Brad DeLong's Semi-Daily Journal (2004)

"If you are a conservative economist who believes that individuals make good choicew, that markets work well, and that market prices are generally good guides to social shadow values, ..."

On the NYTimes front cover today:

http://www.nytimes.com/2004/08/18/national/18scams.html

With Storm Gone, Floridians Are Hit With Price Gouging
(or The Invisibile Hand Gives Invisible Middle Finger to the Unfortunate)

By JOSEPH B. TREASTER
August 18, 2004

"Charlie Crist, Florida's attorney general, said Tuesday afternoon that he had received more than 1,400 complaints of overcharging from throughout the disaster area. This morning he filed formal complaints against the Crossroads Motor Lodge in Lakeland and the Days Inn Airport Hotel in West Palm Beach, accusing them of price gouging and deceptive business practices."

Or is the free market "working" here?

What is your problem, Brad? Bush has proven that everything is a free lunch! Tax cuts, increased spending, and no negative consequences what-so-ever!

Just like his entire life -- do whatever he wants, and no negative consequences what-so-ever!

"If you are a conservative economist who believes that individuals make good choicew, that markets work well, and that market prices are generally good guides to social shadow values, ..."

On the NYTimes front cover today:

http://www.nytimes.com/2004/08/18/national/18scams.html

With Storm Gone, Floridians Are Hit With Price Gouging
(or The Invisibile Hand Gives Invisible Middle Finger to the Unfortunate)

By JOSEPH B. TREASTER
August 18, 2004

"Charlie Crist, Florida's attorney general, said Tuesday afternoon that he had received more than 1,400 complaints of overcharging from throughout the disaster area. This morning he filed formal complaints against the Crossroads Motor Lodge in Lakeland and the Days Inn Airport Hotel in West Palm Beach, accusing them of price gouging and deceptive business practices."

Or is the free market "working" here?

Prof, i'm sure as a "technical" matter, Feldstein might say something like this if you cornered him.

But as a real-world matter, Feldstein wrote the piece the way he wrote it because that's how you get published in the WSJ. The collapse of honesty in the WSJ editorial pages has been so striking over at least the last 10-12 years that no one who wants an article published there on a topic that is near and dear to the editorial board's heart has any incentive to write something truthful....

What is your problem, Brad? Bush has proven that everything is a free lunch! Tax cuts, increased spending, and no negative consequences what-so-ever!

Just like his entire life -- do whatever he wants, and no negative consequences what-so-ever!

As i understand it, social security in its current form is not supposed to provide all retirement income for most retirees; it needs to be combined with individual savings and private pension funds. what it does it provide a floor.

if an individual PRA is invested in a broad stock market fund (i.e. some of what was paid into the social security is now diverted into a private account) and the individual also has a private pension fund that is invested in more or less the same thing, the individual's overall retirement portfolio becomes more highly correlated ... i.e. what was social security does poorly when the individual's private pension fund does poorly. That adds to the set of assets that have systemic risk in the average individual's overall retirement portfolio. To me, one of the virtues of social security's current structure is that it effectively provides a retirement asset whose value is not correlated with a typical individual's other retirement assets.

Forcing individuals who rely primarily on Social Security for retirement income to individually bear the risk of shortfalls is beyond repulsive. The idea that someone can maintain their academic credentials while doing so does not argue well for academia.

Isn't Feldstein also glossing over the fact that the private accounts nonsense would need to come up with additional funding since Social Security relies on each generation funding the majority of the benefits for the prior one? Or has the Bush "plan" been revised to address this?

"Isn't Feldstein also glossing over the fact that the private accounts nonsense would need to come up with additional funding since Social Security relies on each generation funding the majority of the benefits for the prior one?"

Yes!!!

Brad said: "I haven't tracked Feldstein down, cornered him, and asked him what he thinks he is doing."

How about emailing him, or emailing him and publishing the email (and the response, if any).

Or, emailing him and sending the email as a letter-to-editor of a few well-known papers (like the NYT, WaPo, Chicago Trib, and even the WSJ)?

Take him on more publicly!

(or do professional economics guys not bloody noses in public?)

Ultimately, the same amount of money is under discussion. Any changes in SS tax collections will be offset by other taxes or selling of bonds to pay off the deficit. There is no plan for net increase in national savings or investment. If there is no net increase in national savings, then we end up with net benefits "expected to be at least as large as the benefits projected in current law" but no larger. Correct me if I am wrong.

Unless there is an overall increase in national savings due to change in policy, changing SS from the way it is today to a new formula will have no net effect.

SS is not a big looming problem compared to Medicare and health care costs. Current SS surplus is invested in government bonds (more or less). In the calculations, you have to subtract the difference between the current surplus earnings and the "expected earnings" of a mixed portfolio.

This proposed system will create winners and losers. The stock market is best characterized by periods of expansion interspersed with periods of going sideways. If I retire at the end of an expansion, fine. If I retire at the end of a long sideways march, it will suck.

Wall Street loves this plan. They salivate just looking at the potential commisions on all those dollars.

Why is Feldstein saying such nonsense?

As I've mentioned before - my significant other was part of the comission looking into social security reform. This was a comission intentially stacked with people who wanted to privatize social security.

Feldstein's idea was one of the first examined, and rejected, for various reasons - primarely that if some poor worker finds out that his entire social security payments were put into Enron stock right before its collapse, he would like pick up one of the newly-legalized assult weapons and gun down Grover Norquist or Karl Rove after going to the store to stock up on cat food. The report called it what it was, a hidden (at least temporarily) benefit cut, which, in any case, couldn't be implemented without additional money.

So the question remains - why do these people think they can keep serving up steaming loads of hippo dung and say it's "economic analysis" - usually justified on 19th century Austrian economic critiques of utilitarian economics?

