Tuesday, March 30, 2010

Entitlement Apocolypse? - CNBC.com

Tonight I was on the Larry Kudlow show on CNBC, debating entitlements with the diminutive but crafty former Labor Secretary Robert Reich. One would think that my natural rudeness would make me well-suited for the "Jane, you ignorant slut" format of TV news, but for whatever reason I find it hard to interrupt enough. Next time I'll just talk straight through the segment, regardless of what everybody else does.

Entitlement Apocolypse? - CNBC.com Read more!

Are state finances doomed? It's not looking good...

The New York Times reports on the rise of state debts, including in them the market value of public sector pension deficits, derived from this AEI working paper. Here are the top debt offenders.

When combined with states' shares of the rising federal debt, its easy to imagine the states and/or their taxpayers being overwhelmed. Click here to read the whole story.

Read more!

Monday, March 29, 2010

Rubio v Crist on Social Security reform

From the Enterprise Blog

I caught the debate between Florida Republican Senate contenders Governor Charlie Crist and Marco Rubio on "Fox News Sunday." I hadn't previously paid much attention to this race, but—as a Social Security specialist—their answers regarding how to fix this program said a lot to me about the relative virtues of the candidates and, perhaps more importantly, regarding Americans' willingness to take on tough issues.

Rubio pointed out the problems facing the Social Security program and stated that we're going to have to look at the tough choices, which include raising the retirement age for younger Americans, possibly reducing Cost of Living Adjustments, and other changes to benefits. If you don't want to raise taxes—which both Crist and Rubio say they oppose—then these are pretty much your only options.

Crist replied that he opposes either a retirement age increase or changes to annual COLAs. Instead, he would focus on attacking "waste and fraud" in the system.

As a general rule, when a politician mentions "waste, fraud, and abuse" it should be interpreted the same as if the candidate wore a sign saying "I'm not serious." That's not to say that we don't have problems with fraud, but that the real problem is simply that the government spends too much.

This is particularly so in the case of Social Security, which is one of the most efficient federal government programs. Social Security takes money from young workers, calculates a benefit for retirees based on their earnings and their years in the workforce, and cuts them a check. There's not a lot of discretion involved, which reduces chances for things to go wrong. Sure, there are problems in the disability program and I'm confident there are folks getting disability benefits who actually could work. But that's the fault of the eligibility criteria passed by Congress in the 1980s more than any problem of vetting applicants by the Social Security Administration. On this issue, at least, Crist was very unimpressive.

What did impress me, though, was the fact that Rubio—who, after all, is running for the Senate from Florida—was willing to be upfront about the hard choices awaiting us on Social Security. In part this may be due to the character of the candidate, who struck me as a principled conservative.

But even more so, this may be due to the dawning on Americans that the clock is truly ticking in terms of getting our fiscal house in order. Rubio brought up the problem of Greece's debt crisis and related it to what America may be looking at in the future. (I discussed this issue here.) It's a sure sign a country is in tough shape when candidates on national television worry about the value of their currency. Yet, while it's bad that we have to discuss these things, it's at least comforting that we're at last willing to do so.

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Social Security in Deficit; Will It Ever Rebound?

The New York Times reports that the Congressional Budget Office (CBO) projects that Social Security will run a cash deficit of around $29 billion this year, something that hadn't previously been predicted to occur until 2016. This isn't huge news, as the program was only barely in surplus this past year and the demographics aren't getting any better.

But here's one thing I wonder about: will the program ever come out of deficit again, or is this it? The CBO projects that Social Security will return to small surpluses (in blue) of $5 billion in 2014 and $4 billion in 2015, before again going into deficits—this time permanently—in 2016.

But as far as I know, the CBO's "current law" projections assume that the Bush tax cuts are repealed in their entirety when they expire at the end of 2010. If, however, the cuts are retained for low- and middle-income households—as President Obama has promised—then Social Security revenues from income taxation may be slightly reduced. This could be enough to tip the balance.

In 2014, for instance, Social Security's own actuaries predict that the program will receive around $31 billion in revenues from income taxes levied on retirement benefits. If that amount is reduced slightly, then the chances of a surplus are reduced.

In the end, the difference between a small surplus and a small deficit isn't a big deal substantively. Over the next 10 years, CBO projects that Social Security will run a total cash deficit exceeding $200 billion.

But it may be a big deal in influencing if and when Americans and their representatives in Washington come to terms with the fact that Social Security and other entitlement programs aren't going to fix themselves. As long as Social Security has been in surplus, it has been easier for policy makers to forget that fact.

Update: Marc Goldwein over at the Committee for a Responsible Federal Budget caught this first -- I'm losing my edge as I get older...

