This article by Norma Cohen, which Paul Krugman and others think is very important, strikes me as proving too much. Cohen writes,
Britain’s experiment with substituting private savings accounts for a portion of state benefits has been a failure. A shorthand explanation for what has gone wrong is that the costs and risks of running private investment accounts outweigh the value of the returns they are likely to earn.
If that’s true, then all private investment vehicles, from personal savings accounts to 401(K) plans to mutual funds to TIAA-CREF, ought to be shut down immediately and replaced by government commissars.
Social Security is a set of promises backed by the government’s ability to collect taxes. You can earn a decent return on your Social Security contributions, as long as the government continually has the ability to extract ever-larger tax revenues from subsequent generations. That strikes me as a system that’s bound to prove risky sooner or later.
Meanwhile, if Krugman would like to trade me his current TIAA-CREF balance for what his original investment would have earned if invested in Treasuries, I’ll be glad to make the deal.
For Discussion. What lessons are there to be learned from the British experience?
READER COMMENTS
Bernard Yomtov
Jan 15 2005 at 7:33pm
Isn’t part of the problem that the British system has many small accounts? Marginal management cost as an account increases in size surely declines rapidly. Smith’s account may be ten times as large as Brown’s, but it costs nowhere near ten times as much to manage.
Simply using management costs incurred by mutual funds and the like may easily understate the costs of managing a system whose accounts are much smaller, on average.
Boonton
Jan 15 2005 at 10:32pm
Arnold, I’m surprised at you. Return is always positive as long as economic growth is positive and if growth is negative for any sustained period of time then I wouldn’t think much of market returns.
Consider the following simple model of SS. The gov’t taxes 10% of income each year and distributes the funds raised. Assume the economy grows 5% each year. Start with $100 as income in yr 1.
Yr 1 $100 collected tax $10
Yr 2 $105 collected tax $10.05
Benefit yr 2, $10.05…return 5% since $10 was paid in year 1.
Yr 3 $110.25 collected tax $11.02
This can go on forever. Yes the amount collected grow ever larger but simply because the economy grows ever larger…just like a portfolio that represents US publically traded companies will grow ever larger provided that US publically traded companies grow. Unlike specific stocks or even stock classes, the tax has the advantage of automatically being totally diversified. As long as someone is making money tax revenue is generated…no need to be lucky in picking which companies will make money.
Let’s ask the reverse, why shouldn’t the gov’t just borrow money and pass it out to everyone in the form of 401K type accounts? Pretend social security didn’t even exist, why would it not be a good idea for a gov’t to just borrow $10T, $20T or whatever at 6% and issue 401K accounts to all?????
Rick (Centrist Coalition)
Jan 16 2005 at 12:19am
It seems like the small size of the accounts and the incrementalism is a problem. The Chilean system goes whole hog into privatization, and achieves reduced administrative costs as a percentage of funds entrusted.
Thus, if the plan presented by President Bush creates lots of accounts with small balances, just to get a “foot in the door” it may replicate the problems of the British system.
Brad Hutchings
Jan 16 2005 at 12:33am
The way Cohen tells it, the lesson to be learned is that Social Security is the model for the world and must not be adjusted. This is wishful thinking. Andrea Mitchell appeared on some show with Chris Matthews last weekend and made the 30 second Sunday talk-show case for why this is really a crisis. People are living longer and not having as many kids. Add in that the American public across the politcial spectrum is not officially behind solving the problem via immigration (although we’re happy to pay nannies and garderners with cash off the books). There’s no doubt this is a crisis. Let Krugmann and friends claim it’s not and wind up more irrelevant when they have to switch positions and argue for alternative remedies.
My question… When will racial demographics enter this debate? Black men, on average, have significantly lower lifespans than white men (again, on average) in America. Shouldn’t meaningful, equittable reform at the very least have racially adjusted retirement ages? Or if that’s not a workable political position, can’t we at least agree that privatization is most certainly in the interest of minority groups who have shorter lifespans that whites? More fundamentally, with the current system… what do you tell the person who is diagnosed with terminal cancer at age 64 and has a month or two to live? Social Security tells him/her “sucker, you paid in for 40 years, and you and your heirs won’t see a penny. haha.”.
