Friday, December 16, 2005

Answering Questions on the LMS Plan

Feedback on the Nonpartisan plan has been very thoughtful in general. I want to use this post to pick up on some themes in the comments on the previous two and some issues raised elsewhere in the blogosphere.

1) Mandatory Annuitization

I view this as an important piece of the plan. The explicit purpose of Social Security is to provide insurance against outliving your assets in retirement. An annuity is the appropriate payout vehicle for this purpose. That's why the plan insists on full annuitization by age 68 in the form of joint and survivor annuities indexed to inflation. We allow for 10-year certain annuities. We have nothing against bequests--we just don't think they are fundamental to Social Security.

2) Our Fiscal Priorities

Several folks have commented that the costs of health care (Medicare and Medicaid, and presumably for everyone else too) and the General Fund deficit are more important than Social Security. I certainly agree with the first, and I don't want to minimize the importance of the second, even if I were to argue that it is not as critical as Social Security. So the question becomes, "Do you solve the easiest problem first, or do you solve the largest problem first?" My answer is that if I could solve the largest problem first, I would. I don't think I can do it, at least not in a way that would gain political traction. See the critique here, and some replies here and here.

3) Around the Blogosphere

Nice mentions of the plan over at Asymmetrical Information (which sent a ton of traffic), The Sacramento Bee's blog (ditto), EconLog, Macroblog, Joe's Dartblog, News and Analysis, Outside the Beltway, and Just One Minute. There were some questions raised in two places that I'd like to address:

a) PGL over at AngryBear writes:

The second comment draws from “no transfers from general revenues to achieve sustainable solvency”. Is the converse part of their plan. My main concern with the Bush Administration (beyond their brazen dishonesty enabled by the Cato crowd) is that their real agenda is to transfer funds from the Social Security Trust Fund to reduce the massive long-run General Fund insolvency issue – what I’ve dubbed a backdoor employment tax increase. I hope Dr. Samwick joins me in also saying that this type of transfer should be off the table.

It's way off of my table. It's not in the kitchen. It's not in the house. We can't even see it from the porch. For example, I have been very disappointed at the continued use of the unified budget (conditional on Social Security being in surplus) as the target for policy. I posted this a year ago. I also couldn't follow the money on the GROW accounts proposal in June. I don't share PGL's view of the "real agenda," but I do believe that we are unlikely to get much budgetary improvement until we hold the federal government to either of two fairly easy to specify targets: a balanced on-budget deficit over the business cycle, or no upward trend in the debt/GDP ratio (including anything held by Social Security).

b) Over at Economist's View, Mark Thoma wants more information. Go read his post and come back. I'll address his questions in order, with my paraphrasing:

i. Is it really a problem? Yes, I think so. The problem is mainly one of demographics. Absent a pandemic that selectively wipes out the Baby Boomers but not their children or an immediate end to contraception, I don't see how the demographic burden doesn't increase by enough to make this a problem. In fact, I share the view that the likely improvements in mortality are understated in the projections. I also believe that the actuaries are projecting too little productivity growth in the long term (which would improve the system's finances), but I don't think we can honestly project that we will grow our way out of this.

ii. Does increased life expectancy translate into increased working years? I am sympathetic to the point that the answer is "not necessarily." I think that any reform that lowers the benefits to retirees while trying to hold disabled beneficiaries harmless has to expect an increase in the number of folks applying for and receiving disability benefits. I would appreciate any links to sources that can quantify the answer to this question.

iii. Is a program for the poor destined to be a poor program? This worried Jeff to no end in our discussions. Out of respect to his concerns, the plan contains more benefits at the higher end of the earning distribution than I would have liked. The bottom line is that the changes made have to be progressive--I would have preferred more of that to be in the form of benefit reductions than tax increases. I think Jeff would have preferred the opposite. Poor Maya sometimes couldn't figure out which of us was which. That's what makes a compromise. You can see the actuaries' projections here (last 4 pages).

iv. Why not hold the investment risk centrally? Yes, the answer is perhaps in the realm of the philosophical. I'm not going to allow the federal government this much ownership of private assets. I recognize that this is an accounting cost that we have to pay. It is worth every dime, conditional on the rest of the plan.

v. How can you trust the current federal government to do this? I don't share the underlying skepticism. The main point of the exercise was to encourage a coalition to form from the center and move progressively outward in both directions. The lack of trust is, in my view, between the midpoints of the two parties, which are in fact very far apart. But we are willing to stake the success of the plan on the presumption that there are a lot of people in the center who don't distrust each other, or those who would be added to the coalition as it moves out from the center, and who want to see some judicious reform enacted. If we guessed wrong, then the plan goes nowhere.

Thanks for all of your feedback and comments.

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Anonymous said...

In regards to the personal accounts: it might be worth considering a "flexibility" component to the new 1.5% contribution that is incremental and required. For example, maybe people should be able to opt out of this 1.5% for a relatively short period of time (e.g., 3 years maximum during a working lifetime). Opt out would allow a worker to keep the 1.5% for other purposes (e.g., start a business, pay off debts, etc).

