Keeping the poor poor in the 2nd District
Democrat Congressman Rick Larsen’s “town hall” on Social Security reform wasn’t much of a town hall, and it didn’t talk much about Social Security reform. Instead, it was a thoroughly partisan operation devoted solely to attacking the idea of adding personal retirement accounts to Social Security and frightening seniors into thinking that Bush is out to steal next month’s social security check. Surprising? No. Disappointing? Yes.
The room was about 90% elderly people who won’t be affected by social security reform. Everyone made lots of noises about how it was a shame there weren’t more young people there, but that raises the question of why in the world it was held at a senior center. The answer, purportedly, was that this was the only room big enough they could find that was available. Considering the vast number of elementary schools, middle schools, high schools and churches within a mile of the senior center, I find that very hard to believe.
The event started (after the Lyndon LaRoucheites finished passing out their propaganda) with a presentation by Rep. Rick Larsen about how great Social Security is, about how there’s no crisis, and about how personal retirement accounts are bad, bad, bad. I really was surprised at how shallow the presentation was–quite frankly, I expect a member of congress to think a little harder about such important issues.
I was less surprised, but still disappointed, with how dishonest and one sided the presentation was. Inconvenient facts were ignored, meaningless statistics were tossed about as if they were gospel truth, and unmistakable lies were told. Larsen insisted that, should personal accounts come into being, “every Social Security beneficiary will see benefit cuts.” This ignores the fact that no one (on the Republican side, anyway) has suggested that anything be changed for those over 55, and the fact that it would be political suicide to cut benefits currently being given out. It was a lie, pure and simple, and Larsen made no apologies for it.
Then, we went into question-and-answer time. This was equivalent to hitting one’s head against a brick wall repeatedly. To his credit, Larsen knew I was going to be there (his staff is wisely watching Sound Politics, it appears) and gave me two minutes to say my piece. Unfortunately, I was unaware of this until that point, and so was unprepared (note to self–in the future, always be prepared for that). I did ask two questions, though–why was Larsen lying to people about benefit cuts, and where exactly did he think the money to pay for benefits after 2018 was coming from? To his discredit, Larsen barely pretended to answer either question.
One of the most remarkable aspects of the event was that Larsen utterly and repeatedly refused to say anything about Social Security reform beyond the fact that personal accounts are the devil’s handiwork. Citing the fact that the President hasn’t put forth a plan yet (only partially true), Larsen refused to state a position on any of the additional reforms that Social Security needs, despite admitting that there is a problem (but no crisis! Anymore!). He’s doing this, of course, in order to be able to oppose whatever final plan the President does propose.
The most remarkable aspect, however, was how hostile the environment was, and how clear it was made that Republicans–and anyone who supported personal retirement accounts–were unwelcome. Rep. Larsen informed me during my question that the majority of those in attendance wanted to wring my neck. (If that’s true, it reflects rather poorly on Larsen’s supporters, though I’m happy to report that I didn’t have to fight anyone off afterwards.) Those who supported personal accounts were sneered at and sniped at by the incredibly vitriolic audience, and generally ignored by Larsen.
One good thing came out of the experience (aside from meeting and commiserating with the few friendly faces in the audience). I have determined the root of Democratic hostility (not just resistance–outright hostility) towards personal accounts. They do not believe the poor should have the opportunity to grow wealth. That was a constant theme throughout the meeting–”you already have access to personal accounts–they’re called 401(k)’s.” Leaving aside the fact that many of us who work at small businesses do not have easy access to such things, what about those who don’t have enough money to spare for them after paying payroll taxes?
The poor are forced to put all their retirement money into something with a dismal rate of return that cannot be passed onto their heirs. It keeps their heads above water–but it keeps them in the water. Personal accounts would help the poor to do something the Democrats cannot countenance–stop being poor.
(Cross-posted at Sound Politics.)
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February 27th, 2005 at 6:13 pm
Why do you think Social Security is such a bad deal for poor people? If anyone is getting a good deal on SS, it’s lower income Americans. Maybe the people at Larsen’s town meeting realize this.
