Asymmetrical Information

From the desk of Jane Galt:

Pension problems

Co-blogger Winterspeak had a post this week on his other blog about Malcolm Gladwell's latest article. Even if it weren't a very good post (but oh, it is) I would recommend you read it just to enjoy his use of the phrase "as mad as a box of mittens", which is, as far as I know, a first for economics writing. Days after first reading it, I am still rolling its verbal deliciousness around my mouth.

Now Malcolm Gladwell has responded:

One of the predictable responses to this is that this is the idea behind Social Security is--and look at the problem that program is in. I have to say, though, that what reading I have done into the Social Security issue hasn't convinced me that the program is in all that much trouble--that is, with a number of not entirely painless (but not debilitating) adjustments now, we can avoid a lot of the trouble down the line. Put it this way: would you rather, as a retiree, put your faith in the federal government or General Motors?

On that narrow question, Gladwell is right: it is better to have a government pension than a GM pension, because it is more likely that the government will be around in fifty years than GM (or any other company, no matter how good it looks today). Corporate pensions both have a higher failure rate, and are more volatile than goverenment pensions: Social Security will end up giving everyone a moderate haircut, where in the private system some people get a full pension and others get the scraps doleed out by the Pension Benefit Guarantee Corp.

But Mr Gladwell's article is flawed in a number of ways, some of which my co-blogger touched on. For starters, he attributes Ireland's success as the "Celtic Tiger" to falling birthrates, which (temporarily) reduced the dependancy ratio. He utterly ignores a more parsimonious explanation, which is that Ireland slashed its marginal tax rates in 1987, including a cut in the corporate income tax to 10%, which turned it into Europe's first outsourcing destination. If you look at the handy spreadsheet
I have uploaded, containing data on Irish growth from 1980-2005 obtained from the invaluable Economist Intelligence Unit, you will see that this fits the Celtic Tiger period much better than a 1979 relaxation of birth control restrictions. Moreover, since there is much evidence that economic growth causes falling birthrates by raising the opportunity cost of childrearing, even if there were a correlation it would be hard to say which way it ran. This also applies to his arguments about Asia and Africa.

Second of all, he attributes pension problems to higher productivity, which allows manufacturers to make more stuff with fewer people, and thereby increases their dependency ratio. This is daft. Increasing productivity also increases profits, allowing companies to pay more benefits using fewer workers; in fact, by decreasing fixed costs such as health care, it should make it easier to support retirees. GM's problem isn't that it's just too darn productive; it's that it's too darn unprofitable, thanks to foreign competition.

Many of his other assertions are equally weak. He implies that regional agreements, in which all the tool-and-die makers or auto plants in a given region, work better than company level agreements. But multi-company pensions such as these are creating huge problems: they drain capital from productive companies to prop up failing ones (see UPS), make it hard for new entrants to come in (because they have to take on gargantuan pension liabilities to do so), and ultimately make union shops uncompetitive. This is what is happening in the construction industry in New York, where open shop companies can offer lavish wages and 401Ks to their workers and still outbid union shops, because they don't have the extensive pension liabilities.

Nor does this make much sense:

Under the circumstances, one of the great mysteries of contemporary American politics is why Wagoner isn’t the nation’s leading proponent of universal health care and expanded social welfare. That’s the only way out of G.M.’s dilemma.

But we have nationalised health care for GM's retirees right now. Mr Gladwell may have heard of the programme: I believe it's called Medicare. This has done absolutely nothing for GM's dire fiscal situation, because GM's unions force it to offer benefits that are more lucrative than the national system. Unless we outlaw private insurance, as Canada does, it's hard to see how this would fix the problem.

I believe Mr Gladwell is right that our health insurance, our pensions, and our paychecks should not all come from the same place, particularly a corporation that may not be around when the bills come due. But that doesn't mean that they should come from the government; as P.J. O'Rourke once said "I mean, they can't even deliver our mail and it's got our address right on it and everything." The government solves the longevity problem by introducing huge problems of its own. Pay-as-you-go (PAYGO, in pension lingo) for starters: no private employer would today be allowed to get away with issuing its own corporate debt to its pension fund. Nor treating pension contributions as income without reducing that income by the amount of the accrued liability. Nor making promises without establishing assets to pay for them. Our government is encouraging the ignorant to save less than they will need for retirement. This is morally, if not legally, criminal.

I'll close with Winterspeak's response to Mr Gladwell's response:

Gladwell's first argument -- that it is betted to trust a government who will only renege slightly and shaft other people on your behalf rather than trust a company who will renege a lot and shaft you is true as far as it goes. It's also a weak position when there are perfectly good zero-shaft options out there (private accounts) which, if administered correctly, would have low operating costs and mandatory contributions.

The only dimension on which government pensions are better than private savings lies in the redistributionary potential of government programmes--which Winterspeak, and many of my readers, may think of as a bug rather than a feature. Personally, I think there are people in this country who are too poor to save, and I would like to see them taken care of in their old age. But that is an argument for a forced savings scheme coupled with a minimum, means tested pension--not this vast and crippled attempt by middle-class Americans to pick their own pockets. As Mickey Kaus says, "Sending checks to everyone is a nice thing to do. But we can't afford every nice thing to do."

From the desk of Jane Galt:

Time to stage an intervention?

Michael O'Hare contemplates Europe's demographic decline:

It's difficult, or perhaps it's too easy, to find a metaphor for three nightmares of which I have been watching (two from up close) over the last two weeks, and it's almost as hard to characterize watching while the participants have coffee and pay no attention. Seeing a good friend descend slowly into a debilitating, probably fatal addiction to drugs or suicidal behavior? Watching a town go about its business as the dam up the valley develops cracks and leaks? Wile E. Coyote heading off the cliff with grim determination?

The last one is no good, at least for my first scenario, because the coyote doesn't know about the cliff until his feet are flailing in the air. In contrast, the demographic suicide of western Europe is not only amply documented but obvious on the street: it's a world of grownups and most of them will soon be old. I live in a college town and my perception may be distorted by my own day-to-day experience being out and about, but outside student districts, Berkeley has children on the scene, on my street half a dozen in a stretch of a half-dozen houses. Milan, however, is a city of twenties and thirties, almost all single and childless, and their parents. In any case, all the few people who could have children in the next fifteen-plus years are already born and accounted for; demography is a science of long horizons and very early warning. The only thing I've ever seen to compare with this baby and child vacuum is the city of San Francisco, rapidly becoming a child-free zone with closing schools and empty playgrounds.

. . .

The phenomenon is creepy, but what's like a science fiction movie about zombies is the pervasive lack of concern. Good studies are commissioned and filed away, governments have started some tentative child-subsidy tax programs, especially generous in France, but there's no conversation about it, nothing in the newspapers, an election in a week in Italy and I can't find a word about this impending catastrophe from a candidate in the newspapers or on TV. The current administration seems to have spent its entire term in office keeping the prime minister out of jail, not attending to this (or anything else, as far as I can tell).

What could possibly be more important to Italy than the looming extinction of Italians? And even if the society had decided it's time to roll up the enterprise and pass the peninsula to someone else, or just turn out the lights and close the door, what do the twenties and thirties of today expect to have for dinner when they're old, having paid taxes to support their (more numerous) parents most of their working lives? Why is everyone acting as if this isn't happening??!!

As an italophile on many dimensions, sitting in a comfortable train [this is shorthand for a competent system of public services that provide a high quality of life] between Rome and Milan where life is very good in so many ways, in the land of Giotto, da Vinci, Fermi [supply your own pages of really smart Italians who think outside the box], I find myself suppressing a tendency to grab people at random by the collar and yell at them, "forse queste cose non mi riguardono, ma siete pazzi, voi? ciecchi?" (si, amici miei, questo è per voi) [maybe this is none of my business, but are you people nuts? blind?]

Excellent question. But his proffered explanation--economic insecurity and husbands who don't do housework--isn't very convincing. American men don't do much more housework than European ones (depending on the country, of course), and the birthrate is lower than the decidedly insecure period that followed WWII. A more convincing explanation, to me, is economic:

1. A shift to women working after marriage increases the opportunity cost of each child.

2. Increasing incomes also raise the opportunity cost, by increasing the amount of income that must be forgone in order to put energy into childraising.

3. Generous social security systems, including social workers to replace some of the social functions of children, mean that individuals have no financial need for children in their old age. There is actually evidence on this: several papers suggest that the more generous your social security system is, the fewer children your society will have.

Of course, we still need to come up with an explanation of why America, which is still getting richer and putting women into the workforce, isn't below replacement rate. But much of our fertility comes from poor women and immigrants, who have a much lower opportunity cost for childrearing than overeducated professionals like me. Our welfare policy may be inadvertently pro-natalist--since, unlike Europe, the only way for a healthy woman to collect benefit is to have children.

From the desk of Jane Galt:

Do we have a Social Security problem?

Calculated Risk says it's not worth bothering about compared to other problems:

This chart shows the relative sizes of the three major fiscal challenges over the next 75 years. The NPV for the General Fund deficit is based on deficits equal to 5% of GDP. Note: the fiscal 2006 general fund deficit will be close to 5%.

The estimates for Medicare and Social Security are from the GAO report (pdf): The Long Term Fiscal Challenge

From the GAO report:

"Health care is a bigger problem than Social Security. Participants acknowledged the need for Social Security reform but emphasized that Social Security is a relatively small part of the long-term fiscal challenge when compared to spending on health care. ... Several participants observed that few members of the public are aware of this. Rather, the general public impression is that solving Social Security would solve most of the longterm fiscal challenge, and this is not correct.

And on the General Fund deficit:

"Participants agreed that a key moral context is the impact federal budget deficits will have on future generations."

Conclusion

The debate should be focused on the two major issues: Health Care and the General Fund deficit. Without addressing those issues first, reforming Social Security is irrelevant.

Arnold Kling takes issue with this:

But the premise is also wrong. If we allocated a larger share of payroll taxes to Medicare instead of SS, we could argue that Medicare is not a problem but SS is the big issue. We should be looking at the challenge of funding spending as a whole, not looking at the arbitrary allocation of taxes to different programs. In terms of overall spending, Social Security is a gigantic issue.

Finally, it is disingenous to whine that we need to solve the other problems first, without offering a solution. Overall, this stance of "solve X and Y before you tackle Z" comes across to me as mere demagogic rhetoric, the end result of which will be that X, Y, and Z will remain unsolved.

I agree that the people saying "Social Security's not the problem, Medicare's the problem!" in general show an astonishing lack of interest in fixing Medicare; indeed, they are often the same people who want to add nationalised health insurance to the budget, which seems to betray a lack of committment to solving our budget problem.

But there's another problem with Calculated Risk's argument: Social Security is a major contributor to the General Fund deficit problem. The social security surplus masks the general fund deficit; if you take social security out of the picture, no president has run a budget surplus for more than thirty years. Taking the social security surplus away from our legislators is the most obvious first step to force them to address the general fund deficit. Moreover, after the surplus disappears, social security will become a major drain on the general fund.

It looks to me as if Calculated Risk's chart acts as if the "trust fund" were real. But as discussed many, many times before, the "trust fund" is not, from the perspective of the US taxpayer, funded. I'd argue that the relevant question, for the US taxpayer, is not the accounting distinctions that the US government makes, but what percentage of (tax revenues + borrowing) is devoted to paying Social Security benefits. Bringing the "trust fund" into things arbitrarily changes a substantial portion of the Social Security burden from benefit payments to interest payments. This substantially overstates the general fund deficit and understates the Social Security problem.

More broadly, the deficit has some institutional limits on it: lenders will not continue to indefinitely extend us unlimited credit, and as it goes on, political pressure will build, albeit slowly, to reduce it. Social security, on the other hand, has very weak limitations. While under statute, benefits are supposed to be slashed to meet revenues when the "trust fund" runs out, there seems litle realistic possibility that Congress will allow benefits to be suddenly slashed to 70% of their previous levels. And if they did, that would hardly rate as a good outcome in my mind, or presumably in the minds of the people saying that the Social Security system is "just fine".

