Arnold Kling  

Social Security Deal?

Economics of Higher Education... Manne More Than Ever...

Brad DeLong proposes

1. Shift responsibility for maintaining actuarial balance off of the Congress and onto the Social Security Administration--have it gradually raise (and lower) the retirement age or the benefit-rule bend points in order to keep the system in projected balance.
2. Uncap FICA and apply it to all wage income in order to top-off private add-on accounts for the poor and boost benefits for widows.
3. Make enrollment in private accounts automatic (it's done automatically on your 1040) but voluntary (you can fill in an extra form to get the money the IRS earmarks for your account back as part of your refund).
4. Use the government's existing Thrift Savings Plan as a vehicle for managing private add-on accounts--and keep its choices restricted: churning and extra administrative costs caused by asset shuffling are not your friend.
5. Mandate that in fifteen years a commission consider and recommend whether or not two percentage points of FICA should be diverted and added to the add-on accounts as a forced savings program.

I think that point (5) is redundant and pointless. The reality is that if personal accounts are given a fair trial, then it will be up to the will of the people to decide how much, if any, of Social Security to switch over to personal accounts.

In a better world, instead of raising payroll taxes (point 2), we would finance the savings subsidies and widows' benefits that Brad alludes to by giving me a scythe to use on the rest of the government Budget. In fact, by the time I got done, we might be talking about cutting payroll taxes. But the reality is that I am not going to get to play the grim reaper role.

Other support for something like the DeLong plan appears to come from Ramesh Ponnuru and from your truly.

For Discussion. Would the DeLong plan constitute a victory or a defeat for privatization?

Comments and Sharing

CATEGORIES: Social Security

COMMENTS (31 to date)
Randy writes:

Point 1 won't work. Why? Because Social Security does not solve the freeloader problem. It simply shifts it to a larger group that rationally chooses to retire on social security benefits in lieu of saving. The result is continuous political pressure to increase benefits. Congress cannot extricate itself.

Point 2 would work only temporarily. Because of the freeloader problem, the limit would have to be constantly raised to keep up with rising expectations. If the idea is to replace a regressive tax with a progressive tax, then fine, do that. Dump social security entirely and replace it with a welfare system.

Points 3 & 5 - The generations who will be using the private accounts won't allow them to be mandatory in any way. They know they have been, and will continue to be screwed. They will vote Social Security out of existance at the slightest provocation - such as 3 & 5.

Tom writes:

A defeat. Instead of ending the transfer-payment scheme, which is hostage to the shrinking worker:retiree ratio, it would gain new life and more support. In particular, higher tax revenues (point 2) would enlarge support for the program by making it more redistributive. DeLong's shell game with private accounts is just a way of trying to induce forced saving. Don't fall for it. If we're not going to privatize Social Security, then let's shift from a wage index to a CPI index and raise the retirement age, in some combination sufficient to stave off further increases in the payroll tax rate and taxable base.

p writes:

I must say that this proposal smacks of complete compromise. We are left with only a tax increase. Arnold, how is this even close to where we were trying to go via reform? Let's just raise taxes and recommend people save via their 401(k).

Bob writes:

I largely agree with Randy that the political reality guarantees SS's long-term doom. But there is a chance that an independent board would work. But why go past proposal #1? If we're trying to "save" SS, make the necessary adjustments to retirement age and be done with it. This addresses the basic worker-to-retiree problem. Proposals #2-5 are just a liberal wish list for transfer payments and behavior management of the unwashed masses.

Edge writes:

Shifting from wage to CPI index alone ought to more than do it.

I believe you could get solvent just by tweaking the index by half a point a year above or below the wage index as needed.

Just plugging in this year's productivity number in the formula ought to add a year or two to the trust's projected life.

FWIW, I'd cautiously support add-on accounts, either voluntary or payroll tax funded, though I think it would undermine support for traditional benefits later, and I think that's a problem at least once or twice a century for a big group of people, which probably wouldn't bode particularly well for capital, either.

I think Bush has to choose which way he's going on Wednesday. I'd be suprised if he goes for compromise, but he can probably find something more or less bipartisan if he doesn't bust the budget, doesn't divert revenues from traditional benefits, and doesn't phase out traditional benefits in the long run.

If he sits on the fence any longer, he's going to get a rash.

Boonton writes:

I think 'voluntary 2% personal accounts' are absurd. We already have IRA's and 401K's were people can put more than 2% of their income away each year (unless they happen to have very large which case we should assume they are capable of managing their own retirements).

