Defending Social Security

Well, many many people do not act optimally for themselves, and while I don’t know that government should or can take care of them instead, I’m concerned about what happens if they don’t. Wasn’t poverty amongst the elderly a huge problem that social security was designed to take care of? What was it like if that was so?

I certainly have a problem with Diamond assuming that if my decisions don’t match to what he thinks is optimal for me, then the government should step in and force the decision upon me. Because of the myriad of factors that go into determining my preferences, my optimal decisions cannot be quantified. Therefore, we should actually define the optimal decision as the decision the individual makes. As I understand it, this is what most economists do. When an economist’s theory does not match the decisions made by individuals, we look to correct the theory, but you do not assume that the individual is wrong, requiring behavioral correction.

We do, however, have to realize that there are some people who are risk adverse and others who love risk. The risk takers will be more likely to end up destitute in their golden years than the risk adverse. Now some, like the previous commenter, will state that we do not want to live in a society that will allow those risk takers to live up to the full consequences of their actions; we do not want to see Grandma Betty starve to death. Since we all know that we will require a safety net from the government, the risk adverse will assume more risk than they would otherwise, leading to more people depending upon the safety net.

That said, there are several options that could still be better than the current Social Security system. For example, perhaps the government could require certificates of minimum retirement insurance from all laborers in much the same way we require drivers to be insured. To go through all of these options, however, would be to diverge from the point of discussion, which is Diamond’s paternalistic assumption.

How did people in this country survive for 300+ years before SS? SS was a political gimmick. The retirement age was set so that, on the average, benefits would be paid for only a year or two. Government is only a group of people who think they know what is best for everyone else. Did you ever wonder why Congress excluded itself from SS, only to create their own sweetheart retirement plan?

SSI has not really created such a ‘dependent class’. The only really abusive increase in benefits came from Richard Nixon and that wasn’t due to seniors making unreasonable demands but from his pathological need to win reelection by 100% of the vote.

As for paternalism, I’ll ask a question; Isn’t the tax subsidized status of 401K’s, IRA’s and Roth IRA’s also gov’t paternalism? We could just as easily ask why those who wish to consume more today must pay higher taxes in order to reward those who lock their money away for 30 years? How about those who wish to use unconventional methods of savings such as collecting comic books? Why should their economic choices be punished by gov’t policy that supposedly knows better?

Of course, most people who carp about paternalism are quite enthusiastic about 401K’s. Yet if the world was as rational as they claim, then they too are supporting a form of gov’t paternalism.

There is a huge difference between encouraging retirement savings through subsidy and enforcing retirement savings through a mandatory program.

If you work, you must enroll in Social Security. There are pretty much no exceptions (the Post Office is the only organization I know of that is not a part of SS).

Force is paternalistic, encouragement is not.

Seriously, the 50 something guy who saved dutifully into a money market account, and thus missed the stock boom, has taken a big risk. It wasn’t an investment risk, but it was a risk nonetheless. The money market saver is never going to be able to retire.

The counter argument is that this is not risk. Risk is the expected variation of your return. The person putting money into the money market knews pretty much what his return was going to be. Hence he should have known that his retirement would have to be of a smaller scope.

There is a huge difference between encouraging retirement savings through subsidy and enforcing retirement savings through a mandatory program.

For the person doing the saving there is a difference but not for those who with to do other options. If, for whatever reason, I don’t want to put my money into a 401K or IRA I still am required to pay taxes at a higher rate. Unlike SSI, I’m being required to ‘save’ for someone else’s benefit which is even worse than a mandatory ‘saving’ that I could eventually get back in some form!

Sorry, if you want to rail against paternalism then you are going to have to take on the Middle Classes ‘Newer Deal’ of tax breaks.

>>If, for whatever reason, I don’t want to put my money into a 401K or IRA I still am required to pay taxes at a higher rate. Unlike SSI, I’m being required to ‘save’ for someone else’s benefit which is even worse than a mandatory ‘saving’ that I could eventually get back in some form!

Just because an individual is paying a lower rate doesn’t imply that you are subsidizing that individual. That is a static analysis, it doesn’t take into account the “unintended consequences” of people changing their behavior due to new incentives.

For example, 401(k)s are only taxed deferred, not tax free. Taxes will eventually be paid on that money. It could easily be the case that tax rates in the future will be higher than tax rates in the past, and MORE taxes will be paid on 401(k) money than if the money had gone into a taxable account.

Suppose the government could devise a truly “adequate” insurance and retirement formula. $100,000 for death, $20,000 per year of retirement income for example.

