Asymmetrical Information

Social Security IS forced savings already, no? In a different form than Bush would prefer, but still . . .

And IF (and only if) you feel that the government must not allow old people to fall into poverty, then you must allow some measure of coercion aimed (as narrowly as possible) at preventing just that.

Right now, Social Security is worse than forced savings. It's a forced Ponzi scheme (or a forced transfer of wealth, to use a less-loaded term). So from a libertarian point of view, pragmatic or not, forced savings is still a tremendous improvement.

Of course the libertarian's ideal state is as realistic as the Communist's ideal state. Remember that these evil government programs were created for a reason and that reason was NOT to create a bureaucracy but to solve a perceived problem.

I find your argument very palatable. We are in a forced savings scheme, but there is no promise of return. At least the reform, as I understand it, offers the opportunity for the forced savings to return something that might surpass inflation in the long run.

I found the presidential debates informative on this issue, because the President quoted a short-term fiscal pain of $1 trillion (ouch) and the Senator proposed delaying the fix until it was absolutely necessary (a cost approaching $7 trillion! as I understand it.)Neither option is very attractive, but $1 trillion, as a one time bitter pill, seems more intelligent than a long-term drain on our economy through highly increased payroll taxes to pay for delay.

"As I see it, the primary potential benefit is that we're diverting resources from an unproductive use--the government--to productive investments that will make it easier for a smaller number of workers to support us all in the style to which we'd like to become accustomed."

Could you explain again how a privatized system will result in more "productive investments" than the current one? I'm not seeing how "privatizing through a few trillion of deficit financing or extra taxes" improves the net investment number; it's reshuffling the spreadsheet.

"People will simply work less."

From what I've read, the evidence for this bit of blackboard economics is pretty thin on the ground.

One of the nice things about private accounts is that it's a defined contribution plan, which anyone who's capable enough to earn income is also capable enough to understand: what you put in is what you get out. If what you put in has appreciated sufficiently, you can retire; otherwise, you'll need to work a few more years.

The problem with the current system is that people tend to think of it as a defined contribution plan (I contributed! They're just giving me back what I put in, plus the interest that's due me!), when in fact it's nothing of the sort. They are also susceptible to being persuaded by Democrats and the AARP that it's possible to "shore up" the system for Boomers by loading up a trust fund with government bonds (Perfectly good assets!). But those bonds are simply a liability against future tax revenue, which is exactly what the cost of future Social Security benefits are anyway. The obfuscation is nothing more than an insidious way to collect and spend more than is necessary via the payroll tax, while making it look like any excess revenue is actually being socked away to preserve the future solvency of the system.

Jason,

The portion of social security taxes that is not sent to current retirees is immediately spent funding various government programs. If people had private accounts the money would be invested and would provide capital for companies to do useful, productive things. This will produce more economic growth and less government pork.

Furthermore, if you look at how the US has handled the Indian trust fund money, and if you look at how fast the traditional company defined benefit pensions are being reduced two things should become perfectly clear. 1. You can't trust the feds to handle your money. 2. you can't trust companies to stand by their defined benefits plan. The only person you should trust to handle your retirement is yourself.

As I see it, the primary potential benefit is that we're diverting resources from an unproductive use--the government--to productive investments that will make it easier for a smaller number of workers to support us all in the style to which we'd like to become accustomed.

Am I reading this correctly as saying that you assume that any private sector use of resources is inherently more productive than any government sector use of resources? That sure looks like what you're saying.

"The portion of social security taxes that is not sent to current retirees is immediately spent funding various government programs. If people had private accounts the money would be invested and would provide capital for companies to do useful, productive things. This will produce more economic growth and less government pork."

Just so I have this straight: "calling a tax a social security tax tricks people out of understanding how much government they're buying." You're more-or-less asserting that if you cut social security taxes and it creates extra deficit pressure - no more super-cheap borrowing - this will be resolved by people deciding that they don't want X amount of government anymore, rather than just raising the taxes elsewhere to close the gap.

"Furthermore, if you look at how the US has handled the Indian trust fund money, and if you look at how fast the traditional company defined benefit pensions are being reduced...."

I don't know much about the first, but the implication of "capital is screwing the shit out of labor" is "labor should put themselves even more at the mercy of the capital markets?"

Let's assume arguendo that you're right about all of this. Can we agree, however, that any plan must include a way of dealing with the "whacking great short term cost?" Okay, I know we agree on that one; you say that yourself.

