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PaperclipPerfector  7mo ago (text post)   29323 thread views

Culture War Roundup for the week of October 2, 2023

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What would privatizing Social Security look like?

”No one’s gonna take away your grandma’s pension.” - José Piñera, Minister of Labor and Social Security in Chile, right before he took away your grandma’s pension.

Privatizing Social Security has been a conservative pet issue for as long as I can remember, despite being politically unlikely and unpopular. Even Paul Ryan, who paid for his college tuition with SS survivor funds, still reminisced on halcyon days of planning with his Delta Tau Delta bros to privatize SS at keg parties. If it were possible, what would it even look like?

The Background

Social Security is a defined benefit, "pay-as you-go-system," funded by the $1 trillion Old-Age and Survivors Insurance and $142 billion Disability Insurance trust funds, paid via payroll taxes, plus a $63.78 billion Supplemental Security Income from the General fund.

Before FDR passed SS, senior citizens were the poorest demographic in America. Nowadays it’s one of the most popular programs and everyone wants to preserve it in some way.

Problem is, we’re going broke.

Since 2010, the fund that SSA uses to pay benefits to retirees has been paying out more money than it has been receiving in taxes. At the current rate, the fund's trustees estimate that it will exhaust its reserves in 2033 and be unable to pay full scheduled benefits.

What if Ayn Rand was Acting Commissioner of the Social Security Administration?

It should be said that the freest of free market solutions here still imagines coercion of mandatory contributions. Still, the position advocates switching to a privately managed, defined-contribution system, which would get a higher returns by investing in the private market instead of government securities.

Because these are personal accounts, hopefully you fix the problem where an increasingly smaller working population pays for swelling retirees. In reality, those old obligations don't disapear:

Social Security has accumulated trillions of dollars in liabilities to workers who are already retired or who will retire soon. To make room for a new private system, policymakers must find funds to pay for these liabilities while still leaving young workers enough money to deposit in new private accounts. This requires scaling back past liabilities – by cutting benefits – or increasing contributions from current workers. Most large-scale privatization plans also involve major new federal borrowing.

Given that this transition would be pretty expensive and the main benefit is getting to invest in the private market, the counter is: why not just let the government invest in the private market? Such a case is made here.

More Consumer Choice?

A privatized system should give individuals more control over their investment decisions. It’s hard to weigh that benefit against the risk of dumb people ending up with less retirement savings than they get under the current system.

Would Management Costs be Lower?

Surprisingly hard to figure out! SS obviously has no marketing costs and boasts astoundingly low administrative costs of >1%. However, some admin work is outsourced, ie employers and the IRS collect the funding.

But hey, the government’s gonna keep doing all that stuff anyway; a privatized system would just have to duplicate them elsewhere, plus means testing, plus marketing costs.

Costs in proposed plans vary a lot:

In some privatization plans, contributions would be collected by a single public or semi-public agency and then invested in one or more of a limited number of investment funds…By pooling the investments of all covered workers in a small number of funds and centralizing the collection of contributions and funds management, this approach would minimize administrative costs, but it would limit workers’ investment choices.

Another strategy is to allow mutual fund companies, private banks, insurance companies, and other investment companies to compete with one another to attract workers’ contributions in hundreds or even thousands of qualified investment funds. This strategy would permit workers unparalleled freedom to invest as they chose, but administrative costs might be high.

But forget all these technical hypotheticals. The question we’re all wondering is, what does this look like in practice what would a South American military dictatorship do?

El Ladrillo

The largest scale example of a country privatizing its retirement system is under the Pinochet dictatorship in Chile. Initially their rollout was a big success with high returns. However, even Niall Ferguson, a prominent advocate for their system, notes many of the downsides I wondered about above:

There is a shadow side to the system, to be sure. The administrative and fiscal costs of the system are sometimes said to be too high. Since not everyone in the economy has a full time job, not everyone ends up participating in the system. The self employed were not obliged to contribute to Personal Retirement Accounts and the casually employed do not contribute either. That leaves a substantial portion of the population with no pension coverage at all…

On the other hand the government stands ready to make up the difference for those whose savings do not suffice to pay a minimum pension, provided they have done at least 20 years of work. And there is also a Basic Solidarity pension for those who do not qualify for this.

That public pension was in fact created by a socialist government specifically to make up for extremely low coverage under the neoliberal system. I find it pretty damning that the most extreme example of a privatized retirement system ran into all the problems its critics said it would, and handled it in the same way every public system does - through backup government funding. If we’re going to end up doing a mixed market system anyway, it might behoove us to keep our publicly managed system but give them leeway to invest privately, rather than pay a ton to transition to a privatized system then pay more later to fix the holes that left:

Chile’s system hasn’t worked as promised or expected. The creators anticipated that the average worker would save enough to earn 70% of their salary in retirement; the reality has been closer to one-third. They thought the new system would expand the number of workers with retirement funds; instead nearly 40% of Chileans have nothing to fall back on. Rather than improve the lives of Chile’s elderly, most pensioners live on less than the minimum wage...

The private system hasn’t let the government off the financial hook either. The transition period was always going to be expensive as the government footed the bill for those retiring on the public dime without receiving payroll taxes (as these contributions all headed to private accounts). But the government has also had to backstop far more of the new system’s retirees than expected. Officials thought less than 10% of wage earners would rely on public largesse for a minimum pension. Today, more than 40% need the government to step in.

