February 28, 2004

Saving Social Security

Ron Suskind has an article in Slate about his "Saving Social Security" documents--the 630 word Powerpoint "memo" for George W. bush, et cetera:

The Free-Lunch Bunch - The Bush team's secret plan to "reform" Social Security. By Ron Suskind: 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....

I think it's worth laying out the basic underlying logic of Lindsey's plan. The plan is to:

  1. Borrow lots of money from the private sector by issuing extra Treasury bonds--and pay an interest rate of, say, 3% plus inflation per year.
  2. Invest the borrowed money in stocks and bonds--and receive average returns (dividends plus capital gains) of, say, 5.5% plus inflation per year.
  3. The extra flow-of-funds into financial markets leads businesses to invest in plant and equipment, expand their operations, and raise their profits. An extra 2% of the original sum borrowed is recaptured in additional corporate income tax collections.
  4. Roll over and reinvest the profit margin--the 5.5% return on the portfolio plus the 2% corporate tax collections minus the 3% interest on the borrowing--in stocks and bonds year after year.

In the Lindsey plan, this borrowing cheap and investing dear is an immensely profitable exercise. After twenty years, according to the assumptions underlying this plan (as presented, for example, in Feldstein and Samwick (2000)*), your assets have grown to $2.95 for each dollar borrowed. You can then cash out, retire the original Treasury bond that you had issued, and clear a profit of $1.95 for every dollar originally borrowed. After thirty years your assets have grown to $5.65 for each dollar borrowed. You can then cash out, retire the original Treasury bond that you had issued, and clear a profit of $4.65 for every dollar originally borrowed.

In context, the Lindsey plan places this in a framework of Social Security reform, private accounts, et cetera. But those bells and whistles are unimportant: at its core, the plan is to use the government's credibility and financial soundness to borrow cheap and invest dear, and so earn enormous long-run profits. Why, if Lyndon Johnson had borrowed $1 trillion 40 years ago and invested it wisely, the financial resources the government would now have as a result would allow us to eliminate the individual income tax completely!

It has, however, never been completely clear to me how this argument hangs together. The 2% return in the form of higher corporate tax revenues: does that assume that the additional Treasury debt has no counteracting effect crowding out private capital accumulation? Or is there an implicit assumption that federal programmatic spending will drop when government resources are diverted into these investments in stocks and bonds?

The 2.5% edge that the portfolio earns over and above the Treasury yield: private agents view this as an appropriate premium for risk, so is there an argument that there is a market failure here and this risk premium is too high? (I would be disposed to believe such an argument for some--perhaps three-fifths--of this premium.) Or is there an argument that the government's risk-bearing capacity is far greater than that of the private market? In that case, it would seem that our failure to adopt some form of socialism that socializes systematic financial risk has greatly reduced capital formation and hobbled our economic development for the past century--which is an interesting argument, but not one I have seen widely endorsed.

There has to be some such argument somewhere underlying the Lindsey plan for where the 2.5% wedge comes from, but I've never been able to find it laid out by anyone.

CEA and Treasury in 2001 seem to have had similar worries about the consistency of the Lindsey plan (for example, Kent Smetters is anxious that Bush not be shown it). CEA and Treasury plans for Social Security reform wanted to assure sustainability of the system not by having the government borrowing cheap and lending dear but by throwing $1 trillion of general revenues at the system to fund transition and by making some long-term benefit cuts as well.

*Allocating Payroll Tax Revenue to Personal Retirement Accounts to Maintain Social Security Benefits and the Payroll Tax Rate, Martin Feldstein, Andrew Samwick, NBER Working Paper No. w7767 Issued in June 2000: Abstract: In an earlier paper we analyzed a method of combining traditional tax financed pay-as-you-go Social Security benefits with annuities financed by Personal Retirement Accounts. We showed that such a combination could maintain the level of retirement income projected in current Social Security law while avoiding a future increase in the payroll tax rate. The current paper extends the earlier analysis in four ways: (1) We now specify that the funds deposited in the Personal Retirement Accounts come from allocating 2 percent of the 12.4 percent payroll tax instead of being additional funds provided from outside the system. (2) We discuss the effects of the uncertain return on investment based annuities. (3) We provide estimates of the cost of permitting bequests if individuals die either before retirement or during the first twenty years after retirement. (4) We update the statistical basis for our estimates to be consistent with the 2000 Social Security Trustees Report. Our analysis shows that a program of Personal Retirement Accounts funded by allocating 2 percent of the 12.4 percent payroll tax collections can maintain the retirement income projected in current law while avoiding any increase in the 12.4 percent payroll tax. The combination of the higher return on the assets in the Personal Retirement Accounts and the use of the additional corporate profits taxes that result from the increased national saving in Personal Retirement Accounts is sufficient to maintain the solvency of the Social Security Trust Fund even though the tax payments to the fund are reduced from 12.4 percent of taxable payroll to 10.4 percent of taxable payroll. Although there is a period of years when the Trust Fund must borrow, it is able to repay this borrowing with interest out of future tax collections. In the long run, the Trust Fund becomes very large, implying that it would be possible to reduce the payroll tax further or to increase retirement incomes above the levels projected in current law.

