Tuesday, January 26, 2016

When Parents Are Determined to Cheat Their Kids

by Neil H. Buchanan

Frequent readers of Dorf on Law will not be surprised to learn that I am working on a series of articles about the past, present, and future of Social Security.  Tomorrow, I will be presenting a draft of the first of those papers, entitled Social Security Is Fair to All Generations, at SMU's Dedman School of Law.  I will soon be posting a draft of that paper to SSRN.  When I do, I will surely write a Dorf on Law post to describe that article in more detail than I will provide here.  For now, I want to discuss one argument that I recently added to the paper.  I do so mostly as a way of thinking out loud, and in particular to see whether the argument deserves more than a side comment in a footnote.  I suspect that it does, but I can be convinced either way.

The big empirical question that I address in the paper is whether the Baby Boom generation "saved" for its own retirement.  In particular, the Social Security system is often disparaged for not actually saving anything, whereas many people wrongly think that individual deposit accounts are saved in some more meaningful way.  As I noted in a Dorf on Law post last August, however, deposit accounts are not really saved, either.  That is, the money does not sit in vaults but is immediately recycled by financial firms into loans that are then spent nearly immediately.  There is nothing in those private accounts, other than promises.

In that sense, Social Security's Trust Fund does not deserve to be mocked any more than a stock portfolio or a plain-vanilla savings account does.  They are all accounting fictions, representing obligations that are callable in various ways in the future.  What the trust fund does represent is decades of excess payments of taxes by Baby Boomers, who were forced by the 1983 Social Security act to pay trillions more in taxes than were needed to cover the system's benefits during the following three or four decades.

What happened to that extra money?  Using the most mainstream theory of macroeconomics available, I argue that the excess taxes increased national saving, which is the sum of private saving and government saving -- or, in most years, the difference between private saving and government borrowing.  With the government taking in more money than it otherwise would have in the absence of Social Security's surpluses, it can borrow less, leaving more money to be invested by private firms.  Readers who remember sitting through Econ 102 might recall that this is an application of the concept of "crowding out."

The standard cynical retort is that the Trust Fund was not saved because the government borrowed more money in the rest of its budget.  That, however, misses the point, because what we care about is whether the government borrowed less than it otherwise would have because of Social Security's surpluses.  If the government was otherwise going to borrow $400 billion, but a $100 billion Social Security surplus allows the government to borrow only $300 billion, that is $100 billion more in private investment that Social Security's surplus brought into existence.  It was "saved" in the sense that it added to the economy's productive capacity.

A more sophisticated cynical retort is that the Social Security surplus was spent not in the sense that the government did not put the money into a savings account, but instead that it was spent by politicians who increased the government's other borrowing in the knowledge that there would be a Social Security surplus.  Continuing the example above, this would mean that the government would have only borrowed $300 billion even without Social Security's extra money, and the availability of the extra $100 billion allowed an imprudent Congress to finance supposedly wasteful government consumption spending that benefited people during that year.  If so, it would be wrong for Baby Boomers then to say that they sacrificed and thus can draw down the Trust Fund during their retirements.

In this post, I will not recite the reasons why I argue that that more sophisticated cynical retort is empirically implausible.  But what if my empirical assessment were wrong?  That would mean that the Baby Boomers (at least, as imperfectly represented by Congress) used the Social Security system to hoodwink their children and grandchildren.  Members of Congress would apparently have said something (off the record) like this: "I think that $300 billion is as much as we should borrow this year, but we can get an extra $100 billion in fun money for us to spend like drunken sailors, simply by pretending to build up the Trust Fund."

The result of such thinking, even if it were true, is actually not as pernicious as it might sound, because it would simply mean that Congress set up a transfer scheme within the Baby Boom generation, using current taxes to fund current spending.  Still, it would be pertinent to the question of equity across generations, because it would mean that Congress has already spent the Trust Fund, and everything from this point forward is a matter of reducing future living standards for post-Boomers.

The usual conservative-versus-liberal debate regarding Social Security centers on the preferred mechanism for financing retirement.  Conservatives prefer individual accounts, liberals prefer pay-as-you-go financing.  As I argued above, the supposed difference between those two choices evaporates under scrutiny, at least as a macroeconomic matter.  There are other reasons why conservatives might still prefer private accounts, but they are simply wrong if they believe that their preferred financing mechanism is more real than the alternative.

Now, finally, I can describe the argument that I recently added to the paper. Suppose that the Baby Boom-era Congresses really did want to find a surreptitious way to use the nation's retirement system to finance wasteful consumption spending, to the detriment of future generations.  Suppose counterfactually also that, long ago, we had adopted a system of private accounts rather than Social Security, and that those private accounts in the year in question were also going to grow by a net $100 billion, just as in my example above.  Is the presumptively-selfish Congress stymied, simply because the $100 billion is in private accounts rather than in the Social Security Trust Fund?

Definitely not.  The Congress in my example above settled on $300 billion as the maximum net amount that it could borrow because, under the standard story, the amount of private savings in that year could not finance any more government borrowing, while still leaving enough money to be borrowed and invested by private firms.  Imagine that the amount of total private saving was going to be $1 trillion in that year.  Congress would then have said, "We need to leave $700 billion in private saving, which means that we can borrow no more than $300 billion."  If there were private accounts rather than Social Security, however, the total pool of private saving would be $100 billion higher, or $1.1 trillion.  Congress could then borrow $400 billion, still leaving $700 billion to the private sector.