PGL said...

You have indeed been properly concerned about solvency of the General Fund. When I said the real agenda, I did not mean YOUR agenda but the real agenda of President Bush - at least as far as I see it. Maybe I'm too hard on this President. But tell me - how can we ever reduce the General Fund deficit without reversing those tax cuts - unless the plan is to rob from the Soc. Sec. Trust Fund. The math just don't add up.

Anonymous said...

I am in opposition to this plan. Your premises are preconceptions that (1) Social Security is going to be a big problem, that (2) it is the easiest thing to solve of all the fiscal problems, that (3) your solution doesn't cause another problem, and that (4) an underlying problem (i.e. politicians won't act responsibly,) is unaddressable. NONE of these premises is necessarily true.

See for a nifty animated financial flow-chart and dastardly polemic entitled "Social Security: The Real Connections."

Beyond that, we are talking about a extraordinarily simple compact and transfer, with minimum moral hazard, avoidance of social stigma, and avoidance of political division among retirees. Yet it keeps lots of retirees (half of them) out of poverty. It's nice to know the actuarial projection, but that is not cast in stone; and anyway exactly why does Social Security have to be "solvent?" (To save your fiction that our economic system works entirely properly?) Why is "smaller government" necessarily a good idea, in this case?

I am particularly concerned about the logic of the "personal" accounts. How is forcing everyone to do one thing, different than forcing them to do another? If people opt-out of having an account, can they stay with the old guaranteed system?

Furthermore, as seen along with the current confusion over the new Medicare drug benefit, the mandated accounts will incur a host of extra transactions costs (search and information costs, bargaining and decision costs) and these costs will continue through life. You are not making Social Security solvent, you are mostly relocating the costs. For private individuals these transactions costs are usually in nonmonetized consumption of time and mental application, and could be unquantifiable, but that does not mean they are insignificant. I would venture that millions of people don't understand financial markets, many of them do not care to, and many of them couldn't. Can a more complicated system, with more and continuing transactions costs, have a better benefit/cost ratio than the present simpler system?

Moreover, politically, how are you going to prevent people cashing-out or borrowing against their "personal" accounts, in the next painful recession? Will you restrict their freedom? Or consider the third type of transaction costs, policing and enforcement costs, mostly by the government: If you can't even elect a decent leader to run a decent budget, (the fourth of the automatic preconceptions of the present issue,) how are you going to protect us from the Wall Street lobby's endless efforts to capture the new system?

And who is going to bail everybody out after they lose in recession and swindle, and how much is that going to cost?

This proposal seems to lack a view of the big picture. Why not make everything else "solvent," first? Because you are "unable?" Why does every old retiree, poor AND rich, say "leave Social Security alone?" Do they perhaps know a bit more than thirty-year-olds about the "realm of the philosophical?"

In addition, I just absolutely loathe to inject politics into a non-partisan discussion, but conservatives cannot continue to bemoan the moral hazards for some of our leaders under the hypothesis of public choice, and then continue to support precisely these people at the ballot box.

Anonymous said...

"In order to keep people fully employed, governments have to run deficits when the economy is slowing."

So writes Robert Reich on Keynes.

The deficits from the early 2000s offset overall economic slowdown in the U.S.

Lee Arnold: would have preferred a worse economy in year 2001-2003, with more people thrown out of jobs?

Anonymous said...

I don't know what that comment follows upon or why: no one prefers a worse economy. Perhaps you looked at "The Bush Tax Cuts" movie (scroll down the page at and didn't follow the argument. I suppose it may do no good to point out that the consensus of economists appears to be that a short-term consumer-oriented tax cut would have helped more households sooner, put more people back to work sooner, and then would lead to business investment once capacity is re-utilized, --all as in the usual case--, without the extraordinary deficits we now have.

Anonymous said...

"Lee Arnold: would have preferred a worse economy in year 2001-2003, with more people thrown out of jobs?"

Good point Lee. This admittedly may have implied a false dichotomy. I did not mean to infer that Lee wanted people to lose jobs or have a deeper recession. It was a little bit of an exagerration. Lee makes good points that there may have been other ways to make the economic slowdown less of a slowdown.

I have found your movie to be very helpful in understanding government budgets. Thank you and nice work!

Arun Khanna said...

Good job. I hope you succeed in influencing inside the Beltway crowd.

dearieme said...

"Mandatory Annuitization" - entirely sensible, but a widely and deeply loathed feature of the equivalent British pensions.

Anonymous said...

There is a very basic dictum in engineering:
Keep It Simple.

And the dictum in chess when you have no hope to win by normal means is just the opposite: Move to Complicate.

These dicta have a common root. When you keep a system (or a chess gambit) simple, it's easy to see how it works, what's wrong when it doesn't, and what really needs to be changed to make it work right. When you're trying to build something that works, that's exactly what you want. When you're trying confuse your opponent into a wrong move, it's exactly what you don't.