Posted by DeLong at February 28, 2004 02:37 PM | TrackBack


Best laid plans of mice and men.

See Crash of '29

Posted by: Stirling Newberry on February 28, 2004 02:56 PM



I don't have sources at my fingertips but as I recall there are certain aspects of the Singaporean industrial policy of the 70's and 80's that seem to bear this notion out.

Posted by: Michael Carroll on February 28, 2004 03:20 PM


I used to hear the phrase "hand-waving economics". Before, it always meant well-intended, wishful, unrealistic economic theories (mostly Marxist) which claimed to bring wonderful results, but which in reality never worked.

Recently this kind of thing has been coming from the ultra-right. Not satisfied with the destruction of the welfare state in the pursuit of their Randian individualist Utopianism, now they are threatening to destroy capitalist economics itself if it stands in their way. Sounds like the revolution is eating its own.

Posted by: zizka / John Emerson on February 28, 2004 03:35 PM


"The 2% return in the form of higher corporate tax revenues: does that assume that the additional Treasury debt has no counteracting effect crowding out private capital accumulation?"

That is just what I have heard Larry Lindsey argue, but why it should be so is a mystery to me. Also, corporate tax revenues are steadily declining and there is no reason to expect increased earnings will proportionally increase tax revenues. These plans for taking Social Security private are worrisome indeed.

Posted by: anne on February 28, 2004 03:36 PM


Are you sure you are an economist?

This idea, government ownership of capital assets has a name. Hey wait a minute, aren't the Republicans the guys who are supposed to be saving us from Socialism?

The idea of a mixed economy in which the government finances the provision of public goods through taxation of public enterprise presupposes that the private sector will make more efficient allocations of capital that the public sector and the government participates in the increased output through higher tax revenues. It is not a particularly new idea to suggest that it would be more efficient to just let the government run things but it would be very very unRepublican. Isn't this just privatization in reverse?

Of course these folks haven't figured out that they're facists so it isn't too shocking to learn that they don't recognize socialism either but it is damn wierd.

Posted by: Dave Richardson on February 28, 2004 03:42 PM


followup, I had always understood this approach to be that the huge flow of assets into the stock market would create equally huge gains for current holders of shares, who would then pay higher taxes on the windfall. This business of taxing the suckers , er , folks that choose to voluntarily opt out of SS to chase higher returns makes no sense at all since they don't actually stand to earn higher returns.

Posted by: Dave Richardson on February 28, 2004 03:48 PM


As economics fundamentally deals with opportunity costs and comparing the relative costs of different options, stand alone criticisms of various proposals rarely have much meaning.

So I'd imagine that the pros and cons of having the gov't finance Lindsay's proposal (or some such) in the nearish term could be meaningfully considered only in contrast to those of *not* doing so and instead having the gov't finance that full $45 trillion-or-so-(current value)-and-growing later, after 2018. I wonder what the effects of that will be, in comparison?

Posted by: Jim Glass on February 28, 2004 04:12 PM


This whole thing sounds like complete bull. Where are the outcries of those who are always quick to call Social Security a Ponzi scheme?

How do these guys think to get a _real_ annual 5.5% yield on equity held in that volume? Do they think _actual_ productivity (not the poppycock number that is being, ahem, produced) will grow at that rate and up for two decades?

And that they view the people building private accounts as gullible suckers from the get-go leaves me speechless. (I have to work on my cynicism.)

Posted by: cm on February 28, 2004 04:47 PM


a pension fund the size of CalPERS can barely 'invest' any more. by necessity, most of its assets are indexed. as a result, CalPERS most important activity now (after duration-matching) is investor activism, not security selection. California has about 10% of US population, and the state employs fewer than one in ten. so, running a pension fund for less than 1% of the US population you already lose much of the ability to "invest" per se. were Social Security suddenly to start investing on behalf of a couple score percent of the population... whew.

that's the kind of plan with which a loony-left state planner comes up. what's the GOP doing floating it?

