Arnold Kling  

Prescott on Social Security

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Reputation Systems and Brands... Debating Forced Saving...

2004 Nobel Laureate Edward Prescott does not care for paternalism.


let's begin by dismissing the notion that individual savings plans are somehow dangerous to U.S. citizens. Some politicians have vilified the idea of giving investment freedom to citizens, arguing that those citizens will be exposed to risks inherent in the market. But this is political scaremongering. U.S. citizens already utilize IRAs, 401Ks, PCOs, Keoghs, SEPs and other investment options just fine, thank you. If some people are conservative investors or managing for the short term, they direct their funds accordingly; if others are more inclined to take risks or looking at the long run, they make appropriate decisions. Consumers already know how to invest their money -- why does the government feel the need to patronize them when it comes to Social Security?

...Further, about two dozen countries have reformed their state-run retirement programs, including Chile, Sweden, Australia, Peru, the U.K., Kazakhstan, China, Croatia and Poland. If citizens in these countries can handle individual savings accounts, especially citizens in countries without a history of financial freedom, then U.S. citizens should be equally adept. At a time when the rest of the world is dropping the vestiges of state control, the United States should be leading the way and not lagging behind.


Prescott argues that the benefits of private accounts would be that they reward work and thrift, while Social Security punishes work by taxing wages and punishes thrift by redistributing income from savers to those who do not save.

For Discussion. Which arguments against privatization do you find most persuasive?


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CATEGORIES: Social Security



COMMENTS (19 to date)
Lawrance George Lux writes:

One. Has Chile yet reached the level of benefits Chilean labor enjoyed before the alteration? Sweden is doing relatively well, but the rest cited are finding problems. Could it be that Sweden's tax rate was so high, any release of funds was a blessing? Decentralization may only work where there is vast opportunity for improvement. lgl

Mark Nau writes:

When some people fail to properly plan, or take risks and lose, there will be political pressure to provide benefits for them. This creates a poor incentive structure.

V from San Francisco writes:

The IRAs, 401Ks, PCOs, Keoghs, SEPs and other investment options Prescott refers to are generally used by (relatively) sophisticated investors. Those without an education on the fundamentals of investing will find managing their accounts challenging; in addition, there would/should probably have to be some sort of educational mechanism to impart this knowledge to account holders. One can look to the troubles of the Enron 401(k) plan to see the troubles that education of plan participants can result in if not properly executed.

Boonton writes:

The gov't sponsored savings plans like the 401K actually argue against privitization of SSI 'cause they are doing the job for it. Those inclined to save already have a huge advantage over those who don't.

Compare two individuals who make the same money and face the same tax rate (30% to keep things simple). One person is inclined to save and takes advantage of his 401K to the max (let's assume a 50% company match up to 8%):

Income = $50,000


Saver:
Income____________________$50,000
Saving in 401K (10%)______$ 5,000
Match_____________________$ 2,000

Total Income:_____________$52,000

Taxable Inc:______________$45,000
Tax_______________________$13,500
Effective tax_____________25.96%
After tax income__________$36,500

Non Saver:
Income____________________$50,000
Tax_______________________$15,000
Effective tax______________30%
After tax income__________$35,000

p writes:

Excellent point by Prescott on those who seek to patronize the American people.

Some have commented that Chile has not yet reached pre-plan levels - so what. The pre-plan levels were not sustainable nor were they just (equitable).

The argument that some Americans are not "sophiscitated enough" is a sad staement on the people making it. The statement shows a lack respect (Oh, how wise some of us are).

A plan can be built to address the majority of the problems. Yes, there will be those after all the safeguards are in place still will mess it up. Again so what. We cannot imprison the greater majority for a few. A few will always be able to screw-up. SS probably has a higher failure rate.

As for the arguement that the current saving plans already provide savings is another so what. To say that some Americans are already saving is missing the point that they may feel the need to save more (and Dr. Kling agrees). Why must they be penalized for savings?

Boonton writes:
As for the arguement that the current saving plans already provide savings is another so what. To say that some Americans are already saving is missing the point that they may feel the need to save more (and Dr. Kling agrees). Why must they be penalized for savings?

Who is penalized for savings? Who really? You try to butter both sides of your bread and then keep you fingers clean my friends. If people are rational enough to save for themselves then why do they need special incentives to save? If they need special incentives to get them to 'do the right thing' then why do you assume they will save in the right way?

Explain why the tax code should give any consideration to someone who makes $50K a year and saves every penny he can and less to someone who spends every penny he can? Why should the market not be trusted to make the correct calls in how much (or little) savings is necessary?

