Monday, October 8, 2007

Martin Feldstein on Social Security

Via Mark Thoma comes an op-ed by Martin Feldstein. Mark focuses on this:

As everyone now recognizes, the current 12.4% Social Security employer-employee payroll tax will not be enough to finance the benefits specified in current law as the population ages. Continuing to finance those benefits with a pure tax-financed system would require raising the payroll tax rate to more than 18%, or finding other ways to raise tax revenue.

Mark rebuts by turning the microphone over to Dean Baker:

The Congressional Budget Office's projections show that the program can pay all benefits, with no changes whatsoever, through the year 2046... The projected shortfall over the whole 75-year planning period is 0.4 percent of GDP, approximately 30 percent of the current cost of the war in Iraq

Besides playing the shock figure nonsense, Martin Feldstein peddles the free lunch fallacy of privatization so let me focus on this:

Unfortunately, Democratic critics argued that individual accounts would be "gambling" with the retirement savings of working men and women.

I never bought into this increased risk argument, but the flip side of the same coin is that we should not false claim there is some overall increase in expected returns as I tried to explain here by quoting Andrew Abel:

Some economists have argued that investing part of the Social Security Trust Fund in equity is simply a rearrangement of paper assets without any real allocational effects, and they have described such a policy as a “shell game.” The shell game argument is similar to the Ricardian equivalence proposition in public finance and macroeconomics and the Modigliani-Miller theorem in corporate finance. The argumentis that private investors will react to any rearrangement of the social security system’s portfolio in a way that completely neutralizes the effect of the portfolio change. For example, if the social security system sells a dollar of bonds and purchases a dollar of equity, private investors would buy a dollar of bonds and sell a dollar of equity.

Robert Barro and Gary Becker have made similar arguments. So why does Martin Feldstein think that this argument is incorrect?


Anonymous said...

with full defference to those who say that no tax increase whatsoever will be required, it is nevertheless interesting to point out that

the four percent projected increase would not become necessary until 2041. that it is 2% for the worker and 2% for the employer. that 2% of the average workers wage today is about 15 dollars per week... not a staggering burden. that by 2041 the average workers pay will have increased by 43% (using Trustees intermediate projection, the same one used to project the need for the increase in tax), or about 300 dollars per week(from current 700 to then 1000).

this would mean that in 2041 a workers payroll tax would increase about 20 dollars per week compared to what it would have been without the tax increase, on an income that is 300 dollars per week more than it is today.

moreover, rather than increase the tax all at once by 20 dollars per week, the increase could be phased in at the rate of one dollar per week each year starting in about 2030 and levelling out by about 2050.

so, if you don't mind, i and most workers cannot follow the fancy economic arguments, but we get kind of short tempered at using fancy economics and scary numbers to obscure the plain fact that we are talking about a trivial tax increase, at most.

and some of us are smart enough to understand that that money is not going into a gummint black hole but will come back to us when we need it most.

or we would be smart enough if we were allowed to hear the case made fully and honestly and clearly.

Bruce Webb said...

Gosh Feldstein can't even get this distortions right. From the 2007 Summary Conclusion of the Trustees Report.

"For example, payroll taxes could be raised to finance scheduled benefits fully in every year starting in 2041. In this case, the payroll tax would be increased to 16.41 percent at the point of trust fund exhaustion in 2041 and continue rising to 17.60 percent in 2081."

Now if he had used some phrase like "about 18%" or simply "18%" then I could cut him some slack on the lack of temporal context, but "more than 18%" seems thoroughly dishonest. It is kind of the economic equivalent to the foul of 'Piling On'.
As to pgl's point on equity investments. First we need to make clear the difference between varying returns on asset classes (which is an argument for diversification) and the argument for private accounts. There is no a priori relationship between them. Social Security could and in my view should diversify the portfolio for reasons that are partly economic but mostly political, but that does not require private accounts. I bring this up not as news to pgl or Dale but because privatizers always try to blur this point.

On the question of return I always thought the proper target of Social Security investing should be in buying State and Local Bonds. First you should get a better return than simple treasuries, local jurisdictions should be able to get a better rate, and you could eliminate both the political and economic distortions by allocating purchases by Congressional District, each of course having roughly the same population as the next.

If we froze the current portfolios in place and start directing the entire surplus, all newly accrued interest and some small fraction of the principal into a CALPERS style fund (with or without a focus on munis) we would acccomplish all of the good points of say LMS without significant economic distortion. Over the seventy five year window you could end up with a Social Security system that did not require any General Fund obligation at all.