Posted by: wcw on February 28, 2004 04:53 PM


Let's imagine a rational investor (say Robert Barro) who knows part of his retirement funds are being placed in low return, low risk bonds by the government. So to balance his portfolio, he puts most of his private funds into stocks. The government changes the allocation ala this Feldstein-Clinton line of thinking. Does not Robert change his private portfolio in the opposite direction? And if so, the change in the demand for assets is zero.

Posted by: Harold McClure on February 28, 2004 05:00 PM


Having a charlatan like Lindsay as an advisor to Mr Bush way back in 1999 should have sent warning flags up in all quarters. During the first debate in 2000, Al Gore steamrolled Bush and his idiotic SS and fiscal plans. Did the press pick up the cue? Did they notice the fuzzy math? Nope. The press ignored this issue and instead reported on the number of times Al Gore sighed during the debate. When the opposition proposes a pile of hog wash that is easily demonstrated to be hogwash, but that candidate does not know that his own economic program is pile of hogwash, is that not reason to sigh?

Posted by: bakho on February 28, 2004 05:09 PM


Somebody correct me if I'm wrong here, but we could borrow a bunch of money, issue bonds, invest in the market, repay the bonds (with interest) and cream off some kind of premium? So, if we did this on a massive scale could we, like, wipe all poverty and human suffering in 50 years? Would taxes eventually disappear?

Sounds like paradise. Anybody got any free money to donate? I'd like to get started.

Posted by: bobbyp on February 28, 2004 05:19 PM


Reviewed the plan, might be something wrong there in the first step. Damn.

Is this one of those gonzi schemes?

Posted by: bobbyp on February 28, 2004 05:24 PM


As Brad points out, one of the weird aspects of the Feldstein Samwick Lindsey plan is that the partial privatization of social security would, according to those guys' logic, be a terrible idea given those guys' aims.

The idea is that there is a killing to be made out of the equity premium. Oddly the idea is to share some of this with retirees. Why ? Feldstein et al hate social security because it reduces capital formation, at least that is the reason they give. Why add an option which would make it more generous ? If the treasury should own stock, why encourage people to buy stock with their social security wealth ?

Basically Feldstein et al claim that they have found an N trillion sure thing so they can afford to give 1 trillion to people who choose private social security accounts.

OK now the other way. Brad you seem to partly agree with them. Sorry to be rude. Let me put it this way. Maybe I agree with them (I have no ideological problem with socialism) This is long so see http://rjwaldmann.blogspot.com

Posted by: Robert Waldmann on February 28, 2004 05:39 PM


Is that really Martin Feldstein's name on there? I thought he was a reputable economist.

What is a reputable economist, anyway?

Posted by: Luke Lea on February 28, 2004 06:48 PM


>> In that case, it would seem that our
>> failure to adopt some form of socialism
>> that socializes systematic financial
>> risk has greatly reduced capital
>> formation and hobbled our economic
>> development for the past century

Haven't we sort of followed this policy with respect to the housing stock through Fannie & Freddie?

Posted by: P O'Neill on February 28, 2004 08:11 PM


We seem to be hearing a lot on this site about Powerpoint "memos." In which context I'd like to mention Edward Tufte's screed, "The Cognitive Style of Powerpoint," which is available here:


My copy hasn't come yet; but, based on the (very favorable) review in Science, it's quite germane to the way the Bush administration makes policy.

Disclaimer: I have no association with Tufte other than as an admirer of his books, which are considered by many to be classics. Their general subject is the presentation of information, especially quantitative information.

Posted by: Jonathan Goldberg on February 29, 2004 07:26 AM


Two observations.

First, the scheme would surely be self-defeating. Government borrowing (i.e., issuing of debt) at this scale will surely affect interest rates. Increasing the supply will drive down their value, meaning higher borrowing costs than anticipated. The money that goes into the markets will force up the price that the government is trying to buy equities at, thus lowering their returns. The combined effect will surely be to squeeze the 2.5% margin that the theorists see here.

Second, I think that the scheme can be described as a mechanism to tap into the economic growth of the coming decades. As the companies owned through this scheme grow and are profitable, funds will flow to the government. We already have such a mechanism by which funds come to the government through the activity of its economy--taxation. Doesn't the scheme merely create a highly inefficient tracking mechanism for the tax system?

