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Not Perfect, But Good

April 14th, 2011 . by economistmom

[CORRECTED 10:15 am Thurs to say tax expenditures are "economically inefficient" (not "efficient"). Thanks, npm, for pointing this out to me!]

Some of my “likes” about the President’s speech and his general “framework” for deficit reduction:

  • advocates a “balanced” approach with a mix of spending cuts and revenue increases;
  • recognizes that a lot of spending occurs in the form of “tax expenditures” which are economically inefficient and also disproportionately benefit the rich, and proposes to raise additional revenue by reducing some of these tax expenditures;
  • acknowledges that the Bush tax cuts played a large part in turning the surpluses of the late 1990s into the record deficits in the following decade;
  • clarifies that the choice is not reducing the deficit versus not reducing the deficit, but reducing the deficit by cutting benefit programs versus reducing the deficit by raising taxes;
  • reminds Americans that we all benefit from safety-net programs even if we don’t personally need that safety net at this very moment (or even ever use it)–the “there but for the grace of God go I” sentiment;
  • outlines a vision quite different from the Ryan one by refusing to use savings from spending cuts or tax base broadening to fund tax cuts for the rich;
  • proposes an approach generally similar to that of the President’s fiscal commission.

Some of my “dislikes” or at least “disappointments” about the proposed framework:

  • proposes a mix of spending cuts versus revenue increases that is probably still too heavy on the spending side, and gives the President an “opening bid” that is basically where I think he wants to end up.  (Is that the best negotiating strategy to counter Ryan’s all-spending-cuts proposal, or has the President already negotiated with himself?)
  • suggests that the broadening of the tax base/reduction of tax expenditures would be limited to households with incomes above $250K–such as those “millionaires and billionaires” the President kept referring to today.  Not clear that this would raise adequate revenue or that the President is willing to go after the largest tax expenditures or pare them back enough (even on the rich).  (Still, in terms of economic efficiency, raising taxes on the rich by broadening their tax base is still preferable to raising taxes on the rich by simply raising their marginal tax rates.)
  • fails to acknowledge that even the “middle-class” portions of the Bush(-now-Obama) tax cuts were deficit financed and were fiscally irresponsible, and that President Obama has always supported the deficit-financed extension of the great bulk of the Bush(-now-Obama) tax cuts;
  • takes a pass on Social Security reform, just like the Ryan plan;
  • doesn’t cut defense spending as aggressively as the commission recommended (and yes, probably for the same political reason that it doesn’t raise as much revenue as the commission proposed–which by the way I still think was too low with its ceiling of 21 percent of GDP);
  • proposes a “fail-safe” trigger that I worry would be either ineffectual because of its exemptions (Social Security and Medicare, and “emergency” situations) or even economically damaging because of its procyclical nature (cutting spending during recessions).

I thought the President’s speech was great in terms of tone and delivery, but just good in terms of substance. Not perfect, but at least good–and I am reminded that the wise adage applies well here, that we can’t let the perfect be the enemy of the good. It actually exceeded my expectations from before the speech, and I am somehow comforted and reassured to see the House Republicans react the way they did to the speech (in the video below)–lashing out with accusations of the President’s “partisan rhetoric,” basically shocked that the President disagrees with them on the issue of tax cuts for the rich and the draconian spending cuts they require. (So I guess the President did provide a decent counterpoint to the Ryan plan, even in taking that “balanced” approach of still three-fourths spending cuts to the one-fourth tax increases.)

47 Responses to “Not Perfect, But Good”

  1. comment number 1 by: Vivian Darkbloom

    I’m not sure Economist Mom has read the same document I have. For a supposed non-partisan observer, this post comes rather too quickly as a big wet kiss to the administration.

    As far as her “likes”:

    –the proposed tax increase on incomes over $250,000 has already been baked into the Obama budget (the overall effects of which have been discounted by the CBO). There is nothing new here except the same old class warfare. What’s to like about a warmed-over lunch?

    –Eliminating “tax expenditures” might be a good idea; however, Obama has not indicated which ones he intends to eliminate. I thought in an earlier post we were demanding specifics ? (see also comment below on the debt “trigger” which is relevant here);

    –What’s to like about a speech blaming the problem on someone else in a over-politicized manner?

    –Since when is noting that reducing the deficit involves choices between taxing and spending something to “like”? Rather than “like” this, I think one would have to conclude “Duh, really?”, particularly when it was not backed up with any credible commitment to raise taxes across the board or cut spending. Obama made absolutely no hard decisions here;

    –If you like the idea that all Americans benefit from entitlement programs (albeit some more than others), perhaps the president should have insisted that all Americans contribute a bit more to financing those benefits. This simply perpetuates the myth that we can solve our debt problems by leaving unaffordable and runaway entitlements intact and financing them solely by “taxing the rich”;

    –Since when does cutting spending “fund tax cuts for the rich” more than they “fund” tax cuts for any other class?

    –The President’s has been consistent and steadfast in failing to endorse the proposals of his own Deficit Commission. That did not change yesterday. And, as the President has not given us any details, other than tax increases that have been know since before the election, and some very gauzy notion about unspecified spending cuts, how is one to know that it’s approach would resemble anything like the recommendations of his Commssion?

    As regards the “trigger” mechanism, there seems to be much more here than meets Economist Mom’s eye. Keith Hennessey has a pretty good initial take on that and on other shortcomings of this “proposal”. He’s partisan, but his insights are usually pretty good, and this is no exception: http://KeithHennessey.com/2011/04/13/obama-budget-v2/

    Basically, what it is seems to mean is a mechanism by which the deficit would be reduced solely by increasing taxes on the “rich”.

    As more details (if any) come out, I think we will see that this vague proposal doesn’t begin to achieve the deficit reduction that the administration claims it would. Economist Mom and others have criticized Ryan for using the Heritage Foundation to evaluate his plan, but at least he did run it by CBO (which he was not required to do), for whatever that might be worth. The Obama “plan” also does not have sufficient details to be “scored”, but let’s see whether his document is submitted to the CBO for their review. The OMB scoring of the Budget and the CBO scoring was off by a few trillion and I suspect this one would be, too.

