We seem to have a confusion here: the problems with Social Security are minor; the massive tax cuts to which the triumphant GOP is ideologically committed are a problem for the rest of the federal government, but an obligation is an obligation, and after 2015 it would have been necessary to pay off maturing bonds no matter who owned them. However, there is a very widely-held belief that Social Security is tottering on the brink of utter calamity and that this is the result of a pay-as-you-go scheme. So I would like to address these matters in an orderly fashion.

1. CLAIM: Social Security is a pay-as-you-go system. Isn't that like a ponzi scheme? After all, a pension plan is obligated to have a pool of assets whose net present value is ≥ to the net present value of all liabilities.

   REPLY: The reason private pension plans are obligated is, that's the only way they can meet liabilities. It is in the nature of governments that their sole source of revenue is taxation. Think of it this way: when a firm employs a worker for a length of time T, it may have committed to a pension payout of Y_T at some time in the future; the mean probable duration of that payout, times the rate of pay, is calculated by an actuary and time-discounted, then submitted to the employer as a bill. I'll resist the condign the urge to tell readers what the formula is, since everyone has heard of an annuity. Economically, however, it is not all that different from a pay-as-you-go system, since the underlying wealth in the pension plan is actually a claim on future income; in others, a legal entitlement to future wealth.

After all, I'm arguing that pay-as-you-go is as sound (fiscally) as a pool of assets. Think of it this way: almost 20% of federal government expenditures are SSA entitlement obligations. We could actually calculate the net present value of all future US government obligations, including those of the states, and buy an annuity to pay out US$3.4 trillion annually in perpetuity. It sounds great. We could distribute shares of the annuity to everyone, so that people directly owned a share, and people could chose how to spend theirs. To libertarians, this is the sovereign remedy; to me, it is sort of like the old Irish joke of an elderly man making out his will.

ELDERLY MAN: So to my sons Charles, Kerry, and Seamus I bequeath ten million punt each, and to my daughters Rosaleen and Shannon, eight million with a bequest of six million for each child they have, to be be paid on the occasion of their majority. Notice I allowed for four children each; should they have fewer than eight children among them, the remainder shall be donated to...

SOLICITOR: (astonished) Where is all this money to come from?

ELDERLY MAN: *Aurruggkh*, let them earn it same as I did, the lazy good-for-nothings.

2. CLAIM: Isn't the exploding number of elderly going to accompany a plummeting number of workers? We'll be buried alive under a leisure class of sick old people on life support systems!

   REPLY: Projections of a huge boom in the numbers of retirees have been made; one popular version of this alludes to the baby boomers retiring as if this were a main battle tank driving over a pedestrian bridge. However, this would be an issue no matter what system we had. A rational response would be to increase saving, either by running a surplus or by adopting policies to encourage saving; we would be discussing which policies of high-saving countries we wanted to imitate. Instead, the government is ideologically committed to policies that reduce saving.

   All the same, the ratio of retirees to workers has not grown faster than productivity per worker-not by a long shot (during the course of the 1990's, the ratio of retirees to workers actually declined slightly). PGL explains this here;

3. CLAIM: JRM's contention that there is nothing serious wrong with the SSA fiscally is drawn from his liberal ideology: there's no problem that a 2% tax increase can't fix. Let's ignore for the moment that after a while, a lot of 2% tax increases sum to an exorbitant tax bill. The fact remains that the nation has vigorously declared it rejects JRM's liberal agenda, and for him to persist in using it for prescriptions is as unrealistic as assuming away a law of physics. IS IT NOT SO that the system requires drastic action to achieve solvency, given the IMMUTABLE and EVERLASTING rejection of liberalism? Let's consider Arnold Kling's argument here:

   Let me start with an analogy. Suppose that your house has a very dilapidated roof. The next big winter storm is likely to cause huge damage unless it is repaired. So you borrow $20,000 and fix the roof.

   What is the cost of this transaction? The "cash flow cost" is that you have to pay back the loan... The economic cost of this transaction may be zero. In an economic sense, you have exchanged a certain, visible cost - the cost of repaying the loan - for an uncertain, invisible cost - the cost of trying to get through winter with a dilapidated roof. Chances are, if you did not fix the roof, [...] a storm could cause water damage and force you to pay huge repair bills.

   Social Security's dilapidated roof is its unfunded liability. [...] Your Social Security "contributions" [...] are used to pay for the benefits of current retirees. What you get in return for your contributions is the government's promise to tax future workers to pay for your benefits. That promise is the unfunded liability. Like the dilapidated roof, it is a liability that does not show up on the balance sheet.

   Suppose that we want to reform Social Security so that your contributions go into a reserve account. One particular form that this reserve account could take would be a savings account in your name and under your control (within limits). That is called "privatization." But any reform that creates a reserve will have the effects discussed in the rest of this article.

