Linda Lutton on Bush tax cut

Great Debates
281

Seems like a paradox. I’m going to give my grandson shares of a mutual fund with the reasonable expectation that its value will be much greater in 18 or 20 years, when he’s in college. It would seem that a SS investor could do even better, because SS will get extremely low admin expense and because the money will appreciate without income tax being taken out. (I may be able to avoid stae and federal income tax, but I will have to pay higher admin costs and will have a reduced seleciton of plans.)

Why isn’t an investment that’s good for little Aaron also good for a SS investor?

282

Sure, and after the fact we can tell when the stock market wend down.

However, famed mutual fund manager Peter Lynch said that he couldn’t tell when the market as a whole was high or low. He kept his fund fully invested. He focused on investing in particular industries at the right time. His outstsanding results speak for themselves.

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Everybody’s supposed to be Peter Lynch now? Your not seriously proposing this as a way to run a country’s pension plan, are you?

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Tejota: <<<As you know, but seem to keep ignoring. past performance is no gurantee of future performance.>>>

Well, if you’re looking for a guarantee, I’ll give you one: you’re guaranteed to be broke. But we have 200 years of market data to suggest that capital markets appreciate in 7 of 10 years, and tend to do so at about 10-11% interest.

<<<Then I guess you haven’t done your homework. The T-bills that the current SS surplus are put into are credited with 6-7% interest.>>>

Well, and that interest is paid for by whom, exactly? Answer: the taxpayer. Hence, the interest paid to the taxpayer is zero. It’s meaningless to suggest that the government can lend itself money and pay itself interest. Actually, since the lost investment opportunity represents opportunity costs, contributors in the aggregate are losers.

<<And, of course, you will find that SS is a poor rate of return for the rich and a good rate for the poor.>>

Well, ya gotta be careful with saying “of course:” the National Bureau of Economic Research published a study in 2000 which found that the net redistributive effect of Social Security is close to zero, and may actually be slightly regressive. Why? Poor people tend not to live as long. They have higher rates of obesity and diabetes and other health problems.

Meanwhile, the payroll tax gouges the working poor most severely, and represents either a lost opportunity to buy necessities, or a lost and desperately needed opportunity to invest in, say, a Roth IRA.

<<<The only way everyone could win is if privatization could somehow cause a growth in the total wealth of the nation. The only problem is, it can’t. (you already agreed to this in this very thread).>>>

Well, december may have agreed to it, but I never did. I believe it’s a ridiculous assertion. It’s fundamental premise is that capital markets are no more efficient at the allocation of capital to create wealth than government bureaucrats.

It’s been pretty soundly demonstrated that capital can be leveraged to create wealth. Mathematically, capital leveraged to create wealth at a 9% clip will grow the economy much faster than capital leveraged to create wealth at a 6% clip.

If it is true that efficiently allocated capital can generate wealth, and if it is also true that free capital markets generally allocate capital more efficiently than do government bureaucrats, then it follows that intelligently executed privatization will increase the total wealth of the nation, and do so faster than will a non-privatized model.

pantom: <<< In your mind you can’t even fathom something like P/E contraction.>>>

Are you kidding? I’m dollar cost averaging. I pray for P/E contraction every day. :slight_smile: They’re called “buying opportunities.”

And you might want to be careful about making assumptions about what I can and can’t fathom. You really aren’t in any position to say.

<<<I’ve got another piece of news for you: earnings can go down.

And yet another one: so can dividends. In fact, they can even stop paying them, if it comes to that.>>>

Ok. I’ve got news for you: dividends HAVE been going down for the last decade or more. Looked at alone, there’s no correlation between dividends and total return.
If a company decides to reduce or cut its dividend, then earnings go up by an exactly equivalent amount, because dividends come out of earnings.

