January 20, 2004

The Clown Show that Is Bush Administration "Social Security Reform" Opens

Kash of The American Street Writes About the Opening of the Clown Show that Is Bush Administration "Social Security Reform"

the american street: Social Security Reform: Everyone knows that Social Security (SS) faces a looming financial crisis in a couple of decades, that serious changes will need to take place to fix it, and that little is happening in Washington right now to do so. But that might be about to change. Chances are high that in his State of the Union (SOTU) address tonight, President Bush will put forward his plan to fix the SS problem. While few people know for certain exactly what Bush will say in the SOTU, numerous sources (for example, this and this) have indicated that Bush will call for a renewed push for the privatization of Social Security.

Bush will claim that his plan will save Social Security. It will allow individuals to reap higher returns on their retirement assets in the stock market, maintain benefit levels for present and future recipients of Social Security (SS), restore solvency to the SS trust fund (as it stands the SS trust fund will run out of money in 2042) – all without increasing SS payroll taxes by one cent. Oh, and it also slices, dices, does basic home repairs, and builds bases on the moon.

Wow, people will say. It’s MAGIC! George Bush is a magician.

No, it’s not magic. It’s just deceptive.

Why do I expect Bush to make such deceptive claims? Because a) he has a proven track record of presenting proposals that magically cure all manner of ills while concealing any downsides (e.g. tax cuts, war in Iraq); and b) because that is what all recent privatization proposals have claimed recently.

The plan put forth in the Senate by Lindsey Graham (R-SC) last year is one such example. It’s a relatively modest privatization plan, but one that proponents claim would fix the SS problem without raising taxes. A bolder example is the proposal recently authored by Peter Ferrara, which involves much more privatization. Ferrara's plan was warmly praised by the Wall Street Journal, endorsed by the Club for Growth, and also claims that it will also fix the SS problem “without cutting benefits or raising taxes.”

In fact, the wondrous claims of such privatization plans are all true (okay, maybe not the part about the moon base, and I haven’t personally tested the slicing and dicing) – except for one tiny detail: to make them work, they require tremendous payments from the US government budget into the SS trust fund. What does that mean? It means that privatization proposals actually add hundreds of billions of dollars in extra expenses to the federal budget per year. Which means, of course, hundreds of billions of dollars in additional taxes or national debt. Far from being a free ride, privatization will cost taxpayers dearly.

The graph below shows how much extra money the government will have to come up with to pay into the SS Trust Fund over the next 20 years in order to finance the substantial Ferrara privatization proposal and the more modest Graham privatization proposal.

ssgraph1.jpg

As you can see, the privatization plans can only work by imposing huge additional expenses on the federal government. By the way, if you’d like to put these numbers in the context of President Bush’s mysterious budget plans for the next five years, simply whack another $125 to $300bn off of annual discretionary spending to reach his stated goal of halving the deficit by 2009 without raising taxes. That should pretty much eliminate all non-defense government spending by the end of the decade.

Let’s put things another way. According the SS Administration, the total deficit that the SS Trust fund is facing over the next 75 years is currently about $3.5 trillion in terms of today’s dollars (present discounted value). As it stands, that deficit will have to be made up through other government taxes. Meanwhile, the SS Administration estimates that the Graham privatization proposal will increase that deficit to $4.9 trillion. The estimate of the Ferrara plan's deficit is even bigger, at $6.9 trillion. The lesson is simple: the bigger the privatization proposal, the more expensive it is.

There’s a simple and unavoidable reason for that, by the way. Any privatized SS system requires that each individual’s own retirement benefits come out of their own contributions, unlike the system today where much of the benefits paid to retirees actually come directly from taxes paid by people who are still working. To switch to a privatized plan, today’s workers will have to pay both for current retirees’ benefits and also will have to fully provide for their own future retirement. Instead of honestly forcing workers to pay for such increased costs directly through higher SS taxes, the deceptive privatization schemes effectively propose paying for it through other taxes. But the result is the same.

Privatization of Social Security has numerous other potential problems, of course, including the inherent riskiness and variability that it would add to retirement income, a reduction in the ability of the SS program to serve as a safety net, the huge transfers in resources that it will entail to a handful of investment firms, the potentially huge and poorly-understood effects that it could have on the stock and bond markets more generally, and the vast scope that it would allow for fraud and abuse.

But the proposals that I’ve mentioned here are more insidiously flawed, in a way, because they entail deliberate concealment of their true costs. Which is exactly why I expect President Bush to echo such proposals tonight.

Posted by DeLong at January 20, 2004 01:04 PM | TrackBack

Comments


Clown Shoe?

That's a very different image than "Clown Show".

Posted by: Jon H on January 20, 2004 01:09 PM

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Dow 15000. Krugman said he was out of the stocks.

Posted by: Leopold on January 20, 2004 01:39 PM

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Brilliant article, just brilliant. Wish it had been written 9 years ago, when we implemented our own privatization plan here. Maybe our budget deficit would be smaller now. Does someone realizes that it's more expensive to implement Ferrara proposal than to solve the SS "crisis"? Just look at the results this reform had in Argentina and Uruguay and you will see how it works.

Posted by: Carlos on January 20, 2004 01:45 PM

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In round numbers, solving the Social Security problem would be about as expensive as putting a base on Mars. I expect that the Bush administration will fund the former as vigorously as it has pledged to fund the latter, which is to say not at all.

Posted by: alkali on January 20, 2004 01:47 PM

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Thanks very much for that post. Before we hear charges about Ponzi schemes, and the 50 or 70 or 100 year average annual returns on the stock market (with nothing mentioned about medium term variances), etc., I suggest people run to the library or the bookstroe and take a look at the book references below. Then we might have a more constructive debate on this.

The good Prof DeLong will correct me if I am wrong, but almost all responsible and reputable economists who have looked at this, even those who favor some kind of privatization, agree that the cost of transition is in the neighborhood of a trillion dollars over a generation. (Gee, isn't that the figure O'Neill quoted in his book?)

I think the privatization schemes that reputable economists recommend do not look at all like what Bush has proposed. If tonight the Pres. proposes something that turns social security into millions of little stock market piggy banks run by Wall Street brokers, that will remain true tomorrow.

People willing to read through that kind of stuff should also review Bush's social security reform commission's report, to see what kind of hash they came up with, working within Bush's framework. Sorry, I have no idea where to find that right now. But I guess I should look.

I don't have anything to do with MIT Press and am not one of the authors' cousins or nothing. Just don't want to read anymore charges about Ponzi schemes.

Should the United States Privatize Social Security? Henry J. Aaron and John B. Shoven
Edited by Benjamin M. Friedman, MIT Press

"Here's the deal. Spend a few hours with this book, and Aaron, Shoven and the others will bring you up-to-date on the most important social policy debate now going in America. Not only that, you'll enjoy the read."
-- Alan S. Blinder, Department of Economics, Princeton University

Posted by: jml on January 20, 2004 01:55 PM

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Carlos -

Terrific article. But, there is no "crisis" in Social Security. Mild changes in the benefit ages and supporting tax, and reasonable economic growth, will insure the success of the system for decades. The notion of a crisis undermines support for this wornderful wonderful social benefit program.

Posted by: anne on January 20, 2004 01:55 PM

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I am thinking that perhaps the calculations pointing to SS funds running out of money in 2045 or so are not taking into account productivity increases, which could more than compensate for increased number of retirees per working population.

I really can't see how the SS funds can run out of money in a country where one percent of population can feed the whole nation and manuf and services are going in the same direction.

Tax rates, of course, would have to increase. But it should not be important in itself, as long living standarts for the working population somehow keep increasing.

Posted by: Bulent Sayin on January 20, 2004 02:29 PM

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For a fair and balanced primer on Social Security (which prompted an angry reply from Peter Ferrara), see

http://www.techcentralstation.com/063003B.html

Posted by: Arnold Kling on January 20, 2004 02:37 PM

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Re Bulent Sayin's post:
I have seen references to analyses that look at the difference between soc sec costs given the very conservative estimates productivity growth by the actuaries and more realistic estimates. Some of this is discussed in reference I gave here an in other threads. Anyone know of a detailed analysis of this topic? I would be interested.
I've heard some older folks say that they remember social security crises from decades past (in 40s and 60s) that resolved themselves without nearly as much tinkering as people thought necessary. I suppose that might be because of differences between the conservative actuarial projections and more realistic ones. Anyone know of a good reference for the history of social security panics?

