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Archive for the ‘Social Security Privatization’ Category

I sometimes feel guilty when commenting on Paul Krugman’s work.

In part, this is because I don’t want to give him any additional attention, but mostly it’s because it’s too easy. Like shooting fish in a barrel.

His advocacy of Keynesian economics, for instance, makes him a very easy target.

And it’s always amusing to cite his words when exposing horror stories about the U.K.’s government-run healthcare system.

That being said, I feel obliged to write about Krugman when he attacks me or the Cato Institute.

Now he’s attacked Cato again and he looks like an even bigger fool.

Here’s some of what he wrote on May 15.

David Glasner has an interesting post about how the Cato Institute suppressed an old paper of his, refusing either to publish it or release it for publication elsewhere, not for a few months, but for decades. What Glasner may not know or recall is that Cato has a long-standing habit of trying to send inconvenient history down the memory hole.

When I first read that, I wondered why this was a bad thing. After all, should Cato be obliged to publish articles if we don’t fully agree with them?

But perhaps we had made some sort of commitment and were guilty of reneging. That certainly wouldn’t reflect well on us. So was Cato indeed guilty of spiking a paper we had promised to publish?

Nope.

On the same day that Krugman published his attack, Mr. Glasner published a correction. After emailing back and forth with the relevant person at Cato, he acknowledged that “my recollection of the events I describe was inaccurate or incomplete in several respects”  and that “Cato did not intend to suppress my paper.”

Since Krugman wrote his attack on Cato before Glasner wrote his correction, one presumably could forgive Krugman for an honest mistake. After all, surely he would immediately correct his column, right?

Nope.

On May 19, Jonathan Adler wrote about Krugman’s unseemly behavior in the Washington Post.

Krugman’s charge is false… As Glasner recounts in an update to the post that Krugman cited, the initial allegation was based upon a misunderstanding. Cato had not sought to suppress Glasner’s paper. Indeed, Cato had offered to publish it, albeit not as quickly as either Cato or Glasner had hoped. Once this was cleared up, Glasner forthrightly acknowledged the error. “Evidently, my recollection was faulty,” Glasner wrote. Krugman, however, has yet to update his post.

Wow. That doesn’t look good for Krugman.

But perhaps Adler’s comments had an impact because Krugman did add an update to his post.

In an amazing bit of chutzpah, however, he said it didn’t matter.

Glasner has retracted, saying he got his facts wrong. Unfortunate. It has no bearing on what I wrote, however.

Wow again.

I can understand that it’s no fun to admit mistakes. I’ve had to do it myself. More than once.

But you own up to errors because it’s the right thing to do.

Ethical behavior, however, is apparently not necessary if you’re Paul Krugman.

By the way, Krugman also attacked Cato in his column for supposedly trying to “pretend that they had never used the term privatization” when writing about Social Security personal accounts.

I’m not sure why this is supposed to be damning. All groups try to come up with terms and phrases that work best when trying to advocate particular policies.

Heck, I recently wrote about whether advocates of economic freedom should discard “capitalism” and talk instead about “free markets” or “free enterprise.”

So if Cato people decided to write about Social Security personal accounts instead of Social Security private accounts, the only crime we were guilty of is…gasp…marketing.

P.S. I’ve had some fun over the years by pointing out that Paul Krugman has butchered numbers when writing about fiscal policy in nations such as France, Estonia, Germany, and the United Kingdom.

P.P.S. In addition to defending Cato, I’ve also had to explain why Krugman was being disingenuous when he attacked the Heritage Foundation.

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The most depressing data about America’s economy is not the top tax rate, the regulatory burden, or the level of wasteful of government spending.

Those numbers certainly are grim, but I think they’re not nearly as depressing as America’s demographic outlook.

As you can see from this sobering image, America’s population pyramid is turning into a population cylinder.

There’s nothing a priori wrong with an aging population and a falling birthrate, of course, but those factors create a poisonous outlook when mixed with poorly designed entitlement programs.

The lesson is that a modest-sized welfare state is sustainable (even if not advisable) when a nation has a population pyramid. But even a small welfare state becomes a problem when a nation has a population cylinder. Simply stated, there aren’t enough people to pull the wagon and there are too many people riding in the wagon.

But if America’s numbers are depressing, the data from Europe should lead to mass suicide.

The Wall Street Journal has a new story on the utterly dismal fiscal and demographic data from the other side of the Atlantic Ocean.