By far the biggest problem with our budget, to my mind, is that we are communicating to senior citizens, and more importantly to future senior citizens, that they do not need to save all that much for their retirement, because someone else will cover their medical expenses and help them pay their bills. This is not an affordable promise, either financially or politically, and when it finally breaks down, either young workers or senior citizens--and probably both--will find themselves in big trouble. The purpose of reforming Social Security is to force people to consume less and save more, thus increasing the productivity of the economy that will have to support them. This is a very big problem, and pretending it isn't is just making it bigger.

From the desk of Jane Galt:

That sounds like a plan

Andrew Samwick blogs a plan that sounds like it is not only sustainable, but also could achieve broad consensus across the left-right spectrum--although not across the old/young spectrum. I imagine the AARP will go nuts, making such a plan DOA. But one can hope.

From the desk of Jane Galt:

Worried about social security?

Believe it or not, our public pension system is actually in relatively good shape. countries everywhere are desperately seeking a solution to the impending demographic crisis.

From the desk of Mindles H. Dreck:

Dreck's Annuity

[UPDATED BELOW - 'WE GET (incremental, complex) RESULTS (back in February)']

I recommend almost all of the NY Times Magazine this week, but the article I spent the most time with was the cover story by Roger Lowenstein on the Pension Crisis. Lowenstein provides a convenient inventory of key hazards that can be generalized to all the components of our retirement systems:

1. the moral hazards of government pension insurance combined with the tendency of providers to over-promise future benefits relative to current benefits
   

   Given that pension promises do not come due for years, it is hardly surprising that corporate executives and state legislators have found it easier to pay off unions with benefits tomorrow rather than with wages today. Since the benefits were insured, union leaders did not much care if the obligations proved excessive.

   
   
2. the problems associated with estimating future liabilities when a variety of assumptions about future events are plausible
   

   Corporations have been gaming the system by using the highest rates allowable, which shrinks their reported liabilities, and thus their funding requirements. The P.B.G.C., when calculating the system's deficit, uses what is in effect a market rate; whatever it would cost to buy annuities for everyone covered in a pension plan is, it argues, the plan's true "liability." The difference between these measures can be extreme. Depending on whom you talk to, General Motors' mammoth pension fund is either fully funded or, as the P.B.G.C. maintains, it is $31 billion in the hole.

   
   
3. the very human tendency for investors/pensioners to undervalue 'annuitization' or certainty of future income
   

   pensions typically annuitize - that is, they convert a worker's retirement assets into an annual stipend. They impose a budget, based on actuarial probabilities. This might seem a trivial service (some pensioners might not even realize that it is a service). But if you asked a 65-year-old man who lacked a pension but did have, say, $100,000 in savings, how much he could live on, he likely would not have the vaguest idea. The answer is $654 a month: this is the annuity that $100,000 would purchase in the private market. It is the amount (after deducting the annuity provider's costs and profit) that the average person could live on so as to exhaust his savings at the very moment that he draws his final breath.

   
   
4. the tendency to 'smooth out' times of poor fund performance in anticipation of better market results - combined with the tendency to take back excess gains or take 'funding holidays' when the market buoys pension values.
   

   If the stocks and bonds in their pension funds take a hit (as happened to just about every fund recently), they don't have to fully report the impact. Nor do they have to ante up fresh funds to compensate for the loss for five years. A similar smoothing is permitted on the liability side. And though, in theory, Erisa discourages underfunding by requiring offenders to pay higher premiums, its various loopholes render the sanction toothless. Thanks to another loophole, companies that contribute more than the required amount get to skip future contributions even if they later become underfunded. These companies are awarded so-called "credit balances," which remain in place even if the actual balance is showing red.

   
   
5. the tendency to make pension benefit increases a political or social engineering tool or, worse, raiding the funds themselves in pursuit of political goals or simple greed.
   

   California is a good example of the political forces that have driven benefits higher. In the 90's, Gov. Gray Davis, a Democrat who was strongly supported by public-employee unions, pushed through numerous bills to increase benefits. One raised the pension of state troopers retiring at age 50 to 3 percent of final salary times the number of years served. (Previously, the formula was 2 percent at age 50, more if you were older.) Thus, a cop hired at age 20 could retire at 50, find another job and get a pension equal to 90 percent of his final salary...

   ....One of the biggest pension offenders is San Diego, where six members of the pension board, including the head of the local firefighters' union and two other union officials, have been charged with violating the state's conflict-of-interest code, a felony. What is interesting about San Diego is that, juicy details aside, its pension mess actually looks rather commonplace. The six board members are accused of making a deal to let City Hall underfund the pension system in return for agreeing to higher benefits - including special benefits for themselves. Explicitly or otherwise, this is what unions and legislators have been doing all over the country.

   
   

The administration's goal of an 'ownership society' deals effectively with many of these hazards, but it does hit a rock with #3 - given control over the 'lump sum' pension amount, many pensioners will run out of money, which will ultimately rebound on the work force. It strikes me that our current tax system provides a variety of incentives to set aside retirement money but is not structured well to address the lack of annuitization. The recent changes encouraging 'Roth'-style accounts allowing earnings on taxed principal to circumvent the tax system entirely are a step in the right direction, but perhaps a roth-style annuity is called for as well. Wouldn't we benefit from allowing workers to buy a certain amount of a retirement annuity (say $50/month, inflation-protected) every year with pre-tax dollars, and pledge to keep the proceeds of those annuities protected from income tax throughout the pensioner's life?

I may be wrong on some tax details here, but I believe presently such an annuity can be bought only with taxed dollars or a retirement account, and the annuity proceeds are 100% taxable after all taxed basis (purchase amount paid with post-tax dollars) has been returned to the investor. They have a slight and under-appreciated tax advantage. On the other hand, they are complex, and sold through the over-commissioned life insurance distribution network, both of which repel the average investor.

My point is that any outright guaranty or government-run system carries lowenstein's hazards, so an ownership society is probably necessary. However, the government can do much more with the incentive dollars it is spending now to promote annuitization and reduce the hazards of these policies.

UPDATE:

A congressional measure introduced in mid-June aims to encourage the use of annuities by giving people a tax exemption on 25%, up to $5,000, of the income received from annuities purchased through qualified retirement savings plans. The bill, H.R. 2951, called the Lifetime Pension Annuity for You Act of 2005 and introduced by Rep. Earl Pomeroy, D-N.D., was referred to the House Ways and Means Committee. Another bill that offers a tax break for annuities, H.R. 819, now boasts 64 co-sponsors.

See also some typically poignant commentary from Winterspeak:

It probably has to do with social contracts, animism, and the special glow that money from some sources has but money from other sources lacks. I would also add that the last I checked, private savings is available to both the rich and the poor (although their savings rate may be very different) ...

If almost half a trillion dollars is a little moral hazard, I'd hate to see what a lot of moral hazard looks like (although maybe Fannie Mae will show me).

On that first point about savings rates, he may be wrong. I found a fascinating NBER study 2-3 years ago that suggests marginal tendency to save is correlated with factors other than income. I sent it to Jane once but I'm still trying to fish it out. When will people stop calling me 'Jane'?

Here's the NBER study summary (I located my copy on my hard drive):

We show in this paper that at all levels of lifetime earnings there is an enormous dispersion in the accumulated wealth of families approaching retirement. It is not only households with low incomes that save little; a significant proportion of high income households also saves little. And, a substantial proportion of low income households save a great deal. We then consider the extent to which differences in household lifetime financial resources explain the wide dispersion in wealth, given lifetime earnings. We find that very little of this dispersion can be explained by chance differences in individual circumstances largely outside the control of individuals' that might limit the resources from which saving might plausibly be made. We also consider how much of the dispersion in wealth might be accounted for by different investment choices of savers some more risky, some less risky given lifetime earnings. We find that investment choice is not a major determinant of the dispersion in asset accumulation. It matters about as much as chance events that limit the available resources of households with the same lifetime earnings. We conclude that the bulk of the dispersion must be attributed to differences to in the amount that households choose to save.

Lowenstein even says something about the Bush administration that will leave liberals gasping for breath:

Enter the Bush administration: it has essentially declared the era of permissiveness over.

except for steel and autos, of course...

From the desk of Jane Galt:

United in the dock

This post by Kevin Drum implies (with an able assist by Senator Chuck Grassley) that United's pension fund was underfunded through gross company malfeasance:

PENSION PROBLEMS....The New York Times reports today that the failure of the United Airlines pension fund was perfectly predictable. In fact, the SEC knew all about it:

Loopholes in the federal pension law allowed United Airlines to treat its pension fund as solid for years, when in fact it was dangerously weakening, according to a new analysis by the agency that guarantees pensions. That analysis is scheduled to be presented at a Senate Finance Committee hearing today.

.... "We saw similar practices and events at Enron, but unfortunately, this time it's perfectly legal," said Senator Charles E. Grassley, the Iowa Republican who is chairman of the finance committee.

....The Pension Benefit Guaranty Corporation found that in 2002, when United was determining how much it had to contribute to its four plans, it calculated that the plans for its pilots and its mechanics each had more money than needed....Those numbers are on file with the Labor Department. But they do not square with the pension numbers United provided to the Securities and Exchange Commission. That agency requires companies to calculate pension values in a different way. At United, that method showed the four pension plans to be only 50 percent funded.

Anytime you see "Enron" and "perfectly legal" together in the same sentence, you just know that something is wrong, don't you?

As Grassley points out, it's not just airlines that are having pension fund problems. The rules regarding pension fund solvency today are about as rigorous as the rules regarding S&L solvency were in the 1980s. My guess is that the end result is going to be about the same too.

Let's go to the tape, shall we?

First of all, Enron's many problems stemmed from violating Generally Accepted Accounting Principles (GAAP) by using a slew of special-purpose vehicles (168 of 'em, if memory serves) to keep liabilities off the books and artificially inflate their profits in order to fool investors. United didn't violate GAAP; that's the stuff they filed with the SEC. They also didn't violate pension-accounting rules; they prepared their numbers just like the PBGC told them to.

But that is a bad way to prepare their numbers, say critics, and I agree (provisionally, since I know nothing about the difference between PBGC standards and GAAP). Nonetheless, unlike Enron, United did not gin up fancy numbers to cover up the fact that they were getting themselves into trouble, or looting the company.

The article makes it sound as if the bad numbers were covering up malfeasance. But this was nothing of the sort. Note the year: 2002. What happened in 2002? Airlines took two big hits: a nasty recession, and a sharp decrease in passengers. That drove their revenues sharply negative at the same time as the collapse of the stock market bubble knocked the stuffing out of their pension fund. This resulted in an underfunded pension plan at exactly the worst time for them to try to top it up.

Now, there are all sorts of problems with how pension plans were managed in the 1990's; management started expecting 10% annual asset growth a year (then a conservative estimate), and consequently, put very little money into their pension plans. They are paying for that now, although not fast enough for my taste--Congress is letting them slow down the rate at which they top up their unfunded plans. While in hindsight, 10% is clearly too high, it's not clear what a good number would be, and certainly the sharpest critics of corporate pensions seem to have very little to offer on that subject. Nor do I see a good way to codify a number if we did all agree, since markets change, and any bright legal line would be certain to fall afoul of reality in some way down the road.

Anyway, the point is that the problem was not malfeasance at United. You could have forced United to account for its pension any way you like and it would not have made one whit of difference to the final outcome, since by the time United's pensions were clearly grossly underfunded, United didn't have any money to put in them. Nor is the government going to indict a company for taking heavy losses in a bear market. All of this ranting about United is just grandstanding.

That said, there are big problems with pension underfunding now, and Congress, out of an understandable fear of accidentally forcing weak firms into bankruptcy, is allowing corporate America to fund its obligations rather too slowly for my taste. But it doesn't exactly rise to the level of criminal--or regulatory--conspiracy.

From the desk of Jane Galt:

Oooh, yeah . . .

