Matt says we don’t really disagree about transition costs. I argue with some of his other readers in the comments to that thread (and in the comments to this one). Those commenters have convinced me that the explanation in my previous post wasn’t quite right.

What Matt put his finger on was the fact that changing from a pay-as-you-go to a pre-funded system costs money because you gotta find the money with which to pre-fund the benefits. And if you pre-fund a pension system by borrowing, then you need some way to pay off the transition debt if you want a fully sustainable system. Under most privatization proposals, the way that’s done is by cutting traditional benefits in one way or another, and using the higher return from personal accounts to offset those benefit cuts.

So I actually have two criticisms of Matt’s column, which I inappropriately conflated. For reference, here was the passage I focused on in my last post:

Privatizers want you to believe that the costs of their plan merely reflect the cost of closing the long-term shortfall sooner rather than later. In fact, the two costs are unrelated, as you can see by contemplating what would happen if we privatized a system that didn’t have a long-term financing gap. Hypothetically, one year’s payroll-tax revenues would fully finance that year’s benefits each and every year until the end of time. Then, one day, you start allowing workers under 55 to divert their payroll taxes into individual accounts; those workers accept an offsetting reduction in benefits when they retire. The problem is: The year after privatization is implemented, payroll taxes will plummet; but benefits won’t fall at all. For 10 years, revenue will keep dropping, and expenditures will stay the same. By year 11, the first benefit reductions will kick in, but the overwhelming majority of retirees will still be drawing full benefits under the old system — except without anyone paying the taxes to finance their benefits. Around 50 years later, all of the people who were over 55 when the new system was introduced should be dead, and the gap will go away. The debt, however, won’t ever go away unless some huge some of money is found elsewhere. That, as you’ll recall, used to be “where the budget surplus comes in” — until the surplus went away and until privatizers first started talking about it.

So there are two responses to this. First, there’s the strictly mathematical response: it’s important to note that if you implemented privatization the way Matt proposes, if the personal accounts got anywhere near the historic rate of return on equities, future retirees would get a much bigger benefit than they’re getting now. No actually proposed privatization plan does that.

Now, Matt is trying to draw a conceptual distinction between financing the transition (i.e. pre-funding the system) versus closing the long-term shortfall by cutting benefits. And he’s right–under the Bush “carve-out” approach, benefit cuts do all the heavy lifting in terms of closing the financing gap. I just think it’s important to note that Matt’s simplified example is a weird and unrepresentative model of the actual privatization proposals that have been made. Under every real-world plan, personal accounts are coupled with benefit cuts–the whole point being that the increased rate of return from the personal account offsets the benefit cuts. Bush’s plan is weird because he hasn’t actually released all of the details, but Cato’s plan is a better example of a plan that combines benefit cuts with personal accounts in a way that leaves both the government and retirees better off in the long run.

There’s a second issue, which I wrongly conflated with the first issue, and that’s the point about accounting for the costs of pre-funding the system. As I said, pre-funding the system costs money, but the point is that doing so doesn’t worsen the system’s “balance sheet.” That’s because the assets in the personal accounts–although they belong to the worker–represent assets that make it possible for the government to reduce future Social Security benefits to the holders of those accounts. So although on paper, a system with $5 trillion in debt and $5 trillion in personal accounts is technically $5 trillion in the red, it’s not at all clear to me that that’s the right way to think about it. The system’s ability to finance a given level of benefits with a given amount of tax revenue is unchanged by the creation of the accounts.

I think the best way to look at this is from the perspective of our grandkids. Let’s say it’s 2050, and we’re all in our golden years. The system has $5 trillion in debt and we collectively have $7 trillion in our personal accounts (assuming they do slightly better than the T-bond rate). Most retirees are living off the income from their personal account, and the traditional system is nearly phased out. Are our grandchildren made better or worse off in such a scenario?

They have a couple of options. For one thing, if they wanted to, they could choose to go back to a PAYG system at no cost– they would simply stop contributing to their personal accounts and use those payroll taxes to pay off the debt instead. This “reverse transition” would give a one time-windfall of the same magnitude as the one-time costs of the transition. So even in the most pessimistic scenario where higher returns don’t allow any offsetting benefits at all, our grandkids are not in any useful sense more indebted than prior to the introduction of their accounts. In the real world, benefit reductions made possible by the higher rate of return on personal accounts will allow that debt to be paid down over time, leaving our grandkids better off.

[citation needed] Simultaneously, airlines may offer phone services to their travelling passengers either as full voice and data services, or initially only as SMS text messaging and similar services.

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As free logos completely ringtones expanded and neared capacity, the ability to reduce transmission power allowed new cells to be added, resulting in more, smaller cells and thus more capacity.

For the past couple of weeks, Matthew Yglesias has been on a kick about Social Security transition costs. He elaborated on the subject here, but ironically, his critique is at least as sloppy as he accuses the privatizers’ arguments of being.

