Economics With A Face

June 29, 2005

Taking a Break from Domestic Politics

Next week, with backpacks filled to the brim, Emily and I will be crossing the San Diego/Tijuana border and not returning to California for a year. It follows that the postings on this website will change from that point forward.

Many regular readers may have never wandered over to the About section to see why this site was started. “Economics With A Face” is the planned title of a book I plan to write on economics during a trip around the world. This site will be home to our travelogue, and hopefully, lay the groundwork for the book.

But since I started this site, I’ve used this weblog to practice writing on various topics. Readers will know that two of my favorite subjects have been Social Security reform and immigration reform, both currently hot-button issues in U.S. politics. Once we leave the country next week we plan on also leaving behind these domestic disputes. I might find time to comment on them from time to time, but for the most part I’ll leave the debate to the various weblogs on the left sidebar.

For now, as a form of closure, I’ll post some final thoughts on both issues whose causes will hopefully be advanced during our year abroad:

Social Security

Whether you say it’s bankrupt or merely in need of minor reform, I think it’s safe to say that a clear majority now understand that something needs to be done about Social Security, even if few can agree on the specifics of a proposal. To his credit, President Bush has accomplished this goal.

The optimist that I am, earlier this year I was convinced that some form of voluntary private accounts would be in place by this summer. To me, it just seemed like a no-brainer. Social Security is currently run like a Ponzi scheme and, by the very nature of its Ponzi scheme setup, has promised to pay out trillions more than it will take in through payroll taxes.

What better way to fix this mess than to let workers put part of their payroll taxes in private accounts? Much like a 401k, this would allow all workers to build real assets for retirement, instead of being forced to rely on the tax payments of their children and grandchildren 40 years down the road. While it’s true there is no crisis now, in order to fix the crisis coming down the road people need to start saving for themselves and the quicker the better.

I assumed fixing the system would find bipartisan support by slowing the growth of benefits for upper-income workers coupled with frontloading the contributions to private accounts so that even the lowest income earners would be putting aside a substantial amount of money. (For example, the Ryan-Sununu bill is set up so that workers earning as little as $10,000 annually would still set aside $1000 a year in their own account for retirement.)

Unfortunately, as witnessed by the current state of Social Security reform, my optimism has not transformed into political reality.

Somewhat surprisingly Democrats and some Republicans in Congress have come out against both progressive indexation of benefits and frontloading the contributions to private accounts. But if you’re against raising taxes on the middle class, against cutting benefits for anyone (including Bill Gates), and against private accounts, then the only way you can find money to fix the system is to raise taxes on the rich. The problem is that you first need to define rich, and second, when you compute the numbers, that won’t be enough to permanently fix the system. Add to that the coming Medicare crisis and fixing the Social Security problem without raising taxes becomes all the more imperative.

You’ll also hear many politicians say that they’re not necessarily against private accounts; it’s just that right now we can’t afford “the transition costs.” Any time you hear a politician utter these words it means one of two things: they are either stupid or dishonest. I tend to think most lean towards the latter but either way they shouldn’t be in office. As I stated above, Social Security has promised to payout trillions more than it will take in through payroll taxes. Tackling these costs today instead of years down the road does not increase their magnitude in the least. Politicians know that fact. Yet, they also know that they won’t be in office years down the road, and thus, prefer to push off politically unpopular reform for someone else to deal with.

Alas, it looks like the strategy of opposing any and all reform has been an effective political tactic, even if reprehensible. Luckily this can’t work forever. At some point the Democrats in leadership positions are going to have to bring some ideas to the table. Having the basis of your political philosophy “Against-All-Things-Bush” can’t be a long-term winner. After all, he is going to be out of office in another 3.5 years.

So soon politicians on both sides of the isle will have to start putting forth ideas, and at that point, whether in 1 year or 10, I’m sure that good ideas will rise to the top. Regrettably, it’s taking longer than I originally thought for the simple reason that politicians are in charge of any reform. Many politicians believe that they are smarter than the average person, and they seek power with the hope of making a better world through their wisdom. Of course, the government is the means towards their end. Yet many miss the key point that the good of society comes not from a centralized government directing the masses, but instead, from each individual being able to live their life freely.

P. J. O'Rourke sums this up nicely when he said:

Individual liberty is lost when government stops asking ‘What is good for all individuals?’ and starts asking ‘What is good?’

Private accounts get the government asking once again: “What is good for all individuals?” These accounts would take away a massive amount of power from Washington and redistribute it to men and women across the nation. That’s a big pill to swallow for those who prefer to act on “What is good.” For now, I’ll stay optimistic and believe that politicians are going to have to swallow it sooner rather than later.

For those who still desire more on Social Security, scroll down on this link and review my old posts. I hope next summer I’ll be able to add another to the list stating that workers across this nation are accumulating their own assets in their own retirement accounts. It would be a triumph for individual responsibility and liberty.

Immigration Reform

This is another issue that I’ve been optimistic on, only to be brought back down to earth by political reality. When first proposed by President Bush, I though some form of his guest worker program would be in place before the election. Here we are a year and a half past the date of his original proposal and migrant workers are still paying thousands to cross the border illegally. (Yes Pat, I still owe you $5).

Still progress has been made. McCain and Kennedy have introduced legislation in the Senate while Kolbe, Flake, & Gutierrez have introduced legislation in the House. Hot heads on AM talk radio are doing their best to thwart any attempt to reform our broken immigration system, but in the end I’m convinced they will lose the battle of ideas. For the most part, their concerns about security and waste of taxpayer's dollars are overblown.

Getting 10 million illegal immigrants into the system, in addition to making it easier for those who want to come to this country and work, will be a huge plus for our border security. Those who do not come forward are obviously more of a potential threat, and immigration officials could focus on this smaller group. Similarly, if a migrant worker can cross the border legally to do seasonal work, immigration officials will know that those crossing out in the middle of the desert are probably not simply coming here to earn money.

Immigration is a clear benefit to our society. But instead of going into a detailed defense here I’ll simply direct you to my archive section, with special attention to the two touching stories of to Jose Antonio Gutierrez (here and here) and Rafael Peralta.