Tom Kaminski writes:

I want to believe that private accounts will solve the Social Security problem, but I keep coming up with reasons for doubt. The primary problem that I see has already been mentioned: some people, because of bad decisions on their part or normal declines in the stock market, will lose money. The political pressure for bailouts will be irresistable. If we have another bubble and crash like the most recent one, the bailout costs will be enormous. (And, by the way, I would expect all the new forced savings flowing into private investment to cause another bubble over time.) My greatest fear is that we would experience recurring bailouts so that the savings and loan crisis will seem small by comparison. And once there has been one such bailout, others will necessarily follow--that, it seems to me, is practically a law of politics. In addition, the first bailout will decrease the incentive to manage one's money carefully; why shouldn't I pursue the riskiest investments (with the highest potential rewards) if the government will cover at least a part of my losses?

I must say that I agree with Prescott in principle (as if it matters what I think!). We should trust people and allow them to make their own decisions. But I don't trust the politicians to let such a system work. So once again, I WANT TO BELIEVE that private accounts are the solution, but I just can't convince myself that the politicians won't muck things up.

tk

p writes:

First we must be clear that income earned arises from owned assets or work. Both are the property of the owner. Taxes are nothing more than a means by which the government appropriates property from its citizens.

Thus, the notion that not taxing is an incetive is inappropriate. Not taxing is merely respecting a property right. No subsidity is involved.

The larger issue is under what conditions does the state have the right to tax (appropriate) people's property. Again we must only remember our econ 101 to know that taxes always distort markets (and usually for the worst).

Again, not taxing is merely respecting citizen's rights. Savings contributes to general economic welfare by enabling investment.

We cannot afford to turn the tax debate into a discussion about optimization when no Pareto optimal solutions exist (We are immedialty screwing somebody and screwing others in the future, and creating a host of unintended consequences). We must therefore revert back to basic principles and acknowledge that property rights are fundemental to economic prosperity and liberty.

Prescott is correct when he asserts that we must make people accounatble for saving for retirement. We know more about economics today than during FDR's reign. The average American can be taught in a relatively short period more than what FDR knew about economics. Let's quit patronizing Americans and get down to building an America where people are equipped to deal with their problems.

spencer writes:

I still have a major problem with supposed believers in free markets and all that arguing that the solution to the problem is govt forced savings.

Jon writes:

If Prescott were correct that the current system is "patronizing" then we should expect that an overwhelming majority would want it changed. This is far from the truth, as depending on how the questions are framed, either a large minority or a majority oppose "private accounts."

The fact is, contrary to the views of people like Friedman and Prescott, there are many situations where people do not want to make choices.

We already have private accounts. Social security adds a "safety net" on top of these. Rather than go to "private accounts" we can just raise the retirement age, provide disability benefits for those elderly who actually cannot work, and reduce to tax rate. People can then put the savings in what ever "private" account they want or just spend it.

mercedes writes:

People aren't well informed on politics, and other important issues. Most don't know how 401k's work, etc. my boss for example doesn't know how their plan work other than the university they work at tosses some money into it.

When things go south (and they could with privatization) we are going to blame the above people for their 'poor' choices.

Current government plans (socsec) protect those users much like we back our 'dollar;' add in that those most likely to need social security are those who for some reason or another after having worked a good deal of their life and whatever they saved is backed by social security so they can maintain a level of life at retirement (poorer you are the harder it is to save if as some walmart employee once put it as she worked her ass off to get where she is.. "my kids had this bad habit of eating." so it is hard to to earn money.
http://www.motherjones.com/news/feature/2003/03/ma_276_01.html

Any privatization plans will have to go through these people; don't know if the aarp's position is but hey...

end note: prescott is an elite (who he is also arguing against those elites saying people can't handle socsec change) so technically he's falling into his own argument by infering higher information levels on the public but when you look at historical survey data (political, but hey if you ask the same question but on "economic qustions" you are going to no doubt get the same results: low respondent knowledge) shows people are not that well informed.

Stupid no, uninformed = yes; anyone who says they can make good business decisions without being informed is talking out of their a**.

Boonton writes:
First we must be clear that income earned arises from owned assets or work. Both are the property of the owner. Taxes are nothing more than a means by which the government appropriates property from its citizens.

Thus, the notion that not taxing is an incetive is inappropriate. Not taxing is merely respecting a property right. No subsidity is involved.

Nonesense. Taxes are the price of property rights. Reasoning like this is why the tax code is thousands of pages long. Lobbyists are more than happy to apply the above logic to create even more loopholes....err sorry 'islands of respect for property rights'...

I agree that people should be responsible for their own retirements. However, it is also a fact that many people will fall short. Often through no real fault of their own. Additionally, the fear of impoverishment when you are too old and feeble to go out and get a job again probably hurts the economy because it limits risk taking. More than a few people keep themselves in sub-optimal jobs simply because they feel they cannot afford the risk of losing their corporate health benefits....as another example.