Jim Glass
Jan 16 2005 at 12:47am
“Arnold, I’m surprised at you. Return is always positive as long as economic growth is positive…”
Economic growth in the US is positive and expected to remain so into the future, while returns on contributions are now negative and projected to remain so for all cohorts forever more, by the SS actuaries.
Reality rears its ugly head.
Unfortunately, the nice little model of a sustainable SS you present is far, far, far from the real thing.
Jon
Jan 16 2005 at 9:45am
A previous writer states:
>>Return is always positive as long as economic >> growth is positive and if growth is negative >> for any sustained period of time then I
>> wouldn’t think much of market returns.
This is not entirely true. If some of the other articles that have been mentioned on this board are true (i.e. “the long tail”, “capitalism without capital”), then the returns from economic growth will accrue to those providing human resources (i.e. labor) and not capital. The value of investments could then decrease at a time when there is economic growth. It is in this scenario that the current system would really shine, but private accounts would fail.
No system will shine if economic growth and market returns are both negative; private accounts may have an edge in that they would not require political action to balance the system; however, years of negative economic growth would probably cause such drastic political responses (good and bad) that this may be irrelevant.
Tom Emmert
Jan 16 2005 at 9:56am
Ummm, hows that again? Some kind of strange math?
Jon
Jan 16 2005 at 10:00am
A previous writer states:
>>Return is always positive as long as economic >> growth is positive and if growth is negative >> for any sustained period of time then I
>> wouldn’t think much of market returns.
This is not entirely true. If some of the other articles that have been mentioned on this board are true (i.e. “the long tail”, “capitalism without capital”), then the returns from economic growth will accrue to those providing human resources (i.e. labor) and not capital. The value of investments could then decrease at a time when there is economic growth. It is in this scenario that the current system would really shine, but private accounts would fail.
No system will shine if economic growth and market returns are both negative; private accounts may have an edge in that they would not require political action to balance the system; however, years of negative economic growth would probably cause such drastic political responses (good and bad) that this may be irrelevant.
Jon
Jan 16 2005 at 10:04am
Arnold comments:
>> Meanwhile, if Krugman would like to trade me his >> current TIAA-CREF balance for what his original >> investment would have earned if invested in
>> Treasuries, I’ll be glad to make the deal.
Arnold, you must realize that total historical return (or even expected return) is not the sole criterion used for chosing an investment. Would you tell every pension fund, insurance company, and private investor to dump its investments in bonds because stocks have had a hire return in the past?
Lawrance George Lux
Jan 16 2005 at 12:45pm
Social Security is a set of promises backed by the government’s ability to collect taxes. You can earn a decent return on your Social Security contributions, as long as the government continually has the ability to extract ever-larger tax revenues from subsequent generations. That strikes me as a system that’s bound to prove risky sooner or later.
I have trouble with that broad assertion, Arnold. It may be accurate, but it automatically assumes that Life Expectency will continue to rise, and that the Inflation rate will be sustained, especially in the arena of Medical Costs. Life Expectency rates will have to stabilize at some point, alteration of payment of Medical Costs will reduce Costs, and lower Birth rates since 1977 will eventually impact. I propose an alternate Projection that Social Security Cash Disbersements will begin to decrease after 2049–the 100th Anniversary of my birthday. lgl
Boonton
Jan 16 2005 at 1:06pm
I can’t speak for black men but I think they would rather have a policy to address the significantly decreased lifespan first. Racially adjusted ages would end up causing endless headaches, escpecially since all ‘expected lifespan’ tells you is what the current population looks like. If the gap is closed in 50 years (and whose to really say it can’t, look at the difference between the African Americans in 1950 and 2000) will you demand that blacks return the money they get for not dropping dead as early as expected?
That is indeed a downside of social security or any type of annuity that pays you for life. The upside is the reverse situation, if you live excessively long you have more benefit checks. In contrast a fat 401K balance is great if you have fewer years to live but is bad if you live a long time….of course this unreasonably assumes people know exactly how long they got…for most people it is something of a guessing game.