The current system of Special Treasuries is not paricularly flawed (though you have the problem of interest on interest) but it would sure be nice to put 'phony IOU' to bed once and for all. (You get tired of explaining 'Full Faith and Credit')

Anonymous said...

i can't help pointing out that the increase from 16.41% in 2041 to 17.60% in 2081 is an increase of 1.% over 40 years or less than 3 hundedths of a percent per year. In today's terms that would amount to a tax increase of 21 cents per week, or about 10 cents for the employee and 10 cents for the employer. and of course the two decimal places are entirely justified in a prediction over the next 75 years.

so the question should be is it the case that workers 50 or more years from now are going to feel ill used by having about 10% deducted from their paychecks... which will be in excess of 50,000 per year in real value... in order to have retirements, that may last twenty or more years, funded to a level of reasonable comfort.

this is not a question we are allowed to ask them, much less try to explain to them.

nor, apparently, can we explain even to the good guy economists why it is important that the workers continue to pay for their own retirement and not ask for handouts, tax transfers, from the "rich."

nor (Orszag) why it might be insane to try to adjust "generational equity" to the third decimal place to account for an entirely imaginary "legacy debt" as though this would somehow resolve some mystical injustice across generations... you know, my grandparents fought world war two, endured the depression, built the highways and schools that made my income so much easier to come by.. but we can't endure the thought that they got a better deal on their SS than we will.

temporary end of rant here.

Anonymous said...

oh, i forgot..

it's because, you see, because we were forced to pay for their retirement that we couldn't put our money into "investments" which would have returned a higher rate than we will get from out "investment" in SS.

could have. would have. should have.

because you see, i am "owed" what i "might have" earned IF i had invested, and my investment hadn't floundered, or been eaten by inflation, or squandered on a really sexy car, or lost because i was out of work for a year..

and in any case i am owed what i might have made if i didn't have to pay social security for those bums who paid for my education.

and the people who designed Social Security as a pay as you go system entirely independent of financial markets didn't know what they were doing.

so a really smart professor can write a rube goldberg "balanced approach" to reform, and be taught in colleges across the country.

and the people will never notice that the whole point, and security, of Social Security has been destroyed.

Anonymous said...

Well Coberly, since we already have the Chicago School, all that's really required to fix Social Security is our own socially responsible General Pinochet.

Assuming we become deserving of such high caliber leadership, we shall also deserve a new retirement program that

consumes one quarter to one third of contributions as fees.

that, allowing for the above, provides total annual returns more than 50 percent below those calculated by 'trustees'.

that covers only a fraction of total labor force.

and has had 'higher than expected' transition costs ranging from 6.1 percent of GDP to an expected 4.3 percent out to 2037.

Surely you would not deny us our privatization paradise. What are you, some kind of 'pinko'? No, of course not, since we eliminated all those.

Still, you may wish to recall the words of Pinochet's Labor Minister:

"The pay-as-you-go social security system created by Chancellor Otto Von Bismarck has a fundamental flaw, one rooted in a false conception of how human beings behave: it destroys, at the individual level, the essential link between effort and reward--in other words, between personal responsibilities and personal rights. Whenever that happens on a massive scale and for a long period of time, the result is disaster (Piñera 1998)."

Anonymous said...


i assume you know i agree with you (assuming you are being ironic about Pinochet). around here it's not always as obvious as one might hope.

what frustrates me is the easy slide past the fact that in American Social Security, at least, the workers pay for their own benefits. it is always assumed in the media that SS is some sort of welfare scheme. and, i am sorry to say, there is a fatal tendency among some of SS's supporters to turn it into just that.

of course, the other aspect of "the essential link between effort and reward..." that is always overlooked by these righteous people so concerned with the manly virtue of the working class... is that they don't think it is really necessary to fairly reward workers for their efforts.

Anonymous said...

yes, but more sarcastic than ironic.

as you probably know, the post-1981 Chilean system of private accounts has often been used as an example for the U.S., nevermind that it failed, failed the working class but enriched the financial 'community', some politicos and the already wealthy...

the labor minister quote only exemplifies the type of neoliberal ideology used to promote and justify privatizations, reduced social expenditures, bottom to top transfers..

("It strains credulity why top officials at that well-heeled organization have continued to embrace" Pinera, says the newspaper article, which was written by the directors of two U.S. organizations, the Council on Hemispheric Affairs and the Institute for Public Accuracy.

Pinera, currently co-chair of the Cato Institute's Project on Social Security Privatization, was Chile's Minister of Labor and Social Security from 1978 to 1980.

Noting that today "Pinera is a Cato luminary," the article says that while he worked as a top official in the Chilean dictatorship, "Chile was under Pinochet's boot, with the legislature having been shuttered and laws made by decree." Human-rights groups have documented that the Pinochet regime engaged in widespread political imprisonments, torture and murder. "The fact that Cato even hired Pinera is a puzzlement," the article comments, given that "at the heart of its ideological prattle are heated professions against intrusive government, the definition of which presumably doesn't include torture."

After the 1973 coup, which overthrew a democratically elected government, Chile privatized its pension system. In recent years, officials at the Cato Institute and other advocates of privatizing Social Security in the United States have cited Chile as a model.")

most people in latam caught on years ago... most in the u.s. are doing so as well.

Anonymous said...


i wouldn't be too sure that those in the u.s. are catching on. the half life of a good soundbite is many decades longer than the "facts" that gave rise to it.

i have to guess that CATO is not interested in the facts at all, but only in selling an ideology by which thier friends hope to attain or keep power.

