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Is It Really Ownership if...?

Just to pull out a parenthetical phrase in my previous posts:

Do you really have an Ownership Society if you are taxed to create private accounts that:

1. Have very, very limited investment options?

2. You cannot touch until retirement, and when you do, you are not allowed to do anything with them except buy an annuity that would pay a fixed annual benefit?

3. Any gains in the accounts are taxed at a rate of 100%, unless you earn more on your account than the Treasury bill rate?

This last point, which goes to the issue of the "privatization tax," got me thinking about something else:

Whether you call it a "tax" or a "loan," the reduction in guaranteed benefits proportionate to the gains in the private account, up to the cost of borrowing to create the accounts, is a real feature of the Bush plan as we know it. Backers of the plan, like Donald Luskin, would prefer to call it a choice, rather than a tax or a loan -- you can choose at least a 3% gain, whether it comes from the benefit or from the private account, but you can't take the same 3% from both. That sounds perfectly reasonable (if accurate), so let's drop the "tax" concept and treat it instead as a guarantee of a ~3% gain, the more optimistic gloss that Luskin would put on it. If you give participants any investment choices at all, even the handful of index funds that make up the federal employees' Thrift Savings Plan, doesn't this create a huge problem of moral hazard? If you are protected against losses, and in effect guaranteed a 3% gain, wouldn't the logical investment strategy be to go for the riskiest investments possible? If the average stock market gain is expected to be 4.6%, the difference between my guaranteed benefit and my private account is only 1.6% -- a trivial gain. Why not swing for the fences. Give me the biotech startup mutual fund! Bring on the nanotech stocks! And what about that nice boy who called the other day from Arizona offering a once-in-a-lifetime chance to get in on the ground floor of the next Google?

Surely creating this sort of moral hazard is not real ownership, with the choices of security and risk that a real investor faces.

The other possibility is that investors are given no choices at all, compelled to invest in a "life cycle" account that follows broad market indices and shifts the balance from stocks to bonds as retirement nears, a perfectly reasonable way for ordinary investors to operate, and a popular option in 529 college savings plans. If that's the case, and you combine zero choice of investment with a forced annuitization and a guaranteed minimum benefit, then what do you have? In aggregate, something exactly like what you would achieve by simply investing some proportion of trust fund assets in equities, using a broad market index. All the downsides of that approach -- possible politicization of the fund, no feeling of individual ownership -- would remain. The only difference would be that some people would do better or worse depending on the state of the market at the point when they retired, a difference that would be magnified by being forced to buy an annuity.

Posted by Mark Schmitt on February 28, 2005 | Permalink

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Comments

I'm a simple man with simple questions.

1) Is Wall Street going to guarantee me against losses incurred which at the time of retirement would expose me to a reduction in benefits that I would not have suffered if I'd simply stayed with the "old" SS plan?

2) Will the Federal Government?

Let's cut the bullshit. When you have people losing money they will WRITE to politicians and they will GET the money. All Bush is doing is using this to give another handout to his corporate buddies.

Posted by: Liberal AND Proud | Feb 28, 2005 4:34:47 PM

Mark,

I want to suggest that your argument is almost exactly backwards. First, the "moral hazard" you identify is much more relevant if we keep the current system. If you have a guaranteed base of rock solid, safe investment, you will have a strong incentive to "shoot for the moon" by investing in higher risk/higher growth stocks. People will diversify their retirement portfolios with social security already in mind, as the core of their slow-growth/low risk investment.

Second, I don't really think this is a moral hazard, except at the margins (junk bonds, lotteries/etc). Growth portfolios are more variable, but usually have a higher expected growth rate - the risk premium is magnified. And to an extent, this is part of the beauty of the current retirement system. Investment in high risk/high growth stocks promotes economic dynamism - especially when people have the ability to chooseto invest in those stocks. When people are forced to invest in risky stocks because there is no other way they'll have an adequate retirement, the system is failing.

The social security system is an essential part of a dynamic economy. Entrepreneurs can take risks, knowing that, if all esle fails, they'll still have social security to rely on. Employees can choose to switch careers, knowing that there will always be something there. Investors can invest in "crazy" ideas, in the hope that they'll be crazy-genius rather than crazy-Enron.

That dynamism will be lost, or seriously curtailed, if a private accounts scheme passes. It really does seem crucial to me to distinguish between people choosing to accept risk and people forced to bear risk.

I, as a liberal democrat, want people to be able to choose to accept risk, if they so want. This extends far beyond the social security debate. I don't want people to be left to the vagaries of "flexploitation" in the job market, where they are forced to increase their productivity at threat of job loss, rather than in exchange for increased rewards. I don't want people to be forced to accept the risks of a health catastrophe merely because of penury. I don't want people to be forced to gamble on getting into a good college or high school. I want people to be given the option, and the choice of whether or not to take it.

