In Praise of Winston Churchill

Via Powerline, I learn that today is the 130th anniversary of the birth of Winston Churchill. It is something of an embarrassment that this isn't a national holiday the world over. Perhaps we could append it to Thanksgiving, because we should all be grateful that by the force of his indomitable will (and, at times, it seemed, his will alone) Western civilization was saved from the scourge of fascism.

One of the most fascinating accounts of his life that I have "read" (listened to the audio CD on a few roadtrips, actually) was Jon Meacham's Franklin and Winston: An Intimate Portrait of an Epic Friendship. I had always understood Churchill to have been a rock, personifying coolness under pressure as the Nazis pounded England early in the war. The book reveals more of human dimension to Churchill, particularly in the way that the friendship between the two men formed at a personal level and how it evolved as the war drew to a close and the Soviet Union emerged as the new threat to the West.

Social Security in the New York Times

David Altig at Macroblog dissects the article in today's New York Times on Social Security, "Bush's Social Security Plan Is Said to Require Vast Borrowing." I commend the whole post to your attention, but here's the concluding paragraph, which is right on the money:

The deficit is, pure and simple, a pretty poor basis on which to evaluate the pros and cons of any fiscal policy. What matters is how much we spend and what we spend on, how we collect the revenues and who we collect them from, over the long haul. Debate about the short-run deficit is a diversion from the important business.

All deficits matter, but trying to evaluate a change in an intergenerational transfer program based on the surpluses or deficits that occur during a five- or ten-year window is not particularly constructive. I posted about the inadequacies of the budget framework last week.

The NYT article contains more evidence that the issue is not being framed properly in Washington. Consider this paragraph:

The main Republican players in Congress on the issue say they expect to endorse an increase in borrowing to finance the transition to a new system. But they remain split over whether to back plans that would include larger investment accounts and few painful trade-offs like benefit cuts and tax increases - and therefore require more borrowing - or to limit borrowing and include more steps that would be politically unpopular.

This is almost entirely a false tradeoff. The system has projected obligations that exceed projected revenues by $10.4 trillion in present value. This is the amount of "politically unpopular" measures that must be taken to restore the system to solvency. This figure has nothing to do with the size of the personal accounts that may also be carved out of the system, except insofar as a greater opportunity to make private investments in personal accounts makes the whole reform package easier to pass.

I laid out my reform suggestions for Social Security here and here about a month ago (and offered plenty of criticism of the way Democrats in the Congress and on the campaign were discussing the issue). With the election behind us, my biggest fear in this process is that we will get debt-financed personal accounts without the necessary measures to restore solvency.

America's Secret War

STRATFOR describes itself as:

[T]he world's leading private intelligence firm providing corporations, governments and individuals with geopolitical analysis and forecasts that enable them to manage risk and to anticipate political, economic and security issues vital to their interests.

STRATFOR's founder is George Friedman, whose new book, America's Secret War, is getting some discussion in the blogosphere yesterday and today. (Start with Professor Bainbridge's link to Frank Devine's review of the book.)

The book's website contains some interesting Q&A with the author. His answer to the direct question that occupies Bainbridge and Devine is:

Q. Why did we go into Iraq?

A. We went into Iraq to isolate and frighten the Saudi government into cracking down on the flow of money to Al Qaeda. Bush never answered the question for fear of the international consequences. Early in the war, the President said that the key was shutting down Al Qaeda's financing. Most of the financing came from Saudi Arabia, but the Saudi government was refusing to cooperate. After the invasion of Iraq, they completely changed their position. We did not invade Saudi Arabia directly because of fear that the fall of the Saudi government would disrupt oil supplies: a global disaster.

I would like to see some evidence for the key proposition (which I highlighted in red). I'll read the book and search for corroborating evidence. Even if the Saudi's have changed their tune, that does not necessarily mean that achieving that result was the intent of invasion.

Before reading the book, I'm skeptical about the motive. I agree that reform (if not revolution) in Saudi Arabia is critical to peace in the Middle East, but the most pressing issue after the fall of the Taliban in Afghanistan was Iran. Specifically, the next interesting event would be whether the students would oust the mullahs in Iran. Our next step should have been something to tip the balance in favor of democracy and nuclear disarmament in Iran. Failing that (but hopefully only after giving it a chance to succeed), we would need to be ready for a military confrontation with the theocrats in Iran.

EagleSpeak argues, in response to the Bainbridge post, that this is what the invasion of Iraq has been:

As I have argued before, the invasion of Iraq, coupled with the invasion of Afghanistan and the turning of Pakistan completes what is essentially an encirclement of Iran. Further, as a look at a topographic map will tell you, Iraq provides far easier access to Iran's interior than other alternatives.

Saudi Arabia may contain sources of funding and even human assets for terrorism, but Saudi Arabia itself is not, in my view, a hard target to attack if American protection is removed. There is not much need to encircle it. Iran, however, is a much tougher nut to crack, from every direction except the west.

Completing the RealPolitik trifecta is a post at American Digest earlier this month, in which both theories are used to answer to the question, "Why are we in Iraq?"

And they call economics "the dismal science?"

Happy Thanksgiving

One of our better holidays, wouldn't you say?

I am thankful for family and friends, and the freedom to enjoy them. Around the blogosphere on this holiday, two posts caught my eye. Once again, Marginal Revolution finds a way to teach us about the economics, this time in relating the story of how the settlers survived at Plymouth rock. And I particularly enjoyed this photo essay by Donald Sensing.

Happy Thanksgiving.

Steve Friedman to Step Down at the NEC

Via Angry Bear and the Washington Post, we learn that Steve Friedman will be stepping down as the Assistant to the President for Economic Policy and Director of the National Economic Council at the end of the year. I had the chance to work with Steve while at the Council of Economic Advisers and am grateful for the opportunity. I learned a lot from my interactions with the NEC. The Post discusses some possible replacements:

Conservatives are pushing former senator Phil Gramm (R-Tex.), publisher Steve Forbes or a top business leader, such as Fred Smith, chairman of FedEx Corp. Also under consideration is investment banker Gerald Parsky, who served on Bush's Social Security commission, and Indiana businessman Al Hubbard, a longtime friend of the Bush family.