The reason for the comprimise proposal on Social Security is because you guys lied. You tried to rush something through on the pretext of an impending crises that is not there. You tried to tell use we have to take radical steps to avoid a 2% of GDP deficit in 2050 while we blindly run a 4% deficit today.

As you were counterattacked your underlying premises were knocked out from under you. One of them is that Social Security is an inherently unstable Ponzi scheme. Reality is that, properly managed, social security can run forever. Another is social security's returns are sub-par. Reality is that if you take a relatively constant portion of GDP as both tax and benefits your return will roughly equal the growth of the economy. You argued that Social Security was riskier than private accounts because future Congresses can change the rules. Reality is that private accounts carry the exact same risk plus the natural risk of the market plus risk specific to the investments in the private account plus an added measure of political risk to the specific investments (a future Congress, for example, could leave the 401K/IRA rules untouched but outlaw tobacco wiping out any account that was heavy on tobacco stocks).

Bob writes:

Geez Boonton, give me a break. Certainly there's tons of demagoguery on both sides. Your post is a good example, falling far short of your usual thoughtful contributions to the debate. Combine that with your artful use of "roughly" and it looks like you have a bright future as a New York Times columist.

Randy writes:

Boonton. Re; "Reality is that, properly managed, social security can run forever"

The problem is that it has not been properly managed and won't be, because there are political incentives for not properly managing it. The current system separates risk from return. The current generation has in the past, and will in the future, award itself excessive returns while transferring 100% of the risk to future generations. The idea of private accounts puts risk and return back together. It has to be done - and at the expense of the current system.

Edge writes:

Randy, equity can evaporate. You can go from a 7% real return, to a loss of original capital, overnight.

There was an interesting piece on that described what happened in Germany during the 1920s, 1930s, and post WWII. In each case, private equity was decimated, but the government's power to tax and the will of the people preserved most benefits.

A pay as you go payroll tax financed system can't get you the potential returns of a funded equity investment, but you don't need the $10 or so Trillion up front to get to that system, and you don't have the same level of risk. If we had the $10 Trillion and there was somewhere safe it could be invested, we could cut payroll taxes in half and still pay out the same benefits we're paying today, indefinitely into the future, aside from the occaisional tsunami that would wipe out a portion of the equity.

You do need some diligence to keep current benefits in line with future obligations and revenues. You should act 20 or so years ahead to give people adequate opportunity to plan. Right now, though, we've got 40 years of relatively clear sailing ahead, except for the possibility that the SS trust fund promises will be breached because we're bringing in so much less income tax revenue than we're spending.

Starving the beast has been turned on its head. We've got a GOP congress that's grown dependent on spending future revenues today. It's a formula that wins elections, but is it really where conservatives want to be?

Lawrance George Lux writes:

The real trouble with Private Accounts comes in the form increasing numbers will always push into the minimum guaranteed benefit, something which cannot be avoided; those who adjust Private Accounts to draw the Minimum will always gain the most from the program. They maximize their expenditure pattern prior to Retirement, and use political clout to maximize their retirement expenditures. lgl

Randy writes:

Edge, interesting thought. Perhaps that is a major problem with the system, that social security is not invested in true equity, but rather in faith in the governments ability to tax. Can we assume that the government has, and will alway have an unlimited ability to tax? I think not. Especially not in hard times. Had it been possible, FDR would have taxed to create the original program rather than borrowing from the future.

Randy writes:

Lawrence, good point, the freeloader problem will not be resolved even with the use of private accounts. So if social security, no matter how it is organized, creates more freeloaders than would a pure welfare system, why is it mandatory?

Boonton writes:
Geez Boonton, give me a break. Certainly there's tons of demagoguery on both sides. Your post is a good example, falling far short of your usual thoughtful contributions to the debate. Combine that with your artful use of "roughly" and it looks like you have a bright future as a New York Times columist.

I only use roughly because I demonstrated the statement with a simple model. Take a tax that is based on income. Assume two time periods. The 'return' to any particular generation would be found as follows:

Tax Period 1 = T * I(t)

Tax Period 2 = T * I(t+1)

The return to those who paid in during period 1 would be

Return = Benefit / Cost = [T*I(t+1)] / [T * I(t)]

This cancels out to I(t+1) / I(t). In other words the growth of income. The only reason I use the word roughly is because income may not always grow exactly as fast as GDP.

As for the demagoguery on both sides, demonstrate it. I've given what I feel are either outright lies or (to be more kind) mistakes by the pro-privitization side. Feel free to point out the same on the other side.