It’s not very often that a government bill would instantly improve the lives of millions within this country and at the same time improve our security. The bills recently introduced in Congress would do exactly that. The sooner they cross the President’s desk for his signature the better. Again, I hope I’ll be posting on meaningful immigration reform once I’m back in the States.

So That’s All Folks…

And with that I’ll put U.S. politics to rest on this site. Emily says she’ll believe it when she sees it, but truthfully I think I’ll enjoy the break. Instead of reading the news dominated by stories political partisanship, we’ll instead be writing the news ourselves, and approaching it from the much more pleasurable perspective of the importance of individual liberty.

Truthfully, I can’t wait.

Posted by Peter Mork at 2:43 PM | Comments | TrackBack

June 28, 2005

Three "Must Reads" on Social Security

I'll be posting at length tomorrow on Social Security, but in the meantime I wanted to direct everyone's attention to these three "must reads" on the topic:

1) Will Wilkinson takes a much needed look at the moral/ideological dispute over Social Security in a Cato Social Security Choice report entitled “Noble Lies, Liberal Purposes, and Personal Retirement Accounts.”

2) Jim Glass reminds us of his "thought experiment" on Social Security and ties it in with the new Demint-Ryan plan that includes marketable Treasury debt in private accounts.

3) Pat Toomey follows up Glass in today's WSJ with a more detailed look at Demint-Ryan.

Happy reading...

Posted by Peter Mork at 12:43 PM | Comments | TrackBack

May 11, 2005

Social Security a "Safety Net"?

Great letter to the editor from Don Boudreaux:

Wednesday, May 4, 2005

This was a letter to the editor to the New York Times.

To the Editor:

Whether Social Security is the greatest innovation since opposable thumbs or a looming disaster, it is not properly described as a “safety net” (“Introducing Private Investments into the Safety Net,” A1, Feb. 3). A safety net is a last resort – protection that people do not plan to use, or even want to use, but are content to use in the event of mishaps.

Retirement is no mishap. It’s anticipated, planned, and desirable. As currently structured and endorsed, Social Security isn't meant to catch only people who fall from life’s ordinary and expected institutional supports; it’s designed to be a critical part of these expected supports.

Describing Social Security as a “safety net” is heavy on emotional uumph and light on accuracy.

Sincerely,
Donald J. Boudreaux
Chairman, Department of Economics
George Mason University

Posted by Peter Mork at 12:57 PM | Comments | TrackBack

May 3, 2005

Pozen Returns

Democrat Robert Pozen, the architect of “progressive indexing,” has another op-ed in the Wall Street Journal today defending his plan. Not only does he do a good job clarifying his proposal, but he also corrects a mistake he made in his first op-ed by clearly stating that the $3.8 trillion in unfunded liabilities is a present value figure.

Judging any reform plan relative to scheduled benefits is misguided. The schedule represents the benefits we have promised but do not have the money to deliver. That is why Social Security has a long-term deficit with a present value of $3.8 trillion. If the litmus test of a reform plan is not cutting scheduled benefits for any significant group of workers, then no viable plan to restore Social Security's solvency will pass muster.

Posted by Peter Mork at 4:07 PM | Comments | TrackBack

April 29, 2005

Progressive Indexing Making Headlines

In his press conference last night, Bush endorsed Democrat Robert Pozen’s idea of progressive indexing in order to help shore up the massive unfunded liabilities of the Social Security system. The basic idea is that instead of having everyone’s benefits grow at the same rate as wages, benefits for higher income workers would instead increase by the slightly lower rate of inflation.

This would ensure that higher income workers would have the same purchasing power with their social security checks as retirees do today, while lower income workers would have greater purchasing power with their checks than today’s retirees.

Here are Bush’s exact words:

First, millions of Americans depend on Social Security checks as a primary source of retirement income, so we must keep this promise to future retirees as well. As a matter of fairness, I propose that future generations receive benefits equal to or greater than the benefits today's seniors get.

Secondly, I believe a reformed system should protect those who depend on Social Security the most. So I propose a Social Security system in the future where benefits for low-income workers will grow faster than benefits for people who are better off.

By providing more generous benefits for low-income retirees, we'll make this commitment: If you work hard and pay into Social Security your entire life, you will not retire into poverty.

This reform would solve most of the funding challenges facing Social Security.

How did the press report his proposal this morning?

Here’s the front-page headline from the New York Times:

Bush Cites Plan That Would Cut Social Security Benefits

and here is the headline from the Washington Post:

Bush Social Security Plan Would Cut Future Benefits

Deceptive? I’d say so. David Hogberg has more over at the Social Security Choice blog.

What really gets me about this whole debate is when you realize that Social Security benefits have not always been tied to wages. We actually switched from a system of inflation indexing to wage indexing in 1977. Why you ask? It wasn’t an act of benevolence by the government to give future retirees higher benefits. In fact the exact opposite is true.

Unlike today, in 1977 the inflation rate was higher than the rate at which wages were growing. So the Carter administration switched to wage indexing, as the NYT or Washington Post would say, to “cut” future benefits. But somehow I doubt you would find that fact in a headline of their papers, or for that matter, even buried on the 10th page.

Posted by Peter Mork at 10:08 AM | Comments | TrackBack

April 27, 2005

Rep. Paul Ryan and Sen. John Sununu Throw Bush a Lifeline

The question is will he take it?

Ryan and Sununu reintroduced their legislation to reform Social Security last week in an attempt to get more support for their proposal. I personally think that if the White House would support this bill it would have a good chance of passing. Strong points include 1) progressive private retirement accounts ensuring that low income workers can accumulate a substantial amount of assets, 2) a setup that directly ties private accounts to solvency, and 3) according to the Social Security actuaries it turns deficits into true surpluses by 2038 and accomplishes full solvency by 2051.

Here are some highlights:

• From 2006-2015, the Ryan-Sununu legislation would allow workers to devote to tax-free personal accounts 5 percentage points of the current 12.4% Social Security payroll tax on the first $10,000 in wages and 2.5 percentage points on taxable wages above that. Starting in 2016, workers will then be able to shift 10 percentage points of the current 12.4% on the first $10,000 in wages and 5 percentage points on taxable wages above that. Once fully phased-in, this creates a progressive structure with an average account contribution among all workers of 6.4 percentage points.

