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Another Economist Blog on Social Security

The very good discussion of the Social Security issue between Andrew Samwick and Max Sawicky has been extended as Andrew and Max point to this contribution from David Altig.

David’s blog will become a must read for me – and his point is simply that the timing of spending versus tax receipts is less important for the solvency of a fund than their present values if long-run solvency is the concern. If the Social Security Trust Fund will not be asked to bail out the General Fund, then its shortfall = 1% of GDP over the long-run could be readily be addressed by modest cuts in benefits. The problem, however, is that the Bush Republicans have neither the will to raise income taxes nor plans to reduce Federal spending in any other meaningful ways. And since the General Fund shortfall = 3% of GDP, a massive reduction in Social Security benefits would be needed if the Trust Fund is to bail out the General Fund. Solvency issues aside, the Bush Republicans are paying for income tax cuts with increases in employment taxes. In other words, the big issue is the implied redistribution of the tax burden from owners of capital to workers.

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“Advocates” Defend Bush’s Borrowing to Address Social Security

This Reuters story tries to give one of those “fair and balanced” discussions but one word tips us off just a wee bit. The story includes:

Facing record budget deficits, the Bush administration likely will turn to short-term government borrowing to help finance its plan to add personal retirement accounts to Social Security, officials said Saturday… One analysis this year by the White House Council of Economic Advisers found that tapping the bond markets to pay for private accounts would increase the nation’s debt-to-GDP ratio by 23.6 percentage points by 2036. Under this scenario, the debt held by the public would increase by as much as $4.7 trillion.

But then those of us who pay more attention to the total Federal debt might note that the debt held by the public is not the right yardstick assuming the “lock box” is honored. So “fair and balanced” might be in order but this seems to go too far:

While the nation’s debt load would increase initially, it would fall as the reforms are phased in, advocates say…But the new government bonds would be repaid 20 years later, eliminating Social Security’s unfunded liability while reducing the tax burden in the long term, advocates said.

Excuse me for asking but how is reshuffling the chairs on the Titanic going to eliminate the massive Federal insolvency? It seems these “advocates” failed to tell Reuters how, but at least Reuters labeled these folks properly as ADVOCATES (kind term for brazen liars, I guess).

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Kerry’s Corporate Tax Proposal versus The American Jobs Creation Act

Had Senator Kerry been elected President, we would be talking about his proposal to reduce the corporate tax rate to 32% and to eliminate the deferral benefits under Subpart F, which would have reduced the temptation to abuse the transfer pricing regulations under section 482. Instead, there is much discussion of The American Jobs Creation Act, including my own, which may have been a bit premature.

I say premature as recent discussions of this new law suggests that for most domestic sectors, all profits will qualify for the “qualified production activities income” (QPAI) deduction, which will be only 9%. So most companies will have an effective tax rate equal to 91% of 35% or just under the 32% tax rate that Kerry was proposing. Exceptions remain, however, such as food and beverage companies with retail activities as well as power, water, and natural gas producers with transmission and transportation activities. The profits from service activities also would not qualify as QPAI.

But why distinguish between value-added created in most of the U.S. economy versus certain types of value-added created in these sectors? Those sectors with this type of value-added would have to face both higher effective tax rates and compliance headaches if the IRS accuses them of abusive transfer pricing to get their tax rates down to the levels of companies without these types of value-added activities. As if the IRS was not already too busy given its limited resources.

The Kerry plan was both simpler and had the added benefits of accelerating the taxation of profits shifted to offshore shelters under provisions of section 482 such as Cost Sharing – at least as far as how it is practiced. But now I hear that the IRS is seriously considering letting the QPAI deduction apply to this income as well. If the deduction applies only after the income is repatriated, then this IRS consideration is sensible. But if the deduction applies before the repatriation of income, Congress has only enhanced the opportunities for tax accountants to rip-off the Treasury with more transfer pricing abuse.

Of course, the Bush Republicans now say they want tax simplification. But aren’t these the same fellows that have passed all sorts of loopholes for the rich over the past four years in a matter that have made the tax code more complex? Maybe Congress passes such convoluted tax laws to increase the demand for tax attorneys.

