Saturday, December 31, 2011

A link relevant to the public debt/intergenerational transfer point

In the last post, there was some discussion of the difference between transfers to fund consumption by the elderly (Social Security, Medicare), versus borrowing to make public investments.

I've never liked calling Social Security a "Ponzi scheme" precisely because there isn't anything like the duplicitousness of a Ponzi scheme involved, and of course whether or not you're the one who holds the information in a Ponzi scheme matters a lot when you're assessing whether you like the Ponzi scheme or not! So that label obscures more than it illuminates when it comes to Social Security.

But of course insofar as Social Security is a paygo program, it does have elements that are similar to a Ponzi scheme. We need to make sure it's a sustainable Ponzi scheme based on the best projections of revenue and outlays that we have, and we need to be prepared to adjust revenues and outlays if we want to continue having this "Ponzi scheme"-esque transfer program (and Americans overwhelmingly do want to have the program).

The thing is, this "Ponzi scheme" is not the sort of thing you want to finance with debt! If you're curious why, read Nick's post (that's the sort of thing his post is more relevant to). The money goes to consumption by the elderly, not investment, so the program is ultimately constrained by income growth. At some point, if the entitlement is growing too fast, the difference has to be made up by raising taxes and somebody in the future loses.

That's why Social Security in this country is funded by current taxes, not by debt. Things are kept very clear. Each year, young people lose and old people win. Each year young people and old people alike vote for represenatives that are going to preserve or end this arrangement*. And an actuary keeps an eye on things and makes sure the transfer arrangement can keep trucking along year after year.

Until recently, that is.

One of the negative consequences of the otherwise advisable payroll tax cut has been that Social Security has been funded out of the general fund (which is partly financed by deficits), and that sets a dangerous precedent. This Washington Post article details the issue.

Nick Rowe wrote in the comment section of the last post that Social Security and the public debt question are "very much the same". I don't think that's quite right. Social Security is traditionally paid for by taxes, and the only intertemporal element to it is that an actuary and the Congress tries to maintain some continuity in the program. This is not the case with public borrowing, where there is a legally binding intertemporal element. That's a good thing that the two are different. Social Security is consumption spending. For all the reasons Nick lays out, that's a bad thing to finance with debt.


* - I can think of at least two reasons why a young person would vote to keep such a program, and both are reasons I ascribe to. First, that the elderly are deserving of this benefit. Given the way modern society is organized, poverty is a real risk in old age if retirement savings are constrained and continued wage income is not a possibility. We don't die working anymore. That's a good thing, but we love our elders, so we want to make sure they have a safety net. That's the first reason. The second reason, of course, is that it sounds nice to have a safety net in old age and I know that if I vote to maintain the safety net now my chances of enjoying a similar safety net when I'm old increase.

8 comments:

  1. "We need to make sure it's a sustainable Ponzi scheme based on the best projections of revenue and outlays that we have, and we need to be prepared to adjust revenues and outlays if we want to continue having this "Ponzi scheme"-esque transfer program (and Americans overwhelmingly do want to have the program)."

    Want and reality do not always meet at the crossroads.

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  2. A fully-funded pension plan (where each generation gets back the expected present value of what it put in) is like having zero national debt.

    A PAYGO unfunded pension plan, where we start the program by making payments to a generation that put nothing in, is like having a national debt.

    If the interest rate is less than the growth rate, then a PAYGO, and a national debt, are a good idea. Sure it's a sort of Ponzi scheme, but it's a sustainable Ponzi scheme, which is OK.

    (Money is a sustainable Ponzi scheme, because people are willing to hold some currency, even when that currency pays 0% nominal interest and negative% real interest.)

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  3. > (Money is a sustainable Ponzi scheme, because
    > people are willing to hold some currency, even when
    > that currency pays 0% nominal interest and
    > negative% real interest.)

    No it isn't. Holding money has non-pecuniary benefits.

    If I hold a bottle of whisky, that has non-pecuniary benefits because I can drink the whisky. Nobody would claim that distilling is a ponzi-scheme.

    I think you are too accustomed to making a two-way split between financial assets and normal goods. You think of the former as providing a return, profit or interest, or whatever. And you think of the latter as providing a service. But, in some cases that simple split isn't true. Real assets sometimes appreciate (whisky does sometimes) and sometimes financial assets are valuable for reasons other than their monetary yield.

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  4. Daniel,

    It would be very useful if you lot (i.e. Keynesians) would set out exactly what you think about inter-temporal economics in general. I have found no-where that describes this fully.

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  5. I'm not sure I follow, Current. I've always understood Keynesians to take a pretty standard view of intertemporal choice. What's unclear exactly? I think a good Keynesian (ie - with a fair dose of Keynes himself) would note that we don't always make these choices under a great deal of certainty, but I've always understood "what we think about intertemporal economics in general" to be pretty orthodox intertemporal coordination.

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  6. Daniel.... For a start I'm a bit surprised you haven't used the idea of average propensity to consume in your argument above. Surely that means that savings leakage will change depending on the population composition.

    But, it's mostly that I would have no idea what you would think about this before reading this post. What you are talking about here is the idea of "soft liabilities" (that's what Sumner calls them). Before I read this I thought you'd disagree with that idea.

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  7. Current: "No it isn't. Holding money has non-pecuniary benefits."

    Yes it is. But it works as a sustainable Ponzi scheme precisely because of those "non-pecuniary" benefits.

    Holding an inventory of money gives benefits to the owner like holding paintings. But unlike paintings paper currency costs next to nothing to produce.

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  8. Nick,

    In a Ponzi scheme there aren't non-pecuniary benefits that outweigh the costs. If there were it wouldn't be a Ponzi scheme.

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