Also, I think at least one Scandinavian country moved from a pay-as-you-go to advance finance (or funded) system. Sweden? Norway? That wasn't privatization, but the transition cost problem would be similar. Anyone know anything about this?
If one of them did that, what was/has been/is their experience?

Posted by: jml on January 20, 2004 02:46 PM

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Isn't the Lindsey Graham plan one that gives workers upside potential but shields them against downside risk? I'm no fan of Andrew Biggs's Cato pieces on Social Security for a variey of reasons but his review of the Archer-Shaw proposal noted the huge financial flaw in such ideas. Can we say S&L crisis II? Why would anyone wish to put forth a plan that would bankrupt the Social Security program?

Posted by: Harold McClure on January 20, 2004 02:58 PM

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Everyone is talking about the cost to the government of this privatization plans. What is the cost of +not+ doing it and leaving things like they are? Where does the increase in personal net worth and the need for less or no SS in my later years factor in?

In other words, you can talk about how much it costs, but I don't think anyone is denying that it will cost a ton. The key thing to compare is the cost of +not+ doing it to the cost of doing it. Either way we have to pay. Pay less later, have more personal wealth later vs. pay tons and tons now and later is the tradeoff here.

If you do that, I suspect the privatization plans will look pretty good.

Posted by: NickHodges on January 20, 2004 03:14 PM

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"Before we hear charges about Ponzi schemes,..."

It's not a "charge." It's a fact, as I detailed on my weblog:

http://markbahner.typepad.com

From Google's dictionary feature, a Ponzi scheme is:

"A fraudulent scheme. It is a specific form of pyramiding in which money paid by later investors or contributors is used to pay inflated returns to earlier investors — until the funds dry up because no more contributors can be found."

That is EXACTLY what Social Security is. IF the people after the Baby Boom generation were allowed to choose between funding their own retirements, or funding the Baby Boomers' retirements, the people after the Baby Boom generation (i.e., the 20-somethings and 30-somethings, and the younger folks) would get out of the Social Security Ponzi scheme, and it would collapse.

This is a FACT. And if you dispute it, let's change the law to allow the 20-somethings or 30-somethings (and the younger folks) to have their choice of staying in Social Security or getting out. So many would get out that the Ponzi scheme would collapse.

I'd be happy to bet you up to $10 on this. And I'd be happy to give you 20-to-1 odds. In other words, if I lose, I'll pay you $200. If you lose, you pay me $10.

It's a fact. The Social Security system (as presently operated) is definitely a Ponzi scheme. There is no Trust Fund.

Posted by: Mark Bahner on January 20, 2004 03:15 PM

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When Social Security was instituted, those at what we now call retirement age were the poorest age cadre, in a country poorer than the one we live in now. Their poverty was wretched poverty, the country was far less able to support them than it is now, and the public agreed to undertake the expense.

So, let's institute a system in which many participants will end up in fine shape, but some will end up in wretched poverty, a system in which the worst outcome can be worse than under today's SS system. Let's do it in a country far better able to afford keeping the elder from wretched poverty than when SS started. My guess is, after ending public financing of insurance against povery among the elderly, we will find ourselves reinstituting it. At least, that is what I hope we would do.

Posted by: K Harris on January 20, 2004 03:19 PM

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Arnold Kling writes, "For a fair and balanced primer on Social Security (which prompted an angry reply from Peter Ferrara), see..."

"Fair and balanced" is in the eye of the beholder. :-)

The Baby Boomers won't like your proposed fix (i.e., raise the retirement age) because their return on "investment" will be much worse.

Similarly, your alternate proposal to index to inflation rather than wage growth also dramatically cuts back on the return on "investment."

But it *is* important, as a first step, to admit that the "system" is broken, in the sense that there is no way in the world for the Baby Boomers and the generations who follow them to get what they are currently promised (e.g., retirement at 65, benefits indexed to wages rather than inflation) without dramatically increasing federal taxes SOMEWHERE. Both pro-privatizers and anti-privatizers need to admit that fact.

And the problem occurs NOT after the "Trust Fund" is depleted, because there isn't anything of market value in the "Trust Fund." SOMEWHERE taxes will need to be raised as soon as the receipts aren't as large as the payouts...which will occur much sooner than when the "Trust Fund" is "empty." (It already is, in the sense that there is no marketable asset in the "Trust Fund.")


Posted by: Mark Bahner on January 20, 2004 03:29 PM

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"When Social Security was instituted, those at what we now call retirement age were the poorest age cadre, in a country poorer than the one we live in now. Their poverty was wretched poverty, the country was far less able to support them than it is now, and the public agreed to undertake the expense."

The public did NOT "agree to undertake the expense." "Public agreement," under the U.S. Constitution, would have required a Constitutional amendment.

Instead, FDR and Congressional goons, supported by Supreme Court weasels, broke The Law. If they had been private citizens, they would have been thrown in jail (for running a Ponzi scheme).

"My guess is, after ending public financing of insurance against povery among the elderly,..."

Social Security is NOT "insurance against poverty among the elderly." People who are multi-millionaires get Social Security. If it was truly "insurance against poverty" such rich people would not get paid.

Posted by: Mark Bahner on January 20, 2004 03:37 PM

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Stronger productivity growth won't be enough to solve Social Security's problems, for one very simple reason: benefits are tied to earnings, so if productivity growth is stronger, benefits are higher. It helps a little bit, because of the timing (i.e., taxes go up before the higher benefits get paid), but not nearly enough.

It's all demographics: lower birthrates, longer life expectancy. Check out figure II.D3 at www.ssa.gov/OACT/TR/TR03/II_project.html.

Dems need to acknowledge that we need to make some changes to Social Security: raising the retirement age, trimming benefits, perhaps increasing taxes.

Republicans need to acknowledge that privatization requires a ton of money, money that we don't have now because of massive tax cuts. Honest Republicans will acknowledge the transition cost; dishonest ones will claim magic pixie dust. It's never been clear to me that Bush himself really understands the concept of the transition cost.

(Don't get me started on the massive prescription drug benefit Congress just passed, with NO FUNDING SOURCE!)

Posted by: Dave on January 20, 2004 03:50 PM

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thanks, Dave, for the link on alternate projections. I am not sure that this takes the effects of productivity growth into account properly. But I won't have time to research it and back that up until this thread is long gone. But thanks, it is a very good source.

I agree with your basic conclusion. I didn't mean to suggest that productivity growth alone would solve the funding problem. But I am not sure people can estimate the amount of trimming or mild-chopping that will likely be needed using the base-case actuarial projections alone.

I could only find one link still working to Bush's 2001 social security reform commission. It is on a page by a group called Centrist Policy Network, that I have never heard of before. The summary seems to reflect what I remember about the reports' conclusions. There is also a link to the interim and final reports themselves.

The summary says the report offered three proposals. One was a pure personal account approach that would not solve the funding problem.

The other two were versions of personal accounts with gradually phased in reductions in benefits, higher retirement age, caps for high income retirees, etc. They would restore social security to its "current equilibrium" -I'm not sure what that means. But here is the interesting part, both of these options would have transition costs: "The transition funding ranges from roughly $50-75 billion per year, for about 20 years." in the summary's own words. I think that is at least $1 trillion over a generation.

It should be noted that the commission was stacked with supporters of privatization.

It will be interesting to compare Bush's proposal with his commission's report.

The link to Centrist Policy Network's summary page is below

http://www.centristpolicynetwork.org/legislative_updates/csss.html

Posted by: jml on January 20, 2004 06:03 PM

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finally found the link to the soc sec commission itself:

http://www.csss.gov/

I may have accused the final report of being more incoherent that it actually was. I think I confused the final with the interim report. However... I think the original idea was to recommend ways to implement Bush's campaign promises. My take on the final report is that they couldn't to do that.

Let's see what the new line will be.

Posted by: jml on January 20, 2004 06:14 PM

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I'll be quiet for awhile after this... but I wanted to type in the 2001 Bush Social Security Reform Commission's guiding principles.
I will be wondering if the guiding principles will stay the same. (I first typed "guiding principals", which may be Freudian slip. That's an inside joke for all those future individual account brokerage firms out there.)

Guess I better run to the radio to find out.

2001 Commission's guiding principals. (see link above)
1-Modernization must not change Social Security benefits for retirees or near-retirees.
2-The entire Social Security surplus must be dedicated only to Social Security.
3-Social Security payroll taxes must not be increased.
4-The government must not invest Social Security funds in the stock market.
5-Modernization must preserve Social Security`s disability and survivors insurance programs.
6-Modernization must include individually controlled, voluntary personal retirement accounts, which will augment Social Security.

