A Social Security reform that addressed the program’s structural and fiscal problems would begin by transforming today’s complex benefit formula into a two-part system consisting of a savings account and a flat universal benefit. Such a system could be implemented gradually — applying only to new workers as they entered the work force, and so very incrementally and slowly replacing today’s system without breaking any promises already made to working Americans.
First, everyone in this new system — rich and poor alike — would be given an opportunity and a strong incentive to save for retirement. Each worker would be enrolled automatically in an employer-sponsored retirement account such as a 401(k) or 403(b). Workers would contribute at least 1.5% of pay, matched dollar for dollar by their employers. Universal retirement savings accounts would allow Social Security to focus its efforts: If everyone saved as they should for retirement, Social Security could concentrate its resources on low earners who needed the program the most.
Read the whole thing. To me, it comes across as centrist. But he would described as a nutter by most of the people who I would describe as nutters.
I agree with him except that there should be no match by the employer! If you think about tax incidence the employer match just exists to hide from the employee what he is really paying! If fact the first SS reform that needs to made is to show the tax in full on all pay stubs. Increase gross pay by the amount of the employer match and increase the tax. Either that or hide the full amount by putting it all the employer because then at least it would be easier in the future to welfarize the program by paying everyone the same amount. The current setup is to fool the employee.
3% of gross pay is ‘everyone saving as they should’? That strikes me as extremely optimistic.
This! If someone saves 3% of their salary for 40 years, with a 5% raise each year and a 5% per annum ROI on savings, they’ll end up with a nest egg equal to 1.2 years of their final salary. That’s not much of a retirement.
in your example, the interest rate and the rate of inflation appear to be the same. If that is true, then the real interest rate is zero. Be careful about interpreting these sorts of examples.
That’s not much of a calculation. These projections are very sensitive to the assumptions. Typically, investment return outpaces salary increases (especially over a career). A more realistic set of assumptions would be 4% salary increase and 7% return (all nominal). That gives an accumulation of 2.2 times final salary. In order to have an adequate income at retirement, you probably have to save about 20% of income (from all sources). That ignores Social Security and any attempts to reduce living expenses. When you get into the details of your particular situation (married/unmarried, where you retire, whether you work in retirement), the answer varies considerably.
Incoming amateur economic thinking which could be entirely wrong…
I don’t think mandatory savings is the answer – putting money in my 401K doesn’t transports the goods and services I will need into the future. Savings are are only to helpful when competing against non-savers. If everyone saves, this will just bid up the future cost of living. If 401Ks become mandatory, then the “real” savers (that is, people are have enough foresight today to save) will start saving an even higher percentage of their income so that they can still come out ahead.
Nor is funneling all those dollars into the stock market a particularly good idea. If the net effect of all that mandatory savings is nothing, then it seems like straight malinventment, if absent the mandate to save people would have spent on present consumption. It would have been better to let people continue to spend money all along until the real investment opportunities revealed themselves
What you are missing is that those investments are actual resources whose consumption is delayed into the future. The more consumption is delayed into the future, the lower interest rates get, and the more effort is put into innovation and production for future consumption.
It isn’t just a numbers racket or savings arms race. There is real future output improvement, as evidenced by the fact that the last 100 years saw a greater than 7x growth in real GDP per capita in the US. The world of the future is more productive than the world of the present to the extent that delaying present consumption induces future consumption.
Granted, investment can behave like a numbers racket in the short term if there are gross malinvestments due to, e.g., government’s distorting the supply side with Fed stimulus or government’s distorting the demand side with subsidized homeownership. But in the long run those are not sustainable, while actual growth of what people actually want is.
I agree the delayed consumption / current investment leads to greater future consumption. The crux of my argument is that *optimal* investment occurs when the level of consumption is arrived at as spontaneously as possible, without government manipulation. The lowered interest rates created by spontaneous reduced consumption is the signal that it is time to invest.