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New papers from the Social Science Research Network


"The Recent Evolution of Pension Funds in the Netherlands: The Trend to Hybrid DB-DC Plans and Beyond" 

EDUARD H.M. PONDS, affiliation not provided to SSRN
Email: pensioenen@abp.nl
BART VAN RIEL, Government of the Netherlands - Social Economic Council
Email: b.van.riel@ser.nl

According to the classification in official statistics, Dutch pension plans have mainly preserved their DB character in recent years. The dominant reaction of pension funds to the fall in funding ratios at the beginning of this century has been a switch from final-pay schemes to average-wage schemes. This contrasts sharply with the experience in the United States and the United Kingdom, where the fall in pension funding ratios has accelerated the switch from DB to DC schemes.

This paper scrutinizes the recent evolution of Dutch pension plans: how does the evolution of Dutch pension funds diverge from that of Anglo-Saxon pension funds, and how can we explain this divergence.' Using an ALM framework, we argue that the current average-wage pension plans may be better viewed as hybrid DB-DC schemes, as indexation of all liabilities has been made solvency-contingent. Because these hybrid plans make use of two steering mechanisms to control solvency risk, Dutch pension funds display a high effectiveness in minimizing the risk of under-funding.

The current hybrid schemes reflect a compromise between the various stakeholders. We examine the institutional basis for this compromise, and contrast this with the situation in Anglo-Saxon pension funds, where primarily employers are responsible for absorbing funding deficits, which gives them in turn more grip on pension plan design issues. In addition, we look at the role of unions, the strong preferences within the Dutch society for collective risk-sharing, and the underlying high level of social trust, as explanations for the divergence with the experience in the US and the UK.

For the longer term, we foresee that Dutch pension plans will shift further towards stand-alone multimember plans, often being called collective DC. This will be accompanied by more differentiation in risk exposure between younger and older members.

Collective risk-sharing will thus remain an important element in Dutch pension funds. In this sense, the evolution of Dutch pension schemes diverges from the developments of Anglo-Saxon pension funds, where risks are shifted more to the individual. Finally, we argue that collective risk-sharing has some important advantages over individual risk-sharing.

"Retirement Security and the Stock Market Crash: What are the Possible Outcomes?" 

BARBARA A. BUTRICA, The Urban Institute
Email: bbutrica@ui.urban.org
KAREN E. SMITH, Urban Institute
Email: ksmith@ui.urban.org
ERIC J. TODER, National Bureau of Economic Research (NBER)
Email: etoder@his.com

This paper simulates the impact of the 2008 stock market crash on future retirement savings under alternative scenarios. If stocks remain depressed as after the 1974 crash, 20 percent of pre-boomers born 1941-45 and 22 percent of late boomers born 1961-65 would see their retirement incomes drop 10 percent or more. Working another year would reduce the share of these big losers to 14 percent for late boomers. Because most pre-boomers were already retired, their share of big losers would decline slightly, to 19 percent. Delaying retirement would disproportionately benefit low-income people because their additional earnings exceed their stock market losses.

"An Update on 401(K) Plans: Insights from the 2007 Survey of Consumer Finance" 

ALICIA H. MUNNELL, Boston College - Center for Retirement Research
RICHARD W. KOPCKE, Federal Reserve Bank of Boston
Email: richard.kopcke@bos.frb.org
FRANCESCA GOLUB-SASS, Boston College - Center For Retirement Research (CRR)
Email: golubsas@bc.edu
DAN MULDOON, Center for Retirement Research at Boston College
Email: muldoolb@bc.edu

The maturation of the 401(k) system and the enactment of the Pension Protection Act of 2006, which made 401(k) plans easier and more automatic, were expected to enhance the role that 401(k)s played in the provision of retirement income. So, originally, the release of the Federal Reserve's 2007 Survey of Consumer Finances (SCF) seemed like a great opportunity to reassess 401(k)s. But the 2007 SCF reflects a world that no longer exists. Interviews were conducted between May and December, when the Dow Jones was at 14,000 (the peak was October 9, 2007) and housing prices were only slightly off their peak.

Given the collapse of the financial markets and the economy, this paper uses the 2007 SCF data as a starting point in evaluating the condition of 401(k)s and the factors that affect participation and contributions, and relies on more recent data and estimates to paint a full and current picture. The analysis proceeds as follows. The first section describes the evolution of 401(k) plans and how the Pension Protection Act of 2006 would be expected to improve the performance of these plans. The second section uses data from the 2007 SCF and other sources to update previous findings on participation, contribution levels, investments, and withdrawals. The third section explores in more depth how individual characteristics and plan design affect participation and contributions in 401(k) plans. The fourth section then projects how the events of 2008 have affected various aspects of 401(k) plans. The final section concludes that whereas 401(k) plans were showing some improvement in 2007 and the analysis of participation and contribution decisions confirmed the trend toward auto-enrollment and the maturation of the system, the events of 2008 highlight the limitations of 401(k) plans in serving as the only supplement to Social Security.