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Changing the Bush Economic Team

The Washington Post updates us this morning on the current thinking in the White House about changing Bush’s economic team. It looks like Snow will be out soon too:

Aides said changing four of the five top economic officials — including the Treasury and Commerce secretaries, with only budget director Joshua B. Bolten likely to remain — is part of Bush’s preparation for sending Congress an ambitious second-term domestic agenda… [T]he White House is now indicating it may move more quickly to convey a fresh start. Aides also said Bush is considering reaching beyond the kind of administration loyalists who will staff key national security posts in the second term.

…One senior administration official said Treasury Secretary John W. Snow can stay as long as he wants, provided it is not very long. He might stay as long as six months into the term, officials said. Friends say Chief of Staff Andrew H. Card Jr. is one possibility to replace him. Bolten also could move over.

But Republican officials said Bush is also considering well-known officials from outside, including New York Gov. George E. Pataki (R). Conservatives are pushing for former senator Phil Gramm, a Republican from Texas. Also under consideration is John J. Mack, who stepped down in June as co-chief executive of Credit Suisse Group. Mack has also been considered to lead a bipartisan commission on changing the tax system that Bush will appoint to develop recommendations for the Treasury secretary.

…Bush will almost certainly go outside the government for some substitutions for his economic team, which some Republicans viewed as a weak link during a campaign that was run on the president’s image and national security credentials.

…”They need people who have not been drinking the Kool-Aid and are going to come up here and say breathlessly, ‘This is what the president wants to do, and isn’t it great?’ ” the aide said. “They need someone like a former senator or former member or former governor who can come up here and say, ‘This is going to be hard. There’s going to be blood on the floor, but it’s going to be worth it.'”

“People who have not been drinking the Kool-Aid”? Can it be that even Bush’s own aides feel that they are members of a cult?

Kash

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The Dollar’s Decline

The dollar’s downward slide of the past two months is continuing today. The dollar has hit a new record low against the euro, unsurprisingly; but the dollar is also at multiple-year lows against the Canadian dollar, Korean Won, and Swiss Franc, and has declined significantly against the pound and yen in recent weeks. What had primarily been a dollar-euro story now shows signs of turning into a more broad-based decline of the dollar against a wide array of significant currencies. The following chart of FRB data illustrates.

Interestingly, the Japanese Ministry of Finance seems to be allowing the yen to remain below the heretofore critical level of 105 ¥/$ (it’s at about 103 ¥/$ today); the exchange rate has been below that level for a full week now, and the Japanese have not decisively moved to push it back. Some observers are indeed picking up increasing signs in recent days that some major intervention by Asian central banks (other than China, which has never stopped intervening) may be imminent. But if the yen is allowed to move below 100 ¥/$, a reasonable interpreteation might be that the MoF is effectively allowing a revaluation of the yen.

Of course, that would still leave the other big Asian question unanswered: when will China revalue? Nevertheless, the last couple of months have shown that even without a China revaluation, the dollar can still effectively fall quite a bit.

Kash

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Help Wanted: Economic Advisors for President

The Bush administration will soon have a couple of positions open for economists. Bush’s chair of the CEA and director of the NEC will both be stepping down in the next couple of months:

Stephen Friedman, who left Wall Street to assume one of the top economic posts in the White House, will return to the private sector Dec. 31 after two quiet years in Washington, White House officials announced yesterday. Friedman’s departure as director of the National Economic Council will open a key economic policy position just as President Bush begins his ambitious push to overhaul Social Security and the tax code.

…N. Gregory Mankiw, chairman of the White House Council of Economic Advisers, is also expected to leave early next year. Administration officials are sounding out Massachusetts Institute of Technology professor James Poterba — an expert on Social Security and tax matters — to take Mankiw’s slot.

…Friedman’s slot [is] open for a heavyweight who could bump heads in Congress and forcefully advocate efforts to introduce private investment accounts to Social Security and to simplify the tax code while shifting taxation from savings and investment.

…Conservatives are pushing former senator Phil Gramm (R-Tex.), publisher Steve Forbes or a top business leader, such as Fred Smith, chairman of FedEx Corp. Also under consideration is investment banker Gerald Parsky, who served on Bush’s Social Security commission, and Indiana businessman Al Hubbard, a longtime friend of the Bush family.

Poterba is a highly skilled and respected economist with impeccable academic credentials. The main question that I have regarding his possible appointment to the CEA would be why he would even consider jeopardizing his reputation by being reduced to mouthing the words given him by the political operatives in the White House.

