Arnold Kling  

Social Security Privatization

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In response to this post by Michael Kinsley, I wrote this.


Michael Kinsley is correct to be skeptical that privatization will generate a bonus large enough to eliminate the gap between the promises made to future recipients and the likely revenue to pay for those promises. In that sense, privatization will not "work." Neither will the status quo.

To a first approximation, Social Security's imbalance is not made better or worse by privatization. Instead, economic analysis suggests that the effects of Social Security privatization will be subtle and small relative to the challenges that lie ahead. A much more powerful tool for addressing the problem would be to increase the age of dependency, also known as the Social Security retirement age.


The way I feel about privatization is that it is a necessary but not a sufficient condition for straightening out the system. What would be sufficient would be a scaling back of benefits and a corresponding increase in personal saving. But I do not think we can get from here to there without first setting up private accounts.

UPDATE: Greg Mankiw writes,


While personal accounts can be an important element of a new, sustainable Social Security system, fixing Social Security will also require hard choices to ensure that promises do not exceed resources. But this should not deter us. Avoiding reform is not an option, and delay would leave us with fewer and less-attractive choices.

In the upcoming debate over alternative proposals, everyone should be careful to avoid the sophistry of those opposed to reform. In particular, we should be wary of comparisons between a new, reformed Social Security system and current law. The benefits now scheduled for future generations under current law are not sustainable given the projected path of payroll-tax revenue. They are empty promises. Unless a listener is discerning, empty promises will always have a superficial appeal.


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

For Discussion. How does Kinsley's argument relate to what I wrote four and one-half years ago?


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CATEGORIES: Social Security



TRACKBACKS (3 to date)
TrackBack URL: http://econlog.econlib.org/mt/mt-tb.cgi/171
The author at PRESTOPUNDIT -- feeding memeorandum & econRT daily in a related article titled GREG MANKIW on Social Security writes:
    reform: While personal accounts can be an important element of a new, sustainable Social Security system, fixing Social Security will also require hard choices to ensure that promises do... [Tracked on December 16, 2004 2:37 PM]
COMMENTS (19 to date)
Lawrance George Lux writes:

This furor over Private Accounts came about because the initial setup of Social Security. Raising the Age of getting Benefits will not really do anything but delay the outrage. We need to start Means-testing (tax it back out of them, if nothing else), Means-testing Medicare benefits most assuredly(not caring if they had to pay $40k per year for health insurance if they could afford it), and tell Everyone, "Sorry, Sonny, but We lied, FICA taxes are really taxes, and not your money. You will not get it back, unless you need it. Too bad, so sad." lgl

Lancelot Finn writes:

Arnold,

You put it so clearly that I'm conflicted over whether there's any point in writing more about this topic. What can I add? I end up doing it mostly so that people don't think you're the only one. And I look for angles you haven't taken. Earlier, I wrote about it in a more poetic/philosophic mode (you linked to it, thanks); now I just posted an article dealing with political risk. The argument is that private accoutns are safer than publicly-funded benefits, because public choice theory reveals that political decisions are subject to randomness. I'd be interested to know if other people find the argument convincing, so I hope people will visit.

I sent AS a response to Kinsley too; it's posted at my blog. People can leave comments about the political risk article there too.

Keep up the good work. We'll push these ideas through eventually.

Edge writes:

On the age of dependency - I agree this is one of the levers that can work to limit benefits paid.

But, it is a lever that punishes those unable to work beyond age 65 or so. This includes most blue collar labor, as well as many people whose physical or mental condition deteriorates so they cannot continue to work.

I think a solution may be to incentivize working beyond retirement age. To be effective (encourage a lot of people to take up the bargain), the incentive has to be at the margin.

That means people should still get their SS benefits, without penalty - and without having the benefits taxed away by means testing.

How might that be achieved? Perhaps taxation of SS benefits should EXCLUDE wage income , or maybe go further, and provide a tax credit, to encourage work, at the margin.

This isn't fleshed out. But the basic idea is to encourage work beyond the benefit-elligible age, without penalizing those unable to work efficiently, probably using the tax code to provide margins at the incentive while remaining revenue-positive for the treasury (just not as revenue positive as for workers under the retirement age).

When SS was created, one goal was to get people to retire - so that jobs would be freed up for younger workers. It seems safe to shift that dynamic, to one which is at least neutral on the issue of when to retire.

glory writes:

btw, here is the FT's take =D

cheers!

