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Understanding The Bush Plan

Several people I've communicated with seemed not to entirely understand Jonathan Weisman's decription of the Bush administration's "clawback" plan, and since the article is now the subject of a White House counterinsurgency, the meaning of all this deserves to be spelled out in some detail.

The Bush actually operates in three distinct phases, and it's important to understand all three, and to understand them as separate, because only phase two is even remotely construable as an effort to improve Social Security's finances. The first phase is to default on the General Fund's debt to the Social Security Trust Fund in order to make room in the budget (sort of) to make the Bush tax cuts permanent.

Once that's done, Social Security doesn't have nearly enough revenue to cover currently promised benefits. The White House wants to resolve this through some unspecified level of benefit cuts. The idea is that promised benefits will now be brought into line with the (reduced) quantity of funds available. From here on out, Social Security's accounts will be balanced in a cash flow sense. The amount of money paid out each year will be equal to the amount of FICA collected. That's phase two.

Phase three is the proposal to allow workers to divert one third of their payroll taxes into something resembling an account under the Thrift Savings Plan. Once a worker -- call him "Matt" -- chooses to do this, Social Security's cash flow will be messed up. Four percentage points of my wage income that were supposed to be going to pay grandma's Social Security benefits are now sitting in my private account. As a result, the government will need to borrow some money to pay grandma's benefits. The administration believes that that money can be borrowed at a 3 percent rate of interest. When Matt retires, his guaranteed benefits -- already substantially cut during phase two -- will be cut a second time. The size of this cut will be equivalent to the value of Matt's total contributions to his private account, plus 3 percent interest per year. Thus, once Matt retires, he will have access to all of the money in his private account, but his guaranteed benefits will have been cut twice. His little brother, meanwhile, who didn't put money into his private account, will only have his benefits cut once.

Now this is all very complicated. The way Weisman tried to explain it was this: Instead of saying that 4 percentage points of my FICA were diverted into a private account and then the government borrows an equivalent amount of money in order to pay grandma's benefits, say that all of my FICA goes to pay for grandma, but the government lends me an amount of money equal to 4 percentage points of my FICA. When I retire, I get the money in my private account, but I need to repay all those loans with an interest rate of 3 percent. In addition to my private account (with the loan repaid) I then get to collect guaranteed benefits that have only been cut one time. My little brother just gets the once-cut guaranteed benefits.

These two alternative descriptions are absolutely equivalent in all respects. The only difference is that the White House thinks the second description (the one Weisman used) casts their program in a negative light. I actually think it makes their program look better than the first one does. But I'm not paid to work such things out. I also think the second explanation is easier to understand, and I am paid to figure out ways of writing that are easy to understand.

Now, the upshot. The White House says the average worker can expect a 4.6 percent real rate of return on his private account. Under explanation two, this makes borrowing the money at a 3 percent rate turn out to be a smart investment move. You get a 1.6 percent net return. Under explanation two, it's a little hard to see why taking the private account is the right move, but the math comes out the same way, a 1.6 percent net return. Thus, having already implemented phases one and two, the private accounts are a good deal for workers. Phase two and -- especially -- phase one, however, are terrible deals for workers. The cuts undertaken in step two (and made necessary by phase one) are bigger than the gains you can make by starting your account. The important thing, as the chart at the bottom of this page indicates, is that what you're being promised by the Bush administration is worse, on average, not only than what you're being promised right now, but worse than what currently scheduled benefits can afford.

If you are in the top one or two percent of the income pyramid, this may be a good deal for you anyway since phase one allows you to keep your income taxes lower. The other 99-98 percent of us are getting the shaft. Note also that this plan will make Social Security's benefit structure less progressive, though how much less progressive depends on the nature of the unspecified benefit cuts. This is also good for you if you are a manager or major stockholder in a company that will be managing the private accounts. It also might be good for you if you own a great deal of stock already (i.e., you're rich!) and this program winds up increasing the share of national wealth invested in the stock market. The plan will also reduce the national savings rate (new private savings will be 100 percent offset by new public dissavings, but the new accounts will crowd out some non-account private savings) and reduce economic growth.

February 3, 2005 | Permalink

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Comments

well, matthew has spelled out what this means in technical terms.

however, what it really means is that the white house is behaving in its typical mode, the mode that diullio and clarke and o'neill have all told us about: there is no policy analysis, ever. There is only political analysis. As they are losing the political struggle over this issue, they are making shit up on the fly. The shit is meaningless: it is the usual bush piffle.

just as the crisis talk is just out of the sell the iraq war playbook, the lack of any actual clue about what to do is right out of the iraq occupation - well, to call it a playbook would be to suggest that there was anything at all to reference.