Sensible talk about Social Security from Voxbaby:

I don't think there is any way to suggest that the government could pre-fund future obligations through running surpluses inside the Social Security system over any sustained period. Whatever lockbox there is has 536 keys, but more importantly no lid.

For me, the debate is becoming less and less about philosophy or efficiency, and more about the inequity of passing such large burdens off to future generations of taxpayers. I freely acknowledge that this burden is coming not just from Social Security, but the growth of Medicare and the inability of the government to balance its budget. A sensible fiscal policy would have the on-budget deficit sum to zero over the business cycle and all long-term entitlement programs to have zero projected long-term actuarial deficits.

That would have been my rejoinder to Mark Kleiman's assertion that we could "fund" Social Security by paying down the national debt. I regard this as true but not useful, since despite the fulsome protestations of some Clintonophilic economists, the surplus of 1998-2000 seems to me much more a product of a unique historical moment than any reproducible political strategy. We had a sudden spike in tax revenues, thanks to the bubble, that involved taking money relatively painlessly from people who had made it relatively painlessly. We had abnormally low military spending, both as a percentage of GDP and as a percentage of the federal budget. We had abrnomally low unemployment, thanks to extremely loose monetary policy linked to the Asian crisis and Y2K. We had managed to control growth in health care costs through HMO rationing, which congress and state governments were busily undermining even in that golden era. In short, we had an unusually high amount of funds, and and unusually low need for them, thanks to a productivity boom, easy monetary policy, and an asset price bubble. This is not sustainable long enough to pay off the national debt.

I don't say this to excuse Republicans in Congress and the White House, who are being grossly irresponsible with the nation's purse strings. But I do not expect any coalition to emerge which will behave substantially differently. For all the rhetoric about balancing the budgets, I do not see many politicians in either party who want to tell voters that the government is not a magic machine for generating free money. Sure, Kerry liked to talk about re-instituting PAYGO rules, but he also liked to talk about covering uninsured people. Which promise do you think he would find more urgent once in office? Which one would be easier to sell to a public that likes to get free stuff, and thinks that the government can provide it? Not that the public doesn't think PAYGO is a nifty idea, in abstract. But deep down it's a dingy little procedural matter that will generate little publicity and less notice. Covering the uninsured, on the other hand, is SPLASHY!

. . . and that is how spending grows in America. I begin to think that big budget deficits may simply be endemic to a bicameral system like ours, where benefits are targeted but legislative responsibility for deficits is diffuse.

Given those constraints, I favour finding programmes that legislators will support, but will nonetheless force them to behave more responsibly. Social security privatisation seems like such a scheme to me. Take the social security surpluses and dedicate them to the thing they are supposed to be doing--funding retirements--and you will force congress to behave more responsibly, because there are limits to the deficits they can run. This is one fewer obligation we are leaving to our children, and, as a bonus, there's no risk that a bunch of pensioners will suddenly find the government has defaulted on its "guarantees", as has happened in places that promised more payments than they could afford.

Update More from The Economist.

From the desk of Jane Galt:

More on Daniel Gross and pensions

Daniel Gross's article on corporate pensions also contains this bit:

Because the national pension system—like many of its private-sector counterparts—is woefully underfunded, we are told, stakeholders must be willing to accept benefits that are lower than were promised and less than were anticipated. But as Zimran Ahmed points out, this comparison is silly. Our pension system (Social Security, for those following along at home) isn't underfunded--it's unfunded. And there isn't any way to fund it, in the sense of storing up assets to cover the liabilities, unless we change the law so that the government can hold stocks or other assets. As P.J. O'Rourke has said, "the people of Eastern Europe had some very pungent names" for government ownership of economic assets.

Given the current legal structure under which our government operates, then, either big tax increases, or big benefit cuts, will be needed to make inflows and outflows balance in the future. Congress hasn't failed its fiduciary duty; the crime is that it has allowed people to think that there is a pension system in the first place.

Posted by Jane Galt at 4:04 AM | Comments (31) | TrackBack

From the desk of Jane Galt:

More on the PGBC and corporate welfare

I think I have discovered the source of one of the arguments I've been having about why the Pension Benefit Guaranty Corporation's assumption of United Airlines' pension funds is not corporate welfare.

The PBGC premiums, my interlocutors argue, are too low. This, they say, is corporate welfare.

Why yes, I say, it is. But that doesn't make the pension bailout corporate welfare.

Huh? They say. Let me explain.

Imagine that congress made a law forcing GEICO to underprice car insurance. We can build a simple model in which GEICO has five customers, all of who have a 1-in-5 risk of having an accident, meaning that, on average, there will be one accident in the insurance pool a year.

Now, let's say that the cost of every accident is $500. GEICO should be charging us each $100, which will just cover the cost of the accident. (This assumes, of course, that GEICO neither needs to make a profit, nor can invest the premiums. But this simplified model works perfectly well in this case.)

Let's say that instead, Congress sets the premium at $50. GEICO collects $250 from the five of us. Then my friend and co-insuree Ual (he's from someplace in central Asia you've never heard of) gets into an accident. GEICO, living up to its excellent reputation for service, immediately cuts him a $500 check. GEICO is out $250. If this keeps up, GEICO will need to be bailed out by the congress that forced it to underfund.

Is this $500 worth of welfare to Ual? No; he's paid premiums. Is it $450 worth of corporate welfare? Again no. To see why, look at the payouts with or without the mandatory pricing:

With congressionally-mandated price ceiling: $500 payout - $50 premium = $450 benefit to Ual

Without CMPC: $500 payout - $100 premium = $400 benefit to Ual

Benefit of CMPC to Ual: $450 benefit w/CPMC - $400 benefit w/o = $50

GEICO is out $250, but Ual only got a $50 benefit! Where'd the rest of the money go?

Why into my pockets, and those of the other 3 insurees. We each received a $50 benefit: we were insured for $100 worth of risk (a 1-in-5 chance of suffering $500 worth of damage to our cars) for only $50.

Now, this is complicated in the real world by several things. First, UAL has a higher risk than other companies of going bankrupt, and its pension fund is larger, so the artificially low premiums, capped by congressional fiat, are more valuable to UAL than many other companies. However, that doesn't change the fact that the benefit of lower premiums is several orders of magnitude smaller than the size of the pension bailout, and took place mostly in the fairly distant past. That's why I'm not excercised about the bailout as an example of corporate welfare.

The second complicating factor makes this look even less like an example of corporate welfare: the PBGC payments in no way benefit the company. They benefit the employees.

The PBGC takes over company pension plans when the companies are in bankruptcy. There is no benefit to the company here; the company can discharge its unfunded pension obligations whether or not there is someone to pick up the tab, because bankruptcy is the legal recognition of the existing fact that the company does not, and will not in the reasonably forseeable future, have enough money to meet all its obligations. The number of companies that did, in fact, discharge their unfunded pension obligations in the early 1970s (often after looting the pension funds to stave off bankruptcy) is the reason that the PBGC and the ERISA regulations governing pensions were put in place.

Rather than benefiting companies, the PBGC forces them to pay premiums in order to insure their workers against underfunded pensions in the event of a bankruptcy. Now, I don't say that the PBGC shouldn't do this; I think it's a rather good idea. But it's obvious that the PBGC in fact hurts "the corporation" as an entity, forcing it to pay premiums for insurance against an event that cannot harm the corporation itself--as if congress had passed a law forcing GEICO to collect its premiums from the estates of your deceased neighbours.

In other words, congress has decided to bail out pensioners whose companies go bankrupt, and to stick corporations with part, but not all, of the bill. There may be an argument for sticking them with more of the bill, but (on the assumption that few companies are planning to go bankrupt), not a very strong moral one (I am assuming that ERISA, which forbids companies in trouble from dipping into the pension plan, is still in force; otherwise the PBGC would be corporate welfare.)

Nor, I think, can the decision not to raise what is essentially a tax on pension plans be construed as "corporate welfare" in the same sense that paying Dole to go abroad and market the hell out of its pineapple, or giving oil companies special income tax abatements, is "corporate welfare".

From the desk of Jane Galt:

Is the Pension Benefit Guarantee Corp corporate welfare?

Battlepanda, who seems to be some sort of left-liberal, is interrogating libertarians about the United Airlines bankruptcy, in which it is being allowed to default on its pension funds, thus passing them off to the US government. This will probably result in cuts in benefits for at least the Pilot's union (I believe the maximum annual pension the PBGC will pay is around $40-50K), and of course, a huge bill for the PBGC.

Alex Tabarrok chooses to respond to the recent horrendous decision to let United screw over their employees by jettisoning their pension plans and letting the taxpayers pick up most of the remaining liabilities by making a convoluted jab at Social Security:

A large organization counts on its younger workers and continuing high revenues to fund the pensions and medical care of its retired workers but finds that rising health care costs, longer life-expectancy, and its own inability to control spending force it to cut pension benefits and switch to personal accounts.

Kinda makes you go hmmm...doesn't it?

You know what makes me go "hmmm..."? The lack of honest libertarian analysis on a situation that could really use it -- corporate welfare. Is Alex's hackles not raised by the violation of free-market principles foisted on the business community by the likes of United being kept on life support? Does he not find it distasteful that his tax dollars are going towards honoring United's liabilities so that it can go on, zombie-like, for a few more quarters?

I'm not sure that Angelica quite understands bankruptcy law and the Pension Benefit Guarantee Corporation. The PBGC, while it is grossly underfunded, isn't exactly "corporate welfare"; it's a government-chartered pension insurer, which forces pension plans to pay it premiums (the worse shape their pension/company is in, the higher the premium), and in return regulates the hell out of the pension plans. It is not incorporated for the benefit of the corporations, who do not like either the premiums or the regulation; it is for the benefit of the workers. The PBGC steps in to cover pensions that have already been discharged in bankruptcy or liquidation. It possibly introduces an element of moral hazard, making bankruptcy judges more willing to discharge pension obligations, but it is not corporate welfare in the same way that, say, the Chrysler bailout was (and even that was done for the benefit of autoworker votes, not Lee Iacocca).

Many, perhaps even most, libertarians object to the PBGC on principle. Personally, it's the sort of programme I can live with. Markets and companies change in unpredictible ways, and the PBGC is a way of making sure that those who, in perfectly reasonable good faith, assumed that they would have a corporate pension to support them in retirement, do not end up destitute. It has its economic costs, as do all regulatory institutions, but as with FDIC, I think the benefits in terms of economic stability outweigh them.

I'm not really sure what Battlepanda's objection is. UAL is insolvent--can't meet its debt payments or its pension obligations. Does she think that bankruptcy law should force liquidation? Hard luck for the workers, suppliers, and so forth, no? It's pretty generally recognized that Chapter 11 bankruptcy is one of the great strengths of the American economy, allowing companies in hard times to restructure rather than expire, salvaging something for workers, creditors, and the company. And allowing UAL to at least try to limp along isn't costing the taxpayers anything, as far as I know. The only people who lose out are the stockholders.

Or is she arguing against the PBGC? But should we really just abandon people who made the mistake of depending on their pensions? Tell a 58-year-old stewardess to suck it up and go to phlebotomy school? UAL cannot survive if its pension and debt obligations aren't reduced; it's pensions are underfunded by billions, and the airline is losing something like $1 billion a year. Pension obligations aren't senior to secured debt, and as far as I know, most of UAL's major assets are either security for debt (planes and other major capital equipment) or non-tradeable (landing slots, which I believe revert to the port authority upon liquidation, though I could be wrong about this). Without a Chapter 11 plan in which it sheds its pensions, UAL will have to liquidate; but because the assets tend to be secured, even if UAL does liquidate, the pensions seem to get little more than they have now. Meanwhile, all the employees who just lost their pensions also lose their jobs.

There are real issues with these sorts of bankruptcies--for one thing, UAL's new and improved balance sheet may allow it to compete harder, forcing already-tenuous companies like Northwest and Delta to follow suit. But I don't think that corporate welfare can be rightly said to be among them.

From the desk of Jane Galt:

Who's the hypocrite?

