Sunday, January 16, 2005

Whistling Past the Graveyard

Several days ago, a member of my extended family (who I shall call Dianne, because that is her real name, and she has nothing to hide) forwarded a Moveon.org point paper about Social Security to me, among others, with the goal of getting a good take on whether to participate in Moveon's petition campaign. By the time I was done, I realized that my response to her could benefit from the hive mind of the websphere.

While I would love to think I completely and accurately crystalized the issues surrounding Social Security privatization, I am sufficiently in contact with reality to know that isn't likely to be the case.

So, by all means, blast away at my shortcomings. I have referred her to the Daily Duck to see the results.



Dianne:

I actually pay a fair amount of attention to the Social Security issue, and I found virtually everything Moveon.org says is either misleading, or woefully ignorant. So, within the category of being careful what you ask for, here is a point-by-point rebuttal of Moveon.org’s “analysis.”

First, a quick survey of the Social Security landscape:
  • SS is funded by a 12.4% tax on wages, up to $90,000/yr.
  • SS payments are indexed against wage growth, not inflation.
  • Roughly 40 years ago, there were about 7 wage earners/retiree; within the next 20 years that ratio will reduce to approximately 3:1 (I can’t remember the numbers exactly, but they are close)
  • When SS started, those surviving to 65 lived, on average, another seven years. Today, those who live until 65 live an additional 20 years
  • At the moment, wage earners pay more in SS taxes than is paid to retirees. The difference is invested in US Treasury bonds.
  • Around 2018, the trends above mean outflow will start to exceed income.
  • Sometime between 2042 and 2047, the surplus available in 2018 will be exhausted
  • The inexorable conclusion is—absent change—benefits to retirees will decrease by roughly 30% when the surplus is exhausted

Using those bullet points as a basis, following is my response to the Moveon.org email:

Social Security provides monthly benefits to some 44 million Americans who are retired, disabled or the survivor of a deceased parent. It provides most of the income for older Americans--some 64 percent of their support. It has lifted generations of seniors out of poverty.

Yes, but through a Ponzi (aka pyramid) scheme that would be strictly illegal if the government was not sponsoring it. And like any Ponzi scheme, it will fail when the number of those paying into the scheme does not greatly exceed the number drawing from the scheme.

Tellingly, and typical for the left, it makes the automatic assumption that only the state can adequately provide for people. Just because SS has prevented poverty in old age does not mean the state is the best solution. Further, such a statement completely ignores the fact that our current SS system penalizes virtue: the better you provide for your own retirement, the less SS income you see because of your higher tax bracket. This is a case of triple taxation. The first taxation is on the income, the second is on the proceeds from saving, and the third is on the reduced SS income compared to someone who did not save.

In other words, the current SS system abets moral hazard by paying people not to provide for their own retirement.

Social Security is not in crisis. That is an outright lie perpetrated in order to create the urgency for radical changes. Under conservative forecasts, the long-term challenges in Social Security do not manifest themselves until 2042. Even then Social Security has 70 percent of needed funds. That shortfall is smaller than the amount needed in 1983, the last time we overhauled Social Security. George Bush's Social Security crisis-talk is an effort to create a specter of doom -- just like the weapons of mass destruction claim in Iraq.

It is not actually in a crisis yet. But as I noted above, the crisis is out there, and the measures required to deal with it only get more drastic with time.

Just because a crisis doesn’t actually occur for some time does not mean it isn’t manifestly obvious now. And if it is manifestly obvious now, does that not also mean that, in some sense, the crisis exists the moment one perceives its eventuality?

In 1983, we did not overhaul Social Security—we jiggered a few numbers to push off the day of reckoning. Only twenty years later, we are facing the same problem, only bigger, and with a worse wage-earner to retiree ratio.

Pres Bush’s crisis talk is actually a case of political heroism—he is taking on a difficult problem that has long been termed the “third rail” of American politics. Finally, whatever one thinks of WMD and Operation Iraqi Freedom, that is a classic example of false analogy. Much more on point would be the residents of Banda Aceh looking at the ocean receding and deciding there is no need to run. After all, the tsunami isn’t here yet.

Phasing out Social Security and replacing it with privatized accounts means one thing: massive cuts in monthly benefits for everybody. Social Security privatization requires diverting taxes used to pay current benefits into privatized accounts invested in risky stocks. Without that money Social Security benefits will inevitably be cut -- some proposals even cut benefits of current retirees. These benefit cuts are inevitable, since diverting Social Security money into privatized accounts means less money to pay current and future benefits.