How long would it be before very sad stories appeared in the paper of people who “lost their homes” due to the inadequacy of this amount for their particular circumstances? How long would it be before hearings would be held with “victims” of this “inadequate” program “demanding justice”?
How long would it be before it was “changed”? How long would it be before the next cycle ensued?

It is utterly impossible to devise a “just” or “adequate” plan that cannot be shown to disadvantage someone. One “good” victim and the inertia to begin tinkering with the numbers would be overcome and the inevitable expansion of the bureaucracy would begin.

People who don’t understand this process probably have never worked in any kind of organization. The only reason bureaucracies are held in check in private business is the need for profits. The only reason they are held in check in “non-profits” are limitations on their ability to generate donations. Give a bureaucracy the ability to expand and it will until the funds run out.

So, a magical “adequate” level of “security” will never exist for long. It will always increase given political pressures. Knowing this does it make sense to even consider pursuing this course since the eventual outcome is totally foreseeable (communism)?

It most certainly is sad that individuals sometimes suffer catastrophic financial loss. However, no a tiny trade-off exists to significantly mitigate this problem without putting a horrific scenario in place, eventual totalitarianism.

B, you are arguing semantics. Theoretically, in a static environment, the tax code is a zero sum game. But I think that the latest stats from the OMB, showing how the top quintile of income earners pay a higher share of all taxes now than in the ’80s, even though tax rates now are actually lower, shows that zero sum has zero value.

Just a couple off-point corrections.

Eric: For example, 401(k)s are only taxed deferred, not tax free.

Actually, the contributions are also tax-deductible. Income is taken off your W2, so you don’t even have to itemize (and indeed, it can help you get below the income caps for IRAs).

Eric: It could easily be the case that tax rates in the future will be higher than tax rates in the past, and MORE taxes will be paid on 401(k) money than if the money had gone into a taxable account.

Possible, but not likely. Especially for people who are no longer drawing an income by that time. And that the future tax has to be high enough to counteract the extra returns earned by the amount that would have been taxed.

>>Eric: For example, 401(k)s are only taxed deferred, not tax free.

>>Actually, the contributions are also tax-deductible. Income is taken off your W2, so you don’t even have to itemize (and indeed, it can help you get below the income caps for IRAs).

What other mechanism is there to defer taxes? Yeah, your 401(k) contribution comes off the top of your taxable income, just like any deduction does. It doesn’t change the fact that taxes are only deferred, not avoided.

>>Eric: It could easily be the case that tax rates in the future will be higher than tax rates in the past, and MORE taxes will be paid on 401(k) money than if the money had gone into a taxable account.

>>Possible, but not likely. Especially for people who are no longer drawing an income by that time. And that the future tax has to be high enough to counteract the extra returns earned by the amount that would have been taxed.

I can create Excel spreadsheet scenarios where I myself could have more income in retirement than I have right now, making some pretty reasonable assumptions regarding investment returns, inflation, and income growth. People with modest incomes, high savings rates, and aggressive investments (fully invested in stocks) could very easily have more income in retirement than they make now.

And this is all predicated on current tax rates. All bets are off if tax rates go up, which there is a high probability of happening.

This is why the Roth IRA is so important. You hedge against having TOO MUCH taxable income in retirement by saving a portion of your investments there.

Of course, you now have the risk that some future Congress will make the Roth IRA taxable. I guess you can’t hedge against every risk.

>>And that the future tax has to be high enough to counteract the extra returns earned by the amount that would have been taxed.

If you are in the same tax bracket in retirement as you are while working, there is no advantage to the 401(k). The fact that your earnings worked for you rather than being taxes just means that you have more income to tax later.

You can prove it to yourself with an Excel spreadsheet. If you have an investment that makes 5% in the first time period and 10% in the second, and the very same investment making 10% in the first period and 5% in the second, you end up with the same amount of money in the final time period.

All that taxes are is another investment expense. They lower your return when you pay them. It doesn’t matter when the taxes are paid, only the tax rate matters. The 401(k) makes sense because you think that you will be in a lower tax bracket when you retire. This may not be a very good assumption.

You can prove it to yourself with an Excel spreadsheet. If you have an investment that makes 5% in the first time period and 10% in the second, and the very same investment making 10% in the first period and 5% in the second, you end up with the same amount of money in the final time period.

Very close Eric, I was almost fooled as well. I simulated two accounts, the first started with $1000 and grew at 5% for 25 years ending at $3,225.10. If the tax bracket was 30%, that would leave $2,257.57. That’s your 401K simulation.

Then I simulated an account that started at $700 (which would be $1000 minus 30% taxes paid at the start). It grew to $2,257.57…just like where the 401K simulation ended.