    I’m deeply disappointed in the President’s proposal, if one could call it that. I’m also disappointed that Economist Mom seems to have given Obama a real pass here, particularly since he did not even remotely meet the expectations she raised in her earlier post.

  2. comment number 2 by: Vivian Darkbloom

    As to the assertion that the President’s proposal generally follows the Bowles-Simpson report, here’s what Paul Krugman had to say:

    “Substance: Much better than many of us feared. Hardly any Bowles-Simpson — yay!”

    Need I say more?

  3. comment number 3 by: npm

    Did you mean ” ‘tax expenditures’ which are economically INefficient”?

  4. comment number 4 by: economistmom

    Ah, npm — Yes, I did! Thanks!

  5. comment number 5 by: mike

    I don’t trust the democrats and I don’t trust the republicans. But I do trust economistmom and the fact that you describe it as “good” made my damn day. Grazie.

  6. comment number 6 by: Brooks

    Diane,

    Has Obama provided a plan with the same level of specificity as the Ryan plan?

    If he has, please provide a link.

    If he has not, isn’t his response well short of “good”? (even putting aside that it’s a response rather than his leading)

    And when I say “good” I mean in terms of fiscal responsibility — moving us closer to substantial mitigation of our long-term fiscal imbalance problem — not “good” as you apparently see it ideologically, and I’d respectfully say that your post comes across to me as the latter overshadowing the former in your assessment.

    I say again, the three magic words for policy-makers should now be “Where’s your plan?” Criticism of someone else’s plan without offering one’s own (or supporting some other, equally substantial and adequately detailed plan) is not only not helpful, it’s harmful, because it reinforces the political lesson that in Washington there’s a perverse form of Darwinism: survival of the least responsible.

    As a side note, re: limiting tax deductions for high income earners, isn’t that what the AMT was supposed to do?

  7. comment number 7 by: Vivian Darkbloom

    Brooks,

    One of the functions of the AMT is indeed to prevent taxpayers from taking advantage of too many deductions. However, the tax code contains a more direct limit on itemized deductions called the ¨Pease Phaseout” rules. Under these rules, most itemized deductions are ultimately subject to an elimination of 80 percent (except medical expenses, already subject to an income threshold, investment interest and casualty and theft losses). The same type of rule, called the PEP (Personal Exemption Phaseout), ultimately eliminates a taxpayer’s personal exemption. These phaseouts were eliminated for years 2010, 2011, and 2012, but are scheduled to re-enter into force in 2013.

    Progressive bloggers are fond of saying our marginal tax rates are too low and that we have too many “expenditures” in the tax code; however, they never, never mention these rules that can eliminate more than three-quarters of a high-earner’s itemized deductions and completely eliminate the personal exemptions.

    So, if Obama is serious about eliminating individual tax expenditures beyond what current law provides (after 2012), the hit should primarily be on those earning less than $250,000. So far, though, he’s not talk’in.

  8. comment number 8 by: Gipper

    I laugh when Economistmom purports to look after my interests:

    “reminds Americans that we all benefit from safety-net programs even if we don’t personally need that safety net at this very moment (or even ever use it)–the “there but for the grace of God go I” sentiment;

    Unfortunately, Medicaid is not a safety net for a large number of people. It is a foundation. Besides, Medicaid can be given to the states to run. No reason the federal government has to run it. With the power to print money and deficit spend, remove as much temptation from the federal level as possible.

    Also, the sophistry in “tax expenditures” is mind boggling. Yes, the economic incentives of tax expenditures and spending are identical. However, the accounting is not. So let’s dispense with the nonsenes of labeling a cut in tax expenditures as a spending cut. It’s a tax increase. So Obama uses taxes almost entirely to cut the deficit. I knew that would make Economistmom happy.

    So Obama is at one extreme and Ryan is at the other. Bowles-Simpson tax revenue increases and 90% of Ryan spending cuts should do the trick. Hope that the Gang of 6 get somewhere close to that.

  9. comment number 9 by: SteveinCH

    More amusing by far is the reference to Medicare and SS as safety net programs. Whatever its deficiencies, at least Medicaid is target to those with some defined need.

    But “there but for the grace of God go I” in reference to reaching 65? Now that hardly makes sense. I rather hope to live to see 65 as do, I imagine, most Americans.

  10. comment number 10 by: Arne

    “these rules that can eliminate more than three-quarters of a high-earner’s itemized deductions and completely eliminate the personal exemptions”

    PEP has a maximum impact of $1277 per dependent. Less than one sixth of my deductions, it would be a small part for someone who makes more than three times what I do. There must be a few more rules to worry about if you have that much money.

  11. comment number 11 by: Arne

    “I rather hope to live to see 65″

    I suspect you hope and even plan to have a lot more than Medicare and Social Security available to you when you reach 65. Much of the success of SS comes because, whether it is 100 percent or 20 percent of your income, it makes a difference for nearly all of its beneficiaries. Medicare will work for the same reason but only if costs are controlled, and that is a big, big if.

    The question should not be just where is your plan, but how does your plan control medical costs.

  12. comment number 12 by: SteveinCH

    Sorry Arne, but my point was that referring to those programs as a “safety net” is entirely incorrect.

    In addition, consider the following two options

    1. You receive no SS and no Medicare benefits. You continue to pay current tax rates for those programs and the government cannot use general fund revenues for either program

    or

    2. You receive full SS and Medicare benefits but are subject to whatever tax increases the government deems necessary to fund the benefits

    I would pick choice 1 every single day of the year. My family’s financial plan assumes no benefits from either program for us. If only I could sign up now for no benefits and be immune from the massive tax increases that are sure to come in order to pay for them (unless of course we run an inflationary spiral which would be an even worse outcome)

  13. comment number 13 by: SteveinCH

    ANd the question should be whether your plan controls government medical costs. It isn’t actually government’s business to control medical costs and more than it is its business to control food costs.

