Yglesias, Krugman get it wrong on Social Security reform

Paul Krugman, playing off another post by Matt Yglesias, brings up an interesting, but I think ultimately wrong, argument against President Bush's plans for Social Security reform in 2005. He says:

If the Bush scheme goes through, the same thing will eventually happen to Social Security. As Mr. Furman points out, the Bush plan wouldn't just cut benefits. Workers would be encouraged to divert a large fraction of their payroll taxes into private accounts - but this would in effect amount to borrowing against their future benefits, which would be reduced accordingly.

As a result, Social Security as we know it would be phased out for the middle class. "For millions of workers," Mr. Furman writes, "the amount of the monthly Social Security check would be at or near zero."

The policy background is this: Bush proposed "progressive indexing," which would reduce benefits on a sliding scale for middle and upper earners. In addition, Bush proposed voluntary personal accounts; those choosing a personal account would then give up an additional portion of their traditional benefits. We called this second-stage reduction an "offset." Jason Furman's argument at the time was that the combination of reduced traditional benefits for everyone plus an additional reduction for account holders could mean that many middle and upper earners would "zero out" their traditional benefits. This, Jason argued, would weaken such individuals' support for Social Security, as they would continue to pay taxes but not receive any traditional benefits from the program.

A couple thoughts: First, Jason's calculations were done using the SSA actuaries' stylized workers, which presume that individuals work every year of their life. Doing so produces higher account contributions, and thereby larger reductions to traditional benefits. In a more realistic context, in which many people take years out of the workforce, far fewer people would zero out their traditional benefits. We checked into this at the time using the SSA's MINT microsimulation model, which uses a realistic sample of the population to simulate Social Security reform. If my notes from the time are correct, our simulation of President Bush's proposal resulted in around 2 percent of retirees zeroing out their benefits by 2050 and around 6 percent by 2061. This shows that zeroing out can happen, but it's a lot rarer than Krugman would have you believe.

Second, I'm not sure how big the sentiment effect would be on people who zeroed out their benefits. These folks would actually receive higher rates of return overall than had they not chosen to open an account – because the offset to their traditional benefits was only incompletely realized – so they were getting a decent deal under the circumstances.

And third, it's not as if plans favored by Krugman and the like would treat high earners any better than the Bush plan did. The only difference would be that instead of high earners receiving lower benefits, these folks would pay higher taxes – much higher taxes, most likely. To assume that the Bush plan would turn high earners against the program while, say, President Obama's proposals wouldn't, assumes either that high earners care about their benefits but not their taxes (I'd think the opposite is more likely to be true) or that they're simply very bad at math.

I recently ran some numbers on how high the tax rate on earnings above $250,000 would have to be to balance Social Security's finances while keeping Obama's promises to not cut benefits or raise the retirement age while raising taxes only on high earners. My guestimate is that the surtax would have to be around 25 percent, not the 2-4 percent President Obama has talked about. My challenge to Mr. Krugman: find some rich folks and ask them how they'd feel about this.

Bonus point: Matt Yglesias says that Bush's plan

was a proposal to destroy Social Security, not a proposal to reduce its project deficit. And it certainly wasn't "any attempt to contain the cost of entitlements." It was a very specific and narrow set of proposals; the administration said they wouldn't consider any ideas that didn't involve privatizing Social Security. The Diamond-Orszag balanced approach to Social Security was an effort to contain the cost of entitlements. Bush didn't propose anything of the sort.

The first part of the quote is basically nonsense, but the latter regarding the Diamond-Orszag plans "balanced approach" caught my eye. As I showed in this post, the claim that Diamond-Orszag is balanced is just plain wrong. Around 84 percent of the plan's improvement to Social Security's finances comes through tax increases, with only 16 percent deriving from benefit cuts. How's that for balanced? The Greenspan commission's recommendations, by contrast, were much closer to 50-50, depending on whether you considered income taxes levied on retirement benefits as a tax increase or a benefit cut.

Moreover, even these benefit cuts don't actually reduce overall Social Security costs, Ygelsias's claims to the contrary. Again referring back to my notes from the time, Diamond-Orszag's total costs over 75-years were almost exactly the same as current law Social Security. (In present value terms, D-O's costs were around 0.2 percent higher). So Diamond-Orszag didn't really contain entitlement costs, it simply raised taxes to meet them. In health care terms, the cost curve was pretty much "unbent."