Tuesday, May 10, 2005

Social Security

It's been a while since we've had a nice meaty political discussion, so I thought I'd throw this out there. What, if anything, would Math Hutters like to see done to shore up Social Security?

I'll post my opinion in a comment.


Blogger Justin said...

If we accept the premise that we cannot continue to promise benefits that escalate faster than social security revenue does, we are either going to have to raise taxes or cut benefits. Raising the tax rate above the current 12.4% would obviously be quite regressive, so that is probably not a viable choice. Raising the social security cap above $90,000 would be an option. Cutting benefits would be another viable option.

Raising the cap

Raising the $90,000 cap would certainly bring more money into the system. If benefits were unchanged, most analysts agree that removing the cap would get relatively close to eliminating the social security deficit. The premise that benefits would be unchanged, though, seems dubious.

Since social security benefits are tied to contributions, capping the amount of income subject to social security taxes puts a natural limit on the maximum social security check. If we uncapped, or raised the cap on contributions, it would seem natural that benefits would also be raised. If we accept the premise that social security is a pure entitlement, not a form of welfare, we would have to raise the wealthiest American's benefits to match their increased contributions, which both eliminates much of the benefit of raising the cap and creates the somewhat absurd scenario of retired CEO's getting social security payments hundreds of times larger than the workers they employed.

Of course, the democrats would also have to have the courage of their convictions to suggest this sort of thing. I've seen no evidence that they would be willing to go out on a limb to suggest raising taxes, though.

Cutting benefits

Reducing benefits, particularly at the higher end of the current contribution level, seems like a much simpler solution. Bush's proposal to index low-income benefits to wage growth and high-income benefits to inflation with hybrid indexing in the middle. strikes the right balance to me.

The major objection to this approach seems to be that it has the potential to turn social security into a welfare program rather than an entitlement. If people are less and less dependent on social security, the thinking goes, they will be less and less interested in preserving the program and more and more willing to scrap it entirely.

This argument seems to spotlight many of the problems the left has articulating a vision to the American people. First, this argument puts the primary focus on saving a government program, not on the actual goal, which is presumably to ensure that seniors do not live in poverty. When republicans talk about curtailing a program, they talk about the benefits that people are likely to see-- more control over their local schools, more control over where their money goes, etc. The democrats talk in the abstract about programs, offices, administrations-- things that appeal to the inner policy wonk; republicans talk in concrete terms about the effect of those programs and how those effects might be changed. The same thing can be seen in the fillibuster/ judicial nominee fight-- if the democrats believe there are a dozen fringe nominees, they ought to be going on every Sunday talk show they can enumerating why these guys are nutjobs rather than fighing about undemocratic Senate rules that most Americans don't care about and don't understand in the first place.

Second, the argument shows a fundamental timidity about the left's core principles. The left seems desparately concerned that this is the next step in "ending welfare as we know it" and reversing FDR's reforms. If you honestly examine FDR's administration, though, you'll note a couple of things-- FDR strongly disliked the thought of government paying welfare benefits and FDR recognized a fundamental difference between the government's responsibility to the elderly and the government's responsibility to able-bodied young men and women. If you read FDR's speeches, he was frequently more critical of the corrupting nature of government welfare programs than were Republican congressmen in 96. He, like most of middle america, strongly preferred finding ways to put people to work. Heck, one of the main criticisms of depression-era workfare programs was that the government wouldn't spend the money to buy equipment to allow people to do more than rake leaves in the park. On the other hand, FDR, like most of middle America, recognizes that the elderly are hardly in a position to pull themselves up-- 75 year olds aren't going to start climbing the corporate ladder. If the democrats recognize this, the "slippery slope" argument loses much of its traction. Responsible people won't accept a change that forces their parents into the streets, though they welcomed changes that gave their kids a kick in the pants in 96.