  14. comment number 14 by: Joe

    The potential danger of a total failure of our global economy is calling for a world leader to resolve this crisis - a scenario found in Bible prophecy.

    The continuing rise in gas prices, the home mortgage crisis, and the failure of some regional banks has the attention of the world - as signs of a threat to the world economy. Economic experts are now saying that if we do not turn this situation around, the global financial system could fail.

    An interesting quote coming from this story was “No world leader seems able to discern the problem, let alone forge a solution.” However, I must remind you that Bible prophecy does lay out a similar scenario and reveals that there will be a world leader who will come to power for the occasion.

    Daniel 7:8 speaks of the “Little horn” - one of 27 names for the Antichrist, this coming world leader. The Antichrist will set in place a one-world economic, political, governmental system that will be headquarter in Babylon - modern-day Iraq, (Revelation 18). Antichrist will control the economies of this world and bring stability out of chaos - only to be brought down at the time that the Lord Jesus Christ returns to the earth, (Revelation 16:17-20).

  15. comment number 15 by: Arne

    “If only I could sign up now for no benefits and be immune from the massive tax increases that are sure to come in order to pay for them”

    By every projection out there that would be the wrong choice. At current payroll tax rates income pays for 98 percent of benefits today and will pay for 3/4 of benefits 50 years from now. Giving up 3/4 to save 1/4 is not a good deal.

  16. comment number 16 by: AMTbuff

    Arne, the tax increases will not be applied as an equal percentage increase to everyone. The affluent will bear most of the cost for everyone. That’s why it could be a good deal for a person making $100k or more.

  17. comment number 17 by: SteveinCH

    And personally, I’m happy to pay a premium for certainty. And to AMT’s point, look at the “increases” thought of to save SS. The only proposal is to increase the cap…so the 1/4 you describe falls entirely on about 5% of the population.

    And of course if you are younger than I, the argument for certainty is even stronger. The history of SS taxes says an increase pretty much every decade is almost a certainty.

  18. comment number 18 by: AMTbuff

    Certainty is the enemy of campaign contributions. This is why you will never see anything approximating certainty.

    But consider the positive side of it. I believe that today’s permanently temporary tax code, with one-year extensions and retroactive fixes, is more honest than an unreliable multi-year commitment.

  19. comment number 19 by: SteveinCH

    Probably true AMT, I’m simply stating that the certainty of a bad outcome is better than uncertainty for me as it relates to government finances.

    I accept that certainty is probably impossible but that doesn’t mean I wouldn’t like it ; )

  20. comment number 20 by: Arne

    “The only proposal is to increase the cap”

    If increasing the cap really were the only possible way to make up the shortfall, you would have a good point.

    I believe the best path is to gradually increase the payroll tax until it makes up the missing quarter. It seems like a stiff increase, but the same forecasts say your income will be goimg up faster, so you will have more disposable income after taxes. (The forecasts will be wrong in many particulars, but thats another long conversation.)

    The issue for SS is not that a pay as you go system does not work, it is that it needs to adjust to the reality that we live longer than the last generation did, and that costs more. The benefit formula provides more back to people who put in more, but each added increment comes with a lower added benefit. Increasing the cap would require more benefits for people who don’t need them.

    Increasing the Normal Retirement Age is another type of proposal that increases revenue while it decreases benefits. I object to most such propoals because they reduce the years of benefits to less than the previous generation’s.

  21. comment number 21 by: SteveinCH

    Only possible way, only proposed way, pretty much yes.

    And any approach to increase solvency will not fall equally on all participants.

    Mark my words, means testing is coming. We can only hope it comes sooner.

  22. comment number 22 by: Jim Glass

    I object to most such propoals because they reduce the years of benefits to less than the previous generation’s.

    Well, that’s just a mechanical reflection of the fact that SS gives less benefits, period, to every generation compared to the previous.

    Here is SSA.gov’s calculation of real return on contributions to SS participants by year of birth cohort:

    1876: 36.5%
    1900: 11.9%
    1925: 4.8%
    1950: 2.2%
    1975: 1.9%
    2000: 1.7%

    Note that the Trustees project the post ‘75ers receive a *negative* return compared to the risk-free return on T-bonds — and thus are made poorer as a group on a lifetime basis.

    The arithmetic forcing this is that in a “paygo” system when you give the pre-1985 retirees $15 trillion more in benefits than they paid in through contributions, the post-1985 retirees *must* receive $15 trillion less than they paid in — and that’s a $30 trillion swing!

    So if you don’t cut benefits by increasing the retirement age you’ll do it some other way. The Iron Laws of Arithmetic insist.

    (Btw, SSA.gov has a whole lot of interesting data on this subject and related analysis that I rarely see reported anywhere. On Google search “site:ssa.gov moneysworth”.)

  23. comment number 23 by: SteveinCH

    And of course, those figures are on average. Near or over the cap, the returns are even worse.

  24. comment number 24 by: Vivian Darkbloom

    “I object to most such proposals because they reduce the years of benefits to less than the previous generation’s.”

    I don’t think this statement is true, even on its face. The “years of benefits” is a function not only of the retirement age, but also of one’s life expectancy. Each generation’s life expectancy is higher; each generation’s “years of benefits” tends also to be higher, not lower, because most proposals increase the retirement age less than the increase in life expectancy. http://www.ssa.gov/history/lifeexpect.html

    Of course, if one is talking about generational transfers within the SS system, “years of benefits” is not a good measure to use. The calculation would need to involve not only total benefits but levels of contributions as well. Thus, “real return” on contributions as presented by Jim Glass is the more appropriate measure. I have not been able to locate the data cited by Mr. Glass; however, I did come up with the following on the SSA site:

    http://www.socialsecurity.gov/OACT/NOTES/ran7/

    It is difficult to reconcile the numbers sited in the earlier post to these; however, I suspect that the numbers cited by Mr. Glass refer to the average for all contribution cohorts (historical earnings subject to SS tax) and all marital status cohorts for beneficiaries. As you can see from the above reference, the return varies dramatically when one considers these cohorts separately.