And that "adding it to the deficit" is not a plan (or not a sane plan, anyway)?

And that the Bush Administration is extemely unlikely to take either of the available sane options (raising taxes or cutting spending, or some combination thereof)?

And if we agree on all of that, why exactly should we expect the Bush plan to help?

There is a lot of smart thinking about social security reform, and I certainly could be persuaded to get behind it (albeit with some reservations). But I have zero faith in that the Bush administration will adopt the smart thinking. The plan that is being floated now, which would not address the short term costs AT ALL, would just make the problem worse.

A lot worse.

The problem with the current system is that people tend to think of it as a defined contribution plan (I contributed! They're just giving me back what I put in, plus the interest that's due me!), when in fact it's nothing of the sort. They are also susceptible to being persuaded by Democrats and the AARP that it's possible to "shore up" the system for Boomers by loading up a trust fund with government bonds

Jason,

I don't understand your first point. Taxes withheld for "social security" are called payroll taxes. Most people have no idea how much of their earnings go to fund their non existent “social security" account. I am proposing that they should be aware of this by clearly making "social security" taxes a line item on pay stubs.

It is fundamentally dishonest to tell people their money is being taken for retirement purpose and then use it for something else. If a private company does this it is fraud, this action is vociferously condemned by liberals and prosecuted by law enforcement as fraud. If the feds do this it is called "social security" and vociferously supported by liberals. I did not say or imply anything about levels of social security taxes or the deficit. I am utterly sick of watching the feds take financial actions that would lead to prosecution and incarceration of the responsible parties if a private company did it.

Jason,

With "social security" you do not own the money taken from you to fund your retirement. Currently if you die 1 day before you are eligible for “social security” payments you get none of the money you put into “social security” If the feds decide to reduce or eliminate your payments they can do this with the stroke of a pen. The debacle of the Indian trust fund accounts illustrates you absolutely can not trust the feds to handle your money responsibly. Thumbnail sketch of Indian trust fund issue. The feds were supposed to hold revenue generated from Indian lands to be distributed back to the Indians. The thinking was similar to "social security" the Indians could not be trusted to be responsible enough to manage this money themselves. End result the feds don't know how much money there should be in the account, they don't know how much money was collected, they don't know where the money went, the revenue that should have been collected sometimes wasn't, and the Indians who were supposed to receive the money have not. Do an internet search for "Indian trust fund scandal" to learn more.

With private accounts you would own the money you put into it. It would be used for your retirement not funding the latest pork boondoggle. If you die before reaching retirement age it would be available to your relatives to help pay for end of life expenses. In other words a much more honest, just, and dare I say liberal system than "social security". Owning your accounts means you don't face the worse screwing possible having your money taken away from you.

If this change had been done twenty years ago it would have been much easier. Additional delays will continue to make a bad situation worse.

'the implication of "capital is screwing the shit out of labor" is "labor should put themselves even more at the mercy of the capital markets?"'

People who base their thinking on the idea, "capital is screwing the shit out of labor", are wasting their time reading blogs like this one. But, for others, if we did begin to invest SS money in capital markets, it would depress returns to capital. It would increase returns to labor.

Those interested in this debate will probably enjoy the drubbing Andrew Samwick is putting on Max Sawicky at:

http://voxbaby.blogspot.com/

He has several posts on SS reform.

"People who base their thinking on the idea, "capital is screwing the shit out of labor", are wasting their time reading blogs like this one."

Hey, talk to the original poster who more-or-less said that about pension plans.

TJIT, I don't follow how "Alan Greenspan and Ronald Reagan raised social security taxes to pay down the deficit and make it easier for the government to pay its baby boomer obligations; this is why social security inflows exceed outflows translates into 'the government is committing fraud.'".

"With private accounts you would own the money you put into it."

You'd also own the multi-trillion dollar transition cost, so I'm not seeing how you come out ahead here. I'm also not seeing how "a backwater government agency, whose clients are a powerless minority, lost their money" is a useful analysis framework for "an enormous government agency tasked with managing the retirement of a powerful majority."

You're more-or-less asserting that if you cut social security taxes and it creates extra deficit pressure - no more super-cheap borrowing - this will be resolved by people deciding that they don't want X amount of government anymore, rather than just raising the taxes elsewhere to close the gap.

