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February 08, 2005
Understanding Social Security
Anderson on Political Economy, Elizabeth Anderson: February 8, 2005
Go over to the Heritage Foundation's Social Security Calculator and you can indulge your outrage at how little retirement income you will get from Social Security compared to what you would get if you invested your Social Security tax contributions in private stocks and bonds. Then you can sober up by reading Pandagon's debunking of the economic assumptions behind the calculator. (Matthew Yglesias does a similar debunking of the Cato Institute's Calculator).
I've got a different criticism of the calculator. It forgets that Social Security is a form of social insurance, not a simple retirement plan. So it's comparing apples with oranges.
This might seem puzzling. Insurance is supposed to shield us against risks, not against certainties. Against certainties, individuals should be expected to save up and provide for themselves. Retirement is a near certainty. So how can Social Security count as a form of insurance?
The answer is that Social Security isn't a simple retirement program. The purpose of Social Security is to insure against a whole battery of risks that are difficult or expensive for many people to insure on the private market, especially if they have modest means or lack financial sophistication. Some of these risks are inherent in strategies that rely exclusively on private sources for retirement (IRA's, 401(k) plans, corporate pensions, etc.). What are the risks Social Security shields us from?
Let's count them up:
1. The risk that you will outlive your retirement savings.
2. The risk that inflation will eat away at the real value of the income derived from your retirement savings.
3. The risk that your private investments will go sour.
4. The risk that your lifetime income will be too low to accumulate enough savings to avoid poverty in retirement.
5. The risk that you will lose your prospects for a decent retirement due to personal bankruptcy. (Some private retirement accounts, particularly those available to the self-employed, are not protected from bankruptcy proceedings).
6. The rapidly increasing risk that your post-retirement standard of living will plunge precipitously because your employer ran your pension plan into the ground. (Although there is an independent federal program that takes over bankrupt corporate pension funds, it offers a far lower payback than promised by these plans, making additional guaranteed sources of income more important for retirement security).
7. The risk that you will become permanently disabled during your working years, leaving you and your family without your income, and hence also without retirement income, given your inability to save up for old age. (Workers' comp only covers disability due to work-related causes, and ends upon reaching retirement age.)
8. The risk that you will die, leaving your spouse and dependents without support from your income.
Social Security protects you against all of these risks, either directly or indirectly. These protections are substantial. Considering just the last 2 risks, it's worth noting that about 1/3 of the current beneficiaries of Social Security, and 1/3 of its expenditures, go to survivors of deceased working-age contributors and to disabled workers, not to retirees.
Social Security calculators like Heritage's compare a fairly pure retirement investment against a package that combines a modest retirement supplement with ample insurance against multiple risks. They assume that nearly all of the dollars you contributed to Social Security are dedicated to retirement. This means that they assume that you aren't going to die, leaving survivors in need of support. They assume that your retirement accounts are protected from bankruptcy proceedings, and that you aren't going to go bankrupt. In assuming steady, high rates of return on your private investments, they also assume that your private investments will not go sour, either through poor investment strategies or through a general fall in the market before retirement. And they pretend that the life annuity you can buy on the market is inflation-indexed, as Social Security's is, even though their figures are unrealistic even for a non-indexed annuity.
(The Heritage Foundation claims that its calculator is for an inflation-indexed annuity. However, when I asked for data on a generic 45 year old female, it popped back a current salary of $31,592 and claimed a lifetime SS contribution nestegg of $559,111 if privately invested, yielding a $4,554 inflation-indexed lifetime monthly annuity. Go over to TotalReturnAnnuities.com, which actually has to make a living selling these things, and you get a different story. Buy a non-inflation-indexed single life annuity for $559,111 for a 67 year old Michigan female, and they'll pay her $3,618 per month for life. The more responsible and cautious Cato calculator claims to preserve insurance against most risks and presumes workers may invest only 1/2 of their SS taxes in private accounts. But its annuity estimates are also optimistic. It claims a 45 year old female earning $31,592 and investing 1/2 her SS taxes privately will retire at 67 with a nestegg of $262,142, which can buy an inflation-indexed annuity of $21,237/year or $1,770/month. TotalReturnAnnuities will offer a lifetime annuity of only $1,696/month for that lump sum--not so bad, only their annuity is not inflation-indexed.)
It's a trivial exercise to show that, if nothing goes wrong, you'll be better off never having paid for insurance than having paid for it. I could produce a calculator like Heritage's, showing how much better off you'd be if you never bought home or medical insurance, on the assumption that your home never gets destroyed and you never get sick.