    And, even those factors are not sufficient to describe the “real rate of return”. Beginning in 1984, 50 percent of the benefits of certain taxpayers have been subject to ordinary federal income tax. Revenues from this tax are allocated back to the Social Security Trust Fund. And, beginning in 1993 with OBRA, 50 percent was increased to 85 percent for certain taxpayers. Additional revenues from this increase in the tax base (from 50 to 85 percent) are allocated back to the Medicare trust fund.. And, the taxation of social security benefits doesn’t only affect the “rich” as defined by the current Commander in Chief—taxation is phased-in when one’s income exceeds $25,000 for a single person and $32,000 for a married couple. Thus, a retiree who is subject to tax on 85 percent of social security benefits at a marginal rate of 35 percent is only receiving 70 percent of the stated benefits. What the right hand giveth, the left hand can taketh away. (the economic realty here is similar to “tax expenditures”–just ask Brooks—what the right hand taketh away, the left hand giveth). Since the SSA and other studies don’t take this into account, the “real rate of return” for later generations of recipients, on average, is somewhat lower than stated. The main effect, of course, is on medium and higher-income recipients whose “real return” is very significantly negative. This convoluted manner of raising revenue and increasing progressivity makes the system very inefficient and opaque (the latter characteristic is likely intentional).

  25. comment number 25 by: Vivian Darkbloom

    Arne,

    I somehow overlooked your earlier point about PEP (comment 10) or I would have responded earlier. You have taken a rather trivial example merely about PEP to trivialize my point about PEP and Pease. I included PEP in the discussion because PEP and Pease are really two Pease in a pod. With regard to these provisions, the ABA summed up the matter fairly well in a White Paper on Tax Policy:

    “The so-called “PEP” and “Pease” phaseouts in sections 68 and 151(d)(3) of the Internal Revenue Code of 1986, as amended, do not even have the merit of targeting. They are acknowledged to be “stealth” tax rate increases. These provisions are scheduled to be completely repealed in 2010 (and the phaseouts themselves are being phased out from prior levels from 2006 to 2009), but under the sunset provisions applicable to this and other tax cuts enacted in 2001, they would return in 2011. We would urge that this repeal be permanent, with any revenue effects being adjusted through explicit rate adjustments or other more transparent tax policies.”

    http://www.americanbar.org/content/dam/aba/migrated/tax/pubpolicy/papers/whitepaper_sopfavoringtaxsimplicitystabilityandtransparency.authcheckdam.pdf

    Of course, the PEP and Pease rules were extended for two years as part of the “Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010”. With that extension, the JCT estimated the revenue loss to be approximately $20.7 billion over two years. While this is not, by any measure, the largest (potential) item in the federal budget, nor the largest (potential) tax expense for high income taxpayers, it is nevertheless not trivial. More importantly, to me at least, is that fact that it represents, for a number of reasons, very bad tax policy. As noted by the ABA, it is effectively a “stealth tax increase” where the political value of this stealth is given precedence over a simpler, more efficient and transparent and tax code. One could achieve much the same policy objective by (1) eliminating itemized deductions for everyone and lowering the tax rates across the board in a manner that achieves the desired progressivity, thus doing away with the necessity of Pease and AMT (my preferred solution); or (2) keeping the present system and increasing the marginal rate rather than mucking up the code (perhaps I misspelled that verb) with PEP and Pease. Given the estimates of the revenues involved, that would represent about a 1 percent increase in marginal federal income tax rate. Aside from the complexity of PEP and Pease, they create the rather stupid situation in which the progressiveness of our tax rates is littered with little bubbles rather than being a straight linear progression.

    Of course, what we have in the administration’s last budget proposal, and in the President’s last speech (presumably) is a curious mix of the following objectives:

    1. Re-instate PEP and Pease, albeit in slightly different form;
    2. Increase the marginal income tax rate from 35 to 39.6 percent;
    3. Increase tax on capital gains and dividends;
    4. Eliminate certain (unspecified) tax expenditures; and
    5. But, not increase the tax burden on the middle and lower income classes (in fact, close examination reveals that revenues will be forgone and spending will increase dramatically by, among other things, extending the $3 trillion “Bush middle class tax cuts” and extending permanently the Making Work Pay Tax Credit, etc).

    6. Increase spending on “investments”, whatever that means.
    7. Decrease spending in unspecified but very selective areas of the discretionary budget.

    I, for one, am quite curious, as to how these various items are supposed to fit together., particularly items 3 and 4. Economist Mom seems too much enthralled by Obama’s lofty rhetoric to pay much attention to these pesky details (or lack of them). What I guess it adds up to is that tax rates will be increased for some, tax expenditures will be eliminated for some, and taxes will be lowered and spending will be increased for the others. It sounds to me like more of the same. I thought that pretending we could balance the budget by merely taxing the rich was long discredited, even by the Concord Coalition.

  26. comment number 26 by: Vivian Darkbloom

    That should have been how items 4 and 5 fit together rather than items 3 and 4.

  27. comment number 27 by: Gipper

    The way to fix SS is to convert it into a defined contribution program. Don’t privatize it. Create a government-run mutual fund that invests payroll taxes into Treasuries reflecting the aggregate of maturities outstanding. Each worker gets their own account knowing precisely what they’ve contributed.

    Each worker gets a safe, guaranteed investment. The government continues to receive tax revenues that privatized plans would divert. However, now a worker will receive in retirement what he personally contributed. Also, if he dies before the minimum age before he could withdraw all the funds, he could pass it on to his estate for his heirs to enjoy.

    Rules would have to be established to ensure seniors didn’t blow their money away and outlive their savings.