BUT what you missed, Eric, is that each year you would pay taxes on that income. For example, after the first year your balance increases from $700 to $735. You had $35 in interest income which would generate $10.50 in tax (@ 30%). So your balance for year two would be $724.50…not $735.00. At the end of the day your balance will grow to $1,723.39. Compare this to the $2,257.57 you would have from the 401K type account after paying taxes on your withdrawl.

Deferred taxes do allow you to earn more income even if your tax bracket never changes. If you wish, I can send you the spreadsheet…email your address to me Brian a Ideas4now dot com.

>>you should consider that 401K’s have a lot of flexibility in distributions so people can plan their withdrawls for periods where their income will be minimal.

There is some flexibility, but not total flexibility. There is a set age that you must start taking distributions, and there is a minimum distribution. Both rules are there so that SOME income tax is generated, and on large accounts the minimum distributions are high enough to generate significant tax bills. This is why I say that, if you are at a lower income during your working years but have accumulated a significant nest egg, you COULD be in a higher tax bracket.

I agree that the minority of people will be in this situation. My concern is that you are penalizing the people who have behaved the best, the ones who followed the rules and saved for their retirement as much as they could.

This is why I say that, if you are at a lower income during your working years but have accumulated a significant nest egg, you COULD be in a higher tax bracket.
I agree that the minority of people will be in this situation

I think it is nearly impossible to end up paying more taxes in a tax deferred account than you would have had to pay in a taxable account….even if a lottery win late in life (or getting hired by Trump to be his apprenctice) put you in the top bracket at 75 while you’ve been working min. wage for your whole life.

Boonton, do a spreadsheet. Start with a 25 year old, who starts out by making $25,000. He saves 10% of his salary in a 401(k). He works to 67. He wants to build a nest egg where he can live off the interest of the nest egg only.

What interest rate would he need to obtain in order to build a sufficient nest egg and generate $25,000 per year it?

My spreadsheet says less than 6%.

I am not taking into account either inflation nor salary increases. They will offset somewhat.

It is not impossible, or even near impossible, to have more income in retirement than you do during your working years. It may be unlikely, but even an unlikely scenario could entrap millions of people.

If interest rates are constant at 6%, a person will need to have $416,666.66 in an account in order to generate $25,000 per year forever.

My rough estimate indicates that if a person made $25K per year for 25 years and put 10% of that per year into a 401K type account earning 6%….at the end of 25 years he would have $137,161.30. If he put 25% of his income ($6,250) per year into such an account it would be $342,903.20 after 25 years.

That would yield him $20,574 per year after 25 years in interest income. Not bad but he still would have a lower taxable income than he did during his working years.

fling93: The contribution deduction lowers your taxable income. Period. You don’t ever pay the “owed” taxes later.

Whoops. I’m wrong about that. You’re right, it’s deferred.

The argument to make is that it’s considerably less paternalism than Social Security, since the amount of money you are forced to pay is much less.

This is the problem with tax based subsidies, their true cost is difficult to figure out. As Eric points out, 401K’s are a benefit to those who use them…hence they are a cost to non-401K taxpayers.

Boonton, just curious, why 25 years? A 25 year old can’t retire before 59-1/2, right? At least, he can’t retire earlier and tap into the 401(k).

No particular reason, maybe the person didn’t get serious about retirement until his low 40’s. The exercises should work if you use 30, 35 or 40 years.

My point is that, even for low earners, all that is needed is a modest savings rate, a modest ROI, and a long working life, and you could very easily have a higher income in retirement than while you were working. I started at 25, I save way more than 10%, I make way more than $25K, and I have average gains way more than 6%. I have a feeling that I am going to get screwed on the 401(k).

So let me do this model with the following assumptions:

1. At 25 years old, you save 15% of your income in a 401K. You earn 5% per year on your balance.

2. Tax rate is a flat 25% (to make things simple).

3. Each year your income goes up by 5%.

4. You stop working after 40 years.

At the end of year 40 your salary is $167,618.78. You have paid $452,999.15 in taxes and your 401K balance is $1,005,712.67. Pretty good.

Now if you didn’t contribute to your 401K you would have paid taxes totalling $754,998.59. So over your lifetime your 401K contributions saved you taxes totalling $301,999.44. Assuming a flat 25% tax rate you can see your withdrawls from the 401K still make you a winner. (progressive taxation would make this savings even more powerful since your tax bracket would be higher as your income went over $100K). What if the tax rate is raised to 50% after retirement?

Even in that case, you will pay $502,856.34 & have the same left in your 401K but your contributions to the 401K were only $452,999.15. You still have earned $49K over and above your income. So what do you have for your savings?