Even if the "trust fund" is technically "insolvent", isn't Bush really trying to fool ignorant people into thinking that it will have no money at all in 2042, instead of the 70% of benefits it will be able to pay out?

Now, I'm the last person to accuse the American public of being financial geniuses, but you'd be surprised at how well they grasp the basics of bankruptcy--working class people tend to know someone, or some company, who's gone bankrupt. So no, I do not think that the Great Unwashed confuse bankruptcy with "having absolutely no income or assets". This is the mistake of college students, whose income generally consists of cash assets donated by their parents.

Let me turn the question around for my Democratic interlocutors. When Democrats tell people the system is "just fine" until 2042, do you think that people understand that either taxes or government borrowing will have to go up, or current spending on other programmes go down, starting around 2015? Or that they would think that "in 2041 you get your benefit; the next year it drops by 30%, followed by more cuts as needed" is really "just fine"?

From the desk of Jane Galt:

Regulating risk

There's a debate that we should be having in this country, about risk, but aren't, because everyone's trading scare stories about Social Security.

In a follow-up post, Matthew Yglesias argues with Alex Tabarrok about whether the United Airlines bankruptcy, in which they have just shed their pensions, means that Social Security is more obviously bad, or more obviously good, than it was before. (Will Wilkinson chimes in here). Defined benefit programmes are risky, Alex points out, because when conditions change, they tend to become insolvent. That's why the government needs to have one, argues Matthew; with corporate programmes blowing up left and right, people need some safe harbor in their sea of troubles. (That's one coherent metaphor, if you imagine the pension system to be something like Pearl Harbor. Luckily, that's not very hard to imagine.)

Who's right? Well, basically, there are three entities that can bear retirement risk: a company, a person, or a government.

There are problems with all three. People are too small to be actuarially sound; they can be wiped out by adverse events. Also, some of them are incredibly stupid about money; others like to gamble.

The defined benefit corporate pension plan has been, for a long time, the holy grail of liberals. It was lavish and safe. It is also dying. Not that it was ever that prevalent in the first place, mind you; liberals who lionize the Golden Days of the fifties and sixties seem to believe that everyone worked for either IBM or GM, when in fact most jobs, just like today, were with small businesses.

But the corporate pension was certainly *more* prevalent. Unfortunately, time has revealed its cracks; companies aren't very good vehicles for managing this sort of risk. Time is the biggest one; pensions require companies to plan over time horizons that span 30 or 40 years. That was fine in the cozy, protected, and highly regulated environment of the 50s and 60s, but when the market changed, the pension promises couldn't. This is what (among other things) is dragging down the major airlines; I expect that within the next decade we will also see Ford and GM default on their pension promises.

The government, which is an actuarially sound pool, seems like a natural to take over insuring away this kind of risk. Unfortunately, government has its own problems. For one, it is even more rigidly unable to cope with changes in the pool than an old industrial firm coping with an intransigent union. T his is saying a lot. But it is justified. Look at Medicare, which everyone except the AARP agrees is a total financial disaster which will destroy the fiscal health of the United States unless something is done to control costs. Our politicians are well aware of the problem, and so they feverishly worked to--tack on a prescription drug benefit that will add trillions to the bill. At least when companies have insufficient accrued assets to meet their accrued liabilities, the government forces them to trim benefits or raise contributions. Government programmes, on the other hand, have a tendency not to self correct until the crisis is upon us--by which time the nature of the fix has gone from painful to catastrophic. And taxation to support government insurance programmes has a high deadweight loss.

What's the best solution, then? I'd say we're converging on it: a system of minimal government insurance for those who have been unlucky, in life or investments, combined with a regulated forced savings plan to make sure that those who aren't unlucky aren't tempted to free-ride on society, and incentives to employers to encourage additional savings among employees. This won't make anyone ideologically happy. But it seems like the least intrusive, most fair, most economically sound possibility.

Update Something I meant to say, but somehow forgot to, is that people have advantages, as well as disadvantages, the chief one being that they are the best judges of their ability to work, their basic needs, and the tradeoff between current and future consumption.

When someone has a pension, that person should retire at the earliest year it will allow him to take a full benefit. On the other hand, when a person has assets, they have to decide between consuming more leisure now (by retiring) or consuming more goods later (by continuing working and leaving their nest egg untouched). In the first scenario, there's no tradeoff-you cannot maximise your later consumption by continuing to work. Given that older people have skills and experience that are generally valuable, it is in the best interest of society that they continue contributing those skills to the labor pool for as long as possible, rather than living off the work of others.

People are also better judges of what is the basic standard of living they will be happy with than the government. (Though there's new behavioral research showing that people may make bad judgements about deferring consumption, there's no evidence that hte government--which is, after all, elected by those same people--makes better ones.) Furthermore, government pensions have a particularly pernicious feature: retired people can vote to increase their pension payout without having deferred earlier consumption to pay for it. This is not quite playing the straight bat. Government pensions also introduce a considerable element of moral hazard--save nothing now, and force your children, and everyone else's children, to stump up when you retire!

[Don't corporate defined benefit pensions introduce the same moral hazard?--ed. No. Workers with defined benefit pensions are trading off current salary for the pension benefit, as you'll readily see if you sit in on any union negotiations. They can't--unless they buy a lot of their company stock--vote themselves higher benefits later.]

Update II Will Collier points out another problem with corporate pensions: depending on the same company for your livelihood, and your retirement, is bad mojo.

From the desk of Jane Galt:

How can a "trust fund" go "bankrupt"?

How can I argue, my critics ask, that the trust fund is going to go bankrupt, when I don't even believe there is a trust fund?

But I'm not arguing that the trust fund is going bankrupt. I think that the trust fund is a political fiction, as is its purported bankruptcy.

But at least it's a consistent fiction. Democrats are trying to argue, on the one hand, that the trust fund is real, and on the other hand, that it is not going bankrupt. These are mutually incompatible. For the trust fund to exist, the Social Security Administration must be an independant entity of the US government. Unless the programme is changed, in 2042 that independant entity will not have enough money coming in to cover the benefits it has promised to pay out. That entity will be insolvent--in common parlance, bankrupt.

(So why isn't the government bankrupt now demand some of my critics. Because, my little chickadees, unlike the SSA, the government can borrow money. And it can borrow money because the market knows that if it needs to, it can raise taxes or cut spending--again, unlike the SSA. The SSA is an entity with fixed revenues and fixed obligations which are getting ready to diverge sharply, in the wrong direction.)

If I don't think the system is going bankrupt, why do I want to reform it?

Well, I don't, all that much. I'm not one of those libertarians who believes, either for economic or ideological reasons, that Social Security represents The End of the World as We Know It. Social Security isn't really a hobby horse of mine, and it certainly doesn't get me worked up in a lather the way, say, school choice does.

Nonetheless, I think we have a very large general budget problem, caused in large part by our demographic problem. Most of that demographic problem is caused by Medicare, but a sizeable chunk--in the neighbourhood of $6-10 trillion, or approximately 30 years worth of Bush's tax cuts--is caused by Social Security.

Now, it's possible to argue, and some have, that the Social Security problem is pretty trivial; over the next 75 years, they say, social security payouts go from 4.35 percent of GDP in 2003 to somewhere between 5.35 to 9.08 percent of GDP in 2075, with a median estimate of 6.65 percent. A mere 3.73 percent increase, at the highest!

There's an element of innumeracy here: the change is, of course, not a 3.73% change, but an 85% increase in spending on Social Security, which is already an enormous programme. The median estimate represents a 53% increase in spending. Current revenues are higher than outlays: 4.97%, in 2003. While the low estimate would mean we barely need to raise taxes, that median "best guess" estimate means your payroll taxes would have to rise by 33%--an extra 4% of your income going to one programme. But since we're already spending that extra revenue on other things, unless we cut those programmes, the better number is a 53% increase, or just under 7% of your income. Doesn't sound like much? If you make $50K, that's an extra $3,500 a year. I don't know about y'all, but the budget at Stately Galt Manor is tight enough that a missing $3,500 would mean foregoing something pretty critical, like food, shelter, or clothing. I don't really feel like I should have to take in a roommate at aged 50 so that my slight elders can make their greens fees.

Want to pay for it out of income taxes? Federal tax haul seems stuck at around 20% of GDP. Income taxes would have to go up by more than 10%. And god help us if people live longer, or productivity growth slows, or both, bringing us to that 9% number. Even assuming no deadweight loss from additional taxes--a heroic assumption--income taxes would have to rise by roughly 30% just to finance Social Security; alternatively, we could more than double the payroll tax.

Can we do this? Probably; Europe already does--and consequently, their pensions really are unsustainable. But it will put immense strain on our budget. (Which won't matter because Medicare will have caused the budget to implode like Paris Hilton's dignity, but that's another rant). Also, it will undoubtedly push more people into working off the books in order to avoid their social security taxes--making both our tax system, and our workers, less secure.

More importantly, why should we? I'll be drummed right out of the Fervent Libertarian Journalist's club, but I see a real role for government in protecting people from the risks of bad planning, or insufficient income to fund retirement. A welfare transfer to those who've had bad luck is undoubtedly necessary. But why on earth should we continue with this mad attempt of the middle class to get rich by picking its own pocket?

Social security as it is currently configured has a number of bad political/economic effects. It encourages people to retire early. The illusory "trust fund" gives congress several hundred billion dollars of income to play with every year even while accruing massive unfunded liabilities for Social Security and Medicare. It seems to discourage not only private saving, but also having children--the free rider problem writ on a society-wide scale. Social security, in short, seems to take money that would have been saved by investing in the private sector, and spend it instead on farm subsidies and underutilised light rail systems. It's not nearly as progressive as a welfare programme funded out of general revenues would be.

The current system also deludes workers into saving less than they need to by providing the entirely false illusion that they are earning benefits with their "contributions". If they realised that the current system is underfunded, and that they have absolutely no legal entitlement to their benefits, they might save more. Private accounts would alter this.

I understand why liberals object--they think that without the middle-class entitlement, benefits at the bottom would be cut. Perhaps, though I think the evidence for that proposition is pretty underwhelming. But this does not strike me as a sufficiently compelling reason to avoid reforming the system. Trying to implement a huge boondoggle system of cross-subsidies in order to maintain benefits for the relatively small number of elderly poor is using a chainsaw to attack a gnat--you're more likely to put an end to yourself than the problem.

A system of forced savings, on the other hand, funnels money into productive private investments, even if you (as I would) force participants to index, and move their savings into progressively safer investments over their life cycle. Backed up by a system of welfare for the unlucky/immiserated, it is more progressive than the current system, at least as safe, forces workers to plan their retirements instead of depending on the government, and reduces deadweight loss from taxation at least somewhat. What's not to love?

From the desk of Mindles H. Dreck:

I wish I'd said it

I wish I'd said it so concisely:

At its heart, the muddle over social security reflects the muddle over other, basic questions, such as "should people save for themselves or should the government save for them", "should the government take money from rich people and give it to the poor or not? If they should, how much?". As social security stands, it saves for no one, and takes from both rich and poor young people and gives to rich old people.

While looking through Winterspeak, I also notice that Zimran also seems to have a perfectly acceptable corrections policy (paging Mr. Cohen), as demonstrated in this post on marginal tax rates.

From the desk of Jane Galt:

Morally Bankrupt?

Matthew Yglesias repeats a claim I've heard from a lot of people who don't understand the meaning of insolvency:

Is the liberal media killing Social Security privatization?

Russ Mitchell of CBS Evening News wouldn't even give the president credit for facts that are indisputable. According to Mitchell, "Mr. Bush said he's open to any good idea to fix a system he claims is heading for bankruptcy." Bush doesn't have to "claim" the system is going bankrupt. According to the Social Security Administration trustees, benefits paid to retirees will exceed payroll taxes collected by 2017. By 2041 the system will be totally broke.