Why do facts not matter to these people? Why do Karl Rove and Karen Hughes get a seat at the table during economic policy discussions? (see Suskind's description of O'Neill's final meeting on the dividend tax cut)

At what point does this irrationality wake up members of their own party? Are they so drunk on power that they can't see that almost every major policy has been a complete failure? (see Iraq, "jobs and growth", stem cells, "alternative to Kyoto", homeland security, etc.)

I'm more angry about this than I thought.

sz

Why is Feldstein saying such nonsense?

As I've mentioned before - my significant other was part of the comission looking into social security reform. This was a comission intentially stacked with people who wanted to privatize social security.

Feldstein's idea was one of the first examined, and rejected, for various reasons - primarely that if some poor worker finds out that his entire social security payments were put into Enron stock right before its collapse, he would like pick up one of the newly-legalized assult weapons and gun down Grover Norquist or Karl Rove after going to the store to stock up on cat food. The report called it what it was, a hidden (at least temporarily) benefit cut, which, in any case, couldn't be implemented without additional money.

So the question remains - why do these people think they can keep serving up steaming loads of hippo dung and say it's "economic analysis" - usually justified on 19th century Austrian economic critiques of utilitarian economics?

Why do facts not matter to these people? Why do Karl Rove and Karen Hughes get a seat at the table during economic policy discussions? (see Suskind's description of O'Neill's final meeting on the dividend tax cut)

At what point does this irrationality wake up members of their own party? Are they so drunk on power that they can't see that almost every major policy has been a complete failure? (see Iraq, "jobs and growth", stem cells, "alternative to Kyoto", homeland security, etc.)

I'm more angry about this than I thought.

sz

"I'm doing the same thing: shifting risk from the government to the beneficiaries is a benefit cut that can be sold as not a benefit cut."

To quote Dilbert: "This may sound like criminal fraud, but actually it's marketing!"

Brad, the issue is not whether the government or individuals bear the systematic risk of social security. It's whether younger taxpayers or older recipients bear that risk. Otherwise you're proposing that there be a free lunch--systematic risk can just go away by reshuffling financial claims.

If the economy tanks in the future, it's the young taxpayers (ahem, people like me) that bear the risk in a defined-benefit system. Tax rates or government borrowing would have to rise to cover the benefits. The whole risk-sharing line of thinking is rather weak for this reason; it's more of a risk shift. To make the market failure argument you'd have to show me that older people currently bear too much risk and younger people too little.

The simple problem of these proposals not adding up (like Anne mentions) sits on much stronger ground. It's also easier for most people to understand and convincing enough for me.

Looks like the "Martin Feldstein for Fed Chairman When Alan Greenspan Retires" campaign is in full swing....

And incidentally, Adrian - read Greg Jaffe's article in the 8/4/04 edition of the Wall Street Journal, page 1+ ("Caught Off Guard: As Ranks Dwindle in a Reserve Unit, Army's Woes Mount"). Among the points made in the article were that the members of the 211th Military Police Company of the North Carolina National Guard "were conviced that, because they were Guardsmen and not active-duty soldiers, they had been given second-rate equipment. They say they had to make due (sic) with older, less-effective flak vests...their Humvees were'nt armored. Even their rifles were hand-me-downs from the 82nd Airborne Division. The sights were out of line and the barrels had too much give in them, the soldiers say. Though they spent hours cleaning and repairing the guns, Capt. Payne (note: the 211th's CO) says, 'Not a soul in the unit had faith in them.'"

Adrian, listen up: THE ARTICLE'S WORDS ARE NOT THE WORDS OF A BUNCH OF LIBERAL DEMOCRATS. THESE ARE SOLDIERS, NATIONAL GUARDSMEN - THE VERY PEOPLE YOU PROFESS TO CARE SO MUCH ABOUT. Our Hypocrite-in-Chief claims to support the troops, and anyone who opposes him is supposedly guilty of failing to support our troops. We - and you - need to tell him to put his (and our) money where his mouth is.

And this may be missing another feature that comes from the notion that households are rational agents. If I know the government held portion of my retirement portfolio has increased its expected return by shifting to a riskier portfolio, would I not offset the extra overall risk by an offsetting change in my 401(K). No net change in overall risk but also no net change in expected return. Does Feldstein assume I'm irrational or has he come up with the mythical free lunch?

What SZ says. Feldstein: another lying liar.

Charles

A question for IPE or international finance types:

Feldstein mentions Australia, Britain, and Sweden as countries using some variation on the PRA/SS hyprid. I don't know anything about these schemes. Do they work? And are conditions there comparable to conditions here?

Comments most appreciated. Thanks.

Well, if we have all of these financial types reading this thread, let me bring your attention to the latest prices in the Iowa Electronic Markets:

Winner-Take-All
Quotes current as of 13:15:03 CST, Wednesday, August 18, 2004.

Symbol Bid Ask Last Low High Average
DEM04 0.493 0.495 0.493 0.493 0.497 0.494
REP04 0.505 0.509 0.508 0.504 0.508 0.507

Vote Share Market
Quotes current as of 13:15:03 CST, Wednesday, August 18, 2004.

Symbol Bid Ask Last Low High Average
KERR 0.510 0.518 0.511 0.511 0.511 0.511
BU|KERR 0.482 0.492 0.480 0.480 0.483 0.481

In other words, the market says that Kerry will take 3% more of the two-party vote than Bush, but that Bush will take more votes overall than Kerry. Interesting.

Or to paraphrase Wonkette:

Arbitrage! Arbitrage! Arbitrage!

Brad, I think you misread Feldstein's sentence:

"The combination of those annuity payments and the traditional Social Security benefits that COULD BE FINANCED without increasing the current tax rate would be expected to be at least as large as the benefits projected in current law."

Feldstein is talking about financing the program, not revenues from it.

And my best guess is that he is doing so to avoid the obvious: if the market outperforms the current expected returns--which it should, since it is riskier--the tax rate would have to change BECAUSE ASSETS THAT WOULD HAVE BEEN TAXED ARE NOW IN PRAs.