If more dollars are going out than came in then the overall return must be positive. That’s a mathematical fact which is what the simplified model demonstrates. Individuals may receive positive or negative returns but overall return cannot be negative. Think about it, SS is projected to consume larger chuncks of GDP. Say it is consuming 8% of GDP today and 12% tomorrow. If current benefits are paid for current taxes that means those paying 8% of GDP today will be receiving 12% tomorrow. How could the overall return be negative if economic growth is positive?????
The example used for that was Amazon.com. Amazon.com is has plenty of stock holders as well as bondholders (I recall they were criticized for issuing bonds when the Internet stock craze was still going on). If Amazon.com grows then the bondholders will receive their interest and principle payments. Stock holders will see either dividends or appreciation (assuming stable P/E ratios). Unlesss! Labor is so powerful that they demand Amazon.com’s management increase salaries to mop up sales growth.
Another possibility is that salaries go up but labor puts the money into their 401K’s and buys Amazon stock. There is appreciation but not from the P/E ratio being stable and earnings increasing but from the P/E ratio rising and earnings remaining constant.
“Ummm, hows that again? Some kind of strange math?”
No Emmert, assume the tax is 10% of income and income grows at 5% per year. In the first year income is $100 and the tax is $10. In the second year income is $105 and the tax is 10% of that or $10.05.
Jim Glass
Jan 16 2005 at 1:07pm
Social Security provides a lower return than gov’t bonds going forward.
If Krugman would prefer to trade — if only he could! — the risky, expense-reduced positive returns that he gets from his private investments for the same negative return that is so efficiently guaranteed by Social Security to today’s young workers, he should come right out and say so.
If he does, I’ll tell you what I’ll do for him: I’ll take his money and contract to give him the same negative rate of return on it that SS provides by statute to the young. And I won’t even take any fee for doing so! I’ll just invest those funds for my own account and keep the difference as my fee.
He’ll get the return from SS that the lauds but couldn’t get otherwise, and I’ll take all the risk! How could he say no?
Boonton
Jan 16 2005 at 1:18pm
Arnold’s originaly point deserves to be addressed, why did the British attempt fail?
A key problem with it is that the accounts were not really private. The gov’t mandated money going into them so individuals had less real say in their management than they do with their 401K’s. In the US consumers have the ultimate check on ‘management fees’…they can simply choose not to invest in 401K’s. They can cut their contribution down to 0% and put the money in their house or non-IRA types of savings vehicles. Mandated private accounts, however, is also a mandated demand for the services of the financial community.
Even with this, however, there ‘management fees’ play havoc with returns for most individual investors. A ‘small’ fee of 1% will destroy 50% of a 2% return, 33% of a 3% return and 25% of a 4% return. This is before you even address the issue that most of the time ‘management fees’ seem to be paying not for better returns but inferior returns.
Krugman is correct when he depicts the issue. If you try to control fees by mandating only index funds and other low cost vehicles you will soon run into protests that you are infringing on ‘freedom of choice’. If you open the door to more funds then you increase the chance of inferior returns and returns siphoned away.
The other ticking time bomb most privitazation advocates overlook is ‘insurance’ for those who end up with bad returns and too little for retirement. This moral hazaard is equilivant to having a retirement plan where the gov’t drops you off at a casino and keeps giving you chips until you win a million. Great for you and the casino but unlikely to work for the taxpayer.
boonton
Jan 16 2005 at 4:34pm
Roger Lowenstein has an excellent piece on SS in this sunday’s NYT Magazine
http://www.nytimes.com/2005/01/16/magazine/16SOCIAL.html?adxnnl=1&oref=login&adxnnlx=1105908962-VmD18LAtUwPFXLD1jloySQ&pagewanted=all&position=
The projections:
So the ‘huge liability’ amounts to only 30% of benefits. Therefore if nothing is changed 70% of benefits will be paid for by not touching taxes. If current taxes will take care of 70% how exactly is the remaining 30% going to swamp the entire GDP????
Past performance is no indication of future success but:
Interesting how critics of global warming are so eager to jump on predictions that failed topan out.