"Social Security and the Joint Trends in Labor Supply and Benefits Receipt Among Older Men" 

BO MACINNIS, Institute for Social Research
Email: macinnis@umich.edu

Using data from the Current Population Surveys, we find an increase in the fraction of older American men who worked without receiving Social Security retirement benefits and a decline in the fraction of men who claimed benefits without working during the period 1980-2006. Using bivariate probit regressions, we find that an increase in Social Security's normal retirement age decreased labor force participation rate regardless of benefits receipt status; that an increase in the delayed retirement credit increased benefit receipt regardless of labor force status; and that labor force participation and claiming Social Security benefits are strongly and negatively correlated.

"Public Pensions, Changing Employment Patterns, and the Impact of Pension Reforms Across Birth Cohorts: A Microsimulation Analysis for Germany" 

IZA Discussion Paper No. 4815

JOHANNES GEYER, German Institute for Economic Research (DIW Berlin)
Email: jgeyer@diw.de
VIKTOR STEINER, Zentrum Fuer Europaeische Wirtschaftsforschung (ZEW) - Center for European Economic Research, Institute for the Study of Labor (IZA)
Email: steiner@zew.de

We analyze the impact of changing employment patterns and pension reforms on the future level of public pensions across birth cohorts in Germany. The analysis is based on a rich dataset that combines household survey data from the German Socio-Economic Panel Study (SOEP) and process-produced microdata from the German pension insurance. A microsimulation model is developed which accounts for cohort effects in individual employment and unemployment and earnings over the lifecycle as well as the differential impact of recent pension reforms. Cohort effects for individuals born between 1937 and 1971 vary greatly by region, gender and education and strongly affect lifecycle wage profiles. The largest effects can be observed for younger cohorts in East Germany and for the low educated. Using simulated life cycle employment and income profiles, we project gross future pensions across cohorts taking into account changing demographics and recent pension reforms. Simulations show that pension levels for East German men and women will fall dramatically among younger birth cohorts, not only because of policy reforms but due to higher cumulated unemployment. For West German men, the small reduction of average pension levels among younger birth cohorts is mainly driven by the impact of pension reforms, while future pension levels of West German women are increasing or stable due to rising labor market participation of younger birth cohorts.

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Friday, March 26, 2010

New paper: Social Security, Benefit Claiming, and Labor Force Participation: A Quantitative General Equilibrium Approach

From the Social Science Research Network:

Social Security, Benefit Claiming, and Labor Force Participation: A Quantitative General Equilibrium Approach

Selahattin Imrohoroglu, University of Southern California - Department of Finance and Business Economics
Sagiri Kitao, University of Southern California - Department of Finance and Business Economics
March 1, 2010
FRB of New York Staff Report No. 436

We build a general equilibrium model of overlapping generations that incorporates endogenous saving, labor force participation, work hours, and Social Security benefit claims. Using this model, we study the impact of three Social Security reforms: 1) a reduction in benefits and payroll taxes; 2) an increase in the earliest retirement age, to sixty-four from sixty-two; and 3) an increase in the normal retirement age, to sixty-eight from sixty-six. We find that a 50 percent cut in the scope of the current system significantly raises asset holdings and the labor input, primarily through higher participation of older workers, and reduces the shortfall of the Social Security budget through a reduction in early claiming. Increasing the normal retirement age also raises saving and the labor supply, but the effects are smaller. Postponing the earliest retirement age has only a negligible effect. When the projected aging of the population is taken into account, the case for a reform that encourages labor force participation of the elderly appears to be much stronger.

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Thursday, March 25, 2010

NY Times: Social Security in the red

The New York Times' Mary Walsh reports on CBO projections that Social Security will run a cash deficit of nearly $30 billion this year:

This year, the system will pay out more in benefits than it receives in payroll taxes, an important threshold it was not expected to cross until at least 2016, according to the Congressional Budget Office.

Stephen C. Goss, chief actuary of the Social Security Administration, said that while the Congressional projection would probably be borne out, the change would have no effect on benefits in 2010 and retirees would keep receiving their checks as usual.

The problem, he said, is that payments have risen more than expected during the downturn, because jobs disappeared and people applied for benefits sooner than they had planned. At the same time, the program's revenue has fallen sharply, because there are fewer paychecks to tax.

Click here to read the whole story.

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Wednesday, March 24, 2010

Simple Steps to Fix Social Security

Over at the New York Times
Room For Debate blog, I and four others – Alicia Munnell, Bill Gale, Tom Saving and Teresa Ghilarducci – weigh in on how to fix Social Security. While I wouldn't say we're all on exactly the same page, I think the differences are more muted than they might have been five or so years ago. In any case, everyone there has something worth listening to. Check it out.

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Jed Graham: A Better Way To Save Social Security

Jed Graham, who writes for Investor's Business Daily and is the author of the new book "A Well-Tailored Safety Net: The Only Fair and Sensible Way to Save Social Security," has a blog post over at IBD outlining how he sees the issue. Here's a taste of it:

Fiscal conservatives are right: Given bigger budget problems outside of Social Security, the benefits that have been promised may be unaffordable — even with significant tax hikes.

