macroblog

March 14, 2005

Old Business: Defending "Defending Mankiw"

A confluence of personal and work-related responsibilities made for very spotty blogging last week.  I'm back, but there are few pieces of unfinished business to which to tend.  First up is my earlier post regarding Greg Mankiw and Phillip Swagel's March 3 pot-shot at critics of President Bush's desires on social security reform -- more specifically, Brad Delong's and pgl at Angry Bear's complaints about my comments.

At issue -- or at least what was at issue in my post -- was the following passage from Mankiw and Swagel:

The introduction of personal accounts will involve some transition financing, but this increase in the budget deficit won't place a new burden on future generations. These deficits are just an acknowledgment of promises that were made long ago.

In his original comments on the subject, DeLong followed this up with an earlier passage from Mankiw's textbook about deficits increasing the demand for loanable funds, raising interest rates, and so on.  I cried foul at this comparison, and Brad cried foul back in a comment to my post.

You chopped your quote from me off too early. The next paragraph is:

"We worry about the budget impact and effect on national saving of the Bush Social Security plan because there is a chance that it will significantly diminish national saving and lower economic growth. If holders of defined-contribution private accounts regard them as close substitutes for their other assets in a way that promised defined-benefit standard Social Security was not, then the Bush plan will be yet another budget-busting shift of the tax burden that will slow economic growth.

Well, creative editing is a hanging offense if it distorts another's position, and I had no intention of doing so.  But my criticism was much more narrowly drawn.  What I objected to was not the omitted paragraph above, but the implication that somehow Mankiw was not being true to his school by claiming that the specific form of debt that might be involved in the conversion of future benefits will be economically neutral.   Pointing out that most instances of deficit finance are non-neutral does not imply that it is so for every policy.  Mankiw (and I) can live quite comfortably with both statements, and to present them as if they are in conflict is pure misdirection.

DeLong is, of course, correct in noting that it all comes down to whether "holders of defined-contribution private accounts regard them as close substitutes for their other assets in a way that promised defined-benefit standard Social Security was not," a point he repeats in his march 12 post "Mankiw 0, Liberals 3."  (I can't seem to get the permalink thing working.)  But my second point remains.

That second point is this.  If debt issued to represent promised future benefits are not viewed as perfect substitutes by beneficiaries, then it is hard to see why the same sort of assets held in the social security trust fund should be. 

pgl notes DeLong's comment about substitutability, but adds this:

Mankiw claims some households are liquidity constrained. Now I’m not sure if the Bush plan would relax those liquidity constraints precisely because Bush refuses to give specifics. But if it does and if one believes liquidity constraints are important as Mankiw does, then how can one appeal to Ricardian logic.

I'm not sure if Mankiw is still appealing to this argument or not -- it's not in the Wall Street Journal article in question. Certainly if the debt were to take the form of individual-specific "recognition bonds" that are otherwise non-marketable, there would be no impact.  That, though, is an issue related to the substitutability of promised benefits, about which I agree reasonable people can disagree.

The main point of my post was that I find it difficult to reconcile the argument that converting promised benefits into explicit debt is non-neutral with the position that those promises are inviolable.  In the case of liquidity constraints, the existence of promised benefits have no economic impact, as the consumption and saving plans of constrained individuals are not contingent on the receipt of future benefits.  (Unless, of course, the future income represented by those payments is the reason for the constraint, which I find hard to believe is what anyone has in mind.)

In short: If I really believe that I am going to be paid the benefits promised at the time I pay my social security taxes, it is an act of bad faith on the part of the government to renege after I have done my life-cycle planning contingent on the expectation of the receipt of those payments.  But if that is so, issuing a paper promise won't affect my behavior.  If that piece of paper does affect my behavior, then I must never have believed the promise in the first place. I guess I'll leave to the philosophers to determine whether a promise not believed is really a promise.  But I think the economics are clear.

P.S. pgl also takes on Mankiw's recent (subscriber only) New Republic article.  For the record, Mankiw does not claim there is a free lunch on Social Security reform in his Wall Street Journal article.

March 14, 2005 in Social Security | Permalink

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Comments

Hi there. I am a graduate student in economics and I enjoy reading your blog. I just finished reading your post defending mankiw and DeLong's attack against Mankiw.

I guess it really does come down to whether consumers view PSC (Private Social Security Accounts) as a replacement for PS(Private Savings. I am not convinced that Delong' arguments have much force, however. I know Delong is a distinguished economist, but I view the situation as follows

Consumer A will want to save X (total retirement savings including PS + TS (Traditional Social Security)

A fully funded system will probably include some form of tax increase and decrease in benefits (either through a raise in the eligibility age or a decrease in benefits, like indexing to inflation instead of wages.)

As I see it, this will decrease TS lowering the amount of money the consumer has to consume during retirement.

If we add private accounts, however, the consumer will (hopefully) be compensated the amount he is losing in the restructuring.

So, in the end X will stay. If the consumer did not want X in his savings account, he would have already decreased X on his own. Social Security restructuring, it seems, will simply be restructuring the way the consumer calculates X.

I guess this analyses depends on how rational consumers actually are

1) It seems that the rational expectations (random walk) model of consumer behavior is wrong..people probably behave utilizing rational "rules of thumbs" that nevertheless have predictable errors.

2) Nevertheless, if the consumer is aware that social security benefits will decrease and that private accounts will be a compensation for this decrease, then I don't see why this would cause a massive shift from IRA's to thrift-savings style private accounts.

Where am I wrong here?

Posted by: Matt Festa | March 14, 2005 at 01:08 PM

David - thanks for this post. There are a lot of respectable positions on this privatization (the carve-out version of personal accounts plus benefit reduction) which get lost in the crankiness. Brad's point about liquidity constraints was an interesting one even if this liberal has his doubts and even as conservative Mankiw has the intellectual ammunition behind Brad's claim. My Sargent-Wallace game of chicken argument that fiscal integrity might raise savings draws from your and Bill Polley's discussions. And on Victor's other argument for a positive effect on savings - that being the alleged increase in expected returns, note Brad and Kent Smetters give the intellectual ammunition behind this oft heard claim - whereas I can point to the logic of Barro and Becker to suggest the Cato version of this claim is simply a fallacy. Simply put - this whole liberal v. conservative thing is a canard.

Posted by: pgl | March 14, 2005 at 01:45 PM

Matt - your view is what I'd call Ricardian Equivalence (RE). One of the RE assumptions is that consumers are not liqudity constrained. The Mankiw Savers Spenders model challenged RE on this very point. This is Brad's starting point - assuming the Soc. Sec. change does somehow lift liquidity constraints. When Brad or I say we don't know whether it will or not, there is a reason we say this - Bush refuses to tell us the specifics of his plan. So David may be right and Brad many be wrong - but we just don't know.

Posted by: pgl | March 14, 2005 at 01:49 PM

PGL,

Thanks for the info. I'll admit that I know about ricardian equivalence (even though the 2 lectures in my macro course aren't coming for another 2 weeks...ask me about consumption theory and I am your man.

To be honest, I haven't the slighest idea why Bush refuses to get behind a plan. It doesn't make a lick of sense. For people like me, who support private accounts in principle, it is hard to attack criticisms that may/maybe/maybe not an actual problem.

Nevertheless, the attacks being made against privitazation take the tone of "privitization is bad." I don't think that is the case. If we do this correctly, we can inform the public that
a) benefits will be cut
b) the deficit will be eliminated
c) as compensation to my generation, we will install private accounts to compensate for this reduction

Whether this takes the form of add ons or diversion is up to debate. But I honestly do not understand the opposition in principle.

