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Posts Tagged ‘Social Security’

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 from 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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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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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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Since it is the single-largest government program, not only in the United States but also the entire world, it’s remarkable that Social Security isn’t getting much attention from fiscal policy wonks.

Sure, Obamacare is a more newsworthy issue because of the repeal/replace fight. And yes, it’s true that Medicare and Medicaid are growing faster and eventually will consume a larger share of the economy.

But those aren’t reasons to turn a blind eye toward a program that will soon have an annual budget of $1 trillion. Especially since the tax-and-spend crowd in Washington is actually arguing that the program should be expanded. I’m not kidding.

If nothing else, the just-released Trustees Report from the Social Security Administration demands attention. As I do every year, I immediately looked at Table VI.G9, which shows the annual inflation-adjusted budgetary impact of the program.

Here’s a chart showing how the program has grown since 1970 and what is expected in the future. Remember, these are inflation-adjusted numbers, so the sharp increase in outlays over the next several decades starkly illustrates that Social Security will be grabbing ever-larger amounts of money from the economy’s productive sector.

It’s also worth noting that the program already is in the red. Social Security outlays began to exceed revenues back in 2010.

And the numbers will get more out of balance over time.

By the way, some people say that the program is in decent shape since the “Trust Fund” isn’t projected to run out of money until 2034. That’s technically true, but utterly meaningless since it is nothing but a pile of IOUs.

You don’t have to believe me. A few years ago, I quoted this passage from one of Bill Clinton’s budgets.

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.

Amen.

This is why annual cash flow into and out of the program is what matters, at least if we care about the Social Security’s economic impact.

And for those who want to know about the gap between the inflow and outflow, here’s a chart showing how deficits are going to explode in coming decades. Again, keep in mind these are inflation-adjusted numbers.

That’s not a typo in the chart. The total shortfall between now and 2095 is a staggering $44.2 trillion. Yes, trillion.

Remarkably, there’s an even bigger long-run problem with Medicare and Medicaid. Which helps to explain I relentlessly push for genuine entitlement reform.

But let’s focus today on Social Security. The answer to this looming fiscal nightmare is to copy one of the many nations that have shifted to “funded” retirement systems based on real savings. I’m a big fan of the Australian approach. Chile also has a great system, and Switzerland and the Netherlands are good role models as well. Hong Kong and Singapore also rely on private savings for retirement, and both jurisdictions demonstrate that aging populations and falling birthrates aren’t necessarily a fiscal death sentence. Heck, even the Faroe Islands and Sweden have jumped on the bandwagon of private 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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There’s a lot to admire about Switzerland, particularly compared to its profligate neighbors.

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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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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I sometimes feel like a broken record about entitlement programs. How many times, after all, can I point out that America is on a path to become a decrepit European-style welfare state because of a combination of demographic changes and poorly designed entitlement programs?

But I can’t help myself. I feel like I’m watching a surreal version of Titanic where the captain and crew know in advance that the ship will hit the iceberg, yet they’re still allowing passengers to board and still planning the same route. And in this dystopian version of the movie, the tickets actually warn the passengers that tragedy will strike, but most of them don’t bother to read the fine print because they are distracted by the promise of fancy buffets and free drinks.

We now have the book version of this grim movie. It’s called The 2017 Long-Term Budget Outlook and it was just released today by the Congressional Budget Office.

If you’re a fiscal policy wonk, it’s an exciting publication. If you’re a normal human being, it’s a turgid collection of depressing data.

But maybe, just maybe, the data is so depressing that both the electorate and politicians will wake up and realize something needs to change.

I’ve selected six charts and images from the new CBO report, all of which highlight America’s grim fiscal future.

The first chart simply shows where we are right now and where we will be in 30 years if policy is left on autopilot. The most important takeaway is that the burden of government spending is going to increase significantly.

Interestingly, even CBO openly acknowledges that rising levels of red ink are caused solely by the fact that spending is projected to increase faster than revenue.

And it’s also worth noting that revenues are going up, even without any additional tax increases.

The bottom part of this chart shows that revenues from the income tax will climb by about 2 percent of GDP. In other words, more than 100 percent of our long-run fiscal mess is due to higher levels of government spending. So it’s absurd to think the solution should involve higher taxes.

This next image digs into the details. We can see that the spending burden is rising because of Social Security and the health entitlements. By the way, the top middle column on “other noninterest spending” shows one thing that is real, which is that defense spending has fallen as a share of GDP since the mid-1960s, and one thing that may not be real, which is that politicians somehow will limit domestic discretionary spending over the next three decades.

This bottom left part of the image also gives the details on built-in growth in revenues from the income tax, further underscoring that we don’t have a problem of inadequate revenue.

Here’s a chart that shows that our main problem is Medicare, Medicaid, and Obamacare.

Last but not least, here’s a graphic that shows the amount of fiscal policy changes that would be needed to either reduce or stabilize government debt.

I think that’s the wrong goal, and that instead the focus should be on reducing or stabilizing the burden of government spending, but I’m sharing this chart because it shows that spending would have to be lowered by 3.1 percent of GDP to put the nation on a good fiscal path.

Some folks think that might be impossible, but I’ll simply point out that the five-year de facto spending freeze that we achieved from 2009-2014 actually reduced the burden of government spending by a greater amount. In other words, the payoff from genuine spending restraint is enormous.

The bottom line is very simple.

We need to invoke my Golden Rule so that government grows slower than the private sector. In the long run, that will require genuine entitlement reform.

Or we can let America become Greece.

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