February 5, 2004

Some lessons from Sweden on the pros and cons of privatizing Social Security.
By Alan B. Krueger - New York Times

"YOUNGER workers," President Bush said in his State of the Union address, "should have the opportunity to build a nest egg by saving part of their Social Security taxes in a personal retirement account."

According to former Treasury Secretary Paul H. O'Neill, the president believes that the reason he was elected was his bold -- some would say risky -- stance on replacing part of Social Security with personal accounts. If the president holds onto office in November and his party continues to hold Congress, the creation of some sort of personal retirement accounts as part of Social Security seems likely.

Although it is impossible to know what form such accounts might take, in 2000 Sweden instituted a system of personal accounts that holds many lessons for any country seeking to reform its retirement system.

Sweden now has a blended system, an approach Mr. Bush apparently favors. Employers and employees contribute a combined 16 percent of payroll toward a "pay as you go" retirement system like Social Security, and an additional 2.5 percent toward individual retirement accounts. Those born after 1954 are fully in the new system, while older workers are phased in.

The reform process began in 1991, when a center-right coalition came to power. At the time, Sweden's generous retirement system was expected to exhaust its "buffer" funds in about 20 years, a more dire situation than what now confronts the United States; Social Security will not exhaust its trust fund until 2042, according to the latest projections.

To address its problems, Sweden set up a committee with representatives from all parties in Parliament. Because the reforms were expected to last for decades, there was pressure to devise a plan with broad support, said Annika Sunden, an expert on pensions at Stockholm University. There was agreement back in 1994 that reform would include individual accounts, so beginning in 1995 the government began tucking away 2.5 percent of payroll for employees to invest once the system was set up.

Personal investment accounts were not established until 2000, with a bewildering array of funds to choose from. Some 456 funds participated initially, and the number has since grown to around 600. Most funds invested in stocks, with a quarter primarily in Swedish stocks. Workers could choose up to five funds.

Anyone who did not choose a fund was automatically assigned to the default fund, which was set up by the government. The default fund must invest 80 to 90 percent of its assets in stocks.

A central pension agency records all the accounts and fund values. The agency also ran an ad campaign to discourage people from going into the default fund.

Nonetheless, a new study by Henrik Cronqvist and Richard Thaler of the University of Chicago finds that a third of Swedish workers did not make an active choice when the system started in 2000, and were therefore assigned to the default fund. Since 2000, fully 92 percent of new enrollees have not made a choice and have been added to the default fund.

Apparently, the large number of funds to chose from paralyzed many individuals from making a choice. This has also been the experience of many 401(k) plans that have a default option in the United States: the default option, whatever it may be, is chosen by a high proportion of investors. People are also reluctant to switch once they are in a fund, a tendency that the economists William Samuelson and Richard Zeckhauser have called status quo bias.

Another bias that Mr. Cronqvist and Mr. Thaler documented is home bias, a tendency to pick funds composed of Swedish companies, as opposed to a diversified portfolio of companies from around the world. Nearly half the money actively invested was in Swedish stocks. The default fund, by contrast, was better diversified: only 17 percent was in Swedish stocks.

They also found that people tended to pick funds in sectors that had done well recently, and to pick funds with low fees. The average fee for active choosers was 77 basis points, or 0.77 percent of the funds invested. For the default fund it was just 16 basis points. Chile's mandatory savings plan provides another point of comparison. Fund management fees were much lower in Sweden than administrative costs in Chile's plan, probably because the central pension agency orchestrated rebates and advertised the fee rates.

How did the funds do?

Sweden had bad timing. The stock market tumbled just after the program started.

It turns out, however, that the default fund lost less money than the aggregate portfolio of selected funds. The average selected fund fell by 40 percent in the first three years of the program, while the default fell 30 percent.

Although three years is a short period, there is no evidence that the active choosers made better choices than those assigned to the default fund.

For the United States, the main lesson from the Swedish experience, Ms. Sunden said, is that the default fund should be constructed very carefully, because it will attract many investors. (Ditto for 401(k) plans.) She also highlighted that more use should be made of generation funds, which move money into less risky assets as workers approach retirement, and that converting funds into annuities should be mandatory for retired workers.

The consequences of making a bad investment decision in Sweden are much less severe than they would be in the United States if Mr. Bush gets his way and allows workers to divert part of the 12.4 percent of their paycheck that goes to Social Security -- half from the employee, half from the employer -- into personal accounts.

Sweden devotes 16 percent of payroll to an earnings-linked pension system, creating a strong safety net beneath individual accounts. Sweden also established a "guaranteed pension" that provides a minimum pension amount, in excess of the poverty line, to anyone with little or no pension income.

All this leads one to wonder if it is possible to design a system that diverts some Social Security contributions into personal accounts yet still provides adequate insurance against bad luck and bad investment decisions. Moreover, the current American system is not beyond repair. In their new book, "Saving Social Security: A Balanced Approach" (Brookings Institution Press), for example, Peter A. Diamond of M.I.T. and Peter R. Orszag of the Brookings Institution outline a plan to preserve the best elements of Social Security by making politically difficult but sensible reforms, like indexing benefits to rising life expectancy and collecting some payroll taxes above the earnings cap.

Sometimes, a little status quo bias is not such a bad thing.

Johnathan King--that's not arbitrage. Bush loses the popular vote, but wins the Electoral College.

Thanks Anne

On Feldstein: I would have thought that in a just society, anything Feldstein wrote on any subject related to pensions ought to have appended to it a big red health warning reminding us all that it was him who was responsible for that joke of a report which kicked off the whole "Social Security is bust" scare in the first place.

On IEM: No, Ken, it's an arbitrage. The Iowa WTA contract is not determined by who ends up in the White House but by who gets a majority in the popular vote (http://128.255.244.60/WebEx/marketinfo_english.cfm?Market_ID=78) They actually paid out on Gore in 2000 for this reason.