I cannot imagine them choosing anyone from this list other than Phil Gramm. Quoting from the White House website, by Executive Order, the NEC has four principal functions:

1. to coordinate policy-making for domestic and international economic issues,
2. to coordinate economic policy advice for the President,
3. to ensure that policy decisions and programs are consistent with the President's economic goals, and
4. to monitor implementation of the President's economic policy agenda.

The first two functions are the "honest broker" role that the NEC plays in coordinating the workflow of economic analyses in the rest of the Executive Office of the President, the Cabinet departments, and other agencies. The key job requirement is to be a taskmaster.

The third function shows up in the way senior staff meetings are run--get all the Principals to agree to a coherent proposal and then present it to the President. The key job requirement is to be smart--really, really smart--because the range of issues that the NEC deals with is very broad and the need to stay focused on good policy is paramount. There is no need to be an economist with a Ph.D.

The fourth function involves making sure that the proposal stays true to the President's objectives when it moves down Pennsylvania Avenue, in conjunction with the White House Office of Legislative Affairs. I have no idea what the secret handshakes are on the Hill. I couldn't learn them in a year in Washington watching from afar. The key job requirement is to get someone who does. This is why it is not surprising to me that the NEC is staffed largely by people who were extremely successful as policy directors or chiefs of staff for prominent Senators and Representatives or their committees.

I don't know enough about the people listed by the Post to be able to judge how well they would do in the job. It does seem that Senator Gramm has enough credibility and experience to be effective in all four of the NEC's principal functions. But the article doesn't say that the White House was actively considering him--only that conservatives were pushing him.

If it were up to me, I'd promote from within. The current NEC deputy director is Keith Hennessey. He not only has the key job requirements for the four principal functions of NEC, but he has them in spades. Let's hope the White House finds a way to keep him on the senior staff.

Social Security Reform and the Budget

Brad DeLong levels some accurate criticism of the Administration's unwillingness to put Social Security reform in the budget. The crux of the matter is summarized in Jonathan Weisman's story in the Washington Post:

Republican budget writers say they may have found a way to cut the federal deficit even if they borrow hundreds of billions more to overhaul the Social Security system: Don't count all that new borrowing.

The issue is that it does not appear that the Administration will raise new revenue to fund personal accounts that will eventually substitute for a portion of Social Security benefits as stipuated in current law. As I have discussed before, this does not mean that the reform is infeasible. But it does mean that the unified budget deficit--which includes the Social Security and Medicare surplus or deficit--will be wider over a period of decades as debt is issued to cover the personal account contributions. Eventually, the unified budget deficit and total federal debt will be smaller, as the other measures included in the reform (if it is the President's Commission's Model 2, for example) reduce future benefits by enough to restore solvency and repay the debt issued during the transition. (See Chapter 6 of the 2004 Economic Report of the President for a full discussion.)

The Washington Post article goes on to quote Senator Judd Gregg of New Hampshire, the incoming chairman of the Senate Budget Committee:

"You cannot look at Social Security in the context of a five-year budget," the window that current White House and congressional spending plans cover, Gregg said. "To do so is naive and foolish. . . . If this is simply scored as a five-year exercise, we're never going to solve the problem."

I think he's right, in a political if not economic sense. We could avoid these five-year budget horizon issues if we funded, rather than borrowed, the money to contribute to the personal accounts. But even with additional funding, for a program that spans all generations of workers and beneficiaries, an alternative perspective may be a more useful guide to long-term budget policy.

I have argued that the virtue of reform is to eliminate the unfuded obligations of $10.4 trillion in the Social Security system. It would seem simple enough for the Administration to say that the goal is long-term solvency, this plan restores long-term solvency, and the additional deficits and debt are just a temporary (i.e., only a few decades) phenomenon that disappears when they are repaid out of program saving. If it's so simple, why is the Administration now contemplating accounting acrobatics to try to move its policy forward?

The answer appears in (among other places) the Fiscal Year 2005 Budget released in February. The budget target announced in the President's budget message was to "cut the budget deficit in half in five years." The budget deficit here is the unified budget deficit--which includes the Social Security surplus--and that's the rub. Look at Table S-12 in the Summary Tables of the budget to see why. That table shows:

Deficit Measure	2004	2009
Unified Deficit	–521	–237
On-budget deficit	–675	–501
Off-budget surplus	154	263

The "cutting in half" is taking the $521 billion down to $237 billion. However, this reduction in the unified deficit involves a reduction of only $174 billion in the on-budget deficit, combined with an increase of $109 billion in the off-budget surplus. When the Administration announced its budget target, it fully incorporated not just the level of the off-budget surplus, but the projected growth in that surplus over the five-year period. (To me, this qualifies as "spending the Social Security surplus," but that's a topic for a later post.) The Administration did not announce, "we can cut the on-budget surplus by a quarter" (i.e., 174/675). That would not have appeared to be an aggressive enough position to take on fiscal discipline.

The Administration is relying on the Social Security surplus (and its growth) to reach its near-term budget target, but it does not want to acknowledge the impact of personal accounts on that unified budget deficit. Had it stated its budget target in terms of the on-budget deficit--to cut it by a quarter over five years--then it would have a much freer hand now in putting the reform of Social Security off-budget. Doing that would be an example of an "alternative perspective" that would be a reasonable guide for long-term budget policy. What is not reasonable is to shift between two budget perspectives in order to make stated targets easier to achieve.

More on the Cabinet

Powerline has a post last evening taking Andrew Sullivan to task for excessive criticism of the President's nominations for Cabinet positions. Here's a quote from Sullivan's piece:

It is not a sign of real strength that you banish alternative views from your internal deliberations or surround yourself with people who owe their entire careers to your patronage.

I am not aware of anything in Sullivan's past that would allow him to have witnessed these "internal deliberations" in person. I have a very small amount of direct experience with White House deliberations a few levels below the ones in question. I gained a tremendous respect for most of the (Special and Deputy) Assistants to the President and their staffs, particularly those on the NEC, NSC, and DPC with whom I worked most closely. I think Sullivan has overstated his case. (But I still read him faithfully!)

Promoting from within does not equal "banishing alternative views." I posted last week on the main advantage of the President's strategy--that it may allow the Administration to better utilize the considerable expertise located in the Cabinet departments--while recognizing the drawback that it does little to draw in additional alternative views in the second term.

And now for the history lesson. Guess the number of times the Cabinet is mentioned in the Constitution, and then check your answer here.

