Monday, April 04, 2005

Social Security Meta-Archive: February 2005

[Part of the Social Security Meta-Archive: 2005]

Social Security Meta-Archive: January 2005

Empty Promise: The Benefit to African American Men of Private
Accounts Under President Bush's Social Security Plan

Dean Baker. [Later summarized by Max Sawicky.]
Big and little black lies
A Daily Kos diary response to Luskin.
Many Unhappy Returns
Krugman on stocks and economic growth projections:

Schemes for Social Security privatization, like the one described in the 2004 Economic Report of the President, invariably assume that investing in stocks will yield a high annual rate of return, 6.5 or 7 percent after inflation, for at least the next 75 years. Without that assumption, these schemes can't deliver on their promises. Yet a rate of return that high is mathematically impossible unless the economy grows much faster than anyone is now expecting.

To explain why, I need to talk about stock returns. The yield on a stock comes from two components: cash that the company pays out in the form of dividends and stock buybacks, and capital gains. Right now, if dividends and buybacks were the whole story, the rate of return on stocks would be only 3 percent.

To get a 6.5 percent rate of return, you need capital gains: if dividends yield 3 percent, stock prices have to rise 3.5 percent per year after inflation. That doesn't sound too unreasonable if you're thinking only a few years ahead.

But privatizers need that high rate of return for 75 years or more. And the economic assumptions underlying most projections for Social Security make that impossible.

The Social Security projections that say the trust fund will be exhausted by 2042 assume that economic growth will slow as baby boomers leave the work force. The actuaries predict that economic growth, which averaged 3.4 percent per year over the last 75 years, will average only 1.9 percent over the next 75 years.

In the long run, profits grow at the same rate as the economy. So to get that 6.5 percent rate of return, stock prices would have to keep rising faster than profits, decade after decade.

The price-earnings ratio - the value of a company's stock, divided by its profits - is widely used to assess whether a stock is overvalued or undervalued. Historically, that ratio averaged about 14. Today it's about 20. Where would it have to go to yield a 6.5 percent rate of return?

I asked Dean Baker, of the Center for Economic and Policy Research, to help me out with that calculation (there are some technical details I won't get into). Here's what we found: by 2050, the price-earnings ratio would have to rise to about 70. By 2060, it would have to be more than 100.

In other words, to believe in a privatization-friendly rate of return, you have to believe that half a century from now, the average stock will be priced like technology stocks at the height of the Internet bubble - and that stock prices will nonetheless keep on rising.

Social Security privatizers usually defend their bullishness by saying that stock investors earned high returns in the past. But stocks are much more expensive than they used to be, relative to corporate profits; that means lower dividends per dollar of share value. And economic growth is expected to be slower.
Delong comment thread
Krugman's Unhappy Returns

Andrew Samwick:

The critical assumption in the Baker/Krugman example is that the dividend yield doesn't rise above a number like 3 percent, forcing the capital gains to cover the other 3.5 percent and be reinvested in the corporate sector. What if the payout ratio increased dramatically, so that capital gains accounted for only the same 1.9 percent return that matched the growth rate in profits and the economy as a whole? The inconsistency goes away, as the P/E ratio is stable…But is a high payout ratio (e.g., 50% larger than what Krugman is positing) so unrealistic?.......

The most realistic impetus to drive the payout ratio higher is that the size of the elderly cohort will increase fairly dramatically relative to the size of the working-age cohort. Over the 75-year period, the projection is for there to be 80 percent more beneficiaries relative to workers. As more and more of the equity is held by the elderly, there will be a greater demand for firms to pay dividends (or repurchase equity) so that the elderly can consume their accumulated wealth.

According to this theory, the reason the economy doesn't grow faster and P/E ratios don't explode despite the solid return to capital is that firms don't reinvest their earnings. They pay out their earnings to satisfy the consumption demands of the large cohort of elderly. That the payout ratio exceeds historical highs is supported by the projection that the relative size of that elderly cohort also exceeds historical highs. Before I hitch my wagon too firmly to this horse, I'd like to know more about the extent to which elderly have a preference for dividends as opposed to capital gains.

MaxSpeak coverage.
Festival of the Stock Returns!
DeLong on the aftermath of Krugman's column.
The Equity Premium Puzzle
More aftermath from the blog The Dead Parrot Society
White House Social Security Briefing
Starring Claire Buchan, White House Spokeswoman, and the infamous Senior Administration Official:
QUESTION: And am I right in assuming that in the way you describe this, because it's a wash in terms of the net effect on Social Security from the accounts by themselves, that it would be fair to describe this as having -- the personal accounts by themselves as having no effect whatsoever on the solvency issue?