A true comparison of Social Security with privatization would compare Social Security benefits with the package of retirement + multiple types of insurance that you could get on the market. The comparison would not be easy, however, because some of the types of benefit provided as a matter of course by Social Security are very hard for many workers to match in the private sector. Inflation-indexed life annuities, for example, are rare and expensive. Most disability insurance companies aren't willing to insure blue-collar workers, perhaps because of the problem of adverse selection (they are more likely to become disabled). (Maybe this is why the Heritage Foundation shrinks from advocating the privatization of the disability portion of Social Security.) Most financial institutions don't want to bother with dozens of minute payments per year into millions of low-balance accounts. Without tight regulation, they would either not offer retirement accounts to low-income workers, or charge draconian fees for administering them. (This is true for Bush's favored TSP model for partial privatization of Social Security.) A few years ago, Dean Baker (now at the Center for Economic and Policy Research) calculated the insurance value of Social Security and found that it compared favorably to what low- and medium-income workers would be able to get in the private sector, even if the Social Security Trustees are right in their gloomy predictions for Social Security a few decades from now. (High-income workers will not do as well, because of the progressivity of Social Security benefits, which are skewed toward lower-income workers to keep them above the poverty line.) Baker shows us the substantial value of Social Security as an insurance package. Check it out.
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Comments
Posted by: Perseus
Elizabeth Anderson writes:
"A true comparison of Social Security with privatization would compare Social Security benefits with the package of retirement + multiple types of insurance that you could get on the market."
So she actually does read the posts on here. I had my doubts. Now please tell us something we don't already know. Specifically, what is the problem with having a private package of retirement plus a government package of insurance to deal with the problems in the private insurance market?
Posted by: Perseus | Feb 8, 2005 5:09:19 AM
Posted by: David Velleman
Think about it for a minute, Perseus (30 seconds should do). The risks listed in the post are risks that affect the "private package of retirement", as you call it. What Bush wants to sell you is just a savings and investment account, whose value can be destroyed by the vicissitudes of the market and inflation. And he's not offering you a "government package of insurance" against those risks. Nor will any private insurer sell you one.
Posted by: David Velleman | Feb 8, 2005 6:52:49 AM
Posted by: noahpraetorius@hotmail.com
My take on SS is that it is perhaps the clearest example of efficient redistribution of income but that it is foundering on flawed fundamentals.
Its defenders refuse for political reasons to acknowledge that it has changed in its character over the years and that due to falling birthrates and lengthening life expectancy that it doesn't make sense anymore. But we have made promises that we must keep.
Posted by: noahpraetorius@hotmail.com | Feb 8, 2005 7:10:03 AM
Posted by: Jay Cline
ok, so SS has lofty goals. It still keeps going into insolvency.
why do we need a single annuity for the entire population? what is wrong with funding your own annuity, your own death and survivor insurance, your own retirement plan?
Why do we have a program that is so contrary to our basic beliefs? why do we need a socialist program (no, I am not a rabid dog here), training everyone to feed at the trough, when there are equally laissez faire ones available based on private ownership that celebrates the individual.
Ok, point for point
What are the risks Social Security shields us from?
Let's count them up:
1. The risk that you will outlive your retirement savings.
Allow for individual annuities.
Anderson says Inflation-indexed life annuities, for example, are rare and expensive. Most disability insurance companies aren't willing to insure blue-collar workers,.
Fine. Nobody said the current SS admin couldn’t provide that. Why can’t we just ‘purchase’ our own through the SS, who could act as a national clearinghouse, providing the economic muscle the same way AARP provides political muscle to millions of seniors?
2. The risk that inflation will eat away at the real value of the income derived from your retirement savings.
3. The risk that your private investments will go sour.
Right now that is ‘guaranteed’ through tax rolls. But very conservative investments, as proposed by Bush, in legitimate mutual funds do a far better job against inflation than dipping into the tax rolls. If the economy tanks so bad that even these investments go sour, well, we will have much, much bigger problems than protecting retirement plans. Even if SS had been in place before the Great Depression, you really think it would have survived? If there is no GDP, there is no tax rolls. The argument is moot.
4. The risk that your lifetime income will be too low to accumulate enough savings to avoid poverty in retirement.
um... define too low. Just how expensive do you think annuities cost?
5. The risk that you will lose your prospects for a decent retirement due to personal bankruptcy. (Some private retirement accounts, particularly those available to the self-employed, are not protected from bankruptcy proceedings).