State-funded pensions are at the heart of Europe’s social-welfare model, insulating people from extreme poverty in old age. Most European countries have set aside almost nothing to pay these benefits, simply funding them each year out of tax revenue. Now, European countries face a demographic tsunami, in the form of a growing mismatch between low birthrates and high longevity, for which few are prepared. …Looking at Europeans 65 or older who aren’t working, there are 42 for every 100 workers, and this will rise to 65 per 100 by 2060, the European Union’s data agency says. …Though its situation is unusually dire, Greece isn’t the only European government being forced to acknowledge it has made pension promises it can ill afford. …Across Europe, the birthrate has fallen 40% since the 1960s to around 1.5 children per woman, according to the United Nations. In that time, life expectancies have risen to roughly 80 from 69. …Only a few countries estimate the total debt burden of the pension promises they have made.

The various nations is Europe may not produce the data, but one of the few good aspects of international bureaucracies is that they generate such numbers.

I’ve previously shared projections from the IMF, BIS, and OECD, all of which show the vast majority of developed nations will face serious fiscal crises in the absence of reforms to restrain the burden of government spending.

New we can add some data from the European Commission, which has an Ageing Report that is filled with some horrifying demographic and fiscal information.

First, here are the numbers showing that most parts of the world (and especially Europe) will have many more old people but a lot fewer working-age people.

Looking specifically at the European Union, here’s what will happen to the population pyramid between 2013 and 2060. As you can see, the pyramid no longer exists today and will become an upside-down pyramid in the future.

Now let’s look at data on the ratio between old people and working-age people in various EU nations.

Dark blue shows the recent data, medium blue is the dependency ratio in 2030, and the light blue shows the dependency ration in 2060.

The bottom line is that it won’t be long before any two working-age people in the EU will be expected to support themselves plus one old person. That necessarily implies a very onerous tax burden.

But the numbers actually are even more depressing than what is shown in the above chart.

In the European Commission’s Ageing Report, there’s an estimate of the “economic dependency ratio,” which compares the number of workers with the number of people supported by those workers.

The total economic dependency ratio is a more comprehensive indicator, which is calculated as the ratio between the total inactive population and employment (either 20-64 or 20-74). It gives a measure of the average number of individuals that each employed “supports”.

And here are the jaw-dropping numbers.

These numbers are basically a death knell for an economy. The tax burden necessary for this kind of society would be ruinous to an  economy. A huge share of productive people in these nations would decide not to work or to migrate where they would have a chance to keep a decent share of their earnings.

So now you understand why I wrote a column identifying safe havens that might remain stable while other nations are suffering Greek-style fiscal collapse.

Having shared all this depressing data, allow me to close with some semi-optimistic data.

I recently wrote that Hong Kong’s demographic outlook is far worse than what you find in Europe, but I explained that this won’t cause a crisis because Hong Kong wisely has chosen not to adopt a welfare state. People basically save for their own retirement.

Well, a handful of European nations have taken some steps to restrain spending. Here’s a table from the EC report on countries which have rules designed to adjust outlays as the population gets older.

These reforms are better than nothing, but the far better approach is a shift to a system of private retirement savings.

As you can see from this chart, Denmark, Sweden, and the Netherlands already have a large degree of mandatory private retirement savings, and a handful of other countries have recently adopted private Social Security systems that will help the long-run outlook.

I’ve already written about the sensible “pre-funded” system in The Netherlands, and there are many other nations (ranging from Australia to Chile to the Faroe Islands) that have implemented this type of reform.

Given all the other types of government spending across the Atlantic, Social Security reform surely won’t be a sufficient condition to save Europe, but it surely is a necessary condition.

Here’s my video explaining why such reform is a good idea, both in America and every other place in the world.

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I’m in Hong Kong for series of meeting and briefings on various economic and policy issues.

As you can imagine, I’m a huge fan of the jurisdiction’s simple 15 percent flat tax. It’s basically about as close to a pure flat tax as anyplace in the world. There is zero double taxation of income that is saved and invested.

That’s not an exaggeration. You don’t get double taxed on the interest you earn on your bank balances and other financial accounts. There’s no capital gains tax. There’s no death tax. And there’s no double taxation of dividends.

There are only a few deviations from a pure flat tax that even merit a mention. First, taxpayers with modest amounts of income don’t have to use the flat tax system. Instead, they can opt for a “progressive” tax system that has a top rate of 17 percent, but also has tax rates of 2 percent and 7 percent, and 12 percent.