1. You’ve netted an additional $49K of income to the person who did not save.
2. Your total lifetime consumption would:
$2,378,245.56 during your working years
$ 502,856.34 when you use your 401K
$2,881,101.89 total lifetime consumption.

A person who didn’t go for the 401K would have a total lifetime consumption of:
$2,264,995.77

It would seem that even if the gov’t taxed your 401K away 100% the person contributing to it got away with slightly more consumption than the person who didn’t. The person who failed to contribute has over $617K less consumption to enjoy than the person who did contribute only to see himself in a tax bracket two times his working age bracket when he retires!

Boonton, your spreadsheet is extremely sensitive to the rate of pay increases. You get the numbers that you get because you assume a 5% rate of pay increases. Pay increases are like a ROI all of their own. They compound just like interest does.

In any case, it is clear that the reason that the 401(k) works is that investment returns are allowed to compound tax free. It isn’t the fact that you don’t pay taxes on the income up front that gives you the advantage. Thus, it is not a better or worse vehicle that the Roth IRA, and you can hedge your bets on tax rates by using a mix of the 401(k) (taxes paid on the back end) and the Roth IRA (taxes paid on the front end). I guess you would choose your allocation based on your perception of tax risk.

Roth IRA vs 401K

So I simulated a contribution each year to a Roth IRA of $2,812.50. This is 15% of the salary that a person who makes $25K a year less the 25% income tax from our simulation. After 40 years:

Roth Balance: $339,749.37
401K Balanc : $452,999.15

401K Advantage: $113,249.78

However, if the 401K is taxed by 25% or more the advantage is gone. So it would seem that Eric’s point is accurate. The Roth IRA works if you expect your retirement tax bracket to be equal to or higher than your working one. The 401K works better, though, if you expect your retirement tax bracket to be less than your working one.

Compounding is very powerful and putting an extra $1000 away in year 1 makes a large difference in year 40. Since the 401K gives you some power over when to start taking withdrawls, most people should be able to arrange a few years where their bracket will be low. I guess for someone like Madonna who will probably be getting high income from royalities long after she stops working the Roth IRA is the best bet….

Ok, I’m wrong!. When I figured a person’s consumption during their working years I simply took taxes away from their income. I should have taken their 401K contribution as well!

A person who makes 25K a year for 40 years & contributes:

Income: $1,000,000.00
Taxes: $ 212,500.00
401K cont:$ 150,000.00

Consump: $ 637,500.00

And a person who doesn’t contribute:

Income: $1,000,000.00
Taxes: $ 250,000.00

Consump: $ 750,000.00

The non-contributor has an advantage of $112,500 in lifetime consumption at retirement. However, the contributor has a 401K with a balance of $452,999. The non-contributor gets to win if the tax rate faced by the contributor is 75% or more on his 401K. If the contributor is taxed less than that rate (but still more than 25%, his working age rate) the contributor gets more consumption!

So, Eric, if you think your retirement tax bracket is going to be very…very high. On the order of 3 times your present bracket or more then you may get screwed on your 401K. However, if you assume that brackets stay where they are now there is no way you can construct a 401K where you earn a positive return but end up losing against the non-saver.

Not really since I’m not trying to estimate a return on SSI. I think the exercise is misguided but I agree that should be considered…. At least you can feel confident that your 401K contributions are a good choice unless the gov’t enacts 75% tax rates on withdrawls in your future.

Real GDP in 2003 was about $10T. If you had a 75% tax that would be $7.5T (ignoring the supply side problems with such a tax) per year. If the unfunded liability was $60T then it would be paid off in just 8 years (60/7.5).

Of course, going into the future GDP will be higher than $10T because of economic growth & that unfunded liability is stretched out over a very long period. Somehow I don’t think 75% tax rates are very likely & that’s good news for your 401K.

There is a good argument that 401K’s will not preserve their as much of their extreme favored tax treatment into the future. It’s hard to imagine telling seniors who are poor that their SSI benefits have to be cut while those who became 401K millionaires will be allowed to live it up.

Also, the stock market is erratic so people retiring in good years will have dramatically better 401K’s than those who retire in slumps. I know good money management would insist that people hedge their 401K’s against risk as they get closer to retirement but will people be that rational? Look at how many of the ‘best and the brightest’ at Enron had 100% of their 401K in a single stock! (Let alone 100% allocation in the stock market)

True…one thing the gov’t could do is tax 401K plans that were in existence before a certain date (say 2010) at a higher tax rate. From a supply side point of view there is nothing the 401K holder would be able to do….his balance is his balance…..

I don’t think the gov’t will resort to such drastic measures but I do think it’s premature to assume 401K’s will be safe from taxation in the future. The arguments in favor of taxation will be that it is unfair for the entire burden of caring for retirees to fall upon the workers & 401K holders benefited from the gov’t sponsored subsidies ever since they were created.