C’mon. That’s too easy. Pass a law that says retirement plans and annuities are protected from bankruptcy proceedings.
6. The rapidly increasing risk that your post-retirement standard of living will plunge precipitously because your employer ran your pension plan into the ground. (Although there is an independent federal program that takes over bankrupt corporate pension funds, it offers a far lower payback than promised by these plans, making additional guaranteed sources of income more important for retirement security).
Another facetious argument. We’re not talking employer pension plans. Point is moot.
7. The risk that you will become permanently disabled during your working years, leaving you and your family without your income, and hence also without retirement income, given your inability to save up for old age. (Workers' comp only covers disability due to work-related causes, and ends upon reaching retirement age.)
8. The risk that you will die, leaving your spouse and dependents without support from your income.
I believe the financial tool you are talking about is Short- and long-term disability insurance.
Social Security protects you against all of these risks, either directly or indirectly.
Nothing Anderson says shows that individuals can't make their own decisions. The obstacles she raises to defend the status quo are no different than the obstacles I encounter at work by people who just don't want change. We have a phrase for people like that. Stop being part of the problem and start being part of the solution. Using Anderson’s arguments, I see no reason why we can’t privatize all of it. The risks she defines can be adequately provided privately and on an individual basis. Is there a place for government? Absolutely. The great malaise with the current system is it shuts out the very people, in the decision-making process, that it is supposed to benefit.
Posted by: Jay Cline | Feb 8, 2005 7:58:03 AM
Posted by: Will
DV states:
What Bush wants to sell you is just a savings and investment account, whose value can be destroyed by the vicissitudes of the market and inflation. And he's not offering you a "government package of insurance" against those risks.
Yes, he is. Bush is not proposing that all of SS be invested in private accounts. The majority of SS dollars would still go into the Government's "social insurance" "benefit".
Also, as noted above, the argument that a conservatively balanced portfolio of stocks and bonds is some kind of risky scheme is ludicrous (and flatly contradicted by historical returns). I'd bet my future SS benefit that Mr. Velleman, for example, has a tidy sum tied up in such securities via his 401K, mutual funds, et cetera.
Posted by: Will | Feb 8, 2005 8:47:11 AM
Posted by: bakho
And the bottom line, for all the insurance risks, SS was and is affordable and will be affordable in the future with minor adjustments. SS is a well managed program with low fees (lower than many private investment accounts) and it works to keep millions out of poverty. What is there not to like other than it is an example of a government policy that works? This annoys people who hate government and want to believe that no government program can be successful. The SS debate is politics driven by impractical ideology.
Posted by: bakho | Feb 8, 2005 9:14:24 AM
Posted by: David Andersen
"And the bottom line, for all the insurance risks, SS was and is affordable and will be affordable in the future with minor adjustments."
No, it is not. The cost-benefit for me is terrible. Social security now costs me $11,160 a year. In return for that premium over the next 32 years (undoubtably more with 'minor adjustments') I'll receive $2,062 a month when I retire at 67. The total I will have put into SS is about 420k. At 2,062 a month, it will take me 17 years to recoup that premium amount. That's certainly possible, but not statistically likely although I am very healthy. Obviously if I live longer I start to come out on the positive side, but how much longer am I likely to live beyond 84? More importantly, this analysis also completely disregards what that 420k could have earned in interest over time (hint: substantially more). Finally, when I die the principal would still exist assuming I was living off the interest (a likely scenario) and I would have an asset to pass on to family or charity (like a university, for example). Of course the idea of passing on estate wealth is apparently anathema to the leftist mindset so I'm wasting my words. The bottom line is that SS is a rip off for me and millions more like me whether you call it insurance or retirement. Can you leftists now understand why there are many of us who don't like SS? Can you understand why the idea of 'minor adjustments' (raising the payroll tax, increasing the full payout age, lowering benefits) only make the cost benefit worse? Go ahead and argue that it's in tune with 'social justice' to redistribute wealth this way, but don't try to claim SS is affordable or cost effective or financially sound. If you really think so, try starting a private business with the same business model and see how many customers you get.
PS. These numbers come directly from my annual SS statement and are expressed in today's dollars.
Posted by: David Andersen | Feb 8, 2005 9:53:09 AM
Posted by: Jay Cline
There are moments in one's life that are epiphanic, intuitively grasping a slice of reality through something simple and striking. After my early morning rebuttal on Anderson's 7 points, admittedly lengthy and clumsy (both mine and hers), I contemplated my navel on my long bus commute. I had vomited up the polemic charge of socialism without really understanding what my point was, except to say it felt right.