Posted by: Claude on February 29, 2004 08:17 AM


aren't we discussing the economic equivalent of the Heisenberg principle here?

In other words, the moment someone observed that you "can't lose money in the stock market" over a thirty year period, that observation was no longer relevant. The moment you tell people there is no risk in the stock market, the risk itself balloons because demand for stocks increases.

In case no one has noticed it, there does appear to be a relationship between the stock market and the popularity of the idea of "privatizing social security." The NYSE was doing far better than one would have expected, given that it had increased its value 160% in five years, then was confronted with a recession, AND 9/11.
The real sustained slump started in the spring of 2002...after the recession was officially over.

And this was the same time that the Dems started criticizing "social security privatization", and the GOP ran screaming from the idea---going so far as to deny ever SUGGESTING that SS should be "privatized".

There are, for all intents and purposes, a finite number of stocks available. And I still remember, from economics 101, the relationship between supply, demand, and price. And at its heart, the prvatization schemes are little more than tulipmania....

Posted by: paul lukasiak on February 29, 2004 02:35 PM


I don't see Lindsey mortgaging his house and liquidating all his assets to invest in stocks. Until I do, this is nonsense.

Posted by: Dan on February 29, 2004 08:25 PM


Good post Paul L. But remember one thing, Wall Street can produce an unlimited supply of stock at a whim (cf. "watered stock", also "IPO's", etc.). As to intrinsic value, well, that's another matter, but they can crank out any level of supply required.

Posted by: bobbyp on February 29, 2004 09:54 PM


Jim Glass: Don't forget the impact of _aggregate_ demand. Cranking out an unlimited supply of stock will lead to declining stock prices unless matched by issuing a corresponding unlimited supply of new money (as in "debt"). If you were to contrast the historic growth patterns of financial instruments, money supply, and debt, is this not what is happening? The underlying "value" (real GDP) of the economy that is supposedly the basis of money issuance is hard to quantify, especially given the various shenanigans like price indexing. (Note: I'm not alleging willful doctoring, but the road to hell is paved with good intentions.)

Posted by: cm on February 29, 2004 11:56 PM


Suppose -- just suppose -- the debt market side of this gambit is a free lunch. Federal borrowings do not distort the bond market, and the corresponding private lendings do not displace capital that might have flowed (as equity or debt) into the corporate sector.

Nagging questions:
(1) What fraction of federal equity purchases go to bidding up (or trading out) the token value of shares in the secondary markets? What fraction ends up inside corporate enterprise available for purchase of real capital assets?

(2) What happens when the corresponding tokens of value as we liquidate the federal portfolio to cover Boomer retirement benefits? Are equity prices massively bid down? Or do "rational investors" then rush in from somewhere to save the day?

(3) If this is such a sure thing, can't we buy the same free lunch more cheaply by sinking borrowed proceeds into out-of-the-money derivatives, rather than the underlying equities?

Posted by: RonK, Seattle on March 1, 2004 12:01 AM


CM wrote:
. Don't forget the impact of _aggregate_ demand. Cranking out an unlimited supply of stock will
. lead to declining stock prices unless matched by issuing a corresponding unlimited supply of
. new money (as in "debt"). If you were to contrast the historic growth patterns of
. financial instruments, money supply, and debt, is this not what is happening?

ultimately, yes. More importantly, "printing money" (e.g. more government debt) is the likeliest "solution" to the "Social Security crisis".... and we all know what the eventual outcome of "printing money" is.

Indeed, the fat cats probably see high inflation as a way of "solving" the Social Security crisis. The notes held by the SS trust are fixed rate, and non-transferrable. The "real" costs associated with paying off the Social Security debt (not to mention the entire debt)would be pretty much cut in half if we have a year of 100% inflation. (Of course, this would make the Social Security trust insolvent much more quickly, but the fat cats could care less about that.)

I would suggest that the decline in the dollar was a direct result of people looking at the long-term prospects for the dollar, and realizing that with higher taxes and lower benefits being politically impossible, ONLY inflation would solve the coming fiscal crisis. If you think that high inflation is inevitable for a currency, you wouldn't want to be holding lots of that currency when the shit hits the fan, now would you?

Posted by: paul lukasiak on March 1, 2004 05:54 AM


paul lukasiak: ".... and we all know what the eventual outcome of "printing money" is."

Yes, "productivity growth" and "prosperity". You only have to get those price indexing coefficients right.

Posted by: cm on March 1, 2004 08:51 AM


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