Robert Barro Anticipates a NonArgument from David Altig (Soc. Sec.) – and then makes one
David Altig co-authored Simulating Fundamental Tax Reform in the United States (AER June 2001), which is a very good paper. So I decided to make his blog a must read. Alas, two posts have been most disappointing. This one seemingly endorses some Donald Luskin claim that the middle class got a large tax break from President Bush as Luskin attacked Senator Kerry’s claim that the burden of taxes has been shifted towards the middle class. I would have expected Dr. Altig to note that Bush is not lowering government spending so we should be talking about tax shifts and not tax cuts for everyone. Maybe Luskin does not understand that permanent tax cuts require reducing the size of the government, but Dr. Altig does.
Altig also takes on my argument that Social Security privatization will not induce an increase in the expected returns of our retirement portfolios if one assumes the “homo-economicacus rationalis” (to coin Fester’s phrase) model adhered to by many of the proponents of privatization:
Privatization that converts mandatory “contributions” into “IRAs, 401Ks, PCOs, Keoghs, SEPs and other investment options” will leave private behavior unaffected under one condition: Savers choose exactly the same saving vehicles after privatization as they do now under the current social security system. And they have to choose them in exactly the same quantities. This seems, to me, a highly dubious proposition. AB’s argument seems to rest on the notion that the Social Security trust fund’s “investment” of Treasury securities just replaces purchases of same by private savers. Even assuming that private savers would freely choose to hold the same fraction of Treasury securities in their portfolios, the argument still has problems. My (and your) payments into social security are not promised the rate of return on Treasury securities. We are promised whatever the payment/benefit formulas of the system indicate. If you were born in 1975, for example, estimates of the average inflation-adjusted internal rate of return to social security under current law run at just under 2 percent.
David’s second argument seems to be that a government run account inherently pays less than the risk-free return. But consider this from Robert Barro. His third and fourth paragraph explain why this often heard 2% figure is a misleading when comparing the returns from publicly run retirement funds versus privately held funds.
Barro’s fifth paragraph goes to the core of David’s first (non)argument. Also consider the introduction of Andrew Able’s AER March 2001 article, which I noted here:
Some economists have argued that investing part of the Social Security Trust Fund in equity is simply a rearrangement of paper assets without any real allocational effects, and they have described such a policy as a “shell game.” The shell game argument is similar to the Ricardian equivalence proposition in public finance and macroeconomics and the Modigliani-Miller theorem in corporate finance. The argument is that private investors will react to any rearrangement of the social security system’s portfolio in a way that completely neutralizes the effect of the portfolio change. For example, if the social security system sells a dollar of bonds and purchases a dollar of equity, private investors would buy a dollar of bonds and sell a dollar of equity.
I go onto to explain that if the opportunity set of investors is not altered by privatization, which is akin to taking funds out of one’s left pocket and places them in one’s right pocket, then there is no substitution effect or income effect. Maybe I should also note the end of Brad Setser’s latest (where Brad’s main point is to demolish this nonsense about 2018 being the bankruptcy date):
The fact that social security benefits are not correlated with the stock market – or the bond/ housing markets for that matter – is another one of the social security system’s key virtues. Most retirees already have plenty of market risk from their private pensions. Social security both diversifies the sources of an individual’s retirement income…
Barro and Prescott might fire back that rational individuals can hold risk-free assets – and in fact would. So why does David label my proposition “highly dubious”? Brad himself might point to the posts of Brad DeLong and the writings of Kent Smetters to suggest this “homo-economicacus rationalis” model is incomplete. And one of our commenters (Victor) suggested a corner solution that I later called a borrowing constrained investor. Beyond these two suggestions – neither mentioned by David – I’m at a lost as to why Robert Barro, Andy Able, and my proposition are not what free marketers teach their students.
Now to be fair and balanced let’s turn to this article from Robert Barro on the current account (OK, 3 topics in 1 post). Barro wants his readers to believe in what appears to be two contradictory propositions: (a) that the fiscal stimulus from the Bush tax cuts did not lower national savings and hence are not responsible for the current account deficits; and (b) that reducing government spending would increase national savings and lower the current account deficit. Traditional (non-Ricardian) types might agree with (b) but would disagree with (a). OK, Barro revived Ricardian Equivalence and hence could argue for (a) but not for (b).
I know conservative economists wish to find analytical frameworks to support at least part of President Bush’s agenda. If good economic analysis can do so – please provide the argument. But I’m rather disappointed at how some otherwise respectable economists present what appears to be contradictory arguments to bolster the ill-defined GOP agenda.