Of course, I'm not happy with that kind of reporting either. Every time the President gives a speech claiming the system is heading for bankruptcy, I'd like to see news services report, "Speaking today in Canton, Ohio, the President repeated his misleading claim that Social Security is headed for bankruptcy. In fact, even after Social Security's trust fund is exhausted (projected by the Social Security administration to happen in 2041, and by the Congressional Budget Office to happen in 2052) tax revenues will suffice to pay seventy percent of scheduled benefits."

Sadly for Matthew and others using this argument, Social Security would still be bankrupt (technically, insolvent--in the US, bankruptcy is generally undertaken voluntarily, as a way of escaping insolvency--but the words are used interchangeably by lay people) in the circumstances he describes.

The belief that bankruptcy means you have no cash is wrong, and further, makes no sense. Oh, bankrupt individuals often do try to wait until they have no cash--why give things to creditors when you don't have to? The liens will be just as dischargeable as the unsecured debts. Bankrupt companies, however, generally have to declare bankruptcy when their long-term cash flow becomes insufficient to meet their bills (though not, of course, until management has executed every Hail Mary Pass it, its family members, and the psychic who works down the street, can think of).

USAir, for example, is not "bankrupt" in the sense that it hasn't any money coming in or going out; it is bankrupt in the sense that it couldn't meet its future obligations with its future cashflows. Much like . . . why, Social Security. So Matthew's preferred formulation would, in fact, be wrong, just like the one that the National Review is objecting to.

From the desk of Mindles H. Dreck:

Scorecard for Private Accounts

UPDATE and BLEG: I created a table version of the graphic below, with a few updates. For some reason when I paste it into the post it breaks open a huge chunk of white space. Any ideas?

I penned a rough draft of this in the comments at the end of my last Social Security* Post in response to this question:

"If the trust fund put $1 trillion into the stock market, and the government issued $1 trillion dollars of extra debt, would in your view Social Security be better off? It sounds like you think so with private accounts."

I'm cleaning my response up here in a table and making it a separate post.

The questioner jumbles private accounts with an equity-invested government reserve, but I answered assuming private accounts and looked from the perspective of beneficiaries and government as a whole (taxpayers..). The 'Social Security System' perspective is meaningless since it's part of the government.

This doesn't necessarily represent the President's Plan, rather a generic combination of private accounts and benefit adjustments. I'm not positive it is complete, so I'm interested in the potential discussion. I don't view this as an advocacy exercise, at least until I feel comfortable it's complete and I can start estimating amounts. Finally, it doesn't take into account distributional effects between beneficiary cohorts.

*The Ancient and Noble Scheme That Shall Not be Altered™ (still making up my mind on the right phraseology. Perhaps 'The Scottish Plan'?)

From the desk of Mindles H. Dreck:

IOUs for dummies

What sort of "asset" requires that you yourself borrow more money to cash it in? If I have to incur a new liability in the exact same amount to liquidate it, do I really have an asset?

In the extended entry, I explain one more time with pictures and ledger balances for the financially illiterate and/or analogy impaired that the assets in the Social Security Trust Fund are of no particular consequence (as my co-blogger already explained).

It is surprising that Democrats have made private accounts their Maginot Line in the Social Security* debate. In addition to the arguments made by the President, and his willingness to take this opportunity to make the system more progressive, there is the simple fact that creating private accounts is the only way to create a funded reserve for promised future social security benefits. To me this is the greatest benefit of such a plan. The government has proved itself incapable of maintaining reserves such as we normally demand from the private sector.

PRESS ECONOMIC ILLITERACY UPDATE: What's amusing is that I'm arguing below against calling the Trust Fund an asset from an external debt point of view. Anna Bernasek, exploring the limits of national debt in the Times on Sunday, doublecounts it as a liability alongside the actuarial shortfall. She actually increases government's net liability for Social Security to over $6 billion! It's both - it's neither! Could we get this straight? [of course this is the reporter who writes about taxes and incentives and conveniently ignores the work of our latest Nobel Prize winner on the subject. It didn't support her desired point, I guess]

DOUBLE UPDATE/CORRECTION: I see now, courtesy of commenter "Tom". I didn't realize the $4.4 Trillion shortfall is shown net of the $1.7 Trillion Trust Fund notes. The total of $6.1 is therefore not doublecounted, but it still is not entirely accurate from an external creditor point of view. The SS block should be $6.1 billion and the Trust Fund notes consolidated away in a presentation of "National Debt". However, I have just issued a special Trust Secured Lockbox Note (TSLN) to the Commenter Ridicule of Dreck Administration (CRDA), a wholly owned subsidiary of me! Now Tom can sleep at night knowing his future ridicule allowance is secured.

TRIPLE UPDATE: The One-Handed Economist did this in simple tabular form in early April.

The 'forces of real' have taken a serious beating in the comments. As well as the purported defenders of FDR. A puzzler for the impaired - what sort of "asset" requires that you borrow more money to cash it in?

*The program that shall not be criticized™ brought to you by the party whose ancient and noble schemes must not be questioned™

**charts have been updated to include gross SS liability of $6.1 Trillion and Medicare's $30 Trillion sinkhole**

Now, on to the accounting lesson....

Hypothetically, my wife and I co-sign a mortgage for $100,000. In exchange for an IOU, I also write her a check for $1 billion which she endorses to the governor, which he uses to educate a handfull of children in Camden, New Jersey. Our balance sheets are as presented. Does our mortage holder take comfort in my $1 billion net worth? Does it make a difference at all?

Now let's look at the SSA and the government as the "Trust Fund is Real" crowd sees it - just make up some balance sheet numbers. The theory here is that the SSA is stronger because it holds the notes from the government. True, as far as it goes. The problem is that the SSA is part of the government, implicitly backed by its full faith and credit. The Social Security beneficiary is in the position of my hypothetical mortgage holder. It makes no difference to the SSA beneficiary where the assets are located between these entities. The note is an 'I-O-ME' it is offset by an equal liability, and the payment or forgiveness of each side of the transaction is controlled by the same entity on the hook for SSA benefits. And just to drive the point home, imagine the notes didn't exist. Make any difference? None. In fact, this is how the government consolidates their accounts, for the reasons outlined above. You can also imagine here that the President instructs the SSA to forgive the notes and the Treasury to retire them. It makes NO DIFFERENCE.

By contrast, if these notes make such a material difference to the solvency problem, let's increase them to $170 Trillion! Does that make a difference? No, SSA beneficiaries still have a claim of $6.1 Trillion on a government net worth of -$43.7 Trillion:

For those of you who would like to know what an actual government reserve would look like - here it is. Note that the net worth in the system is higher by the amount of the reserve, because the money has not been spent in the general budget. Note that the government's consolidated net worth has improved by the amount of the reserve - $1.7 billion. The asset could also be located on the SSA's balance sheet without the intra-govt. note.

And here's what happens if we transfer the notes to the beneficiaries - assuming that they are used to satisfy, dollar-for-dollar, the social security obligations. The situation remains the same in dollars, but not in terms. The beneficiaries still have $6.1 million in claims against -$43.7 Trillion, but the terms of the $1.7 Trillion are now fixed, and these notes can be sold for something that pays a risk premium, potentially bringing more dollars into the system in the future. By 'fixed', I mean they no longer change with political decisions about payout ratio, demographics or longevity of the beneficiary.

Government and SSA figures approximated from here and here. The presentation above does not require exact, current or correct figures anyway.

ANOTHERUPDATE. There is some confusion in the comments that if employers are allowed to put their stock in their defined benefit plan, that must mean that doing so enhances pensioner security. It does not. It is merely a redundant unsecured claim on the company, as the pensioner already has a general claim on the company for his/her DB benefits. This is exactly analogous to the situation of the SSA pensioner with and without the 'Trust Fund'.

This can be illustrated by comparing the total resources available to pay a pensioner's claim with and without a note from the company to the plan using "XYZ Co." and their pension plan:

First XYZ co., its plan and pensioners with with the employer note:

Now without:

In both cases, the total resources available to back up the pensioner's claim remain the same. Hence the note makes no difference to the pensioners until it or its yield is converted into an obligation of some other entity.

From the desk of Jane Galt:

Is the trust fund real

It's time for another argument with liberal defenders of social security who argue that the social security trust fund is too real, because it's got government bonds that have the Treasury secretary's signature right on them! Any attempt to say that it isn't real is a scurrilous attack on the sacred person of our government, denying that Our Fine American Politicians can be relied upon to pay their IOUs.

This is reductionism at it's worst. In case anyone thought it was in any doubt, I do, in fact, believe that there are bonds, and that the government will note the interest rates on those bonds in its account books. But the failure to understand that there is a difference between IOUs written to yourself, and IOUs written to someone else, strikes me as willfully obtuse. Upon even a moment's reflection, it's obvious that the trust fund does not exist in the way that its proponents are claiming -- as a guarantee of benefits -- because the bonds are not obligations to Social Security beneficiaries. They are obligations to the Social Security Administration. And the Social Security administration has no legal obligation to turn the accounting entry representing interest payments from the federal government into cash. According to the supreme court, Americans have no property right in their social security benefits, as they would as creditors of an underfunded private sector pension plan.

Let's say it's 2018, and Congress is running out of money, as the Social Security system stops paying money into the government coffers, and starts taking it out. Congress cuts benefits to the point where Social Security taxes are once again a net contributor to federal revenue. Have we violated the trust fund? Nope. Congress is still paying the interest on those bonds; it's just that the interest they pay is immediately lent back to the federal government. Congress could knock benefits to zero, and keep recording interest payments into the trust fund for all eternity, without violating anything except its constituents expectations.

Now, is this likely? Probably not, because the political cost would be high. But the point is that the continuation of benefits depends on the political cost of offending a highly motivated interest group, not the existance of this trust fund. And the effect on the government of continuing those benefits--forcing it to raise taxes, cut other spending, or borrow money to pay for them--is exactly the same whether or not the payments are recorded on the books as "interest on bonds" or "contribution from general revenue".

Moreover, liberals understand this difference very well. If some conservative jackass proposed a plan to, say, let companies top up their underfunded pension plans by stuffing them with their own bonds, liberals would be justifiably outraged, because that's not funding the pension plan; it's promising to fund it at some later date, provided there's money around to do so. When it's companies doing these sorts of things, liberals understand very well why such "trust funds" aren't, in any meaningful sense, real.

Of course, the US government is less likely to fold than a company is. On the other hand, if a company issued bonds like those, it would at least have to record the size of the liability on the financial statements it issues to its shareholders. Why we don't demand that sort of accounting from our government, I'll never know.

From the desk of Jane Galt:

Fun with numbers

This Matthew Yglesias post arguing that the Social Security deficits aren't really getting bigger is more than a little confused:

So the 75 year deficit increased from $3.83 trillion in 2005 dollars in 2004 to $4 trillion in 2005 dollars in 2005, an increase of $170 billion and not, as The New York Times reported, an increase of $300 billion. But! There's a catch. The reason you see the $170 billion increase is that the 2004 75-year projection covers different years from the 2005 75-year projection. The 2005 report cans one surplus year (2004) and adds one deficit year (2080), leading to an increase. If you do a proper apples-to-apples comparison -- holding the years analyzed constant and using real dollar figures -- there's no increase.

This is true, but only in a wierdly trivial way. The problem is that, just like the Social Security Trustees' forecast, we as a nation have lost one year of surplus, and gained one year of deficit. We will continue to do this each year until the surplus years are all gone. It would no doubt be an interesting academic excercise to issue annual reports showing what the financial position of the social security system would be if we had somehow frozen time in 2004, but unless Mr Yglesias has found a way to actually do so, this would not give us a very good picture of the current financial health of the system.

From the desk of Jane Galt:

Demographics is destiny

People who deny that the aging of our population is a problem often point to the fact that the dependancy ratio isn't changing that much -- workers have to pay more for nursing homes, but less for college educations, so what's the problem? Unfortunately, it's not quite that simple:

Declining fertility rates at first bring a "demographic dividend." That dividend has to be repaid, however, if the trend continues. Although at first the fact that there are fewer children to feed, clothe, and educate leaves more for adults to enjoy, soon enough, if fertility falls beneath replacement levels, the number of productive workers drops as well, and the number of dependent elderly increase. And these older citizens consume far more resources than children do. Even after considering the cost of education, a typical child in the United States consumes 28 percent less than the typical working-age adult, whereas elders consume 27 percent more, mostly in health-related expenses.