These are the people who created a prescription drug bill that is impossible for its target audience (and, frankly, anyone else) to understand. What they are saying so far about social security makes the prescription drug plan look good.

Posted by: howard | Feb 3, 2005 10:24:52 PM

> The Bush actually operates in three distinct phases, and
> it's important to understand all three, and to understand
> them as separate,

I would say the majority of people at my company (whom I do not consider stupid by any means) do not understand our 401(k) (which is not complex by any measure).

Yet they are supposed to understand three complex phases of a plan which is deliberatly designed to confuse them and hide the issue? Riiiiiiight.

Good thing that liberal media is right on top of this with incisive reporting.

Cranky

Posted by: Cranky Observer | Feb 3, 2005 10:44:36 PM

This is what scares me about this Bush "plan." Look at how stupidly baroque this description is: it's a pain for me to follow, and I'm good with numbers (I have a degree in math!). To the overwhelming majority of Americans, the SS plan might as well be written in Linear A.

Which is what is scary: the actual boondoggle clusterfuck of a plan is not important. No on is going to understand it save a very few. This issue is going to be entirely decided in the media wars. Which is why I am still worried about this, even though things seem to be going against Bush.

It's also a great shame to people that call themselves "fiscal conservatives" that they are supporting such a transparently corrupt and inefficient plan.

If this plan were implemented: Social Security is dead; debt is up; the investment industry now has permanent, powerful tentacles into our government to corrupt it; the tax system has become more regressive.

It's some serious chutzpah to stand before the American people and propose this sham -- I'd say Bush thought we were stupid, but I doubt he understands the plan, either.

Posted by: Timothy Klein | Feb 3, 2005 10:54:25 PM

"If you are in the top one or two percent of the income pyramid, this may be a good deal for you anyway since phase one allows you to keep your income taxes lower."

The word "may" is incorrect in the above sentence. The plan will be a good deal for the top two percent of the income pyramid, as income taxes will never be responsible for keeping up their end of the '83 SS agreement.

If I borrow money from you, and then inform you that I don't have to pay it back, that is a good deal for me.

Posted by: Petey | Feb 3, 2005 11:19:27 PM

Hey, where is my daily dish of homophones? Harrumph. Oh well, we have to be satisfied with literate *and* numerate. Holbo was right, brain as big as a planet.

Posted by: Russell L. Carter | Feb 3, 2005 11:26:57 PM

The first phase is to default on the General Fund's debt to the Social Security Trust Fund

Exactly right. That's why all the rightists huff and puff that the trust fund is a fiction, not a real obligation. They're claiming the money wasn't there anyway. It's straightforward from Bush's point of view: paying the debt would require increasing taxes, which is inconceivable.

Whether they can get away with it, when the 14th Amendment requires honoring federal debts, is another question entirely.

Posted by: bad Jim | Feb 3, 2005 11:37:08 PM

"Whether they can get away with it, when the 14th Amendment requires honoring federal debts..."

Doesn't come into play, as the Feds control the creditor.

Posted by: Petey | Feb 3, 2005 11:59:47 PM

I already understood all this and it still was complicated. There is no way in hell average joes with no training in economics or accounting will actually understand this.

Posted by: yoyo | Feb 4, 2005 12:00:07 AM

These two alternative descriptions are absolutely equivalent in all respects.

This is absolutely, totally, and completely false.

It appears that Matthew is just as clueless about Social Security as Mr. Weisman.

The two descriptions are NOT equivalent. In Mr. Weisman's description, an amount equal to contributions+3% would be deducted from your private account, thus decreasing the amount you own and can pass on to heirs. This was not the plan, however. Instead, you get to keep ALL of the money in your account. And that is an ENORMOUS difference.

Let's look at Weisman's own example (from his original example):

"If a worker sets aside $1,000 a year for 40 years, and earns 4 percent annually on investments, the account would grow to $99,800 in today's dollars, but the government would keep $78,700 -- or about 80 percent of the account. The remainder, $21,100, would be the worker's."

http://www.washingtonpost.com/wp-dyn/articles/A60749-2005Feb3.html

As we now know, this was completely wrong. The worker gets to keep THE FULL $99,800. Not just $21,100. But the worker's guaranteed benefits decrease by $78,700.

