Why Is Someone at AEI Proposing a Massive Tax Increase to Finance Ever-Growing Government, Part I?

Serious and responsible people (in other words, not Trump or Biden) know that Social Security has a massive long-run problem.

A fast-growing number of seniors are expecting future benefits but only a slow-growing number of workers will be paying into the system.

But even if this demographic problem didn’t exist, there is the underlying flaw of a retirement system based on tax-and-spend (or debt-and-spend) rather than wealth accumulation.

The solution is obvious.

We need to shift to a system based on personal retirement accounts.

The transition to a modern system will be expensive, to be sure, but not nearly as costly as the $60 trillion-plus burden of propping up the current system.

But some people prefer the more-expensive option.

Andrew Biggs of the American Enterprise Institute and Alicia Munnell of Boston College want to divert a massive amount of money from the private sector to the government, and they want to do it by double-taxing the money Americans have in retirement accounts.

Here are excerpts from their new report.

The U.S. Treasury estimates that the tax preference for employer-sponsored retirement plans and IRAs reduced federal income taxes by about $185-$189 billion in 2020, equal to about 0.9 percent of gross domestic product. …it actually offers policymakers an opportunity to strengthen the nation’s retirement income system. Revenues saved from repealing the retirement saving tax preferences could be reallocated to address the majority of Social Security’s long-term funding gap. …an opportunity to use taxpayer resources more productively. …the case is strong for eliminating the current tax expenditures on retirement plans, and using the increase in tax revenues to address Social Security’s long-term financing shortfall. …Tax expenditures for employer-sponsored retirement plans are expensive – costing about $185 billion in 2020. … reducing tax expenditures for retirement plans could be an effective way to help address other pressing demands on the federal budget, such as Social Security’s financing shortfall.

By the way, it is no exaggeration to say the authors “want to divert a massive amount of money” to politicians over the next decade. Based on the Congressional Budget Office’s latest 10-year forecast, 0.9 percent of GDP is about $3 trillion.

It’s not just that the authors want to prop up a system that needs reform.

They also want to undo provisions in the tax code (IRAs and 401(k)s) that allow people to protect themselves against two layers of tax on income that is saved and invested.

It’s also laughable that the report states that a huge tax increase will “use taxpayer resources more productively.” If higher taxes to fund bigger government was a good idea, Europe’s welfare states would be richer than the United States rather than way behind.

Even the title of the Biggs-Munnell study is offensive. It implies that taxpayers are getting a handout or favor if politicians don’t impose double taxation. At the risk of understatement, being taxed one time rather than two times is not a subsidy.

P.S. The better option is a shift to retirement systems based on private savings, like the ones in Australia, Chile, Switzerland, Hong Kong, Netherlands, the Faroe Islands, Denmark, Israel, and Sweden.

P.P.S. Biggs and Munnell are misguided for wanting a big tax increase to prop up a bankrupt system. That’s the bad news. The worse news is that some people want to expand the bankrupt system. And they are proposing tax increases that arguably would cause even more economic damage.

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The Case for Entitlement Reform, Part I

If Joe Biden’s bungled economic policy is any indication, the GOP may wind up controlling Washington in the not-too-distant future.

If so, I hope Republicans rekindle their interest in the kind of genuine entitlement reform discussed in this interview.

But I’m not sure whether to be optimistic or pessimistic.

On the plus side, the GOP supported pro-growth entitlement reform during the Obama years.

On the minus side, the party largely punted on the issue once Trump took over.

To be sure, punting is the easy route from a “public choice” perspective. Politicians like offering freebies to voters and many voters like getting handouts.

However, that approach means America’s economy is weakened by an ever-growing burden of federal spending and eventually is plunged into fiscal crisis.

And that’s based on the programs that already exist. Joe Biden wants to expand the welfare state with even more entitlements!

The Wall Street Journal editorialized about the downside of making America more like Europe last October.

The result of…expanded entitlements is likely to be reduced incentives to work and invest, slower economic growth, lower living standards, and less fiscal space for essential public goods like national defense. That’s the lesson from Europe’s cradle-to-grave welfare states… Europe’s little-discussed secret is that its cradle-to-grave welfare states are financed by the middle class via value-added and payroll taxes. The combined employer-employee social security tax rate is 36% in Spain, 40% in Italy and 65% in France. Value-added taxes in most European economies are around 20%. There simply aren’t enough rich to finance their entitlements.

Amen. I’ve repeatedly warned that a European-sized welfare state would mean European-sized taxes on lower-income and middle-class Americans.

And what’s remarkable (and discouraging) is that some politicians in the U.S. want to expand entitlements even though many European governments now realize they made big mistakes and need to scale back.

The irony is that some European governments have tried to reform their tax and welfare systems to become more competitive. Germany and Sweden over two decades reformed their welfare and labor policies. …Other European governments are also pushing welfare-state reforms. French President Emmanuel Macron has passed pension reform and cut the corporate tax rate to 26.5% from 33% in 2017… Greece is pulling out of its debt trap with Prime Minister Kyriakos Mitsotakis’s tax, pension and regulatory reforms.

For what it’s worth, I’m happy about these reforms, but I fear many European nations are in the too-little-too-late category.

Why? Because the demographic outlook is deteriorating faster than reform is happening. In other words, most of them are probably destined to suffer Greek-style fiscal crises.

But if (or when) that happens, maybe American politicians will finally wake up and realize we need good reforms to prevent Social Security, Medicare, and Medicaid from causing a similar collapse on this side of the Atlantic Ocean..

Hopefully that epiphany will take place before it is too late for the United States.

P.S. For those who are interested in the history of fiscal policy, John Cogan of the Hoover Institution wrote about pre-20th-century entitlements earlier this year.

Here are excerpts from his column in the Wall Street Journal.

The history of U.S. entitlements is a 230-year record of continuous expansion… The first major entitlement, Revolutionary War disability benefits, was initially restricted to members of the Continental Army and Navy who were injured in battle and survivors of those killed in wartime. Eligibility was then expanded, first to state militia soldiers, then to veterans whose disabilities were unrelated to wartime service, and eventually to virtually all people who served during the war regardless of disability. Civil War disability pensions followed the same…process, except on a far grander scale. Pensions were initially confined to U.S servicemen who suffered wartime injuries and survivors of those killed in battle. Eventually they were extended to virtually all union Civil War veterans regardless of disability. …Congress followed the same liberalizing process with 20th-century entitlements.

If this excerpt doesn’t satisfy your curiosity, here’s Cogan discussing the topic for 46 minutes.

P.P.S. Not all entitlement reform is created equal.

P.P.P.S. Here an informative chart if you want to know whether to blame defense spending or entitlement spending.

P.P.P.P.S. I always argue in favor of a Swiss-style spending cap, which presumably would force politicians to address America’s entitlement problem.

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Social Security’s Ever-Closer Fiscal Crisis

As part of my recent appearance on The Square Circle (we discussed Uvalde police, gun control, and Ukraine), I said that the new Social Security numbers were the under-reported story of the week.

For more details, I was referring to the latest Trustees Report, published yesterday by the Social Security Administration.

Most people, when that annual report is released, focus on when the Social Security Trust Fund runs out of money. But since the Trust Fund only contains IOUs, I view that as a largely irrelevant number.

Instead, I immediately look at Table VI.G9, which shows how much revenue is being collected and how much money is being spent every year.

Here is that data displayed in a chart. The left side shows actual fiscal numbers from 1970 to 2021 while the right side shows the projections between 2022 and 2100.

As you can see in the chart, revenues going into the system (the blue line) are growing rapidly.

But you also can see that Social Security spending (the orange line) is expanding even faster.

And when spending grows faster than revenue, one consequences is more red ink.

This next chart shows that annual deficits between now and 2100 will total $56 trillion.

At the risk of understatement, these two charts should be very sobering. Especially since they only show the taxes, spending, and red ink for Social Security.

If we also add the fiscal aggregates for other entitlement programs, it would be abundantly clear why we face a “crisis” and a “train wreck.”

So how do we solve this mess. I’ve written about the needed reforms for Medicare and Medicaid, so let’s focus today on Social Security.

The ideal approach is to take the current pay-as-you-go entitlement and turn it into a system of personal retirement accounts.

Many nations around the world have adopted this approach, most notably Chile and Australia.

But as I noted two years ago, there will be a big “transition” challenge if the United States decides to modernize.

P.S. I mentioned “public choice” at the end of that clip. You can click here to learn more about the economic analysis of political choices.

P.P.S. I mentioned that Chile and Australia have created personal retirement accounts. You can also learn about reforms in Switzerland, Hong Kong, Netherlands, the Faroe Islands, Denmark, Israel, and Sweden.

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China’s Far-Too-Little Pension Reform

In the make-believe country of Libertaria, there is no such thing as Social Security or any other type of government-mandated retirement policy.

In the real world, however, most nations have created “pay-as-you-go” retirement schemes based on taxing young workers to give benefits to old retirees.

That’s the bad news.

The good news is that a growing number of nations have created personal retirement accounts based on private savings. These “funded” systems are designed to replace and/or augment the government programs.

People who study these issues often refer to “three pillars” that represent the various potential sources of retirement income.

1. Payments from mandatory government tax-and-transfer programs like Social Security in the United States (Pillar One).
2. Payments from mandated private retirement accounts, such as those in places such as Australia and Chile (Pillar Two).
3. Payments from voluntary private savings, such as the funds put in IRAs or 401(K)s in the United States (Pillar Three).

In our libertarian fantasy world, everyone would use option #3 and there would not be options #1 and #2.

In a libertarian-ish world, everyone would use option #2 with option #1 only as an emergency back-up.

A few days ago, I saw a headline that got me excited. I thought China was joining the libertarian-ish world by shifting from a pay-as-you-go government system to mandatory private savings (going from option #1 to option #2). Here are some excerpts from a Nasdaq report.

The China Security Regulatory Commission (CSRC) announced the launch of the first private pension plan due to anticipated economic challenges with an aging population. …the CSRC said that pension money “can provide more long-term, and stable funds to develop the real economy, via capital markets.” …This program was created to add additional resources for China’s aging population. In 20 years, 28% of China’s population will be more than 60 years old, up from 10% today, according to the World Health Organization.

But as I read more details, I learned that China was keeping its government system and simply adding an option #3.

Public pensions are currently in place in China; both employees and employers have contributed fixed amounts under state pension plans. …Private pensions are seen as an additional program to state pension plans. Employees can contribute up to 12,000 yuan ($1,860) per year. Contributions will be eligible for tax breaks.

Since people already had the ability to save money, this is hardly an earth-shaking development.

To be sure, it seems like Chinese workers will not have their saving subject to any double taxation if they use these new pension vehicles, so I suppose that deserves some applause.

But it would be much more exciting and praiseworthy if the Chinese government (which has been backsliding in recent years) had proposed some something far bolder.

P.S. To understand why I’m not optimistic about China, here’s my summary of the nation’s post-World War II economic history.

P.P.S. And if China takes advice from either the IMF or OECD, I’ll be even less optimistic.

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Chile Election Week, Part III: Death Knell for the Private Pension System?

One reason I’m interested in Chile’s election is that the leftist candidate, Gabriel Boric, wants to eviscerate the nation’s successful private pension system.

Bettina Horst of Libertad Y Desarrollo gave me her analysis.

As an economist and Executive Director of the nation’s pro-market think tank, Ms. Horst understands that Chile’s system has helped workers by giving them real ownership of real assets.

And that’s much better than “pay-as-you-go” systems, like we have in the United States.

Chile’s private retirement accounts have enabled workers to build nest eggs, and the system has also provided a valuable source of capital for the nation’s economy.

So why would Chile’s voters consider a candidate like Boric, who wants to wreck that system?

We’ll find out Sunday night after the votes are counted, but a Boric victory would indicate that Chile’s workers decided to trust the free-lunch promises of a politician.

In a column earlier this year for the Wall Street Journal, another Chilean weighed in on this issue.

Axel Kaiser of the Atlas Research Network wrote that the left has a (long-standing) ideological agenda.

In 1981 Chile became the first country to privatize social security, ending the pay-as-you-go system that had been in place since 1924 and had collapsed. Now Chile’s left wants to resurrect it. …Last year a group of senators even introduced a bill to nationalize the pension funds, as Argentina did in 2008. An expropriation of workers’ savings looks increasingly likely, as the radical left dominates Chile’s recently elected constitutional convention. “The destruction of the AFP system is under way,” a far-left lawmaker recently said. …The attack on the AFP system is all about ideology and power. …Its destruction has long been a goal of the radical left. With the AFP out of the picture, politicians will recover the power they once had over retirees.

That’s Mr. Kaiser’s political analysis.

