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February 10, 2005



We don't need to introduce "private" accounts.

What we need to do is cut promised future benefits. Period. Any investing needed to make up the difference can be done by individuals without all this "personal account" nonsense.

Just cut the damn future benefits and the problem is solved. We don't even have to really cut anything - just don't keep jacking up real benefits year after year, but leave them unchanged at today's levels.

Paolo Thompson

Annuities are only a problem if they are annuitized. Annuitization's are always based on the standard mortality tables and do not discriminate for disease etc. Annuitization is almost always a bad deal because if you die early then the annuity company keeps all of the money and there is nothing left for the surviving beneficiaries. This takes away from the inheritability argument for private accounts. Although annuities can make sense for some of the options they offer, such as a death benefit, I would never really recommend annuitizing the policy to my clients. I agree that lowering benefits would help the problem, but there needs to be a mechanism to help the citizen make up for these reductions. The return on money invested in private accounts will help offset this future reduction of benefits.


Re: notional offset. The need to offset something to take into account the diversion of funds into a private account is obvious. But can you explain why the following doesn't work?

Worker A, who has a salary (ignoring for this purpose that we look at 35 years' salaries) of $X, pays FICA taxes of $3,000.

Worker B, who has a salary of $Y (where Y > X), pays FICA taxes of $4,000. However, under the Bush plan, he diverts $1,000 of his taxes into his private account; accordingly, he puts $3,000 of his FICA taxes into the the main SS and $1,000 into his own account.

Now, haven't Worker A and Worker B both put the same amount ($3,000) towards guaranteed benefits? Shouldn't they therefore both receive the same guaranteed benefits? This seems to me to be the "DUH - that's too simple!" way of looking at it, so it must be wrong somehow. I'd just like to understand how.


Annuities (generally) have settlement options - those options include period certain (you get payments for 'x' number of years, if you die in fewer than 'x'years, the balance of the payments go to your beneficiary.

If an annuitant chooses to settle for 'life only' they'll get the maximum payments from their annuity, but at the risk that they'll die the next day ... or the next ... or the next ... and leave nothing to their beneficiary. In the meantime, they've gotten a larger sum of money from their annuity than an annuitant that choose a period certain option.

If both live past the period certain option, the 'life only' annuitant will continue to receive the larger amount ... but, they ran the risk up until they covered the period.

* in other news - I recall, but can't seem to google, a notion thrown out by Jesse Jackson a couple of years back that sought to, basically, nationalize private retirement accounts in order to effect social change. The notion was to take 401k and pension savings and let the government use the funds on the promise that it would pay them back. Is that idea dead or simply lurking?

** Atrios floated the notion of offering life insurance for people <67, his example forgets the basic issues around underwriting.

But is there any downside to having insurance premiums for term life to age 67 become tax deductible? Maybe set the face amount limit to $50-$100K?

Robert Brown


The problem is that SS benefits are "progressive". That is, a reduction in the last $1000 in taxes of a high income worker results in little benefit reduction. That would be seen as "unfair".

Jim Glass

There does have to be an offset to prevent people from collecting two benefit streams from the same $1.

(I'd just love to be able to take $1 out of my savings account to invest it in the stock market and still collect interest on it in my savings account, but ...)

But the offset should be the rate the $1 would have actually earned in SS.

(When I move $1 from my savings account to the stock market my savings account isn't docked the federal bond rate!)

The 3% offest idea looks like a futile gesture towards closing the "transition cost" -- another sap to the "transition cost fallacy" which seems to have hypnotic power even over people who should know better.

Milton Friedman, as almost always, explains reality most clearly:

Social Security faces a "funding gap" equal to all benefits promised to all participants as of the end of business today (excluding all future tax collections and benefit accruals).

The cost of all these benefits promised into the future as of 5pm Pacific time (or Hawaii time) but for which no taxes have been collected as of then, is about $10 trillion. That's the funding gap.

To the extent those benefits are all to be paid, with no promises broken, then going forward SOMEBODY is going to have to cough up that $10 trillion. It's just a matter of arithmetic. People starting 9am tomorrow Eastern time are going to pay $10 trillion more to fund Social Security than they get back from it. There's no way around it.

The question is, WHO is going to pay that money?

The failing of the traditional SS status quo going forward is that it regressively slaps that entire $10 trillion tax bill on workers through payroll taxes and future benefit cuts. That's why they face ever-plunging returns on their contributions into negative territory and future benefit cuts, making SS a terrible deal for the young.

But, Friedman points out, there is nothing in the world (except political path dependence) preventing that tax bill from being shifted from payroll taxes to income taxes, with highly progressive results. (Kotlikoff prefers a VAT, but lets stick with Milton.)

In that case the government's accrued liability - like that incurred financing WW I & II, the moon program, the Vietnam war and so on -- is shifted off the backs of workers and up onto the much richer. And the required tax rate is lowered because it falls on all national income rather than just a subset of workers' wages. (Remember, taxes cause deadweight economic loss by the square of the tax rate -- so a lower rate spread over more income is always better.)

Moreover, with workers no longer paying for the damn backward transfer, they can use all their own contributuions in their own private accounts -- which they can even invest in government bonds if they wish.

Now somebody born in 1970, age 35 today, can invest 5% of pay at 4.6% for 40 years and be hugely better off than after being taxed 12.4% of pay for 0% return over the same time under the status quo -- getting more spending money up front, and more retirement wealth later.

It's win-win-win, except for the very-high-income folks who don't have their income tax increase fully offset by their payroll tax decrease. (It's so progressive, how can liberals possibly not be for it??)

