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Social Security From The Ground Up

I'm not sure it makes sense to take a position on Social Security privatization per se because "privatization" could mean any number of things, some of which might be better than the status quo and some of which might be worse. It occurs to me, though, to think of this. Say we didn't have Social Security or some equivalent program and you were a liberal trying to design some government programs to help out old people. What would you do?

One thing you would definitely do is put some kind of health care plan into place. It's unlikely that you would come up with the current Medicare system, since it treats prescription drugs so oddly and has other problems, but we'll just bracket that and call it "Medicare." What else would you do? What you almost certainly wouldn't do is create a huge intergenerational wealth transfer scheme funded by a very high and regressive tax that pays out money according to a formula whose mild progressivity is undermined by the way it favors the (predominantly wealthy) long lived over the (predominantly poor) short lived.

Instead, you would want to put in place some kind of "welfare for old people" such that a citizen who has worked hard all of his or her life and now is too old to work can live out the remainder of his or her days in dignity.

Such a program would be like Social Security in many respects -- pay-as-you-go financing out of current tax receipts and based around guaranteed monthly checks. But instead of the benefit level being calculated based on how much you used to pay in taxes when you were working, it would be based around how poor you are. The poorest people would get the most generous checks, and it would phase down so that well-off people weren't getting any public assistance. If you indexed benefit-growth to the growth in prices rather than the growth in wages you could make this "welfare for old people" program relatively insensitive to demographic shifts toward an aging population since wages grow faster than prices (barring severe macroeconomic problems that would stress any social spending program) thus making the burden something the economy could support more-or-less come what may.

At this point, if you were smart, you'd worry that you'd created a serious moral hazard problem. Rich people would still save for retirement, since they'd have nothing better to do with their money. But low- and middle-income people who periodically have trouble making ends meet during their working years would save little or nothing for retirement, secure in the knowledge that future taxpayers would foot the bill for their golden years. One good way to address this would be through a forced savings scheme. All workers would be made to contribute a fixed portion of their payroll income to a tax-free retirement account. Since the idea here would be to try and minimize the extent to which your "welfare for old people" scheme needs to be utilized, you would want to prevent people from making extremely high-risk investments unless their forced nest egg was very large. Thus, the first X number of dollars per year in forced savings would have to be invested through a limited menu of schemes. The Thrift Savings Plan for federal employees is, or so I understand, a good model for such a plan.

You could make the forced savings plan progressive by incorporating some fully refundable tax credits into the income tax system so that, de facto, lower-income people would be having their savings subsidized by higher-income people. You would make it so that people couldn't ordinarily draw down their savings account until they reached a certain age, and you would limit the amount of money that could be withdrawn in any given year up until then. You might also want to make it possible to borrow against your retirement account for the purpose of other equity-building activities such as purchasing a moderately-priced first home.

You're looking, then, in present terms at the conjunction of the following proposals -- partial privatization, means testing, and price indexing -- all of which are elements of the contemporary debate. The upshot would be a sustainable, progressive program that was, in large part, pre-funded. It would, moreover, have the benefit of giving relatively short-lived people real assets that could be passed down to their children or other family members.

Now by abstracting away from the fact of actually-existing Social Security you make the task easier in several ways. Fiscally, this simply eliminates the transition costs which, in the real world, are large and important. Second, you alter the political expectations so that a move from the hard-to-justify wage-indexing system to the price-indexing system isn't read as a "cut." Third, and perhaps most importantly, you're assuming the plan would be designed by well-meaning people and not the employees of George W. Bush who will doubtless put forward something similar, but much more scam-ish. So, as I say, better to withhold judgment until we see what, if anything, the president has in mind. But I'm not unsympathetic to something in the neighborhood of what he seems to be contemplating.

November 13, 2004 | Permalink

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Comments

But this doesn't at all eliminate the transition costs, unless we build into your thought experiment that we are willing to go without the benefits from our "welfare for old people" program for the first 50 years after we implement it. If we aren't willing to wait, then we have the transition cost problem back: We have to figure out how to finance the welfare for the people who are now retired or about to retire, who weren't enrolled in our new forced savings plan during their working years.

That, of course, is the source of the current transition problem: When Social Security was set up, the idea was to provide retirement benefits for the people who were then old, not for the then-young who wouldn't be retiring until the 1980s. So they set up a pay-as-you-go system, to avoid having to come up with the money up front to create a fully-funded system.

Incidentally, some economists (google Alan Auerbach, for example) who know much more about this than I argue that the benefits of a pre-paid system for national growth (through increased savings) are exactly offset by the dis-saving that would be needed to set up the pre-paid system in the first place.