The difference is, if people discover that the real cost of government services is actually quite higher than what they had previously realized, they will either (a) be willing to pay the 'taxes elsewhere' necessary to 'close that gap,' or they will indeed demand fewer services. That's called transparency, yes?

The present approach is just obscuring the problem because arguably most people don't, in fact, know that SS taxes and SS payments bear no relation to an actual retirement fund, and that SS payments are really funding a significant chunk of other programs.

You'd also own the multi-trillion dollar transition cost, so I'm not seeing how you come out ahead here.

"You" (and "me") will also own that or worse anyway, when the system reaches unsustainable levels and forces the acceptance of a transition, except it might then also be precipitated by a collapse. What kind of alternative are you proposing?

Jason,

It looks like you are ok with the feds misleading people about what their social security money is used for. You are happy to have the feds do things with retirement accounts that would get a private pension manager sent to jail. It looks like you are happy to have people misled and cheated as long as it is done for the right reasons.

Jason,

The Indian trust fund involves hundreds of thousands of people and billions of dollars. It is not exactly a backwater program. The fact that the feds can't honestly manage this "small" program should not give you a great deal of confidence in their ability to manage an even larger program.

"It looks like you are ok with the feds misleading people about what their social security money is used for."

Oh yes, the fed is clearing lying, what with them being explicit at every point about what they were doing in the 1980s. You can see the magnitude of the chicanery! $140 billion dollars! Why, without that amount, the 2 trillion federal government would collapse like a house of cards! http://www.urban.org/Template.cfm?NavMenuID=24&template=/TaggedContent/ViewPublication.cfm&PublicationID=7240#table1

"hundreds of thousands of people and billions of dollars"

And the SS program involves hundreds of millions of people and trillions of dollars. It's a miracle that SS revenues weren't blown on the world's biggest hooker orgy before now, apparently.

"What kind of alternative are you proposing?"

You own that debt right now, and you'll own it in any proposed privitized system. Where is this increased investment going to come from? You're just shuffling money around.

One issue the pro-privatization folks don't seem to be addressing is the effect of changing demographics on the rate of returns to stocks. What do you think is going to happen when the Baby Boomers go from being net purchasers of stock to net sellers of stock in the next couple of decades? Even leaving aside all the other very good objections to privatization, doesn't the fact that stock market returns are very likely to significantly drop as the Boomers start selling their holdings constitute a serious problem for privatization schemes? It sure looks that way to this Ph.D economist.

"...doesn't the fact that stock market returns are very likely to significantly drop as the Boomers start selling their holdings constitute a serious problem for privatization schemes?"

Not really. It'll still be better than the serious problem it will eliminate.

doesn't the fact that stock market returns are very likely to significantly drop as the Boomers start selling their holdings constitute a serious problem for privatization schemes?

It may actually be too late for private Social Security accounts to play a large role in funding the Boomers’ retirement. Even the youngest of these folks are in their mid-40’s already.

However, tethering retirement aspirations solely to the assets actually accumulated by a prospective retiree, rather than a bottomless entitlement to monthly checks from age 65 "til death do us part", would greatly ease the burden on any “bust” generation that would otherwise be responsible for writing those checks to their “boom” antecessors. This is true even after accounting for the slightly bearish effect of a large age cohort slowly liquidating it’s assets over the latter decades of it’s collective life. Of course, one natural brake on this liquidation is that a broad and severe drop in asset values would force many to delay retirement. So young’uns like me probably won’t see the buying opportunity of a lifetime based on demographic trends alone.

People are living much longer and healthier lives, and if even a fraction of the looming breakthroughs in biotechnology and nanotechnology that some anticipate in the coming decades actually come to fruition, that trend will continue dramatically. If a large number of people are going to live to see 100, we can’t have everyone thinking they have a God-given right to spend ages 65-85 tooling around on a golf course at the expense of younger generations. A long, vibrant retirement is fine if you can afford it, but private accounts would force those who can’t to keep working.

Boom/bust demographics pose a problem to any nation that faces them, but private retirement accounts work to counteract that problem rather than exacerbate it.

"George Bush seems to be getting serious about shrinking government. "

I will believe that when he pushes to reduce the rate of growth in government spending. I will bless him if he can get the rate to be negative. No action that he has taken gives me any expectation of this happening, quite the contrary.

The comments going around about red states recieving tax money from the blue states is reason to have substatial doubt. Does anyone really think Bush can defy all the forces described by public choice theory?

