Bell Curve The Law Talking Guy Raised by Republicans U.S. West
Well, he's kind of had it in for me ever since I accidentally ran over his dog. Actually, replace "accidentally" with "repeatedly," and replace "dog" with "son."

Wednesday, March 16, 2005

What Steams Me About Social Security "Reform"

Hi Everyone,

I recently had lunch with a good friend of mine, and Congress expert, from a public university in Florida (I can report his views on Jeb Bush on request). After a bit of gossip about which political scientists are at what universities etc, we started talking about social security reform.

He pointed out that if we raised the retirement age by one year it would put off the "crisis" by 17 years. At this I pointed out that the crisis is time dependent so delaying it is as good as eliminating it altogether! Think of this way. Social security is a "pay as you go" plan. That means that workers today pay for the retirements of pensioners today. The problem is that as the Baby Boomers retire, they will depend on Generation X to pay their retirement. Since there are about half as many Gen X'ers as Boomers, this is bad news for Social Security. But it is not a permanent problem! As the Boomers die and the Gen X'ers retire, the enormous Boomer Echo or Tidal Wave II will hit their peak earning years just as the number of pensioners declines sharply. So the bottom line is that the Bush administration is proposing a massive restructuring of social security that may destroy the program entirely in order to address a temporary problem caused by a fat spot in the population distribution (the Baby Boom) which will pass through the system in time. Why? I suggest it is about destroying social security for ideological reasons and very little else.

My other major beef with the social security issue is that Republicans like to claim that privatizing social security yields a "higher rate of return" than the social security trust fund. But there are a couple of problems with that. First, while it is true that the stock market is always higher today than it was 20 years ago, it is not always higher today than it was 5 or 10 years ago. What happens if you retire during a "market correction?" Also, that "higher rate of return" is not automatic or for free. The reason you get more money back at the end of an investment than you put in is because that is what compensates your for the RISK that you may not get your money back at all. Generally, the higher the rate of the return, the higher the risk. Misunderstanding this basic economic principal is what caused so many people to lose their fortunes in when the Dot-com bubble burst. People invested in "high return" internet startup investments without thinking that the the reason the returns were high was because the company was in serious danger of going bust. OK, no apply that to privatized social security accounts. Introducing risk into pension plans would be fine if you had enough money to distribute that risk across many types of investments. But if you are poor and can't distribute your investments, you are increasing your vulnerability to risk. Not a good basis for a retirement plan.

Bush probably doesn't understand the relationship between rate of return and risk for a few reasons. First, when his investments go belly up, his friends and his fathers friends bail him out... no risk! Second, empathy is not this President's strong suit. If he hasn't experienced it personally, he doesn't get it. Finally, this President is not known for his performance in the class room so even though he was almost certainly taught this principal in his Harvard MBA program, his grades indicate that he probably just slid through the class.

The Democrats are fighting hard to block the President but I haven't heard them mention the temporary nature of the looming short fall in social security. Also, I haven't heard any clear description of the relationship between "rate of return" and risk. There have been vague alarms raised about the riskiness of the stock market but no direct link between the "rate of return" and risk.

Comments? Discussion?


US West said...

Rather than calling GW names, I like to comment on 3 things I: 1) ideology, 2) risk and rate of return, 3) raising the retirement age.

1) Ideology is the reason. The goal of the most conservative aspects of the right is to eliminate all social programs. Reasonable conservatives think the federal government shouldn’t be involved in social programs and believe it is the job of a state of local government to do this. I call that reasonable because they see a place for social programs, so the discussion becomes a question simply of administration. The unreasonable ones think that anything tied to the New Deal needs to be erased all together. It is socialist. And poverty is a crime. This attitude has been widely talked about in the more liberal leaning media. And for more about who is promoting this “reform”, or dismantling go to

2) Risk and return has been discussed time and again. I hear it on NPR, I have read it in the Economist, the NYT and the Washington Post. I have seen it in all the information I get from my investment firm. But if FoxNews isn’t talking about it. Then no one knows about it. Fox, after all, is the “most watched” news channel, after all. And let's not ignore the bubble in housing. People are now trading houses like stock. That will have serious ramifications for this discussion when the bubble there bursts.

And you never hear about what businesses think and who they are. I would like to hear more about the businesses that are opposed to Social Security reform. I’ve only heard NPR discuss this one time, and then only in passing. These businesses are concerned because they don’t think 401K plans will be enough for people to retire on and they fear that they will have offer bigger matching amounts in their plans, which they can hardly afford to do. I haven’t been able to find more information on that.

3) Raising the retirement age: I find this impractical. Just because I am slated to die at around 80 now doesn’t mean I can or should work until I am 68. If you make me, I may die at 75! People are living longer, but that doesn’t mean they are in better shape to work. I work with people in their mid 60s. They are tired, frustrated, jaded, and expensive. They come in to keep chairs warm. They halt needed changes. I see it in my job every day. Sure, there are some who are energetic, open minded, and adaptive. But not many. They want to be in their gardens or on that cruise to the Bahamas. And frankly, I don’t blame them. They get injured more easily. Their health care costs rise. And no one is talking about how young people are suddenly getting sick sooner. 45 year olds who have bypass operations are growing. By 55, they have cardiac conditions, diabetes, weight troubles etc. So go ahead and raise the retirement age, and then watch your medical costs sky rocket even faster.