• Workers age 55 and over would remain covered under the traditional Social Security system with no change in benefits.

• Workers will be enrolled in a “life-cycle” fund that automatically adjusts the worker’s portfolio based on his or her age - moving near-retirees into safe, government-backed bond funds. Workers may stay with this “life-cycle” fund or choose from a list of five index funds similar to those found in the federal Thrift Savings Plan (TSP).

• The accounts are backed up by a guaranteed minimum benefit equal to Social Security promises under current law.

• Survivors and disability benefits would continue as under the current system unchanged.

• Social Security and the reform’s transition financing are placed in their own separate Social Security budget, apart from the rest of the Federal budget.
  

and here is its affect on solvency:

• Permanent and growing surpluses begin in 2038.

• Permanent solvency achieved in 2051.

• The reform would also greatly increase and broaden the ownership of wealth and capital through the accounts. All workers could participate in our nation’s economy as both capitalists and laborers. Under the Chief Actuary’s score, workers would accumulate $7 trillion in today’s dollars in their accounts by 2020. Wealth ownership throughout the nation would become much more equal, and the concentration of wealth would be greatly reduced.

• The official score shows that by the end of the 75-year projection period, instead of increasing the payroll tax to over 20% as would be needed to pay promised benefits under the current system, the tax would be reduced to 5.18%, enough to pay for all of the continuing disability and survivors’ benefits. This would be the largest tax cut in U.S. history. The bill includes a payroll tax cut trigger providing for this eventual tax reduction once all transition financing and debt obligations have been paid off.

• The reform also achieves the largest reduction in government debt in U.S. history, by eliminating the $12 trillion unfunded liability of Social Security, which is almost three times the current reported national debt.
  

This is a no-brainer to me... but then again I'm not a politician. That's a fact I'm prouder and prouder of after watching one group of Senators on the Finance Committee deliberately twist facts for political gain, while the rest don't even have the backbone to call them on their dishonesty.

Posted by Peter Mork at 9:56 AM | Comments | TrackBack

April 17, 2005

Back from Hawai'i

I'm back from a week in O'ahu visiting my sister and brother-in-law. In case you didn't know, having family living in the state of Hawai'i is a good thing.

While I didn't have computer access to update the website, between the beaches, snorkeling, and some studying for the CFA I did find time to write this letter to the Honolulu Advertiser on Social Security reform. We'll see if it get's published:

Dear Editor:

Visiting family this last week in O'ahu made me realize how many similarities the island has to my home in San Diego. There are great beaches, friendly people, and of course… a lively debate over Social Security.

For example, in his April 13th letter, John Williamson lambastes Rep. Galen Fox for misrepresenting facts about the Social Security trust fund. It is surprising then that he did not hold himself to the same standard of truthfulness.

A few quick points. First, Williamson states that although Social Security will start running deficits in 2017, there is no need to worry as we can draw on the trust fund until 2041. But Williamson conveniently ignores the source of revenue for these bonds. In 2017, when the Social Security Administration takes the bonds currently in trust fund to the Treasury for redemption, where will they get the money?

As Rep. Fox pointed out, the money in the trust fund has already been spent. Today's Social Security surpluses go to aircraft carriers, managing national parks or whatever else the government needs. To account for this spending the Treasury places a bond in the trust fund for the amount of the surplus it has consumed.

But since both the Treasury and the SSA are different arms of the same federal government, by definition, it owes this money to itself. It follows that when the SSA does need to collect on these bonds, the government will have only three choices for revenue: 1) issue more debt, 2) divert money from other government programs, or 3) they can raise taxes. There is no other way around it.

Secondly, Williamson leaves the impression that when the trust fund does run dry, 80% of the benefits will continue to be paid. But if in 2041 we decide to keep benefits unchanged for those in or near retirement (age 55 and above), this would mean cutting benefits by 2/3 for everyone else in the system. Can anyone seriously argue that this would be fair to the younger generation?

One fact that everyone should be able to agree upon is that the Social Security system is in need of reform. Instead of passing this political hot-potato off to our children and grandchildren to deal with, let’s tackle the problem head on. We have the opportunity to create a system that continues to ensure a social safety net, while at the same time allowing all Americans to accumulate real wealth in private accounts.

It’s a noble goal and I commend Rep. Fox for speaking his mind on the issue.

Peter Mork

San Diego, CA

Posted by Peter Mork at 12:57 PM | Comments | TrackBack

April 7, 2005

Thought Experiment

Jim Glass has a great though experiment on his site about the "transition costs" of funding private accounts within Social Security:

Let us imagine that Social Security continues into the future operating exactly as it does today, with just one exception: the US government bonds that currently are deposited in the trust fund are distributed among individual private accounts created for Social Security participants instead, substituting for benefit promises of equal value -- the same benefits the bonds would finance under the status quo. Going forward, additional government bonds that would be deposited in the trust fund under the status quo system are allocated to private accounts as well.

Compared to the current system the change in government tax revenue is $0, there is no change in the government's use of its tax revenue, and there is $0 change in the government's liability on its bonds issued to finance future benefits.

Is there any "transition cost" to the government in creating such private accounts funded with the government bonds?

If yes, identify what it is. If "no", proceed...

The answer is no. Head over and read the whole thing...

Posted by Peter Mork at 7:06 AM | Comments | TrackBack

March 29, 2005

Workers of the World Unite!!!

A friend of mine, with whom I often debate the merits of private accounts within Social Security, was recently offended by this portion of a Gregory Mankiw article in The New Republic:

The second reason the left hates personal accounts is that, over the long term, they could destroy one of its favorite battle cries: the alleged conflict between evil capitalists and oppressed workers. (“Workers of the world unite; you have nothing to lose but your chains.”) No ambitious political figure today would be stupid enough to quote Marx, but let’s face it, much of the left’s rhetoric is a less elegant paraphrase of his worldview.

Social Security reform could put a stake through the heart of this populism once and for all. After workers develop an equity stake in corporate America, they will start watching CNBC and the “Nightly Business Report.” Their view of how they relate to the economy will fundamentally change. Bush understands this, and it is one reason he talks about an “ownership society.” Democratic leaders understand it as well.Their biggest fear is that a nation of stockholders could easily morph into a nation of Republicans.