This doesn’t mean that it won’t be better to retire in 2035 having contributed to your 401K during your working life. It certainly will be. This does, IMO, mean the returns on 401K’s will almost certainly be less than people are projecting when they try to compare them to SSI’s ‘returns’.

Now another argument is what type of returns can 401K’s really generate for everyone. I think they would have to be no more than the overall economic growth rate.

IRA is not paternalism, it’s freedom of use-of-property.

Your suggestion that IRAs and 401k’s are a form of paternalism is rooted in the assumption that the money came from the government, and that it is gifting those account-holders thru tax breaks. The suggestion that SS is paternalism is only slightly more viable – it is based on the same assumption, but in the case of SS, the government takes the money by force (jail-time for un-paid taxes), and then gives it back.

Luke, would you say farm subsidies are not a form of paternalism? After all, the gov’t isn’t forcing anyone to be a farmer or forcing farmers to grow a certain crop? Right?

The fact is that income is taxed at a particular rate. If person A’s income is exempt from tax because he is doing something the gov’t wants him to do, it means that everyone else is paying for that particular person’s tax cut. Suppose the gov’t said anyone named Eric would get a 5% tax cut. Certainly you aren’t going to claim that such a policy is costless or that it’s not paternalistic towards people named Eric because it’s just letting them keep a bit more of their property!

Tax subsidies are still subsidies. Your property argument is a weak way to try to spin the huge amount of pork that is written into the tax code. While the benefits of the 401K are voluntary for those who want to participate, the costs are mandatory and fall on everyone who chooses (for good or bad reasons) not to participate.

The fact is that income is taxed at a particular rate.

And our entire income tax system is a complicated mess of pseudo-subsidies, yes. The definition of paternalism I’m using is one in which the government provides for needs WITHOUT giving citizens rights OR responsibilities. Nearly ALL of our current tax code gives citizens no rights – you comply or you go to jail, while at the same time giving us the full responsibility for the tax. It is not paternalism, but it’s not freedom.

Tax subsidies are still subsidies.

But they are just that, subsidies, and not real paternalism. Farm subsidies are part of that same pseudo-paternlism as the rest of the tax-and-spend system, and so is Social Security.

In every subsidy from the government, the right of the citizens (tax-payers) to their own property (the production of their own labor) is violated to begin with, so that takes care of the ‘no rights’ requirement. But in every subsidized case, you have certain responsibilities to meet in order to receive that subsidy. You have to save your money in a certain account, or you have to take on a certain occupation, or you have to be above a certain age, or you have to be below a certain income level, whatever. None of these are real paternalism.

What we have is a complicated mess of trying to give people rights and freedom, while at the same time relieving them of their responsibilities. What has actually happened is the reverse – we’ve denied people their rights and imposed more responsibility onto them. 4 of my friends and I will be paying for Grandpa Joe’s retirement income, and neither Joe nor the 4 of us have any say in the matter.

The income tax system is a huge mess that makes tax loopholes and subsidies rampant, and at the same time, obfuscated.

But they are just that, subsidies, and not real paternalism. Farm subsidies are part of that same pseudo-paternlism as the rest of the tax-and-spend system, and so is Social Security.

Boonton, if you can’t see the difference between the government encouraging people to use 401(k)s through a subsidy and forcing people into the Socialist Insecurity system, then there really isn’t much point in arguing further.

In both cases gov’t is taxing everyone else at a higher rate in order to provide the benefits of SSI or 401K. To the degree that 401K’s produce better ‘returns’ than SSI then the degree of paternalism is all the higher since everyone else is taxed just that much more to compensate for the lost revenue.

To bring this point home even more, imagine gov’t abolished the income tax in favor of a national sales tax. The effect on Roth IRA’s would be devastating because their main benefit (no taxation) is now gone. Retirees will be paying tax on their Roth IRA & 401K money as they make purchases! If the gov’t wanted to make such a change in tax systems neutral, it would have to end up giving 401K holders actual payments to compensate them for their lost advantage. What better illustration of 401K’s paternalism do you need? Who would pay for those payments? Why the taxpayers and it wouldn’t be voluntary!

If the goal of saving was saving in and of itself, then a national sales tax would not be an issue to 401K savers. On the other hand, if people saving for retirement actually expected to have a retirement then a national sales tax would be harmful. By definition it would reduce the amount of consumption a 401K retired person could enjoy.

What you are missing Eric is that the 401K system does not allow for more net freedom. It gives those that use 401K’s more freedom at the expense of those who don’t. This is like saying sugar subsides give farmers who want to grow sugar more freedom. I could also point out those receiving SSI checks enjoy the additional freedom gained by those monthly checks as well.