Third, the argument demonstrates a fundamental inability in the party to make tactical proposals to counter republicans. Rather than taking Bush's proposal and suggesting changes/ additions that would make it more palatable to the left-- changing how the two indexes are weighted in the hybrid indexing scheme, suggesting increases in the cap, suggesting a social security tax on estates, etc-- they seem able only to oppose any change. This makes their position incredibly brittle-- they have no fallback position if the republicans try to push something through this term. They forgo the opportunity to find a personality that they can either rally around or that can provide useful cover for the more hard-line elements (think of John McCain here). They forgo the opportunity to embarass the republicans by finding a solution that is more acceptable to more people. In short, they've fallen into basically the same trap the Republican congressional minority did for the decades they were out of power-- they've become afraid to be a party of ideas.

5/10/2005 01:53:00 PM  
Blogger Vincent said...

Actually, the fact that the Democrats haven't put forth any concrete proposals on Social Security shows that they're finally getting the political message. When your enemy is shooting himself in the foot, it is not the time to point out that you have feet too. In this case, that means that if the Republicans are going to put forth proposals that are rightfully unpopular with the general public, the Democrats aren't going to put their own ideas out there for the Republicans to target. Should S.S. reform gain traction, you can expect the Democrats to unveil their S.S. plan.

But since I'm not in office, I can suggest two plans:

1. Tweaking the system

First, raising the cap on money taxed by S.S. is an absolute must. It's also an easy argument to make. Someone on dailykos framed it as follows: Alex Rodriguez earns $90,000 in n innings of the season opener. Can't we ask A. Rod to contribute for a whole game? Really, there's no good reason to have a cap at all.

Second, raising the cap would be combined with capping the benefits. Nobody loses out on their benefits, but they stop accruing after a certain annual income (say, $90,000), indexed to inflation. Alternatively (and nearly equivalently, though more fairly), all income counts toward one's eventual entitlement, up to a lifetime maximum.

Third, the government gives up some of the more irresponsible tax cuts in return for paying more money into the S.S. trust fund. This is a bit of prestidigitation -- the government actually borrows from the trust fund rather than paying into it. But putting the government's finances in order would give us greater flexibility in the future, should an actual S.S. crisis materialize.

2. Simplifying the system

The 12.4% tax on earnings is eliminated entirely, or at least the half for which the wage earner is responsible. The S.S. trust fund is similarly eliminated as an accounting entity, although all present entitlements (and future entirements that would have been accrued) are paid directly out of the general fund. To make up for the revenue lost from the earnings tax, income tax rates are increased to be revenue-neutral. This is very progressive because it has the advantage of taxing investment income as well as earned income. And the amount by which income tax brackets would have to be raised would be far less than 6%, so the average person comes out ahead. (Does anyone know a good resource where I could calculate what the income tax rate hike would have to be to generate the same revenue?) Tax brackets could also be raised in a progressive manner so as not to hurt the average retiree living entirely off of interest and investment income.

This option is far more progressive than option 1, although it could never happen because it would hurt the rich, who wield all political power. And it would probably get awful press in the mainstream media, who would parrot all sorts of mischaracterizations of the plan by those opposed to it. But it would be a real net gain for most people. If only the progressives were as good at getting their message out as the archconservatives....

5/11/2005 12:31:00 AM  
Blogger Eric said...

Here are some of my problems with the current social security situation...

1. Social security does not provide people my age any security. Because the current system is not sustainable, about the only thing I can be confident of is that the system will change. But I don't know how it will change. Sure there is a law that says there will be a uniform benefit cut, but it seems almost certain that the laws will change before I collect any benefits. Maybe I'll get 70% of the currently "promised" benefit, maybe 50%, maybe 0%. But since I don't know, it would be irresponsible for me to count on receiving any social security benefits.

Fix: Make the system sustainable, by increasing taxes and/or reducing "promised" benefits. Note that these can be slightly more subtle than just "raise the rate" and "decrease the check". For example, the increase could come largely from removing the wage cap, and the reduction could come largely from increasing the age at which retirement benefits are first paid.

2. It is a humnogous (and possiblely the biggest ever) pyramid scheme. Perhaps such a scheme could work if you could engineer the population (both total and working) to grow at constant rates, but that's not practical (e.g., baby boom, families choosing to be smaller, wait longer to have kids, people living longer, etc.). I think it is irresponsible for me to depend on receiving retirement benefits from a pyramid scheme. Therefore, I feel that I need to pay SS taxes now, and simultaneously save as if I will receive no SS benefits. Not very fun.