I have serious questions about whether #2 can be kept if fiscal policy doesn't change dramatically. I don't understand #4 -what's wrong with qausi public agency that runs index funds in stocks, and some other things as well? #5 is fine if the population wants to go that way... but I don't see how that is a social insurance program anymore and I hope people undertand the implications. And #5 seems to be interpreted by the administration as the conventional Wall Street brokerage account set-up -inefficient, liable to result in waste fraud and abuse. How does that augment social insurance? Replace, maybe, but not augment. If you want to replace, say "replace."

Posted by: jml on January 20, 2004 06:44 PM

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My browser must not be working. On that graph it doesn't show the line that tracks all "the extra money the government must come up with" to finance the *status quo* absent privatization.

You know, the *$18 trillion* of cash flow, $3.5 trillion current value, after the trust fund is gone just for the 75-year budgeting period, after which things get just worse and worse. Or the *$10.5 trillion current value* for actuarial balance on a permanent basis. As per the SSA Trustees.

Oh, wait, I get it! The graph cuts off *before* then -- long before the bulk of today's workers even get near to retirement age -- so it doesn't have to show the period when the privatization proposals have SS fully funded while the status quo requires "extra money from the government and the government" rocketing ever upward forever.

How about that? ;-)

Of course, even that's only possible by using candy-store cash basis accounting. Using accrual accounting like real retirement plans are required to use, SS right now is running up annual deficits that the gov't will be forced to pay for of 1.92% of payroll to just to get though the 75 years -- that's $71 billion for 2003 and *rising forever more* -- or 3.9% of payroll on a permanent basis, which is $138 billion just for 2003 and rising forever more.

Perhaps our host would care to add a couple lines illustrating these numbers on the graph for the sake of a more informative comparison?

"As you can see, the privatization plans can only work by imposing huge additional expenses on the federal government."

Yes -- and we can also see this is also true *in spades* of the status quo.

"But the proposals that I’ve mentioned here are more insidiously flawed, in a way, because they entail deliberate concealment of their true costs."

While the critics of these proposals are publicizing the true costs of the status quo where?

And since we are criticizing other people's honesty (as always, these days, it seems) just how honest is the critique: "Your plan to meet this incurred cost -- which grows larger every year that we don't deal with it -- is *too expensive* compared to our lack of any plan at all." Eh?

Posted by: Jim Glass on January 20, 2004 10:12 PM

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"correct me if I am wrong, but almost all responsible and reputable economists who have looked at this, even those who favor some kind of privatization, agree that the cost of transition is in the neighborhood of a trillion dollars"

Well, Milton Friedman was still a reputable economist last I heard, and he has pointed out that this not true because you incur the same cost even if you *don't* privatize. The purported "transition cost" is the cost of closing the funding gap in the status quo if you privatize. But that very same funding gap must be closed if you keep the status quo.
http://www.ioptout.org/articles/990111.asp

And if you will incur a cost even if there is no transition, you can hardly call it a "transition cost", right?

One might even call it "insidious" to critique privatization proposals on the grounds of "transition cost" while ignoring and even deliberately concealing the cost of retaining the status quo, don't you think?
~~~~~

"People willing to read through that kind of stuff should also review Bush's social security reform commission's report, to see what kind of hash they came up with, working within Bush's framework."

The General Accounting Office did and had an opinion. To quote Tax Analysts on it...

"The report said [the Commission's]Model 2 would 'provide for sustainable solvency and reduce the shares of the federal budget and the economy devoted to Social Security ... regardless of how many individuals selected accounts.'

"However, the report said, with 'universal account participation, general revenue funding would be needed for about three decades.'

"In analyzing benefit adequacy and equity issues relating to Model 2, the GAO determined that 'median monthly benefits for those choosing accounts are always higher despite a benefit offset, than those who do not [and retain current promised benefits].'"

Now, do you see in that "reduce the shares of the federal budget and the economy devoted to SS"? That is a comparison of the proposal to the *status quo*, such as an honest, non-insidious critique requires. (Note that "three decades" is a lot shorter than "forever".) BTW, it's GAO Report 03-130.
~~~~~~~~~~~

"Just don't want to read anymore charges about Ponzi schemes."

Aw, just one more:

"[Social Security] has turned out to be strongly redistributionist, but only because of its Ponzi game aspect, in which each generation takes more out than it put in.

"Well, the Ponzi game will soon be over, thanks to changing demographics, so that the typical recipient henceforth will get only about as much as he or she put in (and today's young may well get less than they put in)."

-- Paul Krugman, Boston Review, Dec/Jan '96-'97

Personally, I figure that when Krugman and Friedman agree on something it has got to be true!

Posted by: Jim Glass on January 20, 2004 10:25 PM

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Mark Bahner: The Ponzi analogy is flawed. The Ponzi definition is based on a static population. With social security, new contributors _will_ be found, unless no more children are born (well, that is happening to some extent).

If you disregard the monetary side for this paragraph, the essence of social security (greatly simplified) is a net transfer of a portion of the current goods and services to current retirees to provide a certain living standard for them, while giving current providers of the transfer (the workers who create the goods and provide the services) an entitlement to draw on future goods and services roughly in proportion to the part they are currently surrendering. The principle works as long as existing entitlements are honored, and as long as the total production is large enough to cut out enough to transfer to retirees (i.e. productivity growth combined with volume of production keeps pace or exceeds the growth of the retiree population).

The strict requirements of a Ponzi scheme are not met -- there are no fabulous returns that require an exponential growth rate of participants. Future retirees presumably will not eat more food or live in more extravagant homes. They probably will want more and better healthcare and live longer, thus increasing their number, but by no means exponentially with a large multiplier. But then we have productivity growth, new technologies, etc., right? Of course the devil is in many details, like more demand for healthcare professionals, more advanced drugs, and so on. But if we don't look forward to tremenduous technological progress, then hello, what are we all doing 40+ hours each week in our jobs? Just trying to keep up current living standards? Give me a break!

Now of course if instead of direct transfers you operate in a monetized economy, the transfer must take on some form of taxation. And here is where the problem comes in -- only wages and salaries (and some other categories of earned (by work) income) are taxed for social security -- and earned income does not fully represent social production or productivity increases. (That is my hypothesis.) When "real" wages are falling, which they are (because of not fully shared productivity increases), then in order to maintain the required takeout of production the rate of taxation of wages/earned income must be increased, or failing that, the relative production takeout (aggregate benefits) must be reduced.

This is where the "crisis" of social security lies. It is not a Ponzi thing, but that the portion of *earned* income that goes into social security tax does not keep pace with the growing amount of goods and services that is needed for the transfer. The lock box and all that stuff are additional technical complications that don't change the underlying principle. What we get in 30 years has nothing to do with what we pay today (in the aggregate that is, benefits will probably still be pro-rated based roughly on individual contribution levels), but with how much production is available in 30 years *and will be allocated* to retirees, unless there is a 30-year long "money path" enforcing a relation.

So the fundamental key to keeping social security afloat is to keep the technological progress up, and create an economic environment where the society can realize its productive potential. That includes quality education, freedom of the individual, human rights, etc.

Posted by: cm on January 21, 2004 12:06 AM

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Thanks, cm, for your responses to the Ponzi accusations.

It seems to me that the Ponzi crowd confuses several issues. Four that come to mind are:

1. Pay-as-you-go versus advance finance (or funded) insurance plans,
2. mandatory participation in a government run social insurance program,
3. use of a government social insurance program to redistribute lifetime wealth from richest to poorest parts of population,
4. approaches to balancing individual incentives and the original goal of spreading risk among individuals in an insurance plan.

Addressing each of these issues one by one would help to clarify things.

All kinds of public and private insurance plans that spread risk and smooth income over long time periods can produce cash flow and individual incentive problems that the critics like to call Ponzi schemes. That does not make them Ponzi schemes. By individual incentive problems, I mean the situation where an individual joins a pool to spread risk over individuals and time, and then later finds that he/she could do better outside the pool and wants out. Or would like to alter the original terms of the insurance plan. This kind of thing caused problems with the first life insurance policies. That is why life insurance policies are heavily regulated. That does not make them Ponzi schemes. Many private company retirement insurance schemes are having serious problems becasue of unexpected changes in demographics, or declining enrollment because of unexpected changes in industrial activity. An advance funded social insurance scheme is as liable to manipulation or errors in forecasting that would result in some generations receiving a greater return than others. That does not make them Ponzi schemes.

