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February 07, 2005

Eddie Lazear on Principled Social Security Reform

Writing in the Economists' Voice, (hint! hint!) Eddie Lazear makes a very nice case for partial privatization of Social Security:

Eddie Lazear: ...the current [Social Security] system has some desirable features, but... [p]rivate accounts accomplish the desired goals... [and] eliminate most of the undesired consequences... none of the advantages of the Government-administered program would be lost with a properly-run system of private accounts.

First, the Social Security system forces saving.... Second, the current system provides insurance.... Third, Social Security redistributes income.... [T]he legitimate goal of Social Security is to ensure that everyone has sufficient income to support some basic standard of living throughout retirement... forced saving is at the heart of the system. Were individuals not forced to save, some would engage in moral hazard, over-consuming when young and allowing themselves to be destitute when old, knowing that they could then count on relatives, churches or communities to care for them. Others would... end up in the same situation simply for lack of foresight....

The current system accomplishes forced saving, but it is unnecessary to have the government administer the system.... [P]rivate accounts, properly administered, can provide adequate minimum income.... Social Security redistributes income and this is more problematic... its redistribution can lack rhyme or reason: Do we really intend low income African Americans who die young to redistribute income to affluent whites who live long lives?...

First, private accounts are more consistent... with... the principle that we ought to honor consumer sovereignty, and keep the market free of significant distortions. Second, private accounts enhance, rather than reduce, the likelihood that contributors will receive what they expect.... Third, private accounts reduce government moral hazard.... John Cogan has shown that for every dollar of unanticipated increase in government funds through the payroll tax, there is a corresponding increase of one dollar in government expenditures....

These advantages of private accounts are attractive, but do private accounts achieve Social Security’s legitimate goals? Yes, they do. The primary goal of Social Security is to force individuals to save. Private accounts... accomplish this goal.... How about Social Security’s second goal... income insurance?... [T]he government might be forced to bail out those who make bad investments, or to bail out a large segment of society if even safe investments turn out to yield very low returns. But there are at least two solutions....

The first solution is... to provide a base level of benefits from government run pension programs, namely Social Security.... An alternative solution is to insure the private accounts... [and] regulate the kinds of investments that can be part of the private accounts...

The big problem that I have with Lazear's position is the same problem that Cicero had with Marcus Porcius Cato. As Cicero wrote to his friend Atticus, Cato believed that the Romans lived in rei publicae Platonis while they actually lived in cloacae Romuli--believed that they lived in the Republic of Plato while they actually lived in the sewer of Romulus. Eddie Lazear could design a private-accounts system that would be a significant improvement over what we have. But that's not what's coming through the pipe.

Lazear wants to see a system that will force saving: my fear is that ten or twenty years down the road Congress will amend the system to allow people to borrow against their private accounts or use them to buy a house or whatever--and such pressure will be very hard to resist for, after all, it is their money. Why shouldn't they be able to do with it what they like?

Lazear wants to see a system that provides substantial social insurance. The Bush implementation of price indexing lowers the guaranteed benefit as a share of income at retirement generation after generation without limit. It means the return of elderly relative poverty over the next century--not old ladies eating cat food, but old ladies with incomes that are grossly disproportionate to those of the broader society.

Lazear wants to honor consumer sovereignty, and here I disagree. Consumers are lousy choosers among long-run investment vehicles, for the normal process of learning that makes us good consumers of DVD players and lamb shanks doesn't have scope to operate.

Lazear wants to guard against government moral hazard--the government's undoing of Social Security's forced saving by using Social Security revenues for spending increases or tax cuts for the rich and so erasing the desired impact of Social Security forced saving on national saving as a whole. This is a real and a huge concern. But I cannot help snarking that an easier solution than reorganizing the whole system is simply to elect Democratic presidents like Bill Clinton, who understand and care about the long run national savings issue. That Republican presidents are feckless is indeed a problem, but one should not immediately jump to the conclusion that the cure is to pass whatever initiatives they propose.

There is one point where I have no quarrel with Lazear: his pointing out that private accounts are the beneficiaries by Right of property, which will be enforced by the courts, while legislated benefits are the beneficiaries' only by Grace of Congress. I'm not certain how much of a difference this is (for Congress has unlimited powers to tax incomes and to distinguish among different income streams as it taxes them), but it is a real difference.

Posted by DeLong at February 7, 2005 11:38 AM