Individual accounts could be put into a special class of government bond. There's no reason that they would have to be put into the stock market. The fundamental problem with the current system is that the individual loses ownership of their payroll tax payment. The Social Security program could be scrapped by a future Congress, and individuals would lose their benefits. This would not be the case if they owned government bonds. Then their money would be lost only if the government defaulted on its debt.

"What economists want to know is, is the market systematically mispricing equities ..., or does the difference in returns reflect the premium that stock issuers have to pay for the added risk of their securities..."

The equity gap includes progress as well as risk. Making your production costs rise more slowly than inflation is nearly like printing money.

"Basically, Mr Prescott sidesteps the arguments made by Brad DeLong, which is that privatisation only makes sense if the equity premium (which is the mysterious extra return that you get on stocks over bonds) is the result of a market failure, rather than the extra risk in stocks."
~~~~

The mysterious equity premium is the difference in return between corporate stocks and corporate bonds. And there's no mystery about there being an equity premium per se, since stocks are riskier than bonds. The mystery is about the size of the equity premium. It looks too big.

But in any event, privatization makes sense for the purpose of:

1) saving SS *politically*, by turning the negative returns to be earned by the young from SS into positive returns, as long as the return on private investments (not just stocks) exceeds *less* than the return on government bonds, which is what the young are going to get from SS as things are.

Hey, even private investment in government bonds does that!

2) reducing the *economic* funding gap, as long as the return on private investments (not just stocks) exceeds the return on US government bonds.

And anybody who predicts that in the coming 50 years the average return on market investments is going to be less than the return on government bonds is predicting the end of the world as we know it. You can write off all forms of SS in that scenario.

small total reit corp total money
stock stock stock bond bond market
12% arithmetic return
-1 almost geometric
-1 survivor bias
10 6 tax deferred nominal
-3 -3 past inflation
-2 -1 investing costs
-1 -1 international
5 4 3 2 1 0 3% while saving
-2 -1 1% while drawing
-1 -1 0% after tax draw

While the S&P 500 may have had a 7% real return, that is not what went into investors pockets. Having read dozens of academic papers on the subject, I've concluded past returns to U.S. investors are similar to the above.

I also question the equity premium model - Why not start with corporate equity = long term corporate debt? certainly 2 investors in one business wouldn't accept different returns for the same risk? While Mr. Corp. Bond takes all his money in cash now, Mr. Stock leaves part of his with the business to be withdrawn later they have the same risk - business fails and they lose money. The fact that Mr. Corp. Bond has nephews and cousins (municipal, short, t-bill)shouldn't disturb the relationship.

Any differences might be accounted for differing investing costs and how investments are taxed.

part of my post seems to have disappeared

or I should say it got compressed to the left side

"...doesn't the fact that stock market returns are very likely to significantly drop as the Boomers start selling their holdings..."

That's not self-evident to me. I'd think businesses (stocks) would continue to be priced by their earnings relative to earnings on other investments available in global markets -- which 20, 30, 40 years from now will be a lot more global than today.

When the boomers are retiring there could be a couple billion Asians looking to save for *their* retirements to whom US investment markets -- the world's safest and most developed, with the longest institutional history -- look pretty attractive.

Bob Leder, I buy your view except the part about "Longer and healthier lives..." Last May (I think), Foreign Affairs magazine ran an interesting bit called "The Coming Baby Bust."

One takeaway was that life expectancy for 65-year old American women is less than in 1980. Obesity. Many will endure SHORTER, more expensive retirements than anticipated, and health will preclude employment. The bit about nanotech seems too "deus ex machina" and will beg the question of rationing expensive health care.

http://www.econ.ku.dk/FRU/papers/2004/2004_01.pdf

another papaer on the equity premium puzzle

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=609226

and one on population aging and financial markets

Several points:

1. It's true that the SSI surplus gets lumped in with the regular budget deficit in the media to report a smaller deficit (or larger surplus) than really exists. This should have no effect in real terms, however. The bond market is made up of very smart people who are paid quite a bit to know everything they can about gov't debt. The interest rate the gov't is charged is not articificially higher due to the gov't's budget accounting.

2. There is no evidence to support that the SSI surpluses cause gov't spending to increase beyond what it would have. This means the surpluses are a real form of saving that can be tapped to at least partially offset the costs of paying boomer benefits.

