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Unseasonable Thoughts On Social Security

By Matthew Yglesias on May 17, 2011 at 3:47 pm

"Unseasonable Thoughts On Social Security"


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Conventional wisdom in Washington is that Social Security benefits should be cut, and probably cut in a distributively progressive way such that the top third or so of seniors bears the brunt. I think this is wrong. Consider Jared Bernstein’s chart of the importance of Social Security to most seniors:

That’s a lot. But it’s not everything. So where else does the money come from? Well:

— Defined benefit pensions.
— Labor income.
— Private savings.

These three alternatives are all deeply problematic. The problems with defined benefit pensions in the public sector (chronic underfunding, etc.) are well-known, and in the private sector those problems are even more severe. Labor income is not a realistic option for people over a certain age. And private savings are, frankly, a disaster. As a country, we’ve tried to deal with the decline of defined benefit pensions by encouraging the mass middle class to engage in private retirement savings with 401(k) plans, IRAs, etc. And it doesn’t work. On the one hand, people don’t save enough. On the second hand, the tax policy is deeply regressive. On the third hand, virtually 100 percent of the management fees extracted from customers through these vehicles are value-destroying rents. On the fourth hand, it’s extraordinarily difficult for a middle class person to properly diversify his portfolio. And on the fifth hand, widespread ownership of index funds and mutual funds undermines corporate governance.

Consider an alternative model of financing widespread retirement. Instead of a fraction of your wages going (or not) into a 401(k) fund, a fraction of your wages could be sucked up by the government. The idea would be to set this fraction at roughly the “right” level, what people would be saving did they not suffer from shortsightedness, akrasia, and (justified) fear that most savings vehicles are scams designed to extract management fees. Then upon reaching retirement age, you’d be paid a defined benefit pension by the government that’s supposed to offer roughly 100 percent of what a normal elderly person needs to live on. In order to make this tax-and-pension system incentive-compatible, the level of benefits you get would be proportional to the amount of money you paid in. Earn more as a worker and you’ll pay more in taxes, but then get more in benefits at the end. But we don’t need to be totally insane paternalists about this. We should “cap” the quantity of wages that are subject to the tax at some threshold in the $100-$200k range. People who earn more than the cap would max out their tax liability and also their benefit eligibility. These wealthy individuals, along with those who have large amounts of investment income, would presumably additional money in the stock market. If said wealthy individuals lose their money, that’s not so bad. They can bear the risks. And they’ll be in a much better position to exercise a meaningful corporate governance function.

This hypothetical program I’m describing is, of course, basically just what Social Security is right now. Except that Social Security taxes are a bit too low and the program is a bit too stingy.

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