The association between Marx and the modern-day left he felt was a cheap shot, and in many ways I agree. It was an easy way for Mankiw to label the opponents of partial privatization, making them guilty by association before any facts were presented.

While I do agree with Mankiw that the flawed ideas of Marx (and Adam Smith for that matter) have had a profound effect on current political philosophies, I believe the case for voluntary personal accounts can stand on its own two feet. Let's keep the debate to the facts (ala the second paragraph quoted above and the many more good points in the article) and I have no doubt that Americans will be convinced of the benefits of PSAs.

But given the context of the discussion above, I had to laugh when I saw the cover of The Nation as I passed an airport newsstand this weekend:

Do you think The Nation, like Mankiw, would be taken more seriously if they stopped the references to Marx?

Posted by Peter Mork at 7:56 AM | Comments | TrackBack

March 25, 2005

Questions for Susan Davis

Tomorrow, Susan Davis, my representative in Congress, will be hosting a local Social Security Forum at the University of San Diego. Unfortunately, I will be out of town this weekend but I thought I'd post some questions that I hope get asked at the event. While Congresswoman Davis doesn't have much in the way of information regarding her opinion of if or how Social Security should be reformed, she does link to a calculator showing how much individuals would lose under a Bush proposal for private accounts. As such, I'll assume she is in agreement with the majority of her party who has been more vocal on the issue, and phrase my questions accordingly:

Questions:

1) No one disputes that Social Security, in it's current form, has promised to pay out trillions more in benefits than it will take in from payroll taxes. Much has been made of the "transition costs" to private accounts, but these "costs" are not new, they already exist within the current system in the form of unfunded liabilities. Wouldn't dealing with these costs now in the form of treasury debt be a better option than waiting for decades when much more debt would need to be issued to fund the system?

2) When Bill Clinton proposed private accounts as a way to help shore up the Social Security system in 2002, there was no uproar of opposition from the Democratic Party. In fact, many Democrats still support some sort of voluntary investment accounts within Social Security. Given these facts, is the current debate more of a battle over political power than honestly evaluating the best options for reform?

3) Much has been made of the White House's Commission on Social Security Reform's recommendations for fixing the system. Specifically, the calculator on your own website estimates the benefit cuts under the commission's "Model 2" plan, which would slow the rate of growth of current benefits by indexing them to prices instead of wages. But your calculator ignores a key aspect for lowincome workers. As the report states the plan:

"would enhance the existing Social Security system’s progressivity by significantly increasing benefits for low-income workers above what the system currently pays. This provision will raise even more of our lowincome elderly – most of whom are women – out of poverty."

Given that benefits cannot continue to be paid at their current levels indefinitely, would this not be a fair solution? Keeping benefits, in real terms, at their current levels for higher income workers, while at the same time increasing the benefits for those on the lower end of the income scale, seems like something Democrats should support. Why then are they attacking this aspect of the plan?

4) Do you agree that the Social Security system in it's current form is a Ponzi scheme where older workers' retirement is funded by a larger number of younger workers? Wouldn't it be beneficial to move towards a system where workers have the ability to rely on their own savings for retirement, instead of the tax dollars of their children and grandchildren?

5) It is often stated that Social Security will be able to pay full benefits up until 2041, at which time it will still be able to pay 75% of promised benefits. But according to Dr. John Cogan at Stanford, if in 2041 we decided to keep benefits unchanged for those in or near retirement (above age 55), this would mean cutting benefits by 2/3 for everyone else in the system. Is this an acceptable solution?

More questions can be found here. I'm looking forward to hear how the event turns out and, again, regret that I will be unable to attend.

Posted by Peter Mork at 12:19 PM | Comments | TrackBack

March 18, 2005

Surpluses, Deficits and Government Accounting

How can Social Security be running surpluses every year and yet have unfunded liabilities in the trillions? And how can New Zealand turn a $7 billion surplus into a $1 billion surplus without spending a dollar? Both come down to a question of accounting.

Jim Glass over at his blog has a great summary of the difference between cash and accrual-basis accounting and how they can lead to vastly different pictures of the financial shape of corporations or the government. I'll quote him at length:

The government computes its $412 billion deficit number using cash-basis accounting.

Cash-basis accounting is what individuals use. "Cash in" measures income, "cash out" measures expense, and the difference is net income or loss, nothing or little else counts.

But cash-basis accounting is illegal for all publicly owned corporations, and even for private businesses that have inventory or which accrue in any significant amount either liabilities or rights-to-income that stretch over more than one year.

Accrual-basis accounting recognizes the full current value of all future income that one obtains a legal right to receive, and of all liabilities one becomes legally obligated to pay. So if one receives $1,000 cash in exchange for committing to pay $10,000 in the future, a $9,000 net cost is recognized, rather than $1,000 of income.

As noted, the government requires that GAAP rules be used by all public corporations and all but the very smallest of other entities that have inventories or accruals -- except itself. The government reserves for itself the right to use cash basis accounting.

And it is such cash-basis accounting, cash in minus cash out, that produces the government's reported deficit figure of $412 billion. (And a rather dubious version of cash-basis accounting at that -- as the Financial Report itself notes, a better measure is $615 billion.)

But what about the government's accruals? What about the currently accrued future cost of the already promised benefits of Medicare, Social Security, military pensions, government employee pensions, and so on, all measured net against the accrued value of the future income taxes, Social Security taxes, Medicare taxes, and so on that have been established to pay them?

Well, for the last few years, as per a legal requirement pushed through Congress by fiscal reformers, the Treasury has published within its financial report, for informational purposes, an annual Asset and Liability Statement for the government that does follow GAAP rules, using accrual accounting. And this statement shows the government's net liability increasing in 2004 by $11.087 trillion -- a good 27 times more than the official budget deficit.

Scary stuff isn't it? Hold the government to the same accounting standards that they require business to comply with and the country is drowning in red ink.

Bizarrely, as Rodney Hide points out on his blog and in this article in The New Zealand Herald, New Zealand has the exact opposite problem. Their government wants to switch it's accounting practices to cash-basis from accrual-basis. Why? To make the government's surpluses look smaller, making it easier for the government to resist calls for a tax cut. As Hide writes:

To [Finance Minister Dr. Michael Cullen], decades of accrual accounting and public sector financial reform were all misguided. The generally accepted accounting practice edicts, while legally required, are apparently misguiding in that they give people the wrong impression of the amount of money the Government has to play with.