Me, I don’t particularly care much for dividends. They create tax problems and reinvestment problems. If I’m getting a big old fat dividend, I have to wonder why it is the company doesn’t feel that the best use of surplus cash flow isn’t to reinvest in the business or to buy back stock? I’d much rather see a stock buyback than a dividend any day of the week.

Apparently, no less a figure than Warren Buffett agrees with me.

<<<Everybody’s supposed to be Peter Lynch now? Your not seriously proposing this as a way to run a country’s pension plan, are you?>>

Not at all. I don’t believe everyone is supposed to be Peter Lynch. Everyone can’t beat the market, by definition.

Rather than have everybody be “Peter Lynch,” I believe we should have everybody be “John C. Bogle,” and invest not to beat the market, but to replicate it, while minimizing costs.

If the markets increase by a rate greater than inflation + expenses, then everybody wins.

Of course, there will always be people who will tell you some venture can’t work, that it’s too risky, that it can’t be done. I don’t pay much attention to people who make such behavior a habit.

I’d much prefer to work to MITIGATE risk and downside. Not avoid all possibility of same.
That’s the biggest risk of all.

285

pantom, I’m seriously proposing that YOU are not Peter Lynch. He can’t tell in advance whether the stock market is going into a contractioon, and neither can the rst of us.

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[<<<The only way everyone could win is if privatization could somehow cause a growth in the total wealth of the nation. The only problem is, it can’t. (you already agreed to this in this very thread).>>>

Well, december may have agreed to it… **
[/QUOTE]
Actually I disagree with both parts of the assertion. In my opinion, it’s not true that private investment accounts cannot improve the total wealth. pman2’s explanation looks cogent to me.

Also, even if total wealth isn’t improved significantly, it would still be very likely that private investment accounts would produce a good return. I have tried to explain the magnitude argument and shall not repeat it.

287

pman2 replied to um, who?: *“And, of course, you will find that SS is a poor rate of return for the rich and a good rate for the poor.”

Well, ya gotta be careful with saying “of course:” the National Bureau of Economic Research published a study in 2000 which found that the net redistributive effect of Social Security is close to zero, and may actually be slightly regressive. Why? Poor people tend not to live as long. They have higher rates of obesity and diabetes and other health problems. *

That’s a little too condensed to give the whole picture, though. Here is the NBER discussion of that research, which confirms that SS is indeed highly progressive for individuals at any given time. That is, the benefits amount for a low-income worker does represent a much higher rate of return on the contributions s/he actually made than it does for many higher-income workers (the “effective progression” is 1.27).

The lifetime redistributive rate of SS, though, is nowhere near as high: that is, over the whole course of their working and retired lives, poor people do not get disproportionately more out of SS than rich people. NBER explains this conclusion as follows:

  • The cap on SS-taxed income: income beyond a certain level is exempted from the payroll tax, so lower-income workers are contributing the standard 6% on all their income while silk-hatted plutocrats like jshore :wink: who earn more than the cap, since they pay SS taxes only on part of their income, are effectively contributing at a lower rate.

  • The lower life expectancies of the poor, as pman2 points out: your individual benefit payments may be quite progressive, but if you die after receiving only a few of them, the net redistribution of wealth to you hasn’t been great.

  • Discounting income disparities between spouses. The NBER researchers lumped couples’ incomes together and divided them by two, so the low-earning spouse of a high-earning worker no longer counts as “low-income”, which reduces progressivity.

  • Analyzing potential lifetime income instead of actual lifetime income: that is, the NBER researchers said that voluntary periods of unemployment or part-time employment shouldn’t count in estimating one’s lifetime income, because they were undertaken voluntarily. So they simply figured each worker’s lifetime income as what they would have made working full-time all the time (except for periods of involuntary employment, I guess). This also reduces progressivity because it makes many workers “artificially richer”, that is, it uses the amount of money they might have made over their lifetimes in place of the money they actually did make.

