Prof: Okay,
today we're going to talk a
little bit more about Social
Security.
Social Security,
remember, is the biggest
program the government runs.
 
Its annual expenditures are
slightly bigger than the
military expenditures every
year, and those two things are
way bigger than everything else.
 
It's been the biggest program
the government's run since the
New Deal,
since Franklin Delano Roosevelt
put it into effect in the late
1930s,
and it seems to be broke.
 
So it lasted for 70 years,
and now it seems on the verge
of going broke.
 
So what happened and how can we
fix it?
And as I said,
this has been a topic of
conversation,
presidential conversation,
at least since 2000.
 
There were a bunch of
commissions before that,
looking at the problem,
and what I said last time was,
the general public and our
politicians seem completely
confused about what's going on.
 
So we need to figure out,
how could it be that the
program went broke?
 
Should that have been a
surprise, and how can we fix it?
And the three standard things
everybody says is,
President Bush and many people
like him saying,
"Well, the system's going
broke.
The rate of return young people
like you are going to get is
less than 2 percent a year.
 
That's terrible.
 
Any bond, any stock,
you can expect a much higher
return than that,
so the program's just awful.
We should stop it or privatize
it."
I'll explain what privatizing
means.
In that way,
your money, instead of going to
old people,
will be put in the stock market
and you'll get a higher rate of
return and you'll do much
better.
 
Then a second thing people say
is, "Well,
the thing lasted all this time.
 
I mean, what's really gone
different?
What could possibly have caused
the change?
It must be those dastardly baby
boom generation-ers,
like me, who are headed towards
retirement in another 20 or 30
years,
and they're going to bankrupt
the system.
 
There are going to be so many
of those old geezers hanging
around needing to get paid,
that young people like you
won't be able to carry the
burden,
and so it's our fault."
 
And then there are the people,
the naysayers,
Gore chief among them,
but many others,
Obama now similarly saying,
slightly similar things,
saying, "Well,
privatization doesn't make any
sense.
 
It's logically impossible,
because if you take the taxes
that the young people are
paying,
and tell them,
those Social Security taxes,
they can invest in private
accounts,
the stock market,
with their own name on it,
then how are we going to give
money to the old people now?
So you'll just be screwing the
old generation."
So privatization is impossible.
 
So those are the three most
standard things people say.
All three of them have some
truth to them,
but on the whole,
they're substantially wrong,
completely wrong,
and once we clarify what stage
the system is in,
we'll be able to think about
what the right solution is.
 
I'm going to tell you my
solution which,
as I said, is not universally
admired, but I'll see what you
think about it.
 
So the program came into effect
in what was the greatest or the
biggest of the New Deal advances
made by FDR.
And I just thought I'd play you
this tape of him signing it into
law,
and behind him is the Secretary
of Labor,
Frances Perkins,
who you'll see in a second,
played a huge role in this,
since she was the first woman
in the Cabinet.
And by the way,
in my generation,
there are many women named
Frances, because their parents
named them after her.
 
So here's the--let's see if
this works.
>
 
Franklin D. Roosevelt:
Today a hope of many years'
standing is in large part
fulfilled.
The civilization of the past
hundred years,
with its startling industrial
changes, has tended more and
more to make life insecure.
 
Young people have come to
wonder what would be their lot
when they came to old age.
 
The man with a job has wondered
how long the job would last.
This Social Security measure
gives at least some protection
to thirty millions of our
citizens who will reap direct
benefits through unemployment
compensation,
through old-age pensions and
through increased services for
the protection of children and
the prevention of ill health.
We can never insure one hundred
percent of the population
against one hundred percent of
the hazards and vicissitudes of
life,
but we have tried to frame a
law which will give some measure
of protection to the average
citizen and to his family
against the loss of a job and
against poverty-ridden old age.
 
It seems to me that if the
Senate and the House of
Representatives in this long and
arduous session have done
nothing more than pass this
security bill,
Social Security Act,
the session would be regarded
as historic for all time.
 
>
 
Prof: Okay,
well, it was regarded as
historic for all time,
and let me now explain what
Social Security does,
and what the rules are.
And I have to open another file.
 
I forgot where I put--I hope
it's--I wonder whether
it's--sorry, I opened the wrong
year, I see.
I'm living in the past.
 
Sorry, that was last year's.
 
 
 
Okay, so we went through all
this last time.
So, after passing legislation,
a massive publicity campaign
was launched,
convincing people that this was
a good idea.
 
And not everybody thought it
was such a good idea,
by the way.
 