Seems to me that systemic risk is currently distributed between between current and future taxpayers and ditto for beneficiaries. Does privatizing some portion of SSA affect systemic risk or just redistribute it? If it is just a redistribution then we have a value question.
ed

Hardly any commentators on S.S. suggest that a portion of the trust fund be invested in equities for the benefit of all.

Hardly any commentators on S.S. suggest that a portion of the trust fund be invested in equities for the benefit of all.

Ken Houghton writes:
>
> Jonathan King--that's not arbitrage. Bush loses the popular
> vote, but wins the Electoral College.

Nope; that's what I thought too...until I read the prospectuses.

From the Winner-take-all prospectus:

# The payoffs in this market will be based on the popular vote
# received by the official Democratic and Republican nominees
# in the 2004 U.S. Presidential election. Payoffs are NOT affected
# by votes received by nominees from other parties, the
# outcome of the electoral college or any vote taken by the
# House of Representatives should such a vote be necessary.

It's just the pure, sweet, popular vote, baby.

From the Vote Share Prospectus:
#
# Payoffs in the 2004 Presidential Vote-Share Market will be
# determined by the percentage of the total two-party popular
# vote received by the Democratic and Republican candidates in
# the 2004 U.S. Presidential Election. For instance, contracts for
# a candidate who receives 32.4% of the popular votes cast for
# the Democratic and Republican nominees, will be worth 32.4
# cents each.

More of the same. The only difference is in the liquidation values. The WTA market pays $1.00 for each share of the winning symbol, while the VS pays the fractional amount.

At this very moment, the situation is this:

Bush Kerry
WTA .507 .493
VS .481 .511

This situation is inconsistent. If the market likes Kerry in the vote share, it should like him just as much or more in the WTA.
So what's going on? A couple of months ago I pointed out that something screwy seemed to be going on that looked like somebody was trying to prop up the Bush prices. Why? Because the IEM has acquired a bit of allure with a certain class of pundits (e.g., Kaus) who will trumpet its standing and (therefore?) change conventional wisdom.

Chris makes a salient point. Leaving the system alone screws those currently in their 30s (me, and apparently Chris) due to demographics. I intentionally didn't say demographic risk because we already know for certain we are screwed. Nevermind calls for free drugs that we will also have to pay for.

A fully privitized system screws those who were never able or chose not to save in a defined contribution plan only when you act as though the most secure investment option available is an index fund of equities. Invoking Enron any time self directed accounts are mentioned is irresponsible granny scaring. There is nothing to say you couldn't purchase an annuity.

A partially privitized system is even less onerous, and has the advantage of being easier (not easy, but easier) to fund in transition.
In any event, it is a matter of perspective which system is 'despicable'.

Over at Yglesias' place, a commenter points out that the goal might be political - to make Wall Street the new third rail of politics. Anything that hurts the investor class can be spun as hurting senior's retirement and the whole boondoggle is a plan to gain political influence.
As political strategy it makes sense to me.

Coach:

Yglesias can stop guessing. That is a fact. I heard Grover Norquist say as much at a libertarian conference earlier this year (don't ask me how he got an invite). He was speaking about coalition building, and specifically mentioned that the Bush 'ownership society' is designed to make redistribution politically infeasible.

People will hesitate to employ the government to harm growth if everyone has an ownership stake in that growth. The whole idea makes sense to me, come from Norquist though it did.

theCoach writes:

> Over at Yglesias' place, a commenter points out that the goal
> might be political

Politics in the Bush administration? I'm shocked, shocked!

> - to make Wall Street the new third rail of
> politics. Anything that hurts the investor class can be spun as
> hurting senior's retirement and the whole boondoggle is a
> plan to gain political influence.
> As political strategy it makes sense to me.

The puzzling thing, though, is that there are some signs (at least in the polls) that the investor class is frankly not that thrilled with Bush. Rasmussen (yes, the same guy who's doing the wacky Badnarik polls) has it down that Bush and Kerry are splitting the self-identified "investor class" vote right down the middle this time, while in 2000, Bush won it handily.

Or if you don't like polls, since "war talk" concerning begain in earnest in the spring and summer of '02, the S&P500 is just about flat. (And that's probably not a ringing endorsement for private accounts either.)

Brad,

did you know that 99% of all statistics about WSJ readers are made up?

I don't understand why the young would be better or worse off NET when they retire under either system. If the economy does well, there will be plenty of money to pay the benefits out of taxes and the youth would do well. PRAs would do well. If the economy does poorly, there might not be enough tax revenue to pay benefits, but the PRA option would suck just as much.

This is a shell game that gives Wall Street brokers a commission from the SS fund. Unless the program increases net national savings, there is no gain whatsoever.

If the government buys stocks, then they are competing with the market for a cut of the corporate profit. But the government could take a cut of the corporate profit without the risk by taxing corporate profits. WTF This is just shuffling the deck chairs.

"The puzzling thing, though, is that there are some signs (at least in the polls) that the investor class is frankly not that thrilled with Bush."

That is because Bush spends like a lunatic, and many people believe that a split government is the only possible way to put the brakes on so that growth can catch up. I also think that Bush has not at all brought the 'ownership society' bit to the public at large. We will likely see it in the convention.

A note related to Anne's extensive and informative comments on the Swedish experience with Personal Retirement Accounts: Roger Ibbotson of Yale, who probably knows as much about the history of U.S. capital markets as just about anybody, was interviewed some time ago about the desirability of PRAs that would be allowed to invest in stocks. Roger was pretty much opposed to the idea, not least because of the behavioral finance-based pitfalls that Thaler et. al. described. Unless there's some very, very careful thought put into this (not exactly a hallmark of the decisions of the Cheney/Bush administration), this has the potential to be a genuine catastrophe for American workers.

"I don't understand why the young would be better or worse off NET when they retire under either system. If the economy does well, there will be plenty of money to pay the benefits out of taxes and the youth would do well. PRAs would do well. If the economy does poorly, there might not be enough tax revenue to pay benefits, but the PRA option would suck just as much."