His column also includes some analysis of the economic benefits of the private system.

The state-run pension system was plagued by corruption and rent-seeking… Pension privatization reversed this perverse dynamic. Instead of taxing active workers to pay pensioners through the bureaucracy, the new system, created by former Labor Minister José Piñera, established that 10% of the employee’s salary is transferred automatically to an account under his name at one of the Administradoras de Fondos de Pensiones, or AFP. These private pension funds compete to attract workers and invest their pensions for a fee. …By subsequently relying on workers’ own savings to fund their pensions instead of taxing younger workers, privatization of social security ended dependency across generations. …Average pensions are also 41% higher in the AFP system than in the old one, according to the Libertad y Desarrollo research center, even as workers contribute a smaller fraction of their salaries. Between 1981 and 2019, the savings accumulated in workers’ accounts at the AFP reached $218 billion, or around three-quarters of GDP. About 70% of these funds weren’t contributions made by workers but profits generated for them by AFP investments. This accumulation of capital contributed an extra 0.5% of GDP a year to economic growth between 1981 and 2001.

As mentioned in the column, Jose Pinera created Chile’s system of personal retirement accounts.

You can click here to see him describing the case for private accounts, both in Chile and the United States.

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The Destabilizing Mix of Demography and Entitlements, Part I

I’ve written many times about demographic change and the implications for public policy – both in the United States and around the world.

Simply stated, it will be increasingly difficult to maintain tax-and-transfer entitlement programs in societies where people are having fewer children and people are living longer.

I’m raising this issue because I spoke on this topic earlier today at an e-symposium organized by Trends Research in Abu Dhabi, UAE. Here’s a slide with my main message.

Why is it bad news from an economic perspective?

As I noted in the next slide, tax-and-transfer entitlement programs for the elderly (most notably Social Security and Medicare in the United States) become harder to finance when there are lots of beneficiaries and too few taxpayers to support them.

So what’s going to happen in various nations when the irresistible force of more beneficiaries meets the immovable object of fewer taxpayers?

In my presentation, I pointed out that there are only three potential solutions.

• More taxes – A policy that Barack Obama, Hillary Clinton, and Joe Biden explicitly have embraced.
• More debt – A policy that politicians such as Donald Trump have implicitly embraced.
• Entitlement reform – A policy that some Republicans supported in the pre-Trump era.

I explained that higher tax burdens and higher debt levels would not be economically prudent.

The right approach is genuine entitlement reform, but I freely admitted that this “pre-funding” model probably won’t happen.

Here’s the relevant slide.

By the way, Singapore is the role model for pre-funding, but many other nations have adopted that approach for retirement income (such as Israel, Denmark, Switzerland, Hong Kong, Netherlands, Faroe Islands, and Sweden).

Unfortunately, most nations are heading for a demographic iceberg (including the U.S.) but I fear few of them will enact the reforms that are needed to avert a bad outcome.

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Israel’s Shift to Private Social Security

What’s the best economic news of the past 40 years?

• Was it Reaganomics, which restored America’s economic vitality?
• Was it the collapse of the Soviet Empire, which freed many nations from communist tyranny and allowed at least some of them to successfully shift to markets?
• Was it partial economic liberalization in China, which lifted hundreds of millions of people out of severe poverty?

Those are all good choices, but let’s not overlook Israel.

This chart from Economic Freedom of the World shows that economic freedom dramatically expanded in that nation between 1980 and 2000 (and has since gradually risen).

Israel’s shift away from the voluntary socialism of the kibbutz has paid big dividends. The nation has become far more prosperous.

I’ve already written how Israel benefited from supply-side reduction in tax rates.

Today, let’s learn about the country’s shift to private social security.

To find out what happened, let’s look at some excerpts from an article in Economics and Business Review. Authored by Moshe Manor and Joanna Ratajczak, it starts by observing there’s been a global shift to private social security systems.

The first paradigmatic shift towards a private pension system was performed in Chile in 1981 and had its followers in Latin America… The Chilean example inspired the World Bank to propose that such a shift should become a key element of the pension reform for postsocialist countries… The shift towards private pension schemes was assumed to meet demographic challenges and the secondary goals of the pension system, especially economic growth accomplished thanks to an acceleration of domestic savings.

This has been a very positive development for the countries that made the shift, by the way.

But let’s focus specifically on the reform in Israel. Here’s some of what the authors wrote.

Israel…abandoned a controlled economy and introduced the market economy only in the last three decades. …In the last 30 years Israel has faced many reforms of the pension system as part of broader economic reforms. …the stabilization programme allowed the Ministry of Finance (MOF) to start a series of structural changes, including pension reforms… The reasons for the reforms were not strictly economic but they also were based on neoliberal economic beliefs, political motives and international relations. …The USA feared Israel’s possible economic collapse and requested that the Israelis execute reforms designed according to Milton Friedman’s neoliberal principles in order to gain American economic support.

For what it’s worth, I’m in favor of “neoliberalism” when it’s defined as pro-market (which seems to be the case in many parts of the world).

Here’s a description of how the reform moved the country from a defined benefit model (often unfunded) to a funded defined contribution model.

The pension reforms were intended to stabilize the system and prepare it for the future difficulties such as ageing and poverty relief; they were also meant to develop the capital market and reduce the burden on the state budget. The main steps included introduction of the mandatory private pension pillar.. The reforms also eliminated PAYG for new joiners and turned the system from actuarially imbalanced, DB…to actuarially balanced, DC, privately managed and invested in capital markets. …The comparison of the reforms in Israel and those in Chile…shows a large similarity: shutting down the PAYG system to new joiners; a shift to funds which are privately managed, DC type, invested in capital markets system; a mandatory pension in the second pillar; development of the local capital markets using the pension accumulation; reduction of government involvement in pensions and of the burden on the state budget.. The main differences encompass low contribution rates in Chile that led to low net replacement rates, while in Israel the contribution rates and net replacement rates are high.

Oddly, the article never states how much of a worker’s paycheck goes to mandatory savings (i.e., the contribution rate).

So here’s a blurb from a recent report by the Organization for Economic Cooperation and Development.

Since January 2008, mandatory contributions have applied to earnings up to the national average wage for all employees… Initially the rates were modest with a total contribution of 2.5% but increased to 15% (5% from employees and 10% from employers) by 2013. In 2014 the contribution rate increased further to 17.5% (5.5% from employees and 12% from employers)and since January 2018 increased to 18.5% (6% from employees and 12.5% from employers). Six percentage points out of the employers’ contribution provides severance insurance which, if utilised, diminishes the pension.

That is a significantly higher level of mandated private savings when compared to countries such as Australia and Chile.

Sadly, the United States isn’t part of that conversation since we’re still stuck with our actuarially bankrupt Social Security scheme.

P.S. While researching this column, I read the OECD’s recent Survey about Israel’s economy. The bureaucrats in Paris groused that there’s a lot of inequality and poverty in that country.

This set of data perfectly illustrates why the OECD is an untrustworthy and biased bureaucracy.

As noted by my Eighth Theorem of Government, it should focus on economic growth to reduce poverty rather than fixating on whether some people are getting richer faster than others are getting richer.

Speaking of which, the supposed poverty data doesn’t actually measure poverty. Instead, “relative poverty” is simply the share of people are below “50% of median household income,” which the OECD then dishonestly characterizes as a measure of poverty (this is how the OECD came up with the absurd claim that there’s more poverty in the United States than in comparatively poor countries such as Turkey and Portugal).

Ironically, the same OECD report admits that Israel is out-performing other developed nations.

Israel is growing faster, as you can see, while also reducing government debt at a time when it’s going up in other countries (I’m sure coronavirus has since wreaked havoc with the Israeli economy, but that’s also true for other OECD countries).

Yet the OECD can’t resist grousing about inequality and lying about poverty.

P.P.S. Shifting back to social security reform, here are some of the other nations (beside Israel, Chile, and Australia) that now benefit from private savings instead of empty political promises: Denmark, Switzerland, Hong Kong, Netherlands, Faroe Islands, and Sweden.

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Australia’s Election and Economic Reform

I’m in Sydney, Australia, but not because I’m confirming that this country will be my escape option if (when?) the United States suffers a Greek-style fiscal collapse.

Instead, I’m Down Under for the annual Friedman Conference.

This gives me an excuse to write about Australia, especially since national elections just took place this past weekend. Interestingly, the incumbent, right-of-center government retained power in an upset, winning 77 or 78 seats (out of a possible 151).

Here’s the breakdown.

The folks at Slate lean to the left, so their article is understandably riddled with anguish.

Australia’s dysfunctional, unpopular, conservative government…held onto power for a third term in Saturday’s national election. This happened despite the fact that most analysts expected it to lose a large number of seats; despite being (seemingly) out of step with the nation’s emerging consensus on climate change.. A Labor Party win had been anticipated for three years, with the opposition winning every single poll of the last term. …Expected swings against the coalition in several regions of the country didn’t materialize, while there was a crucial 4 percent swing against Labor in the state of Queensland (alternately described as Australia’s Alabama or Florida). …Progressive Australians are—to understate things—“hurting,”…(only they’re threatening to move to New Zealand instead of Canada). …Labor’s environmental stance, while not actually all that bold, hurt it in coal-friendly Queensland and among voters worried about the costs of acting on climate change… Progressive Australians are reeling because any lingering illusions that we were a “fair” nation have been shattered. Whatever Labor’s political shortcomings, Australians in general voted against a detailed platform that aimed to seriously address climate change, raise wages, increase cancer funding, make child care free or significantly cheaper, close tax loopholes for corporations and the wealthy, fund the arts, fund the underfunded public broadcaster… Instead, they voted for … not much of anything (other than some tax cuts).

Since I’m a wonk, I’m much more interested in the policy implications rather than the political machinations.

The good news is that Labor’s defeat means Australia will be spared some costly tax increases and some expensive green intervention.

But it’s unclear whether there will be many pro-growth reforms.

The right-of-center Liberal-National Coalition has promised some tax relief, but I don’t know if it will be supply-side rate reductions or merely the distribution of favors using the tax code.

For what it’s worth, Australia needs to lower its top tax rate on households, which is nearly 50 percent. European-type tax rates are always a bad idea, and they are especially senseless for a country that has to compete with Hong Kong and Singapore.

It would also be nice if the newly reelected government chooses to fix some of the housing policies that have made Australian cities very unfriendly to families.

Joel Kotkin explains why this is a problem in an article for City Journal.

Few places on earth are better suited for middle-class prosperity than Australia. From early in its history, …the vast, resource-rich country has provided an ideal environment for upward mobility… Over the last decade, though, Australia’s luck has changed… Despite being highly dependent on resource sales to China—largely coal, gas, oil, and iron ore—Australia has embraced green domestic politics more associated with Manhattan liberals or Silicon Valley oligarchs than the prototypical unpretentious Aussie… Historically, the Australian Labor Party, like its counterpart in Britain, was a party of the working class. …These views seem almost quaint today, particularly for a Labor Party increasingly dominated by those operating outside the tangible economy, as part of the professional class—media, finance, public service—and concentrated in the largely family-free urban cores. …Australia’s commitment to renewable energy dwarfs that of even the most committed green-leaning countries. Per capita, Australia has installed roughly five times as many renewable-energy installations as the E.U., the U.S., or China, and even two-and-a-half times more than climate-obsessed Germany. …The most pernicious assault on Australia’s middle class comes from regulation of land and expenditures to promote urban density. …In Australia, only 0.3 percent of the country is urban. As in major cities in Great Britain, Australia, the U.S., and Canada, “smart growth” has helped turn Australia’s once-affordable cities into some of the world’s costliest. …Sydney’s planning regulations, according to a Reserve Bank study, add 55 percent to the price of a home. In Perth, Melbourne, and Brisbane, the impact exceeds $100,000 per house. Australian cities once filled with family-friendly neighborhoods are becoming dominated by dense apartments. …Today, many Australians face an uncharacteristically bleak future. Urged to settle where the planners and pundits prefer, they’re stuck in places both unaffordable and inhospitable, as part of a needless governmental drive to make life there more like that of the more congested, socially riven metropoles of Britain.

For all intents and purposes, I want Australian lawmakers to rekindle their reformist zeal.

If you look at the historical data from Economic Freedom of the World, you can see that Australia enjoyed a big jump in economic liberty between 1975-2000.

Basically climbing from 6 to 8 on a 0-10 scale.

Sadly, there hasn’t been much reform this century. That being said, Australia’s era of liberalization last century is still paying dividends. The country is routinely ranked in the top-10 for economic liberty.

Interestingly, many of the changes between 1975-2000 happened when the Labor Party was led by reformers such as Bob Hawke and Paul Keating.

