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June 29, 2016
Pay As You Go: Yes or No?
The Atlanta Fed's 2015 Annual Report focused on the graying of the U.S. economy. Part of the report and a follow-up webcast discussed how aging is driving the depletion of the U.S. Social Security and Medicare trust funds.
Based on current projections from the Congressional Budget Office, the Social Security trust fund is forecast to run dry around 2030 (see the chart); the Medicare trust fund in 2025. Barring a change in legislation, once the trust funds are depleted, benefits will be cut so that outlays match revenues. In the case of Social Security, this reduction will mean a 31 percent decline in benefits. To balance the Medicare budget, certain Medicare benefits will also face significant reduction.
As my coauthors and I explain in a recent Oxford University Press blog post, our research has found that pay-as-you-go programs for retirees such as Social Security and Medicare, on average, make people worse off, whereas means-tested social insurance programs for retirees, such as Medicaid and Supplemental Security Income (SSI), improve welfare.
These findings are based on comparing the welfare of individuals born into economies with different types of social insurance programs available. We find that, given the hypothetical choice between having or not having Social Security, the average individual would choose to be born into an economy without Social Security. However, when we ask if an average individual would prefer to be born into an economy with or without means-tested retiree programs, we find that he or she would strongly prefer the economy with these programs.
The preference for an economy without universal pay-as-you-go programs like Social Security is consistent with findings in the literature more generally. These programs are large (Social Security was 4.9 percent of U.S. gross domestic product [GDP] in 2013) and have distortionary effects. In standard economic models, the distortions lead to such large reductions in savings and labor supply that they tend to outweigh the programs' insurance benefits.
In contrast, means-tested social insurance programs for retirees, such as Medicaid and SSI, are much smaller. Together, outlays from these programs for the elderly were only 1 percent of GDP in 2013. These programs provide transfers only to individuals with limited income and assets or with impoverishing medical expenses. However, it is in these states of world, when one is poor and/or sick, that such transfers are most valuable, which is why we find that these programs improve welfare.
Researchers have found that means-tested transfer programs for working-age individuals are highly distortionary because they implicitly tax income and assets. However, we find that such distortions are less severe for means-tested transfer programs for retirees, since individuals cannot use these programs to finance working-age consumption and medical care.
Our findings suggest that one potential solution to the sustainability problems plaguing Social Security and Medicare may be to make these programs means-tested as well. Under such a system, the government would still provide protection against the risks of ending up old, sick, alone or poor, but with programs that are significantly less costly.
Of course, saying that individuals would prefer to be born into a hypothetical economy A instead of economy B is not the same thing as saying that current U.S. citizens want to make such a transition. Moving from the current system to one in which Social Security and Medicare benefits are means-tested would not be attractive to wealthier individuals who are already retired or on the verge of it. A compensation scheme would likely have to be devised and financed through taxes or government debt.
Once the cost of compensation is taken into account, we may find that such a transition is too costly to undertake. And as the population ages and the ratio of retirees to working-age individuals increases, the fraction of individuals in the economy who need to be compensated will increase further. This reality adds impetus to dealing with the Social Security sustainability issue sooner rather than later.
November 13, 2014
A Closer Look at Employment and Social Insurance
The Atlanta Fed's Center for Human Capital Studies hosted its annual employment conference on October 2–3, 2014, organized once again by Richard Rogerson of Princeton University, Robert Shimer of the University of Chicago, and the Atlanta Fed's Melinda Pitts. This macroblog post summarizes some of the discussions.
Social insurance programs in the United States and other developed countries represent a large and growing share of expenditures relative to gross domestic product (GDP). Assessing the costs and benefits of the diverse programs that make up the U.S. social insurance system is a key input into the design and implementation of effective programs. This conference featured seven papers that dealt with various aspects of this assessment. Although each program is designed to address specific issues and hence needs to be studied in the context of those issues, many of the same basic economic questions arise in each context. For example, what is the rationale for social insurance programs? Do they address inefficiencies, or are they mainly designed to redistribute from one group to another? Who benefits from specific programs? How do programs designed to achieve specific objectives distort economic outcomes? These are the questions that featured prominently in the conference.