That brings me to a larger point. You can’t talk about social security and ignore the Medicare problems and medical care crisis in this country. That is where the real crisis is. Let’s address that. The other thing I would mention here is that if you are going to make people work longer, then you had better change your attitude about the work ethic, about upward mobility for the younger workers, etc. You can’t expect people to work like dogs for 2 weeks vacation their entire lives. What we should be talking about is how to create or reform total welfare in this country rather than tinkering with the small stuff. And Social Security has to be discussed in a much broader context than simply retirement.

Bell Curve said...

The social security tax takes 12.4% of your earnings, if you make $89,500 or less a year. Then it stops. In other words, if you make 5 million dollars a year, you still only pay $11,098 (0.22% of their income!) in social security taxes a year, instead of 12.4%, or $620,000. This is a difference of over $600,000! I'm sure the intelligent people who read our blog know this, but a lot of people don't.

Well, wouldn't this be a logical way to help save social security? some people argue that this isn't a complete solution -- well, it's not. But it's certainly a good step. Some would also argue that it would hurt the economy ... using the same arguments people always use when they say that taxing the rich hurts the economy.

Am I the only one who feels this way?

Raised By Republicans said...

How about if we raise the retirement age one year but only for Baby Boomers. When Gen X gets older we can retire at the age stipulated today. By the time we retire after all, social security will be in a vigorous surplus again. ;-)

But seriously, you're right about the link between social security, medicare and medicaid.

And your comment about the real estate bubble reminds me that all predictions are that when the Baby Boom starts to retire and cash out their stock portfolios to pay for their retirement, the stock market will fall dramatically (wiping out any stock portfolios accumulated by Gen X'ers planning to retire 10-20 years later).

Gen X'ers beware! Put your money in bonds until the median Boomer is buried then buy like mad from the tail end of the Baby Boom! We'll make a killling selling it all to their kids 20 years later!

Dr. Strangelove said...

The potential insolvency of the social security trust fund is a red herring. It is much closer to the truth to say social security is a federal program, budgeted annually like every other federal program, and the payroll tax is just another source of income.

The payroll tax has generated more revenue than social security has needed every year since its inception, and the extra money has always been spent as soon as it comes in: just another part of the general fund. Without this extra cash, the $7.76 trillion federal debt would be $1.69 trillion bigger by now. Congess keeps track the accumulated excess; this figure is called the "trust fund."

It is really just a budgeting problem. By 2018, the payroll tax will no longer be enough to cover social security outlays, and so Congess will start to draw on the general fund to fill the gap instead of pocketing the difference. Eventually, in 2042, the accumulated amount drawn from the general fund since 2018 will equal the accumulated amount added into it by the payroll tax prior to 2018: about $4 trillion. Nothing special happens. The "insolvency" projected for 2042 or thereabouts is merely an accounting milestone, nothing more. The extra annual expenditure will start very small and grow slowly to about $300 billion by 2042, then perhaps to $500 billion into the farther future.

In the scheme of fedeal budgeting, this really isn't very big. Annual payments should never amount to more than small fraction of the federal budget. If Congess wants more money for other programs after 2018, they can do what they always do: raise taxes, cut other spending to fill the gap, or just add to the debt. All we'd have to do is roll back a portion--just a portion--of the Bush tax cut and there would be plrnty of money for social security. Why must payroll tax be the only source of revenue used for social security?

Bottom line: there is no need to mess with social security. Investing some of the payroll tax in the stock market, individually with private accounts, will do nothing to make the program cheaper. While the rate of return for the stock market, averaged over many people and several decades, is indeed better than treasury bonds, there is considerable variance across time and portfolios, and thus as RxR says, this higher averaged rate of return is only achievable at the cost of introducing market risk. But the whole point of social security was to guarantee a portion of eveyone's retirement income, risk free, regardless of the economy or the stock market.

America's elderly learned the importance of such a safety net the hard way, in 1929. Hoover did not take action, to help them, so the voters elected FDR and continued to affirm the New Deal and Social Security in election after election, to make sure such a tragedy never happened again. Alas, the Republicans didn't get it then, and they still don't get it now.

US West said...

I think it is worth asking what the tax rate would be on private accounts.

Dr. Strangelove makes a very interesting point about the budget game. And I think it further proves the point that ideology is pushing the agenda.

I brought up the real-estate market because that is a new angle to the social security problem. If social security is meant to guarantee a minimum income in old age, then the real estate bubble may make even that impossible, especially if the bursts is big! Many boomers are re-financing their houses as fast as the papers can be processed. If the bubble bursts, you may have a lot of foreclosures. And that means a lot of old people with big debts. And the banks have made sure that they will still get some of that money back with this new bankruptcy bill. We will be the ones paying for that as well the Echos. So, RBR, I am not encouraged by your generational wave-theory. I am seeing the faint lines of a much bigger, more complex web than just social security.

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