SS privatization does in fact mean increased government borrowing to cover the transition costs entailed in moving from a Ponzi scheme to a soundly based SS system. With respect to Ponzi schemes, there are two critical things to remember: there is no easy way out, and the longer one waits, the faster it gets harder. It is also important to keep in mind that government borrowing to finance transition costs is akin to investing now in repairing a failing roof—the borrowing required to fix it must be considered with respect to the borrowing eventually required by failing to fix it. Just as with a failing roof, doing something costs less than doing nothing, and any fair analysis will consider the cost of inaction.

The line about risky stocks is a red herring. Over any forty-five year span (from when a person just enters the work force until retirement) there is no such thing as a loss in the stock market. Secondly, any even half-intelligent portfolio is going to move to lower risk investments as the worker approaches retirement. Finally, and most importantly, over any historical forty-five year span one could choose, the risk of stock market returns being less than US Treasury bonds—the true benchmark—has been precisely zero.

The line about cutting benefits is also misleading. Some proposals include indexing SS benefits to inflation instead of wages. Doing so accomplishes two things. First, it allows economic growth to help solve the shortfall; right now, wage indexing factors growth right out of the equation. Secondly, because SS is ultimately a Ponzi scheme, indexing SS to wages transfers additional wealth from wage earners to retirees beyond what prices in the economy warrant: not only do retirees become relatively better off while wage earners become relatively worse off, wage indexing increases moral hazard by increasing the attractiveness of not saving.

Every serious privatization proposal raises the Social Security retirement age to 70. That might be fine if you're a Washington special interest lobbyist but it is incredibly unfair to blue-collar Americans with tough, physical jobs, or for African Americans and Latinos with lower life expectancies.

This reminds me of a famous joke regarding a headline only the New York Times would carry: WORLD ENDS, WOMEN AND MINORITIES HARDEST HIT

People are living far longer, healthier lives in retirement now than when SS started. Failing to take that into account requires justifying to those paying for SS—wage earners—why they should be financially worse off in order to subsidize retirement for people who could otherwise work. Absent privatization, there are only two ways to deal with the SS Ponzi scheme: reduce the benefits to retirees, and/or increase the retirement age.

OK, I lied. There is a third, and likely unavoidable, way. Significantly increase the payroll tax. Doing so decreases the amount of money people have to fund their own retirement while simultaneously increasing moral hazard—failing to privatize SS makes it easier for people to not do precisely what they should: save for their own retirement.

Privatization means gambling with your retirement security. There is probably an appropriate place for a little stock market risk in retirement planning -- but it isn't Social Security. Privatization exposes your entire retirement portfolio to stock market risks -- and the risk that you'll outlive any of your savings at retirement. You can't outlive your Social Security benefit.

As I noted above, the real risk to assess is the likelihood the return from the stock market over a working life will be less than that from US Treasury bonds. Historically, that risk has been nil. And, as anyone who has done any retirement planning at all knows, prudent risk changes with age. The only way your entire portfolio, intelligently diversified, could be exposed to significant risk is if the entire economy tanks. In that case, there won’t be enough wage earners, or wages, to fund any sort of income transfer, either.

So who does benefit? Wall Street. Giant financial services firms have been salivating for decades over the prospect of taking over Social Security. Wall Street would make billions of dollars in profit by managing the privatized accounts -- money that would come directly from your benefits.

This is what journalists call the “nut graph,” the part of the story containing the point of the whole exercise. The Left simply cannot abide that all-purpose bogey, Wall Street, making money.

Giant financial services would, in fact, make money. They provide a service, after all. But the point to consider is not whether Wall Street would make money, but rather whether individuals would be better off with the net gains financial services firms produce compared to that available from US Treasury bonds. There is simply no way to look at the US economy and conclude the people are better off putting their money in US Treasury bonds than investing the same amount of money in our economy.

Action is urgently needed today. President Bush and Republican leaders in Congress are joining forces with the financial services industry for a major campaign to convince the public there is a major crisis and pressure members of Congress to vote for privatization. Action is needed now before it is too late. Please sign MoveOn’s petition to protect Social Security at the link below.

Yes, action is needed. But not the kind Moveon is advocating. Failing to do anything—does Moveon have anything in mind other than whistling past the graveyard?—ensures we will ultimately have to resort to increased retirement age, decreased benefits, and taking far more from wage earners to support retirees. Moveon, like all left-wing organizations, is fundamentally dedicated to making individuals dependent upon the state, equalizing outcomes by penalizing virtue, and has utterly no grasp on moral hazard.

President Bush, in contrast, intends to give people more control over their financial lives and reward virtue, all while taking advantage of far greater returns compounded over time.

