use is pouring in, or again later, when a Mississippi of cash needs to be drained off? If prices reflect primarily the availability of money in the market, we'll be in trouble. After all, the layer of liquidity in the markets is thin compared to the total value of the securities.

2. Will stocks provide a vehicle for corporate governance as they do now, once the purpose of national savings is changed? When the capital markets become an auxilliary of the national retirement program, shareholder goals are likely to change. Many shareholders will even insist the government look after (regulate) the economy, to keep bad actors from taking risks and screwing up their retirement security. Is this the attitude that will support wealth-generating American success stories?

It may be the case that the only way to deliver golden eggs to our retirees without strangling the national goose is to tax and transfer.

Posted by: DelbertPGH at November 11, 2004 08:47 PM

Kevin Drum's comment is exactly correct, and the discussion of social security needs to start here, as I have said several times in comments over the past 18 months:

"But in the end it's not really about money. It's about the fact that at any given point in time, there are a certain number of workers who produce stuff, and a certain amount of this stuff is turned over to the nonworking elderly."

Well, not exactly right -some of the real good flows will come from capital stocks that must be in place.

I think the Prof's approach to social security reform is not good. He seems to start from financial gimmicks like this equity premium puzzle stuff and tries to work backwards towards the real economy, but that stays lost somewhere in the financial gimmick mist and he never seems to get there.

The Prof says:
"First, to the extent that any of these Clever Schemes are adopted and actually work, we boost national savings."

How? In the Feldstein approach, isn't the increase in national savings from privatization tied up with reliance his shaky solution to the equity premium puzzle? Correct me if I am wrong. I am not going to bet on this poorly understood and empirically shaky equity premium financial gimmick when the retirement income, of a whole generation's retirementis on the line and also risks heading off on what may very likely be a long and tedious false lead on solving the low rate of national saving.

The idea of personally managed individual retirement stock market accounts stinks for several reasons, many of which are mentioned in the previous comments. Why does the Prof buy into this stinky idea? Other countries have or are successfully adopting partial privatization without them, and they are working OK.

In short, I would like a more empirical, data driven approach in the Prof's social security posts, that starts with "real economy" considerations rather than in the middle of a maze of financial gimmickry. That also looks to other countries' so far rather successful approaches to partial privatization. I would also like to see more attention paid to some issues that might per pertinent to that part of the program (which is a very important part) called "insurance". I have never understood how, given the stock market's intertemporal volatility, a person can have any confidence they will come close to the average return over the relatively short time horizon of 45-50 years. And yes, that is short, unless you cherry pick the most stable 10 to 15 years of market performance and are willing to bet that will be norm forever after right now. And who believes that the last four years have made that more likely? If anyone has an explanation (Prof included) I would very much like to hear it. Everyone go click on your favorite stock index, get a long historical series, click on the log scale and look for lengthy flat sections, which can last up to 15 years. That will blow a real hole in this 10% average historical return stuff, unless you are the sort of person who is willing and able to extend your working life by 15-20 years if you need to.

I think the Bush social security proposal will end up being a gold mine for brokerage houses and no one else. Why is this program, which is in less trouble than Medicare or private pension plans in some industry sectors, the first target for radical, poorly planned, mystery meat reform? My answer: because there are bunch of Bush supporter sleazeballs who think they have found a way to make money off of the solution.

Posted by: jml at November 11, 2004 09:32 PM

Didn't mean to bash the poor hardworking Prof. But his approach to social security really irritates me. Dude, where's the wisdom and nifty data and empirical info that is applied to the other macro topics that come up on this blog?

Posted by: jml at November 11, 2004 09:49 PM

TOO GLIB

Doug's response to Kevin seems too glib.

It might seem that investing the Social Security Trust Fund in stocks increases productivity, since the stock market has higher returns than T-bills, at least on average and over long horizons. But if the Trust Fund is holding stocks instead of T-bills, then somebody else must be holding those T-bills, absent something that changes the aggregate US Govt Debt. Society's aggregate portfolio is unchanged. No boost to national savings here.

Of course voluntary exchange is preferable to government coercion, but at this stage no one is seriously proposing making contributions voluntary. If the current system of benefits amounts to an annuity that is less dependent on the luck of your birth year than anything you can finance privately, then weakening this aspect of the system may end up making us less free by denying access to an asset that most of us would be happy to purchase.

Posted by: Andy McLennan at November 11, 2004 11:03 PM

I agree with Andy McLennan. At least I think I do. I think that the asset currently unavailable on private markets that he is referring to is a share in the total national economy, with risk spread over all sorts of asset types, not just equities or bonds. And the current social security system provides the closest to that asset that anyone has figured out how to provide. If something close to that can be privatized under the BushCo scheme, then I will listen.

I am not a paleo-liberal on this. If the BushCo proposal provided access to more diversified portfolios than normally provided by brokerage houses and mutual funds, and there was some hope of reducing the overall debt growth (which involves describing -even conceptually- a way of funding the loss payroll taxes diverted to private accounts) then there would be reasonable proposal for partial privatization.

I disagree with Patrick that Bush is now opening up the subject for discussion. There has already been a social security privatization commission. It was not formed with the idea for forming a consensus or meaningful national discussion, it was packed with advocates of privatization. They could not reach a consensus and produced three proposals. And concluded that Bush's plan would not work as he claimed it would, and it would require a substantial transition cost. Bush as finally recognized that a transaction cost exists, and seems also to recognize that fallacious use of net present value concepts cannot make the cost disappear. He has not said how he intends to pay this cost.