Try this exercise: Imagine a 65 year-old earning $42000 planning to retire next year. (That $42K might not sound poor, but it’s only 80% of the median income for households headed by someone 55-65.) When he starts receiving SS next year, he’ll get $14100/year, indexed to inflation for the rest of his life. Average life expectancy at 65 (men and women combined) is 20 years. The present value of a comparable annuity (assuming 3% return over inflation) is ~$212K.
Suppose this person had a typical income profile over his life and assume that all his SS payroll tax payments went to a private account instead. What do you suppose the average rate of return would need to be to have $212K today? Don’t forget to account for the fact that about %25 of his payroll taxes went to fund disability insurance and survivor benefits.
I think the answer will surprise you — and lower income people get an even better return.
February 27th, 2005 at 6:55 pm
According to my rudimentary calculations, if you started making $20,000 at age 20 and ended making $42,000, and put just 4% of your income (less than half of payroll taxes) into something with a 6% rate of return (a bit below the historical stock market average of 7-10%), you’d come out even with SS. If the rate of return was a bit higher–say, a more historical 8%, you’d come out with $360,000. If it was 10%–certainly not unheard of–our hypothetical retiree would have just a hair under $640,000. And all this, of course, is presuming that the employer isn’t kicking anything into the pot.
This is all just some quick excel work, but it certainly fits with the fundamental truth that compound interest is very potent stuff.
February 27th, 2005 at 11:11 pm
You didn’t state an annual inflation rate. Since your example shows a present day 20 year-old earning $20K and ending up with $42K at age 65, I assume your calculation is in constant (2005) dollars. In that case, your assumption of an 8% (or even 6%) rate of return is unrealistic. 10% would be literally unheard of.
Take a look at the DJIA average rate of growth for 40-year periods ending in a given month. I have data since Oct. 1928, so there have been 436 of these periods beginning with the one that ended in Oct. 1968 and ending with the one that ended last month.
The median annual growth rate for these 436 samples varied from 2% to 8%. The median value was 6.1%; 25th and 75th percentile values were 5.2% and 6.7%. These figures do not include dividends.
I don’t have data for dividend yield over this period, but I recall the average yield to be about 2%.
My CPI data only goes back to 1952, but the average annual inflation rate since then has been 4%.
So that gives us total 40-year DJIA returns (minus inflation) of:
25th Percentile: 3.2%
Median: 4.1%
75th Percentile: 4.7%
Remember, half the time, returns were less than 4.1% above inflation.
Going back to your example, I assumed a constant annual increase in salary going from $20K at age 20 to $42K at 65. Assuming an investment rate of 4% of salary and a 4.1% investment return, our man winds up with a little under $142K at the end of his 65th year (2005 dollars) — a lot less than the $360K you hypothesized.
At age 65, our man has a 20 year life-expectancy. He could buy a guaranteed payment annuity with his $142K, but the payments would be slightly over half of his expected Social Security benefit.
Hope that’s helpful. If I was wrong about the constant dollar assumption, let me know what your rate of inflation was and I’ll run the numbers again.
February 27th, 2005 at 11:19 pm
Correction:
The median annual growth rate from those 436 samples varied from 2% to 8%.
should read:
The annual growth rate ….
It’s interesting to note that some folks only made an average 2% rate of return over 40 years of stock market investment. An outlier, to be sure, but it’s tough if it happens to your retirement savings.
February 28th, 2005 at 7:32 am
Tim, I am surprised you thought Rick Larsen was so shallow.
The individual in question is only a company hack with no individual thought.
When he ran for office the first time three years ago, he went from one senior center to another. Good political strategy.
And my mom still thinks the Bush proposal is going to hurt her retirement. Unbelievable about the negative info the Democrats pull out.
February 28th, 2005 at 11:55 am
a) You don’t need access to a 401(k) program to save for retirement — IRAs are available to all and everyone, as are simple stock accounts without funny letters and numbers attached. The poor don’t need social security privatization to gain access to these tools.
b) I look forward to your companion post on the outrage that is Rick Santorum’s equally unbalanced presentation of all that is good with Social Security Privatization.