Much easier to go back to cash, says Dr Cullen. That way he can deduct from the operating surplus all the capital items, all the student loans advanced, all the super fund contributions and spending on construction of new hospitals, schools, prisons and police stations.

This way, a $7 billion surplus can easily be transformed into a $1 billion surplus or even a deficit.

Just two examples of how governments will put politics ahead of sound accounting principles. That is not too surprising, but it's all the more reason that the public needs to educate itself about at least the basics of accounting.

Posted by Peter Mork at 1:38 PM | Comments | TrackBack

March 16, 2005

Progressive Indexing and a $3.7 Trillion Shortfall

Robert Pozen had an interesting op-ed in the WSJ yesterday. Entitled "A 'Progressive' Solution for Social Security," it detailed one proposal to eliminate the unfunded liabilities of Social Security by combining PSAs with "progressive indexing." The way it would work is that benefits would continue to be tied to wage growth for those workers who had an average income below $25,000. On the other end, benefits would now be indexed to the slower growth rate of the CPI for workers who averaged above a $113,000 annual income. If your average income was between these two figures, then a portion of your benefit growth would be tied to prices and a portion to wages.

Hopefully that is the kind of solution that will lead political parties to find some common ground on the issue of reform and help up move towards a system where the majority of individuals can rely on their own savings for retirement, and not the tax dollars of their children and grandchildren.

However Pozen has one error in his piece. He states that:

In order to finance the currently scheduled level of Social Security benefits, the federal government must borrow $3.7 trillion over the next 75 years -- the standard period for measuring the solvency of Social Security.

But his figure $3.7 trillion is far too low. $3.7 trillion is the present value of the unfunded liabilities over the next 75 years, not the amount we're going to have to borrow (which is actually in excess of $24 trillion). An easier way to think about it is that if the government found an extra $3.7 lying around last year, it could have put this money in a bank and Social Security would have been able to remain as we know it for the next 75 years.

For an excellent critique of the confusion surrounding all these numbers see here.

Posted by Peter Mork at 4:03 PM | Comments | TrackBack

March 15, 2005

Ignoring Social Security's Unfunded Liabilities

Someone needs to explain to Jonathan Chait, guest blogging over at Talking Points Memo, the difference between debt that is on the government's balance sheet (bonds in the Social Security Trust Fund) and debt that is not (unfunded liabilities in the trillions estimated by the Social Security Trustees).

Chait states that:

Private accounts by themselves make the deficit larger.

with the caveat that:

...Bush now proposes to have those who open private accounts accept in return cuts in their guaranteed benefit when they retire years later. Fiscally, this is better than proposing private accounts without explaining how you would pay for them. Yet it would still lead to huge increases in the national debt.

What's missing from this analysis is that the only way this adds to the national debt is if Chait ignores the trillions of unfunded liabilities Social Security has currently built up. Private accounts don't add to this debt, they bring it forward and make it visible for all to see.

For example, if a portion of your payroll taxes is put in a private account, and you invest this money in government bonds, you would receive the same exact amount of benefits as promised under the current system. But what the private accounts do is give you property rights over this portion of your retirement. You own the bonds today and a future Congress can't just take them away by a majority vote.

Chait states "All in all, the most optimistic thing you can say about Bush is that his plan would do no harm," but the exact opposite is true. Under the most pessimistic forecasts of stocks only yielding 3% annually over a 40 year plus time frame, the worst that happens is that benefits remain unchanged. Clearly, we're going to need to do more than just private accounts to shore up a system which would need an additional $3.7 trillion invested today to make it whole over the next 75 years. Means testing benefits or indexing their growth to inflation are some possibilities, but Chait is silent on that matter.

When you look at the post as a whole, which also likens private accounts to "building immense gold statues" of President Bush, it's shocking that this passes as serious analysis from a senior editor from the respected magazine The New Republic. Hopefully the host of Talking Points Memo, Josh Marshall, brings more than the above to his debate tonight with Paul Krugman of the NYT and Michael Tanner of The Cato Institute.

Posted by Peter Mork at 1:28 PM | Comments | TrackBack

March 11, 2005

Values and Ends in the Social Security Debate

Josh Marshall over at Talking Points Memo makes the following argument with regards to Social Security reform and private accounts:

The real point, though, is that when you set aside all the practical matters of debt and transition costs, this is an ideological debate -- or to put it less antiseptically, a debate over different sets of values.

The idea behind private accounts is that people should rely on themselves alone and bear the consequences of their successes and their failures and random chance on their own shoulders. If things don't pan out for you in retirement, that's something to take up with your children.

The concept behind Social Security is fundamentally different. The first premise is that if you put in a lifetime's work there is simply a level of destitution below which society will not let you fall. Maybe you made so little during your working years that there wasn't enough to save. Or maybe you just didn't plan ahead well enough. Or maybe you suffered some misfortune. Whatever. If you worked you won't be destitute when you retire. People who made big bucks through their lives don't get a particularly good 'deal' from Social Security, if you insist on seeing it in investment terms. But that's a distorting prism, sort of like thinking you got a rotten deal on your medical insurance if you never have a catastrophic illness.

To which Tim Lee responds:

This is just a flat-out misrepresentation of what the various privatization advocates have proposed. Cato's plan, for example, includes a minimum guaranteed annuity of 120% of the poverty line, subsidized from general revenues for those whose personal accounts are too small to cover the amount. The Johnson bill, which is based on Cato's plan, guarantees a minimum annuity of 100% of the poverty line. The Sununu-Ryan bill guarantees workers the current promised level of Social Security benefits.

Tim continues his post with a detailed critique. But I want to stress a few points. Why should someone who has "made big bucks through their lives" get any sort of "deal" from Social Security at all? To put it in more personal terms, every year I contribute the max to my Roth IRA account. Now, if this account grows to $1,000,000 plus by the time I'm 65 (very feasible), why should I be collecting a Social Security check in the first place?

