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December 15, 2004

Saving Social Security

Joshua Micah Marshall's view of Social Security:

Talking Points Memo: by Joshua Micah Marshall: December 12, 2004 - December 18, 2004 Archives: Focused as I've been on the Kerik meltdown, I've given little attention to what will certainly be the defining issue of the next two years, for Democrats as much as the president: Social Security.... [T]he entirety of the president's argument is based on a series of well-constructed lies. The president's advisors were never more truthful than they were when they compared the coming round of disinformation and fear-mongering to their public campaign in support of the Iraq war in 2002.

The Social Security "crisis" is manufactured.... To the extent there are long-term financing problems, the president's plan will gravely worsen them. The problem we face... [is] that our non-Social Security budget continues to run massive structural deficits. Or rather, it has returned to running massive structural deficits after getting into the black in the late 1990s.... I'm going to try to dive more deeply into the dishonesty of the president's plan and explanations of different aspects of the debate....

[T]he Democrats have to start seeing themselves as a true party of opposition in large part because of the way President Bush has reshaped the capital into something much more like a parliamentary system. There's no point in Democrats trying to improve legislation at the margins, because they won't be given any real opportunity to do so.... Making the elimination of Social Security a strictly Republican gambit raises the political stakes dramatically.... [S]uch unity should not be that hard to achieve -- for two reasons. First, very few Democrats support privatization. Second, those relatively few in the centrist wing of the party who are open to the idea in the abstract are scared off by the budget-busting debt the president wants to take on to pay for his plan....

Next, as we've discussed before, this isn't a debate about 'reform', 'privatization' or 'saving' Social Security. It's about phasing out the Social Security program....

Republicans want to make this an argument about people who believe in markets and people who don't.... The issue here isn't markets. Most Democrats favor plans that would make it easier for middle- and lower-income families to save and invest money for retirement.... The issue is balance and commonsense. A breadwinner with dependents who gets a lump sum salary at the beginning of the year and invests it all in a few hot start-ups doesn't believe in the market; he or she is just a fool. A wise investment portfolio is balanced between riskier and more conservative investments. The best way to make this argument (and the most valid one) is to make it clear that Democrats want people to be able to invest. That really is the path to wealth. But Social Security is different. It is, among other things, a baseline of guaranteed retirement security and income for everyone. You get it whether you retire in boom times or bust times, whether life has dealt you good cards or bad cards....

Posted by DeLong at December 15, 2004 06:58 AM

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Tracked on December 15, 2004 10:33 AM


You can probably speak with a greater deal of authority about this than others, Brad, so I have to ask, what was President Clinton's reasoning in trying to partially privatize the system? Was he using some of the same claims as Bush is using?

[That it was worth seeing what would happen if the Treasury sold a little bit less debt to the Social Security Administration, sold a little more debt to the public, and--acting as the SSA's agent--put some money into a broad, diversified index of equities. Nobody thought it would be a big minus: the government is good at bearing risk. And there is the possibility that it would be a significant plus.]

[The big difference between Clinton and Bush here is that Clinton seriously worried about the substance of the government's fiscal position, while Bush's thought processes are indescribable and incomprehensible. We're not going to get a better system out of this.]

Posted by: Brian at December 15, 2004 07:28 AM

If the average boomer has overweighted their 401k to stocks, especially higher-risk stocks, then Social Security is already part of their well-balanced retirement portfolio. If SS will provide 40% of their current income, and they are placing enough in the 401k to result in retirement income equal to their projected SS benefits:

Investment class as percent of current income
Real Estate: 20% *
Stocks: 40% **
Bonds: 40% ***

* currently spent on mortgage payments.
**401(k) split 50-50 between an S&P500 index fund and small-cap/tech fund or an international fund.
*** Social Security income, currently invested in gov't bonds.

If you're close to retirement, that's not a bad job of diversifying. If you're young, that's probably over-weighted to bonds.

Posted by: Silent E at December 15, 2004 08:15 AM


For the life of me I don't understand your comments on Social Security. The government could borrow a gzillion dollars and put such into the stock market, but such will only increase the wealth of current stockholders, because doing such will not increase the supply of good stocks.

Has everyone forgotten the simple concepts of supply and demand. What good ideas are not being funded now?

The only way a program the size of Social Security can work is straight income redistribution.

Take the extreme example: 1 Worker and 100 retirees. Their collective savings will buy nothing which that 1 worker refuses to produce. Regardless of how much they "saved" rising prices are going to wipe out those savings to give the 1 worker an incentive to work. As more people retire, the remaining workers are going to increasing resist ever higher taxes.

The only solution, and it is only a partial solution, is to grow the economy as rapidly as possible and to add more workers.

Where is common sense and reason by Democracts on this subject?

All my best for the holidays.