    In this way we dispense with the entire argument about retirement age. We eliminate problems of racial and sexual discrimination inherent in all benefit and age formulas.

    We also confront the popular myth propagated by Democrats and believed by recipients which is that they are only getting back what they have already put into the system. It would be fun to see Republicans propose this just to see the Democrats and AARP go crazy with cognitive dissonance.

    This plan eliminates the “Trust Fund” concept and converts all SS obligations into publicly held debt. This makes for very precise budgeting and makes the true obligations very stark and plain for everyone to see.

    If SS savings aren’t adequate for a senior, then the states can step in with their own welfare programs. SS suffers from being a welfare program that tries to act like a retirement program. It does a poor job at both roles, plus it is financially broken.

  28. comment number 28 by: Gipper

    Jim,

    Those rate of return figures you listed remind me of a Ponzi scheme. The early participants earn high rates of return. The later ones get screwed.

    That’s the best illustration I’ve seen proving the point about what a criminal enterprise the Social Security System truly is. Someday, FDR’s name will truly “live in infamy.”

  29. comment number 29 by: Arne

    “most proposals increase the retirement age less than the increase in life expectancy”
    http://www.ssa.gov/OACT/TR/2010/lr5a3.html
    For someone reaching 65
    Year NRA Life exp yrs ret.
    2000 65 15.9 15.9
    2025 67 18.3 16.3
    2085 68 21.7 18.7

    2045 70 19.6 14.6
    2085 70 21.7 16.7

    You are right. Only the more agressive proposals actually reduce retirements years.

    I think many (if not most) see retirement as the goal. Working 2 more years and getting only one more year in retirement is at best a borderline acceptable return on investment. Raising the NRA to 70 any time before 2085 provides less than that. (not even taking into account the relationship between wealth and life expectancy)

  30. comment number 30 by: SteveinCH

    Ah the mindset of the entitled : )

  31. comment number 31 by: Vivian Darkbloom

    Arne,

    Another thing. The fact that the social security “retirement age” is increased does not, in and of itself, necessarily reduce average lifetime benefits. The benefit formula is complex, but generally, if the normal retirement age is increased from, say, age 67 to 69, persons retiring at age 69 under this type of proposal would get higher annual benefits, albeit spread over a shorter time span. The average lifetime benefits with the earlier and later retirement dates is a bit of a wash.

    Those who have studied the issue carefully (say Andrew Biggs) would argue, I think, that the real deficit reduction come from increased lifetime contributions, not decreased lifetime benefits. In other words, if the normal retirement age is increased, people will tend to work longer and retire later, thus paying more into the SS system. They also argue this also has general macro benefits because it tends to increase GDP.

  32. comment number 32 by: Arne

    Jim Glass’ numbers can be found here.
    http://www.ssa.gov/policy/docs/ssb/v62n2/v62n2p43.pdf

    This one, http://www.ssa.gov/oact/NOTES/ran5/index.html
    does not go back as far, but does provide more of a breakdown.

    Note that the real return is greater than zero, something which may or may not be true of treasuries.

    Also note that real returns are greater in Table 2 than in Table 3. Increasing payroll taxes provides a better return than decreasing benefits.

    The very high rates are for the years before SS was even remotely on a paygo basis. They represent the start up cost of providing for people who were wiped out during the Great Depression.

    For a median wage earner SS is a good foundational safety net.

  33. comment number 33 by: Arne

    “Well, that’s just a mechanical reflection of the fact that SS gives less benefits, period, to every generation compared to the previous.”

    SS gives more benefits to every generation compared to the previous. Benefits increase as average wage increases. There is downward pressure because we live longer and more people reach retirement, but today’s benefits buy more than last generations benefits.

  34. comment number 34 by: SteveinCH

    Sorry Arne, as I pointed out above, those returns are only true on average. For a single earner near or over the cap and for most dual earners, the return on SS is already negative in nominal terms.

    http://www.ssa.gov/oact/NOTES/ran7/index.html

  35. comment number 35 by: Vivian Darkbloom

    “SS gives more benefits to every generation compared to the previous. Benefits increase as average wage increases. There is downward pressure because we live longer and more people reach retirement, but today’s benefits buy more than last generations benefits.”

    Sure, benefits increase as wages increase, but so do contributions. The fact that benefits increase is not the point at all. That data show that the rate of return has steadily decreased for for each successive generation cohort–that takes both contributions and benefits into account (and ignores more recent taxes on benefits as I note above). If I’m paying 200 percent more in inflation adjusted lifetime earnings and am getting back 150 percent more in inflation adjusted lifetime benefits than the prior generation, I wouldn’t exactly call that an “increase in benefits” in any real economic sense.

  36. comment number 36 by: Jim Glass

    Jim, Those rate of return figures you listed remind me of a Ponzi scheme.

    Gipper, in the 1960s Paul Samuelson praised SS as “a Ponzi game that works“. Of course, all Ponzi games work during their early days.

    Krugman called SS a Ponzi game too, back in the 1990s, when before he became a rabid partisan, while he was still capable of speaking truth to Democrats…

    “Social Security … has turned out to be strongly redistributionist, but only because of its Ponzi game aspect, in which each generation takes more out than it put in. Well, the Ponzi game will soon be over…”

    And, of course, Milton Friedman called SS a Ponzi game in no uncertain terms — and not as a compliment!

    So that is three Nobelists i know of who have called Social Security a Ponzi game (and from every angle: pro, cautionary, and against). Who are any of us to disagree with them? :-)

    But all smiley’s aside: Social Security is a Ponzi game.