The Social Security system works so well exactly because it's simple. Are changes needed? Probably they are, and with the current system it's easy to see just what we need to do: Raise the tax rates, cut payment levels, raise retirement ages, or some mix of these. The only way for the Wall Street wise guys found to game the system was to create a Trust Fund that turned a quarter of our FICA contributions into a concealed regressive income tax surcharge. (An excellent example of how complicating a system is harmful -- how many Americans really understand that?)

These counterproposals amount to nothing more nor less than falling prey to a Move to Complicate strategy of the forces of evil.

Were talking engineering here. Keep It Simple!

JG said...

"The Social Security system works so well exactly because it's simple."

Indeed it is simple. Cohorts of retirees 1940-2000 get $10 trillion more in benefits than they put into the system, and are made more wealthy by it.

Cohorts of retirees post-2000 get back $10 trillion less than they put in, and are made poorer by it on a lifetime basis.

Nothing could be more simple, it's arithmetic. The system worked "so well", --i.e., was so politically popular -- in the past just because of that.

Ah, but imagine that in the past SS had given everyone $20 billion less than it actually did, and had instead made all our parents and grandparents $10 trillion poorer on a lifetime basis.

Would all be praising its "success" then, at making everyone poorer, due to its simplicity? I think the answer to that is simple. ;-) And that is the future of SS, staring right about now.

"Are changes needed?"

The changes have already occurred -- the $20 billion swing making participants poorer in the future has already begun. This is a most fundamental change, and the defenders of the status quo who won't deal with it (after all, if they face the numbers from the SS Trustees they can hardly deny it) aren't doing SS any favors.

Frankly I'm befuddled why so many people think coming up with a formula to close the current funding gap will solve its problems as if enshrining a very bad deal in a permanent formula will make it popular.

The key to "saving" SS as we have known it in the past is giving people positive total returns on contributions -- and that's why private accounts are important. Else its current form is politically doomed in the long run.

Positive returns in even modest private accounts can offset negative returns from the rest of the program, so people get back at least as much as they put in -- like they did in the past! -- preserving its political viability.

Even the Swedes know that, with their private accounts. It's simple.

But Swedish social policy -- it's too right-wing for US Democrats. ;-)

Anonymous said...

Paragraph i: "Absent a pandemic that selectively wipes out the Baby Boomers but not their children or an immediate end to contraception, I don't see how the demographic burden doesn't increase by enough to make this a problem. In fact, I share the view that the likely improvements in mortality are understated in the projections. I also believe that the actuaries are projecting too little productivity growth in the long term (which would improve the system's finances), but I don't think we can honestly project that we will grow our way out of this."

Paragraph ii: "I would appreciate any links to sources that can quantify the answer to this question"

Me too, at least as applied to "I don't see" "I share the view" "I also believe" "I don't think" and "honestly believe". The plural of anecdote isn't data, and the plural oF Samwick's personal beliefs isn't either. You bother not to quantify "demographic burden" or "improvements in mortality" nor to offset them by "too little productivity growth" yet demand your opponents quantify data related to increased life expectancy. To which I will reprise a question I posed to you lo these many months ago: "Whence 3.5% Samwick?"

"You hypocrite! First remove the beam out of your own eye, and then you can see clearly to remove the speck out of your brother's eye."

Or in modern terms: Bring Numbers.

Bruce Webb

Anonymous said...

bad language and possibly offensive, yet timely:

Andrew said...


As it was before, the 3.5% number is in both Table IV.B6 and Table IV.B7 of the most recent Trustees Report.

The rest is linked in the post itself.

economides said...

This is an interesting read. It contain not so much ofs a plan as an excellent catalog of policy options.

bakho said...

If the idea is to transfer the SSTF out of the unified budget and into private accounts, why raise the SS tax from 7.5% to 9%? Why not just take the private account monies out of the 30% of the 7.5% that is surplus?

Why not just transfer all the SSTF into private accounts tomorrow? SSTF only exists on paper, but private accounts would only exist on paper, too.

I really don't see how your plan does anything more than shuffle paper. I do think that your plan would shortchange the poorest workers by transferring more of the SSTF into private accounts of the best paid workers. Why not dole out the SSTF on an equal per person basis?

What would happen to personal account money if there was some still left when a recipient died? Currently, the equivalent of that money stays in the SSTF. If you give the money to heirs, then that money will have to be replaced by taxes elsewhere in the system.

What happens if there is a major stock market bubble/collapse and people retire with negative returns in their portfolios? It will happen.

Your plan really adds up to smaller future benefits paid out by Social Security that may or may not be offset by individual retirement accounts. Since many old people run up large medical bills near the end of their life, then the lower SS benefits will make them poorer, run out of retirement savings earlier and qualify for more Medicaid/Medicare.

A critical problem is that $5.15 per h plus 7.5% employer contribution to retirement is not high enough wage for people to retire. Maybe the money for retirement accounts should come out of corporate profits paid out as dividends? A workers dividend so to speak.