A related claim you will hear over and over again is that Social Security is an insurance program that guarantees everyone a certain level of income at retirement. But Social Security does not only go to those who fall through the cracks so to speak, it is paid to everyone once they hit the age of 65, even Warren Buffett. This distorts the definition of insurance, which should be used to cover rare and unexpected events.

I pay a $45 monthly medical insurance premium along with hundreds of thousands of others in California. Now if I break my leg tomorrow, I have the security of knowing that Blue Shield will cover all my expenses above a certain level. But this works because everyone paying into the system doesn't break their leg each and every month. Our $45 payments are pooled to cover unforeseen and rare emergencies for the unlucky few who do need to collect.

Now, Social Security works in the way that everyone who reaches the age of 65 collects a check paid for by the payroll taxes of the younger generation. This isn't insurance for those who would be "destitute" without their Social Security check. It's a redistribution of payroll taxes from everyone that is working, to everyone that is retired, regardless of their financial circumstances.

But Josh implies that we're ultimately dealing with two sets of values here. There is one group who wants to preserve Social Security as is in order to ensure "a level of destitution below which society will not let you fall," while the other group wants individuals to "rely on themselves alone" and if things go wrong, and they don't have kids to support them, well… looks like you starve homeless.

Tim calls this a "flat-out misrepresentation," but I'll take it a step further and call it flat-out offensive. The reason I support private accounts is not to feed the impoverished to the wolves, but because due to the power of compounding, everyone is going to have the opportunity to accumulate real wealth. I see a world where future retirees have the security of relying on their own savings which has grown to extraordinary levels, instead of relying on the tax dollars of their children and grandchildren for their retirement. That's a powerful concept as less people will need to rely on a social safety net in the first place.

It's always easy for partisans to assume when debating these issues that because their parties are opposite, so are the ends that they are trying to achieve. While that's an easy intellectual route to confirm your own beliefs, I believe it rarely, if ever, holds true. More often than not much of the debate is really about struggles for political power. If we would all wake up to that fact it would be easier to tackle this problem head-on instead of pushing it off for another generation of politicians to deal with.

Update: Reader Gerald Hanner writes in that we've ignored other components of the safety net Social Security provides that are separate from Old Age benefits. While they too face financial difficulties ahead, plans to reform the system leave these benefits unchanged:

Josh Marshall seems to be under informed in his comments on Social Security. Like most commentators, he ignores all the components of the Social Security System other than Old Age benefits. As a reminder, the other components are Disability, Survivorship, and Medicare. A worker who becomes totally disabled qualifies for Social Security benefits, provided that worker meets participation requirements; the surviving spouse and young children of a covered worker who dies also receive Social Security benefits. Medicare is in a class by itself. In fact, my sister-in-law, who is disabled by Parkinson's Disease, is on Social Security even though she is more than a decade short of age 65. She has been on Social Security for a few years now; because of her illness she may never see age 65.

Hanner and I also got to discussing the insurance aspects of Social Security's Old Age benefits. He correctly points out that they involve the pooling of risk, broad participation, and in a sense indemnification for a loss (in this case the ability to earn a living).

With that in mind, I stand corrected as the Old Age benefits could in fact resemble "whole" life insurance (above, what I refute is the claim Social Security resembles what is called "term" life insurance). But there is still a key difference. Companies that offer whole life insurance invest the premiums in real assets. They do not spend the premiums they collect and in place of saving write IOUs to themselves. Unfortunately, this is exactly what the government is doing.

Posted by Peter Mork at 9:57 AM | Comments | TrackBack

March 2, 2005

Rep. Paul Ryan on Social Security

In my opinion one of the best Social Security reform bills on the floor of Congress was put forth by Rep. Paul Ryan of Wisconsin. His bill front loads the contributions to private accounts, which ensures that low-income workers can set aside a substantial amount for retirement even if they make less than $10,000 a year. Specifically:

Workers will be able to shift to their personal accounts 10 percentage points of the current 12.4% Social Security payroll tax on the first $10,000 of wages each year, and 5 percentage points on all taxable wages above that. This creates a progressive structure with an average account contribution among all workers of 6.4 percentage points.

His bill has been scored by the Office of the Actuary of the Social Security Administration, which concluded that the legislation by 2047 would completely eliminate the current $10.4 trillion of unfunded liabilities within the current system. Sounds like a good plan to me. You would think with the progressive aspects of the plan some Democrats in Congress would be jumping aboard... but not so.

At a recent Cato conference, Ryan pointed out it's not his plan that those on the other side of the isle are opposing, there are other factors involved:

"'I have been floating it to Democrats,' said Ryan. 'Each of them replied to me, "I like what you're doing, I like this bill, I think it's the right way to go, but my party leadership will break my back. The retribution they are promising against us is as great as I've ever seen, and I can't do it."'

It's a good idea, but... I've got my next election to think about. Aren't politics great?

Posted by Peter Mork at 9:51 PM | Comments | TrackBack

February 23, 2005

Clinton on Private Accounts

Below is a quote from Clinton in 2002 on reforming Social Security. He's against privatization but for private accounts.

Today, a little more than two years after Clinton's remarks, Democrats in the House and Senate are trying to equate the two for political gain. But everyone needs to keep in mind the following: Allowing individuals to keep a portion of their payroll taxes in an individual account is not equivalent to getting the government out of Social Security.

Clinton grasped this concept. Here is his quote:

If you don't like privatizing Social Security and I don't like it very much, but you want to do something to try to increase the rate of return, what are your options? Well one thing you could do is to give people one or two percent of the payroll tax, with the same options that Federal employees have with their retirement accounts; where you have three mutual funds that almost always perform as well or better than the market and a fourth option to buy government bonds, so you get the guaranteed social security return and a hundred percent safety just like you have with Social Security.

You can't just attack the other guy's ideas unless you have something to say.

Posted by Peter Mork at 9:55 AM | Comments | TrackBack

February 10, 2005

FDR and Social Security

Via John Fund:

Republican members of Congress have a ready response for Democrats crying foul over President Bush's constant references to Franklin Roosevelt and other icons of liberalism to bolster his call for Social Security reform.