Average rates of return in private accounts held for a minimum amount of time are much higher than the current 2% rate social security is paying out and much, much higher than the negative rate that will be experienced when benefits are cut and/or taxes go up on those paying the bills for the boomers.

Also, you are assuming that the government won't spend tax dollars as soon as it gets them when the economy is doing well. PSAs are accounts held in trust, which is a requirement of every account except those the government dabbles in. Even defined benefit plans have minimum funding requirements in the private sector.

Thanks

What interests me is not setting up personal retirement accounts but indexing a portion of social security contributions to the total stock market.

Jason Ligon writes:
> [jking wrote]
>
> > The puzzling thing, though, is that there are some signs (at
> > least in the polls) that the investor class is frankly not that
> > thrilled with Bush."
>
> That is because Bush spends like a lunatic, and many people
> believe that a split government is the only possible way to put
> the brakes on so that growth can catch up.

Just to clarify, I wasn't puzzled about why investors are not wildly in favor of a second Bush term. Hey, Pete Peterson was given a *straight up shot* to say on the radio the other day that he was supporting Bush, and Mr. "We need to reform entitlements" could not pull the trigger.

What I was puzzled at was why anybody but Bush was supposed to be injurious to the investor class (which was the point I was responding to). I could have been more clear.

> I also think that Bush has not at all brought the 'ownership
> society' bit to the public at large. We will likely see it in the
> convention.

And I think that's a very risky strategy. Any random current event (oil at $60 a barrel, further softening in the economy, more problems in Iraq, etc.) could tank the markets in the short term, and then I'm not so sure the message sounds as good.

Of course, maybe the point is that, right now, Bush basically has to rely on risky strategies if he wants to be re-elected. But if you could pick a 4-year term during which I'm pretty sure I would NOT want to be president, 2005-2008 is shaping up to be the one.

Posted by Jason Ligon at August 18, 2004 01:33 PM

Anne:

By indexing, what exactly do you mean? Right now, young people pay payroll taxes, which is promptly borrowed by the government's general revenue to the extent it isn't immediately paid out in benefits to older people.

There is no money to be invested. If you want to maintain the pay as you go system, where do you get the money to pay indexed returns? If you are changing the pay as you go system so that you have money parked somewhere to invest, aren't you awfully close to PSAs?

"What I was puzzled at was why anybody but Bush was supposed to be injurious to the investor class (which was the point I was responding to). I could have been more clear."

Dem rhetoric doesn't help them. Many investors see attacks on corporate profitability as attacks on their wallets - and they are right. Dividend tax cuts and low capital gains taxes are hugely popular, too. The Dem rhetorical strategy is tinged with class warfare, and so investors tend to look anywhere else first for a candidate. The sad state of affairs is that Bush, even with that going for him, can't come up with their votes in large numbers.

Does the risk that is associated with investing in private equities go up with the aggregate amount of money invested? For example, would the S&P 500 have declined to the extent that it did in 2001-2002 if the SSA had been investing the excess tax receipts in those companies? Would $200B or so in "buy" orders in each of those years have propped prices up at least somewhat?

In a private account, would I have the ability to make the full range of investment decisions? For example, during most of 2001-2002, my portfolio did well because I could "bet" that the decline in equity prices would continue. Or will I be forbidden from taking what amounts to short positions on the economy?

Jason

Actually there are surplus revenues for social security. The system invests in treasury bonds now and collects interest on the investment. I am interested in a partial shift from treasury bonds to a broad American stock market index for invested revenues. There are problems, but I think the returns to the system might well be enhanced over time. Still, I just suggest we think about such a change rather than urge change.

I'm in my 30s and don't buy Chris and Jason's line at all.
They're ignorant about history - there's a reason
Social Security was created in the first place.

The government just taxes-more/cuts-spending a little and the system is solvent with no pain for us young workers. The point of the partial privatization is to eventually kill the system and like someone said here, Wall Street is salivating over the commissions they'd make on all that money. I guess if you're young and work on Wall Street, Bush's plan looks good.

And who will take care of our citizens whose PRA accounts go into the tank? The same folk who were supposed to be the Thousand Points of Light?

The burden of caring for impoverished retirees will fall back onto the generous, kind-hearted among us. The brutes and thieves among us will be free to ignore the plight of those whose PRA invesments don't pan out.

Unfortunately with a $500 buyin limit, this IEM arbitrage opportunity might be enough to buy you a cup of coffee in three months. And that's not accounting for the $5 transaction fee to open an account.

"The collapse of honesty in the WSJ editorial pages has been so striking over at least the last 10-12 years" Howard at least since Gigot took over. What used to be essential, I find little of interest to read there anymore.

Has anyone actually asked Bush and received an answer to what he means by "voluntary" and what penalties there are if you do not play roulette in the market? How many people have already postponed retirement because the market crashed?

Picky academic point--Black, Scholes and Merton didn't talk about systematic risk. They said an instantaneously risk-free combination of option and stock should earn the instantaneous risk-free rate of interest. Linter, Mossin and Sharpe talked about systematic risk and Sharpe won his Nobel for that.

arrrgh! LintNer I should have said.

Anne,

Remember what the government 'investing' in its own bonds means. They are writing themselves an IOU so that they have immediate cash available for general revenue purposes. The interest is part of that nasty debt we all keep talking about. Putting the money in an equity index fund changes the game. That money is actually invested and is not available for current use. You are talking about reducing general revenues by quite a bit.

PeterK:

Demographically speaking, who will be taxed and whose benefits will be cut? If you are talking about other spending cuts, I'm all for it, but when has that happened?

What won't happen is a reduction in Boomer benefits. The AARP won't stand for it, and they all vote.