In addition, the tone of this debate on both sides is bordering on the pathetic. It seems to me that there is broad agreement in principle that privitization is the way to go foward. Yet despite this broad agreement--among respected liberal and conservative economists like a Delong and a Mankiw--the tone of the debate is trapped into a "bush is a pathetic loser" "no, democrats are a bunch of loser hippies" ad hominums. How this translates into good public policy is something I cannot answer

Finally, while I am upset at Bush for not backing a specific proposal (if he backs a specific proposal, we can then judge it, make improvements, and get it done) I am also upset at the democrats for blanket opposition to private accounts. Their opposition makes absolutely no sense politically. I simply don't understand it.

Matt

PS PGl etc- Can't we make social security privitization take on the form of "ricardian equivalence" if we educate the public properly. It seems that if we tell people that we will cut benefits and put on private accounts, then consumers will use their "rule of thumb" to realize that "my benefits aren't really changing?"

Posted by: Matt Festa | March 14, 2005 at 02:20 PM

Re: "What I objected to was not the omitted paragraph above, but the implication that somehow Mankiw was not being true to his school by claiming that the specific form of debt that might be involved in the conversion of future benefits will be economically neutral."

I don't see what you object to. He *isn't* being true to his school in claiming that this form of debt will be economically neutral. His school claims that this form of debt *might* be economically neutral, or will *probably* be economically neutral. It doesn't claim that it *will* be economically neutral.

There needs to be a Plan B in case it isn't neutral. And I don't see one.

Posted by: Brad DeLong | March 14, 2005 at 03:08 PM

Brad,

I understand your concern, but there isn't even a "plan a" yet. I don't think this is a good idea (not having a plan) but how can we criticize private accounts when there isn't even a specific proposal yet?

In addition, what would your plan b be? The political world does not work one way here. The democrats have ruled out private accounts a priori. Wouldn't it be better for them to take some of your concerns into consideration and offer up a "plan b" in the negotiating strategy? But they can't do that since they already ruled out private accounts to begin with. And the circle of lunancy continues.

It is upsetting the way this debate is being conducted.

Posted by: Matt Festa | March 14, 2005 at 03:38 PM

Matt: to your reply to my comment. You may be one of the few non-Bush-bashers to realize (a). And (b) is also true but there are other ways to reduce the General Fund deficit besides squandering those Soc. Sec. surpluses that will amass nearly $8 trillion in reserves by circa 2022. As far as (c) compensating for (a), note I have argue the Barro-Becker position that moving money from the Trust Fund back to your pocket will NOT increase holdings of stocks and will NOT increase expected return AT ALL. Brad - along with Kent Smetters - may disagree and argue there is a small efficiency benefit, but even they concede your (c) will be much less than your (a).

Posted by: pgl | March 14, 2005 at 04:30 PM

PGL,

True enough...but my concern here (and again this is a function of the terms of the debate) is that if we do nothing at all we will eventually have to raise taxes (and we will have to raise taxes, probably, now). But the more taxes we raise for social security is less that will be available to deal with medicare/medicaid.

Personally, I am a low tax guy. I want to fix these things with the lowest possible tax increases possible in a humane society.

I know that social security and medicare will require different solutions. But they are similar in that the mechanisms (tax increases, etc) are the same. There is opportunity cost here.

I see your point about the private accounts not raising national savings. But then why not divert money from the income tax? We can then cut benefits, etc. and do what we need to do with social security and still have our private accounts from the income tax. I would even match contributions for the poor.

Then Savings for retirement will be

X = PS + TS + PA

where
PS = Private savings
TS = reduced social security benefits
PA = private accounts from income tax

That is one possible way, I think, of overcoming the problem you pose.

What say you?
Matt

PS-Thank you for the informative and friendly discussion. I always like talking to intelligent people from the other side. This has been educating

Posted by: Matt Festa | March 14, 2005 at 08:35 PM

Brad --

I guess I will agree to disagree on this one. Of course I agree that his school -- in which I am enrolled -- holds that deficit financing *might* or *might not* be neutral. What I don't quite see is why holding the position that a specific type of policy will be neutral implies we are playing hooky. That seems like what you are saying to me, but maybe I am serially misunderstanding your point.

pgl and Matt -- Thanks for the conversation.

And to my friend pgl -- I couldn't agree more with the comment that the liberal/conservative labeling is a canard. I do think Mankiw went down the wrong track drawing lines that way.

Posted by: Dave Altig | March 16, 2005 at 07:13 AM

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March 05, 2005

Defending Mankiw

Not that he needs it from me, and there have already been multiple comments about Brad DeLong's rant on Greg Mankiw and Phillip Swagel's Thursday Wall Street Journal commentary -- at Angry Bear, at MaxSpeaks, at New Economist, at Dead Parrot Society, at EconLog-- but I feel compelled to put in my two cents.

Apparently, IT'S THE HYPOCRISY that got Brad's dander up.

This morning he writes, giving free advice to Democrats like me: 

Mankiw and Swagel: Stop railing about the budget impact [of the Bush Social Security plan]. The introduction of personal accounts will involve some transition financing, but this increase in the budget deficit won't place a new burden on future generations. These deficits are just an acknowledgment of promises that were made long ago. And if you think that complaining about budget deficits will advance your career, just ask President Mondale.

Back in 1998 he wrote:

...the most basic lesson about budget deficits follows directly from their effects on the supply and demand for loanable funds: When the government reduces national saving by running a budget deficit, the interest rate rises, and investment falls. Because investment is important for long-run economic growth, government budget deficits reduce the economy's growth rate. (N. Gregory Mankiw (1998), Principles of Economics (New York: The Dryden Press/Harcourt Brace), p. 557.

If you read carefully, you will detect that DeLong knows these two statements are not necessarily inconsistent.  It is entirely reasonable to believe that deficit spending leads to lower national saving in general, while at the same time acknowledging that there some types of transactions that have Ricardian properties.  I have said it so many times before that I won't even bother to link to previous posts, but if there was ever a policy-driven transaction without consequences for national saving, it would have to be issuing explicit debt for already promised benefit payments.  (OK, I lied -- here's the link.)

It's bad enough that DeLong confused the issue with his largely irrelevant juxtaposition.  What's worse is that he ignores a real inconsistency in the debate.  Roland Patrick at Let's Fly Under the Bridge nails it:

With his pajamas down [DeLong] admits that Social Security's 'Trust Fund Bonds' aren't real assets and future generations will not collect their promised benefits.

At least that is the only logical argument that can be drawn from criticizing Greg Mankiw for saying transitioning to private accounts will simply be a matter of replacing implicit debt with explicit debt.

Right. DeLong goes on:

I am cranky, and annoyed. And I am not asking for very much. All I want is:

  • No more claims that we know that carving-out Social Security revenues to fund private accounts will have no damaging effect on national saving. It might work. It might not.

Fine.  But if your answer is "not" then you should also drop the argument that the trust fund is meaningful.

PROPHYLACTIC COMMENT: I have already conceded that the trust fund should be treated as a meaningful promise to pay future benefits.

SIDE NOTE: For some reason, thinking about the difficulty of pegging a particular policy as Ricardian or not reminded me of the results from this long-ago paper by Jim Poterba and Larry Summers:

Using a lifecycle simulation model, we show that even though deficit policies shift sizable tax burdens to future generations, individuals live long enough to make the assumption of an infinite horizon a good approximation for analyzing the short—run savings effects. In practice, periods of debt accumulation such as that in the United States during World War II are reversed sufficiently rapidly to make their short—run effects on consumption and national savings relatively small.