In my opinion, the Bush administration has already repeatedly lied through its teeth about the program being in big trouble over the medium term, so why should we trust them on anything else? And anyway, focus on the trust fund and the baby boom as a reason for immediate privatization is a mistake. The trsut fund was designed as a temporary cushion for the baby boom which would supplement pay-as-you-go transfers. That is why obsessing over returns to the trust fund is a mistake, or at least not as big a deal as privatizers make it out to be. It would work well if the money had not been spent by the government, with no plan to pay it back (except for the demonic Clinton, who was actually reducing the growth of the debt -admittedly helped by the late 90s boom, but that was not the whole story either). The real permanent problem is the long term imbalance that occurs after the baby boom retires and the trust fund would be exhausted (assuming it will be there in real terms when it is planned to be used). If the growth of the national debt could be reduced, a plan adopted to refund the trust fund, and the real long term problem discussed honestly, then that would be a reasonable start for forming a national consensus on partial privatization.

Posted by: jml at November 11, 2004 11:31 PM

BadTux: Not sure about basic needs of the boomers. You will have to pony up a much larger geriatric/healthcare system, with doctors, nurses, equipment and all. And training capacity for the doctors & nurses, etc. And safe transportation (imagine a lot of 70+ years old boomers in then 20+ years old cars on the road ...).

Posted by: cm at November 12, 2004 12:19 AM

economaniac wrote, "The payroll tax distorts production away from using US labor and so has negative efficiency and distributional effects on American workers. The income tax is more complicated, but seems to generate inefficiencies primarily through tax avoidance."

Maybe. But for taxes on lower incomes via the payroll effect, the disincentive to work (by making leisure relatively cheaper) is at least partly offset by the wealth effect.

As for the income tax, tax avoidance comes mainly at upper brackets and could be ameliorated through better enforcement and changes in the tax code (such as enlarging the tax base and treating capital gains the same as other income, as the 1986 reform did).

Of course, it'd be best to reduce reliance on the income tax with large taxes on Ricardian land rent---land value taxation is both more equitable as well as extremely efficient (as the supply of land is completely inelastic).

Posted by: liberal at November 12, 2004 03:15 AM

BadTux wrote, "Encouraging savings only matters if there is a shortage of investment capital that is holding back advances in production and productivity. There is not. There is a shortage of consumptive capacity to consume the enormous amount of goods and services that the economy can generate. Thus the whole notion that 'encouraging savings is good' is an absurdity in today's economical conditions."

I agree with the sentiment in vague terms, but note that the only reason there's no shortage of capital is because of the willingess of Asian central banks to lend us hundreds of billions of dollars per year.

Posted by: liberal at November 12, 2004 03:17 AM

Jay wrote, "Either view can be correct although historically, the return on stocks has been higher than for bonds (see Stocks for the Long Run by Siegel). If this continues to be the case, then savings will increase by moving from bonds to stocks."

Wrong, at least for the nation in aggregate.

See my post (first post in this thread).

Posted by: liberal at November 12, 2004 03:18 AM

Patrick R. Sullivan wrote, "At any rate, the Bush idea is merely a starting point to get the debate started."

LOL!

As if the Bush administration has ever been interested in an honest debate about anything (even when judged by the usual standards of dishonest political discourse).

Posted by: liberal at November 12, 2004 03:20 AM

And what Andy McLennan and jml said.

Of course, when Andy wrote, "But if the Trust Fund is holding stocks instead of T-bills, then somebody else must be holding those T-bills, absent something that changes the aggregate US Govt Debt." someone will trot out the usual claim that privatization will inhibit spending by cutting down on revenue (in the sense of the unified budget concept). Problem is that AFAICT there's no empirical evidence that, in recent decades, higher revenue leads to higher spending.

Posted by: liberal at November 12, 2004 03:26 AM

jml wrote, "In my opinion, the Bush administration has already repeatedly lied through its teeth about the program being in big trouble over the medium term, so why should we trust them on anything else?"

Right. Though I can't think of a topic on which they haven't lied (again, even judged by the lower standards of political discourse).

Scarier---and downright disgusting, given his role in and rationale for raising payroll taxes in the 1980s---is that Alan Greenspan repeats the same lie about the medium term.

Posted by: liberal at November 12, 2004 03:28 AM

My head is spinning. Let us back up a little.

Currently Social Security is 100% funded out of payroll. It has exactly zero impact on people who gain their income from dividends or capital gains. Unless they have a job exposed to payroll tax they will never pay a dime into the system, or for that matter get a dime out. And yet they by all accounts want to unleash this beast and let it ravage through the capital markets for the sole benefit of stock broker commissions and for those they would in other contexts ridicule as "lucky duckies".

Why are people so willing to commit a trillion or so of transitional costs of General Fund money (largely paid by rich people) to bail out a fund currently entirely funded by workers? Somehow I doubt it is being driven by some deep-rooted compassion for the elderly. Certainly that is not true for a certain Kevin "Hoovering" Drum (could you sound more mean spirited if you tried Kevin?)

There is a huge pool of money sloshing around that Wall Street doesn't have their hands on. And they want it. That is all this boils down to.

Social Security isn't broke. And in the final analysis this money does not belong to the capital markets and they should have no say. They have to date not put a penny into it and absent an economic meltdown will never be called to put a dime into it. And then will not be able to afford it.

This whole argument assumes what needs to be put into evidence. What economic model are you operating on? And what happens if you plug that model into current Social Security financing?