Just eyeball the differences between number paying in and number of recipients once the boomers retire, figure that folks our age will be looking at reduced benefits, figure that we will be taxed to pay for prescription drugs for the boomers, figure that we will be paying on the current debt. The system looks like a great deal to people that never had to pay anything like what we will to support their parents and will get more money out of it than we will. What do you plan on using for retirement money with the current knowledge that your "investment" in social security will definitely have a negative rate of return? Our parents love it because they know they will have a positive return.

I would much prefer a system that promised me absolutely nothing and reduced payroll taxes so I could stow it away somewhere safe from politicians looking to buy votes. I am also perfectly willing to accept a means tested system if it reduces the burden on us by a big enough figure.

J Ligon:

"I would much prefer a system that promised me absolutely nothing and reduced payroll taxes so I could stow it away somewhere safe from politicians looking to buy votes. I am also perfectly willing to accept a means tested system if it reduces the burden on us by a big enough figure."

Where is that "safe" place you would stash it? In a democracy, in the long run, in the real world, what corner is "safe" from these politicians whom you seem to fear more than all else combined?

The problem of social security solvency is more than a baby boomer retirement issue. It is going into long run imbalance given the current tax and benefit structure because of the changing age strcture of the population. Here is an estimate of the cost of the fix, which I have posted before. I am curious what people think about it.

Lee, Ronald and Hishashi Yamagata (2003) Sustainable Social Security: What Would It Cost?, National Tax Journal, v. 56, n. 1, part 1, pp. 27-43. (Acrobat pdf file)

http://www.ceda.berkeley.edu/papers/rlee/PDRDraft7c.pdf

Finally, some of the issues discussed here seem secondary to me. Whether we have the trust fund invested in T-bills or the stock market is secondary -the trust fund is just a short run cushion to get us over the baby boom crisis. It won't solve the permanent funding problem. All the financing debate seems to be a secondary issue. Regardless of how it is financed, the question is how much real product per worker is available to give to retiremees. The rest is about to design a scheme to determine the claims in a way that does not damage productivity growth too much. You can use pay as you go, or give people financial claims ahead of time which they will have to cash in (or have cashed in for them) decades in the future at a price good enough (that is, not too much lower than was expected decades before) to buy food and shelter on the market when they are retired.

Seems to me that bakho has the best take on this so far.

I remember reading someplace that Social Security scares have occured periodically since a decade or so after it was started. Anyone have a history on social security scares?

Adam: Brad is right IIRC; Scholes and Merton also formulated the continuous time version of the consumption-based CAPM (CCAPM) which is the general equilibrium version of the CAPM, and I'm pretty sure it was mentioned in their Nobel citation.

Australia's Social Security system is extremely complex and covers us from cradle to grave. Yes, I know, we're just a bunch socialists. *shrug* - but we can still swim faster than you guys!

Anyway, regarding the grave end of the spectrum, there is the standard pension offered by the government, but it is not easy to live on and is basically offered as "insurance of last resort".

On the other hand, there is what is known as 'superannuation'. The basic idea is that each worker is required to put aside some of her earnings (currently 9%) into a fund. That fund becomes accessible when she turns 60 (or 65, don't quote me, I'm only 30)

The idea is that the fund you contribute to is selected according to your 'risk profile'. You can change funds as your 'risk profile' changes.

There are many rules that are aimed at helping 'low-paid' workers or are aimed at making the system 'fairer', but they're complex and its hurts my head to think about them.

In any case, "superannuation" was never really intended to replace the government pension, more make it redundant, since the pension is means-tested and most Australians nowadays work on the assumption they will not have access to it (they'll be worth too much!).

The superannuation scheme might be applicable to the United States. But it would be working in a different environment and so might suffer as a consequence. For a start, you've left your run very late: we started our plan in the mid-80s and consequently the scheme has had time to mature and should be (fingers crossed) fairly stable for the coming baby boomer retirement onslaught.

When discussing environment, there is also Australia's outrageously efficient public health system to consider. With drug costs way below even that of Canada (yes, Canada), our golden oldies (in fact, all of us) require less disposable income to keep ourselves healthy compared to our friends in the US. (For those of you thinking "silly boy! your cheaper drugs are subsidised with your taxes", I reply "silly old man! check out our PBS system, we buy in bulk and subsidise based on how well the drug works. Its highly cost-efficient and has made us a target for drug companies." )

And finally, Australians are being asked to work longer. Despite what you've been told, we love to work and many will heed the call.

In other words, private pensions seem to be working for us in our environment, but your milage may vary.

"I remember reading someplace that Social Security scares have occured periodically since a decade or so after it was started. Anyone have a history on social security scares?"

'Pay as you go' has returns that are fundamentally based on demographics, not economic performance. I'll look up social security scares in the past if you can point to a demographic problem like the one we have coming that also occurred in the past.

The insolvency of the system given known demographics is a known. There is risk in the market, but known disaster in demographics. Also, it is important when 'we' talk about the costs to 'us' for the pay as you go system, to note who will actually be bearing the costs of the system and what those same people can expect out of it. Finally, since payroll taxes are funnelled directly to general revenue, there is no correlation at all between better economic performance and getting higher returns out of a pay as you go system.

Honestly, Sean's means tested insurance of last resort plus accounts held in trust and invested seems very reasonable to me.

I would note that his drug subsidy program only has low costs because the US doesn't do the same thing, but that is another discussion.

Jason- Where do you get this 2% figure for return on SS?

At any rate having new workers put all monies into PRAs would not necessarily benefit younger workers. SS benefits would still have to be paid to current recipients. This would require over 2/3 of the current SS tax. So unless more money was being withheld from your paycheck on top of the current SS, the MOST that could be invested would be only about 30% of the total tax. If one accepts your 2% figure, that means that your return on investment for the PRA would have to be 6.7% OVER the inflation rate to deliver a PRA return equivalent to 2% return on SS. I don't see how the numbers add up to make you better off.