Mr. Hawke, incidentally, just passed away. His obituary in the New York Times acknowledges that he liberalized the economy.

Bob Hawke, Australia’s hugely popular prime minister from 1983 to 1991, who presided over wrenching changes that integrated his nation into the global economy…, died on Thursday… Rising to power as a trade union leader, Mr. Hawke led his center-left Australian Labor Party to four consecutive election victories in a tenure of nearly nine years, in which Australia emerged dramatically from relative isolation… Confronting chronic strikes, soaring inflation, high unemployment and trade deficits, Mr. Hawke revolutionized the economy. He cut protective tariffs, privatized state-owned industries…reined in powerful unions… “We are now living in a tough, new competitive world in which we have got to make it on our own merits,” Mr. Hawke told The New York Times in 1985.

I’m irked, though, that the article doesn’t mention that Hawke (in power from 1983-91) began Australia’s system of personal retirement accounts.

That excellent reform, which was expanded by the Keating government (in power from 1991-96), is paying big dividends to Australia.

Indeed, let’s wrap up today’s column with some excerpts from a laudatory article in the Economist.

The last time Australia suffered a recession, the Soviet Union still existed and the worldwide web did not. …No other rich country has ever managed to grow so steadily for so long. …Public debt amounts to just 41% of GDP—one of the lowest levels in the rich world. That, in turn, is a function not just of Australia’s enviable record in terms of growth, but also of a history of shrewd policymaking. Nearly 30 years ago, the government of the day overhauled the pension system. Since then workers have been obliged to save for their retirement through private investment funds.

It’s noteworthy that the system of personal accounts, known as superannuation, manages to attract praise from unlikely quarters.

And it is one of the reasons for the country’s success. Here’s an accompanying chart showing that Australia has enjoyed more growth, higher wages, and less debt than other major nations.

Is Australian policy perfect? Of course not.

But does the data from Australia show that better policy leads to better results? Definitely.

P.S. The Aussies also reaped big benefits by unilaterally reducing trade barriers (it would be nice if a certain person residing at 1600 Pennsylvania Avenue learned from that experience).

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More Evidence for Private Social Security

The world is in the middle of a dramatic demographic transition caused by increasing lifespans and falling birthrates.

One consequence of this change is that traditional tax-and-transfer, pay-as-you-go retirement schemes (such as Social Security in the United States) are basically bankrupt.

The problem is so acute that even the normally statist bureaucrats at the Organization for Economic Cooperation and Development are expressing considerable sympathy for reforms that would allow much greater reliance on private savings (shifting to what is known as “funded” systems).

Countries should introduce funded arrangements gradually… Policymakers should carefully assess the transition as it may put an additional, short-term, strain on public finances… Tax rules should be straightforward, stable and consistent across all retirement savings plans. …Countries with an “EET” tax regime should maintain the deferred taxation structure… Funded, private pensions may be expected to support broader economic growth and accelerate the development of local capital markets by creating a pool of pension savings that must be invested. The role of funded, private pensions in economic development is likely to become more important still as countries place a higher priority on the objective of labour force participation. Funded pensions increase the incentive to work and save and by encouraging older workers to stay in the labour market they can help to address concerns about the sustainability and adequacy of public PAYG pensions in the face of demographic changes.

Here’s a chart from the OECD report. It shows that many developed nations already have fully or partly privatized systems.

By the way, I corrected a glaring mistake. The OECD chart shows Australia as blue. I changed it to white since they have a fully private Social Security system Down Under.

The report highlights some of the secondary economic benefits of private systems.

Funded pensions offer a number of advantages compared to PAYG pensions. They provide stronger incentives to participate in the labor market and to save for retirement. They create a pool of savings that can be put to productive use in the broader economy. Increasing national savings or reallocating savings to longer-term investment supports the development of financial markets. …More domestic savings reduces dependency on foreign savings to finance necessary investment. Higher investment may lead to higher productive capacity, increasing GDP, wages and employment, higher tax revenues and lower deficits.

Here’s the chart showing that countries with private retirement systems are among the world leaders in pension assets.

The report highlights some of the specific nations and how they benefited.

Over the long term, transition costs may be at least partially offset by additional positive economic effects associated with introducing private pensions rather than relying solely on public provision. …poverty rates have declined in Australia, the Netherlands and Switzerland since mandatory funded pensions were introduced. The initial transformation of Poland’s public PAYG system into a multi-pillar DC approach helped to encourage Warsaw’s development as a financial centre. …the introduction of funded DC pensions in Chile encouraged the growth of financial markets and provided a source of domestic financing.

For those seeking additional information on national reforms, I’ve written about the following jurisdictions.

• Australia
• Denmark
• Chile
• Switzerland
• Hong Kong
• Netherlands
• Faroe Islands
• Sweden

At some point, I also need to write about the Singaporean system, which is one of the reasons that nation is so successful.

P.S. Needless to say, it would be nice if the United States was added to this list at some point. Though I won’t be holding my breath for any progress while Trump is in the White House.

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Saving America’s Retirement System and Providing Real Middle-Class Tax Relief

President Trump thinks he can boost Republicans next Tuesday by promising a new round of tax relief for the middle class.

I’m skeptical of his sincerity, as noted in this segment from a recent interview, but I also warn that his proposed tax cut is impractical because Republicans have done a lousy job on spending. And I also point out that it is ironic that Trump is urging lower taxes for the middle class when his protectionist tariffs (trade taxes) are hurting the same people.

At first, I wasn’t going to bother writing about this topic for the simple reason that Trump isn’t serious (if he was, he wouldn’t have meekly allowed the big spenders to bust the spending caps).

But then I saw that Tom Giovanetti of the Institute for Policy Innovation wrote a column for the Wall Street Journal explaining how reforming Social Security would be great news for lower- and middle-income taxpayers.

…44% of Americans no longer pay any federal income tax at all, and many more pay very little. …On the other hand, low- and middle-income workers do send the government a large share of their earnings in the form of payroll taxes. That same family of four pays $12,240 at the 15.3% combined rate for Social Security and Medicare. If you want to cut taxes for middle-class and low-income workers, that’s where you have to do it. …instead of…a payroll-tax cut of 4% of income, why not redirect that same 4% into personal retirement accounts for every worker? …With no decline in disposable income, American workers would suddenly be investing for retirement at market rates in accounts they own and control, instead of relying on Congress to keep Social Security solvent.

Not only would personal retirement accounts be good for workers, they also would help deal with the looming entitlement crisis.

America’s entitlements are on a path to collapse, and few politicians—including Mr. Trump—have an appetite to do anything about it. When the crisis comes, no tax increase will be big enough to solve the problem. Knowing the U.S. government is eventually going to fudge its commitment to retirees, policy makers should at least give workers a fair chance to amass the savings they will need to support themselves. The back-door solution to the entitlement crisis is to make workers wealthy. Will you worry about Social Security’s solvency or a Medicare collapse if you have more than enough money in a real retirement account to buy a generous annuity and cover your health insurance?

At the risk of stating the obvious, this is the right approach. Both for workers and the country.

To be sure, I don’t think it’s likely since Trump opposes sensible entitlement reform. But Tom’s column at least provides a teaching moment.

I’m not sure when we’ll have a chance to address this simmering crisis. But if you’re wondering whether changes are necessary, check out this chart I put together earlier this year showing Social Security’s annual shortfall (adjusted for inflation, so we’re comparing apples-to-apples).

P.S. This video has more details on the benefits of personal retirement accounts.

P.P.S. And this video shows why the left’s plan to “fix” Social Security would be so destructive.

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Denmark’s Successful Transition from Tax-Financed Old-Age Payments to Private Retirement Accounts

The United States has a bankrupt Social Security system.

According to the most recent Trustees Report, the cash-flow deficit is approaching $44 trillion. And that’s after adjusting for inflation.

Even by DC standards of profligacy, that’s a big number.

Yet all that spending (and future red ink) doesn’t even provide a lavish retirement. Workers would enjoy a much more comfortable future if they had the freedom to shift payroll taxes to personal retirement accounts.

This is why I periodically point out that other nations are surpassing America by creating retirement systems based on private savings. Here are some examples of countries with “funded” systems (as compared to the “pay-as-you-go” regime in the United States).

• Australia
• Chile
• Sweden
• Switzerland
• Hong Kong
• Netherlands
• Faroe Islands

Now it’s time to add Denmark to this list.

Here’s how the OECD describes the Danish system.

There is…a mandatory occupation pension scheme based on lump-sum contributions (ATP). In addition, compulsory occupational pension schemes negotiated as part of collective agreements or similar cover about 90% of the employed work force. …Pension rights with ATP and with occupational pension schemes are accrued on a what-you-pay-iswhat-you-get basis. The longer the working career, the higher the employment rate, the longer contribution record and the higher the contribution level, the greater the pension benefits. …ATP covers all wage earners and almost all recipients of social security benefits. ATP membership is voluntary for the self-employed. ATP covers almost the entire population and comes close to absolute universality. …The occupational pension schemes are fully funded defined-contribution schemes… Some 90% of the employed work force is covered… The coverage ratio has increased from some 35% in the mid-1980s to the current level… Contribution rates range between 12% and 18%.

A Danish academic described the system in a recent report.

As labour market pensions mature, they will challenge the people’s pension as the backbone The fully funded pensions provide the state with large income tax revenues from future pension payments which will also relieve the state quite a bit from future increases in pension expenditures. Alongside positive demographic prospects this makes the Danish system economically sustainable. … a main driver was the state’s interest in higher savings… Initially, savings was also the government motive for announcing in 1984 that it would welcome an extension of occupational pensions to the entire labour market. … Initially, contributions were low, but the social partners set a target of 9 per cent, later 12 per cent, which was reached by 2009. …it is formally a private system. Pensions are fully funded, and savings are secured in pensions funds. …It is also worth noting that the capital accumulated is huge. Adding together pensions in private insurance companies, banks, and labour market pension funds (some of which are organized as private pension insurance companies), the total amount by the end of 2015 was 4.083 bill.DKK, that is, 201 per cent of GDP.

Denmark’s government also is cutting back on the taxpayer-financed system.

… the state has also sought to reduce costs of ageing by raising the pension age. In the 2006 “Welfare Reform”, it was decided to index retirement age with life expectancy… Moreover, the voluntary early retirement scheme was reduced from 5 to 3 years and made so economically unattractive that it is de facto phased out. Pension age is gradually raised from 65 to 67 years in 2019-22, to 68 years in 2030, to 69 in 2035 and to 70 in 2040… These reforms are extremely radical: The earliest possible time of retirement increases from 60 years for those born in 1953 to 70 years for those born in 1970. But the challenge of ageing is basically solved.

Those “socialist” Danes obviously are more to the right than many American politicians.

The Social Security Administration has noticed that Denmark is responding to demographic change.

The Danish government recently implemented two policy changes that will delay the transition from work to retirement for many of its residents. On December 29, 2015, the statutory retirement age increased from age 67 to 68 for younger Danish residents. Three days later, on January 1, 2016, a reform went into effect that prohibits the long-standing practice of including mandatory retirement ages in employment contracts.

And here’s some additional analysis from the OECD.

…pension reforms are expected to compensate the impact of ageing on the labour force… To maintain its sustainability…, major reforms have been legislated, including the indexation of retirement age to life expectancy gains from 2030 onwards. …a person entering the labour market at 20 in 2014 will reach the legal retirement age at 73.5. This would make the Danish pension age the highest among OECD countries. …As private pension schemes introduced in the 1990s mature, public spending on pension is projected to decline from around 10% of GDP in 2013 to 7% towards 2060.

Wow. Government spending on pensions will decline even though the population is getting older. Too bad that’s not what’s happening in America.

Last but not least, here are some excerpts from some Danish research.

Denmark has also developed a funded, private pension system, which is based on mandatory, occupational pension (OP) schemes… The projected development of the occupational schemes will have a substantial effect on the Danish economy’s ability to cope with the demographic changes. …the risks of generational conflicts seem smaller in Denmark than in many other countries. …Overall, the Danish OP schemes are thus widely regarded as highly successful: they have contributed substantially to restoring fiscal sustainability, helped averting chronic imbalances on the current account and reduced poverty among the elderly.

This table is remarkable, showing the very high levels of pension assets in Denmark.

To be sure, the Danish system is not a libertarian fantasy. Government still provides a substantial chunk of retirement income, and that will still be true when the private portion of the system is fully mature. And even if the private system provided 99 percent of retirement income, it’s based on compulsion, so “libertarian” is probably not the right description.

But it is safe to say that Denmark’s system is far more market-oriented (and sustainable) than America’s tax-and-transfer Social Security system.