The analytical bases I listed at the beginning are not a matter of debate. They are every bit as inevitable, and irrevocable, as gravity.

Doing nothing is the choice of fools.

31 Comments:

Blogger David said...

Skipper: Great job.

January 19, 2005 6:56 AM  
Anonymous Anonymous said...

I think it depends much on the values that your advocating.

Do you believe that people should be responsible for their retirement, or do you believe that it's important for the working class to support those that have retired?

Or somewhere in between?

My opinions go back and forth on this one. I like the fact that a private plan would prevent the government from playing games with the trust fund as it has for the last 20 years. I'm not terribly sanguine that people would make good investment decisions, and I think the evidence of how much people lost when the .COM bubble burst is a good indication that many people would not make wise investments. I do, however, like the fact that any return on investments is a real return (ie the money is sitting in accounts), not a "return" generated by collecting more money from the working class.

I'm also worried about the effect on the deficit and debt in the short term, though I agree that things will only get worse from here on, and something will *have to be done*, though I expect that medicare will hit crisis much sooner.

Finally, I think that those of us who are successfull in this society have a responsibility to help out those that are less fortunate. I don't have a great way of defining "less fortunate", however, except to note that I don't think that the retirees who are well off fit that category, but I think there needs to be some sort of safety net.

So, anyway, thanks for the post - it was thought-provoking.

January 26, 2005 3:14 PM  
Blogger Hey Skipper said...

Anon:

I believe that society is healthiest when, in general, people rely on themselves first and foremost. Clearly the government, in the realm of "good works" can cover the gaps between destitution and sufficiency that the vagaries of life occasionally leave.

Therefore, I think society is best served when retirement, when the individuals own resources are used to fund that individuals own retirement.

I also think too much is made of investment risk. The principles of age dependent investment planning are not exactly rocket science. While I am a conservative of generally libertarian bent, I have no problem with the government replacing the existing SS wage tax with another tax of the same size, only this time, the proceeds go to an government approved and monitored investment plan.

In other words, people don't get to make unwise investments, because they don't have a choice.

You are absolutely right, about Medicare, BTW.

Also, your comment about helping the less fortunate is one that advocates of SS reform have to take on board.

Off the tip of my head, I advocate a 1-2% Retirement Security Insurance tax. That is, there exists a fund that provides an insurance policy that prevents the retirement of the less fortunate from being spend in destitution.

I'm sure someone could poke all kinds of holes in such a simplistic proposal. However, fundamentally we need to disconnect provision for retirement against sharing the risk of avoiding destitution.

January 30, 2005 10:24 AM  
Blogger bimplebean said...

An excellent and thought-provoking post -- and that comes from a liberal.

I do have problems with Bush's "Ownership Society" concept, however. It seems like the philosophy is to pass on the risks of living in a complex, technological world to those least able to deal with it -- individuals. I thus support the fundamental concept of Social Security, along with concepts such as nationalized health care. The main reason I do so is this: if a large organization can provide superior stability, solvency and cost benefit (through economies of scale), then it's folly *not* to use that entity to ensure social stability. I think the government can (and has) filled this role fairly well.

On the other hand, it is important that individual 'virtue' -- or shall we simply call it 'hard work' -- should be rewarded, not punished.

So what's the middle ground? How about this:

Have the *Government* - overseen by watchdog organizations - invest part of the money now in the trust fund in the market. Profits should go back into the trust fund.

This has a number of advantages. The government could make larger investments, enjoying cost and efficiency benefits from economy of scale. Individuals would still be shielded from risk caused by short-term (five-year) market fluctuations. There would be no massive restructuring required. There would be far fewer separate accounts to manage.

The bottom line - everything would stay the same except that the existing trust fund would grow faster based on the higher interest rates in the market.

A closing rebuttal: As a liberal, I am not "fundamentally dedicated to making individuals dependent upon the state, equalizing outcomes by penalizing virtue, ", nor have I "utterly no grasp on moral hazard." Such sweeping and injurious statements have no place in a civilized discussion.

I *do* believe that government should provide a 'safety net' (phraseology from the 80s, I know, but valid still) to keep those less fortunate and/or less powerful from falling completely to the bottom in the event of personal or national crisis. I also think government should use it's considerable legal and financial might to attempt to even out the imbalances in the fortunes of its peoples -- as long as it's done as fairly as possible.

Society is traditionally healthiest when there is a large middle class. Grow the middle class, shrink the poorer classes, and the rich will generally do well doing business with a much larger customer base! THAT's what I call supply side economics. [g]

Many thanks for your intelligent post.

February 03, 2005 4:34 PM  
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