Matt appears not to have fully grokked the distinction between cash and acrual accounting. Companies (and other organizations) typically publish two different statements of their financial condition. One, is a profit-and-loss statement, which shows the revenues and expenses of the firm over a specified period, and whether the net income is positive or negative. The other, is a balance sheet, which allows investors to evaluate the firm’s net worth by showing assets and liabilities. Although these two statements are linked (since each year’s P&L statement affects the next year’s balance sheet) they are separate and distinct concepts. The profit-and-loss statement is important to make sure the company can pay its bills in the short term. The balance sheet shows whether the company will make a profit in the long run.

So Mike Tanner’s claim that there are no transition costs is a statement about the nation’s net worth. It says that in the long run, personal accounts will improve the nation’s fiscal position. Despite Matt’s implication to the contrary, that is not at all inconsistant with a discussion of how to finance those costs in the short run–a discussion about cash flow.

So our “story” hasn’t changed. We argue simultaneously that in there are no transition costs in the long run, and that in the short term, funding them will be expensive. That is, of course, because the up-front costs will be offset by large savings down the road.

The confused, handwaving nature of his math is most obvious in last week’s Prospect column:

Privatizers want you to believe that the costs of their plan merely reflect the cost of closing the long-term shortfall sooner rather than later. In fact, the two costs are unrelated, as you can see by contemplating what would happen if we privatized a system that didn’t have a long-term financing gap. Hypothetically, one year’s payroll-tax revenues would fully finance that year’s benefits each and every year until the end of time. Then, one day, you start allowing workers under 55 to divert their payroll taxes into individual accounts; those workers accept an offsetting reduction in benefits when they retire. The problem is: The year after privatization is implemented, payroll taxes will plummet; but benefits won’t fall at all. For 10 years, revenue will keep dropping, and expenditures will stay the same. By year 11, the first benefit reductions will kick in, but the overwhelming majority of retirees will still be drawing full benefits under the old system — except without anyone paying the taxes to finance their benefits. Around 50 years later, all of the people who were over 55 when the new system was introduced should be dead, and the gap will go away. The debt, however, won’t ever go away unless some huge some of money is found elsewhere. That, as you’ll recall, used to be “where the budget surplus comes in” — until the surplus went away and until privatizers first started talking about it.

“Around 50 years later,” the cash-flow gap won’t just “go away.” It will turn into massive surpluses, since the system will still be taking in the same amount of revenues but will have very few people still dependent on traditional benefits.

Whether the long-term surpluses will be sufficient to fully pay off the bonds depends on the details of the plan and the performance of the stock market over time. But the way the math works out, as long as the accounts earn at least as much as treasury bills (and no one seriously argues they’re going to underperform T-bills over long periods) personal accounts improve the fiscal position of the Social Security system by reducing the government’s costs in giving workers a given level of benefits. But you can only see that if you look at the system’s long-term balance sheet rather than focusing on cash flow during an arbitrarily short budget window. Over any arbitrarily short period, you’re counting costs while ignoring offsetting benefits that occur at a later period of time.

I’m puzzled at the assertion that Cato and other reformers haven’t thought this through. The math just doesn’t work out the way Matt thinks it does, and it’s bizarre to accuse us of “deep unseriousness” when his exposition of the subject is so sloppy.

There are legitimate (but completely unrelated) cash flow concerns with respect to personal accounts, but this post is already too long so I’ll address those in a future post.

Kevin Drum and Will Saletan are arguing about the merits of raising the retirement age. Will says we should. Kevin responds that we shouldn’t.

My question is: why is this a political issue? Yes, I know: it’s a political issue because Social Security has to decide when people are eligible for benefits. But if we can take a broader perspective, it’s not obvious why there should be one official, government-determined retirement age, about which pundits bicker and politicians haggle.

To see how weird it is, let’s take another contemporary debate in American politics: how long should Americans work each week? Is 40 hours excessive, or do we need to work longer to meet the needs of a growing economy?

Of course, that’s not a hot-button issue in America. We decide how much to work based on individual preferences and trade-offs, negotiating with our employers for mutual beneficial employment terms. In principle, we have overtime requirements after 40 hours, but most white-collar workers are exempt from this requirement, and a good many workers work part-time jobs.

Things are very different in France. There, the French legislature decides how long people are allowed to work, and those who want to work more than the proscribed work week must lobby the government for permission to do so. To American eyes, that debate is a little bit ridiculous. Most Americans, I hope, can see clearly that different people have different needs in terms of working hours, and the nation’s economic institutions should be designed to permit flexibility and individual choice.