They note that in an address to Congress on January 17, 1935, President Roosevelt foresaw the need to move beyond the pay-as-you-go financing of the current Social Security system. "For perhaps 30 years to come funds will have to be provided by the States and the Federal Government to meet these pensions," the president allowed. But after that, he explained, it would be necessary to move to what he called "voluntary contributory annuities by which individual initiative can increase the annual amounts received in old age." In other words, his call for the establishment of Social Security directly anticipated today's reform agenda: "It is proposed that the Federal Government assume one-half of the cost of the old-age pension plan, which ought ultimately to be supplanted by self-supporting annuity plans," FDR explained.

"What Roosevelt was talking about is the need to update Social Security sometime around 1965 with what today we would call personal accounts," says one top GOP member of the Ways and Means Committee. "By my reckoning we are only about 40 years late in addressing his concerns on how make Social Security solvent."

Update: I'm getting some complaints that I'm posting Republican propoganda with this selective quote. I'll have more to say but here is a reply to the above by Al Franken and here is the unedited quote from FDR:

In the important field of security for our old people, it seems necessary to adopt three principles: First, non-contributory old-age pensions for those who are now too old to build up their own insurance. It is, of course, clear that for perhaps thirty years to come funds will have to be provided by the States and the Federal Government to meet these pensions. Second, compulsory contributory annuities which in time will establish a self-supporting system for those now young and for future generations. Third, voluntary contributory annuities by which individual initiative can increase the annual amounts received in old age. It is proposed that the Federal Government assume one-half of the cost of the old-age pension plan, which ought ultimately to be supplanted by self-supporting annuity plans.

Sounds to me that FDR A) understood the need to get part of the Social Security system in real assets and B) recongized a way to do this was through "voluntary contributory annuities by which individual initiative can increase the annual amounts received in old age."

But hey... I report, you decide.

Posted by Peter Mork at 5:14 PM | Comments | TrackBack

February 7, 2005

Social Security and KPBS

Last week Full Focus, a local television show on KPBS, had a special on the proposed changes to Social Security. The program featured host Gloria Penner along with three guests, Democrat Congressman Bob Filner, UCSD History professor Michael Bernstein, and San Diego County Treasurer Dan McAllister. Both Filner and Bernstein were both strongly opposed to giving workers the option of investing a portion of their payroll taxes in private accounts, while McAllister agreed that there were problems with the President's proposal and suggested the matter needed further study.

Gloria Penner did her best to add a few Bush quotes to the debate, as she realized her viewers were only getting one side of the story. But as the host of the show, she was not prepared to fully defend some of the proposed changes. The guests left viewers with the impression that there were no imminent problems with Social Security, and that the trust fund was something Americans could count on to fund their retirement far into the future.

I was dumbfounded as to why no guest was present to defend a partial privatization of Social Security, so I fired off an email to complain how one-sided the show was in my opinion.

The next night Gloria read a portion of my letter (below) on the air, followed by an explanation that while they tried to get a Republican in Congress to come on to defend the President's proposal, none took them up on their offer. Still, surely they could have found at least one professor at UCSD, USD, or SDSU who supports the President's proposal I thought to myself.

Nonetheless, I thought that was an adequate response to my complaint but to my surprise the show's Executive Producer contacted me the next day, with another explanation and a response from Bernstein regarding some of my complaints. It led to an interesting correspondence that concluded with the possibility that I might be a guest on their show when they address the issue again in the future. We'll see what happens, but no matter what I was quite impressed with the follow-up on behalf of KPBS.

One final point, the numbers I used in the email below don't really tell the whole story. I'll be posting again on that topic in the next few days so stay tuned.

Posted by Peter Mork at 10:41 PM | Comments | TrackBack

Quote of the Day

"Senate Minority Leader Harry Reid... seems determined to earn the description Teddy Roosevelt applied to President John Tyler -- 'a politician of monumental littleness'...[H]e disparaged the idea of voluntary personal retirement accounts funded by portions of individuals' Social Security taxes as 'Social Security roulette.' This is the crux of the Democrats' argument against Bush's plan: Equities markets are terribly risky -- indeed, are as irrational and risky as roulette. Think about that. Reid is saying that the risks and rewards of America's capital markets, which are the foundation of the nation's economic rationality and prosperity, are as random as the caroms of the ball in a roulette wheel. This, from a national leader, is amazing" -- columnist George Will, writing in Newsweek.

Hat Tip: OpinionJournal

Posted by Peter Mork at 9:43 AM | Comments | TrackBack

February 3, 2005

Social Security: Part 1

Quick post as I've been slightly neglecting my web site. Last week, TIA Daily directed me to an op-ed in the Los Angeles Times entitled: "Privatizing Social Security: 'Me' over 'We' ". In response I sent off this letter to the editor which was not published:

Dear Editor:

Benjamin R. Barber in his recent op-ed ("Privatizing Social Security: 'Me' over 'We,'" January 27) states that Social Security privatization is a "reverse social contract," which would destroy a common bond that holds our society together. But I would suggest that if the basis of our society rests on such an unstable Ponzi scheme, we are in much more trouble than Dr. Barber can imagine.

In the year 2042 I will be 65 years old and ready to retire. This is the same year that the Trustees of the Social Security trust fund estimate that my promised benefits will have to be drastically cut. That, or taxes must be raised on younger workers.

This option would be unfair to my future children and the younger generation as a whole. Why not let me set aside a portion of the 12.4% of my income that currently is taken for social security? This way, I'll be able to rely on my own savings for retirement, instead of forcing younger workers to pay even more into a system they may not collect from themselves.

Ultimately, what bonds us together is not our broken Social Security system, but the principles that this country was founded on, namely, a respect for each individual's right to "life, liberty, and the pursuit of happiness." A mutual understanding of that concept is what makes a "we" truly possible.

Peter Mork

San Diego, CA

The letters that were published can be viewed here. A couple were selected from fellow San Diegans.

Posted by Peter Mork at 11:52 AM | Comments | TrackBack

January 21, 2005

Quick Quote

I'll be out of town until late next week so I though I would put a quick quote up before I leave:

"Those who expect to reap the blessings of freedom must, like men, undergo the fatigue of supporting it."

Thomas Paine, The American Crisis IV

September 12, 1777

Be back next week. In the meantime, if you need some extra reading take a look at Micha Ghertner's latest post on Social Security.

Posted by Peter Mork at 11:27 PM | Comments | TrackBack

December 7, 2004

Has the White House Finalized a Plan on Social Security?

