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Good post. But first, I think you're giving the government too much credit w/ regards to their accounting as they don't keep a true income statement. In the private sector, the income statement isn't computed on a cash-in/cash-out basis for a given period. They make an attempt to match expenses with revenue received (hence the concept of depreciation). The statement of cash flows is then used to connect the income statement with the balance sheet. It's much more sophisticated than how the govt is keeping track of it's books.

Also, one question. In the example above I agree that the system in Matt's oversimplified example would run surpluses if the accounts grew enough so that people could forgo their traditional benefits. But if the accounts performed equally to govt bonds, then there wouldn't really be a savings to the government in my understanding. It would be a wash financially, yet still a benefit since you would now have property rights over a portion of your retirement funds.

Putting numbers that work behind Matt's La-La Land example (so that cash-in and cash-out match forever) let's say that everyone starts working at 20 and retires at 55 contributing $100 a month. People then live until they are 90 receiving $100 a month, and you have a constant number of workers to retires forever (lots of fake assumptions). If everyone below 55 can suddenly put 20% of their taxes in a private account, then the govt will need to borrow $20 a month to cover the difference for each person. Now 50 years down the road if the private accounts' performance only matches that of what you got in the previous system, then people would be getting $80 from taxes from the younger generation, while getting $20 from their personal accounts. But here the govt is collecting $80 a month and paying out $80 so they won't be running any surpluses. It only improves their financial position in the sense they are on the hook for less if something were to go wrong.

Of course this is way oversimplified but does illustrate the point that the real problem is the ponzi scheme aspect where you have a smaller base of workers who need to pay an ever increasing amount to retirees who are living longer and longer. No real saving is getting done. Getting people to rely on their own savings for retirement by putting it in real assets is the only long-term solution to such a problem.

Tim,

Why do you say that 50 years later that gap will turn into a surplus? In Matt's model at that time there are no more revenues.

Make it simple. Suppose people can be in one of two states, state 1 (S1) or state 2 (S2). In S1 they pay into SS. In S2 they receive SS benefits. At any given time they are perfectly matched so in every period those paying in pay the exact amount needed for those receiving benefits. Half the population is in S1 and the other half in S2. It is a perfectly sustainable system.

Then imagine all those in their S1 are allowed to fully divert their payments to private accounts. That means there isn't a dime left to pay people in S2. So the govt borrows the money. When the S1 group moves to S2 there is no need for any borrowing but the debt is still there. There is no more money coming in.

Let's finish this hypothetical. Imagine three periods. In the first period half the population is in S1 paying 100 to those in S2, perfectly balanced. In the second period those in S1 are allowed not to pay. The group in S2 (which was S1 in the first period) is now lacking 100. So the government boorows it and pays them. The S1 group invests in private accounts. In the third and final period S1 and S2 no longer exist. Those that would have been in S2 now get the money from their own accounts and those that would have been in S1 pay into their own accounts rather than pay the S2 group. But the government still has the 100 debt. There is no surplus to pay for that.

GT: every privatization proposal I've seen diverts only a portion of payroll taxes to personal accounts. Under Cato's plan, for example, the "employee half" 6.2% of revenues goes to the personal account, but the "employer half" stays in the system to pay the benefits of current retirees (as well as survivors and disability benefits). That means that once all the retirees in the traditional system have died, that "employer half" becomes a surplus available for paying down bonds.

Now, perhaps Matt was imagining a system in which the full 12.4% payroll tax was diverted into personal accounts--which is a larger account than any of the proposals being considered in Congress. In that case, he'd be right that the proposal would worsen the government's finances. but that's just because you made the system dramatically more generous. Even under very conservative assumptions, a 12.4% personal account would offer much larger benefits than what Social Security promises. It's not surprising that a proposal that massively increases benefits would be more expensive than the status quo.

How would the 6.2% become a surplus? It's still needed to pay benefits. See my #s above. Maybe I'm missing something. If so let me know.

Peter: I'm not sure I follow how your numbers relate to the 6.2%. There are two 6.2% taxes--one paid by the employer, the other paid by the employee. Under Cato's plan, the employee portion is diverted to a personal account, while the employer portion is used to pay beneficiaries.

To use a simplified example, if all workers under 40 switch to personal accounts in 2010, by 2060 (when those workers would be 90) virtually everyone who is retired will not need to draw benefits from the traditional system since they will have personal accounts to draw from. That means that the 6.2% employer share will be more than sufficient to pay the few over-90 folks still dependent on the traditional system.

Ah, followed this link from Matt. Yes, this was not clear to me -- that you could pay comparable benefits without diverting the full measure of the tax payments. It's of course blindingly obvious when you think about it straight... the diverted payments to the "future self" appreciate, whereas the traditional system is an immediate payment so it doesn't appreciate. So a payment of X to the future self is really worth more than X, while a payment of X under this system is just worth X.



