Arnold Kling  

Social Security Incrementalism

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Free Trade with the AARP... Have More Children?...

On the new pro-reform group blog, Kerry Kerstetter makes a case for incremental privatization.


Allowing private control over retirement money that would otherwise go to the Social Security bureaucrats in DC is no different than what we have long had with IRA, 401(k), 403(b) and other personally controlled savings plans. I have seen clients with well over a million dollars in real assets in these accounts. This growth, which is well beyond the value of all of their future Social Security benefits, was almost always through investments in assets that opponents of change are now equating with a pull of a slot machine handle. This is a far cry from the doom and gloom scenario that AARP and their Fellow Travelers on the Left are portraying over the “risky” future ahead for people who are allowed to earmark a small portion of their Social Security taxes.

So, while my ultimate goal is to allow people to control every dime of their own retirement money, I am supporting the current Bush administration proposal to allow workers to earmark a portion of their Social Security taxes for investments that they can decide on and have full ownership of, especially after they pass away. This would be a very positive first step in the right direction.


In my latest essay, I am willing to support an even weaker form of incrementalism.

A number of key former members of the Clinton economic team, including Gene Sperling, Laura D'Andrea Tyson, and J. Bradford DeLong, have come out in favor of personal accounts as an addition to, rather than a partial replacement for, Social Security. The term for these personal accounts is "Social Security Plus."

If I were an adviser to President Bush, I would suggest that he embrace these Clinton wonks and say, "Sold!"

...if proponents are correct and personal accounts are a winner, it seems likely that happy personal account owners under The Plus would press for expanding personal accounts to replace some or all of their Social Security.

Another left-leaning wonk who likes Social Security Plus is Edward Gramlich. Although I do not agree with his views entirely, he emphasizes a number of points that I have been making. For example,


People in my grandfather's generation who got to age 65 paid into Social Security for 40 years and got benefits for about 10. People in my grandson's would collect benefits for more than 20 years. As life expectancy increases, the disparity gets increasingly unfair across generations. An easy way to restore fairness and to make a huge impact on the actuarial deficit of Social Security is to have the retirement age go up in line with overall life expectancy -- in an automatic way so Congress wouldn't have wrenching decisions every few years.

I recommend reading the entire Gramlich Q&A.

UPDATE: In case you were thinking, as I was, that Social Security Plus was a wonk-only proposal, with no support from elected Democrats, it seems that Senator Feinstein (Ca) has spoken in favor, stimulating some wary responses from Russ Roberts and from Don Luskin, the latter at the new Social Security Choice blog.

For Discussion. Would Social Security Plus (private accounts as an add-on rather than a carve-out of Social Security) be likely to increase national saving, as Gramlich believes, or would it be offset by other actions people take with their balance sheets?


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CATEGORIES: Social Security



COMMENTS (16 to date)
Randy writes:

Don't resolve the trust fund shortfall, simply don't pay out more than is taken in. In compensation for the gradual decline in value of social security, increase the limits on IRA's, 401Ks, etc. This will keep social security around almost indefinitely for the truly needy, while gradually shifting the bulk of the program to private accounts. And it doesn't require a new level of beauracracy.

Mcwop writes:

The plus proposal is missing a key detail (actually this proposal is missing many key details) - will the savings be forced or not?

If forced, then it may be a mixed bag. Those who do not save will begin to. Those that already do save may have to reduce their savings from existing retirement accounts to the plus account, and they may not want that option. Especially, if the plus account is saddled with ridiculous restrictions/regulations.

If not forced, then the idea is silly. It already exists through IRA's and any number of other vehicles. This option will not impact savings. About 70% of people already participate in company defined contribution plans.

The details will determine if it will impact national savings or not.

Randy writes:

By the way, there is no shortfall in the trust fund - there is, in fact, a surplus. There will only be a shortfall if we actually pay out more than we take in. This may seem obvious, but then again, we are discussing fixes to a problem that we don't have to create.

Randy writes:

Or perhaps, just perhaps, the problem is that we've made promises we can't keep. Okay, lesson learned, let's apologize and move on. A warning to those who think they can raise taxes and delay the inevitable apology; the younger generations aren't stupid. Try raising taxes and they will vote social security out of existance. Learn, apologize, and move on.

Lawrance George Lux writes:

National Savings indexes must be adjusted for modern realities. The House with mortgage is the new form of Savings account. Economists do not understand some common beliefs of American labor: U.S. Treasuries are about as reliable as the Social Security Trust Fund, Corporate bonds are another sneaky way for CEOs to take your money, Municipals and State Bonds are way too large in amounts to invest in, and Banks don't pay any return on their money.