I’m kind of dubious about the value of that last assumption in realistically assessing how redistributive SS is. It’s claimed that it “captures the value of leisure and home production,” which is nice, but the trouble with leisure and home production is that they tend not to make any money. Heck, if leisure and home production were to be counted the same as income-producing work, most retirees would be well off just by virtue of having retired. That doesn’t really seem useful in evaluating the income-redistributive effect of a pension plan. Moreover, it seems to me that it must systematically underestimate the overall redistributive effect to women, who are much more likely to spend significant parts of their pre-retirement years either unemployed or employed part-time in order to care for children.

So if we leave aside the two kind of theoretical assumptions that reduce the income-redistributive effect—i.e., combining couples’ incomes and using “potential” instead of actual lifetime incomes—the factors that are actually significantly reducing redistribution are the earnings cap and the life-expectancy difference. According to the report, when those two factors are taken into account, the measure of “effective progression” is still just under 1.05.

So yes, if you leave out the NBER assumptions modifying the definitions of “rich” and “poor” people, SS is still comparatively “a poor rate of return for the rich and a good rate for the poor”. The chief factor reducing that progressivity—the life expectancy difference—is not something that privatization is going to change.

288

Kimstu: …(except for periods of involuntary employment, I guess)…

Hee hee, that should of course be “involuntary unemployment”.

289

Actually, people who die early would be better off. (That is, their heirs would be.)The plan as described by the Bush people would build up a fund that belongs to the individual. If s/he dies before age 65, the fund would go to the heirs.

Of course, we haven’t seen anything like a final plan. There’s no guarantee that it would still work this way, if and when it’s ever enacted.

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Thanks for the cite. Speaking as someone who works with data, I have a problem with Kimstu’s statement (even though it’s accurate.) I think one must take the whole study or reject the whole study. One ought not simply assume that it’s partly right and partly wrong (unless there’s evidence that such is the case.)

In this case, the study is entitled, Social Security Does Not Redistribute Income. It includes the statement, “When people are properly classified, no redistribution is found.” Therefore, the 1.27, which corresponds to “individuals at any given time” is based on an improper classification (according to the study authors.)

(Personal note – I can recall giving an exhibit based on several person-weeks of highly technical work to an accountant at the holding company. He added 5% to our projection, saying, “Those people always under-estimate.”)

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december: *Actually, people who die early would be better off. (That is, their heirs would be.)The plan as described by the Bush people would build up a fund that belongs to the individual. If s/he dies before age 65, the fund would go to the heirs. *

That would be a good thing, but I think there are a couple of points you’re not taking into account:

  • The heirs (at least, spouses and children and a few other limited categories of dependant) of people who die early already get survivor benefits from SS, which are redistributive in the same way that the retirement benefits are. So a system of private accounts wouldn’t necessarily make survivors better off, unless their income from survivor benefits plus the legacy of the private fund would be more than what they’d get from survivor benefits under the existing system.

  • Shorter life expectancies don’t just mean earlier deaths in retirement, but more deaths before retirement as well. With a system of private funds, poorer people would be more likely to die before having made their full contributions, which would reduce the benefit of such a system for their survivors.

By the way, I forget who it was who asked about the rates of return on SS for individuals at different income levels, but I did find a 1996 article that says this:

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december: *I think one must take the whole study or reject the whole study. One ought not simply assume that it’s partly right and partly wrong (unless there’s evidence that such is the case.) *

Um, I don’t quite see what your beef is here. I linked to the actual discussion of the study, and went over its assumptions and results in detail. I think I made it quite clear which assumptions produced which results: i.e., if you look simply at benefit amounts, the measure of effective redistribution is in fact 1.27, whereas if you take into account differing life expectancies and the earnings cap, it drops to about 1.05, while if you “reclassify” the income levels workers in the way the NBER suggests, the system produces zero or slightly negative redistribution. If I did not make that clear, I apologize and invite readers once again to read the linked discussion itself, which I think explains the matter pretty lucidly.