But none of this detracts from the basic point, which is interesting. I think the objections to privatization from the left have two sources: First, mistrust of how it will be implemented (heightened by the fact that the Republicans have been talking about this for a decade but have yet to come up with a fully-specified description of what they might do, which suggests that they realize it wouldn't pass muster), and second, concern about the political dynamics. Even if the system that you describe is the best one, it seems likely to be politically unstable, as the wealthy consistently push to de-fund the redistributive aspects of the program and demonize its beneficiaries as welfare queens.

Posted by: Jesse R. | Nov 13, 2004 2:46:49 PM

Actually, I would create a "huge intergenerational wealth transfer scheme" funded by a not-so-regressive [different than existing] tax that pays out money according to a mildly progressive formula.


Means-testing creates rather perverse incentives and is costly to administer, unless you just do it through the tax code which we currently do to some extent by taxing social security benefits for higher income seniors.

I see little which is superior in an indvidual account forced savings plan, and much which could be extraordinarily bad.

And, of course, even if you're 100% correct there is the little problem of introducing the plan. Unless you don't really want a functioning system for about 25+ years, it inevitably begins as an "intergenerational wealth transfer scheme" from workers to retirees...

Posted by: Atrios | Nov 13, 2004 2:52:09 PM


I like Kevin Drum's way of thinking about things: ignore the movements of little green bits of paper, pay attention to the transfers of food, shelter, and clothing. Looking at it that way, retirement is ALWAYS a huge intergenerational wealth-transfer scheme.

Posted by: Josh Yelon | Nov 13, 2004 3:00:21 PM

MY, there are some people who have thought a lot more about this issue than you, go talk/Read stuff by Alicia Munnell for a start.
A key point is that programs are only long-term viable if they include significant middle-class benefits. A program targeted right at poor elderly wouldn't be around for long.

Posted by: CalDem | Nov 13, 2004 3:13:41 PM

"ignore the movements of little green bits of paper"

It is useful not to be distracted by which institutions are handling the transfers. Young people have little in assets, usually in debt until their fifties, so yes it is the young working in the present system that funds SS, but it is the old with their investments and savings that create the jobs.

Posted by: bob mcmanus | Nov 13, 2004 3:15:49 PM

"it is the old with their investments and savings that create the jobs."

I don't buy it. Sure, there's a savings account somewhere with the name of an elderly person on it. But I disagree with the idea that just because there's a savings account with my name on it, I'm a productive member of society. Just the other day, my parents sent me a savings bond that I've apparently owned since I was 13 (my bar-mitzvah). Does this mean that I've been really productive since I was 13? I had no idea, I thought I was just sitting in front of the tube eating junk food, when in fact, I was creating jobs. But don't thank me, thank Paris Hilton: now there's a woman who's really going all out for society.

And yes, I'm familiar with the usual libertarian argument. If the elderly were actually studying the stock market and carefully investing their little green bits of paper into businesses that look promising, then you could say that they were producing knowledge. But if they turn their green paper over to an investment manager, then it's the investment manager who's producing the knowledge.

Like it or not, the elderly are supported by the young. There's nothing morally wrong with that: they have already spent 80% of their lives working their asses off, supporting others. They deserve a break. But that doesn't change the final truth: no amount of playing games with bits of green paper will change the fact that the elderly are being fed and clothed by young people. Pension, social security, privatization - it's all just a shell game, the food and clothing are still coming from young people.

Posted by: Josh Yelon | Nov 13, 2004 3:40:54 PM

> Thus, the first X number of dollars per
> year in forced savings would have to be
> invested through a limited menu of schemes.
> The Thrift Savings Plan for federal
> employees is, or so I understand, a good
> model for such a plan.

The problem here is that x percent of the population can use the stock market to save for retirement. x is some number: 20, 30, 40. But it isn't 100: ALL of us cannot use our own means of production to save for our own future. Aggregation fallacy at work.

So, the "investment" schemes will reap a lot of profit for Halliburton, I mean the Wall Street banks, and then workers will pay _again_ when it is their turn to pay for retirees.

Cranky

Posted by: Cranky Observer | Nov 13, 2004 3:44:39 PM

Part of the problem with all government funded old age pensions, is that they ARE all ultimately paid for out of the taxes of the young. Setting up a classic commons problem: I have chidren, the cost of raising them is directly born by me, but the ultimate benefit is spread out over the entire population.

So children are under produced, and under invested, rationally. See Europe for an example of this.