March 5, 2005 in Social Security | Permalink

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» What will privatization do to national saving? from William J. Polley
Let's start with a quote from macroblog. I won't even bother to link to previous posts, but if there was ever a policy-driven transaction without consequences for national saving, it would have to be issuing explicit debt for already promised... [Read More]

Tracked on Mar 7, 2005 1:59:36 AM

Comments

Your argument about the equivalence of debt now vs. promises later breaks down entirely in cases where you have to start worrying about the other side of the transaction. That is to say, borrowing $2 trillion now requires there to be people out there willing to swallow $2 trillion of bonds now which is a lot different from contemplating the willingness to do so in 40-50 years. Operationally, this means that there is a strong likelihood that "the market rate of interest" is in fact a moving target when we are talking about doing or not doing a $2 trillion trade. If we actually go and try to sell those bonds there is every reason to think the interest rate will rise, economic activity will fall, and none of the assumptions underlying projections will continue to hold. (and that is without even considering the possibility of the more dire "hard landing" scenarios)

As for me personally, if it starts to look like this might actually pass I am going to dump all my dollar assets and move to a basket dominated by euros and Asian currencies. I cant be the only one thinking this and some of the folks thinking it actually have large sums of other people's money at their disposal.

Posted by: steve kyle | March 06, 2005 at 10:20 AM

IMHO, this was unfair to Brad. #1 - he did not say Trust Fund bonds are not assets. #2 - his argument that privatization might lower savings is well grounded in the economics that Mankiw has published. More on this at Angrybear tomorrow as I had to praise Becker's oped and use it to shoot down the spin from Jack Snow as well as from a Dead Parrot.

Posted by: pgl | March 07, 2005 at 02:56 PM

Ahem!

You chopped your quote from me off too early. The next paragraph is:

"We worry about the budget impact and effect on national saving of the Bush Social Security plan because there is a chance that it will significantly diminish national saving and lower economic growth. If holders of defined-contribution private accounts regard them as close substitutes for their other assets in a way that promised defined-benefit standard Social Security was not, then the Bush plan will be yet another budget-busting shift of the tax burden that will slow economic growth.

"Mankiw has no business making a claim that the Bush private-accounts carve-out won't reduce national saving. No business at all. He may hope, but he doesn't know that private account-holders won't regard their private accounts as closer substitutes for 401(k) wealth than Social Security wealth is: the claim that the transition financing will not reduce national saving might be true, but it might no be true. And Mankiw damned well does know the connection between national saving and economic growth."

This proposed fiscal-policy change *may* look Ricardian, and if I had to bet I would bet that it will look Ricardian, but there is a significant chance that it won't be Ricardian. And that will be trouble.

Posted by: Brad DeLong | March 07, 2005 at 02:58 PM

Could Brad be reading my C: drive? Yes, I have started to write why the plan might not be Ricardian and he is already on this 2 minutes after my reply. I'm rushing to this to copy over at Angrybear a bit early.

Posted by: pgl | March 07, 2005 at 03:56 PM

DeLong - "All I want is:

No more claims that we know that carving-out Social Security revenues to fund private accounts will have no damaging effect on national saving. It might work. It might not."

macroblog - "Fine. But if your answer is "not" then you should also drop the argument that the trust fund is meaningful.

PROPHYLACTIC COMMENT: I have already conceded that the trust fund should be treated as a meaningful promise to pay future benefits."

I believe that the issue isn't being phrased properly. Treating the carve out proposal in economic or budgetary isolation offers little meaning.

In my judgment, the issue is whether the additional carve out proposal (deficit) borrowing requirements through say 2025 will create a budgetary imbalance that may tip the scales when added to our known, projected, and/or other likely budget spending requirements. By tip the scales, I am referring to the combined carve out costs of transition funding, surplus elimination (perhaps 6-8 years of such), and post surplus additional funding revenue losses (created by the carve out proposal) for the existing SSI programs. In simple math, one has to add these projected costs by fiscal year to projected budget analysis. Current CBO restrictions do not allow for an adequate presentation of this point or other "not in law yet" projections. Fine, but we can add the projected costs for this program, the extended tax cuts, and similar cost expectations to a budget spreadsheet analysis.

First, I believe that the carved out approach to private accounts will cause a reduction in national savings through 2025 or perhaps longer when viewed within the content of other revenue considerations.

Second, government/Social Security private accounts in any form will likely result in a further reduction of household savings through 2025 if viewed within the context of other known and probable economic conditions that households will have to face.

Third, the Social Security program and its trust fund are meaningful up until the point that the Congress and Administration refuse to honor debt repayment obligations and legally agreed upon (U.S. Code) benefit payments to retirees and those disabled.

I made posts at Brad DeLong's and Angry Bear's blogs detailing why I believe we will see declines in national savings and household savings.

You're welcome to review them and find fault with my reasoning and offer point by point counter arguments. Or agree and add more detailed support.

Posted by: Movie Guy | March 08, 2005 at 12:24 AM

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February 21, 2005

The World Bank On Public Pension Reform

From The Economist:

In 1994, the World Bank set out its thinking on pensions in developing countries in a landmark report. “Averting the Old Age Crisis” became the reference point for the Bank's approach—one given clout by its lending power. It advocated a move away from pay-as-you-go financing, under which contributions from workers pay for today's pensions... The report backed, where possible, a much bigger role for compulsory funded pensions, paid for by workers saving part of their earnings in retirement accounts.

Eleven years on, the Bank has taken stock, reviewing how reforms have worked and taking account of criticism and new ideas. The result is a new report, to be released on February 21st. “Old-Age Income Support in the 21st Century”, a copy of which The Economist has seen, is intended to be the definitive guide to the Bank's current thinking...

The new report says that the case for the Bank to support pension reform has grown stronger in the past decade. Existing systems are not good enough. “Most pension systems in the world,” it argues, “do not deliver on their social objectives, they contribute to significant distortions in the operation of market economies, and they are not financially sustainable when faced with an ageing population.”

... In Latin America, for example, reforms to expensive pay-as-you-go schemes have improved governments' long-term fiscal positions. The new funded individual accounts have been costly to run but have generally delivered impressive returns. Nevertheless the number of future pensioners who will benefit looks set to be disappointingly low, because many workers are not covered by the new arrangements...

Since “Averting the Old Age Crisis”, there has been fresh thinking about reforming existing pension systems. Sweden pioneered the idea of “notional accounts”. These maintain pay-as-you-go financing, but treat workers' contributions as if they were paid into individual accounts, which then form the basis of their pension benefits. Poland and Latvia have also adopted the system. At first, the Bank was sceptical about this idea. However, it has since recognised the potential of notional accounts, which establish a tight link between payroll contributions and eventual pension benefits. They are, says the report, a “promising approach to reform or to implement an unfunded first pillar”.

The report did not appear to be available at the time of this post.

February 21, 2005 in Social Security | Permalink

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February 20, 2005

Mixed Messages

From John Berry, writing for Bloomberg:

Federal Reserve Chairman Alan Greenspan's testimony yesterday before the Senate Banking Committee undermined virtually all of the Bush administration's arguments for diverting some Social Security tax payments to fund private retirement accounts.

From Amity Shales, in the Financial Times (access may require subscription):

Things were looking especially good in midweek, when Alan Greenspan, the Federal Reserve Board chairman, blessed the main components of the Bush plan.

Hmm. Any thoughts on which opinion is "most right"?

February 20, 2005 in Federal Reserve and Monetary Policy, Social Security | Permalink

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depends on who signs your checks.