A broader review of the other countries that followed suit seems similarly disapointing:

Starting in Chile in the 1980s, and then in Mexico, Peru, El Salvador, Colombia, Argentina, and Bolivia in the 1990s, countries turned to systems where contributions would be deposited directly in workers’ individual accounts...

the system has done little to stimulate voluntary savings; few workers have channeled additional resources to their accounts. Further, the market for workers’ individual accounts has been far from competitive. On the demand side, workers as consumers of financial products for retirement had difficulty comparing the various combinations of fees and investment options offered by pension fund administrators, particularly when the “product” that workers were buying (or rather, were being forced to buy) would be delivered many years from today. On the supply side, there were few private firms competing, partly because the presence of economies of scale in the administration of funds naturally led to a monopolistic market structure.

Less Radical Funding Solutions

  1. Raise Payroll Taxes - “even a modest change, such as a gradual increase of 0.3 percentage points each for employees and employers (or less than $3 per week for an average earner), could close about one-fifth of the gap.”

  2. Raise the payroll cap - The payroll tax is actually regressive, exempting incomes over $160,200. “The Congressional Budget Office estimates that subjecting earnings above $250,000 to the payroll tax in addition to those below the current taxable maximum would raise more than $1 trillion in revenues over a 10-year period”.

  3. Widen the tax base - “In 1982, 90 percent of earnings were subject to the Social Security tax, but by 2017 the share had decreased to 84 percent.” “Including employer-sponsored health insurance premiums could close over one-third of Social Security’s solvency gap; including other fringe benefits could close one-tenth.”

Minor point of contention: "The payroll tax is actually regressive, exempting incomes over $160,200."

It's only regressive if you ignore actual retirement payouts. SS payouts scale with how much you put in, and stop scaling up at, you guessed it, $160,200.

Fair point. The regressivity is broader than just the cap, generally as you get poorer people pay a larger sharer of the income for payroll, but payouts should ofc be factored in too.

The progressivity is in the payout structure.

Let's take 3 people. Follow along if you iike there's a quick calculator here. For simplicity lets assume all 3 were born on Jan 1, 1980 will retire in January of 2050 and remain single their entire lives. We'll assume they earn the same amount after adjusting for inflation for the 35 years that are relevant for calculating social security benefits.

  1. Alice earned $13,500. She contributes 6.2% of her income or $837 and her employer contributed the same this year. When she retires in 2050 at 70 she will get a benefit of $14,500 (in today's dollars) per year of retirement.
  2. Bob earned $80,000. He contributes $4960 (nearly 6x as much as Alice) and his employer matches. When he retires at 70, he'll earn a benefit of $40,200/yr (in today's dollars). So, after paying 6x as much as Ailice he gets a bit less than 3x the benefit.
  3. Charlie earns $160,000. He contributes $9,920 and his employer matches this. When he retires he gets a benefit of $55,300 yer year (in today's dollars. Despite contributing nearly 12x Alice and 2x Bob, Charlie will get a bit less than 5x Alice's benefit and 1.25x Bobs.

Alice and Bob's incomes were chosen at the bend points of the PIA calculation, incomes in between any of those three people's will be some mix of those.

Yes, social security taxes are flat, but the benefit is enormously progressive.

Alice earned $13,500. She contributes 12.4% of her income or $837

I'm afraid this math is not mathing.

You're right, I started writing with the full (employer and employee contribution) then split them and forgot to edit the percentage. She contributes 6.2% or $837 and her employer contributes another 6.2% on her behalf. The full contribution per year is 12.4% or $1,674.

Yeah, US social security is a redistribution program stealthing as a forced savings program ("and that's a good thing," many progressives/leftists might add). As if a forced savings program isn't bad enough.

Given the strongly progressive nature of SS disbursements, financially literate high-earners are far worse off than an alternate universe where they just took their social security contributions and their employer matches to go home and invest on their own, even in something vanilla like short, intermediate, or long-term treasuries depending on duration appetite and the shape of the yield curve. The difference becomes even more drastic if one throws the option of investing in equities into the mix.

Unfortunately, while "financially-literate high earners" might be able to outperform on returns, I can't see a scenario where Alice, who likely isn't terribly financially literate or prone to long-term decisionmaking (admittedly, this is generalizing heavily about the lower class, but is probably right in aggregate) doesn't get convinced to invest either in high-risk, flashy strategies (NFTs, bro! Can't go tits up!) or outright frauds (Enron, etc).

If retirees ends up destitute from mismanagement of the funds they supposedly saved on their on behalf, it's easily a sympathetic case (and large voting block) that we'll end up bailing them out anyway. I think privatizing would really need a mechanism to prevent this sort of outcome. For better or worse I could point to how the SEC defines "accredited investor" to only allow rich folks to invest in certain poorly-regulated securities. Is Alice prevented from making those sweet returns? Yes. But if high-income Charlie loses his shirt the median voter is just going to laugh, not support a bailout. It's not a good definition, but it seems to work in that context.

If the only options are index funds covering the S&P 500, msci world ex us, Russell 2000, Lehman bond, and average cost of Treasury bonds it's really hard to lose your shirt.

The government is already admistering a plan with those options. Just make the default option a target date retirement plan based on birthday and 99.9% of people will have an extremely hard time screwing it up.

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