But so are liberals: Social Security is hardly generous to begin with, and significant benefit cuts could leave a big hole in the safety net for future retirees, who will face great risk of living long enough to deplete their savings.

The problem isn't simply one of politics: The only logical goal for Social Security reform is an affordable and effective safety net that meets both the nation's fiscal challenge and the responsibility of caring for an aging population, but none of the proposals on the table have reflected both priorities. They either rely too heavily on tax increases or cut away critical protections, and in some cases they do both.

There's only one route to Social Security reform that can limit the need for tax hikes while still meeting the needs of both the working class and the broad middle class: A safety net that is firmer for low earners than high earners early in retirement, with benefit cuts gradually unwinding to provide robust support for older retirees of all income levels.


Read more!

Monday, March 22, 2010

Public Pension Deficits Are Worse Than You Think

From today's Wall Street Journal: Public Pension Deficits Are Worse Than You Think

How can fund managers assume an 8% rate of return?


Pension plans for state government employees today report they are underfunded by $450 billion, according to a recent report from the Pew Charitable Trusts. But this vastly underestimates the true shortfall, because public pension accounting wrongly assumes that plans can earn high investment returns without risk. My research indicates that overall underfunding tops $3 trillion.

The problem is fundamental: According to accounting rules adopted by the states, a public sector pension plan may call itself "fully funded" even if there is a better-than-even chance it will be unable to meet its obligations. When that happens, the taxpayer is on the hook. Yet public pension plans ignore market risk even as they shift into risky foreign investments, hedge funds and private equity.

A simple example illustrates the flaw. Imagine that you borrowed $100, which you absolutely, positively must repay in 20 years. How much money would you need today to consider that debt "fully funded?"

Here are two correct answers, followed by an incorrect one. All three rely on "discounting," a method of calculating the sum of money needed today to fund a given liability in the future.

First, discount $100 at the 4.5% yield on safe, 20-year Treasury notes. This produces a present value of $41.46, which you invest in Treasury securities. Barring federal government bankruptcy, you can repay your debt with certainty.

Second, discount $100 at the expected return on stocks—say 8%. This produces a present value of $21.45, which you invest in equities. Next, purchase a "put option" giving you the right to sell your portfolio 20 years hence for no less than $100. This option would cost $20.08, for a total cost today of $41.53. Barring the collapse of the options exchange, you also can be certain of repaying your debt.

But here is a third answer: discount $100 at an 8% interest rate. Invest $21.45 in stocks. Declare yourself "fully funded." This doesn't work because there's a very good chance your risky assets won't appreciate in value enough to cover the debt. Yet this is how public sector pension accounting operates.

Vested pension benefits are constitutionally guaranteed in eight states and protected by law in two dozen more. And in most every state politics makes accrued benefits impossible to cut. Orange County, Calif., in the 1980s and New York City in the 1970s effectively made pension obligations senior to government debt by paying full retirement benefits even as they inflicted losses on bondholders.

Yet public pensions discount ironclad liabilities at the high rates of return they project for risky investment portfolios. Consider New York state's Employees Retirement System (ERS), which assumes an 8% return on its assets. Discounted at this interest rate, ERS's liabilities had a present value of $141 billion as of 2008. ERS assets at that time were $152 billion, making the program overfunded by 7%.

But New York's portfolio is hardly likely to produce a steady 8% each year. Since 1990 its returns have varied widely, ranging from 30.4% in 1998 to -26.4% in 2009. A "Monte Carlo" computer simulation (a standard technique for modeling financial risks) incorporating fluctuating asset returns shows that New York's ERS has only around a 45% probability of meeting its liabilities. Instead of an $11 billion surplus, the ERS is almost $100 billion shy of funding its benefits with certainty.

In a recent AEI working paper I've shown that the typical state employee public pension plan has only a 16% chance of solvency. More public pensions have a zero probability of solvency than have a probability in excess of 50%. When public pension assets fall short, taxpayers are legally obligated to make up the difference. The market value of this contingent liability exceeds $3 trillion.

Public pension plans are hiding behind unrealistically low deficit figures. This allows policy makers to dodge difficult choices today at the cost of a much heavier burden on taxpayers in the future.

Mr. Biggs is a resident scholar at the American Enterprise Institute.

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Wednesday, March 17, 2010

New CRR Issue Brief: "Should You Convert a Traditional IRA Into a Roth IRA?"

The Center for Retirement Research at Boston College has released a new Issue in Brief by Richard W. Kopcke and Francis M. Vitagliano titled
"Should You Convert a Traditional IRA Into a Roth IRA?"

The brief finds that converting a traditional IRA to a Roth IRA may appeal to people who:

  • expect their tax rates to rise in retirement;
  • prefer more flexible withdrawal options; and/or
  • wish to increase their tax-sheltered assets.

This brief is available here.

Read more!

Monday, March 15, 2010

AARP Makes Spurious Argument for COLA

Cross posted from The Enterprise Blog.