The NEC position, on the other hand, is the spot where the administration’s top economic policy salesman typically resides. As the article suggests, Friedman has been the most invisible NEC director ever, virtually never contributing his voice to public policy debates in Washington. So rather than good credentials as an economist, Bush is probably looking for someone with some force of personality, and even better if they also have connections on Capitol Hill. But most importantly, based on Bush’s second term appointments to date, the candidate must also have unquestioning loyalty to Bush himself — the best (perhaps only) qualification needed for a position in the Bush administration.

Kash

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Are IRS agents writing Federal legislation?

Via Josh Marshall comes more GOP passing the buck on the Istook Amendment:

WASHINGTON – Sen. Ted Stevens on Monday showed reporters a handwritten legislative proposal from an IRS employee that slipped into and nearly stopped the massive appropriations bill passed by Congress this weekend. Stevens said the note proves that neither he nor any other Republican had crafted the potentially privacy-invading language. The language, which could allow certain congressional employees to look at tax returns, created a furor on the Senate floor Saturday when discovered…Given the speed of the work, few people, if any, had read the whole bill by the time it came to the Senate floor Saturday evening. But it was too late for amendments because the House had already passed the bill. Stevens said the IRS provision had been cleared by senior Democratic staff members, along with Republican staff. He has the e-mails to prove it, he said. So when other senators criticized him for sneaking it into the bill, even after he explained what happened, he blew up, he said. “God that made me mad,” Stevens said Monday. He acknowledged that the language had entered the bill because of a “breakdown of our procedure.” No senator actually looked at the language before it was inserted, he said.

I don’t know which is worse – the GOP trying to let the Congressmen look at our tax returns or letting some rogue IRS employee write Federal legislation.

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Raiding My Retirement Account to Pay Off Your Credit Card

Andrew Olmsted may think I’m kind but I’m beginning to wonder if Andrew gets Social Security at all:

…while PGL is kind enough to suggest that my comment is not as bizarre as he might like to believe. (Of course, the down side to being noticed is that when the better-known bloggers don’t understand your argument…) Look at it this way: consider the social security trust fund as a credit card. We’ve been collecting money to pay our social security bill for years, but instead of putting the money away for the day when we have to pay the bill, we’ve been spending it. That’s allowed us to live above our means, but eventually we’re going to have to pay back the money.

Andrew is trying to find ways to make sure the Federal government does not go bankrupt, which is consistent with the pleas from Brad DeLong, yours truly, and many others. But think about his analogy this way. I have mistakenly allowed an ex-wife (the General Fund) to have a credit card that taps into my retirement account (the Social Security Trust Fund). She decides to shop at Nordstrom rather than going to work knowing I’m trying to pre-funding my retirement account. Now shame on me for trusting my savings will be there when I retire. Yes, it’s time to cut the ex-wife off. But wait – George Bush is helping my ex-wife and Andrew does not understand why I’m so upset.

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Yes, We Can Balance the Budget Next Year

The Bush administration and some congressional allies are considering ways to keep Social Security privatization from adding to the budget deficit: simply put the expenses that necessarily come with privatization “off-budget”, so that they don’t add to the official measure of the US federal budget deficit.

There’s a good justification for doing this, according to some Republicans: the benefits of privatization (including the improvement in future budgets) will come over many, many years into the future, and since the official budget won’t reflect these long-run benefits, it’s not fair to officially count all of the costs today. From the Washington Post:

Republican lawmakers and the Bush administration are examining a number of accounting strategies that would allow the expensive transition to a partially privatized Social Security system without — at least on paper — expanding the country’s record annual budget deficits. The strategies include, for example, moving the costs of Social Security reform “off-budget” so they are not counted against the government’s yearly shortfall.

…”You cannot look at Social Security in the context of a five-year budget,” the window that current White House and congressional spending plans cover, [Republican Senator Judd] Gregg said. “To do so is naive and foolish. . . . If this is simply scored as a five-year exercise, we’re never going to solve the problem.”

Gregg’s thinking mirrors sentiments within the White House, according to administration officials and White House advisers. “The budget should reflect that this is an investment, a down payment that will have very positive implications,” said White House spokesman Trent Duffy.