For pensions that are part of job benefits, yes it makes a lot of sense to have defined contribution accounts that are portable, because workers change jobs and corporations can go out of business. With SS, the US government is not likely to be out of business soon, nor is it likely to default on its obligations.

The first fact is that benefits must be cut or taxes increased. Given that fact, as a young person looking at funding the baby boom retirement and my own, I would much rather take a cut in benefits starting with say those 50 and under who still have 15+ working years. At least then the baby boom has to act responsibly for a portion of their lives. This also has the plus effect of reducing my dependance upon elitists who know better in Washington and political risk. Looking at my current SSI statement, and assuming no cut in benefits, I would need to live until I am 93 to get a 2% return on all I paid in taxes. I can be pretty dumb and still find a local bank CD that would give me a 2% rate on funds in my own account. Most americans are smart enough to figure that out. (Yes the Democrats will be able to find some complete idiots to highlight at conventions as props for power, but the central safety net should not be designed around an idiot threshold.)

Market risk vs. Political risk. I'd take market risk any day. Because what will happen on the political side is that I will fund the boomer's social security to the max and then just as I get to retirement age the boomers finaly die and the echo boom becomes a large enough voting block to finally scrap the silly system truly leaving me holding the bag. And don't give me a line of bunk about how the compassionate liberals wouldn't let that happen. It is simply a fact of where the votes will be. But that gets into the question of why my cohort is so small, which no liberal would touch with a 10 foot pole.

Any republican/conservative knows that they are taking on risk with personal accounts. We just firmly believe that the market risk is much less than the political risk.

As a 34-year-old, why should I believe conservatives who were against the system in the first place? We were told that with a Social Security system, we'd devolve into Socialist penury. As history has proven, it helped the country.

They have the "youth's" interest in mind? Yeah right. They're just being their usual "dividers, not uniters" by trying to get us to disrespect our elders. People who stir up generational conflict should be ashamed.

bakho:

"Where do you get this 2% figure for return on SS?"

http://www.socialsecurity.org/pubs/ssps/ssp31.pdf

Yes, I know it wouldn't be your first source, but they have done more work on social security privitization than anyone else. If you have a problem with the methodology, let me know.

Just recall that these rates of return are only actually accurate for current and near future retirees. Future rates of return, like those for 30 somethings, are entirely contingent on somehow making the system solvent. Raising taxes on us decreases our rate of return. Lowering our benefits decreases our rate of return. Increasing medicare's current liabilities decreases our rate of return. Any possible fix to the system decreases the rate of return for young workers.

As for the market, granting your calculations, you don't think I could manage 6.7% COMPOUNDED for 30 years? The total lifetime rate of return for the current system is 2%, not 2% per year.

Some of the thoughts below don’t lead directly to certain prescriptions for Social Security, but they should be helpful in considering any remedy. Here are my thoughts:

1. Why was Social Security originally implemented? I’d say it was to ensure that older people and the disabled would always have at least enough to get by, and that the children whose bread-winning parent had died would be taken care of through the end of their childhood. While the direct beneficiaries of any of these funds clearly benefit, society would also benefit indirectly. That young people are happy to know that the older people are OK, not just that they themselves will be taken care of in their own old age. That no one wants destitute orphans. Etc.

2. Accordingly, Social Security should be thought of as a minimum safety net (though certain features were inserted to ensure that it was not viewed as a welfare program, in particular, the payroll tax and loosely tying the benefits to contributions).

3. Minimum safety net-type investments should be in the safest investment options available. Why? Because the greater the variation in the potential returns, the larger the required investment to ensure that the minimum safety net is available. And, given the huge nature of providing such a safety net to the entire population, every attempt should be made to keep the required investment (tax) to a minimum. The tax and benefits will have huge impacts on society, even if they are kept to a minimum.

4. The tax should be kept to a minimum to minimize the negative impact such a program has on freedom and choice. This should work to ensure that the program maintains a broad base of support. A much larger program that delivered a wide variation in returns would likely lose the general public support the Social Security enjoys.

5. Social Security was initially implemented during the Depression. At that time, conventional wisdom doubted that society and the economy could make use of the huge savings pool that workers would generate saving for their own retirement and that such a savings pool would lead to continuous depression. Thus, Social Security was designed as a “pay-as-you-go” system.

6. Today, we suffer from the opposite delusion. That the economy can put unlimited amounts of savings to work at high returns. But logically, any additional investment would generate lower returns than the ones currently being generated. Why? Because companies and people are generally rational and choose the most profitable opportunities first. Each additional dollar to invest goes to previously rejected investment opportunities. So, average rates of return would have to fall if investment increased.

7. Once workers know that they can look to Social Security as a base for their retirement needs, they can then take more chances with their private savings than they would otherwise. Thus, even though Social Security investments are ultra-safe (only US Treasuries. Oddly, some people refer to these as “only IOUs” even though the entire world considers these the safest instruments in the history of world finance), that may have little overall impact on the risk profile of society’s overall investment portfolio.

8. If the Social Security trust fund wasn’t buying the treasury bills it currently holds, someone else would have to. Again, this means that society’s overall portfolio would not change. (except that those T-bills might be bought by foreigners or that interest rates on gov’t debt might be higher.)

9. Forcing people to set aside any amount above the minimum required to finance the base program in IRA-like accounts takes away their freedom to save or spend as they see fit. One example would be a person in her 20’s with AIDS. She might not wish to save for a retirement that she isn’t likely to see, but spend the money on treatment for the disease she has now.

10. An often overlooked part of the Social Security program is the benefit paid to children and someone looking after the children if one of the parents dies. Since anyone can die very early in life, it is not possible to say that everyone can do better in the stock market. One could die after only contributing a couple thousand dollars to Social Security, but the children might receive a benefit for more than 10-15 years. Unless we are willing to leave those orphans destitute, some sort of provision must be made for children like that.

