Saturday, March 05, 2005

Mo Money, Mo Problems

UPDATE: I confused "Mark" of Pseudo-Polymath with "Marc" of American Future. AM, tragically, will not be opining on my proposal, since, as Marc has since reminded me, it is solely a foreign affairs blog. My apologies for a truly boneheaded mistake.

Many people have graciously offered responses to my original call for reasons privatizing Social Security will solve the solvency problem. Pseudo-Polymath (whose move to a new server has prompted me to make its long overdue addition to my blogroll) offers the following:
There are only three valid arguments against privatization, being:

"It's not broken" That we shouldn't consider improving a social program, which costs as much as it does seems suspect. Why wouldn't one want to improve a program that comes at such a high cost? Why not consider ways of providing more "bang" for the buck?

Transition costs As to the second argument, alas I have no data to add to the mix. Both sides of this fray have brought forth their personal predictions from their own crystal balls of future trends and have come down firmly holding to answers they want to find. These results would be perhaps more believable, if evidence could be shown that those people ever came up with results which did not jibe with their pre-conceptions.

dependence of retirement on market fluctuations and market fraud. To my mind, the best type of retirement investment would be index funds. There are negligible management fees, and no great profits for managers to gain lots of federal funds due to tweaking of the laws regarding SS privatization funds. Index funds cause one to "bet" on the health of the US industries as a aggregate. There seems to me no more natural thing to base our retirement on than that.

The following are reasons for privatization:

Inheritance Since accrued benefits can be inherited early death does not cause loss of benefits for heirs. While this is often seen as a "blow" to the ability of the system to remain solvent, in reality it really can't be, for benefits allegedly are paid in proportion to money put in. If this is really true, then after "transition" costs are paid, inheritance of money saved can't hurt the "system". Further it aids the solvency of the system in that little money is expected to be paid from sources outside of that which was put into the system in the first place by the investor. Since less "transfer of wealth" is going on, less wealth needs transferring and it's easier to remain solvent.

Investment aids US industry Those funds, while being saved are invested primarily in US industries. This helps the economy, which in turn helps the solvency of the system in general. Malthus notwithstanding, economics is not a zero sum game.

Population dependence is weakened. This lessens the dependency of SS benefits on relative population fluctuations. In the current scheme the SS solvency is closely tied to the relative sizes of the working and retired population ration. As medical advances, unforeseen epidemics, or heaven forbid large scale wars affect these population rations. The privatization scheme removes much of this dependence by allowing each individual to rely on his own accrued investment, removing his ties to the future generations ability to support him.

Other commenters argued that taking funds out of the trust fund keeps it from money-grubbing legislators, and one argues that the $2-3 trillion debt figure only is relevant to spending money on other programs (which isn't true, more on that in a second). While I think PPM raises some legitimate points, to make the long story below short, I think that the risks (both in terms of transition costs and additional liabilities without additional revenue) outweigh the benefits (inheritence, speculative economic growth, and avoidance of population shocks).

The reason I phrased my question the way I did is that I don't have a philosophical objection, per se, to allowing for private accounts. So long as there is still some sort of safety net so my grandparents don't starve on a Miami street corner, I have no issue with people investing their own money for retirement. At the same time, neither are private accounts my top priority. I really don't care about them either way. So if private accounts are a threat to Social Security as is, either by making the problem worse or by pretending like we've "solved the problem" when we haven't, then I oppose them.

Since I wrote my last post, I talked to my friend and brilliant guest-blogger Greg Ihrie, and he told me the following: In the most pure sense, Privatization would provide solvency to Social Security in the long-term (transition costs, once again, are separate). This is because the government wouldn't be "covering" anything anymore, you'd put in whatever money you wanted, and you'd get out whatever money you make. If you make a fortune, congratulations. If you get burned, well, its time to start a price-check on dog food. There couldn't be a debt or a surplus, because nobody is "owed" anything. Of course, we're not talking about complete privatization, but a partial privatization scheme. Partial privatization aids solvency because it reduces the "risk" that the government has to cover--it only has to worry about the amount of social security that is still public, which, thanks to the diversionary effect of private accounts, is a smaller and thus more manageable amount.

The kink is that the system can never work in that "pure" manner. This is because every Privatization program has to include some guaranteed safety net in case folks get burned. Otherwise, we're essentially crossing out the "Security" in "Social Security" (and a program just called "Social" makes no sense). This throws all the solvency assumptions above for a loop, because the government has to cover the losses without being able to access the extra gains. I despise Math, but I'll try to explain in simplified figures.

Status Quo System: $100 coming in (payroll taxes), $110 going out (SS benefits)

Partial Privatization System (w/out Safety Net): $80 coming in (payroll taxes), $85 going out (SS benefits). In addition, there is $20 going into private accounts and $X dollars coming out of Private accounts. The government doesn't have to worry about this at all.