Posted by: dilbert dogbert | February 20, 2005 at 05:25 PM

Depends on what the Bush plan is. Everytime the left tries to pin it down and critique it, the right says "no, no, no" - that is not the plan. My opinion of what the real plan is? Backdoor employment tax increase so SSTF can subsidize that massive General Fund deficit. But then as soon as I say this - someone on the right will say "no" as they pretend there are free lunches.

Posted by: pgl | February 20, 2005 at 05:55 PM

He seemed very positive about limiting the money that passes through the gov't through privatization but concerned that recognition of an explicit gov't obligation might generate a negative reaction in rate markets.

His strongest point seemed to be that changes needed to be gradual. He seems to want small changes now to guage market reactions and participation rates in privatization as a data gathering excercise to set up some real system reform at a later date.

While generally favoring the President's proposal and a change to the system, he did not support the urgency of the problem and pointed out some negatives of the plan for those who are looking.

I don't think the SS reform will hinge on Greenspan's opinion so much as whether democrats and the public perceive a problem that has to be addressed.

Posted by: Michael | February 20, 2005 at 08:07 PM

Ms Shales is pretty well known as the voice of the Bush administration at the FT. That doesn't make her wrong, but certainly, Berry has done a better job of remaining neutral and sceptical in his reporting. The NYT and the Washington Post, in reporting the same testimony, both found that Greenspan said borrowing to finance a transition to another system is OK as long as two conditions are met - the system is fiscally sound in the long run and doesn't require more than $1 trillion in new borrowing over 10 years (a number apparently picked out of the air). However, the NYT emphasised the "it's OK" aspect in its headline, while the Post emphasized "as long as it doesn't require lots of new debt." Even those who realized neither side was given full points could differ over what the Chairman meant.

One has to wonder whether Greenspan wasn't intentionally ambiguous - all things to all politicians. If so, the ethics of the testimony are questionable. Offering a bunch of politicians the opportunity to claim that the Fed Chairman backs their position, when the same claim can be made from the other side, can only obscure the debate. That is already happening, and Greenspan has been around long enough to know that it would happen. Not so good.

Posted by: kharris | February 23, 2005 at 12:29 PM

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Are Federal Reserve Notes And Treasury Debt The Same Thing?

My respected friend pgl at Angry Bear dumps on Charles Krauthammer for saying this:

2042 is the fictional date for the fictional bankruptcy of a fictional trust fund. Let's start with basics. The Social Security system has no trust fund. No lock box. When you pay your payroll tax every year, the money is not converted into gold bars and shipped to some desert island, ready for retrieval when you turn 65... These pieces of paper might be useful for rolling cigars. They will not fund your retirement. Your Leisure World greens fees will be coming from the payroll taxes of young people during the years you grow old. That is why 2042 is a fiction. The really important date is 2018.

pgl trots out a pretty clever argument.

If there are Federal Reserve notes in your wallet, I’ll gladly buy you a cup of coffee if you give them to me.

If you really believe piece of paper called financial assets are worth nothing, I’ll gladly take all of your cash, funds in your bank accounts, and other financial assets. In turn, I’ll even buy a week’s worth of groceries.

Clever, but not apt, I think, because modern institutions really do imply different expectations about the liability represented by a Federal Reserve note compared to that represented by a Treasury security.

Here's what I mean.  I think it useful (and appropriate) to think of my economic relationship with the government in terms of the totality of our financial interactions.  In other words, my net tax burden does not just consist of my social security taxes, or my income-tax payments, or what I remit in Medicare "premiums", etc., etc., etc, but the present value of all my payments to the government less all the payments they make to me.  (This is the fundamental  idea behind the concept of generational accounting, of which I am a very big fan.)

Suppose I hold a Treasury security. That, of course, is a payment the government owes to me, and I have every expectation that it will be made.  But if, for some reason, there has been a miscalculation, a change in economic circumstances, a change in policy, the government may find that it has to raise my taxes to obtain the revenues to honor those payments.  In doing so, it has effectively reduced the return on that security.  Distortionary price effects aside -- granted, a major qualification -- why should it matter to me how it happens?  Lower my social security benefits, raise my income taxes, whatever.  It all amounts to a haircut on that Treasury payment to me. 

Because the distributional aspects of these things can matter, blanket haircuts are probably a pretty bad idea -- foreigners, for example, finance a good chunk of our collective borrowing, and they aren't likely to appreciate the opportunity to finance our fiscal imbalances on an ongoing basis.  Changes in tax and transfer policies are the way we go because they can be targeted (which gets us to positive versus normative questions, which I'll address below.)  But the basic economic distinction is one without a difference.

Why are Federal Reserve notes different?  At some level, they aren't, as pgl has reminded me on numerous occasions.  One way to truly implement a haircut on government debt is to reduce the purchasing power of the currency in which the debt is paid -- by employing, in other words, the so-called inflation tax.  But the United States, and almost all developed countries, have worked hard to ensure people that this won't happen.  This is why the Fed is largely independent of the Treasury.  In essence, we have guaranteed that fiscal imbalances won't be addressed by reducing the value of Federal Reserve notes.  Despite protests to the contrary, no such promise is made for the return to Treasury notes, as the ever-changing tax rate on interest income makes abundantly clear.

Now to Krauthammer's point.  Here we, again, we have the unfortunate confluence of positive and normative assertions.  I think Krauthammer is making the positive point that private debt and equity supports investment. In many cases, public debt supports consumption, and there is a big difference between these two situations.  Of course, you may want to argue that, at the margin, the bulk of public expenditure is actually investment (and more productive than private investment).  That is an assertion that can be adjudicated by evidence, and I'll listen  But there is no fallacy in Krauthammer's assertion.

Then there is the normative question -- whether is right to renege on the government payments promised (and planned for) by retirees and near-retirees.  On this, pgl and I (and President Bush) agree that the answer is "no."

UPDATE: An update at the original Angry Bear post, and more at William Polley.

February 20, 2005 in Social Security | Permalink

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» What does it mean to default? from William J. Polley
PGL at Angry Bear critiqued a recent Charles Krauthammer article for essentially calling the IOUs in the Social Security trustfund worthless. Specifically, Krauthammer says, Let's start with basics. The Social Security system has no trust fund. No lock... [Read More]

Tracked on Feb 20, 2005 11:06:31 PM

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Real wealth is created by digging stuff out of the ground, growing stuff we eat, discovering new facts about nature, creating new intelectural concepts, organizing groups of workers and capital in new and more efficient ways and a lot lot more. However, all of this stuff is dependent on trust. When that trust is lost a lot of these things dont happen. Calling the trust fund debt "just pieces of paper" is starting the process of losing the trust necessary for modern capitalism to work its wonders.
Do we want to go down that road??

Posted by: dilbert dogbert | February 20, 2005 at 10:50 AM

See Angrybear where I have updated this post to note your point - as well as why the IOUs of the Federal Reserve critically depend on the Federal government honoring its IOUs.

Posted by: pgl | February 20, 2005 at 11:49 AM

A federal reserve note is a promise from the government NOW. A treasury bond is a promise from the governmetn AT SOME POINT IN THE FUTURE. There is an inherent danger in your comparing the two via a present discounted value. PDV assumes that the appropriate interest rate to discount at is constant into the future and in fact is knowable today. But the problem is, the government may behave so irresponsibly that the appropriate interest rate at some future date is far higher than you think it will be - thus effectively making the present value of that future promise worthless. The point in your argument where you glide over this problem is where you say "I have every expectation it will be made" about the future payment. Well, maybe yes and maybe no.