Boonton writes:
This isn't fleshed out. But the basic idea is to encourage work beyond the benefit-elligible age, without penalizing those unable to work efficiently, probably using the tax code to provide margins at the incentive while remaining revenue-positive for the treasury (just not as revenue positive as for workers under the retirement age).

I agree with this but creating the incentive will be a challenge. The problem with any incentive is that it will reward those people who were going to keep working anyway. In order to keep the incentive from costing more money than it generates it will have to be crafted very carefully.


I'd like to ask Arnold why increasing the dependancy age would not be enough? We already have private retirement accounts, they are called 401K's, IRAs, Roth IRAs and so on! If we increased the retirement age to, say, 70 why do we need mandatory private accounts to take care of people from 65-70+? We've made it for the last 70 years or so without mandatory savings to carry people from age 50-65!

rvman writes:

A fair number of the "leave SS alone" crowd are saying "It's not broken yet" but mean "There is nothing wrong with Social Security a tax increase wouldn't fix." Any cite to the trust fund is a veiled allusion to increasing income taxes - since that is how one must pay back the trust fund. The "antis" have two good points -

1) Medicare is the bigger problem. Addressing SS while ignoring Medicare is like fixing a leaky joint on the Titanic. It might slow down the sinking, but it won't save the ship.

2) The budget deficit and the debt are as big as SS as a problem.

My prescription is to eliminate Medicare for all but the indigent and disabled elderly (that is require people to be indigent AND disabled AND elderly in order to qualify), cut SS to SS Disability only, for people under 40 (continue current benefits and phase out for the 40-65 crowd, but current under-40s qualify for SS Disability when they are disabled, whether that occurs at 45 or 95, and not before), and cut all federal aid programs to the states - let the states and cities fund their own mass transit, welfare programs, schools, etc. from their own budgets.

Consolidate Commerce, Labor, and Energy into one department of Commerce, eliminate Education entirely, Consolidate HHS, including SS/Medicare, and HUD into one Department of Government Charity. Return the VA either to Charity or Defence.

Oh, yeah, inflation index all capital gains, interest income, and dividends but otherwise tax all income on the same tax brackets. Eliminate unnecessary deductions and credits like mortgage interest and educational expenses - we shouldn't use the tax system for social engineering.

John Brothers writes:

Hi Arnold,

I also think you've missed the point of some of the 'leave it alone' crowd. They feel that a) the impending doom keeps moving farther into the future (30 years ago, it was 30 years away from insolvency, now it's 36 years away from insolvency); b) the expected resies in income and GDP will cover the expense, and c) slight tax increases will cover the rest.

On its face, this is difficult to argue with - why significantly change the existing system when slight (or even no) action will keep the current system working? My biggest concern is the prospect of dramatic increase in longevity over th next 30 years, resulting in a much, much larger retired class than we are expecting right now.

Boonton writes:
On its face, this is difficult to argue with - why significantly change the existing system when slight (or even no) action will keep the current system working? My biggest concern is the prospect of dramatic increase in longevity over th next 30 years, resulting in a much, much larger retired class than we are expecting right now.

This will either be accompanied with amazing economic growth or it will not. If it is, then we don't have to do anything because with amazing economic growth we will be rich enough to afford a huge retired class and work will become a brief period of an otherwise long life. If it isn't, then the retirement age can be notched up accordingly.

Since the future is uncertain it is best to take it slow rather than make radical changes now for a future than may not pan out as we expect.

Edge writes:

Bush acknowledges the long term liability in SS funding as $3.7 Trillion in today's speech.

While this is a big liability, it is less than the $3.8 Trillion liability projected for the federal government to accrue from FY 2003 through FY 2009.

It's commendable that the administration has shown some concern about the government's long term obligations, but perhaps, rather than adding another couple $Trillion of on-the-books liabilities that might reduce future Social Security obligations beginning about 40 years from now, it's appropriate to consider shorter term responsibilities, where an even bigger shortfall is proposed in just six years?

Jim Glass writes:

Shorter Kinsley...

1. His economic analysis: Investing $100 billion more a year via private SS accounts in a $45 trillion world stock market (0.2% of capitalization) will "bid down" the return on all stocks to the level on government bonds. Ergo privatization can't work. QED.