Last Monday in the New York Times, I co-authored an op-ed with Alicia Munnell, professor of economics at Boston College and director of the Center for Retirement Research, regarding proposals to pay an ad hoc Cost of Living Adjustment (COLA) to retirees this year, to compensate them for Social Security not paying an automatic COLA in 2010. Our argument was pretty simple: there's no need for a COLA in a year in which the cost of living didn't increase—and we show that even using an inflation measure geared toward seniors the cost of living didn't rise.

In Sunday's New York Times the AARP responds. As you'd expect, they disagree. AARP's Chief Operating Officer Tom Nelson writes,

The article demonstrates the inadequacy of using textbook economics to discuss the actual experiences of real people. By arguing—despite the biggest economic downturn since the Great Depression—that "retirees did all right over the last few years," the authors demonstrate a lack of understanding of the negative impact of decimated retirement savings on older Americans.

A general note: when someone writes about "the inadequacy of using textbook economics" or something along those lines, what it usually means is that they're not going to bother disputing the arguments and evidence you presented.

As it happens, our article didn't actually rely on much economics, textbook or otherwise. It was really just simple math: when prices rise, Social Security benefits should rise to match them. When prices don't rise, well, you get the picture.

Now, you can make a case that seniors are suffering due to the recession, rising health costs, or what-have-you and therefore deserve government help. But that has nothing to do with COLAs. Moreover, to make that argument you presumably should present some evidence that seniors are suffering more than working age people, who are, after all, the folks who would pick up the tab for this ad hoc COLA. The evidence really isn't very strong: younger Americans have taken bigger hits to their retirement savings and are far more likely to be unemployed than seniors. And, unlike current retirees, younger folks are going to need to save far more for retirement as Social Security and Medicare won't be in nearly as good shape by the time we reach retirement age.

In a sense, I don't blame AARP. They're effectively lobbyists for seniors—very good ones, judging by the state of federal finances—and you can't fault them for trying to get more stuff for their members. But at some point we have to realize that there's no more money to give; it's time to start thinking about where we can cut back. It's very sad that even as deficits reach record levels and the national debt spirals upwards, interest groups continue to make spurious arguments for more. But that's where we stand.

Read more!

Sunday, March 14, 2010

Social Security to Start Redeeming Trust Fund Bonds

The Associated Press
reports that Social Security is like to run a cash deficit this year – meaning it will collect less in taxes than it pays in benefits, administrative costs and other expenses – and will need to redeem some of the approximately $2.5 trillion in special-issue government bonds held in the Social Security trust fund. Repaying these bonds will require the federal government to produce extra cash, implying higher taxes, lower spending or – most likely by far – increased budget deficits.

Social Security's shortfall will not affect current benefits. As long as the IOUs last, benefits will keep flowing. But experts say it is a warning sign that the program's finances are deteriorating. Social Security is projected to drain its trust funds by 2037 unless Congress acts, and there's concern that the looming crisis will lead to reduced benefits.

A good article with reaction from both sides. Worth taking a look.

One line I particularly liked, from the National Committee to Preserve Social Security and Medicare's Barbara Kennelly: "Those bonds are protected by the full faith and credit of the United States of America," Kennelly said. "They're as solid as what we owe China and Japan." I guess, but that doesn't exactly carry as much weight as it used to.

Read more!

Thursday, March 11, 2010

New Pensions Papers from the Social Science Research Network


"Forced Savings and Annuitisation with Cross-Subsidies: A Mutation of the Beast" 

UNSW Australian School of Business Research Paper No. 2009ACTL09

BENJAMIN AVANZI, Australian School of Business at UNSW
Email: b.avanzi@unsw.edu.au
SACHI PURCAL, University of New South Wales (UNSW) - School of Actuarial Studies
Email: s.purcal@unsw.edu.au

We formulate a two-tiered economic approach to classify national schemes which mandate retirement savings (defined contribution type schemes). We extend the plain vanilla concept of a system of forced savings advocated by the World Bank (1994) by allowing for annuitization and cross-subsidies. In this way we treat both the accumulation and decumulation phases of lifetime savings.

The first tier of our model is controlled by government, which mandates contribution rates, interest rates, and conversion into benefits. In contrast, agents make voluntary contributions to the second tier, which earns interest at a rate broadly reflecting market conditions and any cross-subsidy between both tiers. Cross-subsidies within the mandated tier and between both tiers allow for social redistribution as well as fostering the creation of a liquid market of privately provided annuities.

We conclude with a discussion of the Swiss and Australian systems of retirement savings as seen through the lens of our model. The former is system with cross-subsidies and annuities, while the latter is one without.