Imagine, taxpayers getting to choose the system that works best for them, instead of the government forcing them into the system that requires the highest payment!

The other deviations are that businesses are not always allowed full expensing of business investment, and there also are a handful of deductions.

All things considered, though, Hong Kong gets almost everything right on tax policy, whereas the United States gets a majority of things wrong.

Oh, and I should mention that there are no payroll taxes in Hong Kong. Nor is there a value-added tax.

That’s all very impressive, but let’s actually focus on something that may be even more remarkable about Hong Kong.

It currently has a modest-sized government, with spending consuming less than 20 percent of economic output. That’s not as good as the United States 100 years ago, but it’s far better than where America is today.

That being said, Hong Kong has some major challenges. I’ve explained before that demographic changes will put pressure on fiscal policy in America, but demographic change is far more profound in Hong Kong.

As you can see from this data, it has the seventh-highest level of life expectancy in the world.

That’s good news, of course, but it does mean a lot of fiscal pressure, even for a jurisdiction that is justly famous for its very small welfare state.

But then you have to consider the fact that Hong Kong also has the fourth-lowest birthrate in the entire world.

In other words, Hong Kong faces a perfect storm of demographics. More and more non-working elderly over time, combined with fewer and fewer taxpayers to pull the wagon.

Given these unfriendly numbers, the Hong Kong government put together a working group to look at long-run fiscal issues.

In its recent report, the group presented a fiscal forecast that shows how the burden of government spending will slowly climb to nearly 24 percent of GDP over the next 25 years.

Here’s a chart showing actual data starting in the late 1990s and then projections until 2042.

To those of us from North America and Western Europe, where the overall burden of government spending, on average, consumes more than 40 percent of economic output, it seems like Hong Kong has a trivial problem.

But it’s still a problem and something has to change. Hong Kong could finance a bigger public sector by dipping into its large reserves (currently the jurisdiction has saved enough money to finance about two years of government spending) or by increasing the tax burden.

But hopefully Hong Kong will abide by Article 107 of its Basic Law (its constitution) and limit government spending so that it doesn’t grow faster than the private economy.

And there are some positive signs.

About 15 years ago, Hong Kong set up a system of private retirement accounts in order to create a self-funded source of retirement income.

Based on a recent government report on retirement income, here are some key features of this Mandatory Provident Fund (MPF) system.

The MPF System is an employment-based, privately-managed mandatory defined contribution system. …Employers are required under the Mandatory Provident Fund Schemes Ordinance (Cap. 485) to arrange for their employees aged 18 or above but under 65 to join… The MPF System has been implemented for 15 years only. …about 2.55 million employees are enrolled in MPF schemes, representing 100% of the employees required by law to join the schemes. This is a very high rate by international standards. In addition, another 210 000 self-employed persons are also scheme members. …An employer and an employee are each required to contribute 5% of the relevant employee’s income… As at end October 2015, MPF assets had increased to $594.2 billion, of which about $123.1 billion were investment returns.

Here’s a chart from the report, showing the cumulative growth of assets, based on both contributions and investment returns.

Keep in mind, though, that it takes 7.8 Hong Kong dollars to equal 1 U.S. dollar, so $594.2 billion is not nearly as large as it sounds.

In part, this is because the system isn’t yet mature. Workers have only been making contributions from 15 years, while a working lifetime is 40-45 years.

But there also are concerns that the level of mandatory saving is insufficient. Here’s additional language from the report, which cites the private retirement systems in Australia and Denmark.

There are views that the contribution rate or the maximum relevant income level should be raised to strengthen the retirement protection function of the MPF System. Take the privately-managed mandatory occupational contributory pension plans in Denmark and Australia as examples. In Denmark, employers and employees generally contribute a total of 9% to 17%. In Australia, only employers make contributions and the contribution rate will be raised progressively from 9% in 2013 to the present 9.5% and further to 12% in 2025.

I’m personally agnostic on the precise level of mandatory savings. My goal is simply to shrink tax-and-transfer entitlement programs, particularly before demographic changes lead to a larger burden of government spending.

And since I have great fondness for Hong Kong (how can you not get a thrill up your leg about a jurisdiction that routinely gets the highest score in Economic Freedom of the World?), I want it to remain a beacon for advocates of economic liberty.