  37. comment number 37 by: Jim Glass

    Dang, my link to the Samuelson-Krugman-Friedman quotes didn’t take:

    http://www.scrivener.net/2008/06/who-said-social-security-is-ponzi-game.html

  38. comment number 38 by: Vivian Darkbloom

    I don’t know what the current figure would be, but it is telling that the unfunded liability of SS was estimated back then to be 14.4 trillion$. Now, if you are running a Ponzi scheme, this is not a number you want to publicize—rather you focus on the fact that the fund is currently “solvent” in the sense that it has enough in it (i.e. IOU’s) to fund benefits for X number of years. That’s why in our accounting for social security, one hardly ever hears of the unfunded liability amount. Unlike private sector plans, most prefer to use the cash method of accounting rather than accrual when describing the fiscal position of SS. And, that, I think, has a great deal to do with our public misperception of the problem.

    Whether social security is part of the general budget or not, it has a huge impact on our spending habits. Until very recently, Congress has relied on the trust fund as a captive source of borrowing. Now that the fund is cash flow negative, that trend is reversed and we need to pay the fund back from general revenues rather than borrow from it. This, in my view, is like the North Atlantic ocean current changing direction. Part of me thinks that perhaps it would be better *not* to fix social security (i.e., not to raise contribution limits) because that fixing it would simply enable us to borrow more from the fund and push the problem further down the line. I expect Democrats will make a big push to “solve social security”, not in order to save the system, as such, but in order to preserve their line of credit.

  39. comment number 39 by: Jim Glass

    SS gives more benefits to every generation compared to the previous. Benefits increase as average wage increases. There is downward pressure because we live longer and more people reach retirement, but today’s benefits buy more than last generations benefits.

    Entirely wrong. Not even close to the truth.

    What’s happened is there have been three different generations of the SS program, with very different structures so far — and none of them have been anything like “paygo” since 1939. Soon we
    must enter the fourth.

    I. FDR’s own Social Security Act of 1935.

    This gave every generation the 3% return of T-bonds on its contributions, via a 6% payroll tax.

    FDR was insistent and unbending on the principle that each generation finance its own benefits, and **no** “intergenerational transfer” burden be dropped on future taxpayers. So every generation got the same 3% return.

    (FDR famously had a tantrum when some of his staff slipped “paygo” provisions starting in the 1960s into the bill, and he surprised them by reading it. He tore the bill up, made them pull it from a presentation to Congress, and re-write it. Try to imagine Obama or any other modern politicians being so opposed to dropping a cost on the future, eh? )

    When FDR said his SS Act of 1935 was “actuarially sound and out of the Treasury forever”, he *meant* it, and it basically was. If it had been left in place, it would still be running soundly today.

    II. 1939-1983. Congress loots the *first* SS surplus.

    When the first payroll tax collections started coming in long before workers had earnings records long enough to collect benefits, there was suddenly a *whole lot* of free cash available to the govt that FDR intended to use to pay down federal debt as national savings to fund future SS liabilities.

    But what do politicians do with cash flow surpluses? Spend them now! Starting in 1939 Congress slashed the legislated payroll tax rate from 6% to 2%, accelerated benefit payment dates and increased benefits.

    Thus the first participants got a huge benefit increase on contributions compared to what FDR wanted. (Ida May Fuller’s $22,888.92 on $24.25.)

    FDR’s head of SS, Arthur Altmeyer, objected that this would inevitably lead to inter-generational unfairness as future participants would get a worse deal from SS than current ones — but the politicians wanted that! — *and* that it would inevitably make SS insolvent, as a paygo program can’t promise benefits that far exceed its revenue. Altmeyer reported that when he warned that eventual future insolvency of SS would be forced, Congressional leaders told him, “that will be their problem, not ours.”

    FDR vetoed these changes — but Congress overrode the veto. FDR never dealt with SS again. (He had a war to fight.)

    During the following years almost every Congress *increased benefits*. Initially this had minor immediate cash cost, since so few benefits were spread over so many taxpayers (Congress was also widening the tax base).

    And this created the golden years of SS as Sameulson’s “Ponzi Game that works!” giving everyone “five times what they contribute”. What wasn’t going to be hugely popular about that?? Most successful program ever!

    Alas, some years after each benefit increase the cost of it started becoming serious, so congress also had to raise the tax rate time after time to play catch up in paying what previous congresses had promised. Every increase made SS more costly to the younger, giving them a worse deal than the older.

    III. 1983 — circa today. SS goes insolvent and Congress saves the senior voters by sticking it to the young.

    Congress finally hit the political point where it couldn’t raise the payroll tax any further. At that point Altmeyer was proved right, SS ran out of money (the first time).

    Congress “bailed out” SS with the classic 50-50 political compromise, 50% tax increase and 50% benefit cuts.

    But since its objective — as always with SS — was to secure the votes of the seniors, it protected the seniors’ highest benefits ever while dropping all 100% of the benefit cuts and tax increases *on the then young*.

    That’s the swing point for SS. Participants through the protected then-seniors received $15 trillion more than they contributed, compared to the risk-free federal bond rate. As SS is paygo in total, later participants, starting with the then-young (today’s 50-year olds or so) must by the iron law of arithmetic, get back $15 trillion less than they put in.

    Social Security functions as a one-way transfer of $15 trillion to the seniors of the 1980s and earlier from the workers of today and younger. The younger will never get that back.

    That’s $30 trillion more net for old than the young, financed by the young.

    IV. Into the future.

    Politically, SS continues to benefit immensely from the good will earned during the Samuelson “Ponzi Game that works!” era when it gave everyone, rich and poor, $15 trillion of free money. And also on the left from its image being FDR’s “signature social program”

    Of course, SS hasn’t actually been “FDR’s Social Security” since the 1939 changes and its coversion over his veto. And the happy Samueslon “Ponzi game that worked era” ended in 1983. Now we are on the down side of that same Ponzi game (which was itself a total repudiation of FDR’s model of SS).

    Politically, we know how much receiving a $15 trillion transfer made SS *beloved* by the old. What political effect will the opposite — paying a $15 transfer — make the young feel about SS when the cost lands on them in full? We shall see.

    In spite of the 1983 changes, only about $1 trillion of the $15 trillion loss the young must bear on SS has been written into law so far.