So the next time I hear Bernie Sanders say that the United States should be more like Denmark. I’ll be (selectively) cheering.

P.S. The good news isn’t limited to pension reform. Having reached (and probably surpassed) the revenue-maximizing point on the Laffer Curve, Denmark is taking some modest steps to restrain the burden of government spending. Combined with very laissez-faire policies on other policies such as trade and regulation, this helps to explain why Denmark is actually one of the 20-most capitalist nations in the world.

August 8 addendum: Here’s a chart from a report by the European Commission showing that private pension income is growing while government-provided retirement benefits are falling (both measured as a share of GDP).

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The Ever-Expanding Fiscal Burden of Social Security

Writing a column every day can sometimes be a challenge, in part because of logistics (I have to travel a lot, which can make things complicated), but also because I want to make sure I’m sharing interesting and relevant information.

My task, however, is very easy on certain days. When Economic Freedom of the World is published in the autumn, I know that will be my topic (as it was in 2017, 2016, 2015, etc). My only challenge is to figure out how to keep the column to a manageable size since there’s always so much fascinating data.

Likewise, I know that I have a very easy column about this time of year (2017, 2016, 2015, etc) since that’s when the Social Security Administration releases the annual Trustees Report.

It’s an easy column to write, but it’s also depressing since my main goal is to explain that the program already consumes an enormous pile of money and that it will become an every bigger burden in the future.

Here are the 1970-2095 budgetary outlays from the latest report, adjusted for inflation. As you can see, the forecast shows a huge increase in spending.

The good news, as least relatively speaking, is that we’ll also have inflation-adjusted growth between now and 2095, so the numbers aren’t quite as horrifying as they appear. That being said, Social Security inexorably will consume a larger share of the private economy over time.

Now let’s examine a second issue. Most news reports incorrectly focus on the year the Social Security Trust Fund runs out of money.

But since that “Trust Fund” is filled with nothing but IOUs, I think that’s an utterly pointless piece of data. So every year I show the cumulative $43.7 trillion cash-flow deficit in the system. Using inflation-adjusted dollars, of course.

Assuming we don’t reform the program, think of these numbers as a reflection of a built-in future tax hike.

You won’t be surprised to learn, by the way, that politicians such as Barack Obama and Hillary Clinton already have identified their preferred tax hikes to fill this gap.

Let’s wrap up.

Veronique de Rugy of Mercatus accurately summarizes both the problem and the solution.

The single largest government program in the United States will soon have an annual budget of $1 trillion a year. …The program is Social Security, and our national pastime seems to be turning a blind eye to its dysfunctions. …Since 2010, it has been running a cash-flow deficit—meaning that the Social Security payroll taxes the government collects aren’t enough to cover the benefits it’s obliged to pay out. …

Veronique punctures the myth that there’s a “Trust Fund” that can be used to magically pay benefits.

Prior to 2010, the program collected more in payroll taxes than was needed to pay the benefits due at the time. The leftovers were “invested” into Treasury bonds through the so-called Old Age Trust Fund, which is now being drawn down. …In fact, the Treasury bonds are nothing but IOUs. …Treasury…doesn’t have the money: It has already spent it on wars, roads, education, domestic spying, and much more. So when Social Security shows up with its IOUs, Treasury has to borrow to pay the bonds back. …Did you catch that? Past generations of workers paid extra payroll taxes to bulk up the Social Security system. But the government spent that additional revenue on non-retirement activities, so now your children and grandchildren will also have to pay more in taxes to reimburse the program.

So what’s the solution?

Veronique explains we need to reform the system by allowing personal retirement accounts. She was even kind enough to quote me cheerleading for the Australian system.

Congress should shift away from Social Security into a “funded” system based on real savings, much as Australia and others have done. The libertarian economist Daniel J. Mitchell notes that, starting in the ’80s and ’90s, that country has required workers to put 9.5 percent of their income into a personal retirement account. As a safety net—but not as a default—Australians with limited savings are guaranteed a basic pension. That program has generated big increases in wealth. Meanwhile, Social Security has generated big deficits and discouraged private saving. Who would you have emulate the other?

Though I’m ecumenical. I also have written favorably about the Chilean system, the Hong Kong system, the Swiss system, the Dutch system, the Swedish system. Heck, I even like the system in the Faroe Islands.

The bottom line is that there’s been a worldwide revolution in favor of private savings and the United States is falling behind.

P.S. If you have some statist friends and family who get confused by numbers, here’s a set of cartoons that shows the need for Social Security reform.

P.P.S. As I explain in this video, reform does not mean reducing benefits for current retirees, or even older workers.

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Slovakia, Economic Reform, and National Competitiveness

I had mixed feeling when I spoke yesterday in Bratislava, Slovakia, as part of the 2018 Free Market Road Show.

Last decade, Slovakia was a reform superstar, shaking off the vestiges of communism with a plethora of very attractive policies – including a flat tax, personal retirement accounts, and spending restraint.

As Marian Tupy explained last year, “…in 1998, Slovaks kicked out the nationalists and elected a reformist government, which proceeded to liberalise the economy, privatise loss-making state-owned enterprises and massively improve the country’s business environment. …In 2005, the World Bank declared Slovakia the “most reformist” country in the world.”

And these policies paid off. According to research from both Europe and the United States, Slovakia has enjoyed reasonably strong growth that has resulted in considerable “convergence” to western living standards.

But in recent years, Slovakia has gradually moved in the wrong direction, which means I have good and bad memories of my visits.

The nation’s strong rise and subsequent slippage can be seen in the data from Economic Freedom of the World.

The drop may not seem that dramatic. And in terms of Slovakia’s absolute score, it “only” fell from 7.63 to 7.31.

But what really matters (as I explained last year when writing about Italy) is the relative score. And if you take a closer look at the data, Slovakia has dropped in the rankings from #20 in 2005 to #53 in 2015.

This relative decline is not good news for a nation that wants to compete for jobs and investment. Moreover, I’m not the only one to be worried about slippage in Slovakia.

Jan Oravec is similarly concerned about a gradual erosion of competitiveness in his country.

…the World Economic forum, which compares the competitiveness of 140 countries around the world, Slovakia ranked 67^th. …If we…look at the long-term evolution of the Slovak economy’s competitiveness not only in this, but in other rankings, we realize…a tragic story of a dramatic decline in our competitiveness. Let us start by looking back at our previous scores: In 2000, we ranked 38^th, while in 2010 we painfully fell to 60^th – today we hold the aforementioned 67^th place. …If we take a look at the evolution of Slovakia’s situation from the last 10 years, we come to the conclusion that there has been a significant drop in the ranking of our competitiveness. While 10 years ago we usually ranked in the top third or quarter of the ranked countries, today we usually rank in the bottom half… An explanation to this negative trend is twofold: Other countries have been improving while our business environment has been worsening, or stagnating at best.

There are three glaring examples of slippage in Slovakia.

• The first is that the flat tax was undone in 2012.
• The second is that the private social security system was weakened.
• The third is an erosion of fiscal discipline.

To be sure, it’s not as if Slovakia went hard left. The top tax rate under the new “progressive” system is 25 percent. And as I noted last month, that means high-income workers in Slovakia are still treated rather well compared to their counterparts in other industrialized nations.

And the leftist government in Slovakia weakened – but did not completely reverse – personal retirement accounts.

Jan Oravec explains the good reform that was adopted last decade.

During 2003 two main legislative acts – the Social Insurance Act and the Old-Age Pension Savings Act – were prepared by the reform team. …Prior to reform Slovaks were obliged to pay to the PAYGO system contributions of 28.75 % of their gross wages, and the system promised in exchange to pay an average old-age benefit amounting to 50 % of gross wages. The reform allowed workers to redirect a significant part of their contributions, 9 % of gross wage, to their personal retirement accounts.

Under current law, however, the amount that workers are allowed to place in private accounts has been reduced. Moreover, the government is forcing the accounts to invest in government bonds, which means workers will earn sub-par returns. These are bad changes, but at least personal accounts still exist.

Even the bad news on government spending isn’t horrible news. As you can see from this OECD data, the spending burden (measured as a share of GDP) has climbed to a higher plateau in recent years, wiping out some of the gains that were achieved thanks to a period of strong restraint early last decade. That being said, Slovakia is still in better shape than many other industrialized nations.

So where does Slovakia go from here?

That’s not clear. The Prime Minister that imposed some of the bad policies recently was forced out of office by scandal, but his replacement isn’t any better and there’s not another election scheduled until 2020.

That’s the bad news. The good news is that Slovakia has one of Europe’s best pro-market think tanks, the Institute of Economic and Social Studies. Which hopefully means another wave of reform may happen. Hopefully including some of my favorite policies, such as a pure flat tax as well as some constitutional spending restraint.

P.S. Like other nations in Central and Eastern Europe, Slovakia faces demographic decline. To avert long-term crisis, reform is a necessity, not a luxury.

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Reforms to Sweden’s Retirement System and Lessons for the United States

Given Social Security’s enormous long-run financial problems, the program eventually will need reform.

But what should be done? Some folks on the left, such as Barack Obama and Hillary Clinton, support huge tax increases to prop up the program. Such an approach would have a very negative impact on the economy and, because of built-in demographic changes, would merely delay the program’s bankruptcy.

Others want a combination of tax increases and benefit cuts. This pay-more-get-less approach is somewhat more rational, but it means that today’s workers would get a really bad deal from Social Security.

This is why I frequently point out that personal retirement accounts (i.e., a “funded” system based on real savings) are the best long-run solution. And to help the crowd in Washington understand why this is the best approach, I explain that dozens of nations already have adopted this type of reform. And I’ve written about the good results in some of these jurisdictions.

• Australia
• Chile
• Switzerland
• Hong Kong
• Netherlands
• Faroe Islands

Now it’s time to add Sweden to the list.

I actually first wrote about the Swedish reform almost 20 years ago, in a study for the Heritage Foundation co-authored with an expert from Sweden. Here’s some of what we said about the nation’s partial privatization.

Swedish policymakers decided that both individual workers and the overall economy would benefit if the old-age system were partially privatized. …Workers can invest 2.5 percentage points of the 18.5 percent of their income that they must set aside for retirement. …the larger part-16 percent of payroll-goes to the government portion of the program. …What makes the government pay-as-you-go portion of the pension program unique, however, is the formula used for calculating an individual’s future retirement benefits. Each worker’s 16 percent payroll tax is credited to an individual account, although the accounts are notional. …the government uses the money in these notional accounts to calculate an annuity (annual retirement benefit) for the worker. …the longer a worker stays in the workforce, the larger the annuity received. This reform is expected to discourage workers from retiring early… There are many benefits to Sweden’s new system, including greater incentives to work, increased national savings, a flexible retirement age, lower taxes and less government spending.

While that study holds up very well, let’s look at more recent research so we can see how the Swedish system has performed.

I’m a big fan of the fully privatized portion of the Swedish system (the “premium pension”) funded by the 2.5 percent of payroll that goes to personal accounts.

But let’s first highlight the very good reform of the government’s portion of the retirement system. It’s still a tax-and-transfer scheme, but there are “notional” accounts, which means that benefits for retirees are now tied to how much they work and how much they pay into the system.

A new study for the American Enterprise Institute, authored by James Capretta, explains the benefits of this approach.

Sweden enacted a reform of its public pension system that combines a defined-contribution approach with a traditional pay-as-you-go financing structure. The new system includes better work incentives and is more transparent to participants. It is also permanently solvent due to provisions that automatically adjust payouts based on shifting demographic and economic factors. …A primary objective…in Sweden was to build a new system that would be solvent permanently within a fixed overall contribution rate. …pension benefits are calculated based on notional accounts, which are credited with 16.0 percent of workers’ creditable wages. …The pensions workers get in retirement are tied directly to the amount of contributions they make to the system. …This design improved incentives for work… To keep the system in balance, this rate of return is subject to adjustment, to correct for shifts in demographic and economic factors that affect what rate of return can be paid within the fixed budget constraint of a 16.0 percent contribution rate.

The final part of the above excerpts is key. The system automatically adjusts, thus presumably averting the danger of future tax hikes.

Now let’s look at some background on the privatized portion of the new system. Here’s a good explanation in a working paper from the Center for Fiscal Studies at Sweden’s Uppsala University.

The Premium Pension was created mainly for three purposes. Firstly, funded individual accounts were believed to increase overall savings in Sweden. …Secondly, the policy makers wanted to allow participants to take account of the higher return in the capital markets as well as to tailor part of their pension to their risk preferences. Finally, an FDC scheme is inherently immune against financial instability, as an individual’s pension benefit is directly financed by her past accumulated contributions. The first investment selections in the Premium Pension plan took place in the fall of 2000, which is known as the “Big Bang” in Sweden’s financial sector. …any fund company licensed to do business in Sweden is allowed to participate in the system, but must first sign a contract with the Swedish Pensions Agency that specifies reporting requirements and the fee structure. Benefits in the Premium Pension Plan are paid out annually and can be withdrawn from age 61.