Anonymous said...

in the free preview to the wsj article by feldstein they say the democrats offer a compromise which is a private account contributed to by employer and employee at 1% each.

if this is on top of the existing SS which would be left unchanged, it is probably a good idea.

but i don't know what lurks in the part of the compromise i was not able to read.

if the contributions were understood to be part of the routine cost of living increases, then businesses could feel that it wasn't costing them anything, while employees would be getting their cost of living raise in the form of an asset which should be more valuable to them than the same amount of money freed for current consumption.

so... where are the traps?

Bruce Webb said...

Well I think the trap is always in the same place. You can't get historic rates of returns on equities at Intermediate Cost assumptions. That seemed pretty clear in the course of the No Economist Left Behind challenge.

The only fair way to sell some sort of add on account is to set forth your economic assumptions and then rescore Social Security under them. The problem is that fractional increases in initial assumptions shrink the payroll gap and push depletion out and so work against the crisis message.

Already the Dems would apparently be throwing 2.0% at a 1.95% problem. Can they get enough yield out of the premium of stocks over bonds to offset the substantial administrative costs to set up private accounts? Well probably not at 1.7% ultimate productivity and 2.0% GDP. But every fractional point of growth above that shrinks the payroll gap and makes a tax only solution more attractive. The same is true for proposals that would adjust benefits say like Thompson's proposal to adjust future benefits by CPI rather than Real Wage. On paper the health of the system immediately improves, perhaps pushing depletion back a decade or two.

There is a race for the bottom. On average the payroll gap has been shrinking all on its own for more than a decade, and every time it makes a fractional improvement it cuts away at the advantage of private accounts, Low Cost grinding away at Intermediate Cost. Low Cost may in fact be too optimistic at one data point or another, but that is really not the point. Low Cost is a model that for at least eleven years returns a fully funded Trust fund with no changes in taxes, benefits or retirement age. Anything that increases income or decreases cost over Intermediate Cost moves the models closer together.

Since 1997 the payroll gap has shrunk from 2.23% to 1.95% or an average of .028% a year (payroll gap to zero by 2077). But that rather understates the rate of possible improvement. From 1997 to 2000 it went from 2.23% to 1.89% or .11% per year (payroll gap to zero by 2024). More reasonable might be to take the years 1997 to 2004 yielding .048% a year. (Averaging out the effect of Boom and 2001 recession.) (This gives a payroll gap of zero in 2047). But every year that passes on average puts a squeeze on the models. For example ten years at a .048% improvement puts the gap below 1.5%.

Which is why we can win this one on defense. People who say privatizers will never give up don't adequately understand how constricted they increasingly are. In effect they are on a budget in proposing the cost of a fix, each year the logic of Coberly's calculation gets a little sharper. Scrunch!

Bruce Webb said...

The trap that Privatizers are in is one they recognized very explicitly in 1983. And one that Bush articulated in 2004 and Thompson at the debate this week

You simply cannot screw over people who are approaching retirement who have made plans based on a certain level of benefits. You simply have to leave them out of the plan and accept a certain amount of legacy cost. What the practical window for phase in of benefit cuts is debateable, but anyone within four years of early retirement being exempt seems a reasonable minimum. But whatever window you pick increases risk to your plan. Make the phase in window smaller increases political backlash, making it bigger just postpones your effective date. Which is problematic if growth going forward is larger than your model assumes.

Because no change to the structure of a private accounts plan is irreversible. If the Social Security system is strengthening in the years before benefit cuts then the people in the new notch, the ones just outside the window who didn't really have time to grow their accounts are going to be disgruntled, it just happens that this group happens to coincide with the biggest peak of the Baby Boom and is made up of people in prime voting years. On the other hand any further widening of the window to mollify this cohort simply gives the economy to improve further before implementation, and hoping for lower growth in the interim not only being slightly perverse in itself, it tends to wreck havoc on those stock portfolios.

This is a very difficult needle to thread. The Economic Right needs weak growth to sell 'Crisis', but they need strong growth to actually fund those private accounts. Moreover they need it to sell continued tax cuts. The current productivity series being kind of convenient for 'Crisis' but hellishly inconvenient for those who are both in the minority and pushing for tax cut extentions.

On the other hand a return to trend growth even over the short run ruins the case for Privatization, two years of productivity growth above 2.1% and GDP above 2.7% probably turns them into toast.

Oh well. Sucks to be them.

Anonymous said...


i think you are right.

my endorsement of the private accounts was on the understanding that it was an add on, and that otherwise SS would be left alone.

my bet is that by 2041 it would be apparent that straight SS was the better deal. in the meanwhile the privatizers would have a bone and hopefully would shut up.

as to the "facts," i am afraid the facts won't matter. i have no feeling for who knows the facts that has the political will to resist a "bipartisan compromise." said...

Gettting in on this one late.

OF course a central contradiction of the privatizers all along has been that if the economy were to slow down enough to make their pessimistic projections come true, unlike so far, then the stock market would not perform so well either.