    The ONLY problem SS faces going forward is deciding exactly who is going to eat that $15 trillion loss — exactly who among the young is going to eat how much of it.

    All reform proposals — delay the retirement age, means test, up the payroll tax without giving corresponding benefits, use transfers of general revenue, create a VAT … boil down to doling out the $15 trillion loss.

    Now, the whole argument would be a whole lot simpler and more honest if we just said….

    “Look, our political predecessors decided to take $15 trillion from us and give it to our generational predecessors. That’s done, for better or wose, no point in arguing about it.

    “There’s no way to avoid us paying that $15 trillion, because it’s already been spent and the bill is already landing on us.

    “But if we recognized and admitted this state of affairs, we could (1) Break out the $15 trillion as a separate cost owed by the US, and make some provision to pay it, and (2) Create a national retirment system free of the $15 trillion debt that would be fully funded and beneficial for everybody, giving a positive return to all, a any retirement plan should.

    “And we’d all be better off, because (3) insisting on paying both the benefits of today’s workers *and*
    the $15 trillion for past workers through the payroll tax — under the delusion that this is “preserving FDR’s Social Security” (!!!) which served our grandparents so well — is an expression of mental illness, that can only *hurt* today’s workers, and hurt the poorest of them most, by making them $15 trillion poorer overall via a compulsory high regressive payroll tax they must pay their entire working lives.”

    BTW, points (1), (2), and (3) are Milton Friedman’s, so no credit to me.

  40. comment number 40 by: Jim Glass

    Re SSAgov “moneysworth” projections.

    Note that the real return is greater than zero, something which may or may not be true of treasuries.

    The SSA projection for real return on “risk free” Treasuries is 3% (IIRC), which is higher than the average real return from SS for today’s and future workers.

    In fact, this is *definitionally* true because SS as a paygo system from here forward *must* pay today’s and future workers $15 trillion less relative to the bond rate than they paid in, to balance off the $15 trillion more received relative to the bond rate received by earlier workers, and make “pay” = “go” in total. Whatever the risk-free bond rate is, SS must pay less.

    For a median wage earner SS is a good foundational safety net.

    Only if getting less from it than you paid to get it is “good”.

    It’s remarkable how far the left has moved the goal posts on SS to determine what is “good”.

    Before the 80s, the *overt* claim for why SS was so great was because “everyone gets back five times contributions!”, as per Samuelson’s Ponzi Game that Works.

    Now it was created to be “safety net” insurance against poverty. As DeLong puts it, SS is like fire insurance on your home, you don’t expect to get your premiums back, you don’t want to get your premiums back. Never did!

    That’s moving the goal posts not only down the field but out of the stadium and across the parking lot.

    It’s also politics. Any argument enough people will buy ….

  41. comment number 41 by: Gipper

    I can never read too many Jim Glass posts. The citiations are edifying. The erudition is smooth as silk.

    Glass vs. Arne is like watching the Yankees trounce the Brooklyn Dodgers year after year in the World Series.

  42. comment number 42 by: Gipper

    Jim,

    It seems as if my Treasury Mutual Fund proposal exactly incorporates the principles that you say FDR originally wanted Social Security to espouse.

    Maybe Republicans should pull out some of your citations and roll it out as the “FDR Original Social Security Reform.” That would bullox Krugman and the Democrats to no end.

  43. comment number 43 by: Vivian Darkbloom

    Great post, Jim Glass.

    Actually, there is another way to (temporarily) solve the problem. As with all Ponzi schemes, the thing can be perpetuated as long as one can attract people to come into the base of the pyramid.

    Catherine Rampell at Economix has reported a few times (favorably, not facetiously) that the solution to the problem is to attract more immigrants:

    http://economix.blogs.nytimes.com/2010/03/03/why-old-people-should-love-immigrants/?gwh=B2AF82EA3027A8006F6054E51EDF8C4D

    Of course, these immigrants typically pay less into the system than they will collect (due particularly to the progressive nature of the system which gives outsized rewards to those with short work histories and low lifetime contributions), but it will likely be a key element in pushing the can further down the road. If you think our children have inherited a big deficit, I shudder to think of the burden this will place on our grandchildren.

  44. comment number 44 by: Arne

    “FDR vetoed these changes”
    1943 was the only year he vetoed the Revenue Act, and he had other reasons.

    ” later participants… must by the iron law of arithmetic, get back $15 trillion less than they put in”
    “to balance off the $15 trillion”
    Bad math. That $15T keeps increasing every year because every cohort does get more than the previous one. At no point in time does the imbalance ever get paid.

    “Only if getting less from it than you paid to get it is “good”. ”
    A median worker will get out more. Look it up.

    I don’t think SS is a magical source of money for everyone. I am sure you are right that Congress should have done more what FDR wanted, but they didn’t. However, SS still does what we need a retirement insurance program to do.

  45. comment number 45 by: Jim Glass

    “FDR vetoed these changes”

    “1943 was the only year he vetoed the Revenue Act, and he had other reasons.”

    To quote FDR’s message to Congress about the vetoed bill…

    “it cancels out automatic increases in the Social Security tax which would yield $1,100,000,000. [$14 billion 2010 money] … These automatic increases are required to meet the claims that are being built up against the social security fund.”

    Pretty clear, that. He didn’t want the taxes he had designed into SS, as required to finance SS on a sound basis against the claims building up, being slashed by 2/3rds. (Yes, there were other things in the revenue act he didn’t like too).

    Here’s what FDR’s head of the SSA, Arthur Altmeyer, said to Congress protesting against the changes — i.e., FDR’s objections:

    “…it may be said that the reserve fund of this system already has a deficit of $6,600 million…

    “It is a mathematical certainty that the longer the present day payroll tax remains in effect, the higher the future payroll tax must be if the system is to remain financed by payroll taxes.