I know that's quite elementary but it had me confused so just in case anyone else is too.



This was definitely not made clear from Matt's example. but I still respect him as a thinker.

To use a simplified example, if all workers under 40 switch to personal accounts in 2010, by 2060 (when those workers would be 90) virtually everyone who is retired will not need to draw benefits from the traditional system since they will have personal accounts to draw from. That means that the 6.2% employer share will be more than sufficient to pay the few over-90 folks still dependent on the traditional system.

I agree with this. But this assumes that the 6.2% you have invested in a personal account grows to a level that allows you to forgo traditional social security. In that case, then yes, the employers share would represent a surplus to the system.

But if you are diverting your 6.2% into a personal account that earns the same as a T-Bond, when you retire the amount in the account would provide half your traditional SS check. The other half of your retirement check is going to come from the traditional system. So in Matt's example where he assumes no financing gap (which I tried to replicate above), there is no surplus.

Yes individuals would now have property rights over half of their retirement check, and yes the government is responsible for less, but they are not running surpluses. You'd still need a way to finance the debt that Matt talks about because the "surpluses" in Matt's world would have been eaten up by the first generation of retirees who essentially got a free ride.

Now, I don't think it's a valid example that Matt uses since we are dealing with all the demographic issues and since we don't have a system where "one year's payroll-tax revenues would fully finance that year's benefits each and every year until the end of time," but he is right about the debt issue if you grant him a T-Bond return on the personal accounts in his hypothetical world.

Peter,

I think you've got a point. Here's the thing: if we view things from the perspective of just one generation and assume only treasury bond returns, personal accounts are a wash-- generation 1 borrows the money it needs to open the accounts, earns exactly as much interest as the bonds cost, and can pay off the bonds with the money in the personal account. But of course, as generation 1 is retiring, you've gotta borrow the money all over again for generation 2. So in this sense, you're right--if the personal accounts don't earn any more than treasury bonds and there are no benefit cuts, there will always be bonds on the government's books, because each generation has to pre-fund its own expenses and so can't afford to pay off the debt of the previous generation.

At the same time, there will always be money in the personal accounts that offset the value of the debt. So if you view the whole system--personal account value minus bonds--personal accounts don't change the net fiscal position of the system. It's just that at any given point in time, the debt will be on the books, while the reduced Social Security obligations will be in the future.

Of course, privatization would be almost pointless if we expected personal accounts to get the same rate of return as treasury bills. Fortunately, equities have out-performed bonds for more than a century, so in the real world, personal account proposals do improve Social Security's finances by allowing higher benefits with the same tax revenue.

Tim,

As I read your posts here and at Matt's site I think I understand better what you were trying to say. But it is not exactly what you said.

You claimed that Matt was wrong, that his exposition was sloppy and that his math had a confused, handwaving nature to it. But in fact Matt was perfectly right.
Matt's model, as I showed above, leads to transition costs. In my example workers were allowed to set aside 100% of their SS payments. But the model reache trhe same result if they set aside only 50% (or any other number). If workers set aside X and their benefits are reduced by X there will alwys be a transition costs that has to be paid. There will be no surpluses because the drop in benefits is perfectly matched by the drop in revenues.

Your model is different than Matt's. You assume that workers reduce their payments by X and see their benefits cut by Y, where Y is some number bigger than X. Then you assume that the difference is made up by greater returns on the private accounts. Of course, under those assumptions, your model works.

Leave aside the issue of whether private accounts will perform well enough to cover the gap (there is a reason why you see those "past performance is no guarantee" lines). Even assuming you are correct on that this does not mean there is no transition cost. Your model has transition costs but claims to have found a way to pay for it. But that's very different than what you posted. You said there is no transition cost. Maybe you meant no net transtition costs once the greater private account returns are considered. But, again, that is not what you wrote.

In fact your model pays for the transiton cost by taxing the greater private account returns. This can be done by either directly taxing the returns, or indirectly by reducing the benefits. Economically it is exactly the same, in both cases the total return is reduced to pay for transition costs.

In the end Matt was perfectly right, there are transtion costs that have to be paid somehow. Your post could have made that clear. You were wrong to say Matt had his math wrong when in fact it was perfectly correct.

GT: I think you're about right, and arguing with y'all about it has clarified my thinking somewhat, for which I'm grateful. Check out my latest for what I think is a clearer and more accurate statement of the point I was trying to make.

Thanks!

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In fact your model pays for the transiton cost by taxing the greater private account returns. This can be done by either directly taxing the returns, or indirectly by reducing the benefits. Economically it is exactly the same, in both cases the total return is reduced to pay for transition costs.

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