That's why the rapid ageing of populations around the world is such a problem: we're exchanging low-cost dependants for high-cost ones. And there's the possibility that there's something of a vicious cycle: people strapped by the taxes to pay for the old people cut back on their childbearing, which makes the problem worse in the next generation. This is a problem for our society whether we support the elderly off government transfers or private assets; the main benefit private assets have is that they, unlike most government spending, increase the productivity of workers, making it easier for them to support the added burden. (They also probably encourage the elderly to stay in the workforce longer, since assets, unlike social security checks, can be spent down more quickly in advanced age, or passed on to children). But even if we get a perfectly marvelous private account system that takes care of the fiscal problems of social security, the increasing ratio of retirees-to-workers will put quite a strain on our economy.

Of course, there's great danger in extrapolating trends too much. Read science fiction of the middle of the 20th century and you'll find that a lot of it is filled with dire descriptions of overpopulation, based on the not-unreasonable notion that population would keep exploding geometrically just as it always had for millenia in the past. The current demographic trends might continue indefinitely, or they might reverse themselves for some currently undreamt-of reason, leaving us to worry once again about overpopulation rather than Centrum Silver shortages. Or productivity might grow fast enough that it is relatively easy to absorb the added burden. Read any sort of futurist literature from past decades and you'll find that we're almost never worried about what they thought would worry us; the same might well hold true of the coming demographic disaster.

On the other hand, there are some things, like nuclear war, that worry us just like our ancestors thought they would, and rightfully so. So that doesn't make a great argument for complacency . . . just that we should keep Herbert Stein's famous dictum in mind:

"If something can't go on forever, it won't."

Not every problem requires a comission of earnest worriers to find a solution.

From the desk of Jane Galt:

If it ain't fixed, don't broke it

One of the interesting features of the Social Security debate has been the number of people on the "leave Social Security alone" side who cheerfully proclaim that we don't need to do anything about Social Security because it's Medicare that's going to drive our nation into bankruptcy. I find this interesting, and not merely because it has an odd "why should I patch up this broken leg when the patient's just going to die of something else eventually" sort of flavour.

One oddity is that having proclaimed that Medicare is a total catastrophe, not one person I've seen make this argument has displayed the faintest whiff of interest in doing anything about it; indeed, as far as I can tell, most were among the chorus castigating George Bush for making the prescription drug benefit insufficiently generous.

Another is that most of the people pointing out that Medicare is going to drown us all in a flood of red ink are the same people arguing that we should nationalise the rest of the health care system, which surely rivals second marriages as the triumph of hope over experience. I have heard a significant subset arguing that we should move to a single-payer system because Medicare is such a disaster, which seems rather like urging children to play with matches because the house is burning down. I have racked my brains--and on several occasions, theirs--as to how adding a large number of new people to the government's rolls could possibly make it cost less to treat the ones we already have, but have discovered no answer as of yet.

An anonymous economists offers even more reasons why Teddy Kennedy's mad plan to expand Medicare to everyone wont' work.

From the desk of Jane Galt:

Do we have a social security crisis?

The new meme on the left is that we don't have a social security crisis; the system, taken by itself, is solvent until 2042, and then we'd only need a 25% cut in benefits, or a 75% increase in social security taxes, to cover the gap.

As snotty social scientists are fond of saying, this is true, but not interesting. Yes, if we define the parameters narrowly enough, by looking only at the social security administration's books, Social Security will be solvent until (gulp!) two years after yours truly is scheduled to join the Gray Panthers. But who cares?

[Of course, this requires some rather heroic ignorance of what 25%, or 75%, actually looks like. For your median income household pulling in 43,527, that means that their share of social security taxes goes from 2,698.67 to 4,722.67. Know many households making $43K that have an extra $1,000 lying around? And if you argue, as I do, that payroll taxes ultimately fall upon the worker, then that bite is doubled, to more than $2,000 a year. On the other end, the average social security benefit is just $900. How many seniors getting this average benefit can afford to take a $250 haircut off their monthly expenses? Neither of these solutions take into account the horrifying, exploding cost of health care for seniors, which dwarfs teh social security problem, and which will be making it even harder for workers and seniors to make ends meet.]

What proponents of this argument are mostly arguing is that we don't have a social security crisis, we have a budget crisis. And indeed, I have been saying basically the same thing for as long as I've had this blog: the social security administration is basically an accounting system. But the "sky-is-not-falling" crowd is trying to make this argument without admitting that the social security administration is not a pension system, doesn't act like a pension system does, and cannot be treated as a pension system for the purpose of talking about our coming demographic crisis.

What we have coming is a budget crisis, and it is a budget crisis caused by the massive, expensive demographic shift that is coming down the pike. So while saying that social security is not in trouble is trivially true, it is not true in the important way that advocates are implying, which is that it is somehow not going to be damned tricky to have more than 1/3 of the population living off the remaining less-than-2/3 for decades, even without the deadweight loss and moral hazard problems caused by our outmoded state "pension" scheme. And that's even before we get to the 9 zillion pound elephant in the living room, which is health care, a problem I will leave to another day.

Now, as it happens, I think that there will always be a minimal safety net for the poor elderly, no matter what sort of forced savings scheme we adopt (and I'm in favour of adopting one). But I think better a minimal safety net and a forced savings scheme than a generous middle-class entitlement. Along with most liberals, I'm in favour of abolishing the payroll tax, with its ridiculous illusion of saving, rolling it all into a progressive income tax structure, and paying safety-net benefits out of general revenue. I don't think that liberals have thought through their support for getting rid of FICA, since that's clearly a milestone on the road to getting rid of Social Security As We Know It (that's why the AARP, which has thought it through, is vigorously opposed), but I'm happy to have fellow-travelers on the road, whether or not they're misguided as to our final destination.

And I think that all of this will be as expensive as hell, but not nearly as expensive as the current mishmash of misaligned incentives. What I don't think is that if I ignore the demographic problem, it will simply go away (though in fairness I should note that Tyler Cowen, who is about a zillion times smarter than I am, thinks that there is a fair change that it will).

From the desk of Jane Galt:

Precautionary principles

Arnold Kling talks about Social Security ostriches:

Mankiw is arguing against those who say, "Leave Social Security alone. It's not broken yet." The fact that anyone would make such an argument is a sign of desperation, in my opinion. I cannot believe that someone would seriously suggest that we should wait until there is a huge shortfall in Social Security funds before we do anything about it. It seems to me that if you are going to reduce people's retirement benefits, you ought to give them fair warning while they are young, rather than wait until the last minute.

I find it interesting to note that if you replaced "social security crisis" with "global warming", you'd find that most liberals and conservatives had neatly switched positions. Why? Because addressing each crisis requires cutting into something that one side values; free enterprise, on the one hand, and the progressive structure of social security, on the other.

Easy for me to say, of course; I'm one of those rare cats who thinks that we should do something sooner rather than later about both global warming and social security, so it's fun for me to sit on the sidelines with my "Tu Quoque!" sign. But I'm trying to make a serious point, which is that all of us look for ways to defer unpleasant decisions into the future; we differ only on which decisions strike us as unpleasant.

Deferral is not a good strategy for problems of these potential magnitudes. Time gets rid of some problems, but it makes others, like demographic crises and cumulative environmental damage, worse, and as most of us know from our own experience, ignoring problems in the hope that they'll go away generally results in a full scale disaster rather than a manageable inconvenience.

From the desk of Jane Galt:

More Social Security Mistakes

The topic of Social Security is a great one for bringing out all manner of odd assertions. The comment thread on the post to which I linked earlier is full of them.

This is probably the single most common erroneous argument one hears about Social Security:

Assume you have spent your life saving your money and buying government bonds. Assume further, that despite your obvious obtuseness and unwillingness to listen, you live to the age of retirement. You start cashing in. Now how is this a problem? Are you suggesting the bonds are "no good"?

It's a perennial favourite of the AARP. I confess, I don't understand why it works. Are people really unable to understand the difference between lending money to a third party, with a promise to repay in the future, and "lending" money from your future self to your current self to spend now? In case not, let's continue the bizarre anthropomorphising of the social security trust fund, and pretend that the whole US government is a person, you.

You have one paycheck, the taxes you collect from your employer, the people of the United States. You also have a bunch of expenses, some of them the basic things you need to keep alive, and many of them the basic things you need to do to keep your employer happy, like dressing snazzily. Let's say one of the most important expenses you have is commuting, and because your area is growing, and gas is getting more expensive, you know for a fact that your commute is going to get longer and more expensive every year. Getting to work on time is so important that you've set up a second bank account just for your commuting expenses, and you have the nice folks in HR deposit your commuting money directly into it each month. You're so worried about commuting expenses, in fact, that you've decided to deposit more than you need now, to cover the future expenses.

Now let's say that your other expenses are getting out of hand. You take the money out of the "Commuting Trust Fund" and spend it on a snazzy new suit. Does it make a difference if you write an IOU for the money and deposit it in the CTF?

Clearly not. Your future spending is going to be constrained by how much your employer gives you, and how much you can borrow from third parties, not by "cashing in" your IOU to yourself.

Another commenter nails it:

The real difference between 2041 (the last year there are intergovernmential government IOUs remaining for Social Security) and 2042 (when they're exausted) is that in 2041, the 20% of the cost of Social Security paid by general revenue will be explicitly claimed by the otherwise worthless bits of paper called treasury bonds, and in the 2042 this 20% will be diverted due to the political infeasibility of letting old folks starve.

Then there's this one, beloved of the hard-ish left:

One thing overlooked in most discussions about the "privatization" of SS is the employer's contribution, which is an automatic 50% return on investment for the employee. Do the privatization plans call for the continuation of the employers contribution--and does anyone believe it will continue long after privatization is implemented

This assumes, of course, that when the government comes along and slaps a whacking great tax on payrolls, the employers just say, "Oh well, that's too bad, we'll have to tell the shareholders no more profits". [/sarcasm] Payroll taxes are, of course, all ultimately paid by all but minimum wage employees, not their firms. Firms have an upper limit on the cost they are willing to incur to hire an employee; any money taken by the government in tax represents salary they could have negotiated for themselves. There is a brief windfall for the employee when the tax is first enacted, but it corrects itself in a surprisingly short time, and of course results in unemployment for those low-wage employees whose total cost is raised above their value to the firm by the tax.

If the payroll tax were actually redistributing money to workers, we should have seen a large shift in the share of national income accruing to labor (rather than capital), as it's a very large tax. Labor's share, however, is remarkably stable. QED, the tax garners no net benefit to employees.

Then there's the salvational miracle of productivity:

Envision incredible productivity growth on a previously not contemplated scale: One worker at a computer console controls robots supplying all the goods and services for the economy...take it from there.

Today's workers are more productive than past workers. Presumably, future workers will be more productive than today's workers. This is not rocket science.

I'm actually sympathetic to this one, and have quoted it myself. Problem: ultimately, unless labor's share of national income falls (something it shows no sign of doing over the long run), productivity growth translates into wage growth. And social security benefits are indexed to wage growth (rather than inflation). Thus, the cost of social security will grow right along with productivity. While this argument makes sense as a macroeconomic solution to the demographic crisis, it will not make the Social Security system itself stable.

Interesting thought: is it possible that as a way to equilibriate the increasing share of national income devoted to the elderly, we'll see massive inflation in goods largely consumed by the elderly? Health care leaps immediately to mind, as do Florida real-estate and Geritol. What we'd see, then, was a massive increase in the nominal share of income consumed by the elderly of my generation, but a decline in our share of real income, as more and more of our nominal income has to be devoted to chasing a few scarce goods, like gerontologists.

From the desk of Jane Galt:

What's wrong with this picture?