SSI’s returns require you to know how long you will live. Since you could get struck by lighting the second after you get your first check, there is no way to be sure you’ll get positive or negative returns. What is clear, though, is that regardless of what your eventual return will be the first check you get will increase your possible consumption for that amount thereby providing you with an increase of freedom.

Again I ask why should income earned from savings be tax free when other types of income (such as by working) are taxed? The double taxation argument falls apart as soon as you give it even a little scrutiny. What you are left with are paternalistic arguments (mmm…savings are good…okayyyyy).

>>there is no way to be sure you’ll get positive or negative returns.

You are obscuring the fact that the PROMISED benefits are less now than they were in the past, and more importantly, the taxes are much higher than they used to be. Also, the projected deficit is such that the promised benefits are never going to materialize.

So, on that basis, the return on SS is negative, to me. I am going to lose money on the deal, in all likelihood. Probalistically speaking.

Gentlemen, please let me throw some facts in with theory. Boonton, it is entirely possible to pay a higher rate of taxation on a tax-deferred account than you would have paid while accumulating that account, due to the required minimum distributions at ages above 70 1/2 and the progressive income tax structure. By the time you’re in your eighties, the required minimum distributions get higher and higher. If you have a big 401(k) by then, these required minimum distributions can push you into the 35% income tax bracket even though you were in a lower income tax bracket at younger ages. At these levels of adjusted gross income, 85% of your Social Security benefit will be taxable even though half of the money from it was subject to income tax when the SSA deducted it from your paycheck. Hence, you are being taxed twice by the IRS on nearly half of your SS benefit.

Regarding savings, the American savings rate was 8-9% through the stagflation days of the 1970’s and was 6-7% up to the mid-1980’s. Today it’s an anemic 2%. Why? Because the payroll tax, which is the largest tax for 70% of US households, doubled in the mid-eighties.

Congress can offer all the tax sweeteners it likes by raising the 401(k) contribution limit, by granting extra deductions for those over 50, by creating the Roth IRA. But, these will be weak incentives for people in low income tax brackets, which is most people. They’re still paying more money in payroll tax than income tax. After decades of this, they certainly feel entitled to generous SS and Medicare benefits. The fact that their money went out as fast as it came in, a fact that Congress has continuously covered up with a fictitious trust fund, does not inhibit their demands.

The default answer and the most likely prospect is a big increase in the income tax, especially in the upper brackets. This is because first, the Treasury will have to redeem the bonds it has sold the SS Trust Fund through general taxation and second, Congress has no other source of money adequate to the purpose. How will Congress save Social Security? By taxing the hell out of your carefully-husbanded 401(k).

So when we attempt to measure the returns earned on 401K’s, we should take into account the fact that 401K’s are likely to end up being taxed at some point….this is just an indirect way of increasing income taxes since those with the largest 401K’s will have had the largest incomes (income being both wage income and investment income).

This brings me back to my suggests for sensible reform:

1. Index the retirement age to expected lifespan going forward.

2. Removing the payroll tax on earnings would result in excessive marginal tax rates but what could be done is to losen the cap. Let the portion of income over $88K be taxed at 3-4% for SSI. Use 1 or 2% for increased benefits on those who had higher incomes and the balance to help fund the program…including reducing debt today in anticipate of the baby boomer crunch.

3. Find ways to encourage willing and able seniors to delay retirement & continue working. For productive seniors, this would be a double win because their income would be higher & gov’t revenues would benefit from additional SSI & income taxes.

4. Increase immigration for younger people.

5. Rework the healthcare system into a universal voucher funded by a dedicated tax.

Social Security is already on the cusp of being fine. Projections of bankruptcy require decades of below average growth while good growth will make the program sound for over 75 years (who knows what the world will be like then? How different was 1900 from 1975).

Boonton, I don’t see the connection between your assumptions and your claim for the actual health of Social Security so I cannot address them. However, your previous post had these cures for SS if indeed it’s in actuarial danger: 1. Raise the retirement age (cut benefits), 2. Raise the taxable wage base (raise taxes), 3. Encourage old people to work (pay more taxes and get lower total benefits), 4. Encourage immigration of young foreigners, and 5. Nationalize medicine (raise taxes). Each proposal other than increased immigration is a tax increase.

Let me examine #2. You suggest raising the taxable wage base by taxing earned income above the current approx. $80K base, a tax of 3-4%, then use part of that to subsidize people with lower average indexed monthly earnings. That would be like the current system, only more so, since the current system replaces the first block of earnings at a higher rate than the second block above it, and does not replace any earnings at all above the taxable wage base. Hence, SS’s tax is flat up to the wage base, but it is regressive (the lower the amount, the more of it is replaced) in its benefit formula.