P.S. Lest anyone think I’m being too fawning, Hong Kong has several policies that are misguided. Public housing is pervasive, there’s government-run healthcare, and one peculiar legacy of British rule is that only one piece of land is privately owned. Fixing these warts would make Hong Kong even more vibrant.

P.P.S. Another quirky feature of Hong Kong policy is that currency is issued by private banks. If you pull a $20 bill from your wallet, you’ll see that it was printed by HSBC, Standard Chartered, or Bank of China. Unfortunately, this isn’t because Hong Kong has a market-driven system of competing currencies. But it does have a currency board, which – by standards of government-controlled monetary systems – is one of the least-worst options. Of course, that means Hong Kong’s money is only as good as the currency to which it’s linked. And since the Hong Kong dollar is pegged to the U.S. dollar, that might be a cause for long-run concern.

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My views on the value-added tax are very simple and straightforward.

If we completely eliminated all income-based taxes, I would be willing to accept a VAT (or even a national sales tax) as a revenue source for government.

But unless that happens, I’m unalterably opposed because it’s far too risky to give politicians two major sources of tax revenue. Just look at what happened in Europe (and Japan). Before the VAT, the burden of government spending wasn’t that much higher in Europe than it was in the United States. Once VATs were adopted, however, that enabled a vast expansion of the welfare state.

This is why I’m worried about the Rand Paul and Ted Cruz tax plans. On paper, both plans are very good, dramatically lowering income tax rates, significantly curtailing double taxation, and also abolishing the corporate income tax. But I don’t like that they both propose a VAT to help make up the difference. It’s not that I think they have bad intentions, but I worry about what happens in the future when a bad President takes office and has the ability to increase both the income tax and the value-added tax. When the dust settles, we’re France or Greece!

By contrast, if we do some type of tax reform that doesn’t include a VAT, the worst thing that could happen when that bad president takes office is that we degenerate back to the awful tax code we have today. Which would be unfortunate, but not nearly as bad as today’s income tax with a VAT on top.

Bad since I’ve already addressed this issue, let’s focus on a part of the Paul and Cruz tax plans that has received very little attention.

Both of them propose to get rid of the payroll tax, which is the part of your paycheck that goes to “FICA” and is used to help fund Social Security and Medicare.

Alan Viard of the American Enterprise Institute has a column in U.S. News & World Report that explores the implications of this repeal.

Would you like to see the FICA item on your pay stub go away and be able to keep the 7.65 percent that the payroll tax takes out of your paycheck? If so, Republican presidential candidates Rand Paul and Ted Cruz have a deal for you – each of them has proposed getting rid of the tax. The senators’ plans would also eliminate the other 7.65 percent that the government collects from your employer, which you ultimately pay in the form of lower wages.

That sounds good, right? After all, who wouldn’t like to keep 15.3 percent of their income that is now being siphoned off for entitlement programs.

But here’s the catch. As Alan explains, other revenue sources would be needed to finance those programs, particularly Social Security.

The payroll tax finances two large benefit programs – 6.2 percent goes to Social Security and 1.45 percent goes to Medicare Part A. If the payroll tax went away, we would have to find another way to pay for those benefits. Paul and Cruz would turn to a value added tax, known as a VAT. …using it to pay for Social Security would have repercussions for the program that the candidates haven’t thought through. …once the payroll tax was gone, Social Security would no longer be a self-financed program with its own funding source. Instead, it would draw on the same general revenues as other government programs.

Viard thinks there are two problems with using VAT revenue to finance Social Security.

First, it means that there’s no longer a limit on how much money can be spent on the program.

…having a separate funding source for Social Security has been good budgetary policy. It’s kept the program out of annual budget fights while controlling its long-run growth – Social Security spending is limited to what current and past payroll taxes can support.

Second, replacing the payroll tax with a VAT eliminated the existing rationale for how benefits are determined.

And that will open a potential can of worms.

…what would happen to the benefit formula if the payroll tax disappeared and Social Security was financed by general revenue from the VAT? Paul and Cruz haven’t said. …One option would be to switch to a completely different formula, maybe a flat monthly benefit for all retirees. …that would be a big step, cutting benefits for high-wage workers and posing tricky transition issues.

I imagine there are probably ways to address these issues, though they might wind up generating varying degrees of controversy.

But I’m more concerned with an issue that isn’t addressed in Viard’s article.