A classic question in economics concerns the extent to which markets cannot achieve efficient outcomes without government intervention. It is well known that the so-called "invisible hand" can achieve efficient outcomes in a wide range of standard settings, but do these results extend to situations in which information asymmetries exist? In 1976, Michael Rothschild and Joseph Stiglitz's article "Equilibrium in Competitive Insurance Markets" suggested that in the presence of certain kinds of private information, insurance markets could not achieve efficient allocations. In fact, they argued that competitive equilibrium might not even exist in these settings. In "Adverse Selection Is Not a Justification for Social Insurance," Ed Prescott challenges this result and shows that competitive equilibrium exists and achieves efficient allocations in settings that include information problems such as Rothschild and Stiglitz's adverse selection problem. Key to this result is the presence of mutual insurance companies, and how this presence influences the contracts offered by insurance companies in equilibrium. In the Rothschild and Stiglitz environment, insurance companies were effectively agents with deep pockets that were outside the model.
Providing insurance to individuals in situations in which they face bad outcomes may distort individual behavior and lead to negative outcomes that outweigh the benefits of the insurance. This basic issue was addressed by three of the papers at the conference in three separate contexts. Jason Abaluck, Jonathan Gruber, and Ashley Swanson examined how prescription drug coverage through Medicare influences prescription drug usage; Hamish Low and Luigi Pistaferri studied the disability insurance (DI) system; and Bradley Heim, Ithai Lurie, and Kosali Simon examined whether the extension of health benefits to young adults as mandated by the Affordable Care Act (ACA) influenced the behavior of young adults.
In "Prescription Drug Use Under Medicare Part D: A Linear Model of Non-linear Budget Sets," Jason Abaluck, Jonathan Gruber, and Ashley Swanson study how prescription drug use responds to price changes associated with social insurance through Medicare. At the conference, Gruber discussed one key objective of their analysis: uncovering the elasticity of prescription drug use with respect to price. A large elasticity implies that providing insurance in the form of lower prices will distort behavior and lead to much higher drug use, and some recent papers have argued that this elasticity may be quite large. Their basic strategy is to study how changes in the details of Medicare coverage over time influenced individual choices. A novel feature of the estimation strategy is to take advantage of the fact that the marginal price people face depends on their overall annual expenditure on prescriptions, so that individuals can be sorted into groups based on histories of usage, interacted with changes in the details of coverage. A first key finding of this paper is that the elasticity is relatively small. A second key set of findings concerns the extent to which individual choices (in terms of plan selection and yearly expenditure conditional on plan choice) reflect departures from rationality, such as myopia or salience. The paper finds an important role for both of these effects.
Disability insurance (DI) represents a clear and classic example of the tension between insurance provision and insurance. While one would like to provide insurance to individuals who are unable to work, it can be difficult to assess the true ability of an individual to work, thereby creating the opportunity for people who are not disabled to also collect. Luigi Pistaferri addressed this issue in the paper he coauthored with Hamish Low, "Disability Insurance and the Dynamics of the Incentive-Insurance Tradeoff." This paper builds and estimates a structural model that incorporates labor supply, health shocks, earnings shocks, and the key details of the DI application process. The authors conduct various counterfactuals and assess the tension between insurance and incentives in the context of the U.S. DI program. Several results emerge. First, making the review process less strict would enhance welfare despite worsening incentives for people to misreport their health status. This is because the current system denies too many truly disabled individuals from collecting. But decreasing generosity would also increase overall welfare by decreasing the incentives for false collection.
One of the first measures of the Affordable Care Act (ACA) to be enacted was the provision that allowed dependent individuals to remain covered by their parents' healthcare plans until the age of 26. The paper by Bradley Heim, Ithai Lurie, and Kosali Simon, "The Impact of the Affordable Care Act Young Adult Mandate: Evidence from Tax Data," aims to assess the extent to which this provision has affected outcomes for young adults in terms of employment, wages, schooling, and marriage. As Simon described it at the conference, the novel aspect of this analysis is that it tracks outcomes using administrative IRS data, which affords a large sample size. The main empirical strategy is to compare the change in outcomes from before and after the provision was enacted for individuals below the age threshold with the change in outcomes for individuals just above the age threshold. The paper also reports estimates based on triple differencing that uses information on parental health insurance status. The main message from the analysis is that one cannot find robust, statistically significant effects of this ACA provision on outcomes for young individuals. One important qualification is that despite the large sample size, standard errors are still quite large, so that the analysis cannot rule out the possibility of economically significant effects.