11. The current tax and benefit plan calls for Social Security to collect more in taxes than it pays out in benefits from now until 2015. Then, the program begins using some of the interest from the bonds being put in its trust fund to fund the tax shortfall. Beginning in 2025, benefits exceed both current taxes and interest and we begin to draw down the bonds in the trust fund (which means that the gov’t must either issue similar bonds to the public to pay the Social Security benefits, or run a surplus on the general revenue side to be able to redeem those bonds). Finally, in 2037, the trust fund will be empty. At that point, Social Security could either continue with the current tax rate and reduce the benefits being paid out by 29% to stay in balance. Or, it could raise taxes by 41% (from 6.2% to 8.74% on both the employer and employee (or, 12.4% to 17.48% overall)) and leave benefits unchanged. Neither option is very enticing, so I recommend addressing this shortfall soon by introducing a gradual change in the retirement age. Additionally, the financing of the program will continue to deteriorate modestly after 2037, requiring either more benefit cuts or tax increases.

12. There are many factors that Social Security considers when making these projections. These include the ages and earnings of people already born, projected birth and death rates in future years, longevity, immigration patterns, economic productivity and wage growth, tax and benefit patterns, interest rates, and inflation rates. Best estimates are made for each (each estimate is actually slightly conservative, so the program is actually likely to outperform its base case projection), but there is room for small errors that change the funding ability of the program dramatically. In the last two years alone, solvency of the program has been extended by five years. A prolonged recession could obviously have the opposite impact. Accordingly, we must remain flexible in our view of what the program should be doing. That is, our view of the minimum safety net can not be rigid. We can only provide what we can afford to provide, so we need to evaluate the program’s specifics on a regular basis.

13. Current plans began raising the retirement age in 2003. In 2003, the retirement age is raised by 2 months each year until 2008, when the retirement age will be 66. Then, in 2020, the age is again raised by 2 months each year until 2025, when the retirement age will be 67. I propose that starting in 2009, we raise the retirement age by 1 month each year until we see that we have actuarial balance (I believe that most people would prefer a somewhat higher retirement age to higher taxes or lower benefits). The main reason for this is demographics – people are living longer and birth rates are lower than ever before. A look at the number of active workers supporting each retiree demonstrates that this ratio, which was about 16:1 in the beginning, falling to 3.7:1 by 1970, is now 3.4:1 and will fall to 1.9:1 over the next 75 years if we don’t make any changes. I propose that a gradual postponing of the retirement age could be implemented that would stabilize that ratio at 2.5 to 2.8:1, where current benefits would roughly equal current taxes, and the system could then continue on a “pay-as-you-go” basis.

14. It is important to announce any changes as soon as possible to give future retirees as much advance warning as possible to prepare.

15. One very important feature of Social Security has been the fact that it is not seen as welfare. This has lead to its widespread support. Nevertheless, it does have a very progressive tilt in its benefit structure. This is defensible given its purpose as a safety net. The basic retirement benefit is based on one’s lifetime earnings. In 2001, retirees receive benefits tied to 90% of their average indexed monthly wage up to $531, then 32% of their average wage up to $3,202, and finally 15% of their average wage thereafter. Many suggest that the current cap on Social Security taxes paid each year should be lifted as the cap makes the tax regressive. However, when one understands how the benefits are calculated, the program is clearly progressive, not regressive. For instance, someone whose average indexed monthly wage had been $531 would receive a monthly benefit of $478. A person with an average indexed monthly wage 11x that ($5,841) would have paid 11x the taxes of the poorer person, but receive a benefit of $1,728 or 3.6x as much. Clearly, requiring people to contribute beyond a certain income limit in exchange for minimal additional benefits goes against the basic nature of the program. It would no longer be a benefit that one had earned, but a welfare program. It would then risk losing the broad support it has.

16. The same can also be said about meeting any Social Security shortfalls from general tax revenues. It is the fact that the benefits are loosely tied to contributions that support for the program is so widespread.

17. Treasury notes should not be denigrated as IOUs, they are backed by the general revenues of the U.S. Treasury and generally considered the safest investment on Earth.

18. Regarding some proposals to introduce IRA-like accounts into the Social Security system. One reason this is untenable is the enormous cost of small accounts. If we use 2% of the Social Security tax to fund these accounts, a wage earner with $10,000/year of wages would only be saving $200/year. After 20 years, that account might be worth $8,000 – assuming it is not eaten alive by fees.

Regarding Australia's PBS system, it is simply not true to say, "I would note that his drug subsidy program only has low costs because the US doesn't do the same thing, but that is another discussion."

The subsidy part of the program is neither here nor there, since the companies get paid no matter what - the level of the subsidies is simply an internal equity discussion for Australians.

What makes the system unique, however, is the way it encourages research and development into new and *improved* drugs.

The system is ruthessly efficient: As new drugs come onto the market, the more the new drug is an improvement on the current drugs, the more Australians will pay. For new drugs offering no or marginal improvement, no increase in price.

There is an argument of course over how to measure 'improvement', but that does not fundamentally affect the internal logic of the system.

If all governments were to do this, we would have less resources wasted on 'ever-greening' and on drugs that offer only marginal improvement, and more resources put into drugs offering genuine improvements.

Big profits await those innovative companies who do ground breaking research that greatly improve the health of Australians.

Bill:

If GE issues bonds and I buy them, I have lent GE money with the expectation of a return that will be paid out of corporate profits.

If GE issues bonds and GE buys them, what has been accomplished? It is a shell game, where the returns are paid by the people who are investing.

You are correct when you say that other people would buy those bonds, but that would be true for any arbitrarily large amount of debt. They need to stop issuing those bonds as though they are getting free money out of the deal.

Sean:

I wasn't referring to the subsidy part, but the leveraged buying part. If the US adopted a similar system, you would quickly find that your power to buy in bulk means much less than it used to because the high prices paid in the US would no longer be supporting your ability to negotiate prices insufficient to recover sunk costs on their own. You could still have a great system of directed subsidies, but the costs incurred by the system as a whole would be much higher.