KipEsquire quotes a Reuters article that makes it sound like the White House has settled on a plan to reform social security. The quote on his site states:

The Bush administration favors a plan that would allow workers to voluntarily redirect 4 percent of their payroll taxes up to $1,000 annually to a personal account.

Maybe I'm nitpicking but the full quote from the article he links to is as follows (emphasis added):

But Republicans say the Bush administration favors a plan that would allow workers to voluntarily redirect 4 percent of their payroll taxes up to $1,000 annually to a personal account.

Actually, the truth is I'm probably just hoping that the addition of "But Republicans say" means that nothing is set in stone yet. If all we get is 4 percentage points I'll be disappointed. I want this plan front-loaded big time. I prefer a version of Paul Ryan's plan that allows you to invest 10 percentage points of your first $10,000 in income into a private account. This would insure that nearly everyone that works gets at least to the $1000 mark and it would give us some hope of truly creating an "ownership society". After the $1000 investment point has been reached they can scale down the percentage to help fund the current system.

Not to pick on the guy but I have a few other issues with the post. In a way he makes the $1000 a year seem like nothing. But if he'll allow me to goose up his assumed rate of return just a tad, from 7% to 8%, then an individual who starts working at 18 would have over a half-million dollars as they approach their 66th birthday. That's a decent amount and it assumes they never invest more than the bare minimum.

Also, Kip hits the nail on the head regarding several key secondary effects of the private accounts, but doesn't mention one of my favorites. All this money currently moving from our paychecks to consumption expenditures or to purchase U.S. Treasuries starts getting invested in real assets. This should be phenomenal for economic growth and is another important side effect.

Posted by Peter Mork at 6:17 PM | Comments | TrackBack

September 22, 2004

Kerry on Social Security

Kerry went on the offensive today taking on President Bush's proposal to offer workers the option to place a portion of their payroll taxes in private accounts. He states:

"The truth is, the only people who benefit from George Bush's Social Security scheme are the special interests," Kerry said in remarks prepared for a town-hall meeting in West Palm Beach, Fla., a battleground state rich in people keenly interested in the two pillars of retirement, Social Security and Medicare.

Yeah right. Somehow I fail to see how I am worse off if I get to keep the money I make instead of it getting paid out in a government sponsored ponzi scheme. Remember that not a dime of the money you pay in payroll taxes is actually being saved for your retirement.

All the money you receive is going to have to come from future taxpayers, and unfortunately there won't be enough of them to pay the governments obligations when the bill is due. Right now the federal government has promised to pay out $72 trillion more than it expects to take in from future tax revenue. The article continues:

Kerry pointed to a study by Austan Goolsbee, a University of Chicago business professor, who studied a model that proposes workers set aside a small percentage of their pay in private accounts as a method to adjust Social Security to a rapidly graying population.

Goolsbee concluded that fees charged by financial companies could reap them hundreds of billions of dollars and eat 20 percent of the benefits in an account held by a worker making an average salary.

Here is Goolsbee's CV and I'd be interested in taking a look at the study once I find it. Will financial companies "reap" hundreds of billions of dollars over the next century if workers have the option to put part their money in private accounts? I think the appropriate term would be earn. There is no doubt that financial companies have earned billions due to the advent of IRAs and 401Ks. But they earn billions precisely because they deliver trillions of dollars in value to their customers. The average fee of a mutual fund is around 1% of assets under management. If companies were charging more than that you could always switch to another fund or even put it in your local bank.

The Social Security system is not only broken but it's a fraud. Kerry's ranting may "reap" him votes among senior citizens in Florida, but if these tactics do put him in the White House, he will need to start dealing with the facts of this crisis instead of playing on voters' emotions.

Update: Here is the Goolsbee report referenced by Kerry.

Glancing through it the analysis looks pretty weak.

With regards to fees eating up 20% of retirement benefits here is the text from the report:

In each year, the real rate of return pre-expenses is 4.9 percent, so the net yield is 4.6 percent with 30 basis points of expenses, 4.1 percent with 8- basis points and 3.8 percent with 110 basis points. The calculation is done for a worker who starts earning at age 21 and retires at age 65 and is compounded annually. The results show reductions of less than 10 percent in the 30 basis point scenario and 20 to 26 percent with the higher fees. This compares to the results in Congressional Budget Office (2004) and Government Accountability Office (1999) that expense ratios around 100 basis points would reduce account values by more than 20 percent.

So the fees knock down the real return from 4.9% to between 4.6% to 3.8%. Clearly the investor would prefer to get the full 4.9% but do you expect the people investing your money to work for free?!?! There is a reason you would agree to these fees and voluntarily opt into the private accounts: you get a higher real return even with the fees.

Here are some number from the NCPA: low income workers can expect a 2.6% real return from the current Social Security System, median income workers can expect a 1.8% real return, while high income workers can expect a 0.03% return.

So take your pick, 1) a minimum real return of 3.8% paying fees or 2) a maximum real return of 2.6% without fees. Tough choice.

It also should be mentioned that a 4.9% real return is a very conservative estimate. Fees are fixed no matter the real return on your portfolio. So if you were able to get a 8%, 9% or 10%+ return the fees would be much smaller relative to your capital gains.

Goolsbee's report also states:

The collapse of the financial sector from the end of the bubble during 2000-2002 reduced revenues by $117 billion. The increase in revenue from the individual accounts would have a positive net present value more than 8 times larger than this collapse.

Come on!!! Comparing a three year loss to a future income stream over a 75 year time period! This is apples and oranges.

Posted by Peter Mork at 3:52 PM | Comments | TrackBack

September 8, 2004

$72 Trillion of Invisible Debt

Holman Jenkins shows how large the unfunded liabilities of Social Security and Medicare have become in his column today. When politicians talk about the debt they conveniently leave out these numbers.

It would take $3.9 trillion today to retire the visible national debt, and $72 trillion today to pay off unfunded promises to retirees. Yet only the first debt is reported to voters. That's the kind of accounting "oversight" that, in the private sector, leads straight to a cellblock.

In addition he points out that if nothing is done for another 9 years another $18 trillion will be added to this total. One more reason that the transition to private accounts for younger workers should be done as soon as po