Monday, March 2, 2009

UFOs and Social Security.

From "Top Ten Myths of Social Security Reform" :
"a famous poll among younger workers fielded in 1994 indicated that only 28 percent of respondents believed that Social Security would pay benefits to them when retired, compared to 46 percent who said they believed in UFOs."

The current Social Security system is an income transfer system - taxes that are paid by current workers are paid out to current retirees in the form of benefit payments within the same year. Thus, Social Security is highly sensitive to demographic changes. Currently, the worker to retiree ratio is a little over 3:1. In 2040, when the worker to beneficiary ratio is expected to reach 2:1, benefits of 36% of an average worker's earning can only be maintained if the payroll tax on a worker increases to 18 percent from today's 12.4 percent.

Dr. Charles Blahous advocated private accounts in S.S. much like those of the Thrift Savings Plan. He seemed particularly bothered by the argument that transitioning to private accounts would be too costly because, as explained by Brown, Hassett and Smetters, the "transition cost" of having to simultaneously finance benefits to retirees while funding the private accounts is not actually new costs. They call it a "transition investment" because it is simply a re-timing of costs and allows the government to save some S.S. revenue as opposed to paying it all out to current retirees. Dr. B also explained that the government could make the tax code even more progressive with private accounts such that low income workers could benefit more from a S.S. system with private accounts. Redistribution does not necessarily have to be less than that of the current system.

There is also reduced deadweight loss associated with private accounts. Private wealth earns the marginal product of capital while S.S. wealth earns a return equal to the growth of aggregate wages. The capital income loss is the difference between these rates of return. The current pay as you go system does nothing to prevent such losses. There are also distortions to the labor market caused by as people's preferences for different forms of compensation are affected by S.S. tax. For example, maybe people would be more willing to take a job that offers nicer working conditions as opposed to higher salary that is subject to S.S. tax. Deadweight loss caused by the S.S. tax is also much larger than expected since it is imposed on top of federal and state income taxes. Social Security wealth also displaces private savings and provides a disincentive for asset ownership. As of 1992, S.S. wealth reduced overall private savings by nearly 60%. Private accounts could potentially increase real investment and improve incentives for people to save for retirement.
[Martin Feldstein does a better job of explaining all of this.]

Anyway, here's my picture with Dr. B in the West Wing of the White House! I wonder if gov't officials have to practice smiling and posing for pictures...

Peter Orszag and Charles have very different opinions on S.S. reform. But they were both very nice when I spoke to them.
Peter Orszag was the director of the CBO, and he is now director of the OMB.

Basically, he believes that Social Security taxes should be more progressive and that there should be a combination of benefit reductions and tax increases. He believes that those in the higher income bracket should pay legacy taxes and that the gradual increase in the payroll tax should be applied to older people as life expectancy increases.

Charles said that this approach is problematic because it turns S.S. into a welfare program, which is not what it was initially designed to be. There would no longer be a contribution-benefits link in the system, which goes back to Feldstein's point about deadweight loss and displaced savings, etc.

The end!

Thanks to Chands for contributing to this post!