And so, you know,
this is an example of the
advertisements that were
plastered everybody,
you know, telling you about how
much you were going to get,
money after you retired.
 
Now what was the idea of Social
Security?
The idea was that lots of
people, when they were young,
didn't really have the
foresight to imagine what life
was going to be like when they
were old.
In fact, in the late 1930s,
the most destitute of Americans
were the old,
and so the idea was to force
them to save when they were
young,
and then the money would be
there--would be invested in US
Treasury bonds and accumulate
interest,
and the money would be there
when they got old.
So it was imagined to be a
prefunded system,
prefunded meaning the money
comes in and it's that money
which is going to then pay
people later when they get to
old age.
 
And the idea was,
you were going to collect
enough taxes so that when you
got to be old,
you would get 40 percent--every
year,
you would be receiving,
the average person,
recipient, retiree,
would be receiving 40 percent
of the average wage of the
average young worker.
And, you know,
the idea is that when you're
older, you have less expenses.
 
You probably already own your
house, your children are out of
the house, so 40 percent should
be enough to keep you going.
It was certainly more than the
average old person had at the
time.
 
Now this you would get for your
entire life, so when Roosevelt
called it insurance,
what was the main thing that
you were insuring?
 
Well, there's a side part of
the program which he mentioned,
which is insuring people of
disabilities,
things like that.
 
But that's a 1--out of the 12.4
percent tax, it's something like
1.8 percent.
 
But the main part of the
program is insurance against
what?
 
Yes?
 
Student: Living too long.
 
Prof: Living too long.
 
So you get the money your
entire life, no matter how long
you live, so you're being
insured against living too long.
Exactly.
 
So what happened was,
of course in the first year,
a lot of people were starting
to pay taxes.
And in the second year,
they were paying more taxes,
and of course,
they were still not retired
yet,
so they weren't actually giving
out the money to anybody,
and this fund was starting to
accumulate.
 
So Frances Perkins said,
"Well, what are we doing
here?
 
The whole point is that we've
got all these old people,
you know.
 
It's just the Depression.
 
We haven't come out of the
Depression yet."--World War
II hasn't started.
 
It won't, for the US,
start for a few more years,
by the way.
 
"So there are all these
old people sitting here,
totally destitute,
and we've got all this money
also just sitting here.
 
It really doesn't make
sense,"
she said.
 
"What we ought to do is
take the money the young people
are paying in and give it to the
old people who are already
there.
 
That way we are going to be
saving these old people and the
young people,
when they get old,
they'll be saved themselves,
because there'll be more young
people coming along afterwards
who can pay taxes in when
they're young,
and today's young,
when they're old,
will then collect those taxes.
They'll be reimbursed for what
they contributed when they were
young."
 
Well, so Roosevelt resisted for
a while.
Frances Perkins was apparently,
incredibly persuasive person.
One person at the time named
Witt, who was on the Social
Security commission,
tried to tell her that was
going to lead to budget
problems.
She said that he was a
half-Witt, and that we had a
more urgent problem.
 
Not that she doubted him,
but the problem was more
urgent, and so that was the only
way to solve the problem,
the current crisis.
 
So they finally agreed to move
the system from a prefunded
system, to a pay as you go
system.
So the money coming in from
current workers is used to pay
directly to the old workers.
 
So I don't want to get into all
these little variations that got
made.
 
So the program's called the Old
Age Survivors and Disability
Insurance Plan.
 
The insurance is mainly for
living too long,
but also in case you get
disabled, or in case you have
children and you're disabled,
you die, they get something.
Okay, so it's a combination of
insurance, disability,
but the main insurance is for
living a long time.
So as I said,
the tax now is 12.4 percent,
up to a cap of 106,800 dollars.
 
So if you make more than
106,800 dollars,
you pay, you know,
13,000 or something,
and then nothing more on Social
Security.
Okay, so the Social Security
tax stops at 106,800.
So the income tax,
I'm losing track of what it is,
and whether we're going to go
back to the old one,
but let's say it was 38
percent, 39 percent,
something like that,
if you had to pay that income
tax and on top of it pay Social
Security tax of 12.4 percent,
you'd be over 50 percent taxed.
 
So needless to say,
some of the people who think we
can solve our Social Security
problem by eliminating the cap
would be imposing a gigantic
marginal tax rate on a lot of
people who don't have a marginal
tax rate--
who have already high marginal
tax rate.
That would make it sky high,
so that's been resisted.
So 94 percent of workers are
below the cap anyway,
so we're talking about the top
6 percent,
most of which--you'll be in
that top 6 percent,
so you won't have to pay on the
margin Social Security tax.
So there's the taxes,
12.4 percent,
and then there are the
benefits.
Now how do the benefits work?
 