Boonton writes:
If we had the $10 Trillion and there was somewhere safe it could be invested, we could cut payroll taxes in half and still pay out the same benefits we're paying today, indefinitely into the future, aside from the occaisional tsunami that would wipe out a portion of the equity.

Well yea and if we had $20T we could cut payroll taxes 100%. Ultimately you cannot offload risk without paying for it in the form of reduced expected returns. SS's structure is highly free of risk:

SS Risks:
1. Underlying economy.
2. Political Risks.

Take the risks of Microsoft stock:
1. Underlying economy.
2. Political risks.
3. Risks specific to MS's industry.
4. Stock market risk.
5. Risk specific to MS

While some of these risks can be addressed thru diversification, hedging and other non-simple and not-free methods, you cannot eliminate them entirely.

A possible outlet might be investing in foreign countries not subject to the political risks inside the US but considering that the US is a relatively stable country and economy I don't think its plausible that you bring your risk profile down to SS's while preserving a higher return.

This isn't anything radical, just an application of the CAPM model which predicts all returns should be equal once you control for risk.

Randy writes:

What should happen; Social Security will be allowed to gradually devalue over 2 or 3 generations until it eventually retains only its welfare component. Intelligent, informed, individuals will take responsibility for their own retirement savings via IRAs, 401Ks, etc.

What will happen; Future generations will be taxed at an ever increasing rate until a European style welfare state is achieved.

Dewey Munson writes:

I'm with Boonton.

Also why can I not find anyone recommending making benefit ONLY sufficient to help the destitute therefor significantly reducing outflow and returning to the original purpose.

Freeloaders? Would someone who had all assets in Enron be considered a freeloader?

Saving? 50% of IRS filers 2002 had incomes less than $25000. You bloggers dig $25000? How does someone save from that?

Robert Schwartz writes:

Over My Dead Body. This proposal is based on a massive tax increase that tops off a life time of SS tax increases. I am now self employed. If I had been self employed in 1972 when I was 25 (my first year of real full time employment) and I had payed the maximum tax as I do know(this is all in 2005 $s), I would have payed about $5,100 in SS Tax. In fact I will pay almost $14,000 this year.

Furthermore, I make a good deal more than the maximum so the increase would be even greater.

Thanks, but no Thanks. Where would the money go?. To pay for the retirements of our parents? No. I am in my late fifties, three of our four parents have passed on and the last one will not live that many more years. I have long since paid for her next few years and for my SS benefit as well.

No this tax hike will go to pay for the retirement of the worst generation ever, mine, the narcisistic, vain, self indulgent, wasteful baby boomers, who woke up New Years morning a month ago and said to themselves: "Oh $;&!%, I will turn 60 next year and I haven't saved a nickel for my retirement. I took that home equity line but we went to Cancun and we paid for Jennifer's freshman year at film school, too bad she couldn't stay straight long enough to hack it. I took a flier on stock but the dog ate the sock puppet. What will I do? I guess there is always Social Security."

Hey I spent my life trying not to be like these idiots. I always maxed out my 401K. My kids education is in the bank in cash. I have never taken equity out of the house. We have lived in the house for 20 years and the mortgage payment is now less than the real estate taxes. This is the only house on the block without an SUV or a "luxury" car. We have never borrowed money to take a vacation. We are not nearly as tight as our depression era parents were, but we are ants compared to our grasshopper boomer contemporaries. There is no case to increase anybody's taxes so that any of those lazy, improvident, ungrateful, children of female canines can retire a day earlier. Let them work until they drop.

Instead. We must move swiftly to reduce the cost of the boomers retirement to their contemporaries and their children.

1. Increase the retirement age. Currently a slow incremental increase is in place. People born in 1938 had to wait until age 65 and 2 months (in 2003) for full benefits and if they claimed benefits at age 62, they either waited 2 months or experienced a larger cut back. For some reason, the progression stops at age 66 for ten birth years 1943 to 1954, which includes the peak years of the ill famed baby boom. Change that NOW! continue the progression of retirement age increases for all birth years from 1938 onward at the rate of 4 months per birth year until the retirement age is 72. Why 72? Increased lifespans, decreased morbidity. I could be talked into a higher number. In 2001, the national average life expectancy at birth was 77.2. When Social Security was set up it was less than 65.

2. Make all benefits taxable. Currently no more than 85% is taxable and that only if your income is over $34,000. If your only source of income is $1,000/mo. of SS, you should not be paying income taxes, but that is equally true if your income is $1,000/mo earned at a minimum wage job.