In addition, it matters a lot WHOSE tax gets increased in the future to pay the bond. It also matters if the owner of that bond is here in the US or is somewhere else, like China.

On the issue of inflation, remember that the shorter the maturity of the government paper that is out there, the less inflation proof it is. Higher inflation rates simply get included into interest rates when the shorter paper gets rolled over.

Finally, Krauthammer's assumption that private spending is investment and public spending is consumption is just another way of stating the Republican mantra that ALL government spending is bad. NONSENSE. Private entrepreneurs cant make a profit if they dont have roads, educated workers, well functioning courts, etc. etc. And do you really want to claim that all of that household credit card debt and home equity loans are supporting investment?

Posted by: steve kyle | February 20, 2005 at 01:55 PM

Hi guys -- A few responses.

Dilbert -

My point is that I find it kind of puzzling that changing the rate at which I'm taxed after I've purchased government debt is not viewed as a type of default. Likewise, a change in benefit formulas that applies to accumulated payroll tax contributions. I get the sense that people treat the debt represented by the trust fund as sacrosanct in ways they don't treat debt held outside of the trust fund -- otherwise they wouldn't be calling for higher taxes (at least not without a grandfather clause). I think I understand that the different treatment is about the distributional consequences, and I may even agree with the underlying sentiment. But that's religion, not economics.

pgl -- You are obviously correct that federal Reserves notes are backed by nothing but trust. (They are not even backed by Treasury securities in any meaningful sense -- if you try to cash in the securities, you'll just get more Federal Reserve notes.) The thing is, it is seemingly much easier to find your road to collapse by trying to finance imbalances with inflation than it is from explicit taxation or spending reductions. So we appear willing to countenance more "little defaults" with Treasury securities than we are with money. And I'll repeat myself -- if the government raises taxes and reduces the return to the debt I hold in the process, they default. We put up with it (a) because we can verify the state of the world and identify cause and effect; and (b) we can throw the rascls out of office for getting us into the situation if we want to (an idea I know you can embrace).

steve -- A Federal reserve note is not just a promise now, at least we hope it is not. That is exactly why it is important to keep inflation low -- so people can have confidence in its future purchasing power.

And I did leave open the possibility that public investment might be more productive than private investment at the margin. If the evidence is there that this is so, bring it on.

Posted by: Dave Altig | February 20, 2005 at 02:29 PM

Dave,
Your comment about religon brought up the image in my minde of the Hindu(?) concept of the structure of the world where an elepant holds the world up and it stands of the back of a stack of turtles. Someone asked what is below the turtles and the hindu said: It is turtles all the way down. That is the way I think about all of society: It is trust all the way down. It is something that should not be treated lightly. Remember the constiution is only "a piece of paper". I think we have an AG who thinks that way right now.
As far a taxes and tax rates go I thought that markets are for taking that into account.
Politics is always about who is the screwed and who is the screwee. I don't see politics going away any time soon.
Thanks for the blog. Lots of good ideas to think about. Keeps an old retired guys brain working.

Posted by: dilbert dogbert | February 20, 2005 at 05:45 PM

It is foolish to pretend that public and private investment can be separated and rates of return compared. They are complementary. Just try making money from your factory if the government doesnt build a road to it. Other examples abound. The point is that it is not an either/or choice. You need both.

Posted by: steve kyle | February 20, 2005 at 05:58 PM

Count me in agreement on the normative question. That's where Krauthammer goes wrong. More at my blog.

Posted by: William Polley | February 20, 2005 at 09:38 PM

Dave,

I have been puzzling over this issue of "What backs Federal Reserve Notes?" I have repeated the refrain "Federal Reserves notes are backed by nothing but trust" for so long now that I hardly give it a second thought, but perhaps it deserves a second thought. If by this we mean they are not convertable into gold at a fixed price, OK, I understand that, but so what? They are convertable (via legal tender laws) into any number of "real" things (as dilbert dogbert defined earlier) upon demand, including your tax obligations. That they are not convertible at a fixed price is what an inflation target is all about, right? So why don't we say that Federal Reserve notes are backed by the productivity of the U.S. economy? That sounds like a better "backing" to me than gold, for which the relative preciousness is certainly more variable. Would you really feel more "secure" holding a pocket full of krugerrand receipts or dollars? Isn't the "backing" of a paper instrument nothing more than its security?

Posted by: Waterdog | February 21, 2005 at 09:56 AM

Dave --

A small point.

I'll think you will find that our innovative financial sector has found a myriad of ways to use "private debt" to support consumption, not just investment -- think of the various ways of borrowing against your (hopefully rising) home equity to support higher levels of current consumption. Increase in household consumption, if i am not mistaken, has exceeded the increase in household income for a while now.

A small qualification though; no doubt a higher fraction of the expanding fiscal deficit is going to support consumption than the expansion in private debt.

Posted by: brad | February 22, 2005 at 06:31 PM

Noam at TNR & Matt Y. had some great comments on the Krauthammer oped. DeLong has a nice summary.

Posted by: pgl | February 22, 2005 at 07:18 PM

Waterdog --

The government backing issue is an important issue in monetary theory. There are some "deep theory" models of money -- I'm thinking of Randy Wright and co-authors work here -- that suggests government acceptance as payment of taxes is at least a sufficient condition for sustaining a fiat monetary standard.

However, I think of this as an equilibrium selection issue rather than the government "backing" the currency in a commodity-standard sense. There is no trade in government liabilities and credits for example, as would be the case in a standard commodity-backed monetary system. But fiat money is tricky stuff, so maybe I can be talked out of that.

Brad -- point taken.

pgl -- I didn't like the TNR piece. It just seemed to miss the point. As for Yglesias, he just made your point, and you made it better.

Posted by: Dave Altig | February 23, 2005 at 07:36 AM

The OASI Trust Fund is made up of un-marketable special public-debt obgliation Treasury securities.

I think even if you could steal one of these "special issues" from the SSA, I suspect they are only payable to them.

I've never seen one, but Section 201(d) of the Social Security Act says they have to exist in paper form. Moreover, the notes have to state "on its face that the obligation shall be incontestable in the hands of the Trust Fund to which it is issued". In your hands, well, perhaps it is more contestable...

Section 201(e) of the Social Security Act appears to indicate that these special debt obligations cannot be sold at market value, only redeemed from the Treasury, although some of the other securities (held by the DI trust fund, for example) can be sold on the market.

Anyway, don't accept a special public-debt obligation note in exchange for coffee without consulting your lawyer.

Posted by: Mr. Econotarian | February 24, 2005 at 02:57 PM

For my research paper: What top 7 or 8 countries hold what amount of the U. S. debt in Federal Reserve Notes?

Posted by: Jane Pugh | May 08, 2005 at 10:34 PM

Debt: "How To Get Out Of Debt By: John Mussi "

Debt: "Eliminating Credit Card Debt By: Alan Barnes "

Debt: "We all know about debt. If you don't have too much as an individual you can increase the quality of your life,"

Posted by: Debt | June 07, 2005 at 12:05 AM

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February 19, 2005

Indexing Social Security Benefits The Progressive Way

Victor at The Dead Parrot Society offers his variation on a plan to restore actuarial balance in the social security system by adjusting the indexation provisions of benefit formulas. A riff on a proposal by Robert Pozen, the essential idea is to maintain wage indexation at the lower end of the benefit-income distribution, while shifting toward CPI-indexation-only for everyone else (on a sliding scale).