SENIOR ADMINISTRATION OFFICIAL: On the second point, that's a fair inference.
Social Security dupery
The infamous Peter Ferrara.
Third Time Lucky
More aftermath/extended comment in the blog JustOneMinute.
More aftermath with "pseudoerasmus" commenting on Samwick:

This is a clever argument I didn't think of earlier. The dividend payout ratio is currently about 30%. Krugman assumes a 60% payout ratio (which is also assumed by Jeremy Siegel in his optimistic projections for the stock market). But Samwick asks, why can't 90% be realistic? Such a high payout ratio means a much smaller rate of reinvestment of earnings by corporations, which would result in the very thing that the social security actuaries assume, i.e., the low growth rate in GDP. And the reason the payout ratio rises so much in the first place is that the retiree cohort, which is traditionally hungry for income-generating assets rather than growth assets, will be so huge.

Even if it turns out that the baby-boomer retirees are more willing than in the past to forego current income from stocks in favour of capital appreciation, I would have to concede that the a priori inconsistency of high stock return predictions and low growth projections no longer exists.

A possible defeater to Samwick's argument is that a 90% payout ratio is inconsistent with a 1.9% growth in GDP, i.e., a 90% payout ratio might imply an even lower GDP growth rate than what the social security actuaries assume. Which is what Baker seems to be saying, but I have to look over his calculation to see whether that's right.
In repeating Baker's 1999 calculations with updated projections for growth (1.9%) and a P/E ratio of 20, I reckon the highest dividend payout ratio that is consistent with a rate of corporate reinvestment that produces 1.9% GDP growth is 72% (i.e., reinvestment rate equal to 1.4% of stock prices, or 72% of the earnings yield of 5%, which is the reciprocal of the P/E ratio). That produces returns of about 5.5% (=3.6% dividend yield + 1.9% earnings growth). That's approximately what Baker said in his response to Samwick.

However, relatively small changes in a few factors could easily result in returns being around 6.5%, e.g., if the long-run P/E ratio were 17. There is also no particular reason to make the assumption, as Baker does, that growth in capital intensity (i.e., capital deepening) should account for slightly less than half of labour productivity growth. That may have been approximately true in the 1973-95 period, but it's not a long-run historical regularity. If capital deepening accounted for but a third of labour productivity growth (implying that technological improvements bear a slightly larger burden of contributing to the same rate of labour productivity growth than they did in 1973-95), then once again the return would be closer to 6.5%.

In light of the Samwick response, I don't think it's right any longer to say that high stock returns and low GDP growth projections are inconsistent, even if 5.5% is more probable than 6.5%.
Understanding The Bush Plan
A Matthew Yglesias critique.
Signs of Crisis Are Clear
Says Michael Tanner of the libertarian CATO Institute.
CEA Memo on Social Security
President Discusses Strengthening Social Security in Florida
White House transcript:
Q -- really understand how is it the new plan is going to fix that problem?

THE PRESIDENT: Because the -- all which is on the table begins to address the big cost drivers. For example, how benefits are calculate, for example, is on the table; whether or not benefits rise based upon wage increases or price increases. There's a series of parts of the formula that are being considered. And when you couple that, those different cost drivers, affecting those -- changing those with personal accounts, the idea is to get what has been promised more likely to be -- or closer delivered to what has been promised.

Does that make any sense to you? It's kind of muddled. Look, there's a series of things that cause the -- like, for example, benefits are calculated based upon the increase of wages, as opposed to the increase of prices. Some have suggested that we calculate -- the benefits will rise based upon inflation, as opposed to wage increases. There is a reform that would help solve the red if that were put into effect. In other words, how fast benefits grow, how fast the promised benefits grow, if those -- if that growth is affected, it will help on the red.

Okay, better? I'll keep working on it. (Laughter.)
The CEA Forecasts a *Big* Stock Market Crash
DeLong on the implications of what the CEA is and isn't saying.
Gambling With Your Retirement
Krugman on the Bush offer of retirement security as a loan.
Loan Bull
Donald Luskin responds.
Insecure Arguments
A "Special Report" from the American Spectator.
Talking Points Memo
Josh Marshall on defined benefits vs. defined contributions.
More Stock Returns
DeLong responds to Samwick:

Well, let's put GDP growth at 1.9% per year, earnings of companies in the index growing at GDP growth minus one percentage point, so we have 0.9% annual returns coming from there. If we are to have a total return of 6.5% per year, that leaves us 5.6% per year to come from dividends and stock buybacks. At current earnings yields of 3.8% per year, that means that corporate net investment would have to be negative: businesses would have to be spending almost 150% of their net earnings on cash flowing to shareholders, and running down their capital stocks. That can't be done--not if you want to maintain the profitability of the businesses. Failing to replace your capital that wears out and becomes obsolete is a really bad idea.

