Michael Boskin makes his case for Bush’s Social Security deform, while Max Sawicky provides the critique. Max briefly touched on two aspects of Michael’s paper that relate to utility theory. Michael tried to argue that the income elasticity for government benefits (G) is less than unity:
Economists use a term called the diminishing marginal utility of income to express the commonsense notion that as we get richer, the incremental value of yet more income declines .. keeping a constant ratio of government benefits to income, decade after decade as real incomes double, is unnecessary.
Max noted that if the marginal utility of private goods (P) also exhibit diminishing marginal utility, then a strong case for a progressive tax system follows. Some economists might argue for an ordinal utility rather than a cardinal utility measure, but even if one accepts this cardinal utility premise, Boskin’s case for a declining government benefits to income does not follow from his premise. If the marginal utility of both G and P fall as income rises, we would not say that the income elasticity of both G and P are less than one. The allocation of income between G and P depends on the marginal rate of substitution, that is, on the marginal utility of G relative to the marginal utility of P.
Michael also argued:
As for younger workers, they consistently state when surveyed that they do not expect to receive any Social Security benefits; they expect the system to be bankrupt and gone by the time they retire. This, of course, is exaggeration; there will and should be a Social Security system when they retire, although it will change somewhat from the system now in place. It is bizarre to call slower increases relative to today’s levels a cut for people who expect nothing at all.
Here we are pressing the frontiers of utility theory. The fact of an economic change in material circumstances depends on what is in peoples’ heads, not on the change itself.
I can think of a couple of analogies. Imagine a young investor purchased 100 shares of Macromedia for $2000 a year ago and never really thought much about this investment since. Also imagine his broker called him today and said he’d give the young investor $2500 cash for his shares. I guess the young investor would be elated that his broker would make a $500 gift to him even though the broker was about to pocket $1500 of the young investor’s wealth. OK, the young investor would have to be naïve and if the broker would be less than honest. But the Bush road show is telling young workers that the Trust Fund is bankrupt.
I have a less politically charged analogy that parents of teenagers might appreciate. Let’s imagine I have two teenage boys who daily consume an 8-ounce bag of potato chips. Let’s also imagine that their mom decides to ration their consumption to “two servings” per kid per day. Now if the kids think a serving equals 4 ounces, they might think that mom was going to let each kid consume a whole bag of chips each day. But no, mom has read the label, which defines a serving as one ounce. Will the kids be elated at their new ration or will they curse their parents upon realizing that their chip consumption has been cut in half. If your kids would thank you, you are a better parent than me.