E-Commerce

The Census Bureau has been tracking retail E-Commerce on a quarterly basis for about five years. The information is released about halfway through the following quarter, and so the report for the 3rd quarter of 2004 was made available on Friday.

If you have never seen this report, take a guess at the fraction of all retail sales that are conducted via E-Commerce. Since you are reading a blog (and a rather obscure one at that), I'll bet that you guessed too high. It's still only 2 percent, at about $17.6 billion out of $916.5 billion last quarter. The growth rate for E-Commerce is about 2-3 times the pace for total retail sales, but even though that sounds like a lot, it will take a while for the E-Commerce share to become very important in the aggregate. (Simple extrapolation of the last five quarters of growth in each series would get to an 8 percent share in another 10 years.)

Let me give the process a boost. My favorite on-line merchant, at least in the area of food, is Jacques Torres Chocolates. Located in the area of Brooklyn known as DUMBO (Down Under the Manhattan Bridge Overpass), this guy makes the best chocolates I have ever tasted. If you cannot make it there in person, hit the link on the sidebar and treat yourself right this holiday season.

Indiana Pacers, Meet Irony

Earlier this month, the Indiana Pacers benched player Ron Artest for two games for making a ridiculous request for time off to promote an upcoming rap album. I suspect that after his exploits last evening in Detroit as the game against the Pistons came to a close, management is wishing that it had granted the request. After being involved in an on-court shoving match with Ben Wallace of the Pistons, Artest was hit by a beverage thrown by someone in the stands. Artest charged into the stands and started swinging at the Detroit fans, followed by his teammate Stephen Jackson.

What we are witnessing is the collision of two deplorable phenomena in sports: the lack of class and sportsmanship on the part of some players and the unchecked stupidity on the part of some spectators.

For me, the low point in sportsmanship was Roberto Alomar's spitting on an umpire late in the 1996 baseball season, coupled with the remarks he made about the umpire's son afterwards. His career in the major leagues should have been over right there--a lifetime suspension from the playing field (but with no particular implications for the Hall of Fame). Artest should be done for the season, at the very least. There is no reason not to make an example out of him. Artest is a talented player, but he's eminently replaceable. Best of luck with your rap career, Ron.

The low point in spectator behavior had to be two years ago in Chicago when this father and son duo ran out of the stands during a White Sox-Royals game and attacked the Royals' first base coach from behind. The two of them should have gotten jail time (like the 2 to 5 years prosecutors requested), but in a sentence handed down about a year after the assault, the father was given only time served, counseling, parenting classes, a curfew, and probation. What a joke. Those two, like anyone at the Pacers-Pistons game identified as having incited that riot, should be sentenced to jail time. Again, there is no reason not to prosecute to the fullest extent of the law.

NBA commissioner David Stern described last evening's incident as, "shocking, repulsive, and inexcusable." He should stick to that description--this incident calls for more than small fines and temporary suspensions. The league should also use this incident as an occasion for a fundamental change in the way the NBA markets itself. Here's what I would do. I would reserve the first dozen or so rows around the court for free tickets for local school or youth groups. Groups would qualify for the tickets based on their community service and other charitable works. The league and the teams could partner with community organizations and local corporations to donate the tickets. There are over a million kids between the ages of 5 and 17 in the Detroit metropolitan area. They should be the ones watching the games up close. No alcoholic beverages, no unchaperoned rowdiness, and nothing but positive reinforcement for the players from the kids who idolize them.

The National Economic Calendar

One of the things I enjoyed most about being at CEA was the need to track the macroeconomy on a monthly and daily frequency and to be able to explain it to other people working in the Executive Office of the President. In the academic life of an economist, there is very little demand for understanding the real-time economy, and topics of direct relevance for current events are reflected to only a minimal extent in academic publications.

One way to become better informed about the real-time economy is to make the national economic calendar page at the Federal Reserve Bank of New York's website a part of your weekday morning web surfing. Another option is to sign up at the National Bureau of Economic Research for a daily e-mail with a more comprehensive list of data released that day, with links to each report. (I have added both links to the sidebar.) Looking at the NY Fed page, you will see that there is a regular timing to how major pieces of information are released.

For example, the Employment Situation release happens on the Friday after the first Thursday of each month, and it pertains to data collected during (roughly the second week of) the prior month. The highlight of the second week is the Advance Retail Sales report, which tells us about much of the consumption that occurred during the prior month. The third week was less interesting to me, but the highlights were typically the reports on inflation contained in the Producer and Consumer Price Index reports. The monthly cycle heats up again in the last week or so with the Advance Durables report, which tells us about investment in the prior month, and then finally the GDP report, which has advance, preliminary, and final releases in the first, second, and third months of the following quarter, respectively.

If you would like to keep current on the macroeconomy, those reports are the place to start. On the day of the release, read the report and then try to follow the press coverage, particularly the financial markets' reactions. I will also try to post more about what these reports as they become available.

Cabinet Reshuffling

The White House announced three very interesting personnel changes this week and last:

1) Judge Alberto Gonzales to move from White House Counsel to Attorney General
2) Dr. Condoleeza Rice to move from National Security Advisor to Secretary of State
3) Margaret Spellings to move from the Domestic Policy Council to Secretary of Education

All three are movements of people formerly in the White House to head Cabinet departments. Is this a good thing?

Maybe. I don't know enough about any of the three to comment on their particular qualifications for the jobs. But one of the criticisms of this White House is how tightly the policy process is controlled by the White House. The policy experience and analytical talent of the career staff in the Cabinet departments is probably underutilized. Putting people with close ties to the President at the head of those departments does suggest that the experience and talent that reside in these departments will be better integrated into the policy process. That could make for better policy.

Or, maybe not. Cabinet appointments are an opportunity to invite established people with different points of view into the President's inner circle. They should be people who have had management experience at the top of a large organization in the past. Governors often make for good appointments, as do CEOs. The current administration has not been successful in these types of appointees. Tommy Thompson at HHS has been central to some policies, like adding prescription drug benefits to Medicare, but that was a policy with some terrible consequences (a new underfunded entitlement program). Christine Todd Whitman at EPA and Paul O'Neill at Treasury had rocky tenures and seem to have made little impact. The three new appointments suggest no progress toward this ideal.

Agriculture, Commerce, and Energy are also awaiting new Cabinet Secretaries. It will be interesting to see how those positions are filled.