"The Impact of Changing Earnings Volatility on Retirement Wealth" 

AUSTIN NICHOLS, The Urban Institute
Email: ANichols@ui.urban.org
MELISSA FAVREAULT, The Urban Institute

Over the last several decades, the volatility of family income has increased markedly, and own earnings volatility has remained relatively flat. Volatility may affect retirement wealth, depending on whether volatility affects accrued pension contributions or withdrawals or earnings credited toward future Social Security benefits. This project assesses the effect of the volatility of individual and family earnings on asset accumulation and projected retirement wealth using survey data matched to administrative earnings records.

"Evaluating Micro-Survey Estimates of Wealth and Saving" 

BARRY BOSWORTH, Brookings Institution - Economic Studies Program
Email: bbosworth@brookings.edu
ROSANNA SMART, affiliation not provided to SSRN

This paper presents an overview of changes in household wealth accumulation and saving using wealth data from three micro-level surveys: Survey of Consumer Finances (SCF), Panel Study of Income Dynamics (PSID), and Health and Retirement Study (HRS). We provide comparisons to the macroeconomic estimates of wealth accumulation and saving, explore problems in constructing household-level valuations of wealth, and assess the value of using household-level datasets to examine wealth accumulation and saving behavior in the United States.

Our first analysis compares the macroeconomic estimates of wealth from the Flow of Funds to comparable measures from the SCF, PSID and HRS. The Flow of Funds and SCF valuations of net worth correspond closely up to 1998. Yet, after1998, the SCF reports a much more rapid acceleration of wealth, concentrated in equity-type assets. The estimates of wealth in the PSID and HRS are very similar to the SCF for the bottom 95 percent of the wealth distribution, diverging only for the top five percent of households...

"Taxes and Pensions" 

PETER A. DIAMOND, Massachusetts Institute of Technology (MIT) - Department of Economics, National Bureau of Economic Research (NBER), CESifo (Center for Economic Studies and Ifo Institute for Economic Research)
Email: pdiamond@mit.edu

Pension benefit rules depend on individual history far more than taxes do, and age plays a much larger role in pension determination than in tax determination. Apart from some simulation studies, theoretical studies of optimal tax design typically contain neither a mandatory pension system nor the behavioral dimensions that lie behind justifications commonly offered for mandatory pensions. Conversely, optimizing models of pension design typically do not include annual taxation of labor and capital incomes. After spelling out this contrast and reviewing (and rejecting) zero taxation of capital income based on the Atkinson-Stiglitz and Chamley-Judd results, this article raises the issue of tax-favored retirement savings, a topic where the two subjects come together.

"Your Nest Egg on Auto Pilot" 

LEWIS MANDELL, Aspen Institute - Initiative on Financial Security
Email: lewis.mandell@aspeninstitute.org
PAMELA J. PERUN, Aspen Institute - Initiative on Financial Security
Email: pamela@planetnow.com
LISA MENSAH, Aspen Institute - Initiative on Financial Security
Email: lisa.mensah@aspeninstitute.org
RAYMOND O'MARA III, Aspen Institute - Initiative on Financial Security
Email: raymond.omara@aspeninstitute.org

The Obama administration has proposed bold new policies to expand retirement savings. Through a program of Automatic IRAs, the approximately 78 million American workers not currently covered by a plan at work would be able to save through workplace-based individual retirement accounts. As important as money flowing into the Automatic IRA is, the central test of the Automatic IRA policy will be how much money will be available to flow out at retirement. How can the Automatic IRA insure that significant assets are built for retirement? To that end, the investment menu will be critical because it is the engine that grows contributions into retirement assets.

The Initiative on Financial Security at the Aspen Institute has designed an investment vehicle suitable for use as the default investment for the Automatic IRA. Real Savings Plus offers an automatic, inexpensive blend of TIPS and a market index to provide savers with a guaranteed return of their contributions along with the likelihood of upside potential through equity investing. Real Savings Plus thus protects the value of each dollar saved from the most likely risks to retirement income while offering the opportunity for significant growth as well.

We demonstrate in this brief that Real Savings Plus is highly likely to outperform the "R-Bond", another proposed default investment for the Automatic IRA, in building financial assets for retirement. At the same time we show that Real Savings Plus, like the R-bond, is able to guarantee the full return of a saver's contributions adjusted for inflation even under the worst imaginable economic circumstances. Finally, we briefly describe other benefits of Real Savings Plus beyond investment performance, such as its low-cost structure, automatic asset allocation, and potentially wide availability throughout the financial services industry.

"Performance Evaluation of Balanced Pension Plans" 

LAURA ANDREU, University of Zaragoza - Faculty of Business and Economics
Email: landreu@unizar.es
LAURENS A. P. SWINKELS, Robeco Quantitative Strategies, Erasmus University Rotterdam (EUR)
Email: l.swinkels@robeco.nl

This paper examines the ability of balanced pension plan managers to successfully time the equity and bond market and select the appropriate assets within these markets. In order to evaluate both market timing abilities in these balanced pension plans, we extend the traditional equity market timing models to also account for bond market timing. As far as we know, we are among the first to apply this multifactor timing model to investigate equity and bond market timing simultaneously. This performance evaluation has been conducted on two samples of Spanish balanced pension plans, one with Euro Zone and one with World investment focus. This allows us to decompose managers' skills in three components: selectivity, equity market timing, and bond market timing. Our findings suggest that the average stock picking ability of pension plans is positive. World schemes tend to have positive bond timing skills, while Euro Zone pension plans are on average not able to time equity or bond markets.