Now, Matthew thinks that these two things are somehow equivalent. But of course, nothing is farther from the truth: under the way Weisman initially described it, the worker can pass on to his heir only $21,100; in actuality, under the Bush plan, the worker can pass on $99,800.

Now, in Bizzaro-Matthew's world, apparently $21,200 = $99,800.

But in a reality-based world, these two things are COMPLETELY DIFFERENT.

Posted by: Al | Feb 4, 2005 12:12:33 AM

The other insidious part of this scheme is that they are always taking about "real rate of return" most poeople out there see 3% ad think... "even my bank CD's can reutn more than 3%"

"real rate of return" = APR + inflation. Right now it's what 3.26%? So now we are talking 6.26% and rising which means that bonds are right out and the stock market is in.

But... what happens when the deficit continues to excalte to, some are predicting, 30% of GDP.... inflation will skyrocket as the government attempts to deflate the deficit. Now you will have to possibly be making 9, 10, or even 14% APR ... JUST TO BEAT SOCIAL SECURITY.

Welcome to reality people. Bush calls a surplus stealing, but paying back the debt that tax cuts generate are always left to the next person.

Posted by: eric | Feb 4, 2005 12:19:35 AM

Al: check again... the government will defer costs by one means or another. I have heard it called a non-inheratible investment vehicle as well. You can draw an income from it, but it is definatly not yours to keep and pass along.

Oh, I almost forgot, if you want to keep your disability insurance make sure to subtract those premiums from your personal accounts... and if you want linfe insurance too...

So in order JUST TO MATCH THE BENIFITS you have to do better than inflation + 3% + premuims for disability and life insurance. That's a raw deal.

Posted by: Eric | Feb 4, 2005 12:24:17 AM

>in actuality, under the Bush plan, the worker can pass on $99,800.

Nope. I think you'd be forced to put some of it in a government manged annuity system. If you expect to live long, you'd want to put it in an annuity in any case.

Great post, Matt.

Posted by: roublen vesseau | Feb 4, 2005 12:25:48 AM

Al: check again... the government will defer costs by one means or another. I have heard it called a non-inheratible investment vehicle as well. You can draw an income from it, but it is definatly not yours to keep and pass along.


No. Simply wrong.

I hesitate to go back to Clueless Weisman, but, here's from today's story: "The Washington Post incorrectly reported Thursday that the balance of a worker's personal account would be reduced by the worker's total annual contributions plus 3 percent interest. In fact, the balance in the account would belong to the worker upon retirement, White House officials said."

http://www.washingtonpost.com/wp-dyn/articles/A61708-2005Feb3.html

I do, however, think I see the problem with Weisman's work: he apparently relies on CPBB for everything. Obviously, since CPBB is usually putting out false propaganda (e.g.: "the chart at the bottom of this page indicates" - a chart which is false, of course), Weisman is usually going to get his stories screwed up too.

Posted by: Al | Feb 4, 2005 12:33:23 AM

Al, you need to keep up better. No, the worker doesn't get to pass on the $99K; it goes to an annuity (as they described it yesterday. hell, by tomorrow it could go to magic pixie dust). And for the record, while Jonathan Weisman is often clueless about economics, he accurately represented what the fabled senior administration official said. Now, by definition, the senior administration official was clueless, since he wants us to believe this crap constitutes even a conceptual plan, but still, credit where it's due.

Now, we can argue into the night exactly how much value we should impute to the fact that you can leave the residual (to many people, that is worth precisely nothing, since many people think the ideal is to spend it all before they go), but what we can't argue is that there is some enormous difference to your financial position.

And what we certainly can't argue is that this so-called approach makes any sense whatsoever.

Posted by: howard | Feb 4, 2005 12:33:52 AM

As I understand the rather complicated details, Al is correct.

If a worker drops dead at 65, their heirs make hit the jackpot under the Bush plan.

Posted by: Petey | Feb 4, 2005 12:35:42 AM

OK. Here are two scenarios, as I understand them:

If a worker drops dead at 67, the money has already mandatorily gone to an annuity, and the heirs receive nothing.

If a worker drops dead at 63, before the annuity has been purchased, then the heirs hit the jackpot.

---

The details are both complicated and fuzzy, obviously, and the above could be wrong. If the WaPo can get it wrong at first, I can do even worse.

Posted by: Petey | Feb 4, 2005 12:39:03 AM

If my analysis is correct, we should be seeing a rash of patricides by 30-somethings in a generation.

