Mark Thoma and Arnold Kling are having an interesting debate as to whether we should think of the future of Social Security in terms of precautionary savings – with a hat tip to Jane Galt. This is all very interesting but Arnold really needs to explain this line:
The reason we should try to fix Social Security now is that the cure can be painless now. The problem is that under conservative assumptions about productivity, promised future benefits exceed future revenues by an ever-growing amount. So cut promised future benefits, and then if productivity does well, you can restore benefits if you like. The point is, planning for the worst case scenario does not hurt anybody in the non-worst-case scenario.
I tend to get nervous when I here someone talking about painless solutions. There are some conservatives who emphasize the benefits of savings without noting that to get more capital accumulation – we have to cut consumption today. Arnold may protest that he is talking about cutting promised future benefits. OK, but then we don’t get more savings if we decide to cut consumption in the future rather than today. Or as Mark replies:
I’m confused about something though. If you were to tell me that I will receive 1 million dollars on the day I turn 67 would that change my behavior today? Yes. I’m pretty sure it would. Would I feel better off today? Yes again. So, go in the other direction. If you tell me I will have less money in the future because my benefits will be cut, maybe not by a million dollars but by enough to matter, will that change my behavior today? Yes it will, and I’ll feel worse off. More importantly, is it reversible like Arnold says? Suppose I give up a vacation and save instead because I believe benefits will be cut in the future. I can’t always reverse that later (I can’t necessarily climb the same mountain or ski the same slopes when I’m older, and even if there’s no physical constraint, the opportunities will differ with time). Or maybe the benefit cuts make it so I can’t simultaneously send a child to college and save as much as I need to for retirement due to resource constraints. How does cutting future benefits, even probabilistically, leave me unaffected in such a case? The point is that changing expected future benefits alters the time paths for consumption and saving (a premise, or at least a hope, of those in favor of privatization of Social Security) which, contrary to the claim above, does affect people “in the non-worst-case scenario.”
Arnold – when you said painless, you seemed to suggest there is a free lunch. I trust you realize there is no such thing. I’m as confused as Mark is about this passage. Please clarify.
Update: Arnold and I have traded comments under this post. It would seem his position is that households don’t save enough and there is some magic public policy change that will fix that. And I thought I was the liberal! OK Arnold – what is the market failure and how is a change in public policy going to fix that?
Update II: Arnold and I have traded comments again. Arnold seems to be frustrated with me that I don’t get his argument so he tries again. As I read his latest comment, dare I try to interpret it? Well let’s see how far I get this time. He is saying that if we take away people’s promised benefits, they will save more. Well, this is exactly what Ando and Modigliani might say as well so Arnold must be correct. So if we take away a person’s expected future income, which is akin to a reduction in lifetime income, then this person will decide to consume less today so they can save more for their retirement. No quarrel here, but isn’t a reduction in wealth equivalent to pain for that person. So I ask again – what did Arnold mean by “painless”. Painless to who? Yep – I suspected there was some distributional twist to all of this and it seems Arnold has confirmed as much.
Let me go further by suggesting Jane Galt and Arnold have mischaracterized the liberal objection to their proposal. It’s not that we don’t want people to save more. Heavens – the deficit hawk wing of my party – to which I’m a member – have hammered the free lunch fiscal fiasco of Bush’s income tax cuts as reducing national savings. But we have also long suspected that this was part of a grand plan to transfer wealth from the working poor to the “investor class” as Kudlow would have it. If Jane Galt and Arnold Kling want more precautionary savings, I agree. The question is how do we get there? Raise taxes on the rich or go for this backdoor employment tax increase that Arnold is advocating. I prefer the former.