I worry that eliminating the payroll tax would make it far harder to modernize Social Security by creating a system of personal retirement accounts.

With the current system, it would be relatively easy to give workers an option to shift their payroll taxes into a retirement account.

If the payroll tax is replaced by a VAT, by contrast, that option no longer exists and I fear reform would be more difficult.

By the way, this is also the reason why I was less than enthused about a tax reform plan proposed by the Heritage Foundation that would have merged the payroll tax into the income tax.

Yes, I realize that genuine Social Security reform may be a long shot, but I don’t want to make that uphill climb even more difficult.

The bottom line is that I don’t want changes to payroll taxes as part of tax reform, particularly when it would only be happening to offset the adverse distributional impact of the VAT, which is a tax that shouldn’t be adopted in the first place!

Instead, let’s do the right kind of tax reform and leave the payroll tax unscathed so we’ll have the ability to do the right kind of Social Security reform.

P.S. Some of you may be wondering why Senators Paul and Cruz included payroll tax repeal in their plans when that leads to some tricky issues. The answer is simple. As I briefly noted above, it’s a distribution issue. The VAT unquestionably would impose a burden on low-income households. That would not be nice (and it also would be politically toxic), so they needed some offsetting tax cut. And since low-income households generally don’t pay any income tax because of deductions, exemptions, and credits, repealing the payroll tax was the only way to address this concern about fairness for the less fortunate.

P.P.S. Since we have a “pay-as-you-go” Social Security system, with benefits for current retirees being financed by current workers, some people inevitably ask how those benefits will be financed if younger workers get to shift their payroll taxes into personal retirement accounts. That’s what’s known as the “transition” issue, and it’s a multi-trillion-dollar challenge. But the good news (relatively speaking) is that coming up with trillions of dollars over several decades as part of a switch to personal accounts will be less of a challenge than coming up with $40 trillion (in today’s dollars) to bail out a Social Security system that is actuarially bankrupt.

P.P.P.S. It goes without saying (but I’ll say it anyhow) that class-warfare taxation is Obama’s (and Hillary’s) ostensible solution to Social Security’s shortfall.

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Because of the budgetary implications, I think it’s more important to deal with Medicaid and Medicare than it is to address Social Security.

If left on autopilot, Social Security will eventually consume an additional 2 percent of the private economy.

That’s not good news, but Medicaid (which now includes a big chunk of Obamacare) and Medicare are much bigger threats.

Hopefully, though, we don’t need to engage in fiscal triage and we can reform all the big entitlement programs.

So let’s look at why Social Security needs to be modernized.

First and foremost, the programs is about $40 trillion in the red. And that’s after adjusting for inflation!

Moreover, the longer we wait, the more difficult reform will be. I don’t always agree with the policy prescriptions of the Committee for a Responsible Budget, but they are very sober-minded in their analysis. And this chart from one of their recent publications shows that waiting until 2026 or 2034 will require more radical changes.

So it should be obvious we need reform, but now the question is what kind of reform.

Some people think the key goal is making the program solvent, but that’s the wrong focus. Sort of like making balance the goal of budgetary policy.

Instead, the goal should be creating a freer society and smaller footprint for government. And that’s why I think personal retirement accounts are the right goal.

And to understand the implications, consider these excerpts from a column in today’s Wall Street Journal. Professor Jeremy Siegel of the University of Pennsylvania explains how the Social Security system has made his retirement less comfortable.

Last month I turned 70 and, thanks to my earnings, became entitled to Social Security’s maximum benefit, currently $3,500 a month, or $42,000 a year. And so, if I live to 90, I will receive $840,000 worth of (inflation-adjusted) benefits. Over the past 50 years, according to the Social Security Administration, the combined taxes paid into the system by me and my employers equaled $329,640. This sounds like a good deal… But the benefits are only about one-third the $2.27 million I would have accumulated had the taxes instead been invested, over time, in a stock index fund. …the benefits I would collect are even less than the $1.28 million I would have accumulated if my “contributions,” as Social Security taxes are euphemistically called, had been placed in U.S. Treasury bonds. …are affluent seniors making out like bandits? Not at all. The bandit is the federal government, which provides benefits that are millions of dollars short of what anyone whose earnings are at or above the tax cap easily could have accumulated on his own.

In effect, Professor Siegel has been forced to pay for a steak and he’s getting a hamburger. Which is a good description of how all entitlement programs operate.