More Details on Running Up the Score

In an earlier post, I noted that the President increased his relative share of the popular vote between 2000 and 2004 in 35 out of the 51 electoral contests. For example, he ran better in New York against Kerry by about 7 percentage points compared to how he ran against Gore. I hypothesized that the Bush-Cheney campaign actively sought a better showing the popular vote, in addition to a majority of the electoral college.

Via Powerline, I see that Patrick Ruffini has returned to his blog after being the Bush-Cheney '04 webmaster. His post today is excellent reading on how the popular vote shifted in many areas that would surprise the casual observer. This map shows, on a county-by-county basis, where the President improved his popular vote showing. As Patrick writes:

While not enough to shift any states into the Bush column, President Bush’s marked improvement along the Northeast Corridor lays a strong foundation for their return, one or two elections hence, into full-fledged battleground status. This development also lays waste to the notion of evangelical “values voters” being solely responsible for the President’s popular vote margin.

The key question for the Democrats is whether they understand this point--that they cannot ascribe their electoral failure in 2004 to only a set of "values voters." They should be thinking more broadly about where they lost ground.

Patrick also links to a very informative post by Robert David Sullivan, who has devised a map of the U.S. with 10 political regions of roughly equal population. It is the best commentary on the 2004 election (based on changes since 2000) that I have seen and offers interesting suggestions about where each party might look to gain ground in the 2008 campaign.

Should Newspapers Have Editorial Opinions?

A colleague referred me to a recent (pre-election) piece by Al Neuharth, the founder of USA Today, in which he asks, "Should newspapers endorse candidates?" His main point is:

Enlightened newspaper editors and owners have come to understand that when they endorse a political candidate their news coverage becomes suspect in the eyes of readers, even though most reporters are basically fair and accurate.

I'll take it a step further and ask why newspapers would have any editorial opinions--unsigned pieces attributable to the editorial board of the paper--whatsoever. Once newspapers have presented the facts that a reader would use to make up his or her own mind, of what incremental value is it for the newspaper itself to draw a conclusion as if it represents the views of the organization? Having a strong ideology in any part of a news organization calls into question--in appearance if not in fact--the lack of that ideology in other parts of the organization. One would think that any threat to the integrity of the news coverage would be avoided at all costs (financial and otherwise).

There is a popular demand for editorial and opinion writing, and there is still a role that newspapers can play in this regard. They can assemble a team of columnists that provide a wide-ranging but balanced set of opinions--opinions that are directly attributable to the author and not the paper as a whole. I think the Washington Post does this better than any other major paper, but I don't think they do a substantially better job than my usual trifecta of Andrew Sullivan, Powerline, and Brad DeLong. They may still command a bigger readership than blogs, and so could use access to that readership to enforce higher quality from their columnists. I don't think that happens nearly enough.

I also think that the mainstream media will improve (eventually) due to the competitive pressure from blogs, in two areas. First, the MSM will become better about linking directly to sources to provide factual support for its arguments. Second, the MSM will become better about correcting factual errors as soon as they are pointed out and in a more forthright manner. I guess we'll have to hope that these two changes happen sooner rather than later.

Direct Questions that Merit Direct Answers

In the comments on my last post, a commenter asked two very direct questions. Here they are, with my answers:

(1) Do you think that the Bush administration is at all likely to back the kind of proposal that you favor?

I would assign almost a zero probability that the Bush administration (or any elected official) will propose any increases in the normal and early retirement ages, let alone increases of the magnitude that would be sufficient to restore solvency. That is a very hard rhetorical battle to win. I think it is worth trying--as life expectancies increase, we would be well served to have a public debate that the age of dependency (a phrase borrowed from Arnold Kling's blog) should also increase. In the unlikely event that a Senator or Representative did start to win this battle, the Administration might through its support behind him or her. But that is just my speculation.

We should expect something that looks a lot like Commission Model 2--restore solvency through a gradual reduction in future benefits upon retirement for those currently below a certain age, modifications of the benefit formula to better protect survivors and career low-earners, and a voluntary option to divert some amount (e.g., 4% of earnings up to an indexed threshold like $1000) of payroll taxes into personal accounts.

(2) Assuming arguendo that the current reports of the likely Bush proposal - i.e., merely diverting a portion of current social security taxes to private accounts, without other reforms - do you favor such a reform (as opposed to doing nothing for now)? As suggested by the above comment, wouldn't such a proposal just make the short and medium term (2018) problem worse, without making the long term problem (2042) much (if at all) better?

If it is literally diverting some portion of the payroll taxes to personal accounts with no change in the benefit formula (beyond prorating it for the portion of taxes diverted), then I do not favor that, because solvency is not restored simply by that diversion of funds.

Assuming it is Commission Model 2 (as described above) and assuming that it is all debt-financed, then it does meet my main requirement of restoring solvency. We know the $10.4 trillion hole is plugged because, over the 75-year projection period, the annual deficit is reduced to zero and the transition debt is repaid. (This is what Chapter 6 of the Economic Report of the President showed for this reform assuming 100% voluntary participation.) It clearly makes the long-term financial problem smaller. If this is what is proposed, then I do favor it over the status quo.

In fairness to the Commission, its report did not specify that the transition should be debt-financed. They left this as an open question for policy makers to answer. I think they recognized what debt-finance would do to the short- and medium-term unified budget deficits. None of us are sure what would happen to interest rates if an implicit debt (unfunded obligations of an entitlement program) of $10.4 trillion were eliminated but explict debt (Treasury bonds held by the public) were increased by a few trillion before being repaid. And, as we went through before, the Administration hasn't proposed doing exactly that. For example, I have heard suggestions like allowing people to establish personal accounts only if they will contribute some of their money out-of-pocket (e.g., if you contribute an extra 2% of your payroll up to $500, then you can divert 4% up to $1000). I expect a lot of suggestions for how to bring in more revenue to come up in the legislative debate about any reform that the Administration proposes.

Max Speaks, and He Listens and Replies

Max Sawicky kindly (and constructively!) responds to my recent post about whether we need to reform Social Security today. His original statement began:

There is absolutely no reason at present to make changes in Social Security, except out of political fear of the Right.