   REPLY (edited, 28 March '05) In my initial rebuttal to this point I made the argument that all needful government expenditures in coming years are "unfunded liabilities," including national defense. However, this was a misreading of Mr. Kling's argument, viz., that projected payroll deductions (plus accumulated assets) for SSA will be inadequate to cover the systems's projected expenditures.

   REPLY2: In order to close the gap between anticipated liabilities and anticipated income streams for SSA (the "unfunded liability") Mr. Kling proposes to borrow trillions of dollars to pay for the conversion of SSA into a system of "personal" accounts; the reasoning is that the returns on assets currently held by the SSA will net a much higher yield than tresury securities. There are three problems with this thinking:

   (a) The cost of borrowing for the US Treasury will greatly increase. This cost would certainly enrich primary buyers of federal government securities, but it's debatable whether the personal accounts would experience a corresponding windfall. It's difficult to take seriously the idea that it would be more.

   (b) The "solution" (transferring to personal accounts) would have greater known costs than doing nothing. In contrast, the shrinking pool of Treasury securities held by the SSA is expected to buy a smaller pool of non-government assets that would need to have a yield so much greater by about $12 trillion (the size of the putative gap, plus the acknowledged $2 trillion in fees and expenses associated with the transition). While the $10 trillion in unfunded liabilities are supposed to accrue over an infinite time horizon, the new pool of assets is supposed to generate most of this extra income by around 2042 even as securities are steadily being cashed in. Naturally, if the Administration's assumptions were all correct, then by 2042 this pool, while somewhat diminished as retirees draw it down, would have experienced much faster unit growth (i.e., each unit of asset in the pool would be growing in value faster, even as the number of assets was shrinking); so it would still be substantial when 2042 rolled around, and would continue to benefit the liquidity of the SSA. This assumption, however, is handicapped by the different time windows and the $2 trillion in fees to be incurred presently.

   (c) The concept of privately-managed, personal accounts (whose higher return would be contingent on higher risk) defeats the concept of social insurance. People would "take ownership" because they would be reduced to utter destitution if they made poor investment decisions (as did Economics Nobel laureates Myron & Scholes, or oft-cited investment genius Jesse Livermore).

   Please consider what I am saying for a moment. Since Mr. Kling has brought up my father-in-law, let us imagine I approach him with the proposition of borrowing $50,000 in order to buy securities. As the value of the securities go up, I'll pay him back. If this proposition were worth taking seriously, there would be no such thing as scarcity; every man and woman in the world could finance every desire in this way. It might be worth taking seriously if I were a reknowned investment genius, and the odds favored me. However, the US government is not such a genius, and neither is the average American.

4. CLAIM: Damn you, MacLean, you snide snot-nosed prick. I'm sick and tired of you, but I'm even more sick of paying for some doddering geezer's bingo game when I could be paying for ME. So leave me alone and let me or I'll drive my Hummer over you!

   REPLY: Perhaps I'm being harsh, but I believe this is a fair assessment of the balance of Kling's argument (although I am not sufficiently delusional to think I'm important enough for him to resent me so!). If Americans my age or younger had no problem paying for their retirement and that of 25% of a person, then we would have done this long ago. Kling (and the Republicans for whom he shills) know this so he proposes to borrow the difference. I have already said why I think this is silly, but I would like to address the claim that a reserve account is so wonderful. The allure is that one is investing, and creating wealth, rather than consuming it (technically, one would be doing both-people want to ensure that they're able to consume in the future). Instead of taxes on payroll exerting their perverse effect on income-leisure substitution, we get to have a warm pleasant feeling about our savings going to create future wealth.

   This essay would require a lot less time to compose if I were free of the impulse to be sarcastic. However, it relies on a confusion of the different meanings of the term "invest." In common usage, "investing" means buying securities of some kind with one's disposable income. If you invest money in this way you cannot consume it; it's being used by the firm you invested in to create wealth. We could go a step further and call all unspent balances in your checking/savings accounts an "investment," supposing that your bank could and did pay interest on those balances. In economics, however, we would call that "saving." You are foregoing present consumption for future consumption. In some countries this is required through a "mandatory providential fund"; in Singapore, at one time, MPF withholdings were 50% of gross pay (they're a lot lower now). This was during a period when MPF holdings were computed based on the government's notion of optimum saving for the country; it wanted a huge pool of reserves to guard against capital flight. Another way, employed by Hong Kong and other countries, is to run huge government surpluses no matter what.

   In the USA, political commentariat has conflated the two, both conceptually and temporally. If we really were concerned about ensuring there was adequate investment for future growth, then we would run a budget surplus until we had erased twin-deficit effects in our economy. We could replace corporate taxes with a VAT that favored saving by firms, and increase the cap on IRA contributions (after raising the marginal rates). However, what the Bush Administration proposes to do is borrow money so that younger workers can pay into their retirement accounts while the SSA pays its present obligations. This is, in fact, going to sharply increase the country's sovereign debt while money is squeezed into the stock market.

   Returns to stocks will go down and interest rates will soar. That, Dear Readers, is no method to stimulate wealth creation. It's damned stupid, is what it is.