For a forum hosted by an Econ Professor there is an astonishingly small number of numbers here. Because there is a huge difference between fixing a broken system and applying iffy schemes in an attempt to make a sound system better. I like the current system just fine, it is reliable and safe. Some people here want me to turn it in on a Lamborghini. When I am 61 I don't want to have to open the paper to the stock results to see if I can retire at 67. If it ain't broke, let's not fix it. And it ain't broke.

"2 points or 2% - that's all it takes". 1.9% productivity growth or 1.89% payroll tax. Either one 'fixes' the system. And exactly no one is predicting sub 2% productivity growth. I know this is hard. A lot of people have grown up "knowing" that Social Security was going broke. But in the end the numbers are the numbers, and certain armchair Greenspans need to confront them.

Productivity Growth Under the Lost Cost Alternative
2004 2.8% 2005 2.1% 2006 2.2% 2007 2.2% 2008 2.1% 2009 2.0% 2010 2.0% 2011 1.9% 2012 and years forward 1.9%

Per the Trustees that is all the growth we need to save Social Security with no changes in payroll tax, benefits, or retirement age. And we already beat the 2004 number. If you believe the economy will come in south of these numbers then Social Security has a problem. If you can devise a way to make stocks produce historic returns with numbers south of these you are a genius. Otherwise you can keep Wall Street's hands off of my money.

http://www.ssa.gov/OACT/pubs.html 2004 Trustees' Report pgs. 16, 53, 88

Posted by: Bruce Webb at November 12, 2004 03:32 AM

I always find myself worrying, what physical capital will this increase in financial capital be invested in?

The stock market has been a use of funds rather than a source of funds for quoted companies in aggregate for the last several years. This implies to me that companies with quoted securities outstanding are not able to reinvest their existing internally generated cash flow at acceptable rates of return. Why, therefore, do we believe that if we throw a further vast chunk of cash at the stock market, it will all be invested in new plant and machinery, rather than in bidding up the current value of financial ownership claims (something which, obviously, would not increase the amount of stuff to be divided up in fifty years' time)?

The place where it *is* possible to find loads of opportunities to make value-creating investments of savings in physical capital would be the Third World. However 1) I don't think anyone is currently proposing that the majority of Social Security personal accounts should be invested in emerging market securities, and 2) we tried something similar to this during the 1970s/80s period of "recycling petrodollars" and it wasn't what you would call an unqualified success.

Posted by: dsquared at November 12, 2004 04:08 AM

The drift among responses here is pretty clear. The carrot/stick argument is just naive. It is a very narrow argument, predicated assumptions about future emotional reactions, which ignores fiscal, economic and distributional effects.

Drum has a point that the carrot/stick issue does not address - how much stuff will there be to go around? Shuffling investments between stocks and Treasuries may matter in a second order sort of way - the functioning of the economy might change in unanticipated ways under a partially (?) privatized Social Security system - but we can't start our economic analysis by relying on unanticipated good luck, and certainly the first order issues are all about distribution, not output. One distributional issue is that there will be an added expense, with returns to SS recipients lowered by the future value of the fees paid to private managers of the private accounts.

Bruce makes a point that Brad has made in earlier posts - there is a shift of risk from the public account to the private, even though the public account is better able to handle the risk. Present and (particularly) future retirees already face substantial financial and economic risk. We now have a system which provides a mostly risk-free element in retirement plans, which would be diluted under the privatization plan - the value to holdings in privatize SS accounts would have a positive correlation with assets households accumulate for retirement outside the SS system.

The chatter about the equity premium, about second order outcomes, carrots and sticks, all ignore things we know to be true. The Social Security fund is not in bad shape. There is little prospect of it getting into bad shape unless we do something boneheaded to change it. (Very conservative assumptions show no problem at all for about 38 years - everybody knows fiscal estimates beyond 10 years are just plain silly, show why are we breathless about very conservative estimates which show no problem at all for 4 decades?) The transition to even partial privatization implies either more borrowing or tax hikes - we can guess which the Bush folks will choose.

What do we have reason to suspect? That the windfall to private account managers is intentional, not incidental. (In politics, there is a strong tendency to ignore the interests of the poorly organized many in favor of the well-organized few - here we have a good example.) That the reduction in benefits from public sector retirement accounts is part of a wider effort to reduce all direct benefit to households from government, to undermine public support for such programs and to undermine support for the Democrat party along the way. That the Bush administration, even with the best will, has such a poor economic policy record that there is little hope changes to the SS system will work out as promised.

So Brad, why the sudden fascination with finding justifications for this potentially disastrous change?

On the issue of savings vs capital investment, there is certainly a reason to worry about savings despite what appears to be an adequate level of investment. Our low savings rate means that foreign investors are piling up ever greater claims on the returns from those capital investments. No matter how many workers will be available to support each retiree, both the workers and the retirees will be better off if they don't have to fork over a big chunk of what the workers produce before dividing up the rest.

Posted by: kharris at November 12, 2004 04:20 AM

I am certainly no economist, so I am not qualified to address the various arcana above regarding savings rates, etc. What does strike me, though, is that lost in all the debate is the simple fact that by some trick of repetition we have changed our definition of what the Social Security program is about.

Social Security was never conceived as, nor meant to be, an investment vehicle. Neither was it instituted as a prop for the equity economy. It is insurance. It is required of every citizen to participate, just as everyone is required to purchase liability insurance for their car. The current receipts fund the current payouts. If, to use the car insurance model, there is a spate of bad drivers in a particular region, the insurance rates will rise to cover the additional payouts. When conditions warrant, the rates can drop.

