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Monday, January 31, 2005

All you really need to know about Bush's plans for Social Security 

Bush will (someday) espouse a particular plan for Social Security. That plan will almost surely involve borrowing lots of money (selling government bonds) to invest in the stock market, because "the stock market pays better returns than bonds". As has been noted, this is a bizarre plan: who are the chumps buying our bonds instead of buying stocks, if stocks are such a no brainer? So the first problem is that our plan says the market offers better returns, but is full of fools willing to hand that return to the government, for free, over a period of decades.

Imagine your son, fresh out of college, came to you and said: "Dad, you've always told me to save for retirement, and I've always wanted to live it up while I'm young. My new plan is to spend 100% of my income, but simultaneously take out loans, and invest the proceeds in the stock market, which on average will return 8%. So I just need to find someone who will give a loan for less than 8%, and I'm probably set." Asks the father: "What will you do if the market crashes?" The son: "Oh, I'll default, and live off what I can find in dumpsters after I retire." The bank: "Like hell you're getting a loan for less than 8%! We could invest the money directly in the stock market. Why should we take on the risk of a shiftless, insolvent middle man?"

The reason bonds and stocks coexist, despite bonds having a lower average return or premium, is that the former are lower risk, given the government's *historical* behavior. As the risk associated with bonds increases, say, because the currency is sinking, or because the government is hinting at a future default, especially by piling up unsustainable red ink, the premium associated with bonds will increase. Likewise, the more bonds we issue, the more expensive the next bond is to sell, as we tap out demand for low risk assets and increasingly crowd out private investment. In expectation, there is no benefit to the borrow and invest scheme, unless you think your creditors are a pack of fools.

So does Bush really believe there is a free lunch that can be eaten over a period of decades, on the tab of the world's investors? Well, Bush's economic sophistication pales compared to the average housecat's, so what does his "team" think?

I suspect they think they can make out like bandits in the short run by handing over a large borrowed sum to Wall Street. They know they can't fool all the market indefinitely---they just want to fool some voters for a short time.

Re: Social Security, you need to know only a few other things.

1. Though estimates differ abit, non-partisan experts in the Social Security Administration believe the system will pay out 100% of benefits through 2042, and at least 70% thereafter. Those benefits are indexed to inflation, so 70% is still pretty good---and a lot better than zero. Small tweaks---raising the retirment age gradually, eliminating the cap on payroll income that means an executive and his secretary pay the same SS taxes, and perhaps raising taxes a bit or cutting benefits a bit---could ensure the long-run solvency of the system for many generations.

2. Privatization plans that have been examined by SSA don't provide as much expected benefit as the status quo that's supposedly in crisis.

3. Thanks to Bush's insane fiscal policies---unaffordable tax cuts on the very rich, a massive military build up and endless war in Iraq, increased pork barrel spending---and the weak recovery they have produced, the rest of the Federal Government is in far worse fiscal shape than Social Security. Anyone serious about fiscal responsibilty would tackle the budget deficit first, and be willing to consider tax increases to do it.

4. The Social Security Trust Fund is real, and full of real assets---treasury bonds. The goverment must honor those bonds in the future---both as a matter of constitutional law, and to avoid a massive financial panic. The system is not, nor will it be, "bankrupt". Even in 2042, payroll taxes as currently structured will pay 70% of benefits.

5. If you are 28, like me, you can not only expect to receive Social Security, you should be ready to take to the streets to defend it against theft.



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