You’re right that the only alternatives are to cut benefits, raise taxes, or some combination of the two. But, you are proposing to turn a purported insurance plan into an income redistribution plan. Is this fair? Moreover, won’t it aggravate the moral hazard of too many people relying too heavily on Social Security instead of accumulating more personal savings?

Further, Boonton, proposal #2 conflicts with proposal #3. Today, most SS recipients take a partial benefit at 62 since it takes 13 years for the higher benefit at 65 to make up for those three years of early benefits. Consequently, their benefits are reduced by $1 for every $3 they earn above a low level about $12,000. If you would tax a 62-year-old doctor more heavily on his earned income, you’re giving him an incentive to retire that much sooner.

Boonton, if people are to be coerced into providing for retirement, wouldn’t it be more equitable to coerce the average taxpayer into funding his own retirement than to coerce the above-average taxpayer to fund the retirement of people who refuse to provide for themselves?

Only about half of the people between 25-64 have 401(k)’s or any retirement savings plan. Only 10% of 401(k) participants contribute the maximum. Most taxpayers qualify for deductible IRA’s but fewer than 2% of tax returns include any adjustment to income for IRA contributions. Saving for retirement is something most people don’t take seriously. If we’re going to put a gun to a man’s head (which is how laws are ultimately enforced) to make him pay for somebody’s retirement, wouldn’t it be more fair to make him pay for his own than for somebody else’s?

Agreed, benefits are not being cut, merely held stable, if indexed to increasing longevity. When you say to a SS taxpayer that he or she will get benefits at 70 instead of 67 because he or she is likely to live to 83 instead of 80, that doesn’t look like a cut to anybody except the taxpayer.

You have said that the European system sets things up so that the more productive senior citizens can stay in the work force while the less productive ones can start drawing retirement benefits. But, why should that more productive senior citizen keep working? He has a strong financial incentive to take his retirement benefits as early as he can. In most European countries, you don’t get higher benefits by waiting longer than ASAP to take your retirement benefits, while the payroll taxes on your earned income are high to pay for everybody else’s retirement. When you add the payroll tax to the foregone income of missing that first year of retirement benefits, you lose an amount of money equal to about 75%-82% of that year’s earnings in the UK, France, Italy and Belgium. In the Netherlands, it’s 141% since your retirement benefits are free of income tax. (Source for these figures is “Gray Dawn”, by Peter Peterson, a former U.S. Secretary of Commerce)

Under these incentives you’d be crazy not to retire as early as you can, whether you’re among your country’s most productive middle-aged or not. So, that is what they do. The Western Europeans are rightly proud of their average longevity as a reflection of their fine health care systems and this longevity has increased markedly in the past few decades. Yet, in spite of that admirable increase in elder health, their workers retire much younger than they used to.

Again from Peterson: Between 1960 and 1995, average retirement age for German men fell from 65.2 to 60.5. In France, from 64.5 to 59.2. In Italy, from 64.5 to 60.6. In the UK, from 66.2 to 62.7. (In the USA, from 66.5 to 63.6.)

If those 60-year-old Europeans are getting healthier, then why did the share of men 60-64 in the work force drop from 70% to 32% in Germany in the last 25 years? In France, it went from 67% to 22%. Because it isn’t a matter of health, it’s a matter of incentive.

Peterson did not examine whether the more productive middle-age workers were more or less likely to retire ASAP, but under a progressive income tax structure the higher-paid face a bigger tax bite than the lower paid. So, why should they keep working?

You have said that it is “politically easier to force people to save only for themselves”, but I didn’t say it was politically easier. My question was whether it was more fair and just that the first claim on a worker’s paycheck belongs to himself or to somebody else. Would you address that question? Since you can’t eat your cake and have it, too, you seem to be saying that those who have already eaten their cake are entitled to a slice of somebody else’s.

Boonton, what you call paternalism is enforced by coercion whether the first claim on a worker’s paycheck is paid to himself or somebody else. You find this coercion, which is ultimately enforced at gunpoint, preferable to letting improvident people suffer the consequences of improvidence.

But, this creates a moral hazard. Why should a man who might provide for himself make any sacrifices to do so when others will do it for him or coerce third parties to do so? How can you encourage thrift and self-reliance by fining those who practice them, to grant bonuses to those who do not?

Just about every American worker has some type of retirement savings plan available to him. Of those covered by 401(k) plans, only about half participate. Most taxpayers are eligible to contribute to deductible IRA’s and nearly all are eligible for Roth IRA’s.