Naoki Aizawa and Hanming Fang also considered the effects of the ACA in their paper "Equilibrium Labor Market Search and Health Insurance Reform." However, in contrast to the above papers that focus on how a particular program feature might influence individual choices, this paper focuses on how the creation of health insurance exchanges and the individual insurance mandate would affect the overall equilibrium in the labor market, taking into account the firms' decisions on whether to offer insurance and the wages that they offer to workers. In his presentation, Fang discussed building a structural equilibrium model of the labor market and estimating it using a variety of data sets. The authors find that the ACA will reduce the uninsured rate from about 20 percent to about 7 percent. But interestingly, the paper finds that the uninsured rate would drop even further if the employer mandate were dropped from the ACA. General equilibrium responses are key to understanding this result, illustrating the importance of studying these effects.
One of the rapidly growing social insurance programs is Medicaid. Mariacristina De Nardi, Eric French, and John Bailey Jones assess the benefits of this program in their paper "Medicaid Insurance in Old Age." As French described at the conference, this paper uses a structural approach to assess the extent to which households with different income and health status benefit from Medicaid. The analysis focuses on individuals from age 70 and forward using data from the Health and Retirement Study, emphasizing the risks that individuals face as a result of health shocks. Medicaid offers partial insurance against these shocks, particularly the large expenditures associated with nursing home care, and the paper assesses the value of this insurance for individuals in different positions in the wealth distribution at age 70. The paper has two main findings. First, the insurance value of Medicaid is substantial, and decreasing the size of the program would entail large welfare costs in excess of one dollar for every dollar of reduced spending. Second, expanding the size of the program would offer significant insurance value only to wealthy households. The authors conclude that in terms of managing the risks of the elderly, the current scope of Medicaid seems appropriate.
As the above discussion emphasizes, a critical input into the design and assessment of social insurance programs are data that allow us to reliably document the outcomes and groups that the insurance program wishes to help, as well as measure the efficacy of existing programs in achieving desirable outcomes. In the paper "Welfare Programs and Survey Misreporting: Implications for Income, Poverty and Disconnectedness," Bruce Meyer and Nikolas Mittag documented the serious shortcomings of several standard publicly available data sets when it comes to measuring the resources available to the poorer segments of the population. Meyer presented the paper at the conference, and it uses administrative data from New York State that allow them to link income and transfer data, both cash and in-kind, and compare the measures obtained using these administrative data with the measures obtained using data from the Current Population Survey (CPS), which is a standard source for publicly available data on the income distribution. The results are striking. Relative to analysis based on data from the CPS, analysis using administrative data shows better outcomes in terms of inequality and disconnectedness and yield larger effects from existing programs in terms of their ability to affect these outcomes.
Full papers or presentations for most of these papers are available on the Atlanta Fed's website.
By Melinda Pitts, director of the Atlanta Fed's Center for Human Capital Studies, Richard Rogerson of Princeton University, and Robert Shimer of the University of Chicago
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October 09, 2006
If You Care About The Deficit, You Care About Social Security
The projected increase in Social Security spending is relatively modest over the next 45 years and in fact no larger than it was over the last 45 years. In addition, he also knows that workers have already largely paid for this projected increase in spending, paying a designated Social Security tax that exceeds current needs. The Congressional Budget Office projects that future tax revenue, plus the accumulated surplus over the last quarter century, will be sufficient to pay all scheduled Social Security benefits through the year 2046, with no changes whatsoever.
So, Mr. Bernanke was not being honest when he claims there is a problem with Social Security...
At the risk of being labeled one of those "unified budget types" that keep Angry Bear's pgl angry, I object. The trick there is the stipulation that "future tax revenue, plus the accumulated surplus will be sufficient to pay all scheduled Social Security benefits." It is fair enough to say that the Social Security "trust fund" is a promise to workers that the government ought not breach. It is incorrect to say that it will finance "all scheduled Social Security benefits" in any economically meaningful sense.