And here’s a chart from the Swedish Pension Agency’s annual report showing that pension assets are growing rapidly (right axis), in part because “premium pension has provided a 6.7 percent average value increase in people’s pensions per year since its launch.” Moreover, administrative costs (left axis) are continuously falling. Both trends are very good news for workers.

Let’s close by citing another passage from Capretta’s AEI study.

He looks at Sweden’s long-run fiscal outlook to other major European economies.

According to European Union projections, Sweden’s total public pension obligations will equal 7.5 percent of GDP in 2060, which is a substantial reduction from the…8.9 percent of GDP it spent in 2013. …In 2060, EU countries are expected to spend 11.2 percent of GDP on pensions. Germany’s public pension spending is projected to increase…to 12.7 percent of GDP in 2060. …The EU forecast shows France’s pension obligations will be 12.1 percent of GDP in 2060 and Italy’s will be 13.8 percent of GDP.

I think 8.9 percent of GDP is still far too high, but it’s better than diverting 11 percent, 12 percent, or 13 percent of economic output to pensions.

And the fiscal burden of Sweden’s system could fall even more if lawmakers allowed workers to shift a greater share of their payroll taxes to personal accounts.

But any journey begins with a first step. Sweden moved in the right direction. The United States could learn from that successful experience.

P.S. Pension reform is just the tip of the iceberg. As I wrote two years ago, Sweden has implemented a wide range of pro-market reforms over the past few decades, including some very impressive spending restraint in the 1990s. If you’re interested in more information about these changes, check out Lotta Moberg’s video and Johan Norberg’s video.

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The Overwhelming Case for Chile’s Private Social Security System

The United States and other western nations became rich during the 1800s thanks to a combination of rule of law and very small government.

Sadly, very few nations – most notably East Asian tiger economies – have become rich in the modern era. Yes, some other countries have grown, but they are not on a path to converge with rich nations.

Chile, however, may be an exception to that unfortunate pattern. It has enjoyed amazing levels of growth since a shift to free-market policies starting about 40 years ago. It is now the richest country in Latin America and if its “improbable success” continues, it will soon be comfortably part of what used to be called the first world.

The flagship reform in Chile was the creation of a funded retirement system based on personal accounts. Basically universal IRAs.

Writing for the Weekly Standard, Fred Barnes shared what he learned about the nation’s private retirement system.

The rags-to-riches Chile story lives on as a model of what a poor country can achieve if it spurns socialism and adopts free markets and democracy. Peru is now copying Chile. More may follow. …Chile was once a Third World country headed downhill economically after Salvador Allende was elected president in 1970…bent on creating a Marxist state. In 1973, the military led by General Augusto Pinochet staged a coup. …When he took over, Chile had one of the highest rates of poverty in South America. It was a basket case. Now it has the continent’s strongest economy. Without Pinochet’s having heeded the advice of economist Milton Friedman, imposed capitalism, and hired a team of free market economists, many trained at the University of Chicago, the rise to First World status wouldn’t have happened. One of the economists was José Piñera, brother of the new president and Harvard-educated. He created a stable, fully-funded pension program that has become a monument to the success of private markets. …Piñera released a study in January that found “72 percent of the capital accumulated in the personal retirement account of the average Chilean worker, after 36 years in the private pension system, comes from the return on the investments done with their contributions.” That’s a long way of saying the plan is a dazzling success.

Though there are opponents, mostly those inspired by the communist regime in Cuba and a Pope who thinks we should worship the state.

But obstacles remain. …Even with Fidel Castro gone, Cuba exports communism as aggressively as it once did sugar. …socialists have an ally in Pope Francis, who spent three days in Chile in mid-January. …there’s a disconnect between how people here feel about capitalism—as a concept anyway—and the economic success they are experiencing. Pinochet is partly to blame, I suspect. He’s a hard man to credit, given his bloody takeover.

Barnes’ final point is also important.

I’ve had many people tell me that personal accounts are bad because they were implemented during Pinochet’s reign. But that’s a silly argument, sort of like deciding to be against free trade because the dictatorial Chinese government opened up to the global economy.

As far as I’m concerned, tyrannical leaders are awful and should be condemned, but if they happen to grant citizens a slice of economic liberty, that’s a silver lining to an otherwise dark cloud.

Back to our main topic, Monica Showalter, in a column for the American Thinker, explained what makes Chile’s system a role model for the United States.

…the Chilean Model…shows some spectacular new results for ordinary citizens… the Chilean Model is working, big time.  Basically, you skip Social Security taxes for starters, which leaves you a lot more money to play around with.  You then put 10% of your income into a government-certified private pension account (and you have many choices among them)… This is mass-scale wealth creation, and it benefits workers most of all. …Chile has no pension crisis as most of the rest of the developed world does – no worries about a “trust fund” and no Social Security “cuts” to speak of.  This is why.  Thirty nations have adopted the same plan… the left hates this stuff.  It keeps workers out of the clutches of unions and un-dependent on government handouts.  Of course leftists want it gone.  They tried hard in Chile to turn workers against this pension idea.

And here’s a chart that was linked in her article showing how investment returns have played a big role in helping ordinary Chileans build nest eggs for their old age.

Let’s look at some additional research.

In a monograph published by the U.K.-based Institute of Economic Affairs, Kristian Niemietz takes an in-depth look at Chiles’s approach.

Taken together, the value of the assets accumulated by Chilean pension funds is equivalent to about two thirds of the country’s GDP (Figure 1). This places Chile in the same league as countries which have had private pensions for over a century, and miles ahead of countries with traditional Bismarckian systems… The poverty rate among the elderly is lower than that of the population as a whole – 3.9 per cent vs. 10.3 per cent, or 8.4 per cent vs. 14.4 per cent, depending on the poverty measure used… Chile’s 1981 pension reform has given rise to a number of positive economic spillover effects: the prefunded system has been an active ingredient in the accelerated economic development that the country has been experiencing since the mid-1980s. …It has increased employment, especially in the formal sector… It has boosted the development and sophistication of Chile’s capital markets, and thus raised Total Factor Productivity… Despite the current backlash against it, Chile’s pension system is a success story. The system has achieved consistently high rates of return. It offers excellent value for money and solid pensions for those who contribute regularly. … The official retirement age is not as important in Chile as it is in countries with state-run systems. By and large, in that system, people retire when they have accumulated enough savings, not when politicians think they should retire.

Here’s the chart Kristian mentioned in the text. By this important metric, Chile is firmly ensconced in the upper tier of developed countries.

Now let’s address some of the critics.

Under the previous leftist government, there were protests against the country’s famous private social security system and attempts to undermine the model. Indeed, I wrote about that battle back in 2014. And I also noted that even some academics agreed that it would be foolish to undermine a successful approach.

Let’s see what’s happened since then. The Economist reported about the complaints about a year ago.

…tens of thousands of Chileans in Santiago…protest against the country’s privatised pension system. Organisers—a mix of unions, pensioners’ associations and consumer-advocacy groups—say that… Pensions are too small…benefits have not measured up to people’s unrealistic expectations. The scheme’s founders told workers that if they contributed continuously throughout their careers they would receive a generous 70% of their final salaries upon retirement. …But most workers contributed far less. Women took time off to raise children (and retire earlier than men). Many Chileans spent time in informal jobs or unemployed. On average, they contribute for only 40% of their prime working years. …The system has generated high returns for pensioners, averaging 8.6% a year between 1981 and 2013. But…high fees have bitten a huge chunk out of those returns, reducing them to 3-5.4%.

Though the article also noted all the benefits of personal accounts.

Rather than saddle the government with an unaffordable pay-as-you-go system, in which today’s taxpayers support today’s pensioners even as the population ages, Chile created one in which workers save for their own retirement by paying 10% of their earnings into individual accounts. These are managed by private administrators (AFPs). …the system worked. Contributions to the AFPs flowed into capital markets, which boosted growth. Annual GDP growth from 1981 to 2001 was 0.5 percentage points higher than it would have been without the investment, according to one study. This helped lift millions of people out of poverty.

The last couple of sentences of the above passage are worth highlighting. As I’ve noted, even small differences in economic growth – if they are sustained for a long period – make a huge difference in terms of national prosperity. And 0.5 percent more growth every year is actually a big boost when looking at the impact of just one policy.

Last but not least, here’s Ian Vasquez’s response to the attacks on the Chilean system.

Critics in Chile assert that the average pension provided by the private pension fund companies is around $340 per month, which is not better than the public pension system. But as the Chile-based Liberty and Development institute (LyD) has shown, that is like comparing apples to oranges. To calculate the private system’s figures, all those affiliated with it are taken into account, even if they have only contributed to their accounts once in their lifetime. The corresponding figure for the public pension system, however, only takes into account the pensions of those who have contributed for a minimum of 10 to 15 years, something that leaves out half of the people affiliated with that system. In addition, pensions under the private system are obtained through contributions that amount to 10 percent of wages, while in the public system the contribution is 20 percent. Correcting for those distortions shows that the value of the pensions the AFPs provide is three times higher than that of the public system. …it’s true that many Chileans do not contribute regularly to their retirement accounts because too many work outside the formal sector and getting work is still too precarious for many, that is a problem that affects any pension system, whether public or private, and can only be solved with labor reforms. …Chile’s private pension system can certainly be improved, but the reality is that it has been extremely successful. …old-age pensions no longer represent a burden on the treasury. Pension savings have reached $168 billion, about 70 percent of GDP, which has stimulated high growth and domestic investment, and has put Chile on the verge of becoming a developed country—a remarkable achievement.

Amen. Chile’s system isn’t perfect, but it’s far better, by several orders of magnitude, than the debt-ridden, pay-as-you-go models that are wreaking havoc with the public finances of other countries.

And Chile is prospering in a way unimaginable in other Latin nations.

It would be very nice to have a similar system of personal retirement accounts in the United States. And here’s the cartoon version of the argument.

P.S. Chile also has nationwide school choice.

P.P.S. Bill Clinton supported good Social Security reform and was prepared to work with congressional Republicans (and some Democrats) on good legislation for personal accounts, but that effort was sidetracked by the partisan impeachment fight. A genuine tragedy.

P.P.P.S. I’ve written before about overseas bathroom adventures and I now have another episode to add to the mix from my recent trip to India. I like modern facilities, including ones that have energy-saving features. But building engineers should realize that motion-activated lights may not make sense in bathrooms. At least not when people may be locked in stalls with no good options when the lights go out. Enough said.

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The Policy Solution to the World’s Demographic Problem

I wrote yesterday about “the world’s demographic problem,” citing a new study about the fiscal implications of aging populations. The report was produced by the Organization for Economic Cooperation and Development, which is not my favorite international bureaucracy when they make policy recommendations, but I’ll be the first to admit that the bureaucrats produce some useful statistics and interesting reports.

To be succinct, the basic message of the study is that developed nations (the U.S., Europe, Asia, etc) face a demographic nightmare of increased longevity and falling birthrates.

It’s good that people are living longer, of course, and there’s nothing wrong with people choosing to have fewer kids. But since most governments maintain tax-and-transfer entitlement programs, the OECD report basically warns that those demographic changes have some very grim fiscal implications. In other words, the world’s demographic shift is actually a policy problem.

That’s the bad news.

The good news is that there’s a policy solution.

The aforementioned OECD study (which can be accessed here) is a survey of how retirement income is provided in key nations. So in addition to grim information about fiscally unstable government-run retirement systems we looked at yesterday, the report also has data about the nations that rely – at least to some degree – on private savings.

Let’s start with this helpful flowchart in the report. It illustrates that there are three approaches for the provision of retirement income. The first tier is government-run programs such as the U.S. Social Security system and the third tier is voluntary savings such as IRAs and 401(k)s in America.

For today’s discussion, let’s focus on the second tier. These are the systems that are “funded” with mandatory savings.

And I highlighted (in green) the two private options. In a “defined contribution” system, retirement income is determined by how much is saved and how well it is invested. Workers accumulate a big nest egg and then choose how to spend the money when retired. In a “defined benefit” system, workers are promised a pre-determined level of retirement income and the managers of their pension funds are expected to ensure that enough money will be available.

Yes, public options based on real savings do exist. And they presumably are better than the pay-as-you-go, tax-and-transfer schemes found in the first tier. But it’s also the case that these systems (such as pension funds for state and local bureaucrats) generally don’t work very well.