Posted by: Dave M | Feb 28, 2005 6:25:04 PM

"Whether you call it a "tax" or a "loan," the reduction in guaranteed benefits proportionate to the gains in the private account, up to the cost of borrowing to create the accounts, is a real feature of the Bush plan as we know it."

I'd urge you to call it what the Bush administration calls it in press briefings:

"clawback"

The word has a certain vividness which should stick in the mind of the public.

Posted by: Petey | Mar 1, 2005 7:56:23 AM

On annuities:

I haven't seen any reflections on one aspect of the annuity program.

From the standpoint of the fund that is selling annuities, this game is all about betting how long people are going to live. When you give me your lump of A dollars, I wager that you are going to live N years, and I promise to pay you A/N per year, minus a bit for inflation, administration, and some small profit.

If you live more than N, I lose. If you live less than N, I win.

All of that is well known, familiar, no big deal.

But add in to it one further factor: complete access to medical records, including genetic screening information, as well as records of your parents' manner and age of death.

There are increasing pressures to give private insurers access to genetic information about any predispositions towards cancer, heart disease, and so on. These allow insurers to cherry-pick their insured, and adjust rates to individuals.

These people offering the annuities are going to be private insurers (we certainly wouldn't go to all this trouble to destroy SS just to have the *govt* do it).

What are the chances that the govt. will prevent them from cherry-picking their customers, and tailoring their pay-outs to *extremely* accurate predictions of when each individual will die? (Ratchet up genetic screening to 2035 levels).

Imagine when the fat, type A executive goes in with his million dollars, and is told he'll get $500,000 each year (because on the basis of his genetics and his health record to date, he will almost certainly go belly-up in two years), whereas the lean granny goes in with the same million dollar lump, and is told she'll get $25,000 dollars a year, because her mother was a centenarian?

In a big pool where everyone is assigned the same average life-expectancy, early deaths balance out long-lived hold-outs; each person gets promised a decent annual pay-out, and the company can still balance its books.

But that's not going to happen under the Bush annuity plan. That would mean acting like we are a unified citizen body where we help each other out at the end of life. I.e., it would mean being in favor of a national system that insured the financial security of the elderly. We know that Bush wants to destroy any trace of that sort of system.

Could you or someone who knows more about how annuities work please address this aspect?

Posted by: Tad Brennan | Mar 1, 2005 10:41:10 AM

Dave M hits a point that's slowly coming into focus for me - the role that Social Security plays in capitalism. By eliminating one risk - being destitute in old age - SS allows folks to take other economic risks that may produce jobs and wealth. In my view, this is essential, and I can't think of a more appropriate function for the government to serve.

Tad - I don't know much about annuities, but one crucial change that would result from elimination of traditional SS is the elimination of the intergenerational social compact we have. Here in MN a nun at the College of St. Benedicts was recently quoted saying, "The budget is a moral document." The same is true of a government program like SS. SS implies a moral commitment to provide for the economic well-being of the elderly. This goes out the window with privatization, to our detriment as a society I might add.

Posted by: Jon K | Mar 1, 2005 12:18:29 PM

Thanks, Jon.

To clarify: my point was not to say "annuity-writers are bad" or "genetic screening is bad".

Rather, my point was that talk about annuities holds out the hope that there will still be something like a safety-net, something like insurance with a pooling of risk, built into the phase-out plan. However much you have earned by retirement, you will be able to buy an annuity that will at least guarantee some stream of income, no matter how long you live.

In fact, if we factor in the ability of the insurers to segment the market down to the individual level, you might as well just keep your own money and put it into five shoe-boxes, or however many years you think you will live. There will not be any pooling of risk, even with the annuities, because insurers armed with endless medical data will be able to divide up the risk-pools with exquisite precision.

So my point is to suggest (though I'd much rather have it either confirmed or denied by knowledgeable people) that talk about annuities is making phase-out look more humane than it would be.

Posted by: Tad Brennan | Mar 1, 2005 1:34:52 PM

Tad -

I hadn't even considered the possibility of segmenting as you've described it, but as you say, it seems like a possibility if the goal is to tear down the system. And if we ever cross the threshold past which this sort of data is commonly available, it absolutely will happen.

I'm reminded of the film "Gattaca" in which this very segmentation based on genetic code is used by "society" to determine your possibilities in life. In short, it justifies discrimination.

Posted by: Jon K | Mar 1, 2005 1:49:21 PM