BTW, rising wages do push SS more into the black. Contrary to what some critics have said, rising incomes do allow us to ‘grow’ out of any problems:
This point has been explored by other like Brad DeLong. Basically only the beginning benefit is indexed to wages but after that it is indexed to price. If wages are rising and I retire tomorrow, that will boost my benefit. But if wages continue to rise then the tax revenue coming into the system will increase while my benefits remain constant…adjusted only for inflation.
Putting the cost into perspective:
Robo
Jan 16 2005 at 5:08pm
Though there have been a lot of problems with pensions in the UK, most of these have been associated with the low level of returns in asset markets in the last few years, miss-selling of private pensions, longer life expectancy and demographics. Only the first two of these relate to the issue of changing the US system.
Real equity returns have been relatively low recently, maybe this means that the best of fund increases that have been estimated are over-stated. Many people in the UK were sold personal pensions, when it is clear that they would be unlikely to benefit from the system.
The system meant that you would give up your right to a suplementary state pension linked to your earnings and in return you would be given a rebate on some of your “national insurance” contributions and you would pay into to a private scheme (either picked by yourself or by your employer). Many people were persuaded to contribute to schemes with high charges when their likelihood of getting any benfit over the state system was very low. The miss-sellers have recently compensated those involved. These are things that have to be considered and managed if a scheme were to be set up in the US. Charges, incentives and returns are crucially important.
The other factors that have affected UK pensions are familiar to all developed countries. Norma Cohen quotes a government report suggesting these solutions to the UK pension problem
“cutting state retirement benefits, increasing taxes, increasing savings, or delaying retirement.”
To me, this is no different than the broad solutions facing the US, Germany and the UK. I am not sure that privatisation can reduce the pain of these choices. However, the “privatised” system that I would like to know about is that in Sweden where mandatory contributions are amalgamated invested in an indexed fashion.
rw
Jan 16 2005 at 8:17pm
Someone who knows more than I do about the UK experience with pensions has blogged about it here:
http://timworstall.typepad.com/timworstall/2004/12/paul_krugman_li.html
John F. Opie
Jan 17 2005 at 10:42am
Hi –
Odd that the real issue isn’t really being addressed: should social security be a reallocation of incomes or should it be based on real savings?
Where I am in Germany, the social security system is not merely bankrupt, it is deeply in debt and must use gasoline tax funds earmarked for road maintenance in order to meet the shortfall in redistribution. In other words, German social security is now where the US might be in post-2042 when the funds run out.
I work on the German economy and pay more than 25% of my gross income alone for social security costs into the system here. For my financial planning, I must simply accept that I will not get anything out of the system: before I head to retirement, the system will have collapsed and I anticipate not seeing a single cent out of the thousands I have paid in.
So answer the question: do you want to bury your heads into the sand and pretend that there isn’t a problem and continue to redistribute income, or do you want to put the system on a sound fiscal basis and reward saving for your retirement?
The US is in the enviable situation of being able to chose to avoid the mistakes made here.
John
Bigby Riches
Jan 17 2005 at 3:22pm
Ok, a couple things:
1) Britain tried their own version of privatizing social security in the 80s and it was a debacle: http://www.prospect.org/web/page.ww?section=root&name=ViewWeb&articleId=8997
2) Social Security as it now stands is a safety net – that is, if you fall off the high-wire of life you don’t hit the concrete below at terminal velocity. Have any of you even looked at the max benefits lately?!? It’s like $1,400 a month or something – can you even pay rent and groceries in California with $1,400 a month? (answer, no). I can’t believe that they want to mess with what is really barely-enough-to-live security; I mean, even if you managed your own account like Warren Buffet or something maybe you could get the equivalent of $2,000 or $2,500 a month – hardly the high life. And if you bungle it? Or if there is a (even temporary) market decline such as in 2000 right before you retire? Or if the mutual fund that is managing your account (and making hefty money off fees, I might add) goes under? Well, look for a lot more homeless people.
3) Managing my own social security?!? Why the hell would I want to do that? That’s what government is for. By the way, if Bush is wondering, I don’t want to deliver my own mail either.