So now let’s look at another table from the OECD report. It shows nations that have some degree of mandatory private retirement savings, either defined contribution (highlighted in red) or defined benefit (highlighted in yellow). As you can see, there actually are a lot of “privatized” systems.

I’ve actually written about many of these systems, especially the ones in Australia and Chile.

And I have very recent columns on the Dutch and Swiss systems.

A common theme in these columns is that government-run systems are very risky because workers are at the mercy of politicians, who are great at making extravagant promises. But huge unfunded liabilities show that they’re not very good at delivering on those promises.

Nations with funded systems, by contrast, accumulate private savings. That’s not only good for workers, but it’s very beneficial for national economies.

This table from the OECD report shows that Americans and Canadians have managed to save a lot of money, but all of the other nations with pension assets of more than 100 percent of GDP have mandatory funded systems.

When I talk about how the United States would benefit by moving to a private retirement system, people sometimes say it sounds too good to be true.

That’s obviously not the case since other nations have very successful private systems. But there is a catch, as I acknowledged in 2015.

…a big challenge for real Social Security reform is the “transition cost” of financing promised benefits to current retirees and older workers when younger workers are allowed to shift their payroll taxes to personal accounts. Dealing with this challenge presumably means more borrowing over the next few decades.

The appropriate analogy is that shifting to private retirement accounts for younger workers (while protecting current retirees and older workers) would be like refinancing a mortgage. The short-run costs might be higher, but that temporary burden is overwhelmed by the long-run savings. That’s a good deal, at least if the goal is fiscal stability and secure retirement.

Or we can stay with the current approach and become another Greece.

P.S. Social Security reform is especially beneficial for blacks and other minorities.

P.P.S. There is some risk with personal retirement accounts. But I’m not talking about the implications of a falling stock market crash (even a horrible crash would be offset by decades of compounding earnings). Instead, I’m referring to the possibility that future politicians might simply confiscate the money.

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Is Australia Still the Best Country for American Refugees?

Back in 2013, when I was still doing a “question of the week” column, I suggested that Australian was the best option for those contemplating a new home in the event of some sort of Greek-style fiscal collapse in the United States.

I pointed out that America wasn’t in any immediate danger, though I can understand why some people are interested in the question since our long-run outlook is rather grim.

Anyhow, I picked Australia for several reasons, including its geographic position (no unstable welfare states on the border, which is why I didn’t select Switzerland), its private social security system (unfunded liabilities are small compared to the $44 trillion shortfall in America’s government-run system), and its relatively high level of economic freedom.

I’m not the only person to notice that Australia is a good place to live. A recent Bloomberg column noted that millionaires are moving Down Under.

They’re all going to the land Down Under. Australia is luring increasing numbers of global millionaires, helping make it one of the fastest growing wealthy nations in the world… Over the past decade, total wealth held in Australia has risen by 85 percent compared to 30 percent in the U.S. and 28 percent in the U.K., aided by the fact that Australia has gone 25 years without a recession. As a result, the average Australian is now significantly wealthier than the average American or Briton. …At the end of 2016 individuals held about $192 trillion of wealth worldwide…, with 13.6 million millionaires holding $69 trillion of this. There were 522,000 multi-millionaires, having net assets of $10 million or more.

The number of millionaires moving to Australia is especially impressive when looking at global data.

Here’s a map showing the nations with the most incoming and outgoing rich people (h/t: Steve Hanke). Maybe it’s because there’s no death tax in Australia, but it’s remarkable that a nation with less than one-tenth the population of the United States manages to attract more millionaires.

But not everybody is cheerful about Australia’s economic position.

I’m currently in Brisbane for a couple of speeches. I spoke earlier today about how market-oriented jurisdictions grow much faster over the long run when compared to nations with statist economic policy.

But I don’t want to focus on my remarks (much of which will be old news to regular readers). Instead, let’s look at the some of the information in a speech by Professor Tony Makin of Griffith University.

Two of his slides caught my attention. Let’s start with a depressing look at how Australia has declined in the global competitiveness rankings put together each year by the World Economic Forum.

This is not a good trend.

That being said, I think Economic Freedom of the World is a more accurate measure and it shows that Australia (whether looking at its absolute score or its relative ranking) has suffered only a small decline.

Here’s another chart that is depressing as well. It shows that the per-capita burden of taxes and spending has continuously increased even after adjusting for inflation.

To be fair, the numbers aren’t quite as bad when looking at taxes and spending as a share of gross domestic product.

Nonetheless, the trend isn’t favorable, which is a point I made back in 2014.

None of this changes my view that Australia is still a good choice for emigrating Americans. But it does leave me worried about whether it will still be the top choice in 10 years or 20 years.

For what it’s worth, the main recommendation in my speech was for Australia to adopt a spending cap, similar to the ones that exist in Hong Kong and Switzerland. I also should have suggested sweeping decentralization since the government actually is open to that idea.

P.S. One of the most disappointing things about Australia is that the country’s foreign aid bureaucrats are trying to bribe/coerce Vanuatu’s government into adopting an income tax.

P.P.S. Professor Makin was the author of the report I recently cited about the failure of Australia’s Keynesian spending binge.

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Personal Accounts Are the Best Way to Ensure Safe and Secure Retirement Income

Most people understand that there’s a Social Security crisis, but they only know half the story.

The part of the crisis they grasp is that the program is basically bankrupt, though I doubt many of them realize that the long-run shortfall is a staggering $44 trillion.

The part of the crisis that generally is overlooked is that the program is a lousy deal for workers. They pay record amounts of tax into the system in exchange for a shaky promise of a modest monthly check. For all intents and purposes, they are being charged for a steak, but they’re getting a hamburger (with Medicare, by contrast, people are charged for a hamburger and they receive a hamburger but taxpayers pay for a steak that nobody gets).

For groups with lower-than-average life expectancy, such as poor people and minorities, Social Security is even worse. They pay into the system throughout their working lives, but then they don’t live long enough to collect a decent amount of benefits.

I narrated a video that was partly focused on how people could have more retirement income if we shifted to a system of personal retirement accounts, but this video from Learn Liberty directly addresses this issue.

By the way, I have one minor complaint with this excellent video. Social Security is not forced savings. There’s no money set aside. Yes, there’s a “trust fund,” but it contains nothing but IOUs. And if you don’t believe me, see what the Clinton Administration wrote back in 1999.

It would be more accurate to say the system is a pay-as-you-go, tax-and-transfer entitlement.

But I’m digressing, so let’s focus on some potential good news. Americans actually have a pretty good track record of saving for their own retirement. Indeed, total pension assets (measured as a share of economic output) in the United States rival those of nations that have mandatory private retirement systems.

So it presumably shouldn’t be that difficult to transition to a private retirement system in America.

Which was a key takeaway from a column in the Wall Street Journal last week by Andrew Biggs of the American Enterprise Institute. He starts with a pessimistic observation on how major politicians have addressed the crisis.

During last year’s presidential campaign, the candidates promised not to cut Social Security benefits (Donald Trump) and even to increase them (Hillary Clinton). …the Trump administration should reconsider its pledge not to cut Social Security benefits. The program is 25% underfunded over the long term, the Congressional Budget Office projects.

But the good news is that many Americans already are saving for retirement, so it wouldn’t be disruptive to extend personal retirement accounts to the entire population.

…private plans such as 401(k)s have allowed more people than ever to save for retirement…61% of workers… Contributions to private plans have…risen from an average 5.8% of wages in 1975 to 8% in 2014. …in 1984 only 23% of households received benefits from private retirement plans. By 2007 that had risen to 45%. Moreover, during the same period the benefits that the median household received from private plans rose by 141% above inflation, versus only 25% for Social Security benefits.

This is a system that should be expanded, with a prudent transition from a bankrupt Social Security system to a safer and more lucrative system of personal retirement accounts.

And that would be a much better outcome than what the current system will give us.

…Scandinavian-level tax rates or multi-trillion dollar unfunded entitlement liabilities.

P.S. Responding to those who worry about stock market downturns and the implications for retirement income, my colleague Mike Tanner showed that even people retiring after the 2008 crash would have been better off with personal retirement accounts.

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

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The Universal Private Retirement System Is an Additional Reason to Admire Switzerland

There’s a lot to admire about Switzerland, particularly compared to its profligate neighbors.

• It has a spending cap, imposed in a landslide referendum early last decade, that has constrained the growth of government.
• It has a genuinely decentralized system with a very small central government and vigorous competition among cantons.
• There’s widespread gun ownership, and the number of guns owners keeps expanding.
• It has strong human rights laws protecting financial privacy (though unfortunately has been bullied into weakening protections for non-Swiss investors).
• It has comparatively modest tax rates and a relatively low level of redistribution.

With all these features, you won’t be surprised to learn that Switzerland is highly ranked by Human Freedom Index (#2), Economic Freedom of the World (#4), Index of Economic Freedom (#4), Global Competitiveness Report (#1), Tax Oppression Index (#1), and World Competitiveness Yearbook (#2).

Today let’s augment our list of good Swiss policies for reviewing the near-universal system of private pensions. I’ve been in Switzerland this week for a couple of speeches in Geneva, as well as interviews and meetings in Zurich and Bern.

As part of my travels around the country, I took the time to learn more about the “second pillar” of the country’s pension system.

Here’s a basic description from the Swiss government (with the help of Google translate).

The first pension funds were founded more than a hundred years ago… In 1972 the occupational pensions were included in the constitution. There it represents the second column in the three-column concept… The BVG compulsory scheme applies to all employees who are already insured in the first pillar… Pension provision in the second pillar is based on an individual savings process. This starts at 25 years. However, the condition is an annual income that exceeds the threshold (since 2015: 21’150 francs). The savings process ends with the reaching of the pension age. The accumulated savings in the individual account of the insured [are] used to finance the retirement pension.

If you want something in original English, here’s a brief description from the Swiss-American Chamber of Commerce.

The second pillar is governed by the provisions of the laws on occupational pension provision (BVG)… Employees who are paid by the same employer an annual salary exceeding CHF 21,150 are subject to compulsory insurance. The share of the salary which is subject to compulsory insurance is…between CHF 24,675 (the coordination deduction) and CHF 84,600… An employer who employs persons subject to compulsory insurance must be affiliated to a provident institution entered in the register for occupational benefit plan. The contributions into the pension scheme depend on age and include a minimum saving portion of 7% – 18% of the coordinated salary plus a risk portion. Both are equally shared between employer and employee. The benefits of the insured persons consist in the old age, invalidity and survivors pensions.

One of the interesting quirks of the system is that the mandatory contribution rate changes with age. The older you are, the more you pay.

I’m not sure that makes a lot of sense if the goal is for people to have big nest eggs when they retire, but nobody asked me. In any event, here’s a table showing the age-dependent contribution rates from an OECD description of the Swiss system.

Technically speaking, the contributions are evenly split between employees and employers, though labor economists widely agree that workers bear the real cost.

It’s also worth noting that the Swiss system is based on “defined contribution” like the Chilean and Australian private retirement systems. This means  retirement income generally is a function of how much is saved and how well it is invested.

By contrast, the Dutch private system is based on “defined benefit,” which means that workers get a pre-determined level of retirement income. As evidenced by huge shortfalls in the defined benefit regimes maintained by many public and private employers in the United States, this approach is very risky if there aren’t high levels of integrity and honesty.

Though that doesn’t seem to be a problem in the Netherlands. Speaking of the Dutch system, here’s a chart I shared back in 2014.

It was designed to laud the Netherlands, but you can see that Switzerland also had a large pool of pension assets, equal to more than 110 percent of GDP (according to OECD data, now 123 percent of GDP).

Looking at this data, ask yourself whether Switzerland (or the Netherlands, Iceland, Australia, etc) will be in a stronger position to handle the fiscal challenge of aging populations, particularly when compared to nations with virtually no private pension assets, such as France, Greece, and Japan.

The Swiss regime certainly isn’t perfect, and neither are the systems in other nations with private retirement savings. But at least those nations are in much better shape to deal with future demographic changes. Workers in Switzerland and other countries with similar systems have real assets rather than unsustainable political promises. And it’s also worth pointing out that there are macroeconomic benefits for nations that rely more on private savings rather than tax-and-transfer entitlement schemes.

In other words, the Swiss system is much better than America’s bankrupt Social Security scheme.

P.S. Back in 2011, I compared five good features of the United States to five good features of Switzerland. If retirement systems were part of that discussion, Switzerland would have enjoyed a sixth advantage.

P.P.S. Switzerland does have some warts. It is only ranked #31 in the World Bank’s Doing Business. It also has a self-destructive wealth tax. And  government spending, though modest compared to neighbors, consumes slight more than one-third of economic output.

