Arnold Kling  

The "Cost" of Privatization

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The Washington Post adds up the cost of President Bush's campaign proposals. They include this:


An estimate from the Social Security actuary's office, included in the 2001 report of a Social Security commission appointed by Bush, put the cost of adding private accounts to the government retirement program at $1.5 trillion over 10 years. With inflation, the figure would now be about $2 trillion. Much of the expense comes from continuing to pay most retirees at current benefit levels, at the same time that some payroll taxes are being diverted to the stock and bond market.

In fact, the cost of privatization is zero.

Look at it this way. There has been a brouhaha over accounting for stock options in private companies. Companies deny that options are an expense. But as Warren Buffett puts it, "If stock options are not compensation, then what are they? And if compensation is not an expense, then what is it?"

The promises to future Social Security recipients are to the government what stock options are to private companies--off-the-books costs. You could say, "If promised Social Security payments are not obligations of the U.S. government, then what are they? If an obligation of the U.S. government is not debt, then what is it?"

If we decided tomorrow to recognize Social Security promises as obligations, then this would be a huge "cost" in accounting terms, but no change in economic terms. That is what the "cost" of privatization is all about.

For more, see The Ultimate Lockbox.

For Discussion. Is it consistent to favor the expensing of stock options and yet treat the transition "cost" of Social Security privatization as a real cost?


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CATEGORIES: Social Security



TRACKBACKS (6 to date)
TrackBack URL: http://econlog.econlib.org/mt/mt-tb.cgi/120
The author at Sebastian Holsclaw in a related article titled Social Security and Budgets writes:
    There have been recent discussions about Bush's proposed budget (see here or here for instance.) There seems to be some major freaking out about the transition cost of Bush's Social Security Plan. But as Arnold Kling points out the transition... [Tracked on September 22, 2004 2:43 AM]
The author at Republicans & Conservatives: in a related article titled Social Security and Budgets writes:
    There have been recent discussions about Bush's proposed budget (see here or here for instance.) There seems to be some major freaking out about the transition cost of Bush's Social Security Plan. But as Arnold Kling points out the transition... [Tracked on September 22, 2004 3:09 AM]
COMMENTS (9 to date)
boonton writes:
The promises to future Social Security recipients are to the government what stock options are to private companies--off-the-books costs. You could say, "If promised Social Security payments are not obligations of the U.S. government, then what are they? If an obligation of the U.S. government is not debt, then what is it?"

Imagine, if you will, a horrible virus hits the country and everyone over 69 automatically dies for the next 50 years until a cure is finally found. What happens to Social Security? Nothing, the demographic time bomb will be difused and the program would return to the way it was originally when it would provide for maybe two years of retirement (I'm using 67 as a retirement age here).

Now imagine the same virus hits in the Alternative Kling Universe where America has implemented the suggested reform. Privatization now costs real money because current taxes are put into people's '401K style' accounts while the gov't continues to pay out benefits today.

We can play this same game with a company's pension plan. What SSI's 'obligations' are is more like 'expected expenses' rather than debt obligations. We don't know what they are to the penny but we can make some good projections. Then again, we know in 2030 we will have to spend something on defense. I could ask Arnold why that shouldn't be considered an 'off budget' debt of the current Fed. gov't.

Arnold Kling writes:

I'm not sure I understand what you are saying.

Suppose that under privatization, the government gives everybody the expected present value of future benefits, and issues debt to make that payment.

Then, when the virus hits, the government looks dumb, because the amount of money it gave people turns out to be more than what it would have had to pay if it had stuck with SS as an annuity.

Is that your point?

I mean, yeah, if people die unexpectedly early then life insurance that pays an annuity is cheaper (for the insurer) than life insurance that pays a fixed benefit. But so what?

mattew writes:

Pls explain why a government that raises its debt to give people money to invest on the stock exchange is "creating a source of ownership". (As in the president’s remark: "We should make the Social Security system a source of ownership for the American people".)

What if the "American people" would decide to invest in the bond market instead of the stock market? It seems pretty clear to me that in that case the Bush plan is just the shifting of funds.
And in case the money is invested in stocks, the plan is nothing more than the (unwise) strategy of investing with borrowed money (executed on a national scale). Do you really believe that it is a good idea for a government to borrow money and transfer it to personal saving accounts of the citizens? Why?
Where is the benefit in all this?

Boonton writes:
Then, when the virus hits, the government looks dumb, because the amount of money it gave people turns out to be more than what it would have had to pay if it had stuck with SS as an annuity. Is that your point? I mean, yeah, if people die unexpectedly early then life insurance that pays an annuity is cheaper (for the insurer) than life insurance that pays a fixed benefit. But so what?