4) Finally, exasperated by all the red-state (not to stereotype) Bush supporters whose knee-jerk reaction is to support this piratization of social security plan, I have gotten to the point where I’ve told my republican friends that I don’t care anymore. I mean, have you looked at the federal dollar balance of payments information for states recently? Blue states are mostly paying more in federal tax dollars than they receive in benefits – red states take in much more per capita than they pay in tax dollars. Frankly, if Bush wants to cut out social security payments to all the Alabama, Miss., Florida senior citizens – by all means, they voted for it!
Sorry if I’m a little cynical at the end…but I think that red states won’t start going blue again until the situation gets bad enough.
Brad Hutchings
Jan 17 2005 at 4:21pm
Boonton writes: I can’t speak for black men but I think they would rather have a policy to address the significantly decreased lifespan first.
Call up God then… Black men older than 35 are more than 25% more likely to die of heart disease than white men and nearly twice as likely as Hispanic men. Other disparities… Men live shorter lives than women. Perhaps we should start an affirmative action program to fix that one.
This would all make no difference to me (who will be 72 when Social Security goes tits up at its current burn rate — we need to use the term “burn rate” for this Ponzi Scheme) if my effective taxes weren’t over 15% to support this silly system. Anyway, we should count among the coalition to end it, not mend it, black men, anyone under 35, and men in general. If you can do the math, you can see how bad a deal it is for you if you’re in one of these groups.
Brad Hutchings
Jan 17 2005 at 4:29pm
Bigby, The problem with your argument that Social Security is a safety net is that there are a lot of able bodied, well-to-do people who can afford $200 greens fees and still have to take their checks. Your appeal would have a semblance of moral imperative to it if you were for means-testing the system and raising the dependency age significantly. I’m sorry, but a 72 year old man who can run a 10K is able bodied enough to work if he hasn’t saved for a comfortable, early retirement. He should not be getting a welfare check.
Dennis Duggan McMahon
Jan 17 2005 at 4:50pm
Social Security Two-Step
First Step
This year every American should be opening an Early Retirement Account. Not just every taxpayers and not just every worker, but every American who is fifteen-years-old (or older) and who wishes to control their own financial retirement. Even those persons who have taken off the mantle of youth will find these ERAs attractive. Each account will mature when it is thirty years old or when the account holder is fifty-five-years old, whichever comes first. Annual contributions will be capped at $5,000.00 or 5% of AGI, whichever is greater. (These would be pre-tax dollars, where applicable.) Withdrawals at and after maturity will not be taxed. Early withdrawals will be penalized 10%.
For those Americans who are already fifty-five the annual cap might be set at $50,000.00, or even $100,000.00. Since this account will already have matured, gains and earnings on these assets will not be subject to taxation. As soon as these mechanics are understood, the harping of the AARP should cease.
Last Step
In 2006 increases in Social Security payments should be tied to a price index instead of a wage index. With the expected explosion of ERAs, the original concept of FDR can be rewritten to reflect our times. Social Security becomes only a safety net. The current funding dynamics predict that Social Security outflows will exceed inflows in 2018. Re-indexing will mitigate this and push the crossover year even a little further into our children’s future. Also beginning next year, every taxpayer who reports $250,000.00 of AGI will have his/her Social Security payments reduced by 10%. (Remember, this taxpayer is contributing at least $12,500.00 of pre-tax dollars to an ERA; these is no limit on after-tax contributions.) A few Americans may still be paying into Social Security although their benefits have been reduced to zero. This is a small price for the relatively wealthy to pay. In two decades, when ERAs have proven to be very successful and Social Security is flush, citizens could be offered lump sum payouts. ERAs will end Social Security as we now know it.
In due time our legislators can write transition rules so that IRAs, 401(k)s, and all other pension funds and accounts may be moved into ERAs. President Bush has spoken of an ownership society. ERAs should be the first building block.
Capitalism can always make good use of more capital. ERAs will lower the cost of capital for every business in America. There is no downside. And there may be no transition costs.
With these two steps the arguments for and against partial privatization are now meaningless.
Dennis Duggan McMahon
San Francisco
Edge
Jan 17 2005 at 5:15pm
I’ve not studied Brittain’s system in detail, except to note that account fees are one of the biggest problems, as well as lower than hoped for equity returns and a lot more losers than the rosy scenario predicted.