I think the real problem is that these people do not like mandatory participation in social insurance programs. If they don't believe that it is fine for them to say so, as long as we are clear on what we are talking about. I would like a clearer discussion of the issues. Or if I am not clear on this, help me out a little...

Posted by: jml on January 21, 2004 06:24 AM

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Thanks, Jim Glass for the Friedman article. I will read it closely. From a brief look, it seems to me that much of the argument rests on assuming that trading claims that have equivalent net present values will solve the cash flow problems that arise from changing from one funding scheme to another -and correcting some problems that I admit have come from overly generous benefits to current retirees. I think the advocates of privatization in "Should the United States Privatize Social Security?" take a much more careful look at this.

I don't agree with your interpretation of the Krugman quote:

"[Social Security] has turned out to be strongly redistributionist, but only because of its Ponzi game aspect, in which each generation takes more out than it put in.

"Well, the Ponzi game will soon be over, thanks to changing demographics, so that the typical recipient henceforth will get only about as much as he or she put in (and today's young may well get less than they put in)."

Krugman uses the term "Ponzi game aspect" and the last part of the quote implies that social security can (and will have to be) be purged of this aspect, and will still function. So he is not saying that social security is in essence an a Ponzi scheme. I don't see how this shows Krugman and Friedman agree on much of anything. Krugman is talking about the same things that cm talked about in his post.

One of Friedman's examples of the injustice of social security seems flawed to me. That is the person with AIDS who will probably not get the retirement benefit. This is an example of a person who's risk status changes and finds that the insurance is no longer a good buy. How is that different from a person who buys more life insurance after their father dies of heart attack, and then finds out that they themselves are at no greater risk for heart disease, regardless of their father's death? They might regret their decision to buy more life insurance. The difference is that one has a choice and the other doesn't (short of moving to place with no social insurance at all). It seems to me that this is a criticism any kind of mandatory participation in social insurance, or any government requirement for any kind of insurance policy. You're entitled to your opinion on that.

In any case, the mean heartless economist in me says that the unfortunate person who contracted AIDS probably knew about social security, and therefore rationally optimized the chances of contracting it, given the potential lose of retirement benefits. So what is the real loss, and how great the injustice? It's not as simple as it seems.

Of course, kids who contract it at birth are a special case. But Friedman's world has less room to deal with that than one with social insurance.

Posted by: jml on January 21, 2004 06:58 AM

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I do agree with Jim Glass that the government has misled people on how social security works. And I think it would be better for everyone if the general public understood the issues better. I think it would still be a popular program.

The misleading language about accounts may be one reason why some retirees I know think that social security is private program, that has not much at all to do with the federal government. And when Bush talks about social security reform, they think it is the same as reforming company pension plan regulations.

Posted by: jml on January 21, 2004 07:07 AM

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I assume the Graham and Ferrara plans assume no cuts in benefits to current recipients and no pushing back of lower age eligibility? (I had been hoping to begin collecting in 4 years at age 62, but think it would be wiser not to bank on it.)

Posted by: Bob H on January 21, 2004 07:42 AM

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It still seems dishonest for Mr. DeLong to talk of the "cost" of moving to a funded social pension system. The only thing that happens is that you begin to officially recognize the unfunded obligations of the current system. That's a transition problem, but it is not a new "cost," unless you believe that current obligations are bogus and won't be paid. (And likely, some of them won't)

We need a system of private accounts, and benefits should be cut to help us fund the transition. The boomers who think that the Gen X & Y workers of tomorrow will just sit by merrily while payroll taxes skyrocket are fooling themselves. There will be a taxpayer revolt in the future if this system isn't fundamentally changed and the irresponsible folks who bought into this pyramid scheme are going to be sorry.

Posted by: Conor on January 21, 2004 07:47 AM

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Mark, the early investors who reaped inflated returns are all dead. There are no longer any inflated payouts and haven't been since the first wave of subsidized retirees died off. For all of the current participants Social Security is not a ponzi scheme. It may have been once but payouts for all current participants are indexed to what they already paid in. The current Social Security system has a very real debt to all of those living today not just post-Baby Boomers.

_____


Arnold, your review is very accurate. I have a few comments:

"Think of the tax cuts as shifting revenues from government to the private sector. Which sector is more likely to save those revenues?"

You add bias by looking only at savings rate differentials between the private and public sector. If you shift the savings to one specific group in the private sector they may very well save the money, but it will have to be redistributed at some point or it won't be available for the other retirees. Sure the already satiated may well save it, but I'm willing to bet James Glass's shirt :) that it won't do a bit of good to those paying today's payroll taxes. The 2001 and 2003 "tax cuts" were a tax increase for those paying today's payroll taxes.

Also, if Kent Smetter's calculations are correct (abstract below), the answer about which is most likely to save is already known.

---

Is the Social Security Trust Fund Worth Anything? (719 K)

Kent Smetters

NBER Working Paper No. w9845
Issued in July 2003

---- Abstract -----

With over $1 trillion in assets, the U.S. Social Security trust fund is the largest pension reserve in the world, and potentially a model for other developed countries facing future financing problems. But are those assets actually worth anything?' This question has generated a heated debate in the U.S. as policymakers debate options for Social Security reform, with the understanding that the characterization of the trust fund influences these decisions. Some observers claim that the trust fund is not worth anything while others argue that it is valuable. However, different reasons are given for the same position. This paper provides a unified conceptual framework for thinking rigorously about the assets accumulated in the trust fund. Multiple perspectives of the trust fund are identified and are summarized under two categories: (I) storage technology arguments and (II) ownership arguments. Storage technology arguments focuses on whether the trust fund surpluses actually reduce the level of debt held by the public or, alternatively, are used to hide' smaller on-budget surpluses. Ownership arguments focus on property rights, i.e., how trust fund credits should be allocated regardless of whether they reduce the debt held by the public. Only the storage technology argument can be empirically tested, as we do herein. We find that there is no empirical evidence supporting the claim that trust fund assets have reduced the level of debt held by the public. In fact, the evidence suggests just the opposite: trust fund assets have probably increased the level of debt held by the public. Moreover, the adoption of a unified budget' framework in the late 1960s appears to play a statistically significant role in this result. We show how this counterintuitive result can be explained by a simple split the dollar game' where competition between two political parties exploits the ignorance of voters who don't understand that the government's reported budget surplus actually includes the off-budget' Social Security surplus. To be sure based on a limited annual time series (1949 2002) and so the results should be interpreted with caution. But the empirical tests are, if anything, biased toward finding a reduction in the level of debt held by the public, and not the increase that we find.

---

Privatization of Social Security: How It Works and Why It Matters (1553 K)

Laurence J. Kotlikoff

NBER Working Paper No. w5330*
Issued in October 1995

---- Abstract -----

This paper uses the Auerbach-Kotlikoff Dynamic Life-Cycle Model (AK Model) to examine the macroeconomic and efficiency effects of privatizing social security, and a simple privatization proposal, the Personal Security System, to discuss other issues associated with privatization. According to the AK Model, privatizing social security can create major long-run increases in output and living standards which come largely but not exclusively at the expense of existing generations. Indeed, the pure gains refers to the welfare improvement for future generations after existing generations have been fully compensated for losses from privatization. The precise size of the efficiency gain depends on the existing tax structure, linkage between benefits and taxes under the existing social security system and the choice of the tax instrument used to finance benefits during the transition. When the initial tax structure has a progressive income tax, when the existing system's benefit-tax linkage is low, when consumption taxation is used to finance benefits during transition and when existing generations are fully compensated for privatization losses, there is a 4.5 % simulated welfare gain to future generations. But if these circumstances don't hold, the efficiency gains from privatization are likely to be smaller, possibly negative. The Personal Security System shows there are simple ways to privatize the retirement portion of the U.S. Social Security System and credit workers for their past contributions, and even provide more survivors' protection than the current system. But the analysis suggests that benefits must be set against a possible reduction in progressivity and a reduction in longevity insurance for the elderly.

*Published: Tax Policy and the Economy, vol. 10, James M. Poterba, ed., MIT Press, 1996, pp. 1-32

Posted by: Stan on January 21, 2004 08:49 AM

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cm writes, "The Ponzi analogy is flawed. The Ponzi definition is based on a static population."

No, the Ponzi analogy is not flawed. Ponzi's original scheme didn't collapse because it reached the point where every single person in the world was participating. Ponzi's original scheme collapsed because new "investors" couldn't be found at a *rate* that provided sufficient returns to both new and existing "investors." It's not that zero investors could be found. It's that each generation of "investors" MUST be larger than the previous generation, in order to keep the returns on "investment" high. That is true of every pyramid scheme, and that is true of Social Security, as it is currently operated.