Contrast the situation here – money would just pour into the stock market with no signaling. There is no reason to think this “investment” would be any more fruitful than the investment that would otherwise have occurred spontaneously. Is there any evidence that today’s entrepreneur is starved of capital? Unless that is the case (and I don’t think it is), mandating people to dump money into mutual funds will not increase future productivity
You are making some muddled arguments, for example, when you argued that long-term saving was a zero-sum game initially, but you’re not wrong that simply pouring more money into the stock market and expecting returns is a dubious proposition.
The question is what are the alternatives? Right now, that money is lent to the US govt, in the form of the Social Security fund getting hundreds of billions skimmed off the top every year, all to be wasted on the usual government pork. If you think the stock market is bad, Social Security is horrific. The solution is to end all mandatory saving, whether in treasuries or the stock market, but since the politicians will never let that happen, the best we can hope for is that they will let us choose what we’re forced to save with, whether stocks or bonds or entirely new instruments.
I have a better idea. Phase out Social Security entirely, and “low earners who needed the program the most” can just go on welfare. If you don’t save when you are young, you live poorer when you are old, but you won’t starve. How novel.
Social Security and Medicare are the disastrously inefficient programs they are — with millionaires getting transfers from the young and poor — solely so the actually poor elderly can pretend they are not on welfare. It’s abominable.
Great comment MikeP. Can I use that?
Sure, you can use that. Or you could use the crisper version on an old thread, where I see you commented as well.
Here’s more amateur thinking. I don’t even know the proper language of finance, so I’m not sure that I’m using the proper terminology. But until someone explains this to me, I don’t see how mandatory retirement investment accounts can be successful in the long run.
Assume that total stock market capitalization is X. Let’s also say it currently has a P/E of 15. And let’s assume that real value increases at 3% per year (i.e., adjusted for inflation). The market goes up and down, but over time this valuation seems consistent. And the market is driven by the buying and selling of investors–individual, institutional, mutual funds, etc.
Now, all of a sudden, 3% of all wages are set aside for investment. Let’s say that one third of that (1% of all wages) goes into stocks, the rest into bonds, REITS, etc. The total real value of the stock market is X; next year it will be X + 3%, and so forth. But the amount of money chasing that finite value has suddenly increased by 1% of all wages earned. Unless some of the other investors abandon the market, this extra money should push up prices way beyond the fairly valued P/E of 15. When the market comes back down, as it will, all investors will lose a substantial portion of their investments. In other words, if buying a stock means that you’re buying the right to a share of the future profits of a company, the amount of those profits over time is a limiting factor in the stock’s real value. If everyone tries to buy a share of those profits, that does not increase the size of the pie that is available to be shared. Everyone ends up getting less than he expected.
Here’s another way of looking at it. What if every American suddenly decided to invest $1,000 in the stock market. (Some take the money out of their savings accounts, others sell their cars or mortgage their houses, etc.) That would add some 300 billion dollars to the total capitalization of the market, wouldn’t it? But the real value of the goods and services will not have changed. Prices of stocks will go up, but the real value of the firms (the future earnings stream) will be unchanged. This means that
real value = X (P/E = 15)
paper value = X + 300 billion dollars (P/E = 15 + Y)
Isn’t this a bubble?
What am I missing here? Why do great financial minds think that you can make everyone wealthy and fund everyone’s retirement by having everyone buy stocks and bonds? There simply aren’t enough profits to go around.
If everyone tries to buy a share of those profits, that does not increase the size of the pie that is available to be shared.
See my reply above. The people who manage the pie, or newcomers who want to add more to the pie, will see the new demand for future consumption and add more stock in existing companies or introduce stock in entirely new companies.
This isn’t instantaneous, of course, but it doesn’t take more than a few years either. It’s the adjustment that keeps the P/E relatively stable.
Think of this way, it increase the incentive to:
1. Create a new company in hope that it will one day go public at a high price.
2. Fund a start up in hope that it will one day go public at a high price.
3. Invest in productivity increasing machinery.
You are correct to keep in mind some basic laws of arithmetic. The stock market is not a magic wealth machine, just as Social Security is not a magic wealth machine. However, more stock market investment ultimately drives more investment in projects and equipment that increase wealth down the road.