And then, buried in the lint, I found it, that simple yet elegant explanation to my decades-long repulsion towards Social Security.
Social Security takes our money and doles back to us what they decide is appropriate, fair, and possible. Can anyone please explain to me how this is any different than moving back in with my parents, turning over my paycheck to them and living off an allowance and their largesse?
Our Founding Fathers must be churning in their graves. After 200 years, we have replaced one Master for another.
Posted by: Jay Cline | Feb 8, 2005 10:12:53 AM
Posted by: Terrier
Jay Cline, you must hate your car insurance company! Until recently I had paid for YEARS and never received a single penny from them while they had most likely made a bundle of cash off of me. A few weeks ago, after the hood bender that totaled ny 5 year old car, the check arrived and I absolutely love them now! The damn fascists!
Posted by: Terrier | Feb 8, 2005 10:34:31 AM
Posted by: David Andersen
Terrier, please read my comment above. SS is not insurance. Leftists could start gaining some respect in this debate by stopping the comparison of SS to medical, auto, life, or home insurance. It's not the same.
Posted by: David Andersen | Feb 8, 2005 10:37:23 AM
Posted by: Jim Hu
The "debunkings" rely on excluding the employer contribution. The justification for this is that your employers wouldn't give you extra money if there was no payroll tax...of course, if you're self employed this is contributed by you.
Posted by: Jim Hu | Feb 8, 2005 10:43:32 AM
Posted by: Terrier
David Andersen, it is insurance and you are wrong.
Posted by: Terrier | Feb 8, 2005 10:57:19 AM
Posted by: Scott Schaefer
Mr Velleman:
What Bush wants to sell you is just a savings and investment account, whose value can be destroyed by the vicissitudes of the market and inflation.
The current SS system also contains a component which is just a savings and investment "account", whose value has already by destroyed by the vicissitudes of the US Congress, and whose future value is utterly dependent on same.
Nor will any private insurer sell you one.
This is true for some of the risks Ms. Anderson has enumerated today. Please state your estimation of the likelihood that it would be be true in the absence of the current SS system. I believe that dozens (hundreds?) of private insurers would have developed and be willing to sell you any number of innovative and flexible plans, tailored to your specific resources/needs.
Posted by: Scott Schaefer | Feb 8, 2005 10:58:25 AM
Posted by: Jay Cline
Terrier,
I agree with David.
Oh, I have no problems with my auto insurance carrier. They and I have an agreement, as you did with yours. A private contract, if I may use the term. Glad your long-shot paid off.
But I still dislike living off a forced largesse.
Not sure where you are going with the flippant facist remark. Do you think anyone to the right of the Democratic Party is a fascist?
Posted by: Jay Cline | Feb 8, 2005 10:59:24 AM
Posted by: Terrier
Insurance = protection against future loss
NOT
Insurance = means whatever I want it to
Jay, my corporate masters require that I refer to them as fascists; of course, I know the government is socialist. :-) Is everything you don't like socialist? I think I had some socialist pancakes the other day. Look, if it offends your delicate sensibilities work against it. Vote for those who would dismantle it but don't call it a rat just because you think that will make me want to kill it. I know what it is and you apparently don't.
Posted by: Terrier | Feb 8, 2005 11:14:56 AM
Posted by: David Andersen
Terrier,
I don't believe you understand insurance. I also don't believe you understand what a reasonable premium should be with respect to the risk. If you look at my example, I don't know how you can conclude that my SS 'premium' is a reasonable cost for the expected benefit. If what I pay into SS was substantially lower (90%?) and only paid out if I really, really needed it in old age, then it is insurance. As it stands it is a wealth redistribution system.
Posted by: David Andersen | Feb 8, 2005 11:34:10 AM
Posted by: Terrier
David Andersen, I know that if you were running an insurance company you'd need Social Security just to retire.
Posted by: Terrier | Feb 8, 2005 11:45:18 AM
Posted by: noah
I was listening to the Washington Journal on C-SPAN yesterday morning. The callers were whining that uninjured veterans were going to have to pay more in order to get VA health care benefits.
I'm sure the whining will turn into a cacophony when and if the social security reforms come up for a vote. For the life of me I can't figure out why anyone would want to be President. He is not a dictator but to hear people talk you would think he is.
Posted by: noah | Feb 8, 2005 12:05:09 PM
Posted by: David Andersen
"David Andersen, I know that if you were running an insurance company you'd need Social Security just to retire."
????