February 28th, 2005 at 9:59 pm
Scottd–something to keep in mind here is that the SS numbers look as “good” as they do because of employer contributions. If employers contribute a portion of payroll taxes to their employees PRA’s, then those numbers will look far better.
Kevin– the point is that poor people, being poor, can’t afford to put money into IRAs. The money they can afford to save for retirement is being taken by SS. And I wasn’t attacking Larsen’s presentation for being “unbalanced,” but for being a dishonest venomous partisan event.
March 1st, 2005 at 12:37 am
Timothy: I don’t understand your point. Let’s recap:
1. I pointed out that the apparent return on investment for lower-middle income SS beneficiaries is actually pretty good. I arrived at that apparent return by comparing benefits against total contributions from employees and employers. If one only considers the employee contributions, the apparent return is even better because it looks like one gets the same benefits with only half the investment, so I don’t understand why you think employer contributions make the SS numbers look better.
2. You responded with an example showing how contributing just 4% of one’s salary into a private account would yield a nest egg that was just as valuable as the SS benefits received from a much larger contribution. You speculated that in many cases the return on this 4% contribution would be much greater than SS benefits.
3. I responded by showing that your assumptions on investment growth rates were much larger than any historical result, and showed that the 4% contribution to a private account is likely to yield a result that is just over half as valuable as our example worker’s SS benefits — and in many cases would be even less than that.
Instead of acknowledging that your example greatly overestimated likely returns on private accounts, or pointing out the error in my analysis, you just responded with some vague generality about how private accounts will be worth more if employers also put money in them.
Of course, you’re right. Put more money in and you’ll get more money out. But the question is how does your scenario stack up against Social Security? Let’s run the numbers and see:
If employers match the employee’s 4%, they would be putting a total of 8% of salary into the employee’s private account. Bear in mind that only 75% of the current 12.4% payroll deduction goes to funding the old-age pension program in SS (ie, 9.3% of salary — the rest funds survivor and disability benefits), so putting 8% of salary into private accounts just about eliminates the regular SS old-age pension program. It might be worth it if the low income-employee in our private account example gets a better rate of return — but it turns out that in many cases they don’t.
In my example, I showed that investing 4% of salary exclusively in stocks would give a median result that was slightly over half the scheduled SS benefit. Doubling that contribution would make the median result just slightly over the SS benefit. For half the investors, the private account would be less. The results get worse when you understand that few investment advisors would suggest investing one’s entire retirement in stocks alone. A mixture of stocks and bonds gives a more reliable outcome, but the median yield is lower.
So, to wrap it up, it would seem that replacing the current SS system with private accounts would give us a system where the expected value for lower income workers is roughly the same as the current system. For half the workers, the return will be better — but for the other half, it will be worse.
There is no bonanza of much better returns for all — instead we replace a system that currently provides a solid retirement foundation with a riskier system where lower income workers might do better, but they are just as likely to do worse — especially if they have a few bad years of reduced income in their 45-year career. What good is that?
March 2nd, 2005 at 10:26 am
Scottd,
I like your comments, they’re well thought out and more insightful than some of the knee-jerk opposition to the privatization of social security.
It doesn’t seem to me that there’s really much point in quibbling with your numbers. Whethert the rate of return on private accounts are a lot better or about the same for poor people, private accounts do something important that social security as it is now conceived can never do: make it unnecessary to depend on the next generation to fund the benefits of the current generation.
I’ve got my own thoughts on social security reform and where it needs to go, but I’ll make those when I’m not exhausted from a long night at work.
March 2nd, 2005 at 10:52 am
Nathan,
You say:
“private accounts do something important that social security as it is now conceived can never do: make it unnecessary to depend on the next generation to fund the benefits of the current generation.”
Retired persons who can’t work will always primarily depend on the productivity of the current generation of workers and capital for their retirement payments. Ownership of stocks and bonds by retirees are simply legal claims on the cashflows resulting from productivity of the underlying enterprises. Similarly when the government taxes those workers and enterprises to pay retirees they are taking part of those cashflows. Indeed, it can be argued that taxation does not distort economic decisionmaking as much as a large infusion of cash into the capital markets to fund retirement payments, artificially inflating stock prices. In any case, there is no free lunch. Retirees will depend on the productivity of the next generation of workers.