So it is with Social Security. We will have to tolerate a rise in payments to fund the Baby Boom retirements. But that demographic bulge will not last forever. We boomers like to think we'll live forever, but we won't. At that point, rates can drop or stay the same if future retirees would prefer greater benefits.

Workers today have other chances to use tax-advantaged investments to fund retirement, including 401Ks, Keoghs, IRAs. Why, in a rational world, would it be advisable to diminish insurance guarantees to add to the speculative mix?

This is a social compact that we're talking ourselves into abandoning for no good reason and a whole lot of bad reasons. I could remind everyone that Clinton and we, as a nation, followed Greenspan's advice and tinkered with the system and built a surplus to cover the anticipated drain. Remember Gore's "lockbox," which was so ridiculed by Saturday Night Live and every pundit? I wish we had that lockbox now.

Unfortunately, we do not. Bush has squandered our future to fund his profligacy while being cheered on by Norquist and his ilk. And as a nation, we refuse to tighten belts across the board so as to spread the pain. I would point to that as one of the deficiencies in "values" this country must confront.

Posted by: SG at November 12, 2004 07:01 AM

Definitely fromthe Gamma Quadrant this morning. The only savings these schemes are going to increase are the Swiss bank accounts of Bush backers.

Apparently in Brad's mind (and many others) SS privatization has become the Slithery D- they can see the thing is slithery but "it gets everybody but it don't get me".

Read the poem to the end, guys.

Posted by: serial catowner at November 12, 2004 07:58 AM

Certainly a critical observation:

KHarris

"On the issue of savings vs capital investment, there is certainly a reason to worry about savings despite what appears to be an adequate level of investment. Our low savings rate means that foreign investors are piling up ever greater claims on the returns from those capital investments. No matter how many workers will be available to support each retiree, both the workers and the retirees will be better off if they don't have to fork over a big chunk of what the workers produce before dividing up the rest."

Posted by: anne at November 12, 2004 09:01 AM

Then your point is that changing the mix of Social Security market investment in some favor of stocks may result in a quick bidding up of stock prices with no corresponding lasting economic gains to provide for a more robust stock market over the long term. Please add to this explanation. I agree, but wonder what we may be missing.

DSquared:

Why, therefore, do we believe that if we throw a further vast chunk of cash at the stock market, it will all be invested in new plant and machinery, rather than in bidding up the current value of financial ownership claims (something which, obviously, would not increase the amount of stuff to be divided up in fifty years' time)?

Posted by: anne at November 12, 2004 09:09 AM

There are several comments stating the belief that there isn't a problem with Social Security. I find this surprising because I was under the impression that all of the monies that we have put into the trust fund have been spent by the government?

There are some that ignore this issue because its easy to call it politics, but this does not fix the problem. If we are to resolve the boomer retirement problem then we must find a solution that is both economically sensible and politically safe. The status quo passes the first test but fails the second. The concept of privitization as currently proposed seems to fail the first but is slightly closer to passing the second. At least it keeps some of the money from being spent.

Posted by: Keith at November 12, 2004 09:40 AM

http://www.nytimes.com/2004/11/12/business/12norris.html

As Baby Boom Ages, Era of Guaranteed Retirement Income Fades
By Floyd Norris

WE live in an age when a lot of promises regarding retirement are going to be broken. Just how they are broken, and what replaces them, will have profound effects on the future of the industrial nations that have dominated the world economy in the last century.

What is at stake is a reversal of perhaps the most important economic trend in developed countries since World War II, that of guaranteeing financial security for their citizens. In most major countries, governments came to provide health care and an assured pension. In the United States, some of that came from employer-financed health care and pension plans, but the results were often similar.

Now, increased competition stemming from globalization has left many companies scrambling for ways to cut costs. And many pension and health care plans are pay-as-you-go systems whose generous benefits while the baby boomers were working now seem unsustainable as that huge population group begins to retire.

In Europe the problems have been clear for years, although governments have been slow to enact unpopular changes. But there is a widespread expectation that change is inevitable. Bond-rating agencies cite that belief as a reason for not cutting sovereign debt ratings, and it is likely that spending by Europeans has been depressed by worries over just what will be there when they retire.

In the United States, an understanding of what must be done is less well formed. While some companies, like United Airlines, have eliminated defined-benefit pension plans in the glare of publicity, many more have quietly frozen their plans - keeping employees from earning additional benefits - or have barred new employees from joining plans. The number of employees in traditional plans fell to 17.2 million last year, down 23 percent since 1988.

Pension plans seemed to hold their own in the late 90's, when a soaring stock market allowed companies to assume that they did not need to put money in. But the bubble burst, and now the Securities and Exchange Commission is looking into the numbers at some companies that may be using generous assumptions to make their pension picture look prettier than it would otherwise appear.

Workers without traditional pension plans generally have defined contribution plans like 401(k)'s, but these leave the risk of market losses with the employee.

Similarly, it appears likely that President Bush will propose a revamping of Social Security that would reduce guaranteed benefits at some point while creating savings accounts that leave the worker with the possibility - but not the assurance - of coming out ahead.

One can, as Mr. Bush does, hail the trend as part of an ''ownership society,'' in which individuals will prosper if their investments do well, and the markets' strong performance in the 1980's and 90's has left many Americans confident. The hostility to elected governments seen in Europe - partly due to the financial strictures officials have proposed - is not evident in the United States.