IRAs, Koughs, and 401ks are already overfunded, creating a balloon in the Financial Paper markets. Private Social Security accounts will only make it worse. Now there is getting to be too much Home Mortgage paper.

Solution: Dump the Monetary policy which says Bank accounts should pay no rate of Interest higher than the Inflation rate. lgl

Edge writes:

It would increase national savings, relative to Plan II.

Plan II is roughly savings neutral, discounting any shift offsets in personal savings balance sheets. Plan II requires massive borrowing, peaking around 23% of GDP in 2036, with incremental borrowing projected to continue until around 2050. That's enough borrowing over a long enough time - eleven Presidential election cycles - that we can call it, effectively, a permanent debt. There might be net benefits beginning about 75 years from now, if everything goes to plan. But eleven Presidential cycles is a long time to plan to run a deficit in support of a "free lunch". China is certain to either implode or have its own strong central bank long before our borrowing needs would subside.

We'd be more secure to force an increase of national savings rather that extrapolating current international current account and central bank policies 50 years into the future.

Boonton writes:
I have seen clients with well over a million dollars in real assets in these accounts. This growth, which is well beyond the value of all of their future Social Security benefits, was almost always through investments in assets that opponents of change are now equating with a pull of a slot machine handle.

What an idiot. Of course his clients have millions in their 401K accounts. If they didn't they wouldn't hire him as their consultant! For every '401K lottery winner' there are plenty of people with insufficient assets or even negative returns. The author, though, will not see that because those people wouldn't qualify to be clients.

Once again Social Security provides a nice counterbalance to private accounts which suffer from market risk (and to political risk to a lesser extent). Before Bush's 2% plan is implemented on top of Social Security I think free marketers should explain why markets work for everything except allocating the correct amount of savings that individuals choose to undertake.

If you cannot have faith in the market to do that then why the faith that people will correctly allocate their savings to intelligent investments in their 'private accounts'?

Ken writes:

"Once again Social Security provides a nice counterbalance to private accounts which suffer from market risk (and to political risk to a lesser extent). Before Bush's 2% plan is implemented on top of Social Security I think free marketers should explain why markets work for everything except allocating the correct amount of savings that individuals choose to undertake."

Free marketers have no doubt whatsoever that markets will work for allocating the correct amount of savings that individuals choose to undertake. Forced savings is a reluctant compromise position, because people who believe that Americans are too stupid to save properly outvote us at present.

Dewey Munson writes:

2002 50% of incomes were $22000 to $25000.

Who do y'all think you're talking about? How (and why) do you expect this income level to Save?

A bank account @ .3% or 1 share of stock for $50 with in/out cost of say $50?

As economists you really don't have to concern yourselves with the problems? of people with $100,000 salaries from which they can extract $20000 to effortlessly save.

How much can you reasonably expect these marginal incomes to save?

You ignore the fact that whatever I have recd fro SS will be in my kids inheritance.

The SS problem has to be evaluated over life spans. You cannot ignore our monetary system in which a 1939 loaf of bread at $ .05 a loaf now costs $1.40. (5.2% net taxes)

Randy writes:

Ken, the justification for mandatory social security is the freeloader problem. Without social security, there would have to be a welfare program. And some, perhaps many, would rationally conclude that they would be better off to spend rather than save during their working years - then live off the welfare program in their later years.

Boonton writes:
Free marketers have no doubt whatsoever that markets will work for allocating the correct amount of savings that individuals choose to undertake. Forced savings is a reluctant compromise position, because people who believe that Americans are too stupid to save properly outvote us at present.


Err no free marketers would find a better compromise with letting SS remain & ditching mandatory 2% accounts with a shrug. If people want to put 2% of their income into an IRA today there's nothing stopping them. Why mandate it?

Lancelot Finn writes:

Arnold,

Okay, if I understood your column correctly, you are proposing that private accounts be created with NO reductions in benefits or in the benefit growth rate. If so, I oppose this idea, because we need to discipline our Social Security entitlement obligations; to stop, as Dean says it, "putting it on the grandchildren's credit card."

BUT I would like to draw your attention to this proposal, mentioned in a NYT article and then analyzed by blogger Mickey Kaus:

The White House has already floated one approach to the issue of future benefits, suggesting that the benefits be based on price increases rather than on the current formula, which is based on economy-wide growth in wages. Since wages tend to rise faster than prices, the effect would be to set benefits at lower levels than promised under current law.