Which illustrates the difference between a legal debt (such as a Treasury bill) and an expected expense. The expected expense will probably happen but it is not the same thing as a legal debt. Another key difference is that unlike simply issuing people money today, the 'expected expense' can be changed by law. For example, if the gov't paid out the expected present value of the SSI annuity (starting from 67 until the expected lifespan is finished) then there is no option to lower the benefit. For example, future taxpayers cannot raise the retirement age to 69 or 70 to effectively lower the benefit. Before you cry theft remember that today and for quite a bit of time in the future people will be getting more out of SSI than they paid in.

Sam Jew writes:

Stock options should only be treated as an expense if the strike price is below the current price or they're unrestricted and there's a market for them.

They're only compensation to the extent that they're liquid. If they're illiquid and underwater, they're not compensation, but an incentive to take the interests of the company's investors seriously and make the pie bigger, rather than jockeying for a bigger slice, which is the expected behavior when stock options are not a significant factor in the equation.

In my opinion, the dilution of shares as is already reported is sufficient expensing, except in the case of really large corporations that already have established options markets.

For a small company to issue options as an incentive to grow the pie, the "expense" of the potential equity dilution is offset by the bigger pie.

This is in contrast to social security privitization that would require issuing public debt to finance private accounts. This is a case for the failure of democracy in that people can vote themselves large gifts from the public treasury.

Because the pie does not get bigger in the case of social security privitization, (additional funds in the capital markets will be offset by money leaving the capital market to buy t-bills) there can be no comparison between options and social security privitization whatsoever.

Josh Jacobs writes:

As you point out, macroeconomic consequences to privatization are only secondary. All of the arguments here are very well and good, but fail to address the fundamental questions about wealth redistribution as a function of social policy.

Redistributing wealth to retirees presents them with three options, as with any income source: consumption, savings, or investment. However, CHOOSING to give retirees those options, as opposed to workers or even newborns (for purposes of example only) is a matter of social policy, as is the extent of the wealth resdistribution.

We are in this fix due to

1) Population statistics
2) Political unwillingness to "cut benefits." As with any redistribution program, every "benefit cut" has a corresponding beneficiary since it's a zero-sum game.
3) Given the false promise of social security, those who are scheduled to receive it have, on balance, made more choices of consumption, requiring greater wealth redistribution now and into the future.

At its root, Social Security is robbing one demographic to pay another. Now that the beneficiaries far outnumber the contributors, we must once again address the questions

1) "What is the goal?" and
2) "What are the assumptions"

in order to find an acceptable solution.

Based on the above, I would argue that a tax on the accumulated capital of current retirees, e.g., a "living" estate tax or 100% estate tax on death, would be the most "generationally equitable" means of redistribution, although an anathema to many. After all, such a structure would penalize those who had taken care of themselves and give a free ride to those who had not. I also find this disturbing, but a better alternative than saddling future generations with enormous real debt. This is a feasible alternative to "means testing." Unfortunately, the current political leadership has already eliminated this source of wealth from such a levy until 2011.

mcwop writes:

The cost is zero so as long as social Security runs a surplus. Instead of sending the surplus dollars to the general budget, divert each person's surplus portion to a private account.

Lawrance George Lux writes:

Arnold,
As long as there are real transfers of Money, then the cost of privatization of SS is a real cost. The structure of Social Security is wrong, with the introduction of Cost of Living increases and provision of unlimited medical liability. Sweeping promises are a no-no, even for the Government.

Cost of Living increases should be stopped flat. Remember I am on SSDI. They should be replaced with Housing credits, Food Stamps, and Utilities expense credits where actual need can be proven. A simple Government declaration that Medicare and Medicade will pay no more than $50,000 per Patient per year would save about 70b per year, and declaration that Recipients must prove assets of less than $100,000 to gain any benefits would save in excess of $200b per year. Standardization of monthly benefits could save up to $60b per year.

We do not need Privatization, but We do need rationalization. Actual (real) Privatization costs would exceed $12b per year in brokerage fees alone. Financing of Privatization by Government acquisition of Debt would probably add another $30b per year in debt servicing. The Bush plan makes no sense, and never has. lgl

Henry writes:

Privatizing SS may sound good, but lets not go so fast. By allowing people to purchase special notes bearing 7% interests and a non-profit financial guru company to watch over the fund, it serves two fucntions. One; The average citizen is protected and second; it allows the market to shift the funds from stocks to bonds when necessary. The best of all worlds.

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