"Are Age - 62/63 Retired Worker Beneficiaries at Risk?" 

ERIC R. KINGSON, Syracuse University - School of Social Work
MARIA BROWN, affiliation not provided to SSRN
Email: mbrown08@maxwell.syr.edu

This paper provides a longitudinal view, spanning 10 to 12 years, of persons first accepting retired worker benefits at ages 62 or 63 in 1994 or 1996. Using HRS data, matched to Social Security administrative files, we present: 1) findings of variation in income, wealth, health insurance coverage and employability, along such dimensions as race, Hispanic ethnicity, gender, reported health status and functional ability; 2) findings of economic, health and survival outcomes in 2006 for the 1994/1996 pooled sample, paying special attention to variations within the sub-sample of persons who accepted Social Security early retirement benefits by 1996; and 3) estimates of the proportion of persons accepting such benefits who are at risk. The findings indicate that persons first accepting Social Security retired worker benefits at ages 62 and 63 experience varying degrees of risk to their well being at these ages, and that these risks condition their well-being in retirement and survival probabilities. The major policy implication is that consideration should be given to providing a health insurance option for persons first accepting retired worker benefits prior to age 65. The major research implication is that retirement researchers should consider utilizing a range of measures - as opposed to a singular and potentially narrow measure - of risk when assessing the magnitude of risks existing for those accepting retired worker benefits at early ages.

"Financial Hardship Before and After Social Security's Early Eligibility Age" 

W. RICHARD JOHNSON, affiliation not provided to SSRN
Email: wrjohnson@cablelynx.com
GORDON MERMIN, affiliation not provided to SSRN
Email: merming@gao.gov

Although poverty rates for Americans ages 65 and older have plunged over the past half century, many people continue to fall into poverty in their late fifties and early sixties. This study examines financial hardship rates in the years before qualifying for Social Security retirement benefits at age 62 and investigates how the availability of Social Security improves economic well-being at later ages. The analysis follows a sample of adults from the 1937-39 birth cohort for 14 years, tracking their employment, disability status, and income as they age from their early 50s until their late 60s. It measures the share of older adults who appear to have been forced into retirement by health or employment shocks and the apparent impact of involuntary retirement on low-income rates. The study also estimates models of the likelihood that older adults experience financial hardship before reaching Social Security's early eligibility age.

The results show that the likelihood of experiencing financial hardship increases significantly as people approach Social Security's early eligibility age. The increase in hardship rates is concentrated among workers with limited education and health problems. For example, among those who did not complete high school, hardship rates increase from 23 percent at ages 52 to 54 to 31 percent at ages 60 to 61, a relative increase of 36 percent. Hardship rates decline after age 62, when most people qualify for Social Security retirement benefits. These findings highlight the fragility of the income support system for Americans in their fifties and early sixties.

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Tuesday, March 9, 2010

“Entitlement Apocalypse” in National Review

I have a longish article in the new issue of National Review looking at problems and solutions for Social Security, Medicare and Medicaid. It was a nice piece to write, in that it pushed me back from some of the micro-issues I focus on day to day and made me think more explicitly about how I view the programs' purposes, problems and how they should be structured for the future.

Our long-term budget challenge can be summarized in one word: entitlements. Without Social Security, Medicare, and Medicaid, the budget would be roughly in balance over the coming decades. But with these programs, and without reform, a fiscal crisis is inevitable. To balance the budget over the next 25 years would require an immediate and permanent 30 percent increase in all federal taxes. That is the future we face, and it is a future of our own making.

Entitlements traditionally have paid generous benefits--financed by affordable taxes--to rich and poor alike, because the ratio of workers to beneficiaries has been high. Those days are gone and will not return. Maintaining entitlements in their current form will require either crippling taxes or crippling debt. Alternatively, we can rethink the entitlement philosophy, focusing resources where they're needed most, empowering individuals to make choices and giving them incentives to reduce waste, and buttressing personal retirement savings.

Click here to read the whole article.

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Monday, March 8, 2010

Adjusting to Reality in the New York Times

In this morning's New York Times I have an op-ed co-authored with Alicia Munnell, director of the Center for Retirement Research at Boston College, regarding the Social Security COLA and whether Congress should pass an ad hoc payment to seniors to make up for a COLA not being paid this year. We say no.

Click here to read why. I wrote on this subject at (much) greater length here and will have a related paper out soon.

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Friday, March 5, 2010

Schumer proposes new ad hoc COLA payment

Following up on the Senate's refusal this week to endorse a one-time payment to seniors to compensate for not receiving a Social Security COLA this week, Sen. Charles Schumer (D-NY) introduced a new proposal to pay $250 to each retiree. From the Birmingham Press.