But I don’t understand why you think I should have simply “taken the whole study or rejected the whole study” instead of looking at it in depth and pointing out the parts of its reasoning that seemed to me weaker than the others. You are welcome to disagree with any of the specific criticisms I made and to offer your reasons for doing so, of course. But complaining about the mere fact that I made specific criticisms of the study instead of just accepting or rejecting it as a whole? That makes no sense to me.

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december, I wasn’t using a crystal ball. The contraction is happening as I write this. The probability (not certain, but highly probable) is that it will continue because the current level of the market is very high related to its historic norms. What we’ve all been trying to do is shake you and panzer of this notion that the market is a guaranteed road to riches.
I’ll let you & kimstu continue, 'cause you two are bringing up some very interesting stuff. But let me throw this thought out: between the 401(k) and the many flavors of IRA out there we have a highly developed set of defined contribution plans for people who have the means. Why not keep SS a defined benefit plan as a backup? Seems eminently sensible to me.

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pantom: <<<What we’ve all been trying to do is shake you and panzer of this notion that the market is a guaranteed road to riches.>>>

Oh, I’m not saying that the market is a guaranteed anything–only that NOT privatizing it is a guaranteed road to failure, or at least massive increases in costs and debt over the long run.

Conversely, if you’re looking for a ‘guarantee,’ the only guarantee I can give you is that you will fail to keep up with inflation.

At least with private equities, a contributor has a good chance of getting his money back. How good? Well, your average career is 40 years long. Please point out any 40 year period you like where stocks didn’t do better than the SSA.

By the way, how are you invested, personally? Are you putting your own money where your mouth is? George Bush proposed taking about 14% of SS contributions and giving workers the option to invest it in private securities. Are you, pantom greater than or less than 14% in stocks and corporates and agencies combined?
<<<<But let me throw this thought out: between the 401(k) and the many flavors of IRA out there we have a highly developed set of defined contribution plans for people who have the means. Why not keep SS a defined benefit plan as a backup? Seems eminently sensible to me.>>>>

Well, the best reason NOT to keep SS fully a defined benefit plan is because the fundamental assumption underpinning the pay-as-you go system is that the number of workers available to support retirees will continue to expand at a relatively uniform rate.

We already know that that assumption is false.
We also know that the PAYG system is going to start cashing in it’s chips in a decade or so, and we also know that the system is not going to have any chips left to cash in in another 3 decades.

Furthermore, we also know that there are no chips to cash in. That money has been spent already. It doesn’t exist. It’s gone. The only way the coming SS deficit can be made up is by raiding taxpayer’s pockets, slashing benefits, or increasing the efficiency with which the surplus is invested while we still have a surplus.
Raiding taxpayer’s pockets will sabatoge economic growth. Slashing benefits will violate an intergenerational compact.
Only privatizing has a chance of leaving us better off than we were before.

Is there a downside? Perhaps. Is it likely? Not for investors dollar cost averaging over 40 years it isn’t.

295

pman2: Well, the best reason NOT to keep SS fully a defined benefit plan is because the fundamental assumption underpinning the pay-as-you go system is that the number of workers available to support retirees will continue to expand at a relatively uniform rate.

“Continue” to expand? Actually, as one of the articles I linked to above points out, that number has contracted over the last 40 years: “in 1960 there were more than five workers for each beneficiary; today there are 3.3 workers”. Yet SS didn’t go bankrupt in the last 40 years, despite the absence of what you consider to be the “fundamental underpinning” of a growing worker/retiree ratio.

That’s because the situation is more complex than that. What has kept the system solvent (and even running a large surplus over the past couple decades) is the combination of a number of factors, including increases in worker productivity. So it is by no means so clear as you contend that merely reducing the present worker/retiree ratio will really spell disaster for the pay-as-you-go system. These doomsday predictions—“Sure, privatization may have some drawbacks, but if we don’t hurry up and privatize we’ll all be doomed I tell you, DOOMED!!”—need to be examined very carefully.