We have this in Australia (compulsory Superannuation – 9% of income which will gradually increase to 12% by 2019). It receives favourable tax concessions (15% on income earned) but cannot be touched until retirement age. It’s a fantastic one-size-fits-all policy that benefits wealthy people enormously (tax concessions, inflates asset markets like shares & property) at the expense of the poor who treat it as a 9% tax and simply ignore it (low income individuals would arguable benefit more by having that 9% immediately instead of in 30 years).
It also encourages people not to save (same as Social Security) as they assume Super will cover retirement. But by the time they retire compulsory fund managers have siphoned off a considerable chunk of it in “management fees”. It’s not true savings; it’s a subsidy to the financial sector.
The government recently announced a new tax on Superannuation too for incomes over $100k. It’s only supposed to hit the top 1% but is not indexed by inflation, meaning in 40 years it will affect a hellovalot more than 1% of the population. How could they resist a pool of money that large? Can’t let the banks have it all!
What do you mean by “simply ignore it?” They are paying the tax and will have the money when they retire: that’s supposedly the whole point, even if you think the managers’ fees are eating too much of the return. If you think they’d benefit more from having the money right away, then you are against forced saving, which I don’t think you’ll find anyone here to disagree with you about, but that’s unfortunately received wisdom among the uninformed masses.
Self-managing it is too difficult (and expensive with annual regulatory fees / audits) for the average Joe even if he could be bothered. The “reward” of not ignoring the 9% tax is low and it has to be discounted by however many years until retirement. Most people sign up to the default Super plan at their workplace and never even bother to move it around after they leave. By retirement, most of these accounts are at $0 with insurance and management premiums (now 100% as the Government seizes “inactive” accounts – ones with no deposits/withdrawals for 3 years).
Forced savings? More like compulsory subsidisation of finance, government and people who know how to use the system to their advantage, i.e. the exact opposite group of people of who the forced saving is supposed to benefit.
So yes, I am against forced savings because I would rather people had 9% more income today than far less than that (discounted) in 30 years, if ever.
On a lighter note:
http://www.heraldsun.com.au/money/superannuation/overcome-your-super-pain-for-gain/story-fni0cwqw-1226672548005
Nobody talked about “self-managing,” not sure why you brought it up. What does “never even bother to move it around after they leave” mean? You keep making these elliptical statements. Those are some pretty crazy “insurance and management premiums” if they can eat the entire capital! 😀 Why would there be “no deposits/withdrawals for 3 years” if they’re forced to put 9% in every year?
It sounds like you are against the Australian system of forced saving, because you believe it’s badly designed, whereas my point is that most here would be against any form of forced savings, including the Social Security system in the US which puts the money in govt IOUs that are similar to Treasuries. I’m still not sure if you’d be on board with not having any forced saving.
First, I don’t want any forced saving.
Second, it’s clear you don’t understand how it works in Australia hence the confusion. I’m not going to spell out the entire compulsory superannuation scheme to you as it’s not worth my time to write it or yours to read it. But to quickly address what looks like your largest misunderstanding:
Think of it like a bank account. Except if you make no deposits/withdrawals in 3 years the government takes it all. On top of that, you have a tedious opt-out system in place for a multitude of different insurance products and management fees. Most people just leave it as the default.
It’s also an employer-pays scheme so the issue is that most people “ignore” it and never bother to change out of the one your company signs you up to. It involves a bunch of paperwork that is a PITA. When you leave said company, if you fail to transfer the balance out and the deposits stop (but the insurance & management fees remain) you will quickly have nothing left; especially now that after 3 years, the government takes it all anyway (this was only put in place recently).
The latest statistics show there are 3.4 million of these “lost” (“ignored”) accounts amounting to $16.8b as well as 2.8 million “unclaimed” (probably lost but not yet over the 3 years) worth $887m. That’s a lot in Australia.
Not sure that I’d call those who disagree with Biggs “nutters,” more like stupid, there is a difference. 😉 People are far too willing to call the other side crazy, though given how stupid most are on either side and yet all too willing to proclaim their opinion with certainty, perhaps “crazy” is the best description. 😉 Nevertheless, “stupid yet certain” is the most accurate description, let’s reserve “nutter” and “crazy” for the real raving lunatics. 🙂