2. His social principles: Investing SS in real economic assets to close the funding gap can't help and must fail because it is a zero sum game (see 1.), adds nothing to the economy and ends up only taking from others.

OTOH, closing the funding gap on a paygo basis with *tax increases* as we always have since the tax rate was 3%, and with benefit cuts, is *superior* because ... um ... they add to the economy? and don't take anything from anybody??

Both of which are nuts.

So I guess the shortest Kinsley is: He's nuts.

As for the longest Kinsley...

GT writes:

Why do otherwise smart people insist on repeating falsehoods?

There is no SS crisis. None.

CBO estimates that SS will have money for another 50 years! And small changes to the predicted conditions result in SS not needing any changes.

Yes, SS will need reform at some point but there is no urgency. There are a lot of other more important things on the fiscal side that need to be addressed starting with Medicare.

Boonton writes:
1. His economic analysis: Investing $100 billion more a year via private SS accounts in a $45 trillion world stock market (0.2% of capitalization) will "bid down" the return on all stocks to the level on government bonds. Ergo privatization can't work. QED.

How could it not? Jim do you know anything about the CAPM model or the efficient markets theory? Something is very, very wrong if stocks will always generate a higher risk adjusted (note those last two words!) rate of return than bonds.

Paul Zrimsek writes:
Something is very, very wrong if stocks will always generate a higher risk adjusted (note those last two words!) rate of return than bonds.

Yep. It means you've misunderestimated the marginal buyer's level of risk aversion. But the relevance of your point is hard to see in any case. If you believe that the return on stocks is irrationally high already then what has the EMH got to do with it, and why would you expect a proportionally modest infusion of SS money to impose rationality on the system?

mark writes:

Much of the interest seems to assume higher past stock market returns will be repeated in the future. No allowance is made for past investing costs,current higher prices/lower yields, international returns, and the unusually high returns apparently made by our elected representatives (insider information maybe??) To the politicians it may look like a free lunch.

How will strong economic growth fulfill these expectations yet not support higher Social Security costs?

Boonton writes:

In short, there should be only one rate of return which is adjusted according to risk. Stocks have demonstrated a higher return than bonds even after adjusting for risk. This has been called the equity premium and several writers have written about it.

If you believe the equity premium is real and will remain then you've discovered a free lunch. The gov't can borrow $100B or whatever at 5% and buy a large index fund of stocks and collect 7 or 8% over the decades. In essence, the gov't could tap a 'money tree' that could replace not only SS taxes but all taxes!

On the other hand, there's good reason to believe if any economic laws exist there would be one that says free lunches cannot last forever. Maybe the equity premium is an old bias from the Great Depression against stocks but it won't last since rational investors should already be in the process of increasing their stock investments to exploit the 'bias' discovered in returns.

Long story short, you can't count on an equity premium to provide a boost to social security returns above the returns of gov't bonds.

Paul Zrimsek writes:
On the other hand, there's good reason to believe if any economic laws exist there would be one that says free lunches cannot last forever.

Just so. And we all know why: because the market is full of arbitrageurs who gobble up any free lunch the instant it hits the table and don't leave a scrap behind. Therefore when you see a seeming free lunch that's been sitting there growing cold for 75 years or more, you can be certain that it only seems free because you haven't been looking hard enough for the price tag.

David writes:

What about decreasing the regressivity of the payroll tax? I think earnings up to $1 million dollars should be subject to FICA withholding.

According to my calculations, this would actually result in a surplus for the program.

Jim Glass writes:
Why do otherwise smart people insist on repeating falsehoods?

There is no SS crisis. None.

CBO estimates that SS will have money for another 50 years!


~~~~~~~~~

Speaking of falsehoods, actually it's 38 years.

And while the SS "has the money" in the form a totally nonbinding promise that it will come from the Treasury, unfortunately the Treasury does not have the money.

Cashing in the SS bonds will cost the Treasury a cool $5 trillion in extra income taxes exactly while the even much larger bills for Medicare start coming in.

Anyone who thinks that ...

(1) SS is going to get through that period without a major re-write as a result of that fiscal pressure ... and/or

(2) 20 years before the 38 years are up, people who are in their 40s and forsee their promised benefits (negative as they already are) being slashed as they retire, won't be demanding a major re-write ...

... may or may not be a smart person, but sure isn't engaging the brain on this one.

Thinking the SS trust fund secures the current SS benefit scheme until the trust fund runs out is plain foolishness.

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