TCS Daily

Krugman and DeLong on Social Security

By Arnold Kling - January 10, 2005 12:00 AM

"I figure I might as well lay down what the party line is on Social Security:
...'What party?' you ask. Ah, that *is* an interesting question...
-- Brad DeLong

Recently, left-leaning economists Paul Krugman and Brad DeLong have each tried to write seriously about Social Security. The purpose of this essay is to examine what they had to say.

Paul Krugman is an economics professor at Princeton, winner of the John Bates Clark Medal (arguably a more prestigious award than the Nobel Prize within the profession), who has achieved public notice with several books and a New York Times column. His essay that I will be discussing appeared in Economist's Voice.

Brad DeLong is an economics professor at Berkeley, a former official in the Clinton Treasury Department, and an early adopter of the Internet as a communications medium, including one of the leading economics web logs. He is one of the economists most heavily cited in my book. I will be referring to the blog post quoted above.

No Crisis?

Is the Social Security Deficit a crisis? Krugman and DeLong both try to put Social Security in the context of the overall Budget situation. DeLong says,

        "If our current General Fund deficit is like having an impaired driver who has 
        just crashed us into a tree, and if the Medicare-Medicaid problems are like 
        a melted transmission, and if the post-2020 General Fund is like having no 
        brake pads left, then our long-run Social Security deficit is like a slow tire 

Can one separate Social Security from other Budget issues? Krugman writes,

        "if Social Security is just part of the federal budget, with no budget or 
        trust fund of its own, then, well, it's just part of the federal budget: 
        there can't be a Social Security crisis. All you can have is a general 
        budget crisis."

I would agree that Social Security should not be described as being in crisis. However, it is a program whose design flaws are getting worse as time goes on.

Krugman writes as if the condition of the Social Security trust fund is an indicator of the health of the system. I think that most economists focus instead on the ratio of workers to retirees. As Social Security is designed, the higher the ratio of workers to retirees, the lower the tax rate must be to meet the obligations of the system. That key ratio is going to fall over the course of this century. Given a choice, I think most economists would rather see a future with a higher ratio of workers to retirees than more assets in the trust fund.

Krugman points out that "quite moderate projections of economic growth push the exhaustion date into the indefinite future." The way I would put this is that although the expectation is that the decline in the worker-to-retiree ratio will create pressure to either cut benefits or raise taxes for Social Security, there are "good news" scenarios under which the pain can be avoided, as well as "bad news" scenarios under which the pain is worse. A lot depends on what I call The Great Race between Moore's Law and Medicare.

Fixing the System

Although we could wait to fix Social Security, that may not be the most prudent course. Suppose I told you that under plan A we are likely to have to cut benefits down the road, unless we get good news. Under plan B, promised benefits and expected future taxes are aligned, so that if there are pleasant surprises we can increase benefits and/or cut taxes down the road.

My guess is that most prudent people would prefer plan B, which means some change to Social Security now, as opposed to plan A, which is to keep the current system and hope for the best. For the proposals under discussion by the Bush Administration, the plan B that puts Social Security into better long-run balance is to switch from wage indexing to price indexing.

Brad DeLong favors a different Plan B approach. Following up on his "slow leak" metaphor, he writes:

        "1. Pump in more air -- raise Social Security taxes a bit (perhaps by applying 
        the FICA tax to all earned income, rather than exempting income over 
        $90,000 a year from the tax).

        "2. Patch the leak -- raise the retirement age as life expectancy increases."

To economists, raising the retirement age is the obvious fix for a system that otherwise faces an ever-declining ratio of workers to retirees. Unfortunately, it appears to have never stood a chance politically. For that reason, DeLong proposes creating an independent board, modeled on the Federal Reserve, to focus on keeping Social Security in balance.

Private Accounts

Krugman argues against the view that private accounts will generate 7 percent real returns. He says that this historical average is not likely to be sustained, and the future returns are likely to be lower. I made basically the same case more concisely when I discussed "the stock market scenario" here. He and I are in agreement on this point.

My guess is that the Bush Administration also has been persuaded not to bet on 7 percent real returns on stocks. That explains why they have floated the idea of shifting to price indexing, which is a "plan B" that all economists agree would slow the growth of benefits and make it unlikely that Social Security would experience any long-term deficit.

DeLong offers an interesting perspective. He argues that private accounts should be used in addition to Social Security, rather than as a partial replacement. As he puts it, "Private accounts are a good idea -- most Americans save too little." His suggestion is to implement private accounts as forced saving, with perhaps additional Federal matching funds for low-wage workers. However, he would not cut Social Security taxes and benefits -- apart from the retirement age adjustment.

I think that the idea of instituting private accounts in addition to Social Security is worth considering. Gene Sperling, who also was a former aide to President Clinton, has a "universal 401(K) plan" that resembles DeLong's proposal.

However, there is only so much tax blood that may be squeezed out of the American worker turnip. If benefit growth is not slowed, then the taxes required to both pay for Social Security and provide subsidies to low-wage workers's savings plans will be too onerous. Regardless of how private accounts are implemented, we need a "plan B" policy to slow the growth of benefits, using either price indexing or adjustments to the retirement age.

Motives vs. Consequences

Both Krugman and DeLong make clear that some of their dislike of privatization is based on the fact that it is a project of the Bush Administration. Krugman writes,

        "many economists hold the defensible position that a pay-as-you-go system 
        is bad for savings and long-run growth. And they hope that a bad privatization 
        plan may nonetheless be the start of a reform that eventually creates a 
        better system.

        "But those hopes are surely misplaced. So far, everyone - and I mean 
        everyone - who has signed on to Bush administration plans in the hope that 
        they can be converted into something better has ended up used, abused, 
        and discarded."

Thus far, my sense is that the Administration has not been disappointing in its Social Security proposals. Price indexing is perhaps the most sober and courageous proposal to make it as far as the "trial balloon" stage politically. I am also pleased that the Administration has not been emphasizing the 7 percent rate-of-return "stock market scenario" that Krugman and I both find implausible.

In the essay for Economists' Voice, Krugman makes even more aggressive accusations about the motives of supporters of privatization. My view is that these Type M arguments are of questionable value even in a newspaper column. I was shocked and somewhat dismayed to find them in an essay supposedly written for a peer-reviewed professional journal.

My view is that one ought to try to analyze Social Security proposals on their merits. It is important not to become so blinded by partisanship that one loses sight of the consequences of policy.

For example, one consequence to privatization that Krugman might consider is the way it would affect tax progressivity. He complains that "Greenspan and company pulled a fast one back in the 1980s: they sold a regressive tax switch, raising taxes on workers while cutting them on the wealthy."

As I have pointed out, the Bush privatization proposal represents a staggering reversal of the "Greenspan switch." It would cut the regressive Social Security tax, shifting the burden of paying current benefits to other taxes that are more likely to fall on the wealthy. Thus, the consequence of privatization would be quite progressive, even though Krugman assumes that the motives of the Bush Administration do not favor the working class. In my view, this demonstrates the importance for economists of focusing on consequences rather than on motives.


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