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Making Social Security Worse for Rich People Won’t Change the Fact that the Program Is Bad News for Poor People

I’ve repeatedly argued that there are two Social Security crises. The one most people know about is the fiscal crisis. Simply stated, the program is bankrupt.

But you don’t have to believe me. Here are some excerpts from a CNBC column.

The Social Security Administration projects that unfunded obligations will reach $11.4 trillion by 2090. That’s up $700 billion from the $10.7 trillion the administration projected for its 2089 shortfall. …Despite the huge numbers, there’s even a less generous way of looking at the fiscal shortfall. A projection, known as the “infinite horizon,” takes into account all the program’s future liabilities, even those beyond the 75-year period that Social Security actuaries typically use in their calculations. Under the infinite horizon, Social Security will have $32.1 trillion in unfunded liabilities by 2090, $6.3 trillion more than last year’s projection. …The Social Security Administration projects that unfunded obligations will reach $11.4 trillion by 2090. That’s up $700 billion from the $10.7 trillion the administration projected for its 2089 shortfall.

By the way, the projections cited above are based on “present value,” which is calculated by predicting how much money would have to be set aside and invested today to finance future promises.

But that’s not how budgets work. At least not for pay-as-you-go systems like Social Security.

I prefer looking at inflation-adjusted estimates of cumulative deficits. On that basis, the 75-year unfunded liability is $37 trillion. The “infinite horizon” number presumably would be even scarier.

Oh, and don’t be under the illusion that the “Trust Fund” will solve the problem. It’s nothing but a pile of IOUs.

The second crisis is that Social Security is a bad deal for workers. They have to pay an enormous amount of taxes into the program during their working years, yet the monthly benefits they are promised are far lower than they could get if they had been able to put the same money into personal retirement accounts.

An analysis in the New York Times correctly points out that some groups with low lifespans are particularly disadvantaged by Social Security.

Social Security is designed…as an equalizer between rich and poor. It is structured to give more generous retirement benefits to low-income people, given the taxes they pay during their working years. …But in reality, a large body of research shows that the rich live longer — and that the life span gap between rich and poor is growing. And that means that the progressive ideal built into the design of Social Security is, gradually, being thwarted. In some circumstances, the program can actually be regressive, offering richer benefits to those who are already affluent. …because different groups of people have different life expectancies, some groups receive more value from every dollar of payroll taxes they and their employers pay into the system. Over all, women live longer than men and African-Americans die younger than whites. … the Social Security retirement system as a whole is regressive, or more favorable to the affluent than to the poor. …the richest 1 percent of Americans gained three years of life expectancy from 2001 to 2014 alone, while the poorest had almost no gain (0.3 of a year). For anyone who believes that it’s important for the Social Security program to remain progressive, the life-span shifts have big implications that are made more acute by the program’s financial problems.

I’m not motivated by having Social Security “remain progressive,” but I fully agree that it’s bad policy to have government programs that are especially harmful for poor people.

The obvious solution to both crises is personal retirement accounts. We should copy nations elsewhere that have successfully transitioned to systems based on real savings rather than empty political promises.

But some of our friends on the left think that the answer is to make the program even worse for higher-income taxpayers, even though this doesn’t change the fact that the program is a bad deal for lower-income taxpayers. Hillary Clinton embraced this approach during last year’s campaign (as did Obama in 2008).

Moreover, many Democrats in Washington are lurching even further to the left.

In today’s Wall Street Journal, Andrew Biggs dissects their latest plan.

…congressional Democrats…have embraced an ambitious but flawed policy of expanding the program’s benefits via tax increases on all workers, including doubling payroll taxes on high earners. …today’s Democrats…would boost the initial benefits Americans receive upon retirement, and pay larger cost-of-living adjustments, or COLAs, in the years after. Over the plan’s first 10 years, Social Security benefit payments would rise by almost $1.2 trillion, according to an analysis by Social Security’s actuaries. To fund those higher benefits, the plan would increase the Social Security payroll rate from the current 12.4% to 14.8% between 2019 and 2042. The plan also would phase out the ceiling on earnings subject to the tax, currently $127,000, so that by the mid-2030s all earnings would be taxed. For low- and middle-income workers, lifetime payroll taxes would rise by nearly one-fifth from current levels. …the effective top federal marginal tax rate on earned income (inclusive of Medicare taxes and limitations on deductions) would rise from the current 44.6% to 59.4%. State income taxes could boost the total marginal rate as high as 72.7% for California residents. Under the Democrats’ Social Security plan the U.S. would have, by far, the highest top marginal tax rate in the developed world.

And higher tax rates would be bad news.

…employers who are required to pay higher Social Security taxes would reduce wages to help cover those costs. …According to a recent analysis by the Joint Committee on Taxation, lost income and Medicare taxes would offset between 12% and 21% of workers’ Social Security payroll tax increases, depending on income level. …Left-leaning economists Emmanuel Saez and Jeffrey Liebman found in a 2006 study that even modest behavioral reactions could reduce the net revenue gains from a plan like Mr. Larson’s by nearly half. Assume stronger behavioral effects (specifically, an elasticity of taxable income of 0.5), and losses to non-Social Security revenue would, in the authors’ words, “swamp any benefits from the increase in payroll tax revenue.” In other words, the Democrats’ Social Security reform could increase government deficits and debt, permanently.

To augment this research by Biggs, let’s look at an academic study that estimates how government entitlements push older people out of the labor force, which is bad for them and bad for the overall economy.

Baby Boomers appear at risk of suffering a major decline in their living standard in retirement. With federal and state government finances far too encumbered to significantly raise Social Security, Medicare, and Medicaid benefits, Boomers must look to their own devices to rescue their retirements, namely working harder and longer. However, the incentive of Boomers to earn more is significantly limited by a plethora of explicit federal and state taxes and implicit taxes arising from the loss of federal and state benefits as one earns more. Of particular concern is Medicaid and Social Security’s complex Earnings Test and clawback of disability benefits. …We find that working longer, say an extra five years, can raise older workers’ sustainable living standards. But the impact is far smaller than suggested in the literature in large part because of high net taxation of labor earnings. We also find that many Baby Boomers now face or will face high and, in very many cases, extremely high work disincentives arising from the hodgepodge design of our fiscal system. …we find that traditional, current-year (i.e., static) marginal tax calculations relating this year’s extra taxes to this year’s extra income are woefully off target when it comes to properly measuring the elderly’s disincentives to work. Our findings suggest that Uncle Sam is, indeed, inducing the elderly to retire.

Interestingly, there are some honest folks on the left who support personal accounts. Here’s an article on the “progressive case for privatizing Social Security in the US.”

…privatization is an underrated idea, and progressives who oppose benefit cuts should be fighting for it. …With private accounts, the system would be much more transparent. Currently, for every $1 a middle-earning couple (born in 1985) pays into Social Security, they can expect $1.01 back in benefits when they retire. That’s not a great return on investment, and it may fall in the future because Social Security isn’t on track to keep paying this level of benefits. If the government cuts benefits enough to make the program solvent they’d only get $0.80 for every $1 they pay in. …private accounts would change the conversation about entitlements. It clarifies what people expect to earn in retirement. …private accounts should appeal to those on the left who value a generous social safety net.

Amen.

Honest folks on the left should look around the world and see how personal accounts are good news, both for workers and the overall economy. Heck, just compare these two charts on the United States and Australia.

Sadly, we have too many statists who are motivated by penalizing the rich rather than helping the poor.

P.S. The United States was actually very close to genuine Social Security reform during the Bill Clinton presidency. Investor’s Business Daily opined last year on what almost happened.

The U.S. came very close to having private retirement accounts as part of a sweeping Social Security reform…under President Clinton. That surprising bit of news comes 18 years after the fact in a reminiscence by Cato Institute senior fellow Jose Pinera, who once upon a time served as Chile’s secretary of labor and social security, and who designed that country’s highly successful pension reforms in 1980. Pinera says that Clinton began thinking in earnest about privatizing part of Social Security back in 1995… According to Pinera, Clinton saw private accounts as a way to cement his presidential record as a reformer. And the model for doing so that he had in mind was from Chile, where Pinera and a group of reformers created private retirement accounts that helped fuel that nation’s decade-long growth boom. It was a rousing success. Clinton even sent his former chief of staff, Mack McLarty, to Chile in 1996 to see how private personal accounts worked. In a letter to Pinera, he talked about how impressive Chile’s program was… Three years later, in December 1998, Pinera attended a White House conference on Social Security reform. There, he outlined the simple elements of the Chilean Model… It must have struck a chord with Clinton. Just one month later, in his 1999 State of the Union address, he proposed what he called “USA accounts,”… Every American would have had a private savings account, funded by a portion of his or her payroll taxes. …But it was not to be. Clinton’s involvement in the Monica Lewinsky scandal and his subsequent impeachment for perjury and obstruction of justice derailed his plans.

Having been very involved in the Social Security debates back in the last 1990s, I can vouch for this. Clinton was remarkably sympathetic to reform and almost always gave the right answers when discussing the issue (not too surprising since he compiled a remarkably pro-market record).

Unfortunately, the Lewinsky scandal and impeachment fight poisoned the political environment for bipartisan reform. Who would have thought that a sexual dalliance could have killed an opportunity for much-needed reform. That was the most expensive you-know-what in world history.

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

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IMF Data from Asia: Aging Populations Will Mean More Taxes and Fewer Benefits for Workers Trapped in Government-Run Retirement Programs

I’ve looked at some of the grim fiscal implications of demographic changes the United States and Europe.

Now let’s look at what’s happening in Asia.

The International Monetary Fund has a recent study that looks at shortfalls in government-run pension schemes and various policies that could address the long-run imbalances in the region. Here are the main points from the abstract.

Asian economies are aging fast, with significant implications for their pension system finances. While some countries already have high dependency ratios (Japan), others are expected to experience a sharp increase in the next couple of decades (China, Korea, Singapore). …This has…implications. …pension system deficits can increase very quickly, limiting room for policy action and hampering fiscal sustainability. …This paper explores how incorporating Automatic Adjustment Mechanisms (AAMs)—rules ensuring that certain characteristics of a pension system respond to demographic, macroeconomic and financial developments, in a predetermined fashion and without the need for additional intervention— can be part of pension reforms in Asia.

More succinctly, AAMs are built-in rules that automatically make changes to government pension systems based on various criteria.

Incidentally, we already have AAMs in the United States. Annual Social Security cost of living adjustments (COLAs) and increases in the wage base cap are examples of automatic changes that occur on a regular basis. And such policies exist in many other nations.

But those are AAMs that generally are designed to give more money to beneficiaries. The IMF study is talking about AAMs that are designed to deal with looming shortfalls caused by demographic changes. In other words, AAMs that result in seniors getting lower-than-promised benefits in the future. Here’s how the IMF study describes this development.

More recently, AAMs have come to the forefront to help address financial sustainability concerns of public pension systems. Social insurance pension systems are dominated by defined benefit schemes, pay-as-you-go financed, with liabilities explicitly underwritten by the government. …these systems, under their previous contribution and benefit rules, are unprepared for population aging and need to implement parametric reform or structural reforms in order to reduce the level or growth rate of their unfunded pension liabilities. …Automatic adjustments can theoretically make the reform process politically less painful and more likely to succeed.

Here’s a chart from the study that underscores the need for some sort of reform. It shows the age-dependency ratio on the left and the projected increase in the burden of pension spending on the right.

I’m surprised that the future burden of pension spending in Japan will only be slightly higher than it is today.

And I’m shocked by the awful long-run outlook in Mongolia (the bad numbers for China are New Zealand are also noteworthy, though not as surprising).

To address these grim numbers, the study considers various AAMs that might make government systems fiscally sustainable.

Especially automatic increases in the retirement age based on life expectancy.

One attractive option is to link statutory retirement ages—which seem relatively low in the region—to longevity or other sustainability indicators. This would at the very least help ameliorate the impact of life expectancy improvements in the finances of public pension systems. … While some countries have already raised the retirement age over time (Japan, Korea), pension systems in Asia do not yet feature automatic links between retirement age and life expectancy. …The case studies for Korea and China (section IV) suggest that automatic indexation of retirement age to life expectancy can indeed help reduce the pension system’s financial imbalances.

Here’s a table showing the AAMs that already exist.

Notice that the United States is on this list with an “ex-post trigger” based on “current deficits.”

This is because when the make-believe Trust Fund runs out of IOUs in the 2030s, there’s an automatic reduction in benefits. For what it’s worth, I fully expect future politicians to simply pass a law stating that promised benefits get paid regardless.

It’s also worth noting that Germany and Canada have “ex-ante triggers” for “contribution rates.” I’m assuming that means automatic tax hikes, which is a horrid idea. Heck, even the study acknowledges a problem with that approach.