Full Privatization (w/out safety net): $0 in, $0 out.

Partial Privatization (with safety net): $80 coming in (payroll taxes), $85 coming out (SS benefits) + $X coverage of investment losses. There still are some gains in the above X (private accounts), possibly (probably?) even a profit, but the government can't touch them because they are private. Hence, we have our problem: We have additional liabilities (investment losses) without additional income.

The other issue at hand here is the transition costs. These should be dealt with separately because they are a one-time expense--but they're a doozy of one. Contrary to what PPM says, there is no "debate" over whether the transition costs will "happen" or not--they are there. That's a fact, and nobody has adequately explained how they are being paid for. Here's how it works.

The reason Social Security was able to hit the ground running in the 1930s is that the current generation of workers pays the current generation of retirees. The money I put into SS isn't "mine," it's going to my grandparents. When I grow old and frail, my grandchildren will be paying for my account. That's why you keep hearing about the declining worker:retiree ratio--if it was my money going into the system that wouldn't be an issue.

Here's the rub: If I divert however much money into Private Accounts, that money is no longer available to pay the current benefits of retirees. That creates our lovely shortfall. If I was paying in $100 originally, and now am paying in $90 (because I diverted $10 to my account), then that's $10 less that's available to pay the current generations benefits. Magnified across the entire system, that's where we get our $2-3 trillion dollar gap. It isn't based on competing conceptions of how strong the market will be, or crystal-ball gazing. It's a direct characteristic of how the system is set up. Hence, we get back to my original objection to privatization: the short-term hit we take (in the transition costs) is too threatening to justify whatever longterm benefit we're getting, at least when there are other options open to fix the problems (like eliminating the Payroll Tax Cap).

Meanwhile, in comments PPM asked me a question of his own: Why should the government be involved with retirement plans at all? Why can't the middle class simply save for its own retirement?

From the way he framed his question, I believe he thinks a government "safety net" for the poor would be right and proper. But he questions why we need to pay benefits to everyone else to do it. This is a fair question, and I don't think there are obvious answers. I do have two tenative responses.

The first is purely political. As I said above, the highest priority on my end is making sure that our elderly population can be secure in retirement. Shifting Social Security from its current universalistic format to a particularistic government aid program to the poor will rob the program of much of its political potency. Empirically, government programs which are targeted solely at the poor have a disturbing tendency to die slow, quiet deaths on the Hill. That's because a Democratic government will necessarily tailor its spending to give benefits to "us" (IE, White, Middle-Class Americans). When it wants to cut spending, it will look to programs that aid "the other," because they don't have the same level of political influence. Since we know that the poor have virtually no political cachet in Washington, making them the sole constituents of Social Security would likely be a lethal blow to the system. By contrast, when the Middle Class has a stake in a program (like they do in SS now), they will defend it voraciously, hence Social Security's "third rail" reputation. So basically, this argument is that we need to give Social Security to the middle class in order to preserve it for the lower class.

The second response I'd give is that transforming the program only into a safety net (say, a guaranteed minimum income) would destroy any incentive for lower income Americans to save. Let's say the minimum income level is set at $2000/month. If I, Mr. Poor Man, save enough to give me a retirement income of $1000/month, the government will give me the remaining $1000 to make up the difference, giving me $2000/month total. Alternatively, I could spend all my money now, leaving me with no savings. The government will then cut me another check, leaving me with...$2000/month. For person's who will make less, the same, or only marginally higher than the cut-off amount, there will be a disincentive to save--or to go after a better job--under a safety net system. In this respect, the current Social Security program acts like the retirement version of the Earned Income Tax Credit--since earnings are tagged positively to retirement income, it gives an incentive for people to work hard and try and reach the middle class.

I would not be opposed to some type of "means-testing" on Social Security, so long as it only effects upper-income Americans. Call it class-warfare if you want, but it makes perfect logical sense from my standpoint. The rich aren't part of the "us" (so it dodges my first objection), and there is an upward limit on how much the prospect of additional income will motivate one to work (law of diminishing returns), thus avoiding my second objection. And of course, means-testing the rich will reduce SS costs while not throwing any grandmothers on to the streets! It's win-win!

And finally, I want to thank everyone for giving me the chance to title a post "Mo Money, Mo Problems." I don't like rap, but I do love that song.


Marc Schulman said...


You must have me confused with someone else having a similar name. I haven't promised what you said I promised. American Future is strictly a foreign affairs blog. Nothing in it deals with Social Security or any other domestic issue (except elections).

Marc Schulman said...


You must have me confused with someone else having a similar name. I haven't promised what you said I promised. American Future is strictly a foreign affairs blog. Nothing in it deals with Social Security or any other domestic issue (except elections).