From Kevin Drum:

Every year the Social Security trustees produce a 75-year financial estimate. To do this, they make estimates of population growth, life expectancy, economic performance, and so forth, and then add them all up into an overall estimate of long-term solvency. In fact, they make three estimates (see chart on right), and the one you hear about in the news is the middle one, or "intermediate projection." In that projection, Social Security starts running a deficit in 2042. The key assumptions in the intermediate projection from 2015 forward are the following:

* Labor force growth: 0.2% per year.
* Productivity growth: 1.6% per year.
* Average hours worked: no change.

Which leads to the following overall estimate:

* GDP growth: 1.8% per year.

This growth is lower than we're used to, but that's because GDP growth = population growth + productivity growth. Since population growth is slowing down, so will GDP growth.

Still, what if you assume that things will be a little more robust than this? If you project GDP growth of around 2.6% per year, you end up with Estimate I, and in that scenario Social Security never runs out of money. In fact, if you project GDP growth just a few tenths higher than 1.8%, Social Security stays solvent for the next century.

In other words, if GDP growth averages, say, 2.2% over the next 75 years, Social Security is in fine shape and we don't have to do anything. We only need to "fix" it with private accounts if GDP growth is less than that.

So here's the puzzler: for private accounts to be worthwhile, they need to have long-term annual returns of at least 5%, and 6-7% is the number most advocates use. But are there any plausible scenarios in which long-term real GDP growth is less than 2% but long-term real returns (capital gains plus dividends) on stock portfolios are well over 5%?

Privatization enthusiasts are encouraged to leave their answers in comments.

The problem is, this treats economic growth as if privatising the pensions system will have no effect on economic growth.

But from a policy perspective, the effect on economic growth is the only rational reason to privatise (other than the moral imperative of not misleading gullible Americans into believing that their payroll taxes are somehow earning them a pension to which they will be entitled when they retire).

When we divert the FICA money into private accounts, we take money that is currently masking a huge unfunded liability, enabling the government to spend money on unproductive programmes like farm subsidies, and divert it into productive investments. (Even if you are in favour of much of what the government spends money on -- whether it be defense or welfare -- it takes a pretty ideological character to argue that this spending is increasing the growth rate). It forces the government to make hard choices about unnecessary spending, which I think is a good thing, but more importantly, increases the stock of private capital over the long term. (Not of course, over the short term, because the government will be borrowing to fund the gap).

Private accounts should change other pieces of the equation -- making it more attractive to retire later, if you're healthy enough to do so; making it more attractive to work longer hours, because the connection between work and benefits is much clearer than in the steeply progressive Social Security system; and making it more attractive for new entrants to work.

So yes, if privatisation has absolutely no effect on the economy, then there's no reason to privatise, but that's pretty much a tautology; if we assume that something's not going to have any good effects, then we can easily prove that it won't have any good effects.

From the desk of Mindles H. Dreck:

Required Reading for Discussion of Pensions and Demographics

I've referred to this research report on global aging by Maureen Culhane quite a few times over the course of my blogging career, but it hasn't been consistently available on-line. It is available now, and I recommend it to anyone - especially the folks arguing about Social Security in recent AI comment threads. Download it before it disappears again.

From the desk of Mindles H. Dreck:

Thoughts for the "New Plutocracy" Crowd

Instapundit points out an article about Tyler Cowen. Here's an interesting excerpt from one of his papers:

The net effects of the United States Social Security System are complex, and I do not count them as part of the welfare state in this paper. In any case most of the redistribution is across generations rather than to the poor per se. Earlier generations (the current elderly) get the best deal and subsequent generations receive increasingly inferior deals, given the pay-as-you-go feature of the system (e.g., the very first generation received benefits but did not pay a comparable tax burden). More generally, returns are tied to what individuals put into the system. Many aspects of Social Security are regressive, given that the payroll tax stops at $76,200, the poor start working earlier (thus increasing their contribution) and tend to die sooner, thus lowering their payout.

Many of the largest and most expensive government programs benefit the rich or the middle class, rather than the poor. Christopher Jencks estimates that in 1980 only one-fifth of all social welfare spending was explicitly aimed at the poor. Subsidies to higher and lower education do most for the upper middle class. The real value of public goods is greater in wealthy communities, even relative to local tax expenditures. Many health care subsidies benefit the elderly, who tend to be wealthier than the national average. Our tax system is only weakly progressive, all things considered, and many kinds of taxes, such as sales taxes, have a regressive impact. Milk price supports, most tariffs, and corporate welfare are but a few of the many regressive policies enacted by the American government.

So that was the situation in 1980...

From the desk of Jane Galt:

Krugmanwatch: Social Security

Warning: Long column with more numbers than commentary. Not for the faint of heart or those with narcoleptic disorders.

In reading Paul Krugman’s latest piece, I’m reminded of a story.

A long, long time ago, in a galaxy far, far away, when Jane Galt was just another computer consultant in the vast swamp of the New York financial community, I was working on a project that involved duct-taping together the technology infrastructure of two firms that had merged. My firm had produced a new design; it had been signed off on; and yours truly was about to implement it, when wait! A technology manager whose job was about to go bye-bye saw a golden opportunity to save his career by putting himself in charge of the project. To that end, he fashioned an alternative proposal and put it forward.

Now, I am the first to admit that there may be many ways to solve a single design problem, and that many of the variables hinge on value judgments, hazy priority assessments, and aesthetic considerations. Too, I have made my fair share of boneheaded design moves, the stupidity of which, in retrospect, seemed blindingly obvious. So I feel that I am on solid ground when I say that this was the single worst design of anything that I have ever seen, and I include Pepsi Clear.

This fellow was an old mainframe chap, and he took one look at our distributed, high-availability, high-redundancy plan and shuddered. Instead he proposed an enormous NT 4.0 server, the largest then made, maxed out with every bit of memory and hard drive space that any company would sell you. Actually, he proposed two of them, using server mirroring software called Octopus. One server. Running all the file, print, and auxiliary services, excluding market data, for a user base of between 500-1000 users. It was expensive, slow, and it provided a lovely, large single point of failure for the entire firm.

Friends to whom I showed this design were awestruck by its stupidity. “It’s breathtakingly idiotic,” said one. “It has its own weird logic that makes me wonder if I’m missing something.”

“This man needs help,” said another. A third, my most trusted mentor, called me ten minutes after I emailed him the proposal.

“I hope you’re not letting this man near your servers,” he said.

We pointed out all the design flaws in a long letter, and ultimately I ended up in a meeting where we were supposed to discuss the merits, or lack thereof, of the proposal. I started by pointing out some of the more pressing concerns, like the way a bad disk sector could take down the single, enormous volume on which his design depended. And he began to lie.

He made technical claims for his system and its software that were not only untrue of this particular system, but unavailable in any Intel-based system anywhere. No matter what I said, he had a refutation. Which is easy, of course, if the board doesn’t know a NIC from a knicknack, and you have no compunctions about making up features that violate the laws of physics. I gave up when he claimed that the motherboard was hot-swappable. How do you answer that? “My system is not only faster and better than yours, but also shines your shoes and dispenses ice cold beer” would have been the only rational response, but I felt uncomfortable advancing such claims in the presence of other sentient beings.

And now I feel it all again: the tingling on the back of my neck; the icy chill in my veins; the helpless rage forming an aching knot in my stomach. That’s right, Paul Krugman is talking about Social Security.

Remember the "bring out your dead" scene in "Monty Python and the Holy Grail"? It's the one where the old man declares, "I'm not dead!" "Yes, he is," insists his younger companion, who persuades the undertaker to hit the old man over the head and cart him away.

Now you understand the Bush administration's policy toward Social Security.

Makes me feel kinda dumb for running the numbers, when all I really needed was a Blockbuster card.

Ordinarily, the annual trustees' report on Social Security is released at a morning press conference, and simultaneously posted on the Web; this gives reporters a chance to read the material and discuss it with outside experts before filing their articles. Last week, however, the first copies were made available late in the afternoon, leaving hardly any time for analysis. One wag joked that the information was being closely held to keep it out of the hands of terrorists.

But the real reason was surely to avoid too much attention to the report's unwelcome conclusion: that Social Security is in very good shape. True, the rest of the government is running big deficits, and borrowing heavily from the retirement fund — but Social Security isn't the source of that problem.

How does he do it? He knows exactly what went on in the minds of the Bush Administration without talking to a single person in it – knows to virtual certainty. Now I know how he performs his statistical wonders – he reads our innermost thoughts by remote control.

The introductory summary — which, unlike the report itself, is mainly a political document — does its best to make the worst of a good situation. But the bottom line is that the long-run sustainability of Social Security looks better than ever. The staff of the Social Security Administration, using conservative assumptions, now says that the system could operate without any changes at all — no cuts in benefits, no additional revenue — until 2041, three years longer than it projected last year.

I'm sure that 2041 sounds comfortably far off to Krugman; in all likelihood, he'll be dead. I, on the other hand, will be just entering my golden years when -- oops! -- there will only be enough money to pay 73% of current benefits.

I hope this satisfies readers who, when I criticize bogus arguments for privatizing Social Security, demand to hear my answer to the crisis. There isn't any crisis: the system looks good for 40 years, and with a bit of extra resources can survive indefinitely.

And this is where he says “the motherboard is hot-swappable and I don’t have to worry about electrostatic shock because this server won’t run on electricity” and my eyeballs begin to sizzle.

How in hell do you get that from this (or for the hard core numbers fans, this)?

While Federal law designates the Social Security and Medicare accounts as "trust funds," the accounts are not "trusts" in the private accounting sense in which funds of one party are held by a second party as a fiduciary. Rather, the Social Security and Medicare trust funds are financial accounts in the U.S. Treasury into which all income to these programs is credited and from which all benefits and administrative costs of the programs are paid. These accounts are established by Social Security and Medicare legislation. This legislation names the Secretary of the Treasury as the "Managing Trustee" with responsibility for overseeing the trust fund accounts. All revenues into the system not required to pay current expenses are used by the U.S. Treasury for general government expenses or to reduce the outstanding publicly held debt. In return, the Social Security and Medicare trust funds are issued special non-marketable U.S. Treasury bonds that by law carry an interest rate equal to the average market yield on all medium and long-term marketable Treasury securities. Interest on these bonds is paid through the issuance to the trust funds of additional special non-marketable U.S. Treasury bonds.

As financial accounts, these Federal trust funds have income, expenditures and assets. The 2002 Social Security Trustees Reports show the Social Security trust funds, for example, as having $1,213 billion in assets at the end of last year, and anticipated Social Security and Medicare surpluses over the next 10-15 years promise to further increase the assets in the trust funds by a substantial amount. These non-marketable U.S. Treasury securities are properly entered under "assets" on the financial accounting balance sheets of the Social Security system, and are available to the system to meet future obligations. It is this availability to meet future program obligations that results in this year’s Trustees Reports identifying 2041 as when the Social Security trust funds will be exhausted, even though under current law Social Security tax revenues are projected to fall short of expenditures beginning in 2017.

Unified Budget Viewpoint of Trust fund Surpluses

While the bonds held by the trust funds are assets from the vantage point of the Social Security and Medicare programs, from the viewpoint of the unified budget they are liabilities of the U.S. Treasury. No one doubts the U.S. Government will honor the bonds. But since the U.S. Treasury is the ultimate payer of the programs’ benefits and the trust fund assets are also debts of the U.S. Treasury, neither the interest paid on the bonds, nor their redemption, provides any net new income to the U.S. Treasury. When annual revenues from earmarked taxes for Social Security and Medicare begin to fall short of annual expenditures, such shortfalls inevitably must be made up by increased taxation, increased borrowing (i.e., the sale of more U.S. Treasury bonds to the public) and/or a reduction in other government expenditures. This fact is the basis for the view that trust fund assets have no "real" economic value. From a unified budget viewpoint, the trust fund surpluses are a budget accounting device and make no meaningful contribution to funding future Social Security or Medicare expenditures. They simply reflect the fact that in the past, surplus Social Security and Medicare revenues have been used by the U.S. Treasury to fund other government programs or to reduce outstanding Federal debt.

