Social Security roundup
U.C. Berkeley professor Brad DeLong, a leftist friend of ITA, got caught up in a big Washington Post mistake when liberal reporter Jonathan Weisman misstated the way Social Security benefits would be offset for personal account holders, calling it a “clawback.” News of this sent conservatives and liberals alike into a tailspin as both sides criticized the idea. But Weisman had it wrong and the Post worked to quickly update their story. DeLong held on, though, arguing that “there’s no difference.” JustOneMinute explains that in fact there is.
. . . people who make 100% of their contributions to the normal plan get 100% of their normal benefit. People who contribute partly to the normal plan and partly to their personal account ought to have their “normal” benefit reduced, right? Well, this Notional Offset is a way to keep track of how much they diverted from the normal plan, so that the appropriate reduction can be made to their benefit. Folks who die early. . . get the portion of their lifetime tax payments that have accumulated in the personal account.
But as Victor notes, there’s a magical rate of return – 3% it seems – that if you beat you end up with more benefits than if you had stuck with the government scheme. What isn’t mentioned from most Bush press releases, though, is the obvious alternative – earning less than 3% on your account could result in less benefits than you would’ve had under the government scheme. That’s a legitimate criticism of Bush’s plan, and if I opposed the accounts I’d bring it up often, but in the end it’s intuitive. If you personalize OASDI, and your investments fail, you won’t end up with as much money.
Meanwhile Krugman’s at it again in the NYT today arguing, based in part on the faulty WashPo story above, that personal accounts are really just loans. But PK’s very wrong. If it’s a loan at all, it’s a loan you make to yourself, or an opportunity cost. Your future benefits are like the money market fund. In order to invest in stocks in your personal accounts, you have to give up the future benefits. That’s a trade-off called an opportunity cost, not a loan.
12 Responses to “Social Security roundup”
You mean… that we have to take risks in life?
Heaven forbid.
Does anybody know the consequences of having a nation’s worth of social security accounts poured into the market?
From what I understand, right now, there are way more bonds out there as funding sources for corporations than there are stocks. I bet having hundreds of millions of new personal investment accounts out there ready to buy stock is going to change that. Is this going to mean way cheaper sources of stock equity for corporations?
Takethe first day private accounts are turned lose on the market. Suddenly, there’s WAY more cash out there vying for the same amount of corporate equity. Anybody know if that’s really healthy from a market perspective? Or will it lead to inflation? I’d expect the latter.
Matt Yglesias is on the case with this one:
http://yglesias.typepad.com/matthew/2005/02/understanding_t.html
There’s a related question to Aarons, namely “what effect will it have on the American economy if the Social Security Administration (SSA) stops buying the majority of the US Government’s debt?”
Right now, US government debt (~$500 billion annually) is bought by foreigners looking for a safe haven for their assets, by institutions and individuals looking for a safe place to park their cash, and by the SSA looking to invest the surplus. Of those, the SSA is the single largest purchaser of US debt, to the tune of about $100 billion a year.
If the SSA stops buying that debt then we have to either raise taxes to cover the shortfall (i.e. stop borrowing) or we have to find someone else to take the SSA’s place. Problem is, who? Foreigners are spooked on US economy and no longer taking positions (buying debt) in it. That leaves you and me, but we’re being cajoled into buying not debt but equities.
greg
You mean… that we have to take risks in life?
Heaven forbid.
LOL
The Matt Yglesias post is so full of problems, holes, and misconceptions that I don’t know where to begin. But I suppose I’ll have sometime soon.
Here’s another numbers-related question:
As far as I can tell, the administration’s plan charges an effective 3 percent interest rate on personal accounts. Assuming you get a 3 percent return, you break even, and get what you’d get through normal social security, right?
That means that assuming you successfully get the expected market return over the next 40 years(6.4 percent, according to Paul in the column from yesterday) your *effective return* will be 3.4 percent. Am I correct, still?
If that’s true, then under the Bush plan, you get a 3.4 percent return for taking the SAME RISK as someone who plays the market outside social security.
That risk is worth a 6.4 percent return on the open market. We’re being asked to take that risk for HALF of what it’s worth on the open market.
Am I wrong, or does that mean these “personal retirement accounts” are *twice as risky* as the open market, if viewed in terms of risk vs. reward? On the open market, average market risk gains you a 6.4 percent average return. In the “personal retirement accounts,” average market risk gains you a 3.4 percent average return.