On The Baker Test
Matthew Yglesias on the implications of hypotheses on issues beyond Social Security.
Opportunity Costs and Notional Accounts
The Dead Parrot Society mines the implications of the 2001 Bush Commission's Model 2.
Who Would Like To Bet On Paul Krugman?
Tom MaGuire, writing at his blog Just One Minute, challenges Krugman on returns to capital.
Wall Street optimistic yet pragmatic on Social Security
Ron Scherer of the Christian Science Monitor on Wall Street's attitude toward Social Security reform.
Why Capital Gains Are Likely to Lag Economy-Wide Growth
Delong performs a "simple and embarrassingly crude calculation."
Spearing the Beast
Krugman on Social Security, the budget and the drive to privatize.
Truly Outrageous!
Jane Galt's take on Brit Hume's assertions on FDR's attitude toward private annuities supplementing Social Security triggers a long discussion on early Social Security history.
Private Accounts as a Loan from the Government to the Worker...
DeLong introduces today's Peter Orszag testimony.
The Minuteman Asks: Who Would Like To Bet On Paul Krugman?
DeLong counterbets MaGuire.
In Which I Claim The Dean Baker "No Economist's Left Behind" Cup
MaGuire reaches, dsquared comments:

What I mean here is that when Bill Miller reinvests his dividends, it doesn't necessarily have any effect on the GDP, because he is for the most part buying already existing equities on the secondary market. But "the market as a whole" can't reinvest by buying stocks on the secondary market; who would they buy them from?[1]. "The market as a whole" can only reinvest its dividends in newly issued stock; either IPOs or seasoned equity offerings.

But if you're buying stock in new companies or financing stock issuance by existing companies, then those companies are selling you shares because they want to do something with the money. Specifically, they want to buy more capital assets and use them to produce goods and services. Which means that GDP grows, hurray. This is why it's difficult to get a compound return of 6.5% without also assuming GDP growth higher than 1.9%.

And as I say, it has to be a compound return that we're interested in. The basic idea here is that you have to model the effect of reinvesting profits on the economy; to do otherwise (which I would argue you have to do in order to get the low growth/high returns outcome) is to commit something like the mirror image of James Glassman's fallacy; rather than double-counting dividends in the returns forecast, you're under-counting them in the GDP forecast.
Opinions on Shape of Earth Differ (Why Oh Why Can't We Have a Better Press Corps? Department)
Delong takes Jonathon Weisman of the Washington Post to task over his coverage of the economic growth/returns to capital debate.
AARP & Social Security: A Background Briefing[PDF]
The AARP makes its case in 17 pages.
The Days of Wine and Reagan
The Decembrist on the 1983 deal with further resources in comment.
Understanding Social Security
Elizabeth Anderson at Left2Right on the multitude of risks SS insures against.
Misunderstanding Social Security
CATO's Will Wilkinson, at his blog The Fly Bottle responds to Anderson.
America's Senior Moment
Paul Krugman reviews The Coming Generational Storm by Laurence J. Kotlikoff and Scott Burns while discussing the relative burden of Social Security, Medicare, and Medicaid:

Why Bush is right to privatize social security
"Dr Eamonn Butler" weighs in at the right-wing UK Adam Smith Institute blog.
Social Security Actuary scoring of Pozen Progressive Indexing Plan[PDF]
If there are no survivors, and the worker dies before such benefit entitlement, their estate would receive the balance in their IA at death minus an offset that would be paid to the Trust Funds to compensate for their earlier allocations of a portion of their payroll taxes to their IA.
We Move Towards The "Hummina Hummina" Moment
Tom MaGuire on Notional Offset accounts.
Now It Is Krugman Versus The Council Of Economic Advisors
Tom MaGuire on Krugman again.
The Editors on Social Security on National Review Online
Why Oh Why Can't We Have a Better Press Corps? (National Review Edition)
DeLong responds.
The Real Reason for Social Security Reform
Bruce Bartlett says Social Security isn't at risk but current income tax rates are.
Does Your Model Have HAIR?
Tom MaGuire continues.
The Privatization Tax
The Decembrist on Senate framing and Center on Budget and Policy Priorities calculating on the price of Privatization to many individual accounts.
The Amazing Disappearing Trust Fund
Washington Post ombudspersons let a liberal question from Dan Froomkin slip through:
Let's assume that it's not just a rhetorical device, or an attempt to confuse the issue. Let's assume that the president really believes that the Social Security trust fund doesn't exist. And let's just forget about the past two decades, during which workers overpaid more than a trillion dollars in payroll taxes. We'll write that off to an unfortunate misunderstanding.

But now take this one more step. Shouldn't Bush therefore call for an immediate cut in payroll taxes, effective immediately?

If Social Security is really pay-as-you-go, and any excess payroll tax revenue just goes into the general fund, why are American workers paying more than it costs to run the program? Why should they overpay Social Security payroll taxes for one more minute -- if in fact it doesn't do the Social Security system any good at all?