Actually, that's a trick question. I know where he got it: he cribbed it from two reports (found here and here) from the Center on Budget and Policy Priorities, which is, you’ll be shocked to hear, a liberal think tank opposed to Bush’s tax cuts. Paul Krugman’s column is a rehash of their talking points.

More specifically: The long-run actuarial shortfall of Social Security is less than half the revenue that will be lost due to last year's tax cut. The common perception that the tax cut was no big deal, but that Social Security faces a terrible crisis, is completely upside down. But the powerful forces that want to dismantle Social Security won't take yes for an answer; they insist that the system is doomed.

Those numbers are a little funny, given that the CPBB itself estimates the cost of the tax cut at $2.5 Trillion, and the shortfall at $4.9 trillion -- how does he get them? By projecting the "Bush tax cuts" out for 75 years. But wait a minute, I hear you say; those tax cuts expire in 2010. Well, yes, technically that's correct. But if we pretend that they don't, you can see that the Social Security crisis is really all Bush's fault. You do see, it don't you?

Never mind trying to imagine the accuracy of a tax revenue forecast for this year from 1927; Krugman is telling us that the current problem with Social Security is a tax cut that hasn’t been enacted yet.

It isn’t. This is the problem:

Chart C-Number of Workers per OASDI Beneficiary

Which is what’s causing this:

How do you call plain numbers “political”, except in the sense that the real world is getting in the way of your ideals? I’m sure Mr. Krugman would like to ignore that bit about outlays exceeding intake in 2017, 24 years earlier than the date that Krugman tells us we’ll be “just fine”, but it’s hardly a political statement; it’s a mathematical extrapolation from numbers we can guess relatively well, at least compared to tax revenues: the number of people in the labor force, and the number of retired people.

Let’s go over it one more time. There is no trust fund, any more than you can start a “trust fund” by writing yourself IOU’s due in 2017 and spending the hell out of all your income now. Come 2017, you're gonna have exactly the same annual income whether or not you take those IOU's out of the "lockbox". Now I'm sure that 2017 sounds comfortably far away. But remember how awfully far off the year 2000 used to sound? It is later than you think.

The system is broke the minute outlays begin exceeding intake; that’s when we have to cut spending, raise taxes, or start borrowing. In 2017. Actually, we’ll feel the pinch even before, as the Social Security Surplus that’s been masking our deficit disappears and we have to make hard choices about spending. Hard choices Krugman doesn’t want us to make – a lightbulb goes off -- that’s why he’s using Social Security to campaign against the tax cut now, even though he knows that restoring every bit of those taxes won’t save us.

2041 is the year when it becomes a total frigging catastrophe. Best summed up in this email I received from Mindles H. Dreck:

Look at the table on page 67 of the report.

I added at the bottom a line that indicates the percent of payrolls that the
"balance" is deficient in the year the "trust fund" disappears:

Intermediate (2041) =4.5%
Low Cost = NA
High Cost (2029) = 15.4%

So, in those years, taxes or debt, of one sort or another, might have to be
raised by 4.5% or 15.4% of total payrolls just to fund that year's retirees. And
that deficit persists.

As Mindles points out, saying that we’ll be fine until 2041 is like saying that people who jump off the Empire State Building will be fine – until they hit the ground.

Krugman also conveniently leaves out Medicare, which itself has an unfunded liability of $8.9 trillion (unfunded liabilities are what we call "Promises we've made to give people money at some date in the future without setting aside the money now to cover those promises". Like, for example, when you promised little Johnny you'd send him to the best college he got into.) That unfunded liability is how much we're gonna owe Medicare benificiaries after we subtract the imaginary trust fund.

Notice Krugman likes to discuss Social Security and Medicare separately, never in the same column – that way he can blame the shortfalls in both programs on the Bush Tax Cut, with room left over for The Poor Condition of Our Public Parks and The Disgraceful Behavior of Young People Today. Now, Paul, you have to pick. Either the tax cut is responsible for the Medicare deficit, or it could cover Social Security. Even if the Evil Bush Administration makes the cut permanent and throws in a free week at the Palm Beach Hilton for all its billionaire buddies, it can’t be responsible for both.

No, no, no! Says Paul. It’s not the fault of demographics – it can’t be! Not my beloved welfare state! It must be the Bush Administration, eager to starve the old people so their rich friends can use the bodies as mulch on their diamond ranches.

Never mind the rhetoric about retirement security; the real reason for the attack on Social Security is ideology. Here's what Edward Fuelner, president of the Heritage Foundation, wrote to supporters: ". . . today's policies are a product of the Great Society of the 1960s, which grew out of the New Deal of the 1930s, which was an assault on founding principles articulated in the 18th century. . . . Connecting the historical dots is no small task." For Great Society, read Medicare; for New Deal, read Social Security. And the real task is to connect the contemporary dots.

For Heritage is the intellectual engine driving today's conservative movement. The foundation's Web site proudly quotes Karl Rove: "We stole from every publication we could; we stole several key staff persons; we want to steal more of your ideas." Indeed, before Elaine Chao became secretary of labor — and hence a trustee of Social Security — she was a fellow at Heritage. And the influence of Heritage spreads far and wide, from employees like Virginia Thomas (wife of the Supreme Court justice) to the stable of columnists featured on its opinion site TownHall.com, most notably Ann Coulter ("We need to execute John Walker in order to physically intimidate liberals, by making them realize that they can be killed too").

Honey, get the torches -- the freemasons are poisoning the wells!

And it won't surprise readers of my last column to hear that Heritage was founded with financial backing from Joseph Coors and Richard Mellon Scaife.

But I digress. The important thing is to understand what's really going on here. The ideological powers behind the current administration want to do away with Social Security — not to offer retirees a better deal, but because they are opposed to the program in principle. Unfortunately, that's an argument that won't work in the political arena; Social Security is very popular. So the strategy they have adopted is to declare that the program is already dead, or nearly so. If the facts say, on the contrary, that Social Security is very much alive, the administration doesn't want to hear about it. And it doesn't want you to hear about it, either.

The important thing is not to address our demographic crisis. It is certainly not to look at the actual numbers and try to fix things.

No, the important thing is to make sure that we all know that Joseph Coors and Richard Mellon Scaife and their friends in the Bush Administration are trying to kick the old people out of their condos and make them live on the street so that all the billionaires can use them as slave labor in their yacht factories. The ones where Johnnie Walker Lindh’s dead body will be hung on the wall as a visible reminder of what can happen if you cross the Bush Administration.

Hell, I don't have to tell anyone, Democrat or Republican. You can add -- go look at the report. Then look at what Krugman says about it. You tell me whether he's being up front or lying through his teeth.

I’m reminded of another story. Actually a quote. From my economics textbook: “Economic value (wealth) is created when resources are moved from lower-valued to higher valued uses.”

I don’t know about you, but I’m sure glad Paul Krugman’s moved from writing books on international monetary theory to this.

From the desk of Jane Galt:

Story Hour

So let’s imagine that you have a small business. Perhaps you sell annuities to the many employees of the local fur-bearing trout farms. Let’s say that you recently inherited this business from your father, who started it during the great Fur-Bearing Trout Boom of the 60’s, when women everywhere were wrapping themselves head-to-toe in lustrous trout pelts, and the number of farms in the area quintupled.

For years, this has been a great business. You take in a lot of cash; you pay out a little money to the retired trout skinners and pelt-tanners. Your family’s fortunes wax along with those of the trout farms, which are growing like wildfire. Everything has been so good, in fact, that your father several times raised the promised annuity, to the general acclaim of all. Prosperity seems assured.

Then one day, perhaps a day much like today, you notice that some of the trout-skinners are getting a little long in the tooth. Not quite ready for the glue factory, perhaps, but certainly no longer spring chickens. It occurs to you that someday soon, they are going to expect to live off those annuities you’ve been selling.

As you walk among the green fields and gently burbling streams of the farms, you notice something else: there are a lot of old workers, but not so many young ones. When you gently query one of the farm owners about this, he explains that the pelt business isn’t what it used to be; many people no longer care for trout fur, and have switched to Jackalope Skin jackets, hats, and toaster cozies. Moreover, to stay competitive the farms have switched to machinery for many of the tasks that used to be done by hand The labor force isn’t growing anymore.

Back at the annuity building, you do a little calculating. While you’ve been coasting along briskly when there were a few retirees supported by a lot of workers, it looks like in about ten years there are going to be almost as many retirees as workers. The annuity business suddenly doesn’t look so profitable. A quick calculation indicates that over the next fifty years, you’re going to have to pay out $13 million more than you’re taking in.

If you haven’t guessed yet, I’m talking about Social Security. Now, let’s see where this goes.

In a panic, you ask your Chief Operating Officer and your CFO to give you plans to deal with this crisis.

Your COO, who we’ll call Al, goes first. He suggests paying down all of the debt you’ve accumulated, mostly in the form of loans from the Trout Valley Bank, which holds all the deposits for the trout workers. He also suggests offering more generous benefits to attract new customers and bring in more cash.

Your CFO points out that offering more benefits is hardly the recipe for solvency.

The COO retorts that people need the benefits, and anyway, the important thing is paying down your debt.

Your CFO points out that since the present value of your debt is less than a quarter of the present value of the annuities you owe payments on, it’s not mathematically possible for this to solve the crisis.

The COO stutters.

The CFO points out that the only thing paying down the debt is good for is lowering interest expenses a little, producing a trivial delay in the onset of the crisis, but making it easier to borrow money in the future. If there’s anyone to borrow money from, that is, since all the money for the loans comes from the trout skinners and pelt-tanners who will be living off their savings, not making new loans.

Your COO goes into the corner and sulks. However, the non-financial departments think that his idea sounds swell, since it doesn’t involve cutting benefits.

The CFO presents his idea: do a partial liquidation. Hand some money back to the customers both by reducing rates, and opening a mutual fund arm of the annuity business where part of their payments can be funneled. The mutual funds can channel money into productive investments, like buying Jackalope ranches, and by the time the future arrives, hopefully there will be enough money to pay off the annuity holders; at the very least, one hopes they’ll have something to live on, what with the Jackalope ranches.

The COO comes out of the corner to point out that if we give the money back to the customers, it will be even harder to pay them off when the time comes.

The CFO rejoinders that overhead expenses are out of control, largely because of your brother-in-law Tom, the sales manager, who lards every budget with gifts for his friends in the form of “investments” like, oh, say, light rail systems for their backyards. Cutting the budget will funnel money away from chump choo-choos into whatever more productive investments the people can make for themselves.

The COO points out that this will leave the firm incredibly over budget. Ands anyway, we can always do that later. Like, after the COO retires.

The CFO points out that it’s going to be hard to make productive investments after the bailiffs have carted away all the furniture and equipment.

The COO punches him.

Meanwhile, a guy from payroll asks why, since the firm is bankrupt, you don’t just say so and give people as much of their money back as is possible before it’s too late.

The COO and the CFO both punch him. Everyone else goes out for drinks.

Perhaps you can see now why the Bush plan is better, even though it’s inadequate. It at least tries to address the problem; the Gore plan to “fix” things by retiring a little 5% debt is like trying to save for your kid’s education by prepaying your mortgage. The Bush plan is partial, and didn’t stand up like a man and say “some of you aren’t going to get paid.” But at least the hope was that that 2% would ease things a bit for those who got the short end of the stick. Al Gore’s plan was to tell everyone everything was okay so that brother-in-law Tom wouldn’t have to give up his friends. (Would you be friends with him unless he paid you?)

Still a better plan would be the Chilean radical surgery approach: guarantee current benefits for those over 55 and move everyone else towards defined-contribution plans. Unfortunately, it may well be that you need a dictatorship to accomplish it. Anyway, hopefully you now understand a little about why I get so $#%! mad when Paul Krugman pretends that the Democrats have a better Social Security plan.

It’s not that he disagrees with me. It’s that it’s bad economics.