As I noted, first in "Why is Social Security a Campaign Issue?" and then again in the post to which Max is responding, my reason is that we make the problem about $300 billion worse every year that we delay. This is roughly the interest that we accrue on the unfunded obligation of $10.4 trillion in a year when the real interest rate is 3 percent, as in the 2004 Trustees Report's long-term assumptions.

I should reiterate that my preferred solution--raising the age of full benefit entitlement (with some other modifications) for future beneficiaries--does not require new funds to flow into the system today (or ever). And there is no need to do that immediately, except to give people as much time as possible to react to the new law and plan accordingly. If we don't mind giving them one fewer year of notice, then I don't suspect that we would mind enacting the same reforms to plug a $10.7 trillion hole tomorrow rather than a $10.4 trillion hole today. But taking a "wait and see" approach does not strike me as sound fiscal management.

In addition, to the extent that the reforms will include raising revenues in the near-term to provide investment returns to support benefits in the future (whether through personal accounts or the Trust Fund), then delay does have distributional consequences across different age cohorts. According to the way Social Security played out in this year's campaign, neither side was willing to ask more of or give less to those cohorts who are "at or near retirement." If an additional year of delay means one more birth cohort crosses the threshold of being "at or near retirement," and thus exempt from its share of filling the $10.4 trillion hole, then we should reform sooner rather than later.

I don't think Max and I disagree about the math underlying this calculation, but we do disagree about how relevant it is. Max writes:

I don't get excited about measures of the present value of unfunded liabilities from now till forever because I think they are jive. It's a way of ginning up a huge number. If you want to do that, compare it to the present value of GDP.

Fair enough. In "How to Reform Social Security, Part I," I noted:

Once new revenues are being added to the system, then it becomes important to figure out where they should go--the Trust Fund or personal accounts.

Confronted with that choice, I opt for personal accounts. For me, an immediate and permanent contribution of 3.5 percent of taxable payroll into personal accounts for all workers, in addition to the 12.4 percent payroll tax that they and their employers already pay, is preferable to the current system. The contributions are 3.5 percent because that is the amount that the Social Security actuaries say is required to restore solvency even if invested entirely in Treasury bonds. But such a reform, though preferred to the current scenario, is also far from ideal.

The 3.5 percent figure is roughly what Max is asking for in the way to make the comparison. (The small difference is that taxable payroll is projected to fall by about 5 percentage points relative to GDP over the next 75 years.) Max and I can differ on how much confidence we have in the Social Security actuaries' projections. The Trustees Report does contain some sensitivity analyses and additional projections that factor in uncertainty, but not on these two measures. The latter projections do suggest that there is essentially no chance that the system won't be running annual deficits in 75 years. Factoring in the uncertainty suggests to me that there is more, not less, of a need to act sooner rather than later.

Max also wonders:

One thing that is baffling about this whole privatization campaign is why a knowledgeable person like Andrew would prioritize the 2042 problem over the 2018 problem. The latter date is of course about when income tax revenue will be needed to redeem obligations to the Trust Fund and, by extension, Social Security beneficiaries.

In fairness, I have never thought of this as a 2042 problem, or even a 2018 problem. (That was, if I recall, the third paragraph in this post by Max.) To me, it is a 2004 problem that I don't want to mushroom into an even bigger problem, in 2005, 2018, 2042, 2080, or any year at all. Entitlement programs should be projected to be in balance--period. Accomplishing that requires changes in the programs in the future (if not the present). Those changes should be debated and legislated sooner rather than later, so that the changes can spread the burden as evenly as possible across cohorts.

Max concludes with some statements about the politics of reform:

As far as politics goes, you can hardly blame the Dems for declining the opportunity of leading with their chins with tax increases and benefit cuts, in the face of a hugely fiscally irresponsible Administration.

What does he mean? Of course I can blame them, like I did here. And I can also try to point them to "Democrat-friendly" reforms like the Diamond and Orszag plan, like I did here. Social Security's unfunded obligations are not a creation of the Bush administration and have been widely discussed for over a decade. The Democrats and Republicans alike have had ample opportunity to behave responsibly on entitlements. Some have, but most have not, and the sooner the first group can prevail, the better off we'll be.

Justifying and Administering Personal Accounts

A comment on my last post suggests that, with personal accounts, the devil is in the details. That is true, and the broader point is also true: people who advocate for personal accounts should specify exactly how they would work.

Let me begin by explaining why I think personal accounts are necessary if Social Security's future deficits are to be prefunded. Here are some background numbers. The 2004 Trustees Report projects that the annual deficit will be 6 percentage points of taxable payroll in 2080, that taxable payroll will be about 34.2% of GDP that year, and that GDP in 2004 is about $11.544 trillion. When the Social Security actuaries evaluated the President's Commission's reforms that included equity investments, they use an expected return of 6.5% for the equity component and 4.6% for the whole portfolio, net of investment costs of 30 basis points.

Okay, so if we want to close a gap equal to 6 percentage points of taxable payroll with investments earning 4.6 percent, then we need a portfolio that is equal to 6/4.6 = 130% of taxable payroll at that point to support the beneficiaries. If we had such a portfolio today, it would be 1.30*0.342*11.544 = $5.1 trillion. I think that a portfolio of that size is too big to be managed centrally by the federal government and thus requires decentralized, private management. To put it in perspective, the Investment Company Institute reports that the total of all mutual funds was $7.6 trillion in September 2004.

What about the details? The commenter asked for a reference. The best book that I have seen on the issue of how to administer the accounts is this one: Administrative Aspects of Investment-Based Social Security Reform. Based on what's in that volume, as well as discussions with others and my own research, here's how I would answer the commenter's questions:

How do you propose that the accounts will be managed?

We establish a clearinghouse at the Social Security Administration that keeps track of one extra piece of information--the individual worker's choice of fund management company. As payroll taxes are collected, the relevant portion of each worker's payment that goes to the personal accounts is allocated to the fund company. This takes care of most of the record keeping linking the Social Security system to the accounts. Seems like this is just a spreadsheet with millions of rows and just a few columns.

Under what costs controls, be they fees to private companies or something else?

To be eligible to be a fund management company for this system, each financial institution would have to provide at least one low-cost, diversified option similar to the Thrift Savings Plan for federal employees. This would be the default option at each institution. Investors could voluntarily choose to move their money into more actively managed funds, which charge higher fees, but the low-cost option has to be available. They can change fund management companies by changing their election on their employment forms.