The latest numbers I've seen show that American workers this year will pay about $70 billion more in payroll taxes than will get paid out in benefits and administrative expenses. And it's a brutal tax. It's not the least bit progressive. In fact, because it's flat -- and capped at about $90,000 of annual income -- it's vastly tougher on the working poor than it is, say, on millionaires. Not to mention billionaires.

The only reason it's been socially acceptable to keep such a high, regressive tax on the books is that the system it was ostensibly keeping alive for the future returns money in a highly progressive way.

But if -- as of now -- that's not really the case, how can anyone defend it? A capped payroll tax is a pretty harsh way to raise $70 billion a year for the general fund.
Equity Returns and Economic Growth: Model-Building
PDF of DeLong's latest formulation:

  1. A substantial decline in the stock market in the near future to push dividend yields back up to the levels they need to be.
  2. Stagnant wages and a permanent jump in the profit share to push dividend yields up to the levels they need to be.
  3. A large jump in firm payouts, supported by the fact that accounting earnings are massively understated.
  4. A long-run trade surplus of 6% of GDP.
  5. Now none of these are impossible exactly. But only the first is at all likely.

Thinking Things Through
Matthew Yglesias counters Milton Friedman with a thought experiment, and echoes Dean Baker's noting of Samwick & Co.'s failure to think through the problem of growth vs. returns beyond "clever arguments".
Kevin Drum riffs off of DeLong and Yglesias to summarize the response to Maguire's argument:
However, there's an aspect to this whole thing that bothers me, and Matt Yglesias devoted a considerable amount of philosophical brainpower to it yesterday. If I can summarize for the lay audience, it's this: the problem with Tom's argument is that it's just a random post-hoc effort to explain away a problem the privatizers hadn't thought of before (or had been able to ignore). In other words, it's part of the genus bullshit.

For the last 75 years, real stock market returns have closely followed GDP growth. GDP growth is projected to decline in the future, and common sense dictates that lower growth leads to lower corporate profits which in turn leads to lower stock market growth. When someone finally pointed this out, it meant that privatizers could no longer rely on their usual lazy (but credible sounding!) explanation that stock returns for the past 75 years had been around 7% and it was therefore reasonable to use those same returns going forward. They had to make up something new.

What resulted was a bizarre series of Rube Goldberg inventions designed to figure out something — anything — that might change in the next 75 years to make the low growth/high return scenario plausible. Maybe corporations will suddenly become far more profitable than they have been. Maybe they'll start paying out enormous dividends. Maybe overseas investment will skyrocket. In other words, toss every possible piece of mud on the wall you can think of and hope that something sticks. None of these things have to make sense, after all, they just have to sound plausible enough to create a cloud of FUD — fear, uncertainty, and doubt.

Frankly, the privatizers would be better off just telling the truth: stock market returns aren't going to be 7% in the future, but there's a pretty good case to be made that they'll be higher than the 3% you get from treasury bonds. Brad buys that argument, for example, and so does Dean Baker. Stock market returns of, say, 4% or 4.5% don't provide quite the sizzle of 7%, but they still make a perfectly reasonable story. Why not stick with it?

More Intellectual Garbage Pickup (Just How Bad Were We in Our Previous Lives to Deserve This? Department)
Delong vs. Weisman continued, Luskin thrown in.
The Infernal Machine of Imre Lakatos
DeLong follows up Yglesias and Drum & summarizes Maguire.
How to Talk to a Conservative About Social Security
From Think Progress.
Treasury experts split on Social Security plan
Jonathan Kaplan on the Treasury Department split between politicos and careerists in The Hill.
Alan Greenspan Explains it All
The liberal Center for American Progress harps on some of the implications of the latest Greenspan testimony.
Save and Save and Then Save Some More
Steven Landsburg on the need to formulate savings-encouraging policies.
Bush’s Mad Cap Idea
Larry Kudlow of National Review Online opposes any consideration of raising payroll tax wage caps.
Private-Account Concept Grew from Obscure Roots
Washington Post backstory coverage.
Guest Viewpoint: Social Security is about insurance, not savings
In the Register-Guard, economist Mark Thoma of the University of Oregon on Social Security's Job One.
Social Security and the Race Factor
A link to NPR reporting by Ari Shapiro.
And Another Excellent WSJ Article--This Time by Mark Whitehouse

The most bizarre thing--no, it isn't the most bizarre thing, it is just one of many bizarre things that make me question the good faith or the competence--no, make that the good faith and the competence--of those designing and arguing for the Bush private accounts plan--is the 3% + inflation offset required for those who fund their private accounts. This is likely to generate a substantial increase in elderly poverty when a bunch of people reach 65 and find that their private accounts have not been worth the Social Security benefit reductions they cost.
Social Security Meta-Archive: 2005

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