Topic: Social Security

Bernard Madoff for Social Security Commissioner

As Barack Obama prepares to take office, a few crucial administration positions remain unfilled. Herewith a modest proposal for one still open position: Bernard Madoff for Social Security Commissioner.

True, there may be a minor problem since Madoff is under indictment for running a $50 billion “Ponzi scheme” on Wall Street, but think of the qualifications. Madoff is accused of running a scheme in which he took money from people with a promise to invest it. But instead of making investments, he kept the money for himself, and simply took more money from later investors and used it to pay earlier investors. Now compare that to a Social Security system that takes money from workers but does not save or invest it. Instead the government simply uses money from younger taxpayers to pay benefits to earlier retirees, while spending any “surplus” on other things. In the end, neither Madoff’s scheme nor Social Security are sustainable.

The big difference is that Madoff will likely go to jail; the politicians in Washington will likely get reelected.


Skidmore’s Weak Defense of Social Security

University of Missouri-Kansas City political scientist Max Skidmore recently criticized as “add[ing] nothing” Cal-Berkeley economist Konstantin Magin’s arguments in support of Social Security personal accounts. Let’s examine some of Skidmore’s arguments in favor of the current system:

Magin seems almost to promise guaranteed, risk free returns. Even if this were correct, it is irrelevant. Social Security is not an investment scheme; it offers more than retirement benefits, and its low administrative expenses make it more efficient than any private scheme.

Skidmore’s focus on just administrative costs misrepresents the program’s true costs, which includes distortions in saving and work effort in the economy. The payroll taxes that fund Social Security — to the extent that they are perceived as unrelated to future benefits — reduce worker incentives and, at the same time, Social Security retirement benefits induce workers to exit earlier from the work force. Those effects are well-documented by economists David Wise (Harvard) and Jonathan Gruber (MIT). Tax-financed benefits reduce personal saving (as demonstrated by Harvard’s Martin Feldstein), and the program’s institutional structure — the Trust Fund’s investment restrictions — means the program’s surpluses are not truly saved and invested (as argued by Penn’s Kent Smetters and Stanford’s John Shoven). Thus, overall the program reduces national saving. Those resource costs should be added to obtain a true picture of how costly Social Security is.

It has a mildly redistributive effect: workers who earn less receive a greater portion of their earnings in benefits than do those who earn more.

The redistributive effect is not mild at all when you consider its redistribution from younger and future generations toward older ones. There are any number of measures developed by well-respected economists — such as Alan Auerbach (Berkeley) and Larry Kotlikoff’s (Boston University) generational accounting measures — that document the massive intergenerational redistribution that the program imposes. That redistribution remains hidden because of the cash-flow budget accounting adopted by official scoring agencies. As the program’s shortfalls compel policy adjustments in the future, the true scope of the program’s redistributive force will become obvious — but it will be too late to avoid the negative economic effects of forced higher taxes and smaller benefits for future generations.

[I]nsurance against long life is very valuable, and private annuity markets appear to be quite costly[.]

But annuity markets are costly because we already live in a world with Social Security, which forcibly annuitizes retirement resources. And there is evidence that private insurance purchases do not fully unwind the forced annuitization via Social Security (Auerbach et al.). This is increasingly so as the intensity of desires to bequeath assets to children has eroded over time, as Kotlikoff and I have shown using data from the Federal Reserve’s Survey of Consumer Finances.

Social Security effectively monopolizes the annuity market and any residual purchasers on private markets are the high-risk ones — those likely to live longer than average. That explains the high cost of private annuities. If Social Security were altered by the introduction of personal accounts, private annuity sales would increase and broader risk pooling would lead to lower costs.

Nearly one third of all Social Security checks go to children, and to others younger than retirement age.

Children’s Social Security benefits as survivors and dependents could be replaced easily by independent insurance programs under a Social Security reform that establishes personal accounts.

Because of the independence it gives to seniors, young couples now rarely are required to support their elderly relatives, as documented by Kathleen Mcgarry and Robert Schoeni.

Again, this is an extremely shortsighted view. By encouraging independence among the elderly from their children, Social Security is destroying family cohesion and extended family links that are crucial for transferring human capital to the next generation. By increasing the costs for younger workers through the program’s excessively costly payroll taxes, it is also promoting lower fertility — thereby weakening a key growth-promoting factor in developing countries. Studies by Washington University’s Michele Boldrin indicate that, in countries with generous public pensions, fertility rates have declined.

Personal Accounts for Social Security: Still the Best Deal

With the stock market in turmoil, opponents of personal accounts for Social Security have once again raised the specter of Social Security “privatization” in political campaigns across the country. “Imagine if your Social Security taxes were invested in the stock market today,” they suggest ominously. The implication is that if we had allowed today’s seniors to privately invest a portion of their Social Security taxes when they were young, those seniors would be destitute today.