    “This will eventually necessitate raising employee’s contributions rate later to a point where future beneficiaries will be obliged to pay more for their benefits than they would if they obtained this same insurance from a private insurance company…

    “Retaining the present rate creates a moral obligation on the part of Congress to provide a Government subsidy later on to the extent necessary to avoid levying inequitably high pay-roll tax rates in the future…

    “the present contribution rate, so far below the value of the protection provided, creates a temptation to increase the benefits without giving proper consideration to the true costs involved… [!!!]

    “In the history of social insurance throughout the world the major difficulty of social insurance systems has been the lack of adequate financing of old-age retirement benefits. It is always easiest to delay levying the necessary insurance contributions, thus perpetuating and strengthening the belief that the insurance benefits are meager and the costs of the insurance system are low. Inevitably, when the time comes to increase the taxes, many reasons can always be advanced as to why the imposition of the additional taxes is unwise or impossible. In this country we are still in a position to avoid these mistakes by getting clearly established now that if our people want social insurance they must be willing to pay for it…[!]

    “If we should let a situation develop whereby it eventually becomes necessary to charge future beneficiaries rates in excess of the actuarial cost of the protection afforded them, we would be guilty of gross inequity and gross financial mismanagement, bound to imperil our social insurance system.” [SSA.gov]

    And yet here we are, exactly where he warned against being. With “inequitably high payroll tax rates” — more than double what FDR planned, more than *six times* what these early participants paid, while also charging current participants more than the actuarial cost of benefits, by providing less than the risk-free return on that tax rate … and with SS still being underfunded by $15 trillion, so by this measure things *must* get worse yet!

    He was absolutely right that this situation would be “bound to imperil our social insurance system.” Just look at all the challenges arising to it.

    I’d say Altmeyer was not merely spot on, he was prescient.

    OTOH: That $15T keeps increasing every year because every cohort does get more than the previous one. At no point in time does the imbalance ever get paid … I don’t think SS is a magical source of money for everyone…

    My friend, if you think a paygo program can commit to paying future benefits of $15 trillion more than its expected revenue … and that this imbalance can keep rising forever by yet more trillions as commitments further exceed expected revenue … because at no point in time will the imbalance of future over-commitments over revenue ever have to be either paid or defaulted upon … well, it seems you certainly *do* think you have found “a magical source of money for everyone”!

  46. comment number 46 by: Jim Glass

    For the record, here’s the arithmetic of how return on SS contributions has been falling since 1940.

    [] Citizen Able got his first job at age 20 on 1/1/1940. He worked until retiring after 45 years on 12/31/1984. During this period the SS tax rate started at 2% and gradually increased to 11.4%. He paid an average SS tax rate over his life of 6.23%.

    During this time the taxable wage base started at $46,717 (2010 dollars) then declined steadily to only $26,805 in 1948 (by 42%). From there it gradually rose but didn’t get back to the 1940 level until 1968. In 1984 it was $79,162. The average for 1940-84 was $43,832 (2010 dollars) — less than the 1940 amount.

    So Able’s average tax rate of 6.23% applied to an average wage base of $43,832 giving a maximum possible tax bill over his life of $2,731 annually on average, $122,833 total (2010 dollars).

    [] Zippy, Citizen Able’s grandson, got his first job at the age of 20 on 1/1/1985. His tax rate until 1989 averaged 11.7%, after which it is 12.4% until he retires at 67 on 12/31/2031 having paid an average rate of 12.33%.

    The taxable wage base he owes tax on started at $80,806 and has risen to $106,800 today, for an average of $93,803 over 26 years so far. The inflation-adjusted indexed wage base has increased by an average of a little more than 1% annually since the ‘83 reform. Assuming a 1% average increase going forward, Zippy’s average wage base over the next 21 years will be $119,370 — and over his 47 working years, $105,277.

    So Zippy’s maximum possible tax is $12,980 annually on average, $610,100 lifetime (2010 dollars).

    Benefit-side, Zippy’s taken big cuts from what grandpa got.

    * First, his retirement age is two years later, so he gets two years fewer benefits. And if he works until retirement he pays two years more in taxes to get them.

    * Zippy’s benefits have been further reduced by subjecting them to income tax rates and returning the tax to SSA (not to general revenue, where real income tax goes) as a net SS benefit decrease. This reduction increases annually because the income level at which the tax applies is not indexed to inflation, and so declines in real terms each year.

    In 1984, up to 50% of SS benefits became taxable for the first time when total income exceeded $52,356 (2010 dollars), which affected only a very small percentage of retirees. Today the limit is $25,000. When Zippy retires, assuming 3% annual inflation, it will be down to $13,000.

    In 1994 up to 85% of benefits became taxable when total income exceeded $47,010 (2010 dollars). Today the figure is $32,000. When Zippy retires we can project $16,880.

    TOTAL — Comparing Citizen Able working 1940 to 1984, and Zippy working 1985 to 2031:

    Lifetime tax rate paid:
    Citizen Able, 6.23%
    Zippy, 12.33%

    Average taxable wage base, 2010 dollars:
    Citizen Able, $43,832
    Zippy, $105,000

    Lifetime maximum tax paid, 2010 dollars:
    Citizen Able, $122,833
    Zippy, $610,000

    Benefits:
    For Zippy, begin two years later.

    Benefits subject to income tax rates (2010 dollars):
    Citizen Able, Up to 50% if income over $52,356.
    Zippy, Up to 85% if income over $16,880; and up to 50% if income over $13,000.

    And, of course, the benefits of the Zippys of the world and later are still underfunded by about $14 trillion. None of this includes the further benefit cuts/tax increases that must be dropped on them to close that gap. Eg, Zippy’s personal promised benefits are 20-odd % underfunded after 2037. Whether the Zippys of the world get hit with an extra tax to fund their own benefits, or eat the benefit cut, their return on contributions from the currently legislated level falls yet further.

  47. comment number 47 by: Jim Glass

    I can never read too many Jim Glass posts … like watching the Yankees

    Thanks for the kind words, Gipper, always appreciated — but I’m afraid I’m doomed to being a Mets fan.