…raising contribution rates can have important effects on the labor market and growth, it would be important to prioritize other adjustments.

From my perspective, the main – albeit unintended – lesson from the IMF study is that private retirement accounts are the best approach. These defined contribution (DC) systems avoid all the problems associated with pay-as-you-go, tax-and-transfer regimes, generally known as defined benefit (DB) systems.

The larger role played by defined contribution schemes in Asia reduce the scope for using AAMs for financial sustainability purposes. Many Asian economies (Hong Kong, Singapore, Australia, Malaysia and Indonesia) have defined contribution systems, …under which system sustainability is typically inherent.

Here are the types of pension systems in Asia, with Australia and New Zealand added to the mix..

For what it’s worth, I would put Australia in the “defined contribution” grouping. Yes, there is still a government age pension that serves as a safety net, but there also are safety nets in Singapore and Hong Kong as well.

But I’m nitpicking.

Here’s another table from the study showing that it’s much simpler to deal with “DC” systems compared with “DB” systems. About the only reforms that are ever needed revolve around the question of how much private savings should be required.

By the way, even though the information in the IMF study shows the superiority of DC plans, that’s only an implicit message.

To the extent the bureaucracy has an explicit message, it’s mostly about indexing the retirement age to changes in life expectancy.

That’s probably better than doing nothing, but there’s an unaddressed problem with that approach. It forces people to spend more years working and paying into systems, and then leaves them fewer years to collect benefits in retirement.

That idea periodically gets floated in the United States. Here’s some of what I wrote in 2011.

Think of this as the pay-for-a-steak-and-get-a-hamburger plan. Social Security already is a bad deal for workers, forcing them to pay a lot of money in exchange for relatively meager retirement benefits.

I made a related observation about this approach back in 2012.

…it focuses on the government’s finances and overlooks the implications for households. It is possible, at least on paper, to “save” Social Security by cutting benefits and raising taxes. But such “reforms” force people to pay more and get less – even though Social Security already is a very bad deal, particularly for younger workers.

The bottom line is that the implicit message should be explicit. Other nations should copy jurisdictions such as Chile, Australia, and Hong Kong by shifting to personal retirement accounts

P.S. Speaking of which, here’s the case for U.S. 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.

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Improbable Success: How Free Markets Created the Chilean Miracle

I shared yesterday a remarkable TV show about Estonia’s entrepreneurial miracle.

Today, let’s look at the Chilean version in the series. It shows how the South American nation, which now is ranked very high for economic freedom, is a shining example of how small government and free markets are a recipe for good results.

I don’t follow Chile as closely as Estonia, so instead of five good and bad policy developments (or lack thereof) in the nation, we’ll focus on three favorable items and one unfortunate feature.

Here are the three most positive policy lessons from Chile

First, Chile is the world champion for personal retirement accounts. It shifted from a failed pay-as-you-go tax-and-transfer to a funded system of personal accounts. Workers were given the opportunity to stay in the old system, but more than 95 percent realized it was better to have private savings rather than empty promised from politicians.

Second, Chile’s shift to free trade and away from protectionism has been enormously beneficial for the economy. Openness has produced big benefits for consumers, and also created big markets for exports.

Third, Chile shows the value of monetary stability. If you look at the big increase in the country’s economic freedom since 1975 and break it down by the major sub-categories, there have been impressive improvements in fiscal policy, regulatory policy, trade policy, and rule of law/property rights. But the biggest jump was for monetary policy. The nation went from hyperinflation and instability to a more sensible monetary regime.

Here’s the one thing that worry me about Chile.

Chile has enjoyed reasonably stable and practical leaders since suffering the chaos and brutality of Marxist and military governments in the 1970s and 1980s. Even left-leaning governments have been reasonable, recognizing that it would be a mistake to undermine the goose that has been laying golden eggs. That’s the good news. The bad news is that some recent politicians have adopted strident anti-market views. And the nation’s economic freedom score and ranking have both marginally declined in recent years.

By the way, you’ll have noticed in the above video that Peru also got some positive attention for its economic reform. It isn’t ranked nearly as high as Chile, but the progress has been enormous. Particularly when you consider how other nations in the region such as Venezuela are total basket cases of statism.

P.S. Chile also has one of the world’s best school choice systems, though it also has come under pressure from recent left-leaning politicians.

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Demographics, Insufficient Reform, and the Grim Outlook for Eastern Europe

Changing demographics is one of the most powerful arguments for genuine entitlement reform.

When programs such as Social Security and Medicare (and equivalent systems in other nations) were first created, there were lots of young people and comparatively few old people.

And so long as a “population pyramid” was the norm, reasonably sized welfare states were sustainable (though still not desirable because of the impact on labor supply, savings rates, tax policy, etc).

In most parts of the world, however, demographic profiles have changed. Because of longer life expectancy and falling birth rates, population pyramids are turning into population cylinders.

This is one of the reasons why there is a fiscal crisis in Southern European nations such as Greece. And there’s little reason for optimism since the budgetary outlook will get worse in those countries as their versions of baby-boom generations move into full retirement.

But while Southern Europe already has been hit, and while the long-run challenge in Northern European nations such as France has received a lot of attention, there’s been inadequate focus on the problem in Eastern Europe.

The fact that there’s a major problem surprises some people. After all, isn’t the welfare state smaller in these countries? Haven’t many of them adopted pro-growth reforms such as the flat tax? Isn’t Eastern Europe a success story considering that the region was enslaved by communism for many decades?

To some degree, the answer to those questions is yes. But there are two big challenges for the region.

First, while the fiscal burden of government may not be as high in some Eastern European countries as it is elsewhere on the continent (damning with faint praise), those nations tend to rank lower for other factors that determine overall economic freedom, such as regulation and the rule of law.

Looking at the most-recent edition of Economic Freedom of the World, there are nine Western European nations among the top 30 countries: Switzerland (#4), Ireland (#8), United Kingdom (#10), Finland (#19), Denmark (#22), Luxembourg (#27), Norway (#27), Germany (#29), and the Netherlands (#30).

For Eastern Europe, by contrast, the only representatives are Romania (#17), Lithuania (#19), and Estonia (#22).

Second, Eastern Europe has a giant demographic challenge.

Here’s what was recently reported by the Financial Times.

Eastern Europe’s population is shrinking like no other regional population in modern history. …a population drop throughout a whole region and over decades has never been observed in the world since the 1950s with the exception of…Eastern Europe over the last 25 consecutive years.

Here’s the chart that accompanied the article. It shows the population change over five-year periods, starting in 1955. Eastern Europe (circled in the lower right) is suffering a population hemorrhage.

By the way, it’s not like the trend is about to change.

If you look at global fertility data, these nations all rank near the bottom. And they also suffer from brain drain since a very smart person, even from fast-growing, low-tax Estonia, generally can enjoy more after-tax income by moving to an already-rich nation such as Switzerland or the United Kingdom.

So what’s the moral of the story? What lessons can be learned?

There are actually three answers, only two of which are practical.

• First, Eastern European nations can somehow boost birthrates. But nobody knows how to coerce or bribe people to have more children.
• Second, Eastern European nations can engage in more reform to improve overall economic liberty and thus boost growth rates.
• Third, Eastern European nations can copy Hong Kong and Singapore (both very near the bottom for fertility) by setting up private retirement systems.

The second option obviously is good, and presumably would reduce – and perhaps ultimately reverse – the brain drain.

But the third option is the one that’s absolutely required.

The good news is that there’s been some movement in that direction. But the bad news is that reform has taken place only in some nations, and usually only partial privatization, and in some cases (like Poland and Hungary) the reforms have been reversed.

And even if full pension reform is adopted, there’s still the harder-to-solve issue of government-run healthcare.

Eastern Europe has a very grim future.

P.S. I’m a great fan of the reforms that have been adopted in some of the nations in Eastern Europe, but none of them are small-government jurisdictions. Yes, the welfare state in Eastern European countries is generally smaller than in Western European nations, but it’s worth noting that every Eastern European nation in the OECD (Czech Republic, Estonia, Hungary, Poland, Slovakia, and Slovenia) has a larger burden of government spending than the United States.

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Demographics + Entitlements = Europe’s Doom

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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How Private Social Security Is Helping Hong Kong Deal with Major Demographic Challenges

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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Ted Cruz, Rand Paul, Payroll Taxes, and the Value-Added Tax

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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The Personal and National Case for Genuine Social Security Reform

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’s Private Social Security System Should Be Globally Emulated, not Locally Emasculated

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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The Ticking Fiscal Time Bomb of Social Security

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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The Global Private Social Security Revolution

Last month, I posted “the cartoon argument” for Social Security reform.

My main goal, as an American, is to achieve this important reform in the United States.

And I’ve tried to bolster the argument by citing lots of hard data, including the fact that “funded” accounts already exist in nations such as Australia, Chile, Sweden, and the Netherlands.

In this spirit, I wrote an article for the most recent issue of Cayman Financial Review, and I looked at the issue from a global perspective. I first explained that demographics are destiny.

It is widely believe that aging populations and falling birth rates represent one of biggest global challenges for long-term economic stability. How can a nation prosper, after all, if there are more and more old people over time and fewer and fewer workers? Don’t these demographic changes put every-growing fiscal burdens on a shrinking workforce to support the elderly, leading to crippling tax burdens and/or enormous levels of debt? In most cases, there are no good answers to those questions. So it is quite likely that many nations will face serious economic and fiscal challenge… Here are some charts showing the age profile of the world’s population in both 1990 and 2100. As you can see, demographic changes are turning population pyramids into population cylinders. …virtually every industrialized nation is undergoing demographic changes that will produce some very painful fiscal consequences.

But not all nations are in trouble.

…there are jurisdictions, such as Singapore and Hong Kong that are in reasonably good shape even though their populations rank among the nations with the lowest levels of fertility and longest life expectancies. And other nations, including Sweden, Australia, Switzerland, and the Netherlands, have much smaller long-run challenges than other industrialized countries with similar demographic profiles.

Why are these jurisdictions in stronger shape?

Simply stated, they have personal retirement accounts.

Mandatory pension savings is a key reason why some jurisdictions have mitigated a demographic death squeeze. Whether they rely on occupational pensions, individual accounts, or even central provident funds, the common characteristic is that workers automatically set aside a portion of current income so it can be invested in some sort of retirement vehicle. Over several decades, this results in the accumulation of a substantial nest egg that then is used to provide retirement income.

And there are now about 30 nations that have implemented this critical reform…though that number unfortunately is dwarfed by the number of countries that haven’t modernized their tax-and-transfer schemes.

For advocates of funded pension systems, there is good news and bad news. The good news is that there has been a dramatic increase in jurisdictions that have adopted some form of private retirement system. …the bad news is that mandatory private retirement systems still only cover a small fraction of the world’s workers. The vast majority of workers with retirement plans are compelled to participate in pay-as-you-go government schemes.

Unsurprisingly, I explain why personal retirement accounts are much better for the overall economy.

Economists have been concerned about a triple-whammy caused by traditional tax-and-transfer retirement schemes. First, payroll taxes and other levies discourage labor supply during peak working years. Second, the promise of retirement benefits undermines a very significant incentive to save. Third, the provision of retirement benefits discourages labor supply once a worker reaches retirement age. …Systems based on private savings, by contrast, have very little economic downside. Workers are compelled to save and invest some portion of their income, but all of that money will be correctly seen as deferred compensation. …Perhaps equally important, second-pillar systems boost national savings, which means more funds available to finance productive private-sector investment.

Though I bluntly admit that there will be a significant transition cost.

The…common critique of mandatory retirement savings is that…if younger workers are allowed to shift their payroll taxes into personal accounts, policy makers would need to find lots of money over several decades (trillions of dollars in the American example) to fulfill promises made to existing retirees as well as workers that are too old to get much benefit from personal accounts. This critique is completely accurate. …But here’s the catch. While trillions of dollars are needed to finance the transition to a system of personal accounts, it’s also true that trillions of dollars are needed to bail out the current system. …The real question is figuring out the best way to climb out of that hole. From a long-term fiscal and economic perspective, personal accounts are the more attractive option.

To elaborate, it’s better to somehow find $5 trillion over several decades to finance the shift to personal retirement accounts than it is to somehow find $30 trillion over a longer period of time to bail out the current system.

For more information on personal accounts, you can click here for my video on the topic.

And to learn about Obama’s supposed solution, watch (with horror) this video.

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. While I’m a very strong advocate of personal retirement accounts (my Ph.D. dissertation was about Australia’s very good system), I’ll be the first to admit that it’s even more important to modernize Medicare and Medicaid.

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