We could limit account fees if we stick with a plan like the Federal Thrift Savings plan, where the government does all of the individual account management, and contracts out management of the aggregated funds. Perhaps require people to reach a certain asset level, like $20,000, before allowing them to transfer funds to a private IRA. Perhaps restrict private firms that want to offer such accounts so they can charge no annual maintainance fee and fees no larger than charged for other IRA accounts. Even at that, we really need people to purchase annuities, and the government can offer government guaranteed, inflation-adjusted annuities for a much lower cost than the private sector has ever demonstrated, and is better positioned to smoothe out gyrations across different demographic groups.
Why not simply keep the funds under an independent Social Security custodian, like the independent Federal Reserve. Allow the custodian to contract out for private fiduciaries to purchase specific asset classes – real treasury bonds, perhaps mortgage debt, perhaps foreign government bonds for AA rated governments, perhaps limited equity exposure with an index targeting equity-income with the intention that the equity be held long term. I’d stipulate that the government should maintain a “hands off” policy in terms of micro-managing the equity portion of the portfolio, to minimize concerns about government control of the private sector.
This wouldn’t be as efficient as truly free-market capital, but neither would any form of small regulated personal accounts. It’s also the simplest system, requiring the least change from a system that we know works, and probably requiring the least government intervention in the private sector.
Goal could be to build up the SS trust fund assets sufficient to generate about 2% of GDP as interest and dividends, with internal growth sufficient to keep the fund growing at the rate of GDP growth.
Bob
Jan 17 2005 at 6:17pm
Isn’t the answer to high fees to offer low-fee gov aggregation as an option? Or is the implicit assumption that people will be fooled into moving to high-fee alternatives? If you make gov aggregation the default, very few people will bother switching. But freedom has intrinsic value.
dsquared
Jan 18 2005 at 11:22am
If he does, I’ll tell you what I’ll do for him: I’ll take his money and contract to give him the same negative rate of return on it that SS provides by statute to the young
Jim, are you sure you’re well-capitalised enough to be writing annuity business on Krugman’s life?
Mark Horn
Jan 18 2005 at 11:52am
Quoting Boonton:
I’m having a hard time with this. Isn’t 10% of $105 equal to $10.50 not $10.05? It seems like you intentionally said $10.05 because you did it twice. What am I missing?
Mark Horn
Jan 18 2005 at 12:15pm
Quoting Boonton:
The problem with your model is that you assume a fixed tax rate across all income ranges. As a consequence growth in income results in corresponding growth in tax revenue. But that assumption isn’t true.
The social security tax rate is 6.2% and there’s a maximum income that gets taxed at that rate. In 2005 the maximum income is $90,000. So someone making $90k is taxed at 6.2% and contributes $5580 in taxes to the system. But compare that to someone who makes double that salary: $180,000. They contribute exactly the same in taxes to the system ($5580). Which means that their tax rate goes down to 3.1%. Someone who makes $360,000 has a social security tax rate of 1.55%. As income increases, the tax rate keeps getting lower and lower.
This is why population size matters in social security. If the population is big enough and making low enough wages, then what you’re saying is true. But as the population decreases, the wages of individuals are going to go up (supply and demand), and the rate at which they’re taxed into social security decreases.
This, however, is not true for investments into private accounts. An individual contributes 6.2% into a private account without a cap once their wages go above $90,000. Consequently investment into private accounts responds more favorably to economic growth than does social security.
While this may seem like an argument to remove the cap, I mean for it to be an arguemnt to transition the program to private investment.
Boonton
Jan 18 2005 at 1:29pm
You’re not missing anything, I goofed with the calculator. 🙂
Indeed, if all the growth in income happens above the SS tax threshhold then tax revenue will not grow (although income tax revenue should continue to grow, possibly even faster than income growth since the rate schedule is still progressive). For the sake of simplicity I assumed an even tax as well as even income growth. But is this really important? Assuming SS in the very long run is taking some roughly constant portion of GDP as taxes (say 6%) and distributing the same portion as benefits (6% again) the system will generate returns roughly equal to GDP’s growth. Regardless, it seems odd to assume economic growth will not benefit the under $90K a year crowd. Any particular reason to assume that’s true?