Is this realistic, as a matter of how Congress was probably thinking?  Of course not.  One need not, however, believe that any member of Congress would actually think about the problem in that way, either in the real-world situation where Social Security is running a $100 billion surplus, or in the counterfactual world where private retirement accounts are growing by $100 billion in the same year.  Yet we do know that Congress does seem to respond to projections about the deficit and the debt, in part by looking at what macroeconomists at CBO and elsewhere say.  And the fundamental question in all such analyses is whether the pool of private savings is large enough to finance the projected deficit.  That is, among other things, why so many economists worry about low personal savings rates.

Part of the story might have to do with how the mainstream press reports the government's deficit.  There has been much tussling over the years about whether the "on-budget" deficit (which excludes Social Security's surplus) should be reported instead of the "consolidated" deficit, which measures the net effect of all government financing.  One could argue that, if Congress were only told about the consolidated deficit, that lower number could have lulled even relatively responsible members of Congress into thinking that the government was not spending as much as it was.

Yet if we imagine that Congress is actually not very savvy about accounting, then it becomes more difficult to argue that those same members of Congress are looking at the lower consolidated deficit number and deliberately increasing spending in response.  After all, there is no reason to imagine that anyone in Congress was saying, "Man, I really wanted to run a $400 billion deficit this year."  Without any baseline to which they would be drawn, it means nothing if the Social Security system's surpluses change the reported deficit number.

Similarly, in the counterfactual world without Social Security, there is no reason to think that members of Congress would have some presumptive belief that $300 billion or $400 billion is the right number.  In short, if we drop the idea that Congress is being strategic, then we have to drop that idea under either scenario.  If we assume that Congress is savvy and cunning, however, then we have to assume that to be true under both scenarios.  And if Congress were truly determined to spend an extra $100 billion in a given year, it would not matter how the retirement system was set up.

Fortunately, as I noted above, the evidence does not support that hyper-cynical view at all.  That story, however, will have to await another day.


Michael C. Dorf said...

I vote for more than a footnote!

David Ricardo said...

I look forward to Mr. Buchanan’s forthcoming paper as this is a topic that needs all the analysis and more importantly all the clarification it can get and hopefully he will post a non-protected link when it is available. But his current post raises the issue of monetary concepts of savings vs real concepts and the question of whether or not current generations can encumber future generations.

First of all the ‘crowding out’ occurs only when an economy is at full employment. If the economy is at less than full employment an increase in government borrowing/spending which consumes more resources does not crowd out anything since it is simply causing idle resources to be employed in the production of goods and services. The massive borrowing in the early years of the Obama administration didn’t crowd out anything.

Secondly, looking specifically at Social Security it is easy to see that a Social Security program can cause a current inter-generational shift in income which has no effect on total income by taxing current wage earners and distributing those funds to retired wage earners. Of course as the years go by those younger generations become older generations and in the macro sense they recover the lost income from the new younger generation. And by fixing this scheme by statute the process can be perpetuated. Whether or not this is ‘fair’ is in the eye of the beholder. But it should be noted that if the multiplier effect of an inter-generational transfer of income is positive then the increase in consumption and the resulting increase in investment to service that consumption my create higher economic growth than would otherwise occur, thus benefiting future generations.

Third, it is possible for the current generation to encumber a future generation, but not by creating debt which is held internally. This can be done by

1. Creating externally held debt which will burden future generations by creating a claim on national income by foreign nationals.

2. Consuming resources without replacing them, thus making those resources unavailable for future generations. The U. S. and other countries are currently doing this for example with non-renewable energy sources.

3. Polluting the environment thus shifting clean-up costs to future generations who when they incur those costs will be devoting resources to the clean up or suffering the destruction (climate change). True fairness requires current generations to suffer lower standards of living by paying the full costs of pollution, but that of course runs counter to the massive greed of the current generation. (Yeah, we talking about you Koch brothers)

But the idea that Social Security is ‘unfair’ to future generations is difficult to support. The current Baby Boomers are not placing a burden on the future from the Social Security program even though they may be placing a burden on a current portion of the population and causing a burden on a portion of future populations. As I and others have argued before, if one wishes to reduce the inter-generational shift of income from Social Security a ‘pay as you go program’ would seem to make sense. The currently employed generation shifts some of their income to the currently retire generation in return for a future employed generation to shift their income to the future retired generation.

Joe said...

well, at least more than an a side comment in a footnote

Greg said...

I've made this argument before, but I'll make it again here. Forcing the social security trust fund to be invested in US treasuries has the effect of reducing the interest rate on both the trust fund and US treasuries. This has nothing to do with whether the fund is managed as individual accounts. Thus, by establishing the trust fund the government is effectively forcing all wage earners to invest in U.S. Treasuries, which allows the government to borrow money at a lower interest rate than it otherwise would have to pay.

As ways to rob the trust fund (or future generations) this is a relatively small one, but not a meaningless one.

As far as if the trust fund has caused the government to borrow more than it otherwise would have, I suspect the answer is almost certainly yes. I'm sure there were some who really did think "300 billion is okay, but $400 billion would be too much" and who looked at the consolidated deficit. This was likely a result of misunderstanding and not malice.

In other words I think it went:
1.) Social Security is a good idea.
2.) Saving a little extra Social Security for the baby boomers is a good idea.
3.) Oh, the deficit isn't growing as fast as we though it would, we don't have to reign in spending as much.