The relevant piece of information is this, from the 2006 report of the Social Security and Medicare Board of Trustees: "Projected OASDI tax income will begin to fall short of outlays in 2017..." In other words, the Social Security ceases to be self-financing out of payroll taxes in about 10 years. Absent an increase in overall tax revenues or a reduction in government spending, the payment of scheduled social security benefits adds to the deficit. If you think that deficits are a problem, then logic compels you to treat the payment of accrued Social Security promises as a problem, and one that will arrive in fairly short order.
Note that the same sort of problem does not apply to a large chunk of the Medicare program. Again, from the Board of Trustees:
Part B of the SMI Trust Fund, which pays doctors' bills and other outpatient expenses, and the recent Part D, which pays for access to prescription drug coverage, are both projected to remain adequately financed into the indefinite future by operation of current law that automatically sets financing each year to meet next year's expected costs.
Part A of the program, which covers hospitalization costs, remains a problem, of course, and it is big -- about 1/2 of all Medicare outlays. And you might reasonably argue that the increasing share of medical expenditures in both government expenditures and GDP is worrisome. Though I think this subject to some dispute, I'm not inclined to object too vehemently. But I just don't buy the argument that this is reason for ignoring the very real imbalance that exists in the Social Security system.
Several bloggers I admire have consistently argued that, given the benefit promises they imply, it would be a very good thing to not commingle Social Security taxes with other sources of federal revenues. pgl is in that group. So is Calculated Risk and Andrew Samwick. In the name of transparency, you can put me on that list as well. But unless you harbor pretty firm Ricardian views -- in which case you believe that any discussion of the deficit per se is fundamentally off-topic -- the relevant economic measure is indeed the unified budget. And for that, the trust funds don't mean a thing.
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February 08, 2006
This Week In Entitlement Reform
In this the federal budget week, blogland brings a couple of interesting discussions on social security and health policy reform. First up (in reverse chronological order) is the latest Econoblog installment featuring Mark Thoma and Andrew Samwick. This, from Andrew, neatly summarizes my thinking about the foundation on which social insurance reform must be built:
As global trade increases, the U.S. loses its ability to be the least-cost producer if it stipulates that employment contracts must include taxes for all manner of redistributive programs. If we are to purse both social insurance and economic growth, we need to consider alternatives to the employment relationship as a way to deal with our health and retirement needs.
Mark agrees, but is skeptical about solutions that rely primarily on the private sector:
There are substantial problems -- market failures -- in the private-sector provision of health and retirement insurance that are not easily overcome with market-based regulatory schemes.
For example, adverse selection issues, where high medical-cost individuals are excluded from coverage or are forced to pay extremely high premiums, plague health-insurance markets. High administrative costs of private health insurance are another problem, and there are problems in the private provision of retirement insurance as well. When markets fail, the insured often pay for the uninsured, and for these and other reasons I believe it's best to share the burden more generally through government programs that require individuals to contribute insurance premiums.
I confess that I don't quite buy that one. As Andrew points out, there is a distinction between government regulation of an industry and government production of the service that the industry supplies:
The first mistake is to make insurance voluntary when we don't subsequently exclude those who need care from getting it at the public's expense. We should make health insurance mandatory, but we should do so by putting the mandate on the individual, not the employer...
The second mistake is to allow the tax code to distort the type of insurance offered. Premiums are fully excludable from taxation, but out-of-pocket expenses are only imperfectly tax deductible. This generates extremely generous, first-dollar coverage and little incentive for individuals to economize on the care they receive. Rather than the Bush administration's proposal to make out-of-pocket expenses deductible via expanded medical savings accounts, I favor removing the excludability of health-insurance premiums from taxable income.
The third mistake is to force young workers to subsidize older workers in group health-insurance markets. Insurance is supposed to transfer resources from those who have unpredictably low expenses to those who have unpredictably high expenses.
I agree with Mark that the government should mandate coverage, but that doesn't mean the government should centralize the provision of services or dictate their terms. I would prefer to fix some of the obvious mistakes before making such radical changes to the system.