On additional complication is that if growth did benefit only the $90K+ crowd the Federal Budget would swell with income tax revenue. That would presumably lower the cost of borrowing dramatically thereby reducing the cost of simply borrowing any SS shortfall.
Why? Like Social Security if income growth above $90,000 is not subject to the mandatory contribution into a ‘private account’ then private accounts will not grow with income growth. If you’re arguing that the cap should be lifted entirely I’ll ask you why again? Why should society care if someone who makes $590K a year is putting 6.2% of the portion between $90 and $590K into a private account for their own private benefit? It sounds like you’re approaching the old ‘private accounts will generate better returns than SS because stocks do better than bonds’ argument that has been trashed several times over.
BTW, for my fans (if there are any!), I’ve started to post on my blog again. I’m working on several long Social Security articles. For those interested, feel free to visit at http://TheEverWiseBoonton.blogspot.com
Mark Horn
Jan 18 2005 at 4:21pm
I’m sorry. I didn’t mean to be confusing. I was NOT talking about the transition from social security to private accounts. I was talking about my (and presumably others) private decision to commit some percentage of income into investments. As income grows, so does contribution without limit.
Of course, when we’re talking about transitioning SS to forced investment in private accounts, if there’s a cap on the amount of investment, then you’re right: we are in the exact same financial situation.
I don’t know what society will care about. But society is currently comprised of people who value ownership more than taxation. I think that they’ll be more accepting of owning something that isn’t capped than they would of taking away a cap on a tax. And if that happens, exactly what I said will be true: economic growth will be more beneficial for private accounts than for social security.
But I could be wrong.
Boonton
Jan 18 2005 at 4:52pm
If people value owning something then why can’t they just buy it with the portion of their income above $90K? For that matter, what’s stopping them from buying assets with the untaxed portion of their income under $90K?
The ‘ownership’ idea is just a shell game. What does it mean for private individuals to ‘own’ $1T in assets while at the same time gov’t debt increases by $1T? Since gov’t debt will eventually be paid off with taxes ‘net ownership’ is $0.
Mark Horn
Jan 18 2005 at 5:08pm
Quoting Boonton:
Sorry. Missed this comment.
I don’t think I’m making that assumption. I’m assuming that economic growth helps everyone. And someone who was formerly making $20k may move up to $30k. Well some of those people are going to move past the $90k threshold, and when they do, they’ll be paying less than the 6.2% rate on social security.
Now let’s pretend for a minute. Pretend that economic growth is so good that it pushes everyone past the trheshold. At that point the way to figure out social security revenue is multiply the working population by $5580. At that point additional economic growth does not help social security revenue. Only population growth would help social security revenue.
Now I know that we’ll never get to the point where growth is so good to get everyone past the threshold. I played pretend for a minute to demonstrate that there’s a limit to how much economic growth can help social security.
As I said before, I would be in favor of a transition to forced savings as long as I owned that savings. And if I owned my savings, then I’d be in favor of removing the threshold. For me, it’d simply mean that I can change the percentage of savings that I do above and beyond today’s social security. I think many more people would be in favor of uncapped forced savings than would be in favor of an uncapped social security tax.
Mark Horn
Jan 18 2005 at 5:13pm
If we limit ownership in private accounts to T-Bills, then you’re correct. It’s a shell game. But why would we make such a limitation?
Boonton
Jan 18 2005 at 5:23pm
Let’s take a 3 man economy.
Poor man earns $10K pays $600
Middle earns $30K pays $1800
Rich earns $50K pays $3000
total revenue is $5,400 I’m using a 6% rate to keep things simple, cut off at $90K. Let’s say income doubles!
Poor man earns $20K pays $1200
Middle earns $60K pays $3600
Rich earns $100K pays $5400
Total revenue is $10,200. It didn’t exactly double but it almost did. Since the benefits are progressive the increase in income increases SS’s financial stablility.
My understanding is that SS’s ‘optimistic’ scenero shows it in the clear as far as the eye can reasonably see. If that amazing scenero came to pass we would be even better off.
It would be a shell game no matter what. On the one hand you have the gov’t borrow, say, $5K per person and on the other hand give everyone a $5K ‘private account’. Since taxes will eventually have to raise $5K per person (let’s leave interest aside) the net gain to everyone is exactly $0.