But let’s look at what would really have happened. Someone retiring today, who started paying Social Security taxes when they were, say, 22, would have begun investing 43 years ago, in 1965. As Figure 1 below shows, at that time, the Dow was at 969.26. Even adjusting for inflation, as shown in Figure 2, the Dow was at 43.25.

To show just how much better a deal private investment would have been, look at Figure 3. Assume you had invested a hypothetical $100 in 1965. The redline shows what would have happened if that money had annually earned Social Security’s imputed rate of return (about 2.2 percent for someone retiring today). The blue line represents what would have happened if you earned the actual market return. If you invested $100 in 1965 at Social Security’s rate of return, today you would have $254.91. But if you invested that $100 in the market, today, even with the current down market, you would have $4,135.92.

Any way you look at it, personal accounts are still a better deal.


Obama’s Non-Plan for Social Security

In the closing days of the presidential campaign, Barack Obama has had relatively little to say about Social Security — other than attacking John McCain for his (tepid) support for personal accounts. There may be a good reason for his reticence. 

Senator Obama has explicitly rejected any proposal to allow younger workers to privately invest part of their payroll taxes through personal accounts. He has also ruled out any reduction in Social Security benefits. Instead, he has proposed a 4 percentage point payroll tax hike, beginning in 2019, for individuals earning more than $250,000 per year in wages. While this fits in well with Sen. Obama’s “tax the rich” philosophy, it does very little for Social Security. 

As we know, Social Security will begin running a deficit — paying out more in benefits than it takes in through taxes — in just nine years, by 2017. Of course, in theory, Social Security is supposed to continue paying benefits after 2017 by drawing on the Social Security Trust Fund until 2040, after which the Trust Fund will be exhausted. In reality, the Social Security Trust Fund is not an asset that can be used to pay benefits. Any Social Security surpluses accumulated to date have been spent, leaving a Trust Fund that consists only of government bonds (IOUs) that will eventually have to be repaid by taxpayers. Therefore, in looking at Social Security’s looming crisis, what really counts is the program’s cash-flow solvency, which turns negative in 2017.

Senator Obama’s proposal would do very little to change this. Most people earning more than $250,000 per year receive the vast majority of their income in forms other than wages or salary. In fact, according to the IRS, only a little more than $1 billion in wages were earned by people with more than $250,000 in wage income. Assuming standard wage growth in the future, Senator Obama’s tax would generate barely $50 million per year. That would not even push back Social Security’s cash-flow insolvency by an additional year.

On one hand, compared to Senator Obama’s other proposed tax hikes, this one offers relatively little pain. On the other hand, it offers even less gain.

If you want to see a Social Security plan that actually works, check out Cato’s 6.2% solution.

Choosing What to Worry About

Paul Krugman’s column in today’s NYT laments the lack of a national policy to combat global warming. He writes:

It’s true that scientists don’t know exactly how much world temperatures will rise if we persist with business as usual. But that uncertainty is actually what makes action so urgent. While there’s a chance that we’ll act against global warming only to find that the danger was overstated, there’s also a chance that we’ll fail to act only to find that the results of inaction were catastrophic. Which risk would you rather run?

He then cites the work of Harvard economist Martin Weitzman, who surveyed the results of a number of recent climate models and found that (in Krugman’s words) “they suggest about a 5 percent chance that world temperatures will eventually rise by more than 10 degrees Celsius (that is, world temperatures will rise by 18 degrees Fahrenheit). As Mr. Weitzman points out, that’s enough to ‘effectively destroy planet Earth as we know it.’”

Krugman concludes, “It’s sheer irresponsibility not to do whatever we can to eliminate that threat” and he calls for opprobrium against those who might impede global warming legislation: “The only way we’re going to get action, I’d suggest, is if those who stand in the way of action come to be perceived as not just wrong but immoral.”

There is merit to the argument that society should consider a policy response to the threat of global warming. A small chance of an enormous calamity equals a risk that may deserve mitigation. That’s why people buy insurance, after all.

However, Krugman doesn’t accept that argument — at least, not when applied to other worrisome risks that trouble people whose politics are different than his. Less than two months ago, he wrote this about another future crisis:

[O]n Friday Mr. Obama declared that he would “extend the promise” of Social Security by imposing a payroll-tax surcharge on people making more than $250,000 a year. The Tax Policy Center estimates that this would raise an additional $629 billion over the next decade. But if the revenue from this tax hike really would be reserved for the Social Security trust fund, it wouldn’t be available for current initiatives. Again, one wonders about priorities. Whatever would-be privatizers may say, Social Security isn’t in crisis: the Congressional Budget Office says that the trust fund is good until 2046, and a number of analysts think that even this estimate is overly pessimistic. So is adding to the trust fund the best use a progressive can find for scarce additional revenue?