Now, granted, if social security had some risk associated with it, then a 3.4 percent return would be TONS better than no return. But what the administration is doing is comparing a risk-free system with 0 return on contributions with a system that offers twice the risk of the ordinary stock market in terms of risk-v-reward.
Basically, they’re saying “hey, forget about that no-risk system called social security. You don’t earn any interest on it. Let me offer you a system that has half the return of the market, with all the risk!
Greg’s question is very significant. SS is financing a big chunk of the current account deficit. If that’s removed, the likely result is that the government will have to pay higher interest rates to attract more borrowers, which will increase the debt-service cost and thus force the deficit even wider.
In one of his speeches today supporting his proposal Bush claimed that the rate of return on the private accounts would be “more than double” the return from Socical Security. First, that tends to imply that it’s guaranteed which is false. The other thing that he doesn’t say is that given that you’re talking (his numbers, not mine) in absolute difference a 2% differential on rate of return there is another problem with his claim. How much of that fantastic difference he’s bragging on will mean nothing because the decrease in the payment from the “guaranteed” benefits will make up for it. Keep in mind that the best estimates of how much benefits will be reduced from what the current indexing formula provides is anywhere from 30% to 45%. That’s going to eat a big chunk of the improved returns that Bush is touting. Especially for those of us who are under Bush’s cut off age but still don’t have decades to benefit from that relatively modest difference in returns. Especially given the fact that the proposed scheme doesn’t start until 2009 and even then phases in.
Well, the obvious solution to the T-bill customer problem is to get out of debt. That won’t happen under this administration, of course, but a smaller (or no) debt would very nicely sidestep that problem.
An interesting flip side of that is that if there was no debt, what would Social Security invest their funds into? By law they have to buy T-bills with the money, but T-bills would not be issued if there was no deficit.
Are you wrong, Aaron? No, you’re half-right: you’ve grasped the difference between accounting profit and economic profit, but failed to grasp that it applies to everything, not just to personal SS accounts. What your example overlooks is that, while the holder of such an account is passing up the chance to leave the money in SS and earn 3% on it, making his effective return 3.4%, the person in the “open market” is getting an effective return of only 2.4%– because in order to buy stocks, he has to pass up the chance to invest the same money in Treasuries at 4%. That’s exactly what Joshua means when he talks about opportunity cost.
Paul, thanks for attempting to address my question. I don’t quite get what you’re saying, so let me put this another way:
The guy who chooses to invest in the stock market rather than treasury bonds accepts more risk for a higher reward, based on the price the market assigns that risk.
Assuming an efficient market, the risk associated with investing in the stock market is worth a 6.4 percent return — 2.4 percent more than the risk associate with Treasuries.
We know this because in agregate, people are willing to invest in the stock market when they know the average rate of return adjusted over time will be 6.4 percent.
If the stock market risk was worth less than a 6.4 percent, people would be investing in the stock market more, than they do, and if it was worth more than a 6.4 percent return, people would be dropping stocks because stocks aren’t worth the risk. The risk associated with treasuries, on the other hand, is worth a 4 percent return, if that’s what people are willing to accept as payment for bearing that risk.
Here’s the problem with personal retirement accounts as they’ve been described to me: Because the government takes 3 percent of your return off the top, ANYTHING you invest in will cost too much. It won’t be worth the risk.
The stock market won’t be worth the risk — the market has established that it’s only worth assuming stock-market risk for a 6.4 percent rate of return. Personal retirement accounts get a 3.4 percent rate of return in the stock market. Thus, the stock market isn’t worth investing in — it’s too risky, considering the potential rate of return.
Same story with Treasuries. The market has assigned a value to the amount of risk one assumes owning a Treasury — 4 percent. Personal retirement accounts will only get a 1 percent effective rate of return on Treasuries — thus, Treasuries are too risky.
The only thing that makes Social Security worth it in terms of risk/reward is that *there is no risk* associated with social security.
Maybe some people will use personal retirement accounts to invest, anyway, just on principle — they want to take risks. But I think they’re insane for doing so.
If you think a stock is a good buy, buy it yourself, outside the personal retirement environment. Don’t make it twice as risky by picking it up with your personal retirement account. Leave the personal retirement account in a risk-free fund. Don’t put it in something that’s twice as risky as the stock market ordinarily is.
If you can’t afford to pick it up yourself you certainly can’t afford to be taking double (or more) the market-assigned risk with your one and only source of retirement income.