But there is a risk of a negative cycle as the increased risks become understood. Americans could conclude that they need to save more and spend less to offset these risks, thereby slowing the economy and perhaps worsening the performance of the investments, which could cause them to want to save even more. And the transition to a new Social Security system must involve benefit reductions in the near future or a huge transfer from other tax revenue, meaning either tax increases or rising budget deficits.

Posted by: anne at November 12, 2004 10:40 AM

From the Trustees' Summary of the 2004 Annual Reports...

"Why is Reform to Improve the Medicare and Social Security Financial Imbalance Needed?
Public concern about the financial status of Medicare and Social Security tends to focus exclusively on the HI and OASDI Trust Fund exhaustion dates when benefits scheduled under current law can no longer be paid in full. But there are more immediate and fundamental reasons why Medicare and Social Security financing reform is needed: namely, the two programs together will place rapidly mounting draws on Federal general fund revenues long before trust fund exhaustion, and their financing in the long term is far more problematic than suggested by the 75-year actuarial deficits for HI and OASDI.

The rapidly mounting financial shortfall in these programs is illustrated in Chart E. It shows, as a percentage of GDP, the gap between annual HI and OASDI tax income and the cost of scheduled benefits, plus the 75-percent general fund revenue contributions to SMI's Part B and Part D. The initial negative amounts for OASDI in 2004 and for more than a decade thereafter represent net revenues to the Treasury that result in the issuance of Treasury bonds to the trust funds in years of annual cash flow surpluses. Conversely, the positive amounts for OASDI and HI initially represent payments the Treasury must make to the funds to supplement tax income to help pay benefits in the years leading up to exhaustion of these trust funds, then their widening financing gap thereafter.

The Social Security tax income surplus in 2004 is projected to be more than offset by the shortfall in tax and premium income for Medicare, resulting in a small overall cash shortfall that must be covered by transfers from general fund revenues. This combined shortfall is projected to grow each year--such that by 2018 net revenue flows from the general fund to the trust funds will total $577 billion, or 2.6 percent of GDP. Since neither the interest paid on the Treasury bonds held in the HI and OASDI Trust Funds, nor their redemption, provides any net new income to the Treasury, the full amount of the required Treasury payments to these trust funds must be financed by increased taxation, increased Federal borrowing and debt, and/or a reduction in other government expenditures. Thus, these payments--along with the 75- percent general fund revenue contributions to SMI--will add greatly to pressures on Federal general fund revenues much sooner than is generally appreciated. "

Please read the last paragraph if you do not believe we have a problem with the Social Security and Medicare systems. The problem is real and immediate - general revenue fund contributions are required to fund the combined system this year, and that amount will increase every year for the foreseeable future. One can argue about the meaning of the Trust Fund, but you must recognize that the contributions from the General Fund are what will have a real economic impact...and the impact is now. I'll add that this impact is absolutely identical no matter what the value of the US government securities in the Trust Fund might be.

Posted by: Neil Swanson at November 12, 2004 12:20 PM

Neil Swanson wrote, "The problem is real and immediate - general revenue fund contributions are required to fund the combined system this year..."

Huh? We're talking about Social Security, not Medicare. Combining the two is just a way to obfuscate the issues.

"...the full amount of the required Treasury payments to these trust funds must be financed by increased taxation, increased Federal borrowing and debt, and/or a reduction in other government expenditures'..."

Maybe we could start by increasing income tax rates on upper brackets and cutting wasteful military spending? Just a thought.

Posted by: liberal at November 12, 2004 08:15 PM

It seems to me that the main benefit of SS privatization is indirectly through the political effects of its accounting rather than the direct economic effects. The idea is, as far as I can tell, to make our debts look a lot bigger, so that our politicians will run a more responsible fiscal policy. However, as fiscal responsibility is not a concern to the current administration or congress, I don't really think there is a good case for SS privatization, nor do I really think there's a good case against it.

Posted by: Julian Elson at November 13, 2004 04:13 AM

Oh boy,
Keith
"I find this surprising because I was under the impression that all of the monies that we have put into the trust fund have been spent by the government?"

Brace yourself. The money you deposit in the bank, the money you pay to your life insurance company does not stay there. This is not Gringott's bank. At any one time your bank does not have cash on hand to pay out all deposits, your insurance company cannot pay off the cash value of your policy. They put that money to work and retain only enough cash to handle the normal flucuations of cash coming in and cash going out. Now you could say "Hey the bank spent my money and all I have is this lousy bank statement". And in one sense you would be right. But you would also be displaying a profound ignorance of how the financial system works.

Think of the Social Security Trust Fund as a bank. Money flows in from payroll taxes and your contributions are credited to your account. Money flows out in retirement and disability checks. As long as the influx exceeds the outgo everything is fine, even if that is only by a dollar. Because you can't make a run on this bank, you can't extract your dollars until you are eligible. But just because the Trust Fund cannot open your particular vault and show you your particular pile of Sickles and Knuts doesn't mean your account is not secure: because 12.4% of every eligible paycheck is going to be flowing in until your time comes to start drawing money out, as long as the inflow supports the checks written out it's all good.

People who complain, or explain that the Government has "borrowed" or "spent" the Trust Fund are missing two fundamental points. First Social Security has always been a pay as you go system. The Trust Fund is more akin to a checking account than a savings account, until the nineties it never ran a big positive balance, it didn't need to. As long as the checks didn't bounce who cared?