Posted by: David Andersen | Feb 8, 2005 12:16:10 PM
Posted by: Jay Cline
Terrier,
Sorry to hear you're not a free person. Liberty is a wonderful thing. There are a lot of things that I don't like that aren't socialist (homemade pancakes smothered with real maple syrup is not one of them), but I do dislike most things socialist. State control is a real bummer, man. Hope that doesn't strain your comprehension. Thanks for the electoral advice, but I already successfully exercised it.
Posted by: Jay Cline | Feb 8, 2005 12:52:15 PM
Posted by: Lisa SG
Hey, in most states you are compelled to be auto insurance in order to drive a car.
My father in law was a doctor who would often complain about people who did not have health insurance (but could afford it) and became injured. The problem is, hospitals have to treat people who come in with serious injuries regardless of whether they have the ability to pay, so those uninsured patients end up with service without having paid for it, though they could have afforded the insurance at the outset. Those who do buy insurance are the ones who subsidize these uninsured patients. My FIl did not have a solution to the health care crisis, but certainly favored everyone having health care in one way or the other.
Given the fact that we will not allow people to starve who have not adequately provided for their future, or those who become disabled, or children whose father has died, wouldn't eliminating social security simply mean that those who buy the insurance will simply end up contributing, through their taxes or somewhere else, to those who have not? Is that not a redistribution of income, as indeed it is in the above case? The problem with someone else's freedom is that it can IMPINGE upon mine. Government can rationally settle these disputes and maintain the maximum amount of freedom for all, which I think the SS system does reasonably adequately.
Or are we literally going to let people--the disabled, children, eighty-year-olds--starve in the streets?
Posted by: Lisa SG | Feb 8, 2005 1:15:34 PM
Posted by: David Andersen
"Or are we literally going to let people--the disabled, children, eighty-year-olds--starve in the streets?"
This silly strawman needs to be put to bed Lisa.
Where have you read anyone suggesting that SS reform should eliminate any safety net so that they truly needy are left to 'starve in the street?'
Furthermore, compulsory auto insurance doesn't justify anything. When I lived in such a state, my premiums were significantly more and it didn't even solve the problem it puported to solve! There are still people in these states who don't carry the insurance!
Posted by: David Andersen | Feb 8, 2005 1:27:48 PM
Posted by: Lisa SG
And what happens when an insured person is in an accident with an uninsured person (who is at fault)?
1) The insured person pays for it with their insurance, and the rates go up, requiring them to pay more for something that was not their fault, something which ultimately benefits the uninsured at the expense of the insured, which it seems to me is a form of theft;
2) The insurance company seeks money from the uninsured person through legal system, costing society as a whole lot more, or if it's not worth it, the insurance company does not even try, again benefitting the uninsured scofflaw at the expense of others.
3) There is a government vehicle (in some states) for reimbursing those in accidents with uninsured drivers. The taxpayers fund this, again benefitting the uninsured party, here at cost to society.
4) If the ininsured driver has no health insurance and is injured, he gets health care and we pay for it in our insurance premiums.
Of course, no law will insure 100% compliance. There are criminals out there. I didn't know that there existence (and immorality) made the law worthless.
(And by the way, given that people are not particularly good at saving for retirement, how do you know the cost of the social welfare net for the aged poor will not exceed the cost of SS as it is now? Who is going to pay for that, and how? What sort of program will it be--it won't be welfare, because that barely exists and exists only to get people into jobs--it doesn't exist for those who cannot work. The only program that really exists currently for those who cannot work is--surprise--SS! Which you want to eliminate or severely restructure! So I wonder about your claim that there will be no poverty at the end of life if SS is changed).
Posted by: Lisa SG | Feb 8, 2005 2:11:44 PM
Posted by: miab
David Anderson writes: "This silly strawman needs to be put to bed Lisa. Where have you read anyone suggesting that SS reform should eliminate any safety net so that they truly needy are left to 'starve in the street?' "
She didn't say that.
In fact, her entire point was premised on ". . .the fact that we will not allow people to starve who have not adequately provided for their future, or those who become disabled, or children whose father has died . . ."
Given that you agree with her on that, don't you also agree with her conclusion: ". . . wouldn't eliminating social security simply mean that those who buy the insurance will simply end up contributing, through their taxes or somewhere else, to those who have not? "
I think she's right.
Posted by: miab | Feb 8, 2005 2:12:49 PM
Posted by: Will Curtis
miab:
David's point is that Bush is not advocating "eliminating" social security. Thus, Lisa's use of a straw man.
Posted by: Will Curtis | Feb 8, 2005 2:27:49 PM