What Progressive CPI-Indexing does is to let the current system of benefits work for the lower income classes. In Pozen's version, the bottom 30% of the wage earners in 2012 (and beyond if the wage distribution doesn't change) will get the exact same scheduled benefits that they get now. The very, very top of the income distribution will have their benefits frozen at a constant real level. People in between will fall, well, somewhere in between.

Mechanically, Pozen suggests that a new "bend point" should be created between the two that already exist. To the left of the "bend point", the formula wouldn't change at all. To the right of the new "bend point", the increase in benefits associated with additional income would be reduced by a proportion designed to freeze the benefit levels of a "steady maximum earner" at a constant real level.

That's really all there is too it. For workers just above the 30th percentile (and therefore just above the new bend point), little would change. For workers at the highest income levels, their benefits would be frozen. Over time, the shape of the benefit curve will change.

If you haven't been following reform proposals based on adjustments in benefit-indexation, Victor's post is a great place to start.

February 19, 2005 in Social Security | Permalink

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February 13, 2005

An Entirely Different Type Of Social Security Reform

Here's the abstract from an interesting paper by the University of Chicago's Erik Hurst and the Boston Fed's Paul Willen:

Most young households simultaneously hold both unsecured debt on which they pay an average of 10 percent interest and social security wealth on which they earn less than 2 percent. We document this fact using data from the Panel Study of Income Dynamics. We then consider a life‐cycle model with “tempted” households, who find it impossible to commit to an optimal consumption plan and “disciplined” households who have no such problem, and we explore ways to reduce this inefficiency. We show that allowing households to use social security wealth to pay off debt while exempting young households from social security contributions (but in both cases requiring higher contributions later) leads to increases in welfare for both types of households and, for disciplined households, to significant increases in consumption and saving and reductions in debt.

February 13, 2005 in Social Security | Permalink

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Mayflower Compact Coalition (Wangstas Fo' Shizzle My Nizzle)...

RNC Chairman Ken Mehlman today attended the unveiling of the 21st Century Mayflower Compact at the Mayflower Hotel in Washington D.C.. The nine-point agenda includes support for school choice and private social security accounts. The Coalition is advised in part by former House Speaker Newt Gingrich’s consulting firm.

African Americans often reach different and surprising conclusions on social issues that the casual (Caucasian) observer just won’t understand. For example, Black folks still want to see Michael Jackson find happiness. His high-pitched voice and soulful delivery is the soundtrack of generations and has a permanent place in the Black community’s psyche, no matter the plastic surgery, skin bleaching and alleged child molestation charges. Possibly, it’s the “he’s still Black” phenomenon that African Americans well understand. They want Michael Jackson’s name cleared. In short, they want him to make good music and just leave the damn kids alone.

Likewise, Blacks see Old Age Survivors and Disability Insurance Program, popularly known as Social Security, as an entitlement forced into place during a period when “bigots” wanted to run things. And against the odds, a well respected Franklin Roosevelt was able to established needed protection for the public from the economic fears of old age, sickness, accident, and unemployment. As its original name suggest, African Americans believe the insurance program was created to do much more than provide an old age benefit.

Wangstas (whites and uh oh oreos) are extremely white persons who attempt to be “gangsta” (cool with Black people) in order to “pimp out.” They dress, speak and act for all practical purposes as a African Americans aside from the fact that they are not. Normally they are hated by the fam for being fake.

The White House and its oreos who support overhauling Social Security have launched a highly targeted campaign to convince Black people that President Bush’s plan to create private investment accounts will have special benefits for them. The ghetto fab element about the GOP message to African Americans: “The shorter life expectancy of Black males means Social Security in its current form is not a favorable deal.”

Proponents of privatizing social security who claim no group has as much at stake in the debate over reform as African Americans, in fact, are right. Black families of workers who become disabled or die are much more likely than their Caucasian counterparts to be dependent on the grip available from disability and/or survivor benefits. Blacks make up 12 percent of the U.S. population, but 23 percent of African American children receive survivor benefits, and 18 percent of the community are disability beneficiaries.

Although the wangstas are making a special effort to appeal to the strizzeet with the 21st Century Mayflower Compact, the “lower life expectancies” illusion appears to reached every one except the African American senior. Their attempt to focus on a very narrow element of the system (current program based on longevity is unfair) is misplaced and doesn’t gain cool points. What the oreos fail to realize is their attempt to be “down” for da brothas... is just “gosh-darn” obnoxious (using their vernacular) and another clue identifying the new face of segregation.

“A’ight?”

Social Security is an insurance program that protects workers and their families against the income loss that occurs when a worker retires, becomes disabled, or dies. All workers will eventually either grow too old to compete in the labor market, become disabled, or die. President Roosevelt created the program to insure all workers and their families against these universal risks, while spreading the costs and benefits of that insurance protection among the entire workforce.

It is a “pay as you go” program, which means the Federal Insurance Contribution Act (FICA) payroll tax paid by today’s workers are not set aside to pay their own benefits down the road, but rather go to pay the benefits of current recipients. The tax isn’t progressive. The low-wage workers receive a greater percentage of pre-retirement earnings from the program than higher-wage workers. And, in the 1980's, Congress passed reforms to raise extra tax revenues above and beyond the current need and set up a trust fund to hold a reserve.

As was the case when the program was established, higher-wage workers still oppose the social nature of the program. They argue low rates of return as a reason to switch from the current “pay-as-you-go” system to one in which individual workers claim their own contribution and decide where and how to invest it. In short, rather than sharing the risk across the entire workforce to ensure that all workers and their families are protected from old age, disability, and death, higher-wage workers want to enable opportunity to reap gains from private investment without having to help protect lower-wage workers from their disproportionate risks.

Allowing high-wage workers (who are more likely to live long enough to retire) opportunity to opt out of the general risk pool and devote all their money to retirement without having to cover the risk of those who may become disabled or die, is da fo’ shizzle identifying the republican party’s desire to return to a segregated society.

Roosevelt’s benefit formula currently in place intentionally helps low income earners. Lifetime earnings directly factor into the formula. And, thirty-five percent of Black workers born between 1931 and 1940 had lifetime earnings that fell into the bottom fifth of earnings received by workers born in these years. African Americans’ median earnings (working-age in jobs covered by Social Security in 2002) were about $21,200, compared to $28,400 for all working-age people.

HNIC, president Bush, does acknowledge the difficulty Blacks will have in accumulating enough savings in their individual accounts to provide for a secure retirement once the progressivity of the current system is eliminated. However, he has only suggested allowing lower-income workers to place higher portions of their income into the uncertainties of investment accounts (creating even more risk).

Yes! Private accounts would be passed on to children or other heirs. But, what the HNIC and his oreos doesn’t explain is lower-income workers would be forced to buy an annuity large enough (when combined with their traditional Social Security benefit) to ensure that they would at least have a poverty level income for retirement.

Yo’ playa... da new private social security account fizzle sucks!

Posted by: kstreetfriend | March 23, 2005 at 04:00 AM

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February 10, 2005

Max And I Agree

Unless I'm reading this wrong, Max Sawicky and I agree.

Preemptive response to critics of SS: yes 1.3 or worse is a lousy rate of return. But in my reading of the social insurance lit, the implicit debt of SS is a fait accompli. There is no way on God's green Earth to avoid this result in a pay-as-you-go system where the economy grows more slowly than the rate of interest. That's not a great affirmation of the program, but if it's true, no privatization/reform scheme can avoid hammering somebody with the implicit debt of the system.

That was exactly my point here. But I've yet to hear an answer to the question I posed in that post: Given that a hammerin' is inevitable "in a pay-as-you-go system where the economy grows more slowly than the rate of interest," why the insistence on clinging to this hybrid forced-saving/redistributive system we inherited from the Great Depression? 