Well in 1982 it was recognized that there would come a time when outgo would exceed income. The dreaded Boomers would start retiring. So we collectively decided to start running a positive balance, a rainy day fund as it were. More dollars started coming in than flowing out. So what was the government supposed to do with those dollars in the meantime? Well they could have converted them to $100 bills and stuck them in a warehouse. Or they could have bought gold and stuck that in a warehouse. But neither would give you any return. Or they could have started playing the stock or commodities markets. A bad idea for all kinds of reasons. What they did was buy interest paying government bonds. In doing so they reduced dollar for dollar the need for the government to borrow from the private sector.

Now if the Government was actually living within its means, spending only the amount of General Funds money that they were taking in from other revenue sources, the result would have been a net paydown in overall government debt. That was the Clinton plan. Or we could use that excess money to disguise the fact that the General Funds deficit was worse than we showed. That is the Bush plan.

But either way the money would have been "spent" by the Government.

Posted by: Bruce Webb at November 13, 2004 05:39 AM

Now Neil.
"Please read the last paragraph if you do not believe we have a problem with the Social Security and Medicare systems."

Ah the Greenspan defense. Once the myth of the Social Security Crisis began to be exposed the Rapid Response Team threw Medicare into the mix. But these are two separate issues with two very different solutions. No one has suggested that Social Security was going to make Medicare whole, or that private accounts would ever be directed towards it. This debate has always been focused on Social Security. Lumping a still possible Medicare crisis with a no longer existing Social Security crisis just obfuscates the issue at hand: do we need private accounts to save Social Security.

The Trustees and the Punditocracy are desperate in their attempts to comingle Medicare and Social Security into a single crisis. But this is simply shifting the grounds of debate. If Social Security is whole then set it aside and address the problems of Medicare on its own terms. Dragging it into this boxing match in the 12th round smacks of desperation.

Posted by: Bruce Webb at November 13, 2004 05:57 AM

Bruce damn it, more precision!

"the result would have been a net paydown in overall government debt"

Well actually only a paydown in public debt, that owed to the private sector and overseas governments. The bonds in the Trust Fund portfolio are still debt, though interestingly enough one we may never actually have to pay off. A discussion for another day, after we have driven the stake in the heart of Social Security privatization.

Posted by: Bruce Webb at November 13, 2004 06:10 AM

Bruce Webb

Nicely argued.

Posted by: anne at November 13, 2004 07:34 AM

Last evening, I heard Laurence Kotlikoff go on about debt and our future. The discussion with Bill Moyers on PBS struck me as absurd. There are a group of debt mongers, mongering end of the world figures for affording Social Security and Medicare. The figures are stretched out over much of a century, when we have trouble planning accurately for 5 or 10 years, and the figures are so glum as to suggest we begin asking our parents not to bother going on living past 60. Nonsense. Social Security is fine for another 38 years, and we can surely extend the fineness beyond with ease if we care to. We can as well afford to care for our parent's medical needs. Enough with the end of the world stories that are simply designed to erode support for Social Security and Medicare, and the heck with those who need the programs.

Posted by: anne at November 13, 2004 08:12 AM

Three observations . . .

1. Today, private sector asset managers would be incapable of meeting the responsibilities implicitly shifted to them in any 'privitization of social security.' Cleanly, the problems run from incentive structure to issues of moral risk, more practically they run from muddied financial reporting to bobbled fiduciary muddling. I suspect friction in the private sector would capture any unlikely incremental increase in the productivity of collective savings resulting from a diversion from debt to equity.

2. Perhaps on Lake Woebegone, where all the children are above average, an increase in investment returns could be safely anticipated by pointing the thundering herd in the direction of equities, under the guidance of their private sector financial advisors. Elsewhere, let's not kid outselves.

3. As an amusing, instructive and irrelevant thought experiment, trying designing a retirement benefits system that rewards those who have produced the most children (most productive children?), instead of those who have made the largest incomes during their working lives or obained the best returns on their retirement accounts. In other words, she who contributes the most future workers to supporting the system (or whose fewer in number daughters gravitate toward higher income occupations) would receive the larger retirement transfer payment than he would did not. It highlights demographics and intertemporal choice, and, besides, it's sort of fun.

Posted by: Dwight Cramer at November 13, 2004 11:00 AM

Bruce,
I see several problems with your analogy of comparing the trust fund to a bank, but the primary one is that the relationship between a bank and its loan customers is nothing like the relationship between the trust fund and the federal government. Banks don't "spend" depositor's money--they loan it and expect the borrower to provide a clear plan on how the money will be re-paid. The federal government has no clear plan to repay, and its ability to repay gets worse with every tax cut or spending increase.

In my mind, the trust fund accounting is a dangerous fiction. The increase in the Social security rate in the 80's was supposed to be a "savings" plan, but it was just a tax increase in disguise. The government hides this fact by flowing all of the funds through the trust fund, but then spends every dollar by loaning it to itself. By tapping the trust fund the government is able to claim that it is saving money at the same time that it spends it.

In the end, however, I don't think our opinions are that far apart. You say, "if the government was actually living within its means...", and I agree with this notion. Al Gore said that we needed a "lockbox" for Social Security, but this has not been heeded. So while Clinton would borrow from the trust fund instead of borrowing from the public, Bush borrows from the trust fund in addition to borrowing from the public.

I can live with the notion that we continue with government funded social security if we can find a way to build that lockbox concept. If we can't, then we shouldn't allow the government to handle the savings.

Anne, I am surprised by your position on this since it is so different from your standard take on things. The Republicans created such a clever way of funding tax breaks: They took the surplus from a regressive payroll tax and then "borrowed" it to avoid having to face the capital markets for the full amount of the deficits. People think that the money is still there but it is very, very gone.