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The number of workers did indeed expand. The ratio of workers to retirees declined.

Note that the period from 1960 to 2000 was special because women entered the workforce. The SS income almost doubled, but benefits increased only slightly, because wives and widows were already covered. That was a huge one-shot boost to SS solvency, which cannot be repeated.

Yes, the ratio of wage inflation to general inflation is a key over the long term. I have seen top Social Security acturies disagree on the projected long-term relationship of these two variables.

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p2, first off let me apologize for that “fathom” statement, as it does read like an insult to your intelligence.
Now, personally I bought a house a couple of years ago, which more or less forced me to put everything into money markets or CD’s for a while. I’m just now readjusting, and figured out last night that I’m about 20% of the way back in to equities. I’m in no rush; being in cash in a downturn is a godsend as far as making rational choices.
I thought of something you and december ought to consider, as I was trying to figure out, if the stock market’s such a great investment, why don’t I ever meet anyone who’s done wonderfully for himself over the years with the single exception of a friend of mine who stayed single all these years?
Answer: when you’re young, you don’t put much in. As you get older, you finally have the means, but this gets cut into by family responsibilities. The average duration of all the money people put away for retirement, when you think about it, is probably no more than 20 years max because so much of it is contributed later in life.
Now here’s where it gets interesting.
I found a site which gives you, for free, the total return on the market starting in 1871. You can also get inflation figures back to around 1800. The site is:
http://www.globalfindata.com
Now, the figures for the return over 40 years is as follows:

Average: slightly to the north of 9.4%
Minimum: slightly to the north of 4.5% (period ending in 1941)
Maximum: slightly to the north of 12.2% (period ending in - no surprise here - 1999!)

But only the very first bit of money that you contribute would last that 40 years, assuming you stay solvent the whole time ( a very large assumption). Over the far more realistic assumption of a 20 year average duration for the money you contribute to retirement, the figures are as follows:

Average: nearly 9.7%.
Minimum: nearly 2.4% (period ending in 1947)
Maximum: nearly 16.8% (period ending in - drum roll please - 1998.)

Notice that the best periods just recently ended, which is why I say all this agitation for putting SS money into the stock market is top-of-the-market behavior.
Notice the tremendous variability in those returns. Notice also, these figures are unadjusted for inflation, a very important caveat, because Social Security benefits, once you start receiving them, are adjusted for inflation.
I’ll do the adjustment tomorrow and tell you my results. Feel free to download the figures and do your own math.

298

panzermanpanzerman said

and

(bolding mine)

I see your misunderstanding now. When you use the term ‘Privatization’ you are reallying saying ‘Invest SS funds in the market’. These two things are completely distinct from each other. Privatization is the process of tracking worker contributions and giving them back later with interest. Investing in the market is about where SS funds are invested regardless of how we track contributions

All of the privatizion schemes so far have proposed to allow market investing, but there is no reason that SS couldn’t invest in the market even if we reject privatization.

Now, I have some concerns about whether or not investing SS funds in the market will actually result in returns that track historical trends. The demographic trends that we know will happen suggest that the market performance in the future will not be like the past, because of the change in the ratio of productive to non-productive people in the US.

But that’s neither here or there. The so-called benefits of privatization are nothing of the sort, because you could invest non privatized SS funds in exactly the same way and get exactly the same return. So far, there have been no arguments or data that show the benefits of privatization. There have only been arguments in favor of market investment.

Part of the confusion, of course, is that Bush and the SS commission are also conflating these two things. And with good reason, because while there is reason to hope that investing in the market will help SS solvency, there is no good reason to believe that privatization will be of benefit. By pretending that these two things are inseparable, Bush hopes to sell a bad idea on the merits of a different idea.

The only valid arguments for or against privatization are discussions of features unique to privatization. How we invest the funds is not one of these, and thus not a valid argument either for or against privatiztion.

tj

299

What’s with Moynahan?