How are they determined?
 
So the tax, as I said,
you just take your income below
106,000 and you pay 12.4 percent
tax.
So how do the benefits work?
 
This is a little bit
complicated, but it's actually a
very interesting plan.
 
What they do is they look at
your entire lifetime earnings.
You're not going to get
benefits till after you retire,
so you've got your whole life
history behind you,
and they say,
"Let's look at,
every year, what the fraction
of your wage was relative to the
economy wide average."
 
So it's your relative earning.
 
So when you're young,
it's probably going to be .8,
.9.
 
If you go to Yale,
it's probably going to be
1.5,2, you know,
soon thereafter,
all right?
 
Okay, and it might get even
higher, but anyway,
so that's the relative earning
you have every year.
So then they say,
"Let's average your 35
best relative earning years and
just take the sum and divide by
35."
 
So what is your average
lifetime relative wage,
you know?
 
For the average person,
it's going to be 1.
For some people,
it might be .8,
for some people,
it might be 2 or 3 or 10,
okay.
 
Now the first--all right,
so you've got your average
relative lifetime wage.
 
What do you make when you
retire?
Well, when you hit an age,
which, you know,
they're adjusting now,
but it used to be 65,
when you hit 65,
they compute the average
wage--sorry.
 
When you hit 65,
you're going to be paid a
fraction of the average wage in
the economy when you're 65.
So what is the fraction that
you're paid?
Well, that depends on what your
historical average wage was.
So let's just see what the
function is.
So, if your average wage was 1,
equal to the average wage of
the economy,
your entire,
over those 35 years,
so you're the average guy,
then you get,
you see, that's near .4.
It's actually .44,
so you get 44 percent of the
average wage at the time you
retire, okay?
If on the other hand,
you made 10 percent of the--
your relative wage historically
was 10 percent of the average
wage in the economy,
you would get 9 percent of the
average wage at the time you
retire.
So you can see that this is
what's called a concave
function, just like our utility
function, those diminishing
marginal returns.
 
So it means that if you're
earning very little through your
life, you're going to get a much
better deal.
You're going to be paid--the
ratio of relative wage
historically to what you get of
the young people's wage is going
to be .9,
then the slope drops to .32,
then it drops to .15 and after
you're double--
it's actually,
I think, 1.99--after you're
double the average--
if your historical average wage
was more than twice the average
wage in the whole economy,
it doesn't do you any good.
 
Might as well have been twice.
 
If it's 4 times,
10 times, you don't get any
increase.
 
Okay, so you can see why it
makes some sense to have a cap
to the taxation,
because people who are making
10 times the average wage,
you know, let's say they're
making a million dollars
nowadays,
they aren't going to see any
benefit from having contributed
so much to Social Security.
 
Their benefits would be just
the same as if they only made
200,000 dollars a year.
 
Okay, so anyway,
you see that there's a
connection between how much you
made when you were young,
how much you get paid when
you're old,
but the connection is a concave
thing.
So it redistributes income.
 
People who had very low average
wages when they were working get
a better deal from Social
Security than people who had
high relative wages while they
were working.
And that's a cornerstone of the
idea.
It's meant to help protect the
people who are very poor.
And so it doesn't pay everybody
equally.
Still, you get some return from
having contributed more,
but definitely you don't get a
completely fair return,
because the whole idea is to
redistribute wealth and help the
least well off.
 
Okay, so that's one of the
cornerstones of Social Security.
All right, going back,
now what happens to you after
the first year you retire?
 
After the first year you
retire, so when you're 65,
you're getting 40 percent of
the average wage,
if you're the average worker
throughout your life.
You know, it's 44 percent,
something like that.
After that, your Social
Security benefit is indexed to
inflation, so it grows at the
rate of inflation.
The wage is probably growing
faster than the rate of
inflation.
 
So as you get to be 75,80 and
85, your average benefit is down
to 36 percent of the average
wage of the workers when you're
85,
but it starts off at 44
percent, assuming you were
average your whole life.
It'll be 44 percent and
gradually decline if wages grow
faster than prices.
 
So it's insuring you against
living long, because the benefit
carries on forever.
 
It's insuring you against
inflation, because it's
inflation corrected.
 
It's in a way insuring you
against feeling like a loser,
because you're always going to
start off with a fraction of the
new average wage.
 
So if your children,
if the whole country grows
incredibly fast and your
children are incredibly wealthy
and getting high average wages
and every young person's making
a lot,
the old won't feel totally left
out.
 