As a radical suggestion, to solve this problem we might make the old age pension explicitly a function of the taxes paid by one's children. (Throwing in a constant term to protect those who don't reproduce through no fault of their own.) This would encourage adequate production of children, and provide a rational reason to invest in their future productive capacity by education.

Posted by: Brett Bellmore | Nov 13, 2004 3:45:02 PM

"Setting up a classic commons problem: I have chidren, the cost of raising them is directly born by me, but the ultimate benefit is spread out over the entire population."

Oy. I actually understood that. I wish I didn't. Raising children for the specific purpose that they can support you in your old age: now that's a good way to end up with a sociopath for a child.

OK, I'll play on your turf: the purely financial, ignoring all questions of humanity. So here we go: is keeping the payroll tax low really a sufficient reason to push for higher population growth? I mean, there are certain problems with overpopulation as it is.

Posted by: Josh Yelon | Nov 13, 2004 3:56:23 PM

we might make the old age pension explicitly a function of the taxes paid by one's children.

We could also eat 'em elderly when they get useless; I've heard from one American they are delicious.

Posted by: abb1 | Nov 13, 2004 4:00:39 PM

"the cost of raising them is directly born by me,"

I don't have children, Is Bellmore offering to pay my property taxes?

When I said old people had the assets, wel, Warren Buffet is kinda old. And most of the Waltons. I don't care how they invest it, as long as they don't bury it in the backyard.

When you are are talking about something as big as SS and entire demographic groups, as Kevin Drum says, you better be looking at the entire economy and all macro effects before messing around. And every old person in a hospital bed probably creates one young hospital employee( or insurance agent, or drug company, or a software desginer for dialysis machines).

Posted by: bob mcmanus | Nov 13, 2004 4:05:09 PM


"...you were a liberal trying to design some government programs to help out old people. What would you do?"


How about a system wherein retirees must go hat in hand to politicians for benefits?

An alternative would allow them to accumulate more wealth duting their working years.

Posted by: abdul abulbul amir | Nov 13, 2004 4:07:32 PM

> An alternative would allow them to
> accumulate more wealth duting their
> working years.

Compare and contrast to the period 1830-1930. Include a discussion of the rate of particpation in 401ks in your essay. Hint: google "Bismark -battleship"

Cranky

Posted by: Cranky Observer | Nov 13, 2004 4:10:40 PM

Third, and perhaps most importantly, you're assuming the plan would be designed by well-meaning people and not the employees of George W. Bush who will doubtless put forward something similar, but much more scam-ish

Or scam-tastic; scamadelic; scamular; scamozoic; or scam, scam, beans, and scam. That doesn't have much scam in it.

Posted by: bobo brooks | Nov 13, 2004 4:12:25 PM

A gap in the analysis on Social Security reform is that it is now regarded as a retirement/pension program. In reality it was set up as disability and old age insurance. Age 65 did not come out of thin air, that was the life expectancy when the program was created. So many people paying in would never get a benefit, much like traditional term life insurance.

We would not be having this discussion today if the program had not been distorted into replacing personal savings. Had that not happened the retirement age would be somewhere north of age 70 and we'd have no fiscal crisis looming.

Posted by: Tom Coffin | Nov 13, 2004 4:14:00 PM

Young people consume not save. 30-yr-old saving for his retirement will rent, or buy a smaller house. The fifty-yr-old with her mother in the house will consume more than if mother is state-supported, and save less. Countries with low average age and low life expectancies have little capital formation. Countries with large "commons" (think Sweden) have high political participation and lower suicide rates. Okay I made the last one up.

Posted by: bob mcmanus | Nov 13, 2004 4:18:43 PM

"Raising children for the specific purpose that they can support you in your old age: now that's a good way to end up with a sociopath for a child."

So, we were raising sociopaths throughout almost all of human history? Until the invention of the modern welfare state, children WERE the most common retirement program. They still are, outside of the first world.

As for encouraging population growth, has it somehow escaped your attention that, in the developed world, we don't have a population explosion, we've got a population implosion? As in, below replacement birth rates? The "birth dearth"?

Posted by: Brett Bellmore | Nov 13, 2004 4:28:48 PM

Brett - You're right that for most of human history, it was the only option. On the other hand, I can't help but feel that asking the people on the Jerry Springer show to raise more kids would not be a boon to society. Come to think of it, I have no statistics on how much sociopathology there was for most of human history.

As for the population implosion - no, it has not escaped my attention, and I am grateful for it. The last thing I would want to do is reverse it. Global warming, exhaustion of fossil fuels, etc... these are all strong indicators that the human race is too large for the resource output of the planet. I believe that if we were to allow the population to gradually shrink over a period of a hundred years, it would in the long run be a boon for everyone.

