Economics, Politics, Social Commentary and occasionally Superstring Theory.

Thursday, January 06, 2005

Social Security "Crisis"

Some of you have noticed that I haven't posted in a while. This was partly due to an unexpected flurry of activity at work, and the holidays. Mostly, though, I wanted to think through my position on the Social Security debate that is consuming the blogosphere as of late. There are bloggers whom I thoroughly respect who come down on opposite sides of this issue and I want to give them all their due. Tyler Cowen is doing an excellent job at Marginal Revolution of arguing for the need for reform, while Brad DeLong is doing just as excellent of a job at rebutting him. There is also some good background here and here on how the indexing of Social Security benefits works and how it would work under the proposed reforms.

At the end of the day, I fall into the Brad DeLong camp. Watching Tyler and Brad debate the issue, it seems that they're arguing different things. Tyler is arguing the merits of the proposals, but Brad is arguing that the proposals aren't (yet) necessary and don't need to be as sweeping. Because the debate has the potential to be so large and encompass so much, I'd like to distill the arguments down to a few simple justifications and then evaluate them. We'll move from the general to the specific.

1. Social security needs to be reformed.

2. Social Security needs to be reformed now.
Disagree. Brad DeLong has an excellent post (see above) about how in the greater context of our fiscal problems, Social Security is not that big. But let me add two things: A) It's a waste of time and B) I hope the Republicans try it anyway. When I say it's a waste of time it is not because I am dooming any reform effort to failure. I'm saying it from an economic perspective. There are a finite amount of days in a legislative sessions. The debate on this problem, the work going in to solving it, the amount of media attention it captures are all investments that could otherwise be spent on more pressing issues, i.e. the twin deficit problem, a nuclear North Korea, the real fiscal crisis facing the government, the real health care crisis, etc. Every minute spent on a problem that is not that big is a minute that cannot be spent on problems that are huge. And these are problems that have timetables. That must be dealt with by a certain point. If a sustained effort is not made to get the deficit under control, we'll be adding another 600 billion to the U.S. debt. If health care is not dealt with, its inflation will be in the double digits again. If North Korea isn't dealt with, it will have a nuclear weapon pointed at the mainland U.S. These are immediate problems facing the country which require immediate debate and solutions.

That being said, I hope the Republicans try it anyway. From a policy point of view, I don't agree that benefits should be cut (more about that later.) From a political point of view, it's like watching your enemy walk off a cliff. If there's an up-or-down vote on cutting benefits, and the Republicans toe the party line for Bush, he will find out just how much his political capital is worth. I see a lot of parallels to the Democratic Congress in 1993 voting for Clinton's tax increase. They toed the party line and then got clobbered in the 1994 midterm elections. Fast-forward to 2006: Republican incumbents are vulnerable to the following charges: a) Voted to change ethics rules to allow DeLay to serve as a leader of the party even though he was under indictment (even if he hadn't yet been indicted), b) Voted to cut the benefits to poor seniors while giving itself a pay raise. Put those two arguments together and you have a compelling narrative of a Republican party that is drunk on its own power and out of touch with everyday Americans. It's the same argument the Republicans used against the Democrats in 1994 and will probably have the same results.

In conclusion, the debate over Social Security should be folded into a larger debate over America's long-term fiscal health. Even if you take the "faith-based tax cuts" at their word, there is no way the benefits from them are going to generate enough revenue to plug the hole in the deficit. That being said, there is a stark silence coming from the Hill on how we're going to keep paying for our obligations. The Alternative Minimum Tax needs to be fixed (a topic for a later post), which is going to cost even more money. Iraq is going to cost more, not less. And we're still set on a path of lowering the tax rates and starving the government of revenue. The Democrats have a strategic opportunity here to turn this whole debate into a "Show Me The Money" debate. The fiscal problems America is heading into are structural, not episodic. They require a structural change.