Posted by: Moe Levine at December 15, 2004 08:27 AM

Moe is exactly right. It's a question of when and how to phase out SS, not "if".

"Let's wait and see" = "we'll cut benefits when the time comes". Because the time will definitely come (absent massive immigration). That will begin to dawn on people in about a dozen years when outgo exceeds incoming P/R taxes.

Whether that is a "crisis" is a matter of semantics, not economics. The economics is clear and simple; from a ratio of worker to retiree of 3:1, when you get down to 2:1, you have to increase taxes by 50% to pay benefits at the current level.

That won't happen.

Posted by: Patrick R. Sullivan at December 15, 2004 09:07 AM

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.

Alan B. Krueger is the Bendheim professor of economics and public affairs at Princeton University and a co-editor of The Journal of the European Economic Association.

Posted by: anne at December 15, 2004 09:26 AM

Re: "absent massive immigration"

Clearly we could ease this demographic transition
by allowing productive younger workers to come
to the USA and pay SS taxes as a counterbalance
to the aging boomers. Also for the foreseeable
future there are many people who are very eager
to come and live in the US.

This suggests a possible "global market"-oriented
solution: do an annual Dutch auction of green
cards in sufficient quantity to smooth out the
demographic transition. I would guess the going
rate for a green card might be $20-50K, so the
auction itself would generate significant
revenue (say 0.5M * $40K = $20B/year) for the
SS trust fund, in addition to the ongoing
SS taxes paid by the immigrants. Since the
projected 2042 "crisis" is almost 40 years away,
a steady stream, rather than a flash flood, of
young highly-motivated immigrants would probably
suffice to close the funding gap.

And why could any Republican object to this
(other than the unspeakable truths of racism
and a preference for exploiting illegal aliens
rather than unionized legal workers) ?

Posted by: Richard Cownie at December 15, 2004 09:42 AM

Funny, but I was left with no choice but to rip David Brooks on this subject when he wrote his weekend column about how all the people opposing Bush's privatization plan were simply anti-market chicken littles.

HIs column was the same old 'your with us or with the terrorist' garbage the Republicans are so fond of right now. His column was basically, 'your for Bush's privatization plan or your anti-free markets'

My problem with the plan is that true social security reform may have been possible if Bush did not give the wealthy and the boomers a tax cut, a war of choice, and increasing government expenditures, all at the same time (damn, have they never heard of tradeoffs in the face of scarcity?). Where does that leave people of my generation (I'm 29). We'll be working to payoff our parents SS at a 2:1 worker to retiree ratio(regardless of whether or not Bush's private accounts are instituted), paying ever increasing taxes to pay off the debt of a war the boomers wanted but didn't want to pay for, and the trillions in deficit for SS reform that may or may not work. Our FICA and income taxes will probably be about 90% of our income, unless we somehow figure out how to turn all our income into capital gains and dividend income.

If this goes down as I think it might, people of the boomer generation better not come crying to us when we drastically cut their benefits to give ourselves a tax cut. When their elderly neighbor has choose between eating canned cat food or getting their prescription drugs, they better damn well remember election 2004, because I will.

Posted by: philip at December 15, 2004 10:59 AM

"Since the projected 2042 "crisis" is almost 40 years away..."

2042 is meaningless. In about 12 years SS will begin having to pay out more in benefits than it will take in in payroll taxes. That's when the problem hits.

The "trust fund" is nothing but a number on a piece of paper--actually two numbers on two pieces of paper; the same absolute value, but on one piece of paper there is "+" and on the other "-", which sums to 0. Which is exactly how much help the trust fund will be in paying SS benefits.

The same thing is true of Medicare, but it will hit even sooner.

Posted by: Patrick R. Sullivan at December 15, 2004 12:27 PM

philip, do you still believe that Gen X propaganda? What's it like living in a world where the Boomers voted for Bush, while the Gen X-ers voted for Kerry?

Posted by: Barry at December 15, 2004 12:38 PM

Gen X propaganda? Is there such a thing? Look at the statistical data, people around my age voted for Kerry, but I don't get the "propoganda". Am I missing out on some good information? Can I sign up for a mailing list to start getting a little of this Gen neXt propoganda? I am simply speaking about what I see. Under Bush, gov't revenues have decreased by 400 bil, while gov't expenditures have increased by 100 bil (what happened to the rublican balanced budget ammendment?). Meanwhile boomers got themselves a tax cut right before their retirement while we're still all in school or looking for work in the magical "jobless recovery" that only seems to be able to be created if your last name is Bush. The pentagon is now expected to ask congress for 80-100 bil for Iraq (when will those requests stop comming?), Bush wants to make the tax cut permanent and divert funds that are paying current retirees into private accounts, yet not cut benefits for boomers, but instead make the cuts later.