3. Start shifting the system from defined benefit to defined contribution. Young people should see the system as a forced savings account where they have a balance that will be used to purchase an annuity. If the savings account is not enough to purchase an annuity sufficient to keep them out of poverty at the retirement age, they will surrender the savings account and receive a minimum benefit.

4. Don't change the benefits of any current beneficiaries. Starting with anyone born in 1946 (all boomers) start capping the old (defined benefit ) of any one who is a high income (say lifetime earnings since age 18 of twice the maximum annual taxable amount) at the amount of employee OASI contribution (currently 5.3%). As the years wear on, lower the point where the cap kicks in.

5. Don't get the government in the private account business. Keep it as far from the stock market as possible. Make it much easier for private companies to set up and run 401Ks as long as they are available to all employees. Let anybody set up an IRA even if they have a 401K or pension plan.

Randy writes:


Point 1. Raise the retirement age. Agree, as long as people can still choose to retire with a reduced benefit at age 62 (calculated against the higher basic age, of course).

Point 2. Tax all benefits. Disagree. This would have the effect of decreasing the benefits of individual savings and increase the freeloader problem.

Point 3. Shift to defined contribution. Agree. Future generations will demand ownership - or vote social security out of existance - not that that would be a bad thing.

Point 4. Don't change benefits to current beneficiaries. Agree. It isn't politically feasible anyway. Start capping benefits. Disagree - see point 2 above.

Point 5. Keep the government away from private accounts. Conditionally disagree. If the private accounts are to replace the current system, they must be controlled. If they are in addition to the current system, they should be uncontrolled.

Randy writes:


Re; The people who make $25K and presumably cannot afford to save.

These are the people that the current, mandatory, non-ownership system hurts the worst. The tax is regressive, denying them access to their money when they need it the most. Further, they are the most likely to die early, getting little if any benefit, and with nothing to leave to their children. Indeed, this group would be helped most by a pure welfare system paid for with progressive taxation.

Boonton writes:

What I would consider is mandating the 2% personal accounts on top of Social Security BUT make this refundable against any contributions a person has already made to a 401K or IRA.

Such a plan would have no effect on people who are already contributing to their 401K's but would automatically provide for increased savings for the many who do not.

I would couple this with a proposal Arnold made a while ago regarding unemployment insurance. Make your unemployment insurance go into a private account that you can withdraw whenever you stop working (for any reason, from getting fired to just quitting). The incentive will be correct, work longer and your account will grow...yet you can tap it if you wanted to...say...start a business.

Susan Atwell writes:

Speaking of Brad Delong, Mr. Delong calls Donald Luskin the stupidest man alive on his blog.

Luskin writes:
Krugman betrays a fundamental misunderstanding of the economics of Social Security itself. He write, "we don't need to worry about Social Security's future: if the economy grows fast enough to generate a rate of return that makes privatization work, it will also yield a bonanza of payroll tax revenue that will keep the current system sound for generations to come." Krugman has forgotten -- or chosen to ignore -- that under current law Social Security benefits are indexed to wage growth. If the economy grows like Krugman is talking about, yes, payroll tax revenues will grow too -- but so will benefits, nearly perfectly proportionately. The sensitivity tables given by the Trustees of the Social Security Trust Funds don't show this -- because they arbitrarily cut off the calculation after 75 years. But the reality is that the early benefits of increased tax revenues are eventually offset by the higher cost of benefits. Gee -- think how good Krugman could make that look if he reduced the window of analysis to just 10 years...
Merciful God in Heaven! Is there no end to the stupidity?
Delong writes:
Needless to say, Donald Luskin is wrong--completely wrong. Faster productivity growth improves the finances of the Social Security system. And the 75-year horizon has nothing to do with it: the financial benefits to the trust fund from faster productivity growth are in fact much smaller in the next decade than they are further out.
Leading Delong to conclude:
Once again, it's a mistake that only a real idiot could make.

Edge writes:

Sounds like no deal, eh?

The President would like to divert one-third or so of old age benefit revenue, and his "deal" is that Democrats in the Senate get to decide exactly how to spread the resulting benefit cuts.

If they don't cooperate, the're "obstructing".


Robert Schwartz writes:

"Point 2. Tax all benefits. Disagree. This would have the effect of decreasing the benefits of individual savings and increase the freeloader problem."

I obviously hate freeloaders too. Why do you make this assertion?

Randy writes:


Glad you called me on this one. I'm not sure what the hell I was thinking but it was completely backwards. Taxing all benefits would have the effect of reducing the value of Social Security, thereby increasing the probability of savings, and reducing the freeloader problem.

I agree on points 2 and 4. Of course you realize that doing either will significantly reduce the public's political support for the entire program - not that that's a bad thing.

