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March 06, 2005

Robert Waldmann's Thoughts on Social Security and National Saving

Robert Waldmann resorts to the neoclassical theory of savings, and says that the Bush Social Security reform will reduce national savings unless Bush and company are lying:

Robert Waldmann: I think that Brad may be right that private accounts are likely to be a wash as far as national savings go, but... only... because you assume that Bush, the Cato institute and the CEA are full of it. They all claim that private savings accounts are a better deal than traditional social security. They even claim that young people will be better off with the reform.... [And that is the equivalent of] claim[ing] that the reform will reduce national savings....

If the reform means that people are better off, then the reform should make people consume more and save less. Under standard assumptions that means national savings decline.... [C]onservatives like to go on and on about how offering a better return on savings will cause increased savings due to the substitution effect.... In the case of social security reform, there is no substitution effect. The proposal is to replace one form of forced savings with another.... [I]f, as claimed by Bush and the Cs, private accounts are a better deal, then there should be an income effect causing increased consumption....

National savings = GNP - C [Consumption] - G [Government Purchases].... One might hope that private accounts will, in some way, scare the state into spending less [reducing G] because the huge deficits involved will scare people... [but Bush and] the CEA say those deficits aren't deficits, and are nothing to be scared about (not to mention that they don't seem ever to have been scared about deficits, and why should we listen to their ideas about how to starve the beast: they are the beast).... So I assume that G is fixed.... [I]n standard analyses of national savings, Keynesian effects are assumed to be temporary.... End of story. Give social security participants a better deal and national savings should decline....

To argue that social security reform will increase national savings one must argue that it will make participants poorer or will make the accumulation of national debt more terrifying. The President is effectively saying -- "Trust me, don't worry, I'm obviously lying."

Robert is, broadly, right. The name of the game is increasing national savings, which means--absent fiscal responsibility on the part of Republican leadership--reducing C. In the neoclassical framework, reducing C means either (a) scaring people into thinking that they are poorer over their lifetimes or (b) tax increases. If the plan reassures people, then--in the neoclassical framework--national savings falls.

Now the argument that there will be a demonstration effect--that once the non-rich see their private Social Security account balances grow, they will want to open parallel accounts with their spare cash--is not completely stupid. It is, however, almost completely stupid. Banks and mutual funds and brokerages have spent a lot of money talking about the benefits of saving and ownership of financial assets. And our private savings rate is still very low.

The argument that it is all about habits and defaults (make the default to direct $1000 of your tax refund to top off your Social Security private account in addition to your diverted payroll contributions, and provide a partial match to the extra $1000 out of uncapping FICA, unless you send in an extra form to the IRS) is relatively smart--but there is no sign the administration is thinking along these lines. And this is too bad: I wish it were.

There is yet another argument, which Robert refers to in his discussion of the level of government spending. The argument is that diverting payroll taxes into private accounts will shock the Republican congressional leadership and Bush into fiscal responsibility--an argument Alan Greenspan has made relatively frequently--seems to me to be a forlorn hope: since 1980, after all, nothing has shocked the Republican Party into fiscal responsibility. It is a replay--this time as both tragedy and farce--of the Reagan first term fiscal policy which was conducted by, as Greg Mankiw says, charlatans and cranks. According to David Stockman (see The Triumph of Politics: Why the Reagan Revolution Failed and The Education of David Stockman) the idea was to:

  1. Allow the charlatans and cranks to make outrageous claims about how tax cuts would not create deficits.
  2. Get the tax cuts passed.
  3. Point out to Congress that the outrageous claims had been false, and that in order to balance the budget large spending cuts were needed.
  4. Pass the spending cuts.

Of course, Congress reacted badly to this bait-and-switch: Congress's response to the Reagan administration was "you caused this f--- up, you fix it."

If there is actually a plan to try to use the diversion of payroll taxes into private accounts to shock the Republican leadership into fiscal responsibility, I think it is highly likely to fail as miserably as did David Stockman and company. Congress will react in the same ay to another bait-and-switch: the Bush administration's acolytes may say now that the projected larger cash-flow government deficits don't matter and plan to say five years from now that the cash-flow deficits are horrendous and need to be closed immediately, but Congress has a memory and is very unlikely to buy it.

Posted by DeLong at March 6, 2005 12:00 PM