How will investment decisions be allowed? What investment opportunities will be offered to me?

Similar to 401(k) plans that do not invest in company stock, not IRAs or brokerage accounts. All investments must be in diversified mutual funds.

What will be rules be for taking money out of the accounts once I'm at retirement age?

My preference is mandatory annuitization, but I think this depends on how solvency was restored to the traditional system. If that occurred by raising the normal and early retirement ages, then the rules here can be more flexible, because the late-in-life payments going to the oldest beneficiaries will have the same generosity as under current law. If solvency was restored by a reduction in per capita benefits (like what is suggested in Commission Model 2), then we need stricter rules about annuitization.

I couldn't begin to list all the issues here.

I agree. The one thing that you didn't mention that is always a sticking point is the presence of small accounts, by low-income earners and teenagers and others who currently pay a small amount of payroll taxes to the current system. The clearinghouse mentioned above should simply hold these contributions and accumulate them at the Treasury rate until the account is sufficiently large (maybe $5,000) as to be of interest to financial institutions.

Social Security Reform in the Blogosphere

Beginning with this post, I explained why I think Social Security should have been an important campaign issue and why I believe that the President and Congress must work to reform it. The thrust of the argument is that there is currently a $10.4 trillion hole in the system's finances, and, by not reforming the system, that hole grows bigger each year.

In a post yesterday, Max Sawicky writes:

What would I do, supposing 2042 approached and circumstances were as they are currently projected? I would do a combination of payroll tax increases, increases in the retirement age (ideally voluntary, and with adequate advance notice), a slowdown in benefit indexing, and some general revenue infusions. There is no need to do any of this for some time. (There will be a need for tax increases over the next ten years to redeem debts to the Trust Fund.).

I commend the whole post to your attention, not because I agree with all of it, but because it does clearly state (in this paragraph most of all) the rationale that many on the political left (like Congressmen Matsui and Rangel) have used to delay reform.

The part that is disagreeable to me is that I think Max doesn't fully appreciate (or, at the very least, articulate) what he would find in 2042 if he waited to reform the system. (He says 2042 "approached" rather than "arrived," but for the sake of argument, I'll assume he does in fact wait until 2042.) Here are two ways to characterize the circumstances projected for 2042:

1. The annual cash flow deficits. According to the 2004 Trustees Report, Social Security is projected to run annual deficits of 4.5 percent of taxable payroll in 2042. Over the subsequent four decades, those deficits are projected to widen to 6.0 percent of taxable payroll. So if Max waits, this is the problem he faces in 2042. (To put these in perspective, note that in 2004, taxable payroll is $4.522 trillion, these deficits would be $203 and $271 billion, respectively, if we were running them today.)

2. The unfunded obligations. The 2004 Trustees Report also tells us that the present value of unfunded obligations is $10.4 trillion, using a long-term real interest rate of 3 percent (based on a nominal interest rate of 5.8 percent and a CPI inflation rate of 2.8 percent). If Max waits to reform the system, then the unfunded obligations compound at about 3 percent for 38 years, leading to unfunded obligations of roughly 10.4 x (1.03^38) = $32.0 trillion in 2042.

As I have stated before, the Diamond and Orszag plan is a much better strategy for people on the political left to adopt. They do several things that Max discusses, except that the Diamond and Orszag plan starts doing them sooner rather than later. This is a substantially fairer way to spread the burden of plugging the $10.4 trillion hole, while it is 90 percent of GDP, before it gets to be a $32 trillion hole (141 percent of a much larger GDP). How would you feel if, with the foresight that we have about the demographic factors that will cause the future deficits, policy makers 38 years ago decided to punt on reform, causing you to now have to pay payroll taxes of 16.9-18.4 percent rather than 12.4 percent?

The trouble in this debate is that the people on the political right seem to want to lead with the personal accounts rather than the solvency issue (even though Commission Model 2 achieves both). My fear is that, in the process of making this an issue, we'll get the personal accounts without restoring solvency. The people on the political left are so terrified of personal accounts that they refuse to enter any debate constructively. The Diamond and Orszag plan now stands out as an exception, but, as I noted in the original post on that plan, no Democrats on the Hill have mustered the political courage to advance it legislatively. More typically, we find the attitude that Max has expressed--we can cross that bridge when we come to it. I think that argument does not adequately consider how the size of the problem grows if we wait to address it. Maybe Max will favor us with the magnitudes of the various changes he would suggest as 2042 approaches.

Elsewhere in the blogosphere, Brad DeLong has posted on the circumstances under which he might "accept" personal accounts as part of reform, commented on the post by Max, and linked to some posts by Duncan Black at Eschaton that show some of the political left's misgivings about personal accounts per se.

Some loose ends that I have yet to tie together on this issue, and thus hope to address in future posts: some measures that could be imposed on the personal accounts that might allay the political left's fears of including them in Social Security reform, the relationship between the tax cuts and the underfunding of entitlement programs, and the even more serious problems with Medicare (including the new prescription drug benefit).

Econoblog at the Wall Street Journal

Two of the economics profession's best bloggers are paired up at the Wall Street Journal this week: John Irons of Argmax for the liberal point of view and Tyler Cowen of Marginal Revolution for the libertarian point of view. Their first topic is Social Security, and Tyler references a couple of my earlier posts (and as an excerpt, here) to support his arguments.

This is a great idea for an online forum by the WSJ. At the bottom of the page, the topic for tomorrow's discussion is listed as "outsourcing and its effect on global trade." This must be a typo--the first order concern is not about impact of outsourcing on global trade per se. What we care about is the impact of both global trade and outsourcing on the level and distribution of consumer welfare. I suspect that's how the discussion will go.

Howard Dean and the Democrats

This evening, the Rockefeller Center was fortunate enough to host Howard Dean to share his reflections on the 2004 election and prospects for the future. In my introduction of him, I made three points:

1. There seems to be a perception among Democrats that the President won the election primarily because of divisive social issues that play well only in the so-called "red" states. That hypothesis cannot explain Republican gains in the popular vote share even in states where those social policy issues played little role in the campaign. See my earlier post on how Bush ran better against Kerry than he did against Gore in New York, New Jersey, and California, as well as several states he carried in both years. Something deeper is going on here, and the Democrats will have to figure it out if they want to improve their positions in future national elections.