If the Social Security system was voluntary, hardly anyone in the post-Baby-Boom generations would join, because they know that they won't get a good return on "investment." Since they wouldn't voluntarily join, the Social Security system would collapse.

Again, that is the very *essence* of a Ponzi scheme. The original Social Security "investors" (e.g. Ida May Fuller, the first Social Security recipient, and her generation) got absolutely fabulous returns on their "investment." So they told everyone what a great deal they got on Social Security. So everyone was very gung-ho about getting in on the "investment." But eventually new investors can't be found at a ***rate*** that is sufficient to keep the return on "investment" high enough, and so new "investors" see that it's a bad deal, and they don't "invest."

Social Security *is* a Ponzi scheme. If it were voluntary, most of the people in the generations following the Baby Boom generation would NOT join. And Social Security would collapse. Like every other Ponzi scheme.

So the "Ponzi analogy" is not "flawed." Social Security *is* a Ponzi scheme, by this definition:

"A fraudulent scheme. It is a specific form of pyramiding in which money paid by later investors or contributors is used to pay inflated returns to earlier investors — until the funds dry up because no more contributors can be found."

Posted by: Mark Bahner on January 21, 2004 09:05 AM

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I am impressed with the content of the explanations of how the system works. It seems fairly staright forward. And if you can understand how private companies manage their pension plans, you can understand how SS works.

Early in the post there was a question as to how other countries have taken care of this. In Canada the federal governement looked at the Canada Pension Plan, saw that there was a "inter generational deficit" and increase the payroll deductions for CPP. Yes a tax increase. This was in 1992 and 1998. Since then there have been income tax cuts so I think we are about 2% less taxed overall in real dollars from 1992. This was a payoff for bringing the federal debt under control.

On my Pay check 3.4% comes off for CPP. My employer contributes double that amount for a total contribution of 10.2% on the income earned. CPP is taken from the day I turn 18 until retierment and you only contribute to dollars earned between $3500 and $39500. All income below or above is exempt.

Here is the kicker. Not only is the system balanced, but in 1998 the law was amended to change the pension plan from a pay as you go into a fully funded program. So every year the Feds collect more than they need and invest it with various fund managers across Canada. Eventually all liabilites will be covered up front. This is a 50 year project.

http://www.hrdc-drhc.gc.ca/isp/studies/trends/contributor/con2000.pdf

Wouldn't this be a fairer way to reform the US system?

Posted by: Scott McArthur on January 21, 2004 09:07 AM

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It still seems dishonest for Mr. DeLong to talk of the "cost" of moving to a funded social pension system. The only thing that happens is that you begin to officially recognize the unfunded obligations of the current system. That's a transition problem, but it is not a new "cost," unless you believe that current obligations are bogus and won't be paid. (And likely, some of them won't)

Posted by: Conor on January 21, 2004 07:47 AM

Conor, those costs can be carried indefinately in the current system without ever being paid. Since we are already in that system, it is hardly dishonest to ignore them when analyzing costs. The costs will only surface if the system is changed otherwise they effectively don't exist. They are inertial in that respect. When stopping or turning you must account for the costs, but as long as you continue along the same path you can ignore them.

Posted by: Stan on January 21, 2004 09:31 AM

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Stan writes, "Mark, the early investors who reaped inflated returns are all dead."

They may be dead, but their dead bodies are serving as very useful propoganda for Social Security's advocates, such as the Social Security Adminstration:

http://www.ssa.gov/history/idapayroll.html

From that website:

"Ida May Fuller worked for three years under the Social Security program. The accumulated taxes on her salary during those three years was a total of $24.75. Her initial monthly check was $22.54. During her lifetime she collected a total of $22,888.92 in Social Security benefits."

Note that the Social Security Administration does NOT include any sort of caveat, like, "Past returns on 'investment' are not an indicator of future returns." They have a prominent page for Ida May Fuller, but they do NOT have subsequent pages for later "investors"...who, on average, continue to get lower and lower returns on "investment."

Stan continues, "There are no longer any inflated payouts and haven't been since the first wave of subsidized retirees died off."

No, the current retirees are ALSO getting "inflated payouts." The Social Security system is giving current retirees good returns on "investment" ONLY because the generation of retirees AFTER the current generation of retirees is larger.

The "inflated returns" will only stop when a generation of retirees has FEWER members than the previous generation of retirees. That is an absolutely classical aspect of a pyramiding scheme. You're right in the sense that the returns are LESS inflated. But they are still inflated. The bubble only bursts when a new generation comes that has fewer members than the previous generation...as will likely happen with the post-Baby-Boom generations.

"For all of the current participants Social Security is not a ponzi scheme."

It IS a Ponzi scheme! A Ponzi scheme is a pyramiding scheme. Social Security is a pyramiding scheme. The current retirees are getting inflated returns on "investment" precisely because the generations following them are larger in number. The post-Baby-Boom generations will get crappy returns on "investment" because they will likely have FEWER members than the Baby Boom generation.

A Ponzi scheme doesn't *stop* becoming a Ponzi scheme after the first generation of investors. As long as each subsequent generation is larger, it's still a pyramid scheme.

"It may have been once but payouts for all current participants are indexed to what they already paid in."

That may be the case, but the "indexing" is set artificially high, precisely because the next generation of "investors" is larger. When the "index" goes to a point where people get out, on average, exactly what they paid in, then (I'll concede) it will stop being a Ponzi scheme.

"The current Social Security system has a very real debt to all of those living today not just post-Baby Boomers."

The is no *legal* debt to anyone under Social Security. If there is a "debt," it is only a *moral* debt. I have some advice for you: don't count on politicians (of any stripe) to behave *morally.* (Even legally is pretty much a pipe dream. :-/)

Posted by: Mark Bahner on January 21, 2004 09:54 AM

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Mark, per the definition you provided:

"A fraudulent scheme. It is a specific form of pyramiding in which money paid by later investors or contributors is used to pay inflated returns to earlier investors — until the funds dry up because no more contributors can be found."

Social Security is fully authorized by our government according to the laws of our land as determined by legally binding court decisions. As a legally authorized system, it is not a fraudulent scheme.

Social Security is not an investment regime. It is a taxpayer funded transfer program that provides retirement benefits and various types of insurance such as longevity and disability insurance.

Except for cases where the program is providing insurance and during its initial introduction, retirement payouts are INDEXED to money paid in. The wage level indexing means that for the vast majority of participants payouts are specifically not inflated. They are at best one for one.

Since Social Security is legally authorized, is not an investment program providing returns to investors, and only pays back wage INDEXED contributions, it does not qualify as a Ponzi scheme per the definition you provided.

I am very open to privatizing Social Security. Arnold Kling does a great job of sumarizing my own feelings on the subject:

"I happen to like the idea of privatization. It appeals to my values of personal responsibility and "right-sized" government. But I am completely turned off by the severe demagoguery and counter-demagoguery on both sides of the privatization debate."

Posted by: Stan on January 21, 2004 12:42 PM

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Mark, you are misusing the term "generation." The way it is used in the Ponzi scheme analogy is different from the way Tom Brokaw uses it.

Social Security is self-sustaining if the ratio of payers to payees is held stable. Let's assume a constant population--not even the growing population the U.S. currently has. If the average age is 80, the retirement age is 65, and the average age for entering the workforce is 20, you will have a 3:1 ratio of payers to payees. Three workers pay a certain share of their income to supply one retiree with Social Security earnings. This ratio can carry through the end of time * * * *DESPITE* * * * the unpyramidal shape of the population BECAUSE retirees die and new people join the system AT THE SAME TIME as people who joined earlier stay in the labor force.

What has happened in America is that demographic burps have caused the ratio to shift. People are living longer; the baby boomers will distort the ratio by being uncharacteristically more numerous than a later generation. But there is no * * * * * INHERENT* * * * * problem! Say that there are now 2.5 workers for each retiree. You can fix this by:

1. Raising the retirement age 2
2. Raising the tax each individual pays
3. Lowering benefits

until you reach the * * * *SAME* * * * flows you had before. It's a little rougher for all involved, but here's the thing; it all comes out in the end. My generation (b. 1976) is smaller than the Baby Boomers, but when we're retired, we'll have a *L A R G E R* pool of younger workers to support us. Taxes can be lowered or benefits can be raised or retirement ages can be reversed--or the extra money can be banked in a trust fund for future demographic problems caused by increasing life spans.