And the net cost to the government is $0. There's not a penny of extra tax involved, just a very progressive shift in who pays them. There is no transaction cost to the government at all -- except in *recognizing* and *admitting* that the $10 trillion liability is actually out there, and deciding who is going to pay it.

That's the logical concept of a beneficial SS reform. Bush's little private accounts are a small incremental step in that direction, that's OK, all long political journeys start with a first small step.

But this 3% offset is totally unnecessary in the Friedman scheme above -- and is just an attempt to keep taking as much as possible of the $10 trillion backward transfer out of workers' wages, even with private accounts. Even though that is entirely what's wrong with the status quo.

Like, we're hypnotized, we just can't stop ourselves!

(Hey, why didn't I write all this on my own blog?? Oh, because people read this one!)


My stab at Al's question, why can't we have equal benefits for equal contributions - Soc Sec is set up to provide progressive benefits. So the $3,000 annual contribution by a low earner results in a benefit that is more than (3/4) of the benefit received by someone who contributes $4,000 per year.

If they handled privatized accounts on the basis of dollars contributed, high earners would (in effect) have their low contributions assessed as if they were a low earner; their "high" earnings would skip off to the private account. Great for them, but the system can't afford it - the system needs to redistribute some of those high earnings back down the income scale.

Well, that is my take, which I think is correct but unclear. Other explanations encouraged.

(Hmm. Could the system work if we assumed that all contributions to the personal account came off the bottom, as it were? I don't know offhand (and I have serious reservations), but if I were at the WH, I would find out.

The mechanism would be to calculate benefit A, based on (actual+phantom) contributions, were the phantom contributions instead went to the personal account.

Then, calulate Benefit B, the amount due someone who contributed *only* the phantom amount.

A - B is the new benefit. And I have no idea if that works out reasonably, or why it might not. And I bet someone tried it. But there you are.

Paul Zrimsek

Did I ever tell you about the time I got in an argument with Ralph Kramden and he subjected me to an ad-hommina-hommina attack?


TM -- great work around here, btw. Your explanation to Al is spot-on: it would give rich folks a great deal. On the margin, their last dollars of earnings get rewarded very little with traditional Social Security, therefore they would be more than willing to shunt those off into a private account ... and to your second hypothetical -- why don't you take the money off the "bottom" instead of the "top" you have the reverse problem.

I have just thrown around two ideas: either (1) use the estimated IRR for each individual person -- although note that this means that the rich (who have terrible IRRs) get a negative interest rate on their account (although you could bound it at zero, I guess) or (2) take your top 35 private account contribution years, compare that to your AIME, and divide the two to get a ratio, call it R. Calculate benefits as usual. Take those benefits times R. That amount is the %-reduction in benefits you get. That would be a relatively simple analog to the intuition that if you put 30% of your benefits into your private account, your benefits are reduced by 30%. But I will note that such a system does warp progressivity.

Personally, I think I lean toward entirely notional accounts... the government actually own the private assets and the fraction of those assets that you get to call "yours" is based upon your taxes paid. You get a small boost to your guaranteed SS if the government-owned funds do well (and this boost is in proportion to how much of those assets you own) ... and your overall benefits are guaranteed to be basically the same as if the government never bought any assets. You pay for this guarantee by not giving people all of the excess return when the assets do well.

If you want to be a bit more aggressive, go ahead and actually do the personal accounts, but guarantee that your net payment (with private accounts) can't be lower than it would have been otherwise. Again, pay for this guarantee by skimming off excess gains from returns when things go well. You still have issues about the design of offsets in such a world, but there is a lot less risk and you are pushing further away from the "loan" analogy, so I could stomach a wider variety of offsets in this case. I'd also scrap this idea of inheritability altogether.

Dunno. But whatever you do, you need to do it quick. We only have a decade of surpluses, and even this has to be done while the "General Fund" is in a terrible, terrible mess. As it is, we've let the front-end of the baby-boom get off virtually scot-free, just adding to our long-term burdens. I'm very worried about the idea of homina-homina-homina ...


I've posted a few places that the cost really should reflect at least the real cost of the money (IE, the actual treasury bond rate) plus the cost of life insurance to assure that the money will be paid back.

That would be more or less revenenue neutral for SS. Think about it. You borrow the money from the government "homestead" program, agreeing to purchase a life insurance plan to guarantee you can pay it back. Then pay it back.

Then you get to collect full, regular SS benefits, just like everyone else.

Diamond/Orztag did a more detailed analysis on this a couple days ago, you can find this on DeLong.

Jim would like to borrow the $10 Trillion legacy cost so we can just shut down SS 70 years from now.

I'd say we really ought to save borrowing on that scale for times we really need it, like fighting WWII.

If private accounts are really magic, like you guys believe, set them up with funding, and come back in 20 years with a plan to begin scaling back SS, if that's also important to you.

Jim Glass

"Jim would like to borrow the $10 Trillion legacy cost so we can just shut down SS 70 years from now."

Since when is directly paying off an existing debt through income taxes "borrowing"?

Youse guys gotta problem.


The borrowing never pays off the debt, because the debt keeps rolling forward. When one generation who have opted out retire and receive less benefits, the next generation is diverting new funds.

The only way "Plan II" ever comes into balance - after running up over 23% of GDP of federal debt around 2040 - is with extreme cuts in guaranteed benefits as time goes on, through price indexing.

Without price indexing, the debt would just keep getting bigger.

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