2. I reported the rather astonishing fact, discussed in this post and comments on Coyote Blog, about what will happen in 2008. Assuming that President Bush and Vice-President Cheney finish their next term (and that Cheney decides not to run in 2008), this will be the first election since 1952 in which neither party will have an incumbent President or Vice-President at the top of their ticket. Ideally, the two parties will both have wide open primaries. All Americans have an interest in making that primary system work: encouraging an array of interesting people to run, allowing them the opportunity to connect with the voters, helping them to constructively distinguish themselves from each other, and sustaining them in the race long enough so that everyone--whether in New Hampshire or California--has the opportunity to vote in a contested primary. In my view, the Democratic primary ended too early this year, as did both primaries in 2000.

3. I am truly tired of seeing that red and blue electoral map and the politics of division that it conjures up. Our national motif is a melting pot, not three islands of blue floating in a sea of red. A Party's success in winning a Presidential election is based on how large a coalition it can assemble. Among all of the Democratic candidates vying for the nomination this year, only Governor Dean seemed to understand how the Democrats could win. In a statement he released about a year ago, he said: "The only way we're going to beat George Bush is if Southern white working families and African-American working families come together under the Democratic tent, as they did under FDR."* Governor Dean understood that the way back for the Democratic party is to form the "grand alliance" between poor whites and poor blacks that Martin Luther King, Jr. envisioned decades ago. If the Democrats want to win in 2008, this seems to me to be their biggest challenge.

I don't know if Governor Dean would have been a more successful challenger to President Bush than was Senator Kerry or that I would have voted for him in that contest. But that's the election that I would have liked to have seen.


*As an aside, you may recall that Governor Dean said this after being attacked by his rivals for saying, "I still want to be the candidate for guys with Confederate flags in their pickup trucks." This story provides a pretty good summary. If the Democrats want to understand why they are losing their grip on nationally elected office, they might consider that, instead of the candidate who understood the problem and tried to articulate it, they nominated the candidate who generated this press release:

"Howard Dean is justifying his pandering to the NRA by saying his opposition to an assault weapons ban allows him to pander to lovers of the Confederate flag. It is simply unconscionable for Howard Dean to embrace the most racially divisive symbol in America. I would rather be the candidate of the NAACP than the NRA."

I don't want to make a career out of dissecting Senator Kerry's press releases, but the similarities are just creepy:

1. Dean hasn't pandered to the NRA. He served as Governor of a state in which many people are responsible gun owners. This led him to believe that gun control could be dealt with at the state level.
2. Dean wasn't pandering to lovers of the Confederate flag. As William Saletan nicely put it in Slate, "He wants the votes of these people despite their fondness for the Confederate flag, not because of it."
3. Dean was not embracing the Confederate flag. That is clear in every context in which Dean made the statement. What is unconscionable is Senator Kerry's suggestion to the contrary.
4. Senator Kerry might rather be the candidate of the NAACP than the NRA, but if he wants to be elected President as a Democrat, he will need to provide both groups with a reason to vote for him.

Whither America after November 2, 2004?

I had the opportunity to participate in a panel discussion with the same title as this post this morning. It was sponsored by the Institute for Lifelong Education at Dartmouth (ILEAD). My charge was to discuss the domestic policy challenges facing the Bush administration in its second term. A brief summary of those challenges was published in the Dartmouth faculty and staff paper:

On issues apart from the War on Terror, a second administration for President George W. Bush will be entirely about fiscal policy. The president has gained little traction on new initiatives outside of the budget, like education, job training, and immigration reform. He will need to achieve three fiscal policy objectives.

First: make good on his promise to cut the budget deficit in half between 2004 and 2009. If he doesn't do this, regardless of the circumstances (e.g., the war and inflation), then he validates criticisms of fiscal recklessness that will stick to his party. This objective limits the extent to which he can make his tax cuts permanent.

Second: achieve a bipartisan reform of Social Security that restores the program to long-term solvency. This was a campaign issue in 2000, and the subject of a pre-9/11 commission, but it has not progressed significantly since.

Third: recognize that the unfunded obligations of Medicare are even larger than those for Social Security. He also has to pursue structural reforms of Medicare that reduce its future claims on general revenues.

Running Up the Score

In the aftermath of the 2000 election, when the disparity between the popular vote and the electoral college proved troubling, one quote from the President stuck out in my mind. I found it here in Time magazine's interview with him when he was chosen "Person of the Year" for 2000:

TIME: Are you concerned that Al Gore got more of the popular vote than you did?
BUSH: Not really. If you had told me 15 months ago, "You're going to be judged on who got the most popular votes as opposed to the electoral count," I suspect you'd have seen us run a different campaign. For example, I might have spent more time in my state of Texas trying to run up the score.

The website www.electoral-vote.com keeps track of the popular vote margins by state for the 2004 and 2000 elections (click on the Excel spreadsheets to see the raw data). Looking at all 51 contests, the President's share of the popular vote fell in only Vermont and Wyoming relative to his share in 2000. Some of that is due to the decline in the Nader vote in the two elections (which improved the shares of both the Democrat and Republican). So let's compare the change in the President's share relative to the Democratic opponent's share in the two years (i.e., (Bush - Kerry) - (Bush - Gore)).

The President failed to improve his relative share of the popular vote in the following 16 contests: Alaska, Colorado, DC, Maine, Minnesota, Montana, Nevada, New Hampshire, North Dakota, Ohio, Oregon, Vermont, Virginia, Washington, Wisconsin, and Wyoming. These contests allocated only 111 out of the 538 electoral votes.

The President narrowed his popular vote loss or widened his popular vote win in the other 35 contests. Interestingly, he improved relative to the Democrat in Texas by only 1.7 percentage points. Several other states made large contributions to his improvement in the relative share of the popular vote, including New York (+7.0), Florida (+5.0), New Jersey (+8.8), California (+2.2), Tennessee (+10.1), Georgia (+6.3), and Alabama (+10.8).

New York and California seem like unusual places for the President to have narrowed his popular vote deficit. Doxagora presents some calculations based on exit poll data that suggest significant pickups in big and small cities, with smaller improvements in suburbs and no improvements in small towns and rural areas. This pattern is contrary to what we might have expected.

Are these improvements in the relative share of the popular vote relevant for how the 2004 election turned out? Maybe not, but consider whether the deliberations inside the Kerry camp about whether to pursue litigation in Ohio or other close contests would have been different if Kerry held a small lead or faced only a small deficit in the total popular vote margin, rather than a 3.5 million deficit.