They'll be keeping up with
them, 40 percent of them anyway,
and similarly,
if the young have a horrible
time and aren't making very much
money,
the benefits to the old also go
way down,
because they're getting 44
percent of a much lower number.
So it's every generation in it
together and redistributing
wealth from the richer to the
less rich,
protecting you against long
life, making sure that you have
some money no matter how long
you live.
That's the idea of the system.
 
So are there any questions
about how this mechanically
works?
 
Okay.
 
Now it's very hard to do this
in the market,
by the way.
 
If you wanted to,
for example now,
think to yourself,
"Oh, I'd like to protect
myself against my old age.
 
I'm three years out of Yale and
I've fallen into an incredible
job that's paying me a huge
fortune.
I might want to retire early
and be a writer the rest of my
life."
 
You can't easily find an
annuity in the private market
that's going to tell you that
when you hit 65,
it will continue paying you for
the rest of your life.
You can actually find them,
but they're incredibly bad
deals.
 
The reason that they're bad
deals is that the people who
would have to take the money now
and give it back to you when
you're old,
first of all you have to worry
whether they're going to be
around and still be able to pay
you when you get old.
 
And secondly,
they're worried that the only
people who come to them are
people whose families live 100
years,
and so they're going to have to
pay a lot longer than they would
for the average person.
So they're afraid of getting a
bad selection,
that is, a selection of super
healthy people wanting to make
that deal.
 
And so they basically assume
that you're going to live to 100
and so they're giving you a very
low annuity year by year.
So Social Security is doing
something that's very hard to
obtain in the market.
 
Now, so what went wrong?
 
Oh, I should say a couple other
things about it,
some interesting things.
 
You can choose to retire early
if you want.
If you retire before 65 and you
want to get your payments
starting earlier,
they say, "Okay,
you can do that,
but we're going to cut the
payments every year,"
and they make some actuarial
calculation so that it's fair,
based on how long the average
person lives.
 
So if you start at 63,
you get 2 extra years,
but they know if you live the
average amount of time,
how much to cut it down,
so that on average,
you'll get the same amount as
if you did the normal thing
retiring at 65.
 
They've actually raised this
age to 67.
Now another thing is the
spousal benefit.
This is actually quite amusing,
I think.
So I had a secretary 20 years
ago who got married three times.
So she consulted me about this.
 
If you're a spouse,
you know, traditionally,
one of the spouses wouldn't
work, typically the woman.
And so the wife has the right
to 50 percent of her husband's--
or the husband has the
right--one spouse has a right to
50 percent of the benefits of
the other spouse,
just by virtue of being married
or having been married.
So the rule is that if you've
been married for more than 10
years,
then you can either take your
own Social Security benefits,
or if they're bigger,
you can take 50 percent of your
spouse's.
And if you've been married to
several different guys,
say, and you're not married to
any of them anymore,
you can pick the guy who had
the highest income and get 50
percent of it.
 
So she tracked down her first
husband she hadn't talked to in
30 years, and anyway.
 
So okay, and there are a bunch
of other rules.
Anyway, that's not really the
heart of the matter.
The heart of the matter
is--just to give you an idea of
the size.
 
This was in 2005.
 
So 157 million workers are
paying into it.
There are 48 million
beneficiaries.
It's a gigantic program.
 
So imagine the cost of keeping
track of just who's alive,
you know.
 
When somebody dies,
they're supposed to stop
collecting Social Security.
 
How do they know that the guy's
died?
I mean, that by itself is not
an easy thing to keep track of.
They have to send the checks to
everybody.
Somebody moves,
they have to figure out where
to send the check to the new
address.
They have to get the taxes,
they have to make sure people
are paying the right amount.
 
It's a huge thing involving
basically the entire population,
a couple hundred million people
almost,
either getting taxes,
paying taxes or receiving
benefits,
you know, over 200 million
people.
 
It's an incredible amount of
paperwork and moving stuff
around and figuring stuff out.
 
So how much does it cost?
 
How much money do they waste
running the whole thing?
Less than 1 percent of the
benefits.
Okay, so it's one of the most
efficiently run programs,
maybe the most efficiently run
program government has ever
devised.
 
So it isn't that the thing is
going broke,
as you might believe listening
to George Bush,
because somehow they're pissing
away the money and just losing
it.
 
That's not the reason.
 
Something else is happening,
because they don't waste much
money running the program.
 
Okay, this gives you an idea
just of the size of it.
So this is 2005,
so you have to add 20 percent
or something or 15 percent.
 
So the benefits,
the contributions,
593 billion.
 