Andrew's diagnosis gets a second from Dr. Becker in this week's installment of the Becker-Posner Blog:
...many of the problems in the health system are correctable with the right policies. I believe the three most important defects are the over 40 million Americans who are not insured, the weak incentives to economize on unnecessary medical spending by most people covered by some form of health insurance, and the tying together of health insurance with employment as a result of special tax privileges provided to employers.
Arguably the best parts of President Bush's State of the Union address are his suggested reforms in the health care system. They do not fully attack all the problems, but they do offer significant improvements. I will concentrate particularly on his proposals to extend Health Savings Accounts (HSAs), and to improve the portability of health insurance when workers change jobs.
Professor Becker goes on to an extensive discussion of the HSA proposal, the benefits of such a plan, and a very wise observation about at least one of the costs:
President Bush has proposed changes in the health care system that initially will reduce tax collections and increase federal spending at a time when the US government is already spending too much and running a sizeable budget deficit. However, by making the health delivery system more efficient, this important set of proposals in the State of the Union address might end up raising tax collections, and certainly would improve the efficiency of the American economy.
There are plenty of other interesting things in these two items -- the discussion, for example, of the Liebman-MacGuineas-Samwick social security reform proposal which I have endorsed (and which was met with a resistance I find as baffling as members of Congress giving themselves a standing ovation for doing absolutely nothing about fixing a system that clearly needs to be fixed).
Really, I beg you. Read the whole things.
UPDATE: William Polley agrees the key question is "How much social insurance should be provided by the government and how much should be provided by markets."
You'll find some thoughts about the Posner half of the Becker-Posner conversation at winterspeak.
Max remains a consistent reform-skeptic (at least as it relates to social security).
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December 15, 2005
Why Social Security Reform?
My (admired) colleague-in-blogging Calculated Risk is unimpressed by my call for support of Andrew Samwick's latest proposal for reforming the U.S. social security system. In the comment section of my previous post, CR writes:
Of course I oppose the Samwick, et. al. plan. The reason is simple: the two major fiscal problems facing America are 1) Health Care and 2) the General Fund deficit. Both of those problems dwarf any SS shortfall.
Any good manager would start with the most serious problems first. Wouldn't it be great if the blogosphere banded together and pushed the National debate to those two issues?
Ahhh. Now I remember why I haven't written about social security reform in awhile. Oh well. I opened the door, so I may as well walk on through.
I'll start with this: I don't understand CR's position at all. By his logic, we ought to avoid grabbing the perfectly edible fruit on the branches that can reached from the ground because there is some really juicy stuff way up at the top of the tree (that can be reached only after a fairly arduous climb.) That just doesn't make much sense to me.
Here's my view, in brief:
a) I agree with CR ranking the health care issue in front of social security, but believe it is a much harder nut to crack. Where, for example, is the nonpartisan proposal on that one? If some civic-minded across-the-political-spectrum group like Samwick-Liebman-MacGuineas have a simple well thought out compromise plan, by all means let's all jump on board. I've yet to see it, though. and am disinclined to let other opportunities languish while we wait for it to arrive.
b) Let's put things in perspective. No matter what side of the issue you are on, the most important immediate subject for the country is the war, as there is much more at stake than today's treasure. If you are going to argue we can only do one thing at a time, then it seems to me everything on the economic policy list goes off the table for now. I, of course, am willing to accept that we can walk down the policy street and chew a few pieces of gum at the same time.
c) My philosophy on the federal deficit is that if you get the spending, tax, and transfer stuff right, deficits per se -- especially of the magnitude we are experiencing now -- are of second or third order importance. It is better to let the (completely manageable) deficits we have now run for a bit, while we get the big picture on fiscal policy right. By getting some sensible social security reform, for example.
UPDATE: Calculated Risk posted his arguments mentioned here, and generated plenty of reaction. Jane Galt correctly (un my view) notes that the social security problem and deficit problem are inextricably linked. Arnold Kling reinforces the argument that we ought to be looking at the fiscal policy as a whole. And Andrew, not surprisingly, agrees that we ought to first solve the problems for which ready solutions exist.