It might be beneficial to boost the societal savings rate. But the private accounts don’t do this. Since we are not reducing current consumption expenditures but are borrowing to fund those private accounts there will be no net savings gain. The GOP has been pushing a free lunch borrow and spend society for some time now.
Also the rates of return usually quoted for stocks and bonds, do not include transactions costs. These can reduce returns by as much as 1 to 2%, as in Chile and Great Britain with their private pension accounts.
March 2nd, 2005 at 6:15 pm
Chew, that doesn’t make any sense. All wealth accumulated by PRA’s will be done while someone is still working–they’ll be depending on their own generation’s productivity, not their childrens’. I’m also baffled by the idea that putting more money into the stock market is somehow a bad thing.
Additionally, we won’t be borrowing to fund the savings accounts. We’ll be borrowing to pay the social security benefits that would have been paid down by the money going, instead, into the savings accounts. So that’s not exactly “artificial.”
Last, obviously transaction costs need to be looked at, and kept to a reasonable level. But that’s true in the private market too, and that hasn’t stopped the AARP from suggesting that people invest.
March 2nd, 2005 at 10:41 pm
Tim,
You buy a stock now to save for retirement, but you don’t cash out or realize any of your value until you retire 40 years in the future. At that time the value of your stock is based on the current productivity and cashflows generated by its workers and capital. You have a claim on their productivity. If they are not productive your investment is worth less. That is why you are dependent on the next generation’s productivity. Note that it would be no different in principal if the government simply taxed those corporations and workers to pay for your retirement when you retire. The government would simply be claiming a part of that generation’s productivity.
Re: Economic distortion:
Almost all initial private pension investment will go into large cap stocks like microsoft etc. So you are simply pouring more money into the same number of shares, increasing the share price, but not increasing any of the underlying productivity of microsoft. Remember, microsoft doesn’t get any of this money, it goes to its shareholders (although it will reduce it’s cost of capital). So you create a little investment bubble.
Eventually, the shareholders spend or invest their little bubble, but there is no guarantee this will lead to higher productivity or greater productive investment. Indeed, if we assume capital markets are efficient (the common economic assumption), then any investment projects chosen by this new investment will have a lower rate of return than those currently undertaken, because the better investment projects have already been invested in by the Corporations.
Borrowing:
You are playing dishonest word games by claiming we are not borrowing to pay for the private accounts. The only reason you have to borrow to pay social security benefits is because you have diverted the tax dollars that would have paid for those benefits to fund the private accounts. If you hadn’t created those private accounts, you wouldn’t have to borrow. In any case, regardless of why you borrowed, the fact that you did means you are not increasing net savings. If you wanted to increase net savings then you would have to raise taxes to fund the private accounts. But the GOP is a free lunch borrow and spend party.
Moreover, one should deduct the 2-3% cost of borrowing from the private accounts projected rate of return, since we have to borrow those funds to invest in the first place.
For me the transactions costs are a big issue. In Chile, these were very high because investment firms marketed their investments and tacked on large sales and management fees which reduced the rates of return tremendously. Note that if these were public pensions, the management fees would have been much less and there would have been no sales and marketing fees.
BTW, The claim that the trust fund is in dire stratits is based on fake economic assumptions by the same people who brought you Sadaam’s weapons of mass destruction.
March 3rd, 2005 at 8:33 am
Alan Greenspan believed there were weapons of mass destruction?! I had no idea.
March 3rd, 2005 at 9:58 am
“Alan Greenspan believed there were weapons of mass destruction?! I had no idea.”
I thought you knew that already!!!
March 3rd, 2005 at 10:18 am
Alan Greenspan is the guy who “fixed” Social Security the last time!
In the early 1980s, he put together the plan to raise payroll taxes (mainly hitting lower and middle class taxpayers), so SS could build up a trust fund surplus that would fund Baby Boomer benefits. Now that most of the money’s been collected, he wants us to think the trust fund bonds are not available to pay those benefits, so we should accept benefit cuts.