Which brings me to my point about Social Security. Right now, Social Security does allow you to retire early in exchange for reduced benefits, but the process isn’t actuarily fair and the range of options is very limited. If I wanted to work until 70, I would recieve no additional credit for the extra payroll taxes I paid in between 67 (my official retirement age) and 70. That both reduces my freedom to make a tradeoff between the length and prosperity of my retirement and creates a perverse disincentive to work longer, which would increase tax revenues.

Under a system of private accounts, in contrast, workers could retire any time they liked after the minimum retirement age. In fact, one could easily envision a personal accounts system that allowed workers to retire as early as they wanted, provided they had accumulated enough assets in their accounts to finance a minimum retirement benefit. Likewise, a personal accounts system would make it a simple matter for workaholic retirees to continue working into their seventies, using the extra income to finance a comfortable retirement or leaving the larger nest egg to their kids.

Reform opponents like to scoff at the notion that there’s an issue of liberty involved in the Social Security debate. But is it not obvious that a system with a one-size-fits-all retirement age (or even one that gives a narrow range of options like early retirement at 62) is a reduction of liberty compared with systems that accomodates a wide variety of choices in the work/leisure tradeoff? If the French debate over how many hours people should work is absurd, is the American debate over how many years we should work any less so?

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Cato has updated its Social Security Calculator, revising the numbers for 2005. In the process, a few changes were made. The rate-of-return assumptions were made more conservative for both the investment portfolio and the annuity calculation. Most importantly, a bug in the way that the recognition bond value was calculated has been fixed. All of those changes have lowered the expected value of personal retirement accounts. A hypothetical 25-year-old man with $25,000 in earnings can now expect about $16,000 annually from the current Social Security system (if, that is, it wasn’t projected to go bust when he’s in his 60s) and $21,000 from a personal account invested in a conservative 60/40 stock/bond portfolio.

In the interest of full disclosure, I should mention that this post turns out to have been wrong. About 3 weeks ago, I said:

More to the point, even if you grant all of Matt’s objections, personal accounts still end up doing better. I whipped up a little calculator of my own, which does the math in a transparent fashion. Cato’s calculator says that if I start out at 25,000 at age 25, that I’ll end up with a stock portfolio of $406,000 and an annuity of $38,685. My calculator more or less duplicates that result. If we grant all of Matt’s objections and use a 4.2% rate of return (60% stocks at 5%, 40% bonds at 3%, with let’s say a higher .5% transaction cost), then my personal account still ends up being worth $310,000. And if we assume the annuity pays out a conservative 7%, instead of Cato’s assumption of 9%, I would still end up with an annual benefit of about $22,000. According to Cato’s calculator, Social Security would pay $15,748 for the same wage profile.

My error was in assuming that the wage growth was 4% real, when in fact Cato’s calculator assumes 4% nominal (or about 1% real) wage growth. If I change it to assume 1% real wage growth, the personal account ends up being worth only $186,000, which at 7% translates to an annuity of $13,000 per year.

It needs to be stressed, however, that all of those estimates are extremely conservative– probably unreasonably so. It assumes a rate of return on stocks that’s a full 2% below the historical average, administrative costs considerably above the Thrift Savings Plan that’s being bandied about as a model for the program, and I’m not including the value of the recognition bond the 25-year-old would recieve under Cato’s plan, which would add about $1000 to the final value of the personal account.

To match the value of Social Security, the rate of return need only be raised from 3.7% to 4.2%–that is, a stock return of 5.5% and administrative costs of 30 basis points. 5.5% is more than a full percentage point below the historical average, and a 60/40 portfolio seems unneecessarily conservative for a worker who has 42 years to ride out any stock market volitility. Of course, if stock returns are closer to historical levels– say, 6.5%, the worker has the potential to do much better than Social Security currently promises–about $19,000 annually with the 60/40 portfolio.

Finally, it’s important to remember that Social Security can’t pay its promised benefits. If the Social Security actuaries are right, that $16,000 benefit will drop to about $12,000 after 2042. So simply paying the benefits that Social Security has promised but can’t deliver is an accomplishment in itself. Even under very conservative assumptions, Cato’s plan keeps the promises that the current Social Security system can’t.

Matt would respond by pointing out that Cato’s plan involves transfers of funds from general revenues to pay for transition costs– transfers that could be used to shore up the existing pay-as-you-go system. That’s a fair point, but it’s important to remember that Cato’s plan would put Social Security on a permanently secure footing. Once the transition was paid for, future generation would enjoy a permanent, fully pre-funded retirement system that would never require additional tax money to stay solvent. In contrast, merely transferring revenues to plug the gap in the PAYG system simply delays the inevitable. To keep the current Social Security structure afloat will require general revenue transfers until the end of time.

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I’m gonig to do my best not to sound like a 15-year-old girl, but OMG, check out Google’s new “beta” map software. I’ve been a regular and enthusiastic user of MapQuest for years, but after playing with this gem for about 15 minutes, I’m more or less sold, as soon as Google adds a few must-have features to bring it up to parity with Mapquest.