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Vox Baby Does The Work Of The Angels
Andrew Samwick, Jeff Liebman, and Maya MacGuineas have unveiled their new "Nonpartisan Social Security Reform Plan," which Andrew describes in brief at Vox Baby. Long-time readers know that I am a proponent of privatization, primarily because a demographically-centered transfer system seems to me an inferior way to run a pension program. But I am sensitive to the better arguments of privatization's opponents -- that a purely private system might shift too much risk to those in or near retirement, that private accounts do not themselves guarantee sustainability of the system, that too many of privatization's proponents serve up their proposals as if there is free lunch to be devoured by one and all.
The Samwick-Liebman-MacGuineas plan suffers none of these deficiencies and, Solomon-like as it is, essentially splits the difference between many different reform proposals -- part privatization and part traditional fix-er-upping, paid for out of a combination of expanding tax coverage and raising the retirement age. As Jane Galt says, "that sounds like a plan" that "could achieve broad consensus across the left-right spectrum."
Much has been made of the power of the blogoshpere to move agendas that are overlooked, or resisted, by the traditional seats of power. And much has been said about the growing influence of econ blogs. Wouldn't it be something if we could band together and finally get real social security reform off the dime?
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April 26, 2005
Do Americans Support Privatization?
Mark Thoma gives the heads-up on Congressional hearings on the subject that begin today, noting this bad-sounding piece of news for the administration.
And despite the president's efforts to rally support for his Social Security plan, seven in ten Americans say they're uneasy about his approach to the issue.
More people (49 percent) say the president's plan to partially privatize the system is a bad idea than say it's a good idea (45 percent).
There is certainly news there about confidence in whatever the public perceives the adminstration's plan to be, but I'm not sure how much we learn about attitudes concerning privatization per se. Is it not possible that one could be a proponent of reforms that include privatized accounts and still be profoundly uneasy about the administration's approach?
Paul Krugman, of course, thinks he's got it figured out. In yesterday's column, to which Mark links, Krugman starts with the results from a Gallup poll question on the general state of the economy, throws in a little Terry Schaivo and Tom Delay red (er, blue) meat, before finally moving to the (ambiguous) CBS poll question and somehow concluding that the evil Bushies and their minions are about to shove privatization down the throats of a resistant public.
The truth about public sentiment is more complicated, I think. Last month, I posted on a March Gallup poll on attitudes about privatization. Here's a quick round-up of the responses.
-- 56% of respondents favored reform that included some provision for private accounts invested in the stock market
-- 58% of respondents favored legislation that would allow people who retire in future decades to invest some of their Social Security taxes in the stock market and bonds
-- 51% of respondents felt it was necessary to make changes to Social Security this year
-- a slim majority -- 50% vs. 46% -- responded that they relying on the current system to delivered promised benefits was riskier than investing in stocks and bonds
-- A significant majority favored limiting benefits to wealthy retirees and eliminating the cap on wages subject to taxation as ways to address concerns about Social Security
Interestingly, today's Wall Street Journal reports that the wealthy may not be particularly enthusiastic about privatization.
... affluent Americans are split on the merits of Social Security overhaul, although about 45% of respondents believe that this move could boost stock-market returns...
[The April UBS/Gallup survey of investors] showed similar results, with 50% saying that the Social Security system should be kept as is, and 47% opting for personal savings accounts. This is the first time since June 2000 -- when respondents were first asked about their support for Social Security overhaul -- that more people preferred the status quo.
Do Americans support privatization? Who knows? I think what we are seeing in all these survey results is good old-fashioned common sense. I'd bet that most Americans think some sort of privatized account option is a good thing, recognize that there is no free lunch, and know that the devil lives comfortably in the details.
UPDATE: John Irons has more on the survey of "affluent Americans."
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» Social Security Debate Degeneration from The Dead Parrot Society
President Bush's recent campaign stop in Galveston, Texas, was a public relations disaster. Years ago, the President's Social Security Commission articulated a Social Security reform that (a) increased benefits to the poorest of the poor, (b) increased... [Read More]
Tracked on Apr 28, 2005 6:39:07 PM
April 23, 2005
Mark Thoma takes a shot at the latest Cato Institute blast at the anti-privatization crowd, and pgl at Angry Bear asks "Will the Cato Institute Even Offer a Reply to Mark Thoma?". Probably not, but I'll give it a try.
