Argentina attempts to nationalize personal accounts system; workers object

Joaquin Cottani at the RGE Monitor reports on some interesting pension developments in Argentina that shed some light on Social Security policy in the U.S. Argentina, like most Latin American countries, bases its pension program on personal retirement accounts. Individuals contribute to their accounts during their working years, then at retirement use the account balance to purchase an annuity paying them a monthly benefit for life.

But the government of Argentina, led by President Cristina Kirchner, is attempting to end their personal accounts system. Is this a response to public pressure from Argentines who want the supposedly greater security and lower risk of a government-provided benefit? Not at all. In fact, it's a scheme by the Argentine government to paper over its current budget deficit and has parallels to what has gone on in the U.S. Social Security system for the past 25 years.

In the Argentine personal accounts system, workers pay contributions to their account fund, not to the government-run pay-as-you-go program. Argentina's government, however, is running a budget deficit and is setting their eyes on workers' account contributions. If workers are forced back into the pay-as-you-go system, the government gets access to their contributions which can be used to cover up deficits elsewhere in the government. Of course, the government is also obligated to pay these workers retirement benefits in the future – but these "implicit debts" aren't counted on the government's balance sheet , as they aren't counted on the U.S. balance sheet, and so the Argentine government effectively ignores them.

The Argentine government first tried to bribe workers back into the pay-as-you-go system by promising increased benefits later. This shows how eager the government is to get its hands on the workers' cash today. But few workers took the deal, and so now President Kirchner is apparently pushing legislation that would force Argentinean workers back into the pay-as-you-go program.

How does this relate to Social Security in the U.S., in particular the budgetary debate between the current pay-as-you-go system and proposed reforms using personal accounts? Since the last reforms in the mid-1980s, Social Security has been running payroll tax surpluses – collecting more in taxes than is needed to pay benefits. This surplus in Social Security helps cover up deficits in the rest of the budget. In fact, many analysts think that the Social Security surpluses encourage deficits in the rest of the budget. Moreover, when the rest of the budget borrows from Social Security, this borrowing isn't counted as part of the publicly-held national debt, the debt measure that most people focus on. In short, if we didn't have the Social Security surplus, both the budget deficit and the government debt would look a lot bigger than they do, and folks in Congress would be feeling more heat to do something about it. This is the situation that Argentina's President Kirchner is trying to restore.

Now, what happens if we allow people to invest part of their Social Security taxes in a personal account? Well, that immediately erases the Social Security surplus, which means that the budget deficit and the debt would start to look bigger. Now, some on the left blame this increased deficit/debt on the accounts, when in fact all the accounts do is reveal a budget shortfall that already existed. Moreover, to the degree that larger accounts create short term deficits, they also create assets that help pay Social Security benefits in the future. In other words, this claimed increase in the debt is mostly a function of government accounting, not of reality.

Update: Here's an editorial from the Wall Street Journal on the same topic.

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My birthday wish for Social Security

I have a posting at the Hill newspaper's Congress Blog on Social Security's 73^rd anniversary. Short story: my wish for Social Security reform is less wishful thinking from both sides. Once they realize what's really involved in fixing the system, they'll be more likely to reach a compromise.

Today is the 73rd anniversary of the Social Security program, which provides retirement, survivors and disability benefits to over 50 million Americans. While there is reason to celebrate the past, we should also focus on the future. The retirement of the baby boomers and aging of the population will put pressure on Social Security's finances. Between today and 2040, the U.S. population will add three seniors over age 65 for each American under age 20. Social Security is already the largest program of the federal government, and over the next 30 years its costs will rise by 50 percent relative to its tax base.

Click here to read the rest.

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Treasury releases Issue Brief on pre-funding Social Security

The Department of the Treasury today released its fourth issue brief on Social Security reform, entitled "Mechanisms for Achieving True Pre-Funding." This excerpt summarizes their argument pretty well:

Any reform of Social Security that makes the system permanently solvent and that seeks to maintain contributions and benefits at some stable fraction of people’s wages while working must accumulate resources in the near term when there are relatively more workers (that is, when the old age dependency rate is relatively low) so as to help finance benefit payments in later years when there are relatively more retirees (that is, when the old-age dependency rate is relatively high). This accumulation of resources is known as “pre-funding,” and is accomplished by having current revenues exceed expenditures and by safeguarding the resulting surpluses so that they provide resources with which to fund future benefits. If instead no attempt is made to pre-fund future benefits, then it will be necessary in a solvent system to reduce benefits for the cohorts of retirees that are relatively large and/or to require higher contributions from the later, relatively small cohorts of workers who are paying for the retirement benefits of the earlier cohorts. Either outcome would be viewed as unfair by most people because it causes the net value of Social Security to vary across birth cohorts depending on their size.

The brief explores pre-funding issues in great detail. I recommend it.

Significantly, the Treasury brief examines pre-funding using the Liebman-MacGuineas-Samwick reform plan as a model. In theory, any plan with pre-funding -- either via personal retirement accounts or trust fund investment -- could be used. Unlike almost all other plans, however, the LMS plan is almost totally self-financed. That is, it does not utilized transfers of general tax revenue to finance the "transition" to personal retirement accounts.