As I did with Gmail less than a year ago, (can you believe GMail has been public for less than a year?) a bulleted list of stuff I love about Google Maps:

Lefty bloggers like Atrios have started displaying this image a lot:

Pretty damning stuff, huh? Even after you include the returns from personal accounts, Graham’s proposal (which is based on CSSS Plan 2–also the basis for the president’s proposals), the average person would have lower benefits than not just schedule Social Security benefits, but payable benefits as well. Who would be in favor of that?

Well, let’s look at the fine print. Here’s the study the table comes from. Of particular interest are the assumptions it makes about personal account returns:

The table shows the benefits that would be paid to median wage-earners under the Graham plan — that is, the sum of their Social Security benefits and the monthly payments from their private accounts.  These figures are calculated using CBO’s assumptions and methodology, as set forth in CBO’s analysis of the President’s Social Security Commission plan.  (CBO applies “risk adjustment” in estimating income from individual accounts; see the box on page 11.)

OK, that’s sounds reasonable. What do “CBO assumptions and methodology” entail?

The Congressional Budget Office, the Bush administration’s Office of Management and Budget, and leading economists incorporate the effects of risk when they calculate the expected returns of a portfolio that includes stocks.  The basic concept they apply is that there is no such thing as a “free lunch” and that investments made in the stock market produce higher average returns over time but also carry a higher risk and may perform poorly and lose money.

The difference between the average return on stocks (often referred to as “equities”) and the average return on risk-free Treasury bonds is known as the “equity premium.”  According to standard economic theory, this premium represents compensation for the additional risk associated with investing in stocks.  In other words, since investments in stocks are riskier and can lose money, average returns on stocks have to be higher over time, or else no one would invest in them.  Most policy analysts subtract this risk premium when projecting the returns on a portfolio.  This produces what is known as a “risk-adjusted” rate of return…

If that risk was taken into account, the returns on private securities would be no greater than the returns on government securities.”  In other words, CBO concluded that the rate of return that should be used in assessing the returns that stock-market investments would produce is the “risk-adjusted” rate of return.  The risk-adjusted rate of return is simply the expected rate of return on Treasury bonds, which are essentially risk free if held to maturity.

Now, the folks at the CBO certainly know more about economics than I do, so I won’t disagree with their methodology for projecting the return on government trust funds. But here’s what’s dishonest about blithely using that assumption in this context: as I’m sure CBPP knows perfectly well, given the way the plan is structured, a 3% return leaves the worker exactly where he would have been without privatization. In other words, the CBPP chose a rate-of-return assumption that makes personal accounts completely irrelevant.

Maybe “risk adjusting” the returns in this fashion is a reasonable thing to do. But if they’re going to make an assumption that pre-determines the conclusion, they’d better have a damned good argument. Blithely ascribing their assumption to “leading economists” in footnotes doesn’t cut it.

At least CBPP has the intellectual integrity to be explicit about its assumptions, albeit in a somewhat circuitous manner. Here’s Atrios’s informative commentary:

The first column under the Graham plan says it all. That’s the total retirement income generated — both from your guaranteed benefit and your private account

And we’re supposed to support this why?

Why indeed? Maybe because some of us don’t like piling enormous financial liabilities on our grandchildren? Maybe because some of us are willing to take prudent risks in order to improve our standard of living in retirement?

Unrelated tangent: has Atrios always been so foul-mouthed and angry? I’ve never been a regular Atrios reader, and after reading his last dozen or so posts, in which he spends more time calling conservatives names than responding to their arguments, I don’t think I’m going to start any time soon.

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With third generation (3G) networks, which are also known as IMT-2000 networks, about three out of four networks are on generic picture .5 xanax (also known as UMTS) standard, usually seen as the natural evolution path for GSM and TDMA networks.

In celebration of Ayn Ran’d 100th birthday, I’ll repost the link to this excellent introduction to Objectivism. Most interesting, perhaps is the geometry puzzle in step 8.

On a more serious note, my boss explains her enduring appeal:

Rand’s books first appeared when no one seemed to support freedom and capitalism, and when even capitalism’s greatest defenders emphasized its utility, not its morality. It was often said at the time that socialism is a good idea in theory, but human beings just aren’t good enough for socialism. Ayn Rand insisted that socialism is not good enough for human beings.

Her books attracted millions of readers because they presented a passionate philosophical case for individual rights and capitalism, and did so through the medium of the vivid, can’t-put-it-down novel. The people who read Rand and got the point didn’t just become aware of costs and benefits, incentives and trade-offs. They became passionate advocates of liberty.

Much as I like to make fun of her “philosophy,” (which, I’ll admit, I found extremely compelling as a 17-year-old) her fiction had a large and positive impact in making the moral case for individualism and free markets at a time when that perspective was distinctly unpopular.