But that approach drew intense criticism from Democrats and some Republicans. Administration officials are now reviewing an idea called "progressive indexation." The idea is in effect a compromise that would allow initial benefits for low-income workers to rise in line with their wages but would peg benefits for affluent workers to the inflation rate.

The effect would be to direct relatively more benefits to lower-income people than to higher-income people.

Kaus comments (if you link, scroll down):

As foreshadowed in this eerily and somewhat accidentally prescient item, the Republicans are trying to strike a Social Security compromise with the Democrats by introducing ... means-testing (cutting the benefits of the affluent). True, it's only a back-door version of means-testing--offering full wage-indexing only to those "at the lowest rungs of the income scale" while more affluent retirees get lower 'price-indexed' benefits. But it's a start. ... If the Republicans want to cover, not just the shortfall in the current pay-as-you-go Social Security system, but also the transition cost of establishing a pay-for-yourself private account system, they will have to do a lot more cutting of the benefits of the affluent, no? ... The result could be a subsidized system so progressive--new benefits for the poor, cuts for the rich-- that no Democrat would have dared introduce it. ...

What do you think?

Suppose that 1) high-end SS benefits were indexed to inflation, 2) low-end SS benefits continued to be indexed to wage growth, 3) benefit levels in between would be indexed on a sliding scale between inflation and wage growth, 4) private accounts are created with 2% of the payroll tax.

Gradually, over time, the minimum benefit would converge to the maximum benefit: thus social insurance would be gradually replaced by a guaranteed income for the elderly, at least those who worked.

If the better-off wanted to maintain their post-retirement standard of living at the level it would have been without the reform, they will have to rely on their private accounts to do it. Poorer people will also have private accounts, but these will be smaller, and "extra": their prospective SS benefits will not have been reduced.

Over time, if private accounts work well, there will be political pressure to "carve out" more of the payroll tax and put it into them. In a decade or so, there might be more willingness to slow the growth rate of the minimum benefit.

The plan would probably not solve the long-run problems of Social Security, because the reduction in the growth rate of total benefits would not be sufficient to make long-run financing sustainable. But it would ease the problem somewhat, while de-poisoning the well for future political solutions.

If conservatives favor the free market, accountability and ownership, and liberals care about the poor and want economic redistribution for their benefit, this plan should go down well with everyone. Liberals get a more progressive tax-and-transfer system. Conservatives get private accounts, and a political dynamic more favorable to them in the long run.

If conservatives are defending the class interests of the better-off, and if liberals believe mainly in a statist economic system, this plan will offend them both: the better-off will pay the same taxes for (unless the private accounts make up the difference) less benefits, while liberals will foresee losing political support for a large government bureaucracy.

Anyway, let's try to float the idea. What do you say?

P.S. Kaus finds a hint of this idea in David Brooks' column from Dec. 11.

Randy writes:

Lancelot,

It seems feasible to me. The objective is to create a mandatory sustainable system that keeps seniors out of poverty and avoids the freeloader problem. My guess is that the wealthier benificiaries will balk at the idea of any income redistribution, but would prefer your approach to higher payroll taxes. As for the private accounts, as Mcwop says, if they're not mandatory they don't make sense - use IRAs, 401Ks, etc.

Edge writes:

Won't it turn out to be a laugh if real living standards decline, but inflation soars, over the next 50 years, and all this fuss about indexes is flipped on its head.

FWIW, I believe that simply indexing to prices for the top bend point, while leaving the others alone, would probably cover a good chunk of the actuarial shortfall.

Going to price indexing for everyone for about 20 years would probably cover the whole shortfall.

Permanent price indexing would leave SS with an actuary surplus probably around $10 Trillion, present value, if you go out to infinity.

Probably reasonable to assume that any indexing formula will be revisited every 20 years or so to match reality. Given that knowledge, and given the President's propensity to go for broke, I'd not be suprised if he comes out with either nothing at all, or perhaps since he's already tipped his hand on the price indexing thing, either stick with the cards he's shown or go for some razzle dazzle new formula that confuses the issue enough to push it aside.

Knut Wicksell writes:

The dems want to create SS Plus as a diversion. Ultimately, were the Congress to adopt a plan which encouraged people to opt into the plus accounts (by reducing benefits by changing to CPI inflator or by raising the age some more or some other combination of changes) then the deal might be a good one. But you know what they will ultimately do - allow the Plus accounts only for a limited number of people and raise the tax base. That is a lousy deal on all sides.

Adam writes:

What is the difference between "social security plus" and a Roth IRA? They sound exactly the same to me.

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