Fix: Transition the system so that current assets are at least approximately equal in value to "promised" future benefits. Note that this could be done either with personal accounts or by having the government invest the money as one big pot.

3. Currently, SS taxes collected in excess of SS expenses are being used to buy Treasury bonds, so in effect they are funding the current spending of the federal government. Now if that money was being invested wisely in infracstructure or faciilties that will make future generations more produtive, then maybe that would be ok. But if that money is being spent in ways which will not be paying dividends during the baby boomer's retirement years, then the government has already squandered the money baby boomers have been paying into the system. Once SS taxes are less than the currently "promised" SS benefits, and the government will need to pay back those bonds, but how will it do that? Raise taxes? At the risk of sending the economy into a tailsping that further reduces production and tax revenues?

Fix: Take the money out of the government's hands. This is the primary reason I like the idea of personal accounts. See reservations later in post. It's just the only way I can think to prevent politicans from spending the money now.

4. The current SS system tends to make seniors dependant on the whims of politicans. I don't think it is healthy for a democracy when people are dependant on politicans for the bare essentials.

Fix: Personal accounts. (See reservations later in post.)

5. Social security was originally meant to be a benefit paid to a small fraction of the population that happened to have the "bad luck" of living unusually long and/or living longer than they were able to work. Now, the average American feels that they are entitled to retire, even when they could keep working, and even if they haven't saved much. I don't beleive that it is healthy for society when a large fraction of people who able to work don't.

Fix: Index retirement age to life expectancy. Basically keep current social security disability insurance
program for workers who are unable to work before they reach that age. If Americans want to retire while they are still healthy and able to work, then they should save on their own.

6. As far as I know, the SS payroll tax is the only federal tax which falls disproportionately on people of lower incomes.

Fix: Remove cap on wages subject to SS tax.

7. The government repeatedly uses bookkeeping tricks to make things appear better than they are, and the government's projections hence can't be trusted. For example, the government simulatneously lends, borrows, and invests money at different rates.

Fix: All calculations which require a rate of return, should use market-based rates, and not assume numbers that appear to justify the position of the person preparing the report.

8. Most every scenario proposed has my generation will paying into SS much more into the system than we will get out of the system. I'm basically resigned to that happening. Still I find it a little disturbing that everyone agrees that there will be no benefit cuts for current retirees, and no benefit cuts for near retireees. All the solutions discussed address the problem only by benefit cuts for future (non-near) retirees (my generation) and tax increases (which would fall on young people, but barely affect current or near retirees), gradually raising the retirement age (which affects younger people more), and reducing the rate at which benefits increase (mosty significantly affecting younger people). I have not heard a single politican or lobbyist express any concern that virtually the entire burden is being placed on future generations.

Fix: I'm afraid there is a lack of good options. Still, this is one reason why I would be interested in hearing more about the idea of a national sales/consumption/value-added tax. At least then current and near retirees would bear some of the burden. (At the same time I don't like the idea of the government getting a new tax stream. I'm just scared they'll get carried away spending it, too.)

So my SS reform proposal consists of the following:

1. Raise the standard retirement age to ~70-72, effective as soon as possible. And index it to life expectancy. (This is essentially a benefit cut for younger folks).

2. Effective immediately, the rate of return used for computing future retiree benefits should be the market-determined rate of the ten year TIPS (tresury inflaction protected security), currently yielding 1.65% above inflation. (This is probably a benefit for distant future retirees who currently are scheduled to get a higher rate of return, but there's also a chance it will result in a benefit increase for distant future retirees, depending on future interest rates.)

3. Remove the cap on earnings subject to social security taxes. (This is essentially a tax increase for high-earning currently working folks.)

4. Eliminate the tax-exempt status of municipal bonds, and make them subject to income taxes. I beleive this is the most blatant tax loophole for the wealthy, and should be closed. Use the increased tax revenues to fully fund SS, so it is no longer a pyramid scheme. Use excess to start to address the budget deficit/national debt.