In Krugman’s view, policies to address Weitzman’s 5 percent risk of ecological disaster by the early 23rd century (Weitzman’s time frame, which Krugman didn’t specify) are responsible and moral, but policies to address the economic crisis of Social Security’s insolvency in less than four decades’ time are unnecessary and overly pessimistic. And Krugman clobbers anyone who suggests otherwise .

Make sense to you? Me neither.

Krugman’s double-standard on risk is not confined to Social Security. He has (rightly, IMO) blasted the Bush administration for going to war in Iraq. But couldn’t the war be justified as mitigating a small risk of a great catastrophe? Was there, perhaps, a one-in-20 risk that Hussein’s Iraq would develop weapons of mass destruction and direct them at the United States (in the next 200 years)?

I write this not to argue that the United States should be unconcerned about global warming, or about rogue states’ possession of super-weapons, or about Social Security’s (and Medicare’s) unsustainability. All are risks, and it is right for us to consider policy responses for each of them. My point is that it makes little sense to say one risk must be addressed while we should dismiss another risk with an expected value that’s probably the same order of magnitude.

Moreover, if this dichotomy is simply the product of Krugman’s political allegiances (“Red team fears are stupid, Blue team fears are heroic”), isn’t he being irresponsible, wrong and immoral?

Retirement and Fuel Prices: A Match Made In Heaven?

Get ready for Washington D.C.’s Mall to be filled with seniors in the not-too-distant future.

About 25 percent of seniors depend entirely on Social Security for their consumption. And for two-thirds of them, Social Security makes up the majority of their monthly income. With soaring fuel and food prices, they are beginning to complain about being unable to make ends meet — as in, having to cut down on leisure and travel activities.

The rise in gas, food, and commodity prices is unlikely to be a bubble and won’t ”burst” anytime soon. Furthermore, the Fed’s recent interest rate–cutting binge has promoted a weaker dollar and risks higher future inflation and inflation expectations. That means our itinerant seniors will soon demand a larger inflation adjustment on their monthly checks than allowed by Social Security’s post-retirement benefit formula.

No prizes for guessing whether Congress will capitulate!

Shiny, Happy SSA Employees

I recently had the opportunity to conduct a pair of briefings for congressional staff regarding electronic employment eligibility verification. A pair of bills are vying for the attention of Congress these days. I suggested in my recent paper, “Electronic Employment Eligibility Verification: Franz Kafka’s Solution to Illegal Immigration,” that Congress should ignore both. Indeed, it should eliminate “internal enforcement” of immigration law entirely.

One of my co-briefers provided staffers with some interesting information pertaining to the idea of building a regulatory contraption for automatic nationwide verification of workers’ identity and immigration status. He was a representative of SSA workers from the American Federation of Government Employees, National Council of SSA Field Operations Locals.

The programs slated to go national under these proposals would compare data about new workers (and in some cases, existing workers) with databases at the Social Security Administration and the Department of Homeland Security. When the data didn’t match, workers would receive what is called a “tentative nonconformation.” With the 4.1% error rate in SSA files (as found by its Inspector General), that’s a lot of tentative nonconfirmations going even to law-abiding American citizens. A higher percentage of the time, naturalized citizens would get them, too, as government data about them is even more error-prone. Bad government data is just one source of error.

Anyway, when a tentative nonconfirmation is issued, employers are supposed to communicate this to the employee (not all do) and the worker is supposed to report to a Social Security Administration office or the Department of Homeland Security to clear the problem up. This is where the interesting new information comes in.

What would the process be like? Well, try calling your local SSA field office to find out. The SSA worker rep reported that 50% of those calls aren’t answered because field offices are too busy. Calls to the SSA’s national 800-number don’t go through 25% of the time.

It’s not just a phone problem. The agency currently has a backlog of 752,000 on disability rulings. That’s three quarters of a million people who aren’t getting an answer from SSA. It takes 530 days – a little under a year and a half – to get a disability ruling out of SSA.

In my paper, I wrote about the experience American workers would get at the Social Security offices when they went to clear up their tentative nonconfirmations:

Disputes of tentative nonconfirmations would not happen in lushly carpeted offices with marble columns, hot coffee, and friendly, attentive staff. The experience of American workers when they sought permission to work would be much more like their trips to the nation’s departments of motor vehicles, post offices, and dentists—long lines, unfriendly service, and painful procedures.

The SSA union rep assures me that SSA workers are friendly. Any perception of unfriendliness is due to overwork. Fair enough; I may have been slapdash in my writing about SSA employees. But a national electronic employment eligibility verification system would result in 3.6 million new visits to these folks, overworking them and eroding their courtesy even more. These visits, and administering tentative nonconfirmations at SSA, would cost $1 billion, according to the union rep.

Of course, an SSA employee union rep would happily take the money and add workforce to do whatever Congress wants. My preference is to save the money. Enforcement of our abnormally restrictive immigration law causes us to spend taxpayer money on undermining the productive economy. That shouldn’t make sense to anyone.