One reason for the proposal is that Social Security recipients will receive no cost-of-living adjustment this year because inflation has been stagnant. But medical costs have continued to increase, and seniors spend a larger portion of income on those costs than other groups spend, said Democratic Sen. Charles Schumer of New York, a cosponsor of the proposal. "Those costs have been rising much quicker than the costs of other goods," he said.

The $13 billion in extra Social Security payments would put $900 million back into the pockets of New York seniors, Schumer said. The proposal failed Wednesday on a procedural vote, but Schumer and other supporters are trying to move it as an amendment to legislation to extend unemployment benefits.

AARP, the national lobbying group for seniors, supports the amendment, said Nancy LeaMond, the group's executive vice president. "For the first time in over 30 years, the benefits 57 million retirees, veterans and people with disabilities count on to make ends meet have been frozen," she said in a news release. "What this means for many is even though they will have to spend more because of the rising cost of prescription drugs and health care, their Social Security checks will remain flat." LeaMond said older Americans spend at least 30 percent of their income on health care, which is expected to get more expensive this year.

But Paul Van de Water, a senior fellow at the Center for Budget and Policy Priorities, said the case for the extra payments is weak. "The bottom line is that inflation didn't go up from the end of 2008 through 2009," Van de Water said. He said the average increase of prescription drug costs is about $2 per month per beneficiary.

Click here for the full story.

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New paper: Social Security Does Not Need a “Bailout”

Kathy Ruffing at the Center on Budget and Policy Priorities has a new short paper titled "Social Security Does Not Need a 'Bailout'." It gives a good explanation of the different ways you can measure Social Security's financial health and the different meanings to these measures. Worth taking a look.

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Thursday, March 4, 2010

Senate rejects ad-hoc COLA payment

The Associated Press
reports that the Senate voted against making $250 payments in lieu of a Social Security COLA, which was not paid this year and may not be paid last year to due falling prices in late 2008.

The Senate on Wednesday rejected a proposal by President Barack Obama to give people on Social Security a $250 bonus check. Republicans and Democratic deficit hawks combined to reject the idea by a 50-47 vote. The plan, offered in the Senate by Bernie Sanders, I-Vt., would have added $14 billion to the out-of-control budget deficit.

(Small editorial note: "Out-of-control budget deficit?" It's not a force of nature, folks; it's something we determine.)

Last year I did a fair bit of writing on the Social Security COLA issue, including this piece in the LA Times that argued that no COLA was needed; this piece in Forbes which argued that there are some people being hurt, just not the ones you think; and finally this long Policy Outlook for AEI that really ran through the issues.

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Monday, March 1, 2010

New working paper: An Options Pricing Method for Calculating the Market Price of Public Sector Pension Liabilities

This is more pension-related than Social Security, but I have a new working paper for AEI titled "An Options Pricing Method for Calculating the Market Price of Public Sector Pension Liabilities." Here's the abstract:

State and local public sector employee pensions are widely known to be underfunded, but pension financial reports do not reveal the true extent of funding shortfalls. Pension accounting methods assume that plan investments can earn high returns without taking any account of the market risk involved. This gives a false sense of the financial strength of public sector pensions and understates risks to taxpayers.

This paper first uses a Monte Carlo simulation of current pension assets and projected market returns to calculate the probability that public sector pension assets will be sufficient to fund accrued benefits. The typical public sector pension has only a 16 percent probability of paying full accrued benefits with assets on hand. A larger number of public pension plans have zero probability of paying accrued benefits than have a probability in excess of 50 percent.

But since accrued pension benefits are legally and constitutionally protected, any pension funding shortfalls must be met by taxpayers. This benefit guarantee amounts to an effective put option on plan investments, the cost of which is not disclosed under current actuarial accounting.

This paper uses an options pricing method to calculate the market value of taxpayer guarantees underlying public sector pensions. The average funding ratio declines from 83 percent under actuarial accounting to 45 percent under this options pricing approach. The typical state has unfunded public pension liabilities three times larger than its explicit government debt. Public pension shortfalls equal an average of 27 percent of state gross domestic product, posing a significant fiscal challenge in coming years.

Accurate measures of public pension liabilities are important for policymakers, taxpayers, investors considering the economic environment in which to start or locate a business, and bond purchasers considering the risk premia appropriate to municipal government bonds that are in practice subordinate to public pension liabilities.

This work (slowly) grew out of earlier work on guarantees against market risk for Social Security personal accounts. The idea in both cases is that government guarantees should be priced the same way they would be in the market, since ultimate the risk of honoring these guarantees is passed off to taxpayers. (Here's a link to a paper on Social Security guarantees.) As this is a working paper that will likely be revised I'm happy to hear any comments.

Click here to view the full text of this working paper as an Adobe Acrobat PDF.

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