5. Whatever percentage of the SS taxes are not spend immediately (but not less than half), that fraction of each workers SS taxes should go to personal retirement savings accounts. Any year where more than half of the SS taxes are needed to cover current expenditures, the extra money would come from general funds. I beleive my proposed change #4 will be more than sufficient to cover this. Any near-retirees that will get to keep the current benefit would not get any personal savings accounts. Workers who have already contributed to the SS system, should receive credits to their personal retirement account approximately equal to 70-100% of the value of the SS benefit that they have already earned. These credits would have to be spread out over several years, and would be funded by suggestion #4. Note this step addresses the problem of the pyramid scheme, lack of security, and government squandering the money, but not the funding problem. Therefore, if you don't agree with my complaints #1, 2, and 4, then you would see this step as unnecessary.

That said, I do have reservations about personal accounts...

1. Unfortunately, most Americans need much guidance to invest wisely. I'd want there to be a small number of low-cost, diversified investment choices (e.g., Vanguard's bond and stock index funds or "Target Retirement" funds) and there be some constraints on how much risk can be taken with the personal accounts (e.g., minimum 40% in some combination of short term bonds and/or cash).

2. One you retire or even approach retirement age, you should be required to use your personal retirement account to buy at an annuity that will provided a guaranteed revenue stream of $XX,XXX (indexed to inflation) for the rest of your life. Perhaps there could be other options if you have more than is needed to purchase the minimum required annuity.

3. I worry that Americans will see a balance of ~$100,000 and think "wow, I'm rich, I should spend more and save less" (not that different from what congress has been doing), and not realize that $100,000 won't last them more than a few years of retirement. Therefore, I would suggest that each statement to show not just a "current value", but also (and more promiantly) the monthly/annual payment that you would receive if your current savings were used to purchase an annuity (as described above) at various ages (e.g., 65, 70, 75).

The federal government has convincingly demonstrated that they certainly can't be trusted to be good stewards of our retirement savings. With the above safegaurds, I think that individual Americans have a better chance at being better stewards of their retirement savings than the federal government has been.

5/11/2005 02:56:00 AM  
Blogger acg said...

If personal accounts were introduced, the administrative costs of Social Security would go up (a lot)! Also, isn't it kind of misssing the point? I thought the original idea wasn't to be "fair", but so retired people wouldn't have to eat dog food. If Social Security is supposed to be like a safety net, it doesn't make sense to require people to make good investment decisions (about their personal accounts). No matter how much investment guidance is provided, someone will always make the wrong choices, or just be unlucky (oops, we lost your paperwork/database entry/etc., sorry).
Eric, you say that Social Security has a greater effect on people with lower incomes. But then you suggest a national sales tax? Sales taxes affect poor people the most, because they spend such a large percentage of their income on necessary items -- like food.

5/11/2005 09:20:00 PM  
Blogger Eric said...

WRT costs... Costs might be somewhat higher if there are personal accounts as opposed to one massive account, but perhaps not as much as you thing. Besides, I think that for most Americans the the security of having it be "yours" (rather than totally at the whim of politicans) is more than worth paying a total expense ratio of 0.20%-0.30% (typical for mutual funds I suggested).

WRT the purpose of social security... I beleive it should prevent people who are no longer able to work from eating dog food. But I don't feel that retiring at age 65 is a human right. So I don't beleive that social security should be paying a large fraction of healthy americans to stop working when they are still able to work and contribute to society. If Americans want to retire while they are still healthy and able to work, then I beleive they should save more during their working years.

WRT bad investment choices/luck... Yes, some people will make better choices or have better luck than others. That happens in most of life, not just retirement savings accounts. But under the current system, all working americans are being forced to make the choice of contributing to a unsustainable pyramid-scheme retirement plan that is not saving, but rather spending the contributions (and more). And many of those expenditures are quite dubious in my opinion (e.g., another $80B for war). It is important to realize that the currently planned social security benefits are not at all secure. The current system is not sustainable, and the currently "promised" benefits are totally dependant upon the government's ability to collect tax revenues. If the economy has a sustained major downturn, then there would simplely have to be some form of significant benefit cuts. So our social security benefits are dependant on a healthy economy, regardless of whether they are "invested" in personal accounts or some giant government slush fund.