The man has no credibility on this subject.
March 3rd, 2005 at 2:19 pm
President Bush is not asking anyone to accept “benefit cuts”. Alan Greenspan understands the economy far better than any of us, I don’t see anything wrong with disagreeing with him but one should think twice before criticizing his ability.
Chew, I agree with you on two points but disagree with you on an important third one.
I agree, “old folks” will always be dependent directly on the “young folks”. Even with Private Retirement Accounts (PRAs), there will be a dependence on the earnings and financial productivity of the current working generation. In addition, old folks can’t police streets, can’t repair highways, can’t rivet airplanes. So it is silly to think that PRAs will eliminate that dependence, financially or otherwise.
Second, I agree that we would be in effect borrowing to pay for the institution of PRAs. This is kind of a technicality; the borrowed money is replacing the money used to jump-start PRAs. So while Tim is right that we are not directly borrowing to pay for PRAs, we are borrowing to allow normal SS payments while the program is started. I don’t think Tim was being dishonest, but I do think it is better to admit that PRAs will require borrowing, there is no way around it. I may be GOP, but I recognize there is no free lunch involved here, there simply is no “free” plan.
I have to disagree with what seems to be your underlying premise, though I do it as someone who has a very poor understanding of economics. So I admit that outright.
Nonetheless, I take issue with the concept that we cannot “create wealth”, that instead we are stuck with what we have and all we can do is choose how it is divided. I believe the influx of capital will trigger more than just “artificial growth”; over time it will allow increased investment, and it will allow new companies to go public, thus potentially increasing productivity. There will always be poor people and rich people, but that doesn’t mean we can’t move them both up a bit so that most people enjoy a higher standard of living than those generations before them. If the concept of an “efficient” capital market insinuates a permanent lack of actual growth, than I’m not sure if that is the best model to use.
I realize that this is a bitter, partisan “all or nothing” argument and that you likely won’t agree with me even if you wanted to, but I dislike the pessimism that is underlying the concept of limited wealth, although the definition of wealth can be very loose which could certainly allow ample room for disagreement.
I appreciate all of you guy’s comments, this has really got me thinking over this debate and it is good to hear the “other side” put forth well thought-out arguments.
March 3rd, 2005 at 4:44 pm
Ryan,
Thanks for your comments.
I agree that savings and investment can create wealth when invested and used wisely. We invest in new technologies and capital. We invest in education (human capital). But the benefits of this are not limitless, which is sometimes what economic snake oil salesman imply: The more money you pour into the stock market the richer you will become. The real economy doesn’t work that way. When the capital markets are in equilibrium and efficient, there are diminishing returns to investment.
We depend on efficient capital markets to allocate business investment wisely. Sometimes those markets get out of whack, like the dot com bubble which saw a huge rise then collapse in stock prices. When they get out of whack, bad investments can result like all the failed investments during the dot com bubble. In retrospect these were stupid investments that didn’t create any wealth.
And as I pointed out the benefits of additional investment are also negatively counterbalanced by the additional burdens imposed on the economy by the borrowing to finance those investments.
I think most economists (but not me necessarily) believe that we could benefit from additiona societal savings and investment. But you don’t achieve this by borrowing to fund the private accounts which is what the GOP is proposing. You achieve this by reducing consumption, then investing, but the GOP isn’t willing to reduce spending or raise taxes to fund the accounts, because that would hurt too much. So they are borrowing.
One other thing which hasn’t been mentioned is that stock investments are much more risky (that is they fluctuate in value) than the social security system which is backed by government bonds (the safest investment) and the taxing power of the government.
BTW I think Greenspan is a conservative political hack and not much of an economist now, if he ever was. But that is a subject for another post.
June 7th, 2005 at 10:31 pm
[…] e, and he is challenging Rick Larsen for the 2nd District House seat. I’ve had my own run-in with Larsen, so it gives me great pleasure to say that Roulstone is a fantastic candidate, t […]