Out of the gates, Mark takes issue with this statement from Cato:
Yes, if solvency is the only issue at hand – and it does appear to be the singular focus of the Bush administration thus far – then raising the retirement age is a fine idea.
First, the claim that the Bush administration has had a singular focus on solvency is wrong. Privatization does nothing to address solvency as the White House now admits, and no proposal from the administration addresses solvency, in no small part due to the fact that contrary to popular belief, the administration has no proposal for reform on the table. Their singular focus has been on privatization, not solvency, and the two issues are independent.
That's a pretty ticky-tack foul to be calling, if you ask me. Without jumping into the issue of what the Bush administration has or has not claimed, the passage in question is hardly material to the Cato piece. And I see no claim in the offending piece that privatization per se addresses the solvency problem. In fact, the admission that raising the retirement age is sufficient to restore solvency explicitly separates the solvency issue from the privatization issue.
Second, the claim that the Johnson-Flake proposal solves the solvency problem through privatization is false. The proposal replaces wage indexing with price indexing, a cut in benefits, it covers downside risk which increases the burden on the system, more so with moral hazard factored in, and there is the matter of the 6.5 trillion transition cost that is conveniently ignored in Cato’s analysis. The proposal achieves solvency by cutting benefits, not through privatization (there is another version of the proposal which also achieves solvency by cutting benefits).
I think Mark is misreading what the Cato folks are actually claiming. This is from Cato's February post on Rep. Sam Johnson's proposed legislation, which is based on Cato's own preferred plan:
Workers who do not choose this option would remain in the current system, but their benefits would be based on a price-indexed formula, rather than the current wage-indexed formula. Workers choosing individual accounts would forgo future accumulation of Social Security retirement benefits, but would receive a tradable "recognition bond" based on those benefits already accrued under the current Social Security system.
The solvency issue is addressed by the change in indexation and the reduction of benefits. To my knowledge, there has never been a claim to the contrary. (And the recognition bonds, by the way, are all about the transition -- honest people can disagree about whether these represent "costs".)
pgl gets a little closer to the Cato argument:
The most recent “Daily Debunker” from Cato discusses the Johnson-Flake proposal, which sounds to me like an old song: (a) reduce government expenditures by switching from wage indexing to price indexing; and (b) allowing workers to take half of their contributions and invest them anyway they want. Yes, (a) addresses this alleged solvency problem by cutting benefits, but Cato claims that workers will be somehow better off because of (b).
Even though their free lunch claims have been refuted numerous times over the years, the Cato crowd just keeps repeating these bogus arguments.
Close, but still no cigar. pgl is correct about what the Cato clan believes, but incorrect, in my opinion, in characterizing those beliefs as "free lunch claims." Their argument, as I understand it, goes something like this: There are many avenues to restoring long-term balance to the system. Demographics (and delay) make fixes that rely on sustaining a payroll-based pay-as-you-go scheme an increasingly bad deal. Alternatives that effectively cash out the system over time, coupled with capital-based returns on mandatory saving would be a better deal. There is no free lunch -- just better and worse diets.
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April 12, 2005
Inequality and Social Security
A nice article on the topic from Greg Ip appears in yesterday's Wall Street Journal (page A2 in the print edition).
The debate over Social Security has managed to drown out other longstanding issues in American society, including the widening gap between rich and poor and surging health-care costs. Yet these two phenomena play an important, though little appreciated, role in Social Security's problems. That is because they are eroding the base of taxable wages available to support Social Security benefits.
The reason is that taxable payroll is expected to expand more slowly than is GDP and, by 2080, to equal just 33% of GDP, compared with 38% now. Stephen Goss, Social Security's chief actuary, says there are two main reasons why. One is that a "somewhat increasing share of all the earnings in the economy [is] above our taxable maximum," and the second is that a growing share of "employee compensation...is going not to wages but to fringe benefits, which are not included in our tax base," Mr. Goss says.
Social Security payroll taxes are levied on wages up to a certain cap, currently $90,000 a year, which rises annually with the average wage. In the past 25 years, a growing share of income has been paid to people who earn more than the cap.
This increasing concentration of income at the upper strata of society is an important reason why, from 1980 through 2000, taxable payroll fell to 83% of wages of contributing workers from 90%...