February 10, 2005 in Social Security | Permalink

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Barro's 2000 Business Week oped got this exactly right. Whether we maintain the status quo or jump to PRAs does not change the past which had cohorts long retired and now dead getting a transfer from us and/or future generations. My problem with the 2% v. 3% comparisons is that the privatization crowd (excepting Barro) wish to ignore this. You, Max, and I are all in agreement with Barro.

Posted by: pgl | February 10, 2005 at 11:52 AM

Barro's 2000 Business Week oped got this exactly right. Whether we maintain the status quo or jump to PRAs does not change the past which had cohorts long retired and now dead getting a transfer from us and/or future generations. My problem with the 2% v. 3% comparisons is that the privatization crowd (excepting Barro) wish to ignore this. You, Max, and I are all in agreement with Barro.

Posted by: pgl | February 10, 2005 at 11:52 AM

Why the insistence? Easy to answer: Because the current administration and its institutional supporters are not honest brokers of information. (We see this time and time again in their manipulation of the public debate using false accounting and statistics.) Their goal is to dismantle SS over time; they do not believe in the philosophical justification of SS.

Therefore, though it is possible to imagine some kind of effective revamping of SS that includes private accounts of some kind, such a reform is not politically possible due to who is in power. The best way to prevent a trojan horse privatization program (i.e. one that paves the way to the dismantling or eventual bankruptcy of the current system) is to embrace a modest reform of the existing system. We're all much better off this way until the political climate is slightly more honest again, which I do believe is inevitable. Someday.

Posted by: Crab Nebula | February 10, 2005 at 12:06 PM

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February 06, 2005

Social Security Once More

Speaking of Vox Baby, Andrew's most recent entry (as of the time I write) has his take on the Social Security part of the State of the Union address.  It is characteristically thoughtful, and I commend it to you.  But there are a few points on which I differ, or am not fully convinced.  But first, the points that I agree with (which make up the bulk of the post):

[The President] excluded the possibility of raising the payroll tax to restore solvency. That will make it more difficult...

I did not like the statement, "By the year 2042, the entire system would be exhausted and bankrupt."...

The President was clear that everyone 55 and over is in the traditional system with benefits as specified by current law. Good. He was also clear about a gradual phase-in. Good. He explicitly mentions the Federal Thrift Savings Program as a guide for the sort of investment options available. Very good...

An item not discussed--exactly how progressive the reductions in future benefits from the current system would be. I expect this to be another area for compromise--make the traditional system that continues even more progressive, to make sure that the lowest-income people, who are less able to bear financial risk, are depending less on the personal accounts than other workers.

So what are my quibbles?  They are minor, but here they are.  Andrew writes:

There is a vagueness about the "greater than anything the current system can deliver" phrase that is troubling. It doesn't mention the risk associated with obtaining those returns.

The whole issue of risk seems, to me, vastly overblown.  First, I've yet to see any compelling case made against Jeremy Siegel's observation that, for the long-run investor, equity does not look like a particularly risky bet.  (Although Professor Siegel concedes the possibility of lower-than-historical equity returns going forward, that would presumably go a long with lower-than-historical bond returns. This was pointed out in the comment section of this Vox Baby entry.)  The option for moving to a "safe" fixed-income account should, of course, be made available in a private account system -- maybe even mandatory at some point near retirement.  But most of the people I know under the age of, say 55, have the great bulk of their saving in equity funds.  I think revealed preference counts for something.

There is certainly the question of what happens if their is a gigantic market meltdown of the magnitude that eventually led to the creation of our current social insurance system.  It could happen, I guess.  But if it does, nothing like the revisions contemplated by those who favor the status quo would be sufficient.  In that case, the solution is a set of intergenerational transfers that look like the picture in this post.   Nothing on the table comes even close to that (nor should it).

Which brings me to the second point.  In what sense is the present social security system riskless?  I'd say right now I'm pretty uncertain about what my true returns are likely to be.  If I was 20, I'd be even more uncertain.  Commentary in the blogosphere is chock full of discussions about productivity trends, demographic assumptions, and the like, all of which are highly uncertain.  There seems to me very little probability that, twenty years from now, the fixes we might put on the current system today will reveal themselves to have been exactly the right medicine.

This has led some to suggest that we implement reforms that include some set of automatic adjustments -- in retirement ages, benefit formulas, and the like -- to guarantee the program is always in actuarial balance.  In other words, they would make the net returns in the system explicitly state-contingent -- which they already implicitly are.  Which exactly makes my point.  It would be appropriate for the opponents of private accounts to at least acknowledge this uncertainty whenever they invoke the dreaded "risk" dragon.

I'd make a related point regarding this comment from Andrew:

It is a stretch to say that the government "cannot take these accounts away." I agree that it would (probably) be more difficult for the government to impose a surtax on the accounts than it would be to cut benefits coming from the pay-as-you-go system, but "cannot" is too strong.

The point is, there is substantially less reason to "take these accounts away" in a defined contribution system.  The problems inherent in the pay-as-you-go, defined benefit scheme are the reason we are talking about "take aways" today.

And finally, Andrew says:

The issue of bequests is completely unnecessary. Social Security exists to provide insurance against outliving one's means. Nothing prevents people from leaving bequests currently if they so desire. I am not aware of any failures in the life insurance market that need government attention.

I disagree.  Even if I don't plan to leave a bequest, I can still receive residual utility from unintended bequests.  And that possibility may cause me to provide more "self insurance" against outliving my means than I might otherwise,  potentially (at least) "bringing new money into the system," as Andrew desires.

Other than that, I completely agree with him.

February 6, 2005 in Social Security | Permalink

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re: risk

Seems to me that the biggest risk in the current system is the one you refer to later on. Assuming two similar individuals retire at 65, the one who dies at 66 gets 1X and the one who dies at 85 gets a discounted 20X, maybe 14X or so. That seems a far greater risk than anything that could happen to the equity markets.

QS

Posted by: quietstorm | February 06, 2005 at 11:07 AM

The variance of the average return is not the long-run issue as was noted by Samuelson's 1963 paper. The relevant risk is the unpredictability of one's wealth upon retirement. Why do folks get these two concepts so utterly confused? Thanks to quietstorm for understanding the point Samuelson made clearly 42 years ago.

Posted by: pgl | February 06, 2005 at 03:48 PM

pgl --

I'm not sure that's exactly what quietstorm had in mind. In any event, I agree that short-run volatility is an issue as "time T" approaches, but that issue is manageable. The long-run averages seem to me exactly the right thing to focus for most of the life-cycle portfolio decision during working years. But maybe I'm missing something? (I confess: Samuelson 1963 isn't ringing a bell.)

da

Posted by: Dave | February 08, 2005 at 06:16 AM

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February 04, 2005

Why Is Social Security The Right Vehicle For The Social Safety Net?

Yesterday brought an informative exchange between Don Boudreaux at Cafe Hayek and the host of Calculated Risk

The essence of the argument at Cafe Hayek:

So even if you are unalterably in favor of Social Security, if you're honest and frank you, too, should reject descriptions of it as a safety net. Such a description is used for the added, unthinking emotional umphh it adds to the arguments of those who press to keep Social Security in its current form. That may be good, or, as I believe, it may be bad – either way, it’s no safety net.

And at CR:

I’ve argued before that Social Security should be considered retirement insurance. It should be intended to insure against the vagaries of life...