I think this is a great idea. It seems only fair to exclude from the budget deficit those portions of government spending that are “investments”, with positive effects on the US and its budget for decades to come. In fact, I think that we should be able to wipe out the budget deficit completely with this new accounting system:

  • Education: The $50 billion per year that the Federal government spends on education is clearly a long-term investment. It will provide our country with better-educated citizens that will in turn increase productivity and thus income — and government tax receipts — in the US for decades to come. Clearly it is therefore unfair to count our educational spending in the official budget of any one particular year, when it has such long-term payoffs. Let’s move it off-budget.
  • NASA: Space exploration costs us $15 billion per year today, but in 50 or 100 years we could have enormous technological capabilities that are the direct result of today’s NASA spending. These NASA-generated advances will potentially provide huge boosts to the US economy. So clearly it’s unfair to just count all of those costs on this year’s budget, since that ignores its stream of future potential benefits. Let’s move it off-budget.
  • Iraq: Sure, our adventure in Iraq is costing us $200 billion (and counting), but it is also building a democratic and stable country in Iraq will provide us with greater security, lower oil prices, and lower future defense costs in the Middle East for decades to come, according to the Bush administration. So it’s not appropriate to just count the costs over 1, 2, or even 5 years when it’s really a long-term investment. Let’s move Iraq spending off-budget.
  • Defense: For that matter, all of our other defense spending (about $400 bn per year) is really going to have dividends for decades to come, since maintaining a strong defense today is an important ingredient to providing long-term geopolitical stability in the world — clearly a crucial element to long-run economic growth. Since it will generate higher income (and tax receipts) for decades to come, it makes no sense to look at the defense budget just in terms of one-year costs. Let’s move it off-budget.

Hey, look at that! Our budget deficit is gone. Why didn’t we think of this earlier?

Kash

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Is the Social Security Trust Fund Worth Anything?

Kent Smetters poses this question as the title of this paper. Several economists including myself would answer yes to this question but then Smetters notes that we are assuming policymakers set spending and tax rates for the other levels of government so as to insure that the General Fund adheres to a long-run balanced budget constraint. In particular note that his Figure 1 shows the assets of the Social Security Trust Fund still rising after 2018 when payouts to retirees start to exceed payroll contributions. The reason for this is that the diagram assumes that the interest on Trust Fund bonds will not be used by the General Fund.

Also note that even the on-budget surplus (deficit) has the interest paid to the Social Security Trust Fund being counted as an offset to the overall interest expenses from total Federal debt. In other words, any funds placed into the Trust Fund today are akin to zero coupon bonds with the amount contributed being the face value at some future date – say 15 years from now. But in that case, about half of the present value of this contribution has effectively been turned over to the General Fund.

If policy makers are viewing the Social Security Trust surpluses as funds available for general spending or to allow for lower income tax rates, then comments such as this one are not as bizarre as we supporters of the current system would like to believe. In other words if the Trust Fund assets and/or their accrued interest income are used to pay for Bush’s fiscal irresponsibility, then the Trust Fund will go broke much sooner than 2042. I say this in light of a recent email from Bruce Bartlett, which simpy said:

I have made the point that it is silly to attribute debts long in the future to the current generation of taxpayers, as is often implied.

as Bruce pointed to his NRO oped, which tries to claim the Smetters-Gokhale $44 trillion present value of government deficits represented only 6.5% of GDP if GDP will be $682 trillion as of 2075. I find it odd that one would compare the present value of government deficits as of 2002 to the future value of GDP in 2075, especially since $44 trillion invested in bonds paying 5% for a 74-year period would become $1627 trillion by 2075. In other words, the Smetters-Gokhale calculation implies a debt-to-GDP ratio equal to around 240% by 2075 if neither the (modest) Social Security insolvency and the massive General Fund insolvency are not addressed by either spending cuts or by tax increases.

Bruce might be right to suggest this calculation is silly if policy makers decide early enough to either cut spending (his preference) or raise taxes (given that even conservative Republicans have no appetite for serious spending reduction – the more likely reality). This Smetters-Gokhale calculation notes that most of the insolvency problem is from the General Fund so if the “lock box” is in effect so the Social Security pre-funding of our retirement is not touched, then the General Fund will have to do the adjusting.

But here is what concerns me. Many conservatives, including apparently Bruce, take the view that the payment for our future retirement will be borne by payroll taxes (as opposed to contributions) on future generations so the alleged Trust Fund assets can be siphoned off so as to reduce current taxes on capital income. As someone who believes in the pre-funding of our own retirement, I am troubled by this suggestion that we “attribute debts long in the future” when at least part of this attribution goes to paying for our retirement in a couple of decades – something we should be pre-funding now.

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