3. Social Security needs to be reformed by cutting benefits.
Disagree. Currently, benefits are calculated by the average of your 35 highest wage-earning years and then multiplied by the average increase in wages between then and now (a more detailed explanation is in the posts I listed above.) The Bush proposal would multiply the wages by the rise in inflation, specifically the CPI, not wages. Wage growth is typically stronger than inflation, so this results in a benefit cut.

Most of the arguments against this are premised on the theory that inflation-based indexing more accurately represents what our seniors are "entitled" to receive. I think this argument misses the boat. Who will really be affected by this change? Poor seniors. You're talking about a demographic that arguably should be receiving the most help from the government (second only to poor children.) Seniors are being eaten alive by skyrocketing medical costs, drug costs, property taxes, etc. So what if the inflation-based model is a better way to reflect what their benefits should be worth? If the seniors have to go on public assistance to make ends meet once their benefits are cut, does it really matter? Poor seniors have a fixed amount of expenses to meet and a fixed amount of income they receive. If you take away part of that fixed income, where will they make it up? Not in the workforce. So, you'll essentially be fixing the problem by saddling the general fund or the states with more expenses. Robbing Peter to pay Paul.

But what about the seniors who aren't struggling, who can make ends meet even if we shave off some of their benefits? If that's your argument, then simply raise the tax rates on benefits to generate revenue. As long as it's done in a progressive manner, it shouldn't hurt those who need the benefits most and will be a de facto benefit cut targeted at those who can most afford such a cut.

Increasing the retirement age in a staggered process could also be beneficial. People work and live longer these days then when the system was first designed, so it makes sense. What does not make sense is exempting income after 90K from Social Security tax. Make it all taxable to generate more revenue.

4. Social Security should be reformed by personal investment accounts.
Disagree. I think personal investment accounts are a wonderful idea. Anything that gives people the option to save more in a convenient way is okay by me. I would disagree with Brad's idea (on his post above) to automatically divert people's tax returns into a savings account unless they fill out a form. First off, I don't think it's a politically viable option ("Politicians telling you that you have to fill out a form to get your money, etc.") Second, it adds another level of bureaucracy between people and their money, which doesn't do much to sharpen the image of government in the minds of the people. Instead, I would offer a government form of a 401(k). A lot of small businesses don't offer 401(k)s, and this would be a good way to make such an option available to them. They would work like this:

A) Every paycheck, a certain amount is deducted. It is placed in an account that is indexed to either the NYSE or the NASDAQ. If these go up, your account goes up. If they go down, your account goes down. Your investments are pegged to a wide and deep index so that temporary swings won't wipe you out and that historically have grown in value as time went on.

B) These deductions are tax free. The accounts cannot be used as collateral for loans, cannot be attached by creditors, cannot be part of any divorce settlement and are completely portable between jobs. They are inheritable.

C) You have a limited ability to draw back out of these accounts. Once your account hits $1,000, you can never draw it back down below $1,000. Once it hits $2,000, you can never draw it back down below $2,000. If you had deposited $5,000 and Wall Street took a hit that lowered your account to $4,000, you would have to wait to get it back up to $5,001 to withdraw $1. The deducations are also tax free. This system gives a generous award of tax-free dollars while limiting its use as a tax shelter to roughly $1,000 per investor. The award would provide a powerful incentive for people to save, without forcing them to do so, and avoid the trap of being a tax haven.

D) At any time, some or all of the account may be used to fund college tuition for either the account-holder or a child. This reflects that while savings is important, it is more important for people to get a college education. Think about it. What is a tuition anyway but an investment in the future earnings potential of the student? Because college graduates earn about sixteen times more than high school graduates, it has the potential to be an even more lucrative investment than the NYSE. Economic trends almost mandate a college degree if one wants to be considered for entry into the middle class in the future.

So, that's what I think. Social Security should be reformed, but not at the expense of other problems that need our immediate attention. Whenever it is done, it shouldn't be done in a way that penalizes poor seniors when there are other options available to generate the needed revenue. Personal savings accounts are good, but should be used on top of Social Security, not in lieu of it.


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