Posted by: Josh Yelon | Nov 13, 2004 4:49:51 PM


"Until the invention of the modern welfare state, children WERE the most common retirement program. They still are, outside of the first world."


They still are in the first world as well. Only now its indirectly. When the baby boom is out to pasture, it will be their children that are producing the food, clothing, energy, shelter, and just about everything else the the oldsters consume. Higher US birth rates ameloriate all sorts of problems.

Posted by: abdul abulbul amir | Nov 13, 2004 5:26:29 PM

They still are in the first world as well.

In the first world most things are produced by machines (and by the third-worlders to some extent). You need very few people to produce food, energy, shelter and the rest of it; and I don't think old people consume a lot of stuff produced by marketing specialists, salesmen, accountants, lawyers and stock brokers.

Posted by: abb1 | Nov 13, 2004 6:07:52 PM

This topic always brings out the looney comments. One of my favorite today is how the young are paying for the old people.

Of course, if you were older, you might think that the highways, schools, airports, hydroelectric dams, hospitals, and in fact pretty much everything had been paid for by the old, and is being used by young people who cannot have worked long enough to buy any of it.

Of course, if you thought that, you might think that an older person spending their savings was now discharging productivity stored from an earlier age.

According to some on the thread, YOU WOULD BE WRONG. Think of everything as "intergenerational transfers" and ignore the concept of private ownership, and then you'll see how the elderly cruelly mistreat the younger generation.

Well, one thing is painfully clear- we may have built schools for you, but we fell far short of ensuring you got a good education.

Posted by: serial catowner | Nov 13, 2004 6:10:36 PM

"Of course, if you thought that, you might think that an older person spending their savings was now discharging productivity stored from an earlier age."

Well, here's a simple thought-experiment you can try.

Put 1000 people on an island, all aged exactly 20. Let them form a bank. Make sure they save money diligently for their retirements. When they all retire at exactly the same time, they'll all have big bank accounts, so they'll be fine, right?

Uhm, no. If they had stored canned food, then you could say realistically that they had stored productivity and were discharging it. But as it is, they only stored little bits of green paper. The food, they already ate. The savings were an illusion, if they didn't save real physical goods.

Now you *could* argue that the central bank of the island used the money to stimulate yadda-yadda. No argument. But that's not saving resources for the future, that's just moving money from one guy to a different guy. There's a difference.

It's not at all obvious that the effect would be positive. Basically, you're taking money from workers and giving it to the stock market. That's moving money from the demand side to the supply side - a useful move when there's a capital shortage, and a destructive move when there's a capital glut.

Posted by: Josh Yelon | Nov 13, 2004 6:36:22 PM

Excuse me Yosh, but you've just used a hypothetical world in your thought experiment that has only one verifiable quality- it is totally unreal.

In the real world people who get a lot of "little scraps of paper" end up living in Tuscon and flying private airplanes to their golf course. People who save canned food die alone in a house full of cats.

But, using your "just moving resources" idea, a ton of resources got moved before you were ever born, and for a long time you use that for free, in practical terms.

And most of us think that's a good idea. I'm happy to pay taxes for a certain amount of roads so you won't have to, in the hopes you will use this loan or gift in some productive way. A lot of young people do just that, going to school or learning a job, and that's worked well enough to make this a pretty nice place to live.

Of course this all gets into ideas like equity and opportunity costs and other things you have to learn about to understand them. It's really a mystery how so many unlearned people in the 30s could put together a system that's worked so well for so long. Maybe they had some recent or vivid experience that helped them understand what to do.

Something that didn't make them want to put their money in the stock market.

Posted by: serial catowner | Nov 13, 2004 8:04:26 PM

I say pass a constitutional amendment stating that all Americans must let their mother-in-law come live in their house if she is destitute.

This will ensure that SS is properly funded.

Posted by: bakho | Nov 13, 2004 8:33:12 PM


Serial - I can't tell what you're disagreeing with. The entire content of my post was arguing that retirement is a cross-generational wealth transfer. Are you disagreeing with that?

I think that's fine. I also agree with you that you supported me when I was young - also a cross-generational wealth transfer. I appreciate it. But this isn't about moral judgements. It's about understanding the situation so that we can know what effect privatization is likely to have. I'm saying it's not going to relieve the economic stress when the baby boom retires. Are you disagreeing with that?


Posted by: Josh Yelon | Nov 13, 2004 8:33:13 PM

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