To fully fund a $250/mo. IRA, the average worker would have to give up cable television ($60), his cell phone ($40), brown-bag lunches instead of eating at McDonald’s ($70), and drive a $20,000 car instead of a $25,000 car. Why should he give up all these things he can enjoy today to have a prosperous retirement? Will taxing him more heavily to provide for others teach him to save more to provide for himself? Or will it teach him to try to get the government to redistribute income to him?

The 2004 Retirement Confidence Survey by the Employee Benefits Research Institute says that 68% of Americans are very or somewhat confident of being financially comfortable in retirement, even though 45% of them have only $25,000 or less in total financial assets. More than half expect to work until or beyond age 65 even though most Americans today retire at 62. Two out of five recent retirees say they were forced to retire earlier than planned due to health problems or layoffs.

Surveyed workers gave a variety of reasons for not saving more. About one-third expect to get money from an employer. Others are relying on God, an inheritance, saving later, and Social Security. If you want to know what God thinks of spendthrifts, you can find it in Proverbs, but if you want to know what other people think of the respondents’ plans to retire on Other People’s Money, ask the other people.

B, regarding that future tax rate, yesterdays WSJ has a book review of “The Coming Generational Storm”. In it, the authors project a future tax rate of 70% if no changes are made in the current SS system.

Coincidence, huh? I know, we’d have to look at all the assumptions and whatnot, and I don’t believe that there is a snowballs chance in hell that the current system will survive intact. No way is there going to be 70% tax rates anytime, ever. But its funny that they predict the exact tax rate that you say will cause 401(k) savers to lose money.

B, you are going to have to buy the book!

I am sure it was all generational transfers. I believe that the extrapolation was “only” 75 years, so say 2080 or so. I agree, such a projection is pretty preposterous, but it is a starting point for argumentation.

What was interesting to me was that the “crisis” doesn’t go away when that baby boomers die. I was under the impression that they were “the pig in the python” and that, once they were all dead (the sooner the better ;)) the problem goes away. But in 2080 the projections are still for more retirees than people under 20 years old. That isn’t because of the baby boomers, that’s because of TODAY’s 20 year olds! Or kids even younger.

Eric,

I skimmed thru the book at Borders (cost, $1.80 for mug of coffee!). One feature I found really intersting was that they looked at 401K’s from the perspective of taxation of SSI benefits. It didn’t occur to me that SSI benefit reductions should be included when one estimates their return on a 401K!

I wonder what your thoughts are on his call for a revised SSI with private accounts invested in a universal ‘global stock/bond fund’? Such a reform would be ok by me, but I wonder how Wall Street will feel with SSI money not going into the endless number of fee burning mutual funds they create?

The problem, IMO, with the 401K model boils down to a few things:

1. It is tilted towards those with higher incomes. Why should taxpayers pay higher taxes to encourage a $100K a year doctor to correctly plan for his retirement? If he screws up, it is unlikely that he will be living on the streets..so to speak.

2. It is a subsidy to mutual fund managers, financial ‘advisors’ and a host of other people who are basically parasites. These people typically charge fees that can end up eating 30% or more of a person’s returns (many of the fees are hidden and almost impossible to discover). In exchange, these people end up producing returns that are actually below the market! (for a given level of risk, it’s possible to appear to ‘beat the market’ if you’re generating higher returns by investing in securities that have above average risk).

3. The authors have a dead on analogy; it’s like the gov’t is providing for retirement by driving people up to a casino, handing them some chips, and telling them to do their best.

If people want to play the market, they should do it with their own money. Tax payer money should only be invested in the ‘global index fund’ that the authors lay out. Basically this would simply be an index fund of all the world’s stocks and bonds weighted according to their market capitalization.

For example, if Microsoft represents 1.2% of the total market cap of the entire global market then it would represent 1.2% of an ideal index fund. The fund would require administrators to do the number crunching and periodic rebalancing as different securities change in price. Also, there would have to be some descision making on the margins…such as do you include the shares of Afghanistan’s stock market or wait and see if they really have their act together?

But such a fund, even though it would be gov’t controlled & sponsored, would be insulated from politics. By law, no politician could influence the fund to, say, buy or sell RJR Tobacco or Playboy…the allocation would be taken from the market & investors would basically be ‘betting on the world economy’.

Let’s be clear, though, that’s all anyone can bet on. SSI, funded thru taxation, is a bet that the economy of 2030 will be able to provide for the retired people in 2030. If a comet hits earth in 2029 & wipes out civilization it doesn’t really matter if your savings was in SSI, a 401K or a modified SSI. Likewise, if economic growth is not strong for the next few decades the retirement of the boomers and post-boomers will be difficult regardless of what system is in place.