And it’s not just high-income people who get a bad deal. Social Security is particularly bad for young people. And many minorities also are disadvantaged because of their shorter life lifespans.

Moreover, everyone will pay more for their steak and get even less hamburger if politicians deal with the program’s giant shortfall by imposing the wrong type of reform.

But it’s not just that Social Security is bad for individuals. It’s also a burden on the overall economy.

Andrew Biggs of the American Enterprise Institute looks at how private savings is impacted by government-run retirement schemes

fixing Social Security by raising taxes – or, going further, expanding Social Security as many progressives favor – won’t increase retirement income so much as shift it from households to government. …A new report from Canada’s Fraser Institute looks at how Canadian households’ personal saving habits responded to increases in the tax rates used to finance the Canada Pension Plan (CPP). …The Fraser study, authored by Charles Lammam, François Vaillancourt, Ian Herzog and Pouya Ebrahimi,  found that for each dollar of additional CPP contributions, Canadian households reduced their personal saving by around 90 cents. As a result, total saving – and thus total future retirement income – would increase by a lot less than you’d think. Households would receive more income from the CPP but less from their own saving.

These results are similar to what’s been found in other nations.

I found a similar result across OECD countries: when a country’s government provided an additional dollar of retirement benefits, retirees provided for themselves about 93 cents less in income from savings and work in retirement. …a 2003 analysis by Suzanne Rohwedder and Orazio Attanasio which found that, for the United Kingdom’s earnings-related pension system, individuals reduced personal saving by 65 to 75 cents for each dollar of benefits they expected to receive from the government.

Here’s a very powerful chart on the relationship between private savings and government retirements benefits from another one of Andrew’s articles.

Wow, that’s a powerful relationship. And Biggs isn’t the only expert to produce these results.

All of which underscores why I think we should have a system similar to what they have in Australia or Chile (or even the Faroe Islands).

Here’s my video making the case for personal retirement accounts.

P.S. Two economists at the Federal Reserve produced a study examining why Social Security was first created. It might seem obvious that it was a case of politicians trying to buy votes by creating dependency, but they actually go through the calculations in order to explain how it made sense (from the perspective of people alive at the time) to create a program that now undermines the well-being of the nation.

A well-established result in the literature is that Social Security tends to reduce steady state welfare in a standard life cycle model. However, less is known about the historical effects of the program on agents who were alive when the program was adopted. …we estimate that the original program benefited households alive at the time of the program’s adoption with a likelihood of over 80 percent, and increased these agents’ welfare by the equivalent of 5.9% of their expected future lifetime consumption. …Overall, the opposite welfare effects experienced by agents in the steady state versus agents who experienced the program’s adoption might offer one explanation for why a program that potentially reduces welfare in the steady state was originally adopted.

Gee, what a shocker. Ponzi schemes benefit people who get in at the beginning of the scam.

P.P.S. Speaking of Ponzi schemes, here’s the case for reform, as captured by cartoons. And you can enjoy other Social Security cartoons here, here, and here, along with a Social Security joke if you appreciate grim humor.

P.P.P.S. I’m not sure whether Hillary’s plan or Obama’s plan for Social Security would be worse.

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Chile is one of the world’s economic success stories.

Reforms in the 1980s and 1990s liberalized the nation’s economy and resulted in rapid increases in economic growth and big reductions in poverty.

Unfortunately, the current government is pushing policy in the wrong direction.

This drift toward statism has been unfortunate, featuring higher tax burdens, more spending, and increased intervention.

But I’ve always assumed that Chile’s private pension system would be safe from attack. After all, as noted in a new column for Investor’s Business Daily by Monica Showalter, it’s been a huge success.

Chile’s 35-year old private pension program…is working spectacularly well. …savings, ownership, control, responsibility and wealth building…are the pillars of the Chilean Model — and have as their ultimate reward a comfortable retirement, which Chileans now do.

But Monica warns that an ongoing education campaign is necessary to make sure that workers realize the benefits of the system.

And that’s been lacking.

…successive socialist governments in Chile have pretty well limited their recognition of the Chilean Model to criticism of it, many of them still unhappy that it’s not a state model that’s providing such high returns. …All the issues that had been called problems were largely the result of widespread public ignorance of economics…the people who should know better aren’t educating the public.

Given that Chile has enjoyed such strong growth in recent decades, you would think ordinary people would be happy, even if they’re not aware of the relationship between pro-market reforms and rising living standards.