Randy writes:


Re; "resulting benefit cuts".

The benefit cuts are not the "result" of personal accounts.

Benefit cuts, in the form of direct cuts or higher taxes, are necessary to resolve the coming shortfall in the trust fund. The idea of personal accounts is a bone thrown to future generations to keep them from simply voting Social Security out of existance. An effort to keep one or two more generations on the hook long enough to transition to a needs based system.

Personally, I think ending Social Security over one or two generations, letting it gradually evolve into a pure welfare program, is precisely the correct approach.

Edge writes:

Yes, but.

If you carve out revenue for private accounts, you have to cut traditional benefits by much more than the 13% projected if you simply want to bring the system into balance. And, you wind up with a big increase of the publicly held federal debt for about 75 years, and benefit offsets taken back from the "private" accounts.

And, you may wind up with negative net savings, since some people will view these private accounts as offsetting savings they otherwise would have felt necessary.

If you fund the system up front, instead, you avoid all of these risks and costs, and you'd increase net savings.

But, it sounds like this debate is over. We're still borrowing and spending.

Robert Schwartz writes:

Randy: Thank you for the clarification. One thing that I did not like about the SOTU last night was Bush's guarantee to not touch the benefits of those 55 and older.

Well, that includes birth years 1946 through 1950, the leading edge of the boomers. I think that this is an economic and political mistake. Economic because there are way too many people in those birth years. Political, because the second most important aspect of this battle is making the Boomers grow up and start acting like adults now that they are ready to go into nursing homes. (the most important is drawing a curtain over the New Deal)

After some reflection I think I was not tough enough on raising the "normal" retirement age. I had suggested increasing the progression to from 2 months per birth year to 4 months. That is silly. Life expectancy at birth has gone up from 63 when Social Security was started to 77. I know that life expectancy at higher ages (say 20, 40 and 60) may not have increased quite so dramatically, but I think that we need to move the SS age up to 72 very quickly.

Therefore I suggest that the normal retirement age be increased from 66 for birth year 1946 (2012), which is currently scheduled, to 67 for birth year 1947 (2014) and by one year per birth year each year thereafter until it is 72 for birth year 1952 in 2024. There should be corresponding cutbacks in early retirment benefits and and increases in early retirement ages.

Randy writes:


Honestly, I'm not sure why you're being so hard on the boomers. We didn't create this problem. It was created by whoever first thought of giving 100% of the returns in advance to the current generation while passing on 100% of the risk to future generations. And it is the boomers who are taking the initiative to avoid passing that problem on to the future. I do believe we must take the hit. It is the right thing to do. The fact that we were robbed is simply not justification for robbing our children. But the blame is not ours.

Randy writes:


I'm not in favor of borrowing and spending either. But for the sole purpose of keeping another generation or two on board long enough to gradually diminish the program to a pure welfare system, I think it would be 2 trillion well spent.

Benefits will be cut. That is inevitable. The idea is not to sustain the system. The idea is to end it without chaos.

Robert Schwartz writes:

Randy: You asked: "Honestly, I'm not sure why you're being so hard on the boomers."

It is a moral judgement. As I wrote above:

No, this tax hike will go to pay for the retirement of the worst generation ever, mine, the narcisistic, vain, self indulgent, wasteful baby boomers,

There is no case to increase anybody's taxes so that any of those lazy, improvident, ungrateful, children of female canines can retire a day earlier. Let them work until they drop.

Ask yourself, what have they accomplished, in any field of human endeavor, music, art, literature, science, scholarship, law, politics, or arms? I think their record in any of those fields is so scanty both absolutely and in relation to their numbers as to lead us to wonder whether they were here at all.

The ponzi scheme has to end. Somebody has to take the hit. And it is poetic justice if the Boomers do.

Dan writes:

Although I am against any plan that preserves a tax and spend plan by increasing taxes, reducing benefits and making the rate of return zero or negative; I have my own suggestion.

Eliminate the connection between income and the contribution toward the private account. That means allow voluntary contributions at any time. The only contribution that makes sense is one that is made by a parent for a child. For example a parent who contributes 60 cents a day and convinces the child to do the same as he grows will have $286,517.89 at age 65. (7% compounded annually). Contrast that with the 4% planned contribution ($1,000.00 annual limit) limited to employment years of 21 to 65 would yield virtually the same $283,465.21 (7% compounded annually).

I don't care if the individual makes $25,000 or $250,000, the cost would be so small, anyone could afford it. A parent should be allowed to sign up with the social security administration to make automatic payments to the child's account.

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