Being self-financing allows for much greater confidence that a reform plan actually will accomplish pre-funding. If transition costs are financed with general revenues, which in effect means that much of the cost will likely be borrowed, it is very difficult to determine how the financing burdens are distributed over generations. Given that pre-funding is all about distributing financing burdens over generations, self-financing plans have a strong advantage in this regard.

Update: Also see posts from Andrew Samwick and Angry Bear.
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CRS Report on Social Security Transition Costs

Several blogs are reporting an update (or perhaps simply the public release) of a 2007 Congressional Research Service policy paper on the transition costs associated with Social Security personal accounts. While any exploration of this tricky issue is welcome, this study – perhaps due to a desire to produce quantifiable results with limited data – unfortunately mischaracterizes the question.

“Transition costs” arise when a pay-as-you-go program is converted in part or whole to a pre-funded program. In a pay-as-you-go system today’s retirees are supported by today’s workers; in a funded system today’s retirees are supported by their own savings, accumulated during their working years.

Any effort to prefund future benefits involves transition costs, be it through “carve out” accounts funded out of the existing payroll tax, “add on” accounts funded on top of the payroll tax, or through investment of the Social Security trust fund in assets other than Treasury bonds. (I will discuss this latter case in a separate post).

But for simplicity, let’s stick to the common example where today’s workers invest part of their payroll taxes in personal accounts. Since Social Security is a pay-as-you-go program, today’s taxes are earmarked to pay today’s benefits. If part of those taxes are invested to pay tomorrow’s benefits, the system face a temporary shortfall. This shortfall, which declines and eventually disappears as workers with accounts begin to retire, is referred to as the transition cost. Intuitively, the larger the amount of prefunding – that is, the larger the accounts and the higher the share of workers who participate – the larger the transition cost.

Transition costs bring with them transition benefits. When workers with accounts retire, the tax rate needed to provide a given level of total benefits declines since part of those benefits are provided by the accounts, which were funded in the past.

Where things get difficult, and where the CRS report runs into problems, is when we attempt to quantify the transition costs of a given reform plan and compare to other plans. The CRS report defines transition costs as “the dollars put into the IA (Individual Account) by the government [minus] any dollars taken from the IA to help pay benefits over the 75-year actuarial period.”

While this definition sounds reasonable, it encounters several significant problems.

First, in any measure that consistently counts both the contributions to accounts and benefits paid from accounts (e.g., closed group or infinite horizon measures), the measured transition costs for any given cohort of participants will be negative so long as the accounts’ assumed returns exceeds those of the Social Security trust fund. This is simply because the account contributions would be compounded forward at a higher interest rate than they are discounted back at. This is unnecessarily generous to personal accounts: if accounts earn more than the riskless interest rate it is because they invest in riskier assets. In any case, it's not clear how netting benefits paid against account contributions relates to the intuitive view of transition costs.

Moreover, the net transition costs of reform plans can differ based upon the assumed interest rate earned by their personal accounts. Accounts with aggressive investment portfolios will pay more benefits and thus have lower transition costs than accounts with more conservative investments. The accounts in Kolbe-Stenholm, for instance, are invested in 50% stocks and 50% long-term Treasury bonds. With assumed returns of 6.5% and 3.0% and administrative costs of 0.3% of assets, the net projected return is 4.45%. The Ryan plan, on the other hand, assumes 65% investment in stocks and 35% in corporate bonds with administrative costs of 0.25%, for a projected net return of 5.2%. As a result, the Ryan plan has among the lowest transition costs and Kolbe-Stenholm the highest, despite the fact that Ryan’s accounts are twice as large as Kolbe-Stenholm’s. This conclusion simply seems wrong. (There may be other plan-to-plan measurement issues as well: it appears that for some plans the study counts the actual benefits paid out of personal accounts, while for others it counts the reductions in traditional benefits due to account participation. While related, these are not the same thing. In particular, cuts in traditional benefits for personal account holders are larger in plans with guarantees of receiving at least scheduled benefits. Without these guarantees most workers would not accept accounts on the terms presented. If so, however, then the cost of the guarantee would need to included.)

Second, countering the above methodological generosity is the use of a 75-year measurement period to calculate transition costs. In fact, the only reason any of the reform plans show any significant transition costs is due to measurement using a truncated 75-year period. Net transition costs are driven almost entirely by account contributions made during the 75-year period that are paid after the 75^th year. While one can argue about measuring system financing with a 75-year period or the infinite horizon, in this case the 75-year horizon seriously skews the results. And, as above, it’s not clear how this measure relates to the intuitive view of transition costs outlined above.

The problems presented above don’t imply that measuring transition costs is easy. The President’s Commission to Strengthen Social Security presented a measure of “transition financing” that stated:

In every year where financing needs are greater under the Reform Model than they would be under current law, that year is identified as a “transition year.” All required extra financing is added up for each transition year, and the sum is given on the table.

Under this definition, a reduction in the Social Security surplus due to personal account is not counted as part of a transition cost. In addition, if reductions in traditional benefit growth reduce the need for overall financing to the program, this also reduces measured transition costs. Again, it’s not clear that this measure hits on the intuitive notion of transition costs.

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