I don't know what will happen. What is important is that small changes CAN restore the system to balance; there is * N O * inexorable, unpreventable trend to collapse like there is in * * * EVERY * * * Ponzi scheme by definition.

All it takes is tweaking and fine tuning, but as long as Americans are willing and able to work, on average, a certain multiple of the number of years that they will spend in retirement, Social Security can provide some level of income proportional to that proportion.

The * * *system* * * can go on forever without the collapse that is * * *INHERENT* * * to TRUE Ponzi schemes.

Posted by: Brittain33 on January 21, 2004 01:09 PM

____

Heh, heh, heh!

Thanks, Jim Glass.

I have been repeatedly criticized on this site for (correctly! :-)) writing that Social Security is a "Ponzi scheme."

Now, Jim Glass finds a Paul Krugman quote:

"Well, the Ponzi game will soon be over,..."

There you have it. Dr. Krugman, a man who on this site is worshipped as a g@d (only a tad exaggerated, for effect) says that Social Security is a "Ponzi game."

But does anyone write, "Gee, Mark, maybe you were right all along...maybe Social Security really *is* a "Ponzi scheme..."?

No! Of course not! :-)

Instead, people who disagree with me try to twist Dr. Krugman's quote into proof that Social Security is NOT a Ponzi scheme! (!!!!) :-) :-)

Their reasoning is that Dr. Krugman wrote that "Ponzi game will soon be over..." So they say that Social Security is NOT a Ponzi scheme because Paul Krugman writes that the "Ponzi game will soon be over."

A suitable analogy:

Mark Bahner: "We are playing basketball."

Response (from jml, Stan, and others): "No, that's wrong! We're *not* playing basketball, because Paul Krugman says it's late in the second half of the basketball game, and we'll soon have soon have to go to work."

?!!! The logic truly boggles my mind! :-)

jml, Stan, and others: It won't kill you to admit that I'm right; Social Security IS a Ponzi scheme. Even Paul Krugman admits it.

Posted by: Mark Bahner on January 21, 2004 02:28 PM

____

"It still seems dishonest for Mr. DeLong to talk of the "cost" of moving to a funded social pension system. The only thing that happens is that you begin to officially recognize the unfunded obligations of the current system. That's a transition problem, but it is not a new "cost," unless you believe that current obligations are bogus and won't be paid. (And likely, some of them won't)

Posted by: Conor on January 21, 2004 07:47 AM

Conor, those costs can be carried indefinately in the current system without ever being paid. Since we are already in that system, it is hardly dishonest to ignore them when analyzing costs. The costs will only surface if the system is changed otherwise they effectively don't exist. They are inertial in that respect. When stopping or turning you must account for the costs, but as long as you continue along the same path you can ignore them.

Posted by Stan at January 21, 2004 09:31 AM "

I agree with Conor. See http://www.techcentralstation.com/012104H.html

Stan's point about being able roll over the social security obligation indefinitely is correct. However, by the same token, you could roll over debt indefinitely.

The way I put it is that the obligation to pay entitlements walks like a debt and talks like a debt, but it is not counted as a debt on the government books. If it were counted as such, the absence of any real transition cost would be transparent.

Posted by: Arnold Kling on January 21, 2004 02:36 PM

____

Sigh. I probably should get a life, and realize that some people will simply never admit that they are wrong, and I am right. But here goes...

Stan writes, "As a legally authorized system, it is not a fraudulent scheme."

Every "fraud" is not illegal. The Shroud of Turin is likely a "fraud." But that doesn't mean it's illegal. One definition of "fraud" (from dictionary.com) is:

"A piece of trickery; a trick."

Social Security is such a piece of trickery. Look at all the people who think that the Social Security "Trust Fund" actually has marketable assets in it. They have been tricked.

H@ll, look at the fact that you refuse to admit that Social Security is a Ponzi scheme, even when confronted by the fact that Paul Krugman himself has called it a "Ponzi game." Do you think Paul Krugman is wrong?

Stan continues, "Social Security is not an investment regime."

The definition I provided does not REQUIRE it to be an "investment regime." The definition I provided says "investors OR contributors." (My emphasis.) I'm sure you've heard the phrase "Contributions to Social Security."

Stan concludes by quoting Arnold Kling: "I happen to like the idea of privatization. It appeals to my values of personal responsibility and 'right-sized' government. But I am completely turned off by the severe demagoguery and counter-demagoguery on both sides of the privatization debate."

Stan, I don't mind keeping Social Security public, as long as everyone makes it very clear to the post-Baby-Boom generations (or any generations that aren't larger in size than the generations before them) that those generations who are smaller than the generations before them are going to get screwed. At least the way Social Security is currently being operated.

In other words, I want *everyone* to admit the truth (like Paul Krugman already has) that Social Security is a Ponzi scheme. There is no Trust Fund; it's a fraud.

Do you admit that?

Posted by: Mark Bahner on January 21, 2004 02:51 PM

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Arnold Kling writes, "The way I put it is that the obligation to pay entitlements walks like a debt and talks like a debt, but it is not counted as a debt on the government books."

Yes, because the books are fraudulent. And those fraudulent government books are all perfectly legal. (Note to Stan: this again demonstrates that all frauds aren't illegal.)

Posted by: Mark Bahner on January 21, 2004 03:02 PM

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Without offense to anybody, you are all making good points, but I think the framing of the social security debate is besides the point (and maybe even the framing of the social security system itself).

There is an often unstated assumption that any social security system has to be based on some kind of carried-forward financial debt. That is, today's contributors are paying into a fund, the fund supposedly grows (even if only on certain books and without "real" assets), and at retirement the accumulated debt is paid out, financed by taking in new taxes. (And probably to some extent the current system is operating in this way.) This is what leads Mark Bahner to speak of a Ponzi scheme, and if framed like this there is indeed something to that.

However, even if so, the scheme is at best vaguely Ponzi-like. The problem is not primarily that contributors can't be found at a high enough rate, but that by the definition of the FICA system, "real" (inflation/production adjusted) contributions are declining at a faster rate than real benefit levels needed to uphold a constant living standard. *This* is why more contributors or higher FICA tax rates are needed to uphold benefits. Demographic factors (longer life and larger retiree cohorts) make it only worse. (There are many other details, like higher incidence of medical problems like obesity, various cancers, etc. that are driving up costs.)

In other words, the financial construction of the system is what artificially limits the payouts, not any intrinsic problems. Along Bulent's lines, due to productivity increases it takes much fewer workers (FICA payers) to produce the goods and services for retirees. The consequence is that contributions per unit of benefit go down, instead of staying constant (in real terms).

Leaving aside the complication that goods and services constantly change, and considering for example bread (not as a realistic example, but I have to pick something, and let bread stand for "food" which will supposedly be in roughly constant demand). Now if the productivity increases that we have been seeing and looking forward to are real and not just bullshit, then we can judge, just to say some number, that producing a given amount of bread used to take 40 people in the past, takes 20 people today, and will take 10 people in the future (assuming sustained exponential, i.e. same annual-percentage, increases in productivity, which is perhaps too rosy). If productivity increases sub-exponentially, then those may be 30, 20, 15 workers or whatever.

Now if bread in real terms becomes cheaper at the same rate as worker input declines, or real-term FICA contribution per worker (not necessarily from only the worker's pocket) increases to reflect productivity growth and the real price of bread stays flat, we are fine. But what appears to happen is that

(1) bread does not become cheaper in real terms at the rate of production growth, and
(2) worker's wages (and thus relatively constant-rate FICA takeouts) do grow more slowly than productivity.

That is, there is a gap between productivity increases and increases in FICA contributions. Bringing in the infamous outsourcing, worker input in foreign countries does not lead to any US-FICA contributions at all (?). If goods and services are not fully matched by FICA contributions, then of course the system will get into trouble. Now this is not the whole truth, but it appears to be part of it.

Would you please point out fundamental flaws in this reasoning, aside from artefacts of the simplification?

Posted by: cm on January 21, 2004 04:08 PM

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Re: social security by force

Mark, I suggest that boomers would drop out of social security not simply because they don't see the ROI. Different people may have different reasons, but aside from financial hardship, people have the tendency not to enter or uphold reciprocal deals that require extending a lot of trust. And also social security is easier to start than to terminate. If people drop out massively, the consequence would be that they would have to pick up their parents' tab from their own pocket, or pay into a private scheme for them *and* for themselves.

And I'm not saying there are no problems with the current social security implementations in the US and other countries. Monies have repeatedly been misappropriated for non-retirement purposes.

My description of the "essence" of social security in previous posts assumes a pure pay-as-you go system (adorned with fluctuation reserves etc.)