Who's going to get left holding the bag on this one. Wait le'me guess, its all just propoganda right?

p.s. Note that I am not against a partial privatization plan, just the concept of a free lunch. Someone, somewhere, must pick up these bills, and the boomers in their infinate wisdom have decided it wont be them, wouldn't want to cut into their SUV drivin', Starbucks drinkin', suburb livin', draft dodgin' youths war mongerin' adult, lifestle.

Posted by: philip at December 15, 2004 12:58 PM


As part of the giant bargain of the Social Security reforms in 1983 all working Americans agreed to contribute more to the Social Security System than is required to pay benefits. We did this in order to build up a trust fund. This has been our way of saving for the future and is exactly like a large, shared, communal savings account. These excess contributions are what have allowed Social Security to run a surplus.

This surplus money is held by the government for our benefit in the form of bonds as the social security trust fund and at the beginning of 2004 the government was holding in our communal savings account $1.5 trillion.

The actuarial report for Social Security says that this communal savings account will not need to be used until the year 2018, until then current taxes will pay all current benefits.

The excess of social security taxes over payments will be $200,000,000,000 for each year from 2005 through 2018.

The conservative CATO Institute reports that since 1926, the average real rate of return on the stock market has been 7.56 percent.

So, the alternative plan would be:

1. Have the government sell our bonds on the open market and then invest the money in an index fund like the Vanguard S&P 500 fund. At 7.56 percent return we would earn $113,400,000,000 the first year.
2. The current overpayment from social security taxes is $200,000,000,000 and we would add this to the index fund each year for the next 14 years.
3. If we simply kept the profits in the stock market each year for the next 14 years (2005 through 2018) that value of the account would grow to $8,877,590,914,470.
4. This simple change is more than enough to cover the projected shortfall of $3.7 trillion in the Social Security System.

The advantages of this plan are:

The government would do the investing in one single account, instead of 80,000,000 separate accounts, thus saving all those separate management fees. This would save the system $140,000,000,000 (80,000,000 accounts paying a management fee of $125 per year for 14 years.)

Our $1.5 trillion would be investing as capital to grow the economy.

We would not need to cut benefits or raise the retirement age.

John Otti

Posted by: John Otti at December 15, 2004 01:12 PM

John Otti writes:

As part of the giant bargain of the Social Security reforms in 1983 all working Americans agreed ... John, I respectfully disagree. Dick Gephardt and his fellow democrats sold out working Americans for votes from retirees. This event was the seminal departure point for the failure of the Democractic Party and the circumstances in which we now find ourselves.

I said it was wrong then and I have opposed Dick Gephardt ever since. All that we voted to do was balance the budget with regressive payroll taxes.

Posted by: Moe Levine at December 15, 2004 02:54 PM

Economic Assumptions under the Three Alternatives
Trust Fund Ratios under the Three Alternatives
What is the Low Cost Alternative

If we hit the very modest numbers of the Low Cost Alternative of the 2004 Trustees Report, we see a Trust Fund Steadily growing to 600% in 2019 and then drawing down the equivalent of one year of contributions over a 20 years period before leveling out at a Trust Fund ratio of 500%. We will barely need to tap those bonds and Patrick's argument remains without merit.

We soundly beat the 2.8% productivity figure for 2004 proposed by the Low Cost alternative. No one predicts that 2005 growth will sink to 2.1% under that same alternative. And given that early years numbers have much more impact than numbers in the out years the rational conclusion is that not only is Social Security not broke, under any reasonable economic projection it is currently overfunded.

Too bad for privatizers. The spate of postings and articles in the last week or so show that people are finally waking up and taking a look at the actual numbers underlying that 2019 shortfall and the 2042 exhaustion. They are not Platonic Ideals, they are not carven in stone, they are estimates based on a very concrete set of economic and demographic assumptions. Assumptions that were not realistic to start with and are getting crushed today.

If you deploy those dates you have implicitly bought into the economic assumptions that produce them. You do not get to cherry-pick. 2019 does indeed represent the year we begin to tap the Trust Fund, but that tap will be almost unnoticable depending on your views of future growth. And 2042 is only a reality if you accept that long-term productivity settles in at 1.6%.

Endless debate about the reality or unreality of the bonds in the Trust Fund is beyond the point now. The numbers show a fully financed system unless you believe the economy is sinking into permanent near recession. In which case no privatization scheme saves the day.

People who don't confront the numbers underlying the dates they throw around are simply incompetent to join the discussion, or being dishonest.

Produce an economic model that shows historic rates of return on stocks that doesn't meet or beat the numbers of the Low Cost Alternative. Then make a case.

Posted by: Anonymous at December 16, 2004 07:20 AM

Has Patrick Sullivan ever made it through a sentence without getting at least one thing wrong?

I'm not saying he doesn't get two, three, or sometimes as many as nine things wrong. I would never say that. I'm just wondering if he's ever produced an error-free sentence.