Posted by: Keith at November 13, 2004 02:32 PM

"Anne, I am surprised by your position on this since it is so different from your standard take on things. The Republicans created such a clever way of funding tax breaks: They took the surplus from a regressive payroll tax and then "borrowed" it to avoid having to face the capital markets for the full amount of the deficits. People think that the money is still there but it is very, very gone."

Keith, Actually I am coming to agree with you completely but I surely do not wish to. Grumble, grumble.

Posted by: anne at November 13, 2004 04:36 PM

Keith, the government does indeed have the ability to pay off the bonds currently held in the Social Security trust fund -- they simply borrow the money (sell more bonds). The government does this every single day -- every single day, U.S. treasury bonds come due and must be paid, and every single day, more U.S. treasury bonds are sold in order to pay off the previous generation of treasury bonds. The fact that the bonds are held by the Social Security trust fund rather than by a private investor does not change this equation. All it changes is the investment equation. If the bonds were on the private market, we (the taxpayers) would need to pay more interest in order to attract investment from other areas of the economy.

And indeed, this is what will happen when the baby boomers retire and those bonds are being sold off onto the open market -- taxpayers will end up paying more interest on the bonds sold to pay off the bonds currently in the trust fund, meaning either more public debt, or higher amounts of general fund tax revenue necessary to cover the government's debt load. However, as long as the economy grows a sufficient amount between now and then, there is nothing which seems to indicate that there is any "crisis" here -- the shift in bonds from the trust fund to the open market should be quite doable with a minor tax increase at best to handle the increased interest payments. Let us say that, of the 7 trillion dollar federal debt, we must raise interest rates from the current 4% all the way to 8% (i.e., double them) in order to sell the bonds currently in the trust fund onto the open market. That would mean either borrowing an additional 240 billion dollars, or raising taxes enough to pay 240 billion dollars (i.e., if you are currently paying 25% tax, you'd end up payig 25.5% tax). So, assuming that there is NO growth in government income caused by economic growth (not to mention growth of the deficit itself), the only real effect would be a general adverse effect upon capital investments from this shift, but assuming that the economy as a whole has grown sufficiently that investment capital is still in the absurd situation of surplus that currently applies, this effect should effect the economy as a whole more as a slowing of growth, rather than as a complete shutdown of economic growth for the time of the retirement of the baby boomers.

In short, there's no problem here, people. Bonds are bonds, no matter who is holding them. All that having them in the social security trust fund allows us to do is to temporarily pay less-than-market interest rates on the bonds, thus allowing capital to flow more into investment instruments that have a chance of growing productivity and the economy as a whole enough to get us over the baby boom bulge without even the small dislocation that would happen at present.

But I forget, those of us in the reality-based community with our little insistence upon numbers and evidence are "out of touch with America", and should have faith, faith I say, in woe is me predictions about the impending doom of Social Security... darn, I guess I'm gonna have to go to my preacher-man and have him exorcise me again regarding those little "fact" things that keep tripping me up!

- Badtux the Reality-based Penguin

Posted by: BadTux at November 13, 2004 04:41 PM

The problem I have is generally agreeing with Keith, and wishing I did not.

We took a regressive payroll tax that was supposed to have generated enough of a surplus to support baby boomers, especially those will most need the support, and used the excess funds for general spending. Now, we learn there is a problem and thier precious children will be sore pressed to support the baby boomers. Good grief.

I care about the baby boomers who have supported Social Security so fully and I care about their children, and I find the idea of weakening the intergenerational commitment to Social Security most disheartening.

Posted by: anne at November 13, 2004 04:46 PM

anne wrote, "Last evening, I heard Laurence Kotlikoff go on about debt and our future."

Yeah, I heard about that from my dad. I told him Kotlikoff is a scare-monger. Also, I've seen too many examples of K. making dubious assumptions in his models.

Posted by: liberal at November 14, 2004 06:27 AM

Thanks Liberal,

There has been so much damage done by reporters, who speak of Social Security as though there were an impossible problem to solve in maintaining benefits for any significant length of time. There is no crisis, the question is whether we wish to honor the wonderful institution of cost of living indexed Social Security.

Posted by: anne at November 14, 2004 06:59 AM

http://www.nytimes.com/2004/11/14/books/review/14HALL.html?

'The Truth About the Drug Companies' and 'Powerful Medicines': The Drug Lords
By STEPHEN S. HALL

DURING the past year, when I was driving my children to school, I'd hear the same advertisement on the radio again and again. You've probably heard it too: as somber music played in the background, a young man, his voice cracking, explains how he developed a rare and deadly form of cancer. He wonders if he will ever play baseball with his son, and then relates how, thanks to a company called Novartis and its new cancer treatment (never mentioned, but a drug called Gleevec), he's been given a new lease on life.

What is most fascinating about this ad is that it should seem necessary. As Marcia Angell points out in ''The Truth About the Drug Companies: How They Deceive Us and What to Do About It'': ''Truly good drugs don't have to be promoted. A genuinely important new drug, such as Gleevec, sells itself.'' So why advertise a cancer drug that cures a fatal leukemia and has no competition? The answer, of course, is that Novartis is not advertising Gleevec, but the company itself -- and the virtues of the drug industry as a whole. Why? Because, as Angell notes, a ''perfect storm'' of indignation -- on the part of consumers, regulators+and even doctors -- may be developing around the pharmaceutical business.