Posted by: Petey | Feb 4, 2005 12:41:19 AM

Al, here's the actual discussion from the senior administration official:

SENIOR ADMINISTRATION OFFICIAL: The way that the election is put before the individual in a personal account structure of this type is that in return for the opportunity to get the benefits from the personal account, the person foregoes a certain amount of benefits from the traditional system.

Now, the way that election is structured, the person comes out ahead if their personal account exceeds a 3 percent real rate of return, which is the rate of return that the trust fund bonds receive. So, basically, the net effect on an individual's benefits would be zero if his personal account earned a 3 percent real rate of return. To the extent that his personal account gets a higher rate of return, his net benefit would increase as a consequence of making that decision.

Q So he would only get a benefit to the extent that his portfolio performed in excess of 3 percent?

SENIOR ADMINISTRATION OFFICIAL: Right. You can think of it as saying -- if you were making a decision on where to put your money going forward over the next 10 years, and you're saying, should I put it in this account or that account, if you're choosing to put your money over here instead of over here, then the net effect on you, as an individual, is to compare what would be the rate of return you get from this system, as opposed to putting it over here. And that would be the difference between the two.

So are we now all clear on this one, Al? The SENIOR ADMINISTRATION OFFICIAL said that the net difference is if you earn a higher rate of return. period. end of statement. so you can't blame weisman on this one.

now, Petey, i haven't seen the full transcript, only accounts of it, so the amount of money you are supposed to spend on an annuity, and how that annuity will work, remains to be made clear, but as of yesterday, no, you didn't get to pass on all the money because you spend most or all of it on an annuity.

Posted by: howard | Feb 4, 2005 12:44:01 AM

We're all going to be very tired of the word "clawback" in a couple of weeks. The WH will be very sorry for coming up with that unfortunate word.

Posted by: Petey | Feb 4, 2005 12:44:02 AM

howard,

Al is correct on the particular point that the amount you have to give back comes out of your SS benefits, not out of your private account.

As to the annuity, I assume that if you drop dead before purchasing the annuity, your heirs get the best of all possible worlds. They get the private account, and the clawback out of the SS benefits becomes moot.

Posted by: Petey | Feb 4, 2005 12:47:42 AM

well, petey, just to bring this all full circle: they don't have a plan. This thing doesn't even merit the "rube goldberg" label: it's beyond ridiculous.

So we may or may not be talking about clawback in two weeks, because we may be talking about pixie dust in two weeks. or mandatory execution at age 70. or whatever the latest label for what they used to call privatization will be by then. who the hell knows? they are making it up as they go as for as the policy part goes.

Posted by: howard | Feb 4, 2005 12:48:26 AM

petey, just to try to get us on the same time zone, yes, i agree that there is a difference along the lines that Al suggests, although not the precise difference that Al suggests, because he seems unaware of the annuity issue.

I disagree with al that his has anything to do with weisman (and with you that it has anything to do with the post); this is how the briefer put it.

And i, like you, have no actual knowledge of how the annuities work and you may well be right about patricide....

Posted by: howard | Feb 4, 2005 12:50:17 AM

Yeah, that's the net difference. But it ignores the entire issue I was talking about!

Posted by: Al | Feb 4, 2005 12:51:58 AM

Here's how it works:

Each worker gets to take 4% of their 6%, or $1000,
whichever is smaller (or larger) less the inflation-
adjusted 3% bond return, and will personally receive
their very own forwarded email from the heir of the
Nigerian Minister of Mining. With the 3% of the 4%
(if it's in excess of the expected compounded bond
return rate), they get to purchase either an annuity
which will pay at least $17/month, or alternatively
a voucher for lifetime free dogfood and curry
powder, or they can choose to invest up to 30%
of the remainder in a combination of bonds, stocks,
and of course the deposit to redeem the key to
the safe deposit box full of Nigerian diamonds.

Those who have managed to save at least $450K will
automatically be invited build a stadium in the
red-state city of their choice using state money,
guaranteeing a 1200% return.

If your personal fluffy-cuddly-bunny motherhood-and
apple-pie account is inadequate to meet the
poverty threshold, you will be allowed to cash it
in for a one-way ticket to Baghdad (after basic
training).

Posted by: Richard Cownie | Feb 4, 2005 12:51:59 AM

The annuity only is necessary to the extent that the guaranteed benefits are below the poverty level. You can get anything above that level as a lump sum at 67.

Posted by: Al | Feb 4, 2005 12:54:01 AM

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