Even if inequality stopped widening, Social Security's tax base probably would continue to be eroded because of rising health-care costs. Since 1996, health-care costs have risen to 7.3% of employee compensation from 6.3%, and Social Security's actuaries expect it to keep rising. This is a big problem for Medicare, the federal health program for the elderly, but it also affects Social Security, because payroll taxes aren't levied on health-care insurance premiums. Mr. Goss says that is the main reason for taxable payroll's shrinking share of GDP.
Wholesale prices for popular brand-name prescription drugs rose an average 7.1% in 2004, more than twice the general inflation rate, a new study commissioned by the nation's largest seniors lobby says.
The increase is the biggest in the five years that AARP, with 35 million members, has sponsored the study. It's just slightly higher than the 7% price rise in 2003.
... although the results are, apparently, under some dispute:
Ken Johnson of Pharmaceutical Research and Manufacturers of America, the trade group of brand-name drugmakers, called the study "exaggerated and misleading." He said the use of wholesale prices excludes factors such as rebates that could cut retail costs.
"Price data clearly shows prescription-drug prices have increased about 4% a year," Johnson said. He called that in line with growth in other health costs.
That observation, of course, doesn't diminish Ip's point.
As if to underscore the point, there was this report from this morning's USA Today...
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March 26, 2005
Barro on Social Security
With an assist from Tyler Cowen, pgl at Angry Bear notes a new Business Week article by Robert Barro, wherein Barro repudiates his previous support for introducing private accounts into the Social Security system. pgl likes Barro's piece because he emphasizes again the fact that the differential between current internal rates of return from the Social Security program and returns on capital is not prima facie evidence that private accounts dominate. And he is right -- Barro is cogent, as usual, on this point. Although they arrive at a similar spot, however, I don't think the boys at Angry Bear entirely endorse the reason Barro no longer favors the private account option.
Contributions that fund just the minimum cannot go into a meaningful personal account. People would opt for too much risk, knowing they would be bailed out if they fell short. Also, contributions that cover the minimum provide no individual
return and, therefore, amount to a tax that discourages work.
Personal accounts have to supplement the minimum payout. But then why have a public program at all, rather than relying on individual choices on saving? I think there is no good reason to go beyond the minimum standard; that is why I view personal accounts as a mistake -- they enlarge a Social Security program that already promises too much.
What's the minimum payout? Barro provides an example.
Knowing this, some people will save too little and rely on public support when old. Thus, there is reason to require workers to save for retirement. How much depends on what is viewed as a minimal standard of living; suppose it is $1,000 per person per month. (Currently, a person with the median earnings history gets $1,200 from Social Security.)
Barro goes on to propose some of usual fix-ups...
...baseline Social Security benefits should be indexed to prices. The practice of indexing initial benefits to past wages should be eliminated. Moreover, the price index should be an accurate one, such as the Bureau of Labor Statistics' chain-weighted consumer price index, rather than the standard flawed index. In addition, the normal retirement age should effectively be indexed for changes in life expectancy, going beyond the current plan to raise the age to 67. These three adjustments are all-important.
... and oppose others:
A mistake even greater than personal accounts would be, in addition, to raise the maximum earnings taxed by Social Security above the current $90,000, a proposal that President Bush seems to welcome. This change increases marginal tax rates by about 10 percentage points on a productive group that already faces high marginal rates.
As I noted in a previous post, this last method is the only one that appears to be politically popular (if you believe the polls, anyway.) This is where I find the puzzle. It seems to me that Barro's position leads to to the implication that Social Security be means-tested to the extreme. Figure out what the "minimum payout" should be, and provide it only to those who, for whatever reason, find themselves with retirement income flows that fall below that level. In other words, make it look like the welfare system that Barro seems to think it should be. (That may mean some phase-out of benefit payments so that there are not large jumps in effective marginal tax rates for those just above the minimum payout level. But this would presumably still look very much different than the system we have today.)
I'm only guessing, but my presumption is that Barro did not spell it out this way because he believes that such an extreme position is politically infeasible. But if that is so, then it seems quite likely that squeezing the program down to the minimum payout is infeasible as well. And if that is the case, Barro's reasons for previously preferring private accounts come back into play.
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