I conjecture that in future elections in which the electoral college outcome is projected to be close, candidates will independently seek a high popular vote count--even in states not perceived to be battleground states--to set themselves up in a favorable position to pursue or defend lawsuits. It may be that the Bush-Cheney campaign did exactly that in 2004, so quietly that no one really noticed until Tuesday night.

Social Security in the President's Press Conference

There were some encouraging statements about Social Security reform this morning from the President's press conference. Here's the first question on the subject:

Q Thank you, sir. Mr. President, you talked once again this morning about private accounts in Social Security. During the campaign you were accused of planning to privatize the entire system. It has been something you've discussed for some time. You've lost some of the key Democratic proponents, such as Pat Moynihan and Bob Kerrey in the Congress. How will you proceed now with one of the key problems, which is the transition cost -- which some say is as much as $2 trillion -- how will you proceed on that? And how soon?

THE PRESIDENT: Well, first, I made Social Security an issue -- for those of you who had to suffer through my speeches on a daily basis; for those of you who actually listened to my speeches on a daily basis -- you might remember, every speech I talked about the duty of an American President to lead. And we have --we must lead on Social Security because the system is not going to be whole for our children and our grandchildren.

And so the answer to your second question is, we'll start on Social Security now. We'll start bringing together those in Congress who agree with my assessment that we need to work together. We've got a good blueprint, a good go-by. You mentioned Senator Moynihan. I had asked him prior to his -- to his passing, to chair a committee of notable Americans to come up with some ideas on Social Security. And they did so. And it's a good place for members of Congress to start.

The President must have the will to take on the issue -- not only in the campaign, but now that I'm elected. And this will -- reforming Social Security will be a priority of my administration. Obviously, if it were easy it would have already been done. And this is going to be hard work to bring people together and to make -- to convince the Congress to move forward. And there are going to be costs. But the cost of doing nothing is insignificant to -- is much greater than the cost of reforming the system today. That was the case I made on the campaign trail, and I was earnest about getting something done. And as a matter of fact, I talked to members of my staff today, as we're beginning to plan to -- the strategy to move agendas forward about how to do this and do it effectively.

Here's what I wrote toward the end of my post last week:

I believe that the President should submit some plan to Congress that restores the system to solvency--whether the Commission's Model 2, another plan that has been scored by the actuaries, or something better--to restart the bipartisan reform process.

Let's hope the White House follows through, that there is a bipartisan willingness to engage on the issue in Congress, and that progress is made as soon as possible.

Amendment 36 in Colorado

One of the more interesting state ballot initiatives yesterday was Colorado's Amendment 36, which would have split the state's 9 votes in the electoral college based on the state's popular vote. The amendment failed pretty dramatically (almost 2-to-1), as reported in the Denver Post. Most analysts figured that the current configuration of voters in the state would generate 5 to 4 splits on a reliable basis. This, in turn, would take Colorado off the political radar screen, first in the Presidential election and second in the state's Congressional delegation's clout with the White House.

Colorado is a medium-sized state that is currently receiving attention in the electoral college. Smaller states would probably do the math the same way, even if they are more safely in one party's camp or the other. Would Wyoming or Vermont receive more attention nationally by adopting such an allocation rule? Probably not--they could go 2-to-1 rather than 3-to-0. Larger states currently receiving attention, like Florida, Pennsylvania, and Ohio, would also not benefit from a switch.

But what about California, Texas, New York, and Illinois--all of which went by 10 or more percentage points to one candidate or the other? In Texas or New York, for example, an electoral vote would be awarded for roughly every 3 percentage points of the popular vote. With advanced polling information, how much of the state would really be in play enough to attract national attention during a given campaign? Maybe 2-5 electoral votes in each election. Not all that much to gain in terms of national attention, but certainly it would have made as much sense for California to get the same attention that, say, New Hampshire did this time around.

What the electoral college does is to reward states that are closely divided with national attention, in proportion to the size of the state and the closeness of the race. If those divisions happen to mirror the divisions in the nation as a whole, then that's probably not such a bad way to carve up the Presidential race. If California switched, it would get more attention immediately, but it would lose the opportunity to get much more attention in some future year when it is more closely divided in its popular vote.

Bottom line: I don't expect too many more of these ballot initiatives to appear, interesting as they are.

Yes, You Should Vote

There have been two interesting threads in the blogosphere of late about whether people should vote. The first, being carried out at Marginal Revolution and other sites, concerns the cost-benefit approach to voting, which is based on the idea that I should only vote if there is a sufficiently high probability that my vote will break a tie (and that the personal benefits of breaking that tie in my favor exceed the personal costs of casting the vote). With regard to these mathematical discussions, I can only add that there are always multiple races being decided on each ballot. So the relevant probability is that you will be the deciding voter in any of the races, not just the top one for President. That improves the mathematical case somewhat.

The second thread started a couple of weeks ago, with the interview that Trey Parker and Matt Stone gave to Salon.com in which they responded to an open letter from Sean Penn criticizing their movie (Team America). According to Stone:

"All we ever said was that we thought that uninformed people should not vote -- on either side of the political spectrum. It doesn't matter who you're gonna vote for. If you really don't know who you're gonna vote for, or are uninformed, or haven't really thought about it? Just stay home."

So now the question becomes, should you vote even if you are uninformed? In my opinion, the answer is yes, particularly among young voters. According to the Census, for the November 2000 elections, the number of voters was equal to about 59 percent of the number of the U.S. citizens age 18 and over. The ratio was only 36 percent for those 18-24 and rose with age to be over 70 percent for those 65 and over.

I conjecture that if a cohort demonstrates that it will overcome the personal costs of voting, then it will attract resources from the federal government. The elderly turn out to vote, and we have enormous (and underfunded) entitlement programs for the elderly. These two facts are not unrelated. Would Social Security and Medicare really have developed into the programs that they are today if the 18-24 year old cohort had a 70 percent turnout and the 65+ cohort had a 36 percent turnout? I think not. Imagine if student loans were the "third rail" of American politics.

I am not advocating that people should keep themselves uninformed or that they should think of voting as a way to redistribute resources toward themselves. I think that greater voter turnout, particularly among the young, would add some balance to the way the elected officials pursue their policies.