I object to the notion of a lock box, as it has nothing to do with a pay-as-you-go system. It is just a smoke screen to hide the fact that the delta between contributions and payouts is used for other purposes. Extending massive debt to the same economy that has to produce future benefits does not look to me as a very good insurance against demographic changes. The only viable solution I see is to adjust the social security tax base in such a way that it fairly accounts for increases in social production, not tinkering around with an ever-shrinking contributor base.

I still don't see why we should have problems with allocating social security benefits in an economy where productivity and the state of science and technology are growing at the rates that we observe. Maybe somebody could point this out to me.

Posted by: cm on January 21, 2004 04:59 PM

____

Krugman's (godlike or not, take your pick) take on transition costs.

http://www.wws.princeton.edu/~pkrugman/socsec.html

At the risk of offending the god Krugman, this is not the only take on the subject, but it is a reasonable and intuitve as anything I have read here.

I don't follow some of the charges agains social security. If it is an insurance and a redistribution program, obviously some people will get more than they contributed. And I don't see how an advance finance scheme that has to be planned over 60 to 80 year life cycle would not be subject to same problems of intergenerational inequities, unwise politcal manipulation of benefits to reward certain generations more than others, cash-flow problems due to demographic change, etc.

When it gets to point that poor old Krugman's quotes are displayed and repeatedly represented to mean what they manifestly do not mean, then I begin to wonder if some of the posts are jokes.

Anyway, good luck everyone.

Posted by: jml on January 21, 2004 06:19 PM

____

The way I put it is that the obligation to pay entitlements walks like a debt and talks like a debt, but it is not counted as a debt on the government books. If it were counted as such, the absence of any real transition cost would be transparent.

Posted by Arnold Kling at January 21, 2004 02:36 PM

Arnold, the entitlement overhang doesn't walk like a normal debt, nor talk like a normal debt because it only has associated costs at transition to some other system. At that point the debt has to be paid. It isn't shady book keeping that makes it different. It is that fact that we are already in this system and only need to look at the cost if we change.

It is inertial. Our car is already moving. The energy needed to change direction or stop is greater than that needed to keep going. Going straight includes a debt in energy. The energy debt already exists and it has no associated costs as long as we go straight. At this point we have to PAY MORE to change direction or stop. It is reality.

If we weren't already in the system, you, Milt, James, Conor, et.al. would have a point.

Posted by: Stan on January 22, 2004 06:20 AM

____

Why won't Mark acknowledge my post when insisting that he's right? Should I have used more asterisks?

Posted by: Brittain33 on January 22, 2004 07:53 AM

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"Conor, those costs can be carried indefinately in the current system without ever being paid."

This is blatantly false, obviously.

Otherwise $18 trillion of cash flow from outside the current system -- $3.5 trillion current value, if financed with set-asides today -- wouldn't be needed to finance SS's promised obligations just through the 75-year look-ahead period.

"The costs will only surface if the system is changed otherwise they effectively don't exist."

False, obviously.

The costs surface the day the Trust Fund runs out, upon which day formula benefits will be underfunded by 27%, say the SS Trustees, with the percentage rising forever more.

(I am ignoring, for simplicity's sake, the growing extra cost that must be financed by the gov't from general revenue as of the day SS goes cash-flow negative relative to payroll taxes in order to pay off the bonds in the Trust Fund to fund SS's operating deficit.)

Upon that day the money to make up that 27%-and-rising will have to be made up by the government somehow -- by either slashing benefits or raising taxes.

Note that borrowing to pay the benefits is the same as raising taxes. Every extra $1 borrowed must be financed by an extra $1 current value of interest paid by the gov't on the borrowing -- and the government gets the money to pay interest on its bonds from *taxes*. So when the gov't has to raise the $1 to pay an unfunded SS benefit it can either collect $1 more of income tax right away, or collect (say) 6 cents more of income tax every year forever. And when you are not borrowing temporarily to get over a hump, but to finance growing unfunded liabilities forever, the two amount to the exact same thing.

OTOH, investment programs to fund SS eliminate all the vast future SS under-funding -- the 27% collapse in funded benefits, etc. -- by using, self-evidently, additional investment funds in the near term.

But to call a current investment a "cost" by ignoring the long-term benefit it produces is either incompetence or insidious dishonesty. And this is exactly what the "transition cost" argument against SS reform does -- it treats the cash flow amount of investment as a "cost" while totally ignoring the much larger cash flow benefit from the investment in the future. (While, of course, making no alternative proposal to close that $18 trillion cash flow gap!)

This is exactly the same as treating your personal retirement savings in an IRA or 401(k) as a "cost" and thus concluding that you will better off by their amount if you avoid that cost and just don't make them.

Posted by: Jim Glass on January 22, 2004 09:03 AM

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"I don't follow some of the charges agains social security. If it is an insurance and a redistribution program, obviously some people will get more than they contributed. "

FDR's original Social Security plan enacted in 1935 was a funded retirement plan that basically gave everybody a 3% return on the amounts they contributed to it -- it wasn't going to pay *full* benefits to anybody until they had contributed for a full 40-year working life -- in 1980! (IIRC).

It was moderately redistributional in that a dollar of earnings taxed at the lowest wage level earned a higher return under the benefit formula than one taxed at the highest level.
But to the modern eye it is recognizable as a pretty normal "defined benefit retirement plan" like GM or any old big employers has, and that is indeed what its designers called it.

But starting in 1939 Congress started rewriting it -- immediately cutting the payroll tax funding it in half, and boosting and accelerating benefits. Before long this turned SS into "paygo", and of course it greatly increased the rate of return on contributions to participants, giving *everybody* very *high* returns. The beneficiaries of this largess of course being the voters of the day who elected those Congresses.

Almost every Congress continued this game thereafter -- although in time they had to start increasing the payroll tax as the bigger promised benefits came due -- until SS was *bankrupt* in 1980. Thereafter the Greenspan reform commission refinanced it with the current 12.4% payroll tax-and-Trust Fund set-up.

Now the REAL problem SS faces in the future isn't the "financing gap" itself -- closing that gap is a trivial exercise of raising taxes or cutting spending (on benefits -- higher retirement age, etc.). No different than cutting a financing gap for the Agriculture Dept, Defense Dept. whatever.

The REAL problem is a political one -- SS obtained its huge political popularity in the past by giving near EVERYONE a *lot more* than they paid into it. Hey, it's kind of hard for a program like that *not* to be popular, eh? And that was in a world where most people had few other retirement savings options -- no IRAs, 401(k)s, Keoghs, etc.

But for today's young workers going forward near EVERYONE is going to get *less* back than they put into it. And this is in a world where everyone can save for retirement themselves in IRAs etc, without receiving *less than zero on 12.4% of their pay.* This situation has never existed before! Well, not for any social program that has survived. It is the opposite of the history of SS, and likely to have the opposite effect on its popularity.

The real issue with the "funding gap" is that however it is closed in the present system -- either by raising taxes cutting benefits -- it drives return on SS contributions *still lower*. On the current benefit formula many groups, including many of the poor, will receive negative returns while the average return is under 2% -- but even these returns are 25% underfunded! Closing that gap, however, drives everyone's return down that much further.

And *that's* why the politicians haven't taken the easy steps needed to close the funding gap. If they did, and announced "Gap closed!" millions of voters would say "Why the hell I'm I going to be getting back so much *less* than I've paid in?? What happened to all my money in the Trust Fund?!?!?" Voters would suddenly *SEE* that they are going to get less back than they put it.

The politicians are terrified of that happening on their watch. So they let the status quo ride, and the funding gap that some *future* politician is going to have to pay the price for gets larger every year. Not to mention what future taxpayers will have to pay, and what future SS recipients will have to pay through slashed benefits.

Well, I should say Democratic politicians flee from any proposal to close the funding gap. Republicans have made several proposals to do so through the combination of advance investment benefit adjustments, the Moynihan Commission and all.

The Democrats then bash them for it up and down -- without making any proposal of their own, of course. Just like here.

"And I don't see how an advance finance scheme that has to be planned over 60 to 80 year life cycle would not be subject to same problems of intergenerational inequities"

A funded plan has no intergenerational problems because each generation saves for *its own* retirement. There's not net transfer from one to the other.

FDR's original Social Security was like that. Every generation was to receive the same 3% (actually the return on bonds) as every other.
No problem.

Until Congress started rewriting it to buy votes in 1939, bankrupting it in a mere 40 years. FDR's original plan was designed to have $500 billion invested in 1980.