And since Chile has grown far faster than other nations in Latin America, you would think that the political elite actually would understand that there is a strong relationship between economic freedom and national prosperity.

But that’s not the case, and the current left-leaning government is an obvious example. It even created a commission to review Chile’s pension system, and that decision was perceived as an effort – at least in part – to undermine support for the private system.

Fortunately, it’s very difficult to look closely at the Chilean system and conclude that personal retirement accounts have been unsuccessful.

Professor Olivia Mitchell of the Wharton School at the University of Pennsylvania served on the Commission and wrote a column based on that experience for Forbes.

She starts by acknowledging Chile’s personal retirement accounts are a gold standard for reform and then asks why there’s a desire to change something that works.

Chile’s retirement system has been hailed as “best in class” by pension experts near and far. The country’s fabled individual and privately-managed accounts include around 10 million affiliates, hold $160 billion in investments, and pay retirement benefits to over a million retirees. So why did President Michelle Bachelet establish a Pension Reform Commission that just delivered to her 58 specific reforms and three comprehensive proposals to overhaul remodel Chile’s retirement system?

A benign explanation for the Commission is that it’s a helpful way of helping people learn about the system.

Ms. Mitchell (no relation, by the way) points out that workers in Chile suffer from genuine and widespread ignorance.

…only a handful (19% of men, 11% of women) know how much they contribute to the accounts: 10% of pay. This underscores my own research showing that most Chileans had no idea how much they paid in commissions, how their money was invested, or how their benefits would be determined at retirement. Only one-fifth of the participants had the faintest idea about how much money they held in their accounts (even within plus or minus 20%!).

But if those people paid close attention, they’d learn that the private system – particularly when combined with the government’s safety net – does a very good job of protecting the less fortunate.

Chile’s retirement system actually does a rather remarkable job of protecting against old age financial destitution. …Adding the means-tested to the self-financed pension generates replacement rates of about 64%, levels even above what retirees in the US get from social security.

Nonetheless, some of the Commissioners want to weaken the current system and give government a bigger role.

Prof. Mitchell is not impressed by their thinking.

…reforms offered by others on the panel have a major flaw: these would – slowly or rapidly – eat into the money so painstakingly built up in the private accounts over time. My view, along with the majority of the Commissioners, was that wrecking Chile’s funded pension system is not the answer. Instead, this would destroy decades of national saving and economic growth, not to mention the well-being of future generations. This is an especially critical concern in view of Chile’s rapid aging: this nation is set to become the oldest country in South America within 15 years. …Chile needs a resilient retirement system that encourages continued work, incentivizes saving, and offers credible pension promises that can actually be paid when the time comes. It would be unfortunate to see Chile dismantle the system that has done so well for so many, over the past 35 years.

The good news, as you can see from the column, is that most Commissioners don’t want radical changes to Chile’s private pension system.

This is a positive outcome. Assuming, of course, that the current left-wing government follows their recommendations.

What we don’t know, though, is whether other governments learn any lessons from all this analysis.

America’s Social Security system has gigantic unfunded liabilities, for instance, and many other nations also have big fiscal shortfalls in their tax-and-transfer systems operated by their governments.

The right answer is a transition to personal retirement accounts. That’s what will happen if policy makers from elsewhere in the world learn from Chile’s success.

P.S. This comparison of Chile and Cuba tells you all you need to know about markets vs statism.

P.P.S. Here’s a comparison of real savings in Australia’s system of private accounts compared to the growing debts of America’s pay-as-you-go government-run system.

P.P.P.S. If you want to see a strong case for personal retirement accounts, click here for an explanation from the man most responsible for Chile’s remarkable reforms.

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America has a giant long-run problem largely caused by poorly designed entitlement programs such as Social Security, Medicare, and Medicaid.

So when I wrote last month about proposals by some Democrats to expand Social Security, I was less than enthusiastic.

…demographic changes and ill-designed programs will combine to dramatically expand the size of the public sector over the next few decades. So it’s really amazing that some politicians, led by the clownish Elizabeth Warren, want to dig the hole deeper. …I’m surprised demagogues such as Elizabeth Warren haven’t rallied behind a plan to simply add a bunch of zeroes to the IOUs already sitting in the so-called Social Security Trust Fund. …If Hillary winds up endorsing Warren’s reckless plan, it will give us another data point for our I-can’t-believe-she-said-that collection.

But it turns out I may have been too nice in my analysis.