Posted by: A Tiny at December 16, 2004 09:03 AM

Given the amply demonstrated incompetence and mendacity of the Bush administration, why are we even discussing the merits of privatizing Social Security?

No. No. A thousand times no. This corrupt, fanatical gang of white-collar crooks is utterly unqualified to reform anything. Nothing they say can be trusted: nothing.

Whatever they want, the answer must be no.

Posted by: ChristianPinko at December 16, 2004 09:40 AM

"Has Patrick Sullivan ever made it through a sentence without getting at least one thing wrong?"

I'm saying that +2 -2 = 0. Which is exactly the arithmetic of the SS "trust fund". The "bonds" held by the SS system as an asset are exactly offset by a liability.

Posted by: Patrick R. Sullivan at December 16, 2004 09:54 AM

Patrick Sullivan and the other privateering salts on this list have hit on a great strategy: repeatedly make the genuinely and intentionally stupid assertion that US Treasury issues are not "real money." This infuriates educated privatization opponents and lights their didactic fires, pushing them into a fruitless--and endless--attempt to educate our opponents about why bonds are real assets, and why everyone can't make a 7.56% return off stocks from now until the end of time. While we're busy doing that, they're making logistical arrangements for W.'s cross-country wank-a-thon to convince Americans to get the Social Security Trust Fund off their backs.

My suggestion is this: let's talk strategy. Brad's suggestion of diverting this back into a question about why Bush is looting the general fund seems like a promising avenue; it has the virtue of *simplifying* the issue, and vastly reducing the number of "strategic objections" raised by the other side. It also puts the administration on the defensive, and every minute they have to spend defending their profligacy is a minute they can't spend selling this truly horrible idea.

Posted by: Julian Apostate at December 16, 2004 10:25 AM

While I agree with most comments here that what Bush really wants to do is to distroy SS program, I am still not fully convinced that we should be against his plan.

As many people have pointed out, the SS trust fund is currently subsidizing the general federal spending and making Bush's tax cuts look less costly than they actually are. And currently SS taxes are projected to be higher than payouts for the next 14 years, i.e., this situation is expected to continue for the next 14 years, at least 4 of the 14 is entirely under the Republicans' control. So why should we be against a cut in the regressive SS tax? Privatization is basically a cut in the SS tax, right? I think the democrats should go for it -- let's starve the Republican beast before they start another war in Iran or make all Bush tax cuts permanent.

Will the privatization destroy SS? Not necessarily -- when the time comes, the public could choose to raise SS tax again (if privatized accounts have enough disasters). Look, even without privatization, the public has to agree to an increase in taxes such that the federal government can payback the SS trust fund. The bottomline is that as babyboomers retire, tax on the generations that are working THEN will have to be raised to finance a larger portion of retirees, one way or another.

It appears that some people are confusing national saving with individual saving. Moe's example should make it clear: in a closed economy, the only way to increase national saving is to increase stored goods or increase productivity. To the extend that changes in SS tax have little impact to either, they do not change the outlook for babyboomer retirement either way. Increasing SS tax in 1984 did not increase national saving, and reducing SS tax NOW (through privatization) is not likely to reduce national saving either.

Posted by: pat at December 16, 2004 12:27 PM

'the genuinely and intentionally stupid assertion that US Treasury issues are not "real money." '

Who said "money"? They are not normal US Treasury issues, because they are both an asset and a liability of the government. Hence they net to $ 0.

Grade school arithmetic.

[They are an asset to the Social Security Trust Fund, and a liability to the General Fund...

Would things really be very different if the SSTF invested in banks, which then bought Treasury bonds? Then the SSTF would have an asset (bank stocks); the banks would net to zero (Treasury bond assets and equity liabilities); and the General Fund would have a liability (Treasury bonds). The government's assets and liabilities would still sum to zero, after all... ]

Posted by: Patrick R. Sullivan at December 16, 2004 03:25 PM


"The "trust fund" is nothing but a number on a piece of paper..."

Your assertion about basic accounting identities is not stupid because it's wrong; it's stupid because it's irrelevant to the discussion at hand. We can all agree that 1-1=0. Great. You win.

Now, these Treasury issues you refer to as abnormal will continue to be redeemed by the US Government until such time as the Four Horsemen of the Apocalypse swoop down from heaven and lay waste to the revenue collecting apparatus of the US Government—whether the issues are owned by the Trust Fund, the Central Bank of Thailand, or anyone else who has decided to invest in the world’s safest security. If you contend that this is an imminent threat, then all bets are off concerning the provision of all government services, and we can extend the crisis histrionics to include lots of things that are much scarier than Social Security only being able to cover 80% of its commitments.

Obviously then, the real issue is President Drunken Sailor and the threat he and his administration pose to the long-term economic health of the country.

Damn! You made me talk about it after all.

Posted by: Julian Apostate at December 16, 2004 05:16 PM