3. In a self-enclosed system no piece of the system can grow faster than the whole system. In other words, stocks cannot grow at 8% while the economy gros at 4% forever. If they did then some things must be true:

3 a Stocks might grow an average of 4% above the economy as a whole but entail more risk. This means there has to be some lucky people making more than 8% (say 12%) and also people making less than 4%...even negative returns.

b The average return is not the same as realized returns. Just because a share was $10 in 1980 and $100 today doesn't mean that someone made $90. Along the way some people might have brought that share at $110 and lost while others may have brought it at $1 and gained more.

4. Finally the economics of the situation cannot be escaped. The economy of 2030 will pay the benefits of the retired and not the economy of today no matter what system is in place. The only thing that really matters is whether a particular policy will make the economy in 2030 stronger or not. If its 'or not' then you might as well not do it.

5.

The main benefit of social security reform, economically speaking, is not that it finds some previously untapped well of cash from which we can pay for our oldsters' retirements. As I see it, the primary potential benefit is that we're diverting resources from an unproductive use--the government--to productive investments that will make it easier for a smaller number of workers to support us all in the style to which we'd like to become accustomed.

Jane nailed this on the head but she allowed her ideology to botch things up at the end a bit. If gov't is saving that does not mean that gov't is putting resourses to use. Quite the contrary, when gov't is saving it is by definition freeing up resources for use by the private sector.

Imagine the gov't runs a $100 surplus. It goes into the debt market and buys back a bond for $100. Gov't's debt goes down but now the private sector (whoever owned that bond) has $100 cash. They are now free to buy a stock or corporate bond that should be a productive investment if all goes well.

In contrast when the gov't runs a $100 deficit it then directs $100 of resources OUT of the capital markets. If you believe the private sector is usually more productive then you have to accept this as a costly scenero.

At the end of the day if you channel 'savings' into the private market thru 'personal accounts' you have to also take into account the dissavings that will happen by eliminating the savings caused by the SSI trust fund system. It's quite likely they will cancel each other out leaving you in exactly the same boat.

You know, Jane, when it comes to Bush's will to push for private accounts in Social Security, I told you so.

Since Jason seems to be dead set aginst privatizing SS, I was wondering what combination of raising payroll taxes, raising the retirement age and cutting benefits he'd be in favor of. That's your other alternative. In your world, Jason, I guess I just get to sit and wait for the train to fly off the rails and burn.

I'm 33. I'd like to retire too. It's tough when I have to rely on myself to do it and I already start short 13% of my income, which is currently going down a giant rathole.

I'm willing to pay temporarily higher taxes to pay for the transition costs it would take to convert to private accounts.

A somewhat different view, perhaps, is that of S. Malanga, "The Myth of the Working Poor", found at
http://www.city-journal.org/html/14_4_working_poor.html .

You own that debt right now, and you'll own it in any proposed privitized system. Where is this increased investment going to come from? You're just shuffling money around.

One of us is way off track. I hope it's me, misunderstanding what you are saying, because otherwise it looks suspiciously that you aren't paying attention. In a nutshell, we are having this conversation because it appears that if current age-demographic and workforce trends continue, the problems in the current Social Security structure are going to grow and become much more expensive to deal with later, possibly (worst-case) even to the point of collapse.

Here's a radical proposal: Eliminate Social Security altogether. Get rid of payroll taxes, forget forced investment accounts, just reform the whole lot by simply ending it.

And then...

Give $X a month to every citizen over the age of Y. Where X and Y can change from year to year.

No, I'm serious.Here's why:

1) It's simple. Nobody understands Social Security. Everyone will understand that this year ElderIncome (the new plan) pays $X to everyone over Y.

2) It's honest. With Social Security, most everyone is pretending that it's not a pay-as-you go system they are funding their own retirement. ElderIncome destroys that fiction - a good thing - by being unabashadely pay-as-you-go.

3) It's easy. No keeping track of people's Social Security contributions or investment accounts. ElderIncome would have to be easier and cheaper to administer than Social Security is.

4) It's fair. Payroll taxes are regressive. And poor people get less money from Social Security than rich people. (Which might be fine if Social Security were a forced investment scheme, but it's not). ElderIncome treats everyone the same.

5) It's open. No hiding of Social Security "surpluses", no mystery as to where all that money goes. Every year we simply split $Z billion dollars evenly amongst our old people.

6) And there's no forcing people to save. People can still save if they want to.

So... what's the downside?

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