BTW, the little history above shows how those who argue "We must defend today FDR's Social Security" are happily spinning political myth for political gain. Today's SS *ain't* FDR's Social Security.

Posted by: Jim Glass on January 22, 2004 10:05 AM

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"When it gets to point that poor old Krugman's quotes are displayed and repeatedly represented to mean what they manifestly do not mean, then I begin to wonder if some of the posts are jokes."

Some aren't, some are unintentionally, some are intentionally to point out the former.

Of course when Krugman writes columns claiming "the Bush tax cuts cost *more* than enough revenue to top off Social Security and Medicare for 75 years" you should maybe be asking the same question about him personally.

Posted by: Jim Glass on January 22, 2004 10:07 AM

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Arnold, Conor, James, et.al., I stand corrected. The associated cost issues (potentially higher interest rates, crowding out, etc.) are the only real costs of transition, and they can be expected to be offset to a large extent (higher investment). The debt exists no matter which case.

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Mark, several posters have politely tried pointing out the many flaws in your analogy. After one attempt I succumbed to beating you with your own stick. Instead of continuing down that track, I'm going to take one last shot.

The basic flaw in the analogy is mistaking similarity for equivalence. Social Security has pyramid like qualities, but it is very different from a ponzi scheme in very important areas. The largest difference between our current Social Security system and any ponzi scheme is in the area of sustainability. With tweaks to payouts, age requirements, etc. Social Security is sustainable indefinately. Ponzi schemes are not sustainable under any condition. The population is limited. A ponzi scheme must eventually fail.

When Paul Krugman describes the "ponzi game" he is not saying that Social Security is equivalent to a ponzi scheme. He is saying that with the current pay outs, age requirements, etc. it will behave like one under our population overhang. He wants to see changes to the program to ensure its sustainability but he does not believe it is destined to fail. The quote does not support your contention.

Of course, the likely reasons the ponzi scheme analogy is being used against Social Security is that most people will know that ponzi schemes are destined to fail and that they reward early investors at the expense of later investors. The apparent hope is people will therefore believe there is an inherent flaw undermining our current system and that it is inherently inequitable. Neither points are true. Changes to address demographic changes can ensure our current system's sustainability in perpetuity. Likewise, equity can be maintained. Increasing age limits and indexing payouts to inflation now could easily protect the post-Baby Boom crowd from higher taxes.

Posted by: Stan on January 22, 2004 11:15 AM

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Jim, per my post above, I agree that the debt exists either way. I was not correct.

In these last three posts you acknowledge that "The real issue with the "funding gap" is that however it is closed in the present system -- either by raising taxes cutting benefits -- it drives return on SS contributions *still lower*." Thus, you mischaracterize our situation with Social Security by saying "bankrupting it in a mere 40 years." It isn't bankrupt. We just face unpopular choices.

Further, is Moynihan a Republican? (Just kidding :). Neither party has behaved stellarly. A Republican Congress and President just gave the trust fund away as an income tax cut. If there isn't a surplus, there isn't a trust fund.

Posted by: Stan on January 22, 2004 12:05 PM

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Stan writes, "Mark, several posters have politely tried pointing out the many flaws in your analogy."

And I have just as politely pointed out how I am right, and their critiques are invalid.

Stan continues, "The basic flaw in the analogy is mistaking similarity for equivalence. Social Security has pyramid like qualities, but it is very different from a ponzi scheme in very important areas. The largest difference between our current Social Security system and any ponzi scheme is in the area of sustainability."

And I have already pointed out that the only thing that keeps Social Security "sustainable" is that the government REQUIRES that people contribute to Social Security. If people that are younger than the Baby Boomers were allowed to choose either funding their own retirements, or staying in Social Security, they would fund their own retirements.

Now, you and Paul Krugman and a lot of other people say, "But that's not fair! The people younger than the Baby Boomers owe a debt to fund the Boomers' retirements...just like the Boomers funded the retirements of the generation before them!"

But as I've already pointed out to you, that debt is MORAL...it's not LEGAL. No one has a LEGAL right to get back what they put into Social Security.

"With tweaks to payouts, age requirements, etc. Social Security is sustainable indefinately. Ponzi schemes are not sustainable under any condition."

Ponzi schemes ARE sustainable indefinitely...IF they are mandated by the government! IF Carlo Ponzi had the power of government behind him, he could still be running today. His scheme ONLY collapsed because contributors were allowed to choose *not* to contribute.

I think I offered this bet to you, already...but maybe it was someone else. Let's pass a law that does the following: every year, there is a vote among all 18 year olds. By majority vote, they decide whether they ALL get into Social Security, or they ALL have private accounts (that require them and their employers to pay the same amount that they'd pay into Social Security into a private account). If that's done, I'll be happy to give you 20-to-1 odds on a $10 bet that the 18 year olds would vote for the private accounts.

You KNOW that I'm right. And the fact that I'm right PROVES that Social Security is a Ponzi scheme; Social Security would collapse if the younger people were allowed to bail.

"When Paul Krugman describes the "ponzi game" he is not saying that Social Security is equivalent to a ponzi scheme."

Like I've already written, this is completely analogous to me saying that we're playing a basketball game, and you claiming that we're not, because Paul Krugman says that the game is almost over.

"He wants to see changes to the program to ensure its sustainability but he does not believe it is destined to fail."

Paul Krugman KNOWS it would fail, if 18-year-olds were allowed to vote themselves in or out.

I will extend my bet to Paul Krugman. (My limit on this betting is...ummmm...3 people.) We will address 1000 college seniors, chosen at random. Paul Krugman can tell them why they should staying in the public Social Security system (imagine the lies he'll have to tell to do that!). I will tell them why they should choose private accounts. Then those 1000 college seniors will vote. If a majority of them vote to stay in Social Security, I'll give him $200. If a majority vote to go into private accounts, he will only have to give me $10.

Stan concludes, "Of course, the likely reasons the ponzi scheme analogy is being used against Social Security..."

The reason I call Social Security a Ponzi scheme is because I'm smart enough and honest enough to call a Ponzi scheme a Ponzi scheme. But I don't take a lot of credit for my honesty on this issue. Apparently, even Paul Krugman is honest enough to admit that Social Security is a "Ponzi game."

Posted by: Mark Bahner on January 22, 2004 03:47 PM

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K Harris wrote that in a privatized SS system "some will end up in wretched poverty, a system in which the worst outcome can be worse than under today's SS system". This is a red herring. If there is some worst level of income below which nobody over 65 (or 62) should fall, then we could just institute the appropriate negative income tax. Better yet, make said negative income tax independent of age. (Why is "wretched poverty" OK for 61-year-olds?)

Holtz for Congress http://marketliberal.org Free Minds Free Markets

Posted by: Brian Holtz on January 23, 2004 08:34 AM

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Mark, as far as I can tell you have not disproved any of the posters above. You have made so many logical errors and jumps that it is embarassing to read what you have written. As an example, you wrote:

"And I have already pointed out that the only thing that keeps Social Security "sustainable" is that the government REQUIRES that people contribute to Social Security."

Mark, this statement is not true and your logic in making the statement is not valid. Allowing people to opt out is only one of many potential things that can undermine a pay as you go system. We could double current payouts to undermine it as well. I can think of many other ways to undermine it.

In making this statement you are engaging in a logical fallacy. Just because something is sustainable doesn't mean that it has to operate in that fashion. There are no basic conditions that prevent a pay as you go system from operating indefinately. This is what the statement "it is sustainable" means.

While social security can operate sustainably, it does not have to be operated that way. This was the point of Krugman's analysis. He was saying that our current payouts, contributions, etc. are making the system unsustainable. He recognizes that just because something is sustainable doesn't mean it has to operate that way.

A ponzi scheme is not sustainable under any condition. It requires an exponentially increasing population. The Earth has limited resources. An exponentially increasing population would overwhelm our resources thus a ponzi scheme must fail. This is what the statement "it is unsustainable" means.

The embarassing part of reading your posts is that you don't seem to understand when you make these errors. Because you cannot understand your mistakes, you really seem to believe that you are "right". It makes for a comically painful parody to have you rowing around in a logical boat full of holes with no recognition that it is sinking beneath you. It also makes it extremely difficult to make points to you.

None of us are perfect. We all make mistakes. We are all ignorant of more than we know. We are all rowing around in that boat full of holes at some point or another. I highly recommend you take some courses in logic. Should you ever decide to do so, you are going to be embarrassed to review what you have written on this blog. Good luck.

Posted by: Stan on January 23, 2004 09:30 AM

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