WRT sales taxes... A national sales tax would not have to be regressive. In many states, sales taxes do not apply to some items, such as groceries, and prescription drugs. A well designed national sales/value added tax could exclude those and similar items, so that people who spend a larger fraction of their income on "essentials" would be taxed on a smaller fraction of their spending. Such a tax would also have the benefit of taxing consumption rather than earning, thereby providing a tax incentive to people who choose to live frugally, rather than discouraging people from working.

5/11/2005 10:13:00 PM  
Blogger Vincent said...

Private accounts are a horrible idea. If there are any choices as to how to invest money, half of Americans will choose worse than average. Just look at mutual funds -- all that talent running the funds, and yet many (sometimes most) do worse (sometimes far worse) than the S&P 500. How much worse will the typical uneducated, uninterested investor do?

The stock market is essentially a zero-sum game where the sum slowly increases because many corporations create wealth. Stock market gains are only sustainable to the extent at which they keep pace with that growth. But supply and demand on individual issues create winners and losers. When it gets out of control, a bubble forms, and money gets redistributed from late arrivers to those that got there early and get out at the right time. In essence, it can devolve into a pyramid scheme. If you suddenly dump a huge amount of money into the stock market as with private S.S. accounts, I guarantee that the losers will be primarily average investors.

However, I disagree with the statement that S.S. in unsustainable. There's always a tax rate that can sustain S.S. benefits. It's a multivariate function dependent on retirement benefit amounts, the retirement age, the GDP, the demographic profile, etc. As the independent variables change, the tax rate may have to change as well. But it's a lot easier to adjust that rate if you do away with the whole payroll tax system and instead treat S.S. benefits as any other government expenditure.

The real issue is that the current Congress/President has engaged in profligate spending. I believe that the tax rate required to pull in the revenue to meet S.S. benefit obligations isn't unreasonable if you have a balanced budget and a low national debt. But this administration has built such huge deficits that that tax rate would have to be a lot higher. This is one of the reasons I hate the current Republican party with a passion. They've abandoned fiscal responsibility in favour of a Grover Norquist approach to government whose eventual goal is the dismantling of social programs. It's class warfare that's great for the rich but sucks for everyone else.

5/11/2005 11:47:00 PM  
Blogger Eric said...

If you're dead set against personal accounts, then I beleive implementing steps 1-4 could provide the SS system with long term financial stability, provide the economy doesn't do too badly and the government doesn't squander our savings. Personally, I don't trust the government to spend responsibly, so I like the idea of taking it out of the government's hands. Hence, my suggestion #5. Still, I'd much prefer taking steps 1-4 without personal accounts than doing nothing.

Yes, half will do less than the median, by definition. But if the median in the new system is much better than the median of the old system, that can still be an improvement.

I agree that it would be bad if the government suddenly decided to invest all the money in the stock market. My proposal would allow people to start putting some of their SS taxes into the stock market, so it would not be sudden.

No, there is not always a higher tax rate that will solve the problem. Changing tax rates will indirectly cause secondary changes in individual/corporate behavior, investment choices, work patterns, etc. If the tax increases slow the economy such that they're taking a bigger slice of a smaller pie, then the problems get much worse.

I agree that the Republican party is no longer a stong advocate of fiscal responsibility. IMHO, Democrats aren't much better on this issue.

I think there are two "real issues". One is the dangerous combination of the current US debt, large budget deficits, and simultaneous trade imbalances. This is a problem which is easy to solve in theory, but hard to solve in practice, because it does require making some hard choices.