So when we reform Social Security, we should design it to catch those people that do “fall from life’s ordinary and expected institutional supports”. If we consider Social Security as "retirement insurance", then obviously Bush's plan of forced savings accounts is moving in the wrong direction.

And finally, Boudreaux’ final paragraph is inappropriate to the debate. Social Security should be a safety net, so lets work together to make it one.

My take is somewhere between the two.  Let me motivate my comments by way of the following scenario.  Suppose the Great Planner in the Sky has every American who will ever live congregate together at the beginning of time.  We are told the following: After the meeting breaks up, we will all be randomly assigned a birth year, indicating our arrival time on earth.  But there is a catch.  Some of us are going to be surprised by a really bad event -- let's call it the Great Depression -- that will wipe out a great deal of the financial planning of those alive at the time. And one more thing.  After that Great Depression thing, the number of us arriving on earth will, for awhile, explode.

Behind the veil of ignorance, I bet most of us would choose an intergenerational transfer system -- a safety net, if you will --  with "rates of return" that look something like this:

Internal_rates_of_return

One thing this picture does not look like is a sensible mandatory savings plan.  It looks like what it actually was (and still is): An intergenerational transfer program.

I suppose that there were other ways to implement the intergenerational insurance scheme represented by this picture -- a plain-vanilla deficit plan would seem to have worked, for instance -- but I have no real quibbles with the plan that was implemented.  An implicit social contract that shares the burden of cohort-specific systemic disaster seems like the right thing to me.

My question is this: What is the rationale going forward?  The demographics, the present-value imbalance in the current system, and, as Andrew Samwick has made completely clear, the cost of delay in making adjustments to rectify those imbalances, mean that the burdens will be increasingly pushed to future generations.  I don't get how those of us who drew the good number in life's temporal lottery can think that's a good idea.

If we were to start a mandatory saving scheme from scratch, I don't think we would ever pick the one represented by a pay-as-you-go social security system.  We would choose a defined contribution program, coupled with a progressive income tax system to implement the socially agreed upon intracohort transfer program.  If a forced retirement-planning scheme is what we need, why not begin the process of cashing out those payments made to generations past, and reconstruct the system into something sensible?

I completely agree that phrases like "bankrupt" and "insolvent" are not very useful descriptions of transfer programs run by the U.S. government.  I also agree there are lots of relatively simple ways to bring the current system back into long-term balance.  But I ask: What's the point?

February 4, 2005 in Social Security | Permalink

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Comments

Excellent points. Pay-as-you-go was sensible in the '30s, but today much less so. Funding the insurance portion of the social contract out of a progressive income tax sounds has always sounded like a better idea to me than funding it out of payroll taxes on the first $90,000 of income. It's time to decide what we want and go from there. The tail has been wagging the dog for some time now.

Posted by: William Polley | February 04, 2005 at 12:12 PM

Thanks for your feedback. Dan Froomkin makes many of the same points today:
http://www.washingtonpost.com/wp-dyn/politics/administration/whbriefing/

Also on excerpted on DeLong's blog:
http://www.j-bradford-delong.net/movable_type/2005-3_archives/000279.html

I think Social Security should be a safety net and not a retirement program. As Froomkin wrote today: "Social Security is a complex social insurance program that uses payroll taxes from current workers to pay benefits to the elderly, the disabled and their families in a progressive manner that guarantees an income floor below which the least fortunate are not allowed to sink."

I would like a debate on the purpose of Social Security and how it should be funded. But first I'd like to address the more pressing issues of the Medicare shortfall and the General Fund deficit.

The recent GAO report shows Social Security with a $3.7 Trillion actuarial shortfall. But the report shows Medicare has a $27.8 Trillion actuarial shortfall. Shouldn't we address the more pressing issues first?
GAO report: http://www.gao.gov/new.items/d05282sp.pdf

Thanks again for the feedback.


Posted by: CalculatedRisk | February 04, 2005 at 03:58 PM

Americans' Future In One Plan
I know that most of you are busy to read my book. As I explained previously that Taman Health Plan (www.trafford.com) takes care of all the health care, Medicare, Medicaid and social security. It will threw away all bureaucracies out of window. Let me explain shortly how it works:
1- there will be no more health care insurance companies, no Medicare, Medicaid or Social Security. My plan will take care of all.
2- Basically will be only one Big Health care organization (Taman Health Plan or THP).
3- The center of the plan will be in Washington while the health departments in every state will be the branches.
4- One organized body will be taking care of the Health Care and long term care of all Americans replacing 1500 insurance companies, Medicare, Medicaid and Social Security.
5- This will allow us to provide a uniform service to all Americans every where in both inpatients, outpatients and long term care.
6- When you go to any Duncan Donuts branch your expectation is to have a fresh coffee and a donut with no long wait. We will try to provide a similar predictable service everywhere as Duncan Donuts. With having only one body will be able to do that.
7- The Capital of the plan will be the funds of Medicare and Social Security (before the bankruptcy of both systems). The maintenance will be a yearly tax from each of us (will replace our yearly social security and Medicare holding taxes). A percent of each of us go to his account cards and a percent go to THP itself. The money of the plan will be invested by the investing sector of the plan very likely in Wall Street.
8- We will have 5 ATM cards with a corresponding accounts. Card A (children), Card B (working group 18-65years old), Card C (Medicare card >65 years old), Card D (Medicaid card), Card E ( expensive medicines or investigations).We will have the health cards devoted to health care and long term care. Thus we will have: health cards, banks with accounts to each card and credit card machines in outpatients care and hotelling part of hospitals and nursing homes.
9- Cards will pay for the outpatient medical care including doctors, emergency room visits, investigations, medical supplies, pharmacies and the hotelling part of hospitals and nursing homes. While the medical part of hospitals and nursing homes will be budget by the plan itself.
10- In the first year of issuing cards: Card B and C (most of people) will have a bonus it could be a percent of their Medicare and social security withholding (70 % or so). We will try to be fair to every one but every one has to now that most of us already lost a lot of money with the HMO's. For next year new comers to card B at age of 18 when first issued will have a bonus of 50,000 dollars. It will change every year by a percent a according to inflation.
11- every one of us will get a statement every one or two months of his card account. Card B account will phase in card C at the age of 65. If card C account is vanished Card D will be issued (hoteling part will be less luxurious). Only few of Card B will have card D if there account vanish most likely those with severe medical problems.
12- So basically most of us will have our own account Card B then card C. Say you are 45 and you have now in your account $ 200,000 you can take one or more years out of work, you Can retire early if you like and with your card you will control all the medical services and its prices.
13- With this card system we will end all bureaucracies of health care, Medicare and Medicaid. No one will stand between you and any medical or long term service (only your card). Shop around with you card, have early health care security and responsibility and invest in your health.
14- We will not need Social Security since after age of 65 we will be able to use our cards to stay in any nursing home each according to his account in card C or card D. So when you invest well in your health you will be able to enjoy a nicer nursing home when you get old (actually it will be also a kind of tourism).
15- The money in cards do not get inherited when we pass away but recycle in the plan to support the next generations.
16- The plan will have very positive effects not only in simplifying our care, save a lot of waste in health care, give early health care security and responsibility to Americans it will also have a positive effect on the economy, saving billions of dollars to Americans, creating jobs in health care and cutting outsourcing.
Very likely, you figure it out by now I could have sold the plan to one of the presidential candidate before the 2004 election for millions of dollars (they already spent 2 billion dollars). It is my gift to the American people (it will help the healing process of the two worlds America and the Muslim/Arabs).

Maged Taman.
2/20/05

Posted by: maged taman | February 21, 2005 at 11:45 AM

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