As reported by USA Today, independent researchers have discovered that Social Security is even more bankrupt than suggested by official estimates.

New studies from Harvard and Dartmouth researchers find that the SSA’s actuarial forecasts have been consistently overstating the financial health of the program’s trust funds since 2000. “These biases are getting bigger and they are substantial,” said Gary King, co-author of the studies and director of Harvard’s Institute for Quantitative Social Science. “[Social Security] is going to be insolvent before everyone thinks.” …Once the trust funds are drained, annual revenues from payroll tax would be projected to cover only three-quarters of scheduled Social Security benefits through 2088.

By the way, I’m not overly enamored with this analysis since it is based on the assumption that the Social Security Trust Fund is real when it’s really nothing but a collection of IOUs.

But if you don’t believe me, perhaps you’ll believe the Clinton Administration, which admitted back in 1999 (see page 337) that the Trust Fund is just a bookkeeping gimmick.

These balances are available to finance future benefit payments and other trust fund expenditures–but only in a bookkeeping sense. …They do not consist of real economic assets that can be drawn down in the future to fund benefits. Instead, they are claims on the Treasury, that, when redeemed, will have to be financed by raising taxes, borrowing from the public, or reducing benefits or other expenditures.

In other words, what really matters is that Social Security spending is climbing too fast and consuming an ever-larger share of economic output.

That means – in the absence of reform – that more and more money will be diverted from the economy’s productive sector, in the form of taxes or borrowing, to finance benefits.

And when I write “more and more money,” that’s not a throwaway statement.

Returning to the USA Today report, academic experts warn that the long-term shortfall in the program is understated because it is based on 75-year estimates even though the program doesn’t have an expiration date.

The bigger problem with the Social Security Administration is not disclosure, it’s accounting, said Laurence Kotlikoff, a Boston University professor of economics… Kotlikoff…wants the agency to calculate its liabilities using fiscal gap accounting, which considers the difference between the government’s projected financial obligations and the present value of all projected future tax and other revenue. …Under this accounting system, SSA’s projected unfunded liabilities would be $24.9 trillion (instead of the $10.6 trillion projected in 2088). …17 Nobel Prize-winning economists have endorsed Kotlikoff’s push for the SSA and other government agencies to use the fiscal gap accounting method more broadly. “We have a situation that is like Enron accounting,” Kotlikoff said. “And the public doesn’t want to hear about it.”

At the risk of being pedantic, I’m also not enamored with either approach mentioned in the above passage.

Sure, we should acknowledge all expenses and not arbitrarily assume the program disappears after 75 years, but the approach used to calculate “unfunded liabilities” is artificial since it is based on how much money would need to be invested today to finance future promised benefits (whether for 75 years or forever).

Needless to say, governments don’t budget by setting aside trillions of dollars to meet future expenses. Social Security, like other programs, is funded on a pay-as-you-go basis.

That’s why the most appropriate way to measure the shortfall is to take all projected future deficits, adjust them for inflation, and calculate the total. When you do that, the Social Security shortfall is a staggering $40 trillion.

And that’s based on just a 75-year estimate, so the real number is much higher.

Though keep in mind that this is just an estimate of the fiscal shortfall. What really matters is the total level of spending, not how much is financed with red ink.

Which is why the only real answer is genuine reform.

For further information, here’s the video I narrated for the Center for Freedom and Prosperity on the need to modernize the system with personal retirement accounts.

But if you prefer to trust politicians, you can always support the left’s favored solution.

P.S. You can enjoy some previous Social Security cartoons here, here, and here. And we also have a Social Security joke if you appreciate grim humor.

P.P.S. The “Trust Fund” is real only in the sense that the government’s legal authority to pay benefits will be constrained when the IOUs are used up. That’s why the USA Today article says that the government at that point would be able to pay only about 3/4ths of promised benefits (though one imagines that future politicians will simply override that technical provision and require full payments).

P.P.P.S. Many nations have adopted genuine reform based on private retirement savings, including Australia, Sweden, the Faroe Islands, Chile, and The Netherlands.

P.P.P.P.S. Because of lower life expectancies, African-Americans are very disadvantaged by the Social Security system. A system of personal accounts presumably wouldn’t help them live longer, but at least they would have a nest egg to pass on to their kids.

P.P.P.P.P.S. And don’t fall for the false argument that financial markets are too unstable for personal retirement accounts

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