The other "real issue" is the challenge presented by a demographic distribution
where there is a not-large ratio of healthy working age people to (children + unhealthy people who can't work + older retired people who don't work). For reference, in 1950 there were 16 workers providing benefits for each retiree. However, today the ratio has dropped to 3.3 workers for each retiree, and by the year 2030 the ratio will be less than 2 to 1. (ref). While accumulating financial assets can work to any individual's benefits, the large fraction of non-working people will still present a challenge to society as a whole. It is true that technology has helped increase productivity in many areas (e.g., capability of a $1000 computer, ammount of land/labor required to produce food). But technology has not (and perhaps never will) significantly increased the productivity for other areas (e.g., number of teachers required per student, number of doctors/nurses required per hospital patient). You'll recognize that education and health care are some of the sectors of the economy where prices are increasing more rapidly than average. Unless technology is able to significantly increase productivity in service industries such as these, the average standard of living for Americans will almost certainly stagnate or fall while we as a nation provide care for sick baby boomers. This is a hard problem, and I haven't heard anyone even attempt to address this problem in a realistic way. I do know that it would be easier if when that time came, we didn't have a monster debt load to payoff.

5/12/2005 02:00:00 AM  
Blogger Qian said...

Option 1. Do nothing. The Social Security system is not in crisis, yet. The S.S. surplus is not going to run out for another 30 years or so, I believe. At which point it becomes like just any other government program today: running on deficit. And deficit spending, despite much hand wringing from economists (including Mr. "Tax cuts for everyone!" Greenspan), does not appear to worry the average American voter. So instead of S.S. subsidizing other spending (yup, there's a chuck of my retirement in that B2 stealth bomber. hope it's got good resale.) other spending will have to subsidize S.S., which may not even be a bad thing. Yeah things like NIH, NSF, education and environment will suffer, but they're small potatoes compared to the defense budget, for example. So some of the big items will definitely be cut. The pressure on the government will force us to become more efficient and frugal in our national spending.

Option 2. Do something. Ok, #1's got a snowcone's chance in heck. I agree with Vincent that getting rid of the payroll tax is probably the right move. S.S. and Medicare are government obligations just like defense and education. I'm not saying that philosophically they should be. Obviously the government can do more or less. But since we've traveled down the S.S. road for so long and have already taken money "up front," there is no way to get off this particular wagon. So it's just another thing that the government has to pay for, why should it be held to a higher standard of funding than anything else? Getting rid of the payroll tax and raising the income tax will automatically get rid of the current rate cap. Making S.S. and Medicare come out of general revenue will actually give us a clearer view of the country's financial shape and make it harder to cook the books and run up wild deficits. Oh, yeah, we should index the retirement age to the average life expectancy as well. If people are gonna live until 120, I don't think they should spend 55 years in retirement. Especially considering people aren't that productive even when working. :)

Option 3. Pretend to do something. #2 has almost no chance also. So let's try some random stuff and call it a day. This is where most of the proposals fall. Cutting benefits, private accounts, raising payroll taxes. These are all band-aids on a decapitation wound. Sooner or later the issue will come back because the root problem isn't money, it's man/woman-power. I share Eric's worry about the decreasing ratio of working people to retirees. We're either going to have have really good robots by 2030 or we'll have to encourage immigration like some of the European countries are doing now. But there'd still be a shortage of doctors and other professionals. Japan and China are having it even worse since they have higher ratios of old to young.

We really need to stop pretending that S.S. is a mandatory savings plan and that what you get out is going to be what you put in. It's a government obligation because we as a civilized society don't want to just ship our aging citizens to the woods and let the bears take care of them. We should tax just enough to take care of those who can't take care of themselves and not make a whole big "entitlement" out of it. Let's face it, if you're a high earner and you're responsible with your money, you're gonna end up subsidizing the less fortunate/able/hard working as you are now. Unless as a country we're willing to bring back the Dickensian poor houses and debter's prisons, the rich and the able are going to get shafted. But I don't think you'll find anyone in the top tax bracket, no matter how much they feel they're overtaxed, who is willing to swap places with someone from the bottom tax bracket. All we can do is decide what we're willing to do for our fellow human beings. That and get cracking on building those robots.

5/12/2005 06:42:00 PM  
Blogger Eric said...

Oh, I wish congressional assistant reads our blog and seizes upon the robots idea. Then there was a social security reform bill than included increased funding for robotics research. Now that would be funny!

5/13/2005 04:12:00 AM  
Blogger Eric said...

WP on changing attitudes about retirement

5/16/2005 01:19:00 AM  

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