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Social Security: Reform, Refund or Opt-Out (Part 1)

Posted: May 17, 2009 | Author: | Filed under: U.S. Economy | Tags: , , , , , |Comments Off on Social Security: Reform, Refund or Opt-Out (Part 1)

gdepression on the roadSeveral years ago, I did some research on Social Security.  I thought I’d share that with you now as we look to more possible reforms coming from the Obama administration.   This part is just introductory.  Part 2 will be on Public Pension Concepts and Alternatives.

One of the most successful and significant programs put into place by the Roosevelt administration’s “New Deal” has been the U.S. Social Security System.  It has met its goal of alleviating poverty among the elderly.  It has become known as the ‘third rail’ of politics because of its success and acceptance by the majority of the populace.  Elderly voters—an active and vocal voting constituency—do not take kindly to any discussion concerning social security reform.  While other countries around the world have been reforming and restructuring their public pension systems, the U.S. social security system remains firmly entrenched in its current form.  Any discussion of reduced benefit or increased contributions is political suicide.  Reform discussions are difficult at best.

Most recently, President G.W. Bush spent a large amount of time and taxpayer money being educated on third rail politics while trying to convince America that some form of privatization was the right vision for the future elderly.   While the highly selected audiences at these events was convinced that opting out completely was the way to go, the rest of America hit their panic buttons then phoned their congressional delegated.  These re-education forums are now part of America history.  The public reform debate has gone quietly into the night while discussion continues in the offices of institutions like MIT, Harvard, and the NBER.

Fortunately, many economists are still researching the efficiency of the U.S. Social Security System.  Additionally, they now have around 20+ years of experience from other countries’ public pension reforms to analyze.  This—at the very least—gives the United States the benefit of not going first so it can learn from the problems of the rest of the world.  Learning the lessons of others may still not be enough to bring sensible and truthful debate back to the public arena.  This must happen before reform or refunding actually occurs.

It is widely accepted that the system in its current form is headed for funding problems somewhere around the years 2017.[1]  This is just one of two challenges facing the nation’s huge commitment to the retired.  A much more pressing gap in Medicare funding exists but is rarely discussed.  This shortage in the Medicare program has just been exacerbated by the addition of new a benefit.  A costly, confusing pharmaceutical program was initiated that seems to be benefiting the industry more than the elderly.  It was introduced by the same President George W. Bush that was trying to convince the public to embrace private accounts to “save” the social security system.  Recent evidence suggests that the true costs of the Medicare benefit were withheld from the public and congress until after passage of the law.  Under these dicey circumstances, it will be a wonder if any real dialogue will be re-established to discuss future funding shortages in either program.   Serious public policy discussion requires trust between public and policy makers.  Current polling shows such trust of both Congress and the Bush Administration at basement levels.

Additionally, much of the discussion in the political realm about the Social Security Reform continually subjects the public to a vulgar error. This error is incessantly made by Steven Forbes, Vice President Dick Cheney, and the social security reformed-minded President George W. Bush.  The vulgar error is elucidated by many academics including Peter Diamond, one of the well-respected economists in the public pension field.  It is difficult to get any real good sound economic policy discussion started when a vulgar error is repeatedly made by the very individuals proposing reform.  Most economists agree that after adjusting for transition costs and risks, there is actually no difference in returns between personal savings accounts and the current system.[2]  Politicians’ looking for free lunches through privatization does not stand up to rigorous study.

This vulgar error suggests that the rates of return on assets and on Social Security taxes are the only available alternatives.  Folks perpetuating the vulgar error continually ignore the cost of the transition if individuals get to buy assets with their tax payments.  It also ignores risk associated with equity investments.  This vulgar error is even made by some academics, but much less so.   The vulgar error will be discussed again in more detail but is introduced here to illustrate the degree of confusion and misdirection that occurs in the public arena when discussing Social Security Reform. 

The big questions remain; lost amid all of the political hoopla and disingenuous promises.  What can be done with the Social Security System so that it approaches efficiency or at least becomes solvent?  Should the U.S. reform or refund the System or should it opt-out of the system altogether mandating some forced retirement savings to the private financial markets?

The answers to these questions require a discussion of available alternatives and with some coverage of intergenerational risk sharing and redistribution concepts.  It is also beneficial to examine lessons from the empirical evidence of the countries that have already reformed their public pension programs.  From this background, it is possible to build the foundation on which to reach conclusions. Academic studies can dissect the problem and provide suggested answers but the biggest problem will still be getting it through the political morass of special interests, talk radio hosts, and entrenched elected officials.  No U.S. politician wants to be beaten with and by the third rail.

 

[1] Bohn (1997), Mitchell & Zeldes (1996) have determined contributions will fall below benefits in 2012 while the trust fund will deplete in 2030.

[2] Barro, Robert, “Why Private Accounts Are a Bad Idea, Business Week, April 4, 2005, Goldman Sachs, “Seven Myths About Social Security Reform, “Daily Financial Market Commentary, February 1, 2005. and Joh Geanakopolos, Olivia Mitchell, and Stephen Zeldes, 1999, “Would A Privatized Social Security System Really Pay a Higher Rate of Return, “National Bureau of Economic Research Reprint No. 2266.

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