Hence SSI in the US and similar programs in other countries evolved as a method for the younger generation to take care of the older one. The argument is really about one of degree. Very few people have the stomach to make the true libertarian argument that people should just fend for themselves. From a conservative POV, the system preserves an earlier tradition where the young directly cared for the old through family bonds.

The modern age made the old system unworkable because now children require a large upfront investment to get them up and running in the working world. In the old days you could have them generating value after just a few years by putting them to work on the farm.

p writes:

"Taxes are the price of property rights." While one can conceptually make this statement, it belittles the rest of the paragraph. With this logic we can tax to what ever level we choose. This is the real nonsense. Please use reasoning when constructing arguments.

Another line of reasoning that has been running through this thread is that because some people will make a mistake we need to regulate everybody. Wow!!! Some will fail with SS what then? We are caught on a slippery slope here. Again we are shy on reasoning.

Taxes are seizing property by government fiat and must be sharply limited. Second just because some will make mistakes is not a reason to socialize the entire system (the fact that we have a larger problem than before we solved the problem is proof enough for this fallacy).

Jon writes:

SSI was started in the 1930s because there was a population of elderly people who were unemployable and totally destitute. In those days the eligible population was rather small. The real problem is both lifespan and expectations for living standards have increased greatly.

Those taking the "libertarian" have considerable safety in their arguments in that no nation state has chosen to live and survive on their principals in anything close to their pure form. Thus they can blame any faults in a society on deviations from thos principles.

Finally to the "property rights" purist, one must ask from where do property rights come? They did not create the land they "own' or the other resources they have consumed to make or aquire their property. Property rights are merely a social construct for rewarding desirable behavior and making life more enjoyable.

Boonton writes:

p,

You failed to address the flaw in your reasoning, by assuming taxes are automatically evil AND then defining any tax break as a reduction of that evil you set yourself up for a tax code riddled with loopholes and exemptions won by lobbyists who now have a nifty moral argument to add to their toolkit.

I agree in principle that taxation should be limited and simply because people make mistakes is not sufficient reason to give them money paid for by taxpayers. Social security's logic, though, is quite a bit more than 'we need this because some people may make mistakes.

Rob Read writes:

I would argue that the portion of taxation used to defend the rights to the asset (Police, Military, Judiciary, Group health (vaccination)) are the price of the asset and the rest is just democratic parasitism.

My father, who has only an 8th grade education and who works in a coal mine, manages his 401K quite well, thank you. Privatization would have several benefits: 1) it would get the money out o fthe hands of the government, who has been "borrowing" the money for the general fund, and 2) the rate of return on anything else at all is better than the rate of return for SS, which is only 1% (average inflation is 3%, meaning the SS money is lagging way behind). And 3) the money paid in goes right out, so there is no "savings" anyway, between this and 1). And 2) shows that what little there is doesn't grow in any meaningful sense of the word. Long term, throughout the history of there being a stock market, the stock market has grown (and at a higher rate of return than any other form of investment) -- so unless long-term world historical trends suddenly and inexplicably change, it will continue to grow.

Mark LaRochelle writes:

Lawrence George Lux askes: "Has Chile yet reached the level of benefits Chilean labor enjoyed before the alteration?"

The answer is yes. In real terms, Chile has far surpassed the pre-reform level of benefits:

"Retirement benefits in the AFP [privatized Chilean Social Security] system already are 50 to 100 percent higher -- depending on whether they are old-age, disability, or survivors' retirement benefits -- than they were in the pay-as-you-go system."

-José Piñera, "Empowering Workers: The Privatization of Social Security in Chile" (International Center for Pension Reform)

Boonton writes:
Long term, throughout the history of there being a stock market, the stock market has grown (and at a higher rate of return than any other form of investment) -- so unless long-term world historical trends suddenly and inexplicably change, it will continue to grow.

This is what is called the 'equity premium'. If you really believe it then you have to believe a nearly magical money machine exists that the gov't can exploit for not cost at all! It would make sense for the gov't to borrow money and just buy a market basket of stocks (say the Wilshare 5000 to keep the choice of which companies to buy from getting politicized). After all, if stocks return 8% then shouldn't the gov't borrow at 5% and use the 3% profit margin to reduce taxes?

But then if stock purchases go up the price of stocks should also go up. That means their return will go down (hint: If stock XYZ will be at $150 in 2005 then you'll make a 50% return if you can buy it for $100 at the beginning of 2004. But you'll only make a 7% return if it costs $140 when you go to buy it in 2004).

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