In just one week this summer, the news included reports that Schering-Plough pleaded guilty to cheating Medicaid; the city of New York sued leading pharmaceutical companies, including Amgen, Bayer, Bristol-Myers Squibb, Eli Lilly, Johnson & Johnson and Merck, for inflating costs and defrauding taxpayers; Janssen Pharmaceutica Products admitted it had withheld from the public information about potentially fatal side effects in a schizophrenia drug it markets; and Wyeth settled yet another in the multibillion dollars' worth of lawsuits against it by people who suffered permanent injury from use of the fen-phen weight-loss drugs. All this against a broad public perception of price-gouging, lack of innovation and bombastic self-congratulation. And that brings me back to the Novartis ad.

An alternative history for Gleevec is recounted in both Angell's methodical multicount indictment of the drug industry and Jerry Avorn's entertaining jeremiad, ''Powerful Medicines: The Benefits, Risks and Costs of Prescription Drugs.'' In this less heroic version, several decades of dogged research by academic scientists -- much of it paid for by American taxpayers through the National Institutes of Health -- had teased out the molecular details of chronic myelogenous leukemia, a rare and fatal hematological cancer. Researchers at Novartis (then Ciba-Geigy) created several compounds that in theory might throw a monkey wrench into the process by which blood cells become cancerous. But these potential miracle drugs sat on the shelf untested, until Brian Druker, a researcher at the Oregon Health and Science University, asked for the compounds and became the first to discern their anticancer properties in the lab dish. Even that wasn't enough. As Avorn tells it, ''Novartis had so little interest in committing resources to the drug's development that cancer researchers had to resort to the bizarre tactic of sending a petition to the company's C.E.O., signed by scientists in the Leukemia and Lymphoma Society of America, imploring him to make more drug available for clinical studies.''

Novartis has overcome its lack of enthusiasm -- it now charges $27,000 for a year's supply of Gleevec. But those heart-warming ads, now the centerpiece of the Novartis corporate identity, say more than intended about how today's pharmaceutical industry takes credit where little is due. As both Angell and Avorn lay out in painstaking, often enraging, detail, a self-serving mythology -- promulgated on a scale possible only in a business with annual worldwide revenues of $400 billion -- has enveloped the pharmaceutical industry. Angell and Avorn cut through the haze, arguing persuasively that Americans are paying an enormous amount of money for some very mediocre medicines.

The rising voices of disillusionment have the credentials to back up their scorn.

Posted by: anne at November 14, 2004 12:12 PM

When this topic was started I did not have a strong opinion about what should be done with Social Security. But the variety of opinions here have helped me firm my thoughts. I believe we should leave the current collection process in place, but change the investment process. The trust fund should be separated from the general fund entirely and should be managed just like any other pension fund. The managers should be free to invest in anything they chose including US gov't debt, corp debt, and foreign gov't debt, mortgage debt,and it may be possible to invest in equities in some instances. This would be no different from the way that most pensions are run, and it should be managed conservatively. This would address the following issues:

1. It would keep the overhead cost of running social security comparitely low as compared with having alot of individual accounts.
2. It retains the insurance aspect, meaning that no one can lose their shirt and then be without baseline payments in retirement as could occur with private accounts.
3. It allows for higher returns to the fund instead of Treasury rates. (I think this reason is a bit dubious, but others think it important, so I include it.
4. It keeps the fund out of reach of politicians who would borrow from it without having a plan to re-pay.

Posted by: Keith at November 14, 2004 06:19 PM

Keith, the current solution maximizes investment capital available to the economy, by insuring that bonds are locked up in the Social Security trust rather than out on the open market attracting capital away from investments. The ultimate goal is to grow the economy enough via this pool of excess investment capital in order to basically "outgrow" the Baby Boomer's retirement. Taking that money out of government bonds and putting it into other investment interests actually is counter to that, because then the bonds are on the open market, attracting investment capital away from productive investment, and furthermore the bonds must be sold at a considerable discount (i.e. high interest rate) in order to make up for the fact that there are so many more of them on the market, meaning yet more investment capital sucked out of the economy in order to sell more bonds to finance these high interest rates.

Now, this process was always going to have to happen as the baby boomers approached retirement -- investment was going to have to slow, because capital for investment instead would be flowing to the baby boomers' retirement. But it is in the best interests of all for the process to be delayed as long as possible so that the economy can be grown as much as possible by the time the baby boomers retire. The larger the economy, the less it will hurt to suck investment capital out of it in order to fund the boomers' retirement.

In short, investing the Social Security fund in the open market would actually have the paradoxical effect of REDUCING investment in the open market. Odd, that, eh?

- Badtux the 1+1=2 Penguin

Posted by: BadTux at November 15, 2004 12:45 PM

Bad Tux,
I don't follow your logic on the flow of capital. As you indicate, the Trust fund is currently providing capital to the Treasury that would need to be provided by other sources if the Trust fund were allowed to invest elsewhere. However, the amount of funding that the Treasury would need if the Trust fund were to invest elsewhere would be equal to the amount of funds that the Trust fund would now provide to the marketplace itself.

On another point, you have the belief that the Trust fund is a benefit because it provides low-cost funding to the Treasury. I believe that this is unfair. We should not have added the incremental FICA tax for the purpose of creating a low cost loan to the general fund. This saddles wage earners with cost that should be borne by all taxpayers.

As I contemplate how some may respond to this post, it strikes me how the real problem is the unclear relationship between the Trust fund and the general fund. Either the budget is unified or it is not. People oscillate between these viewpoints while trying to defend the current state. We would not allow a company to lend all of its pension assets to itself and I see no reason why we should do differently with Social Security.

Posted by: Keith at November 15, 2004 03:38 PM