If that game worked you would have discovered the free lunch. Gov’t could borrow at 6% and give everyone accounts where they would earn 10% or whatever & eventually we’d all be rich.
First Rule: if you analysis leads you to discover a free lunch then something is wrong.
Mark Horn
Jan 18 2005 at 5:53pm
Quoting Boonton:
In a privitized system, I don’t think the government is giving everyone a $5k account. People are putting their own $5k into the account and alleviating the government of a $5k liability. Now, of course, the government already has some liability to someone else who already paid into social security. So we’ll have to either raise taxes to pay that liability or incur more debt. But that’s a one time thing. Once all of those liabilities are paid off, they’re paid off forever. And with everyone owning their own private accounts, the government no longer incurs new liabilities that it has to pay for. It’s difficult to quantify how much we all gain from that, but it’s not zero.
Compared with Social Security in which the government is constantly incuring new liabilities everytime it collects social security tax, I think it’s an improvement.
Boonton
Jan 18 2005 at 8:00pm
Don’t most privitization plans incorporate a guarantee for private plans that either get wiped out in bad investments or otherwise do not have sufficient assets to fund a reasonable retirement for those in need? Basically every dollar that goes into a private plan is an additional liability to the gov’t for this implied insurance.
Boonton
Jan 18 2005 at 8:01pm
More to the point, what does this have to do with social security? You already have private plans, they are called 401Ks and if your employer doesn’t offer a 401K you can open an IRA at any bank and enjoy generous tax subsidies. If this is so great why not simply mandate participation????
Mark Horn
Jan 18 2005 at 9:55pm
I don’t know. But even if that’s true, not every dollar that goes into a private plan is an implied liability. Only the ones that are lost. One would have to presume that if the entire population lost all of their money in their private plans that something catastrophic has happened. Other than such a occurance, only some portion is going to be covered by the hand of the government.
But to be completely frank with you, I don’t think any of it should be insured. The government doesn’t cover us when we fail to save for cars or vacations or computers or all manner of things. Why should they cover us when we don’t save for retirement? It just means we have to keep working longer. But if this is something that we insist on, I’d bet that the cost of insurance is lower than the cost of running the SSA. How much does it cost to provide FDIC insurance?
Of course we have private plans. What we’re talking about here is taking away the social security tax and replacing it with forced contributions to private plans. I’m entirely on board with your madated participation in 401(k) or IRA plans. As long as you also take away social security tax. If we did that, I’d be in favor of taking away the hard cap of $11160 ($5580 from me and $5580 from my employer) per year in contributions and replacing it with 12.4% of income.
Boonton
Jan 19 2005 at 11:31am
FDIC insurance is relatively cheap, although not without its critics. The banking industry is heavily regulated plus it has the unusual feature of the Fed serving as a back up. While its not a gurantee, the Fed can and will pump money into the system if a crises makes it appear that a large bank will be pushed under.
But a more relevant incident to look at would be the Savings and Loan crises. Basically S&L’s demanded to be let loose from tight regulation so they could persue profits in riskier loans but the gov’t ‘insurance’ of the S&L’s were not lifted. What followed as a classic case of moral hazard (when the comfort of insurance makes you take risks you wouldn’t have otherwise taken). Risky loans with high rates were made with the hopes of striking it rich while managers felt safe that if things went wrong the depositors would be bailed out by the Fed. In the end hundreds of S&L’s went bankrupt with hundreds of bad loans on their books.
I appreciate your desire not to have private accounts insured by the gov’t but I don’t think it is realistic. Will people really be sympathetic to the view that blind luck might mean their retirements are a lot less enjoyable than their lucky neighbor who cashed out at a market peak? Its easy to be libertarian on a big paycheck, not so easy while eating out of cans.
Social Security, being a low cost annuity nicely counterbalances private accounts, IMO. This is especially true if you live much longer than you expect or the market suffers a major downturn. Granted these effects can be simulated in a 401K but most people won’t and many financial advisors have conflicted interests. I would rather see SS preserved as part of a diverse portfolio of private 401K’s/savings, employer pensions (where they still exist), and SS.
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