Remember, there's a tax rule of
12.4 percent.
Then you have to pay out the
benefits, which is some other
rule, depending on what you
earned in the past,
so there's no connection
between the two.
And in fact,
the contributions are bigger
than the benefits,
so the trust fund is growing.
Now look at the administrative
expenses, tiny.
And there are some,
the railroad,
when the law was first passed,
railroads were in trouble,
so in order to get some senator
to vote for it,
they had to hand money over to
the railroad.
So anything,
something's going on with the
railroads.
 
But the other benefit is the
trust fund makes returns,
because it's a 2 trillion
dollar trust fund.
It was a little smaller than
that 2005, so it's earning
interest.
 
That's part of the extra
returns.
You see why the surplus is
quite big now,
but it's headed to be quite
small.
Okay, so now what is the
argument about?
What is the crisis of Social
Security?
What do the Democrats and the
Republicans say?
Well, you've just heard what
the program is.
How attractive do you think it
is, and do you really think it's
such a good program?
 
So the main thing is,
it's going broke.
Okay, so now why is it going
broke?
It's not broke now.
 
It's making more money than
it's paying out.
But in the future,
it's very obvious,
you can just look at the
demography.
It's very obvious that it's
going to--
the benefit formula is so big,
and there are going to be so
many people retired that the
payments you make to the old,
when I'm retired,
are going to be way bigger than
the payments that the young are
making in taxes,
provided the rules stay the
same.
So that's the main problem.
 
Somehow the system got out of
whack and we have to figure out
how to put it back together.
 
Now it's no surprise in one
sense that there's an imbalance,
because there's nothing about
the rules that balanced it.
I mean, the taxes you
pay--we'll look at this in a
second--that's just some
formula, 12.4 percent.
What's that got to do with the
benefits you're paying?
Well, the benefits are 40
percent, on average of what
young people are making.
 
So basically,
somehow the system must have
assumed that there would be
three young people for every old
person.
 
So the young people paying 12
percent each,
the old guy getting 40 percent,
you know, 3 times 12.4,
it's close to 40 percent.
 
So if the ratio of young to
old, young workers to old
retirees getting benefits is 3
to 1, then the systems going to
sort of be in balance.
 
But if that ratio is very
different from that,
the system--for example,
two young people for every old
person--
the system's going to be way
out of balance.
 
And the formula has nothing to
do with how many children people
are having or anything like
that.
So it's not so surprising it's
gotten out of balance.
But we're going to see,
there's a much more fundamental
reason why it's out of balance.
 
Okay, so the first problem is,
it's not in balance,
but there are many other
problems.
So why do Democrats like it so
much?
Democrats say,
"Oh, it's wonderful.
We're helping poor people.
 
We're redistributing things on
the basis of lifetime earnings.
We're sharing risks between
generations.
We're all in this
together."
As I said, if the young people
have bad wages,
then the old get less benefits.
 
If the young are booming along,
making huge wages,
then the old guys keep up with
them,
so there's less--so it's not
only insurance,
but it's less jealousy and less
disparity in the population.
And then you're protected
against long life,
you're protected against
inflation,
and you can't blunder away your
money,
because you have no choice
about where your investment
goes.
 
The government's taken care of
it, so if you're a bad investor,
you can't suddenly find that
you've lost all your money.
So now what do Republicans say?
 
And surprisingly--well,
anyway, you'll be surprised
where I come out on this,
I think.
So Republicans say,
"This stuff is much less
good than it sounds at first
glance.
For one thing,
there are no property rights.
I mean, who's to say what I'm
going to get when I'm old?
Nobody even knows what they're
going to get when they're old.
I defy you,"
a Republican would say,
"to tell me exactly what
your benefits are going to be,
or even to explain to me how
they're calculated."
"Virtually nobody in the
population can do that.
That's just not right,
and you have no control over
them.
 
So what's going to happen?"
 
a Republican would say.
 
"One of these days,
the Democrats are going to say,
'Oh, the system's broke.
 
We can't afford to pay
everything, so we're going to
cut all the benefits in half' or
something."
So a Republican would say,
"You know,
they're not even my benefits.
 
In order for me to really feel
good about participating in
Social Security,
I want to know that when I put
the money in,
what I'm getting out,
and I want to own it.
 
I don't want it to be some
vague promise that can be taken
away from me,
and probably will be taken away
from me."
 
Okay, so it's a matter of
property rights and
transparency.
 
Then another thing is,
even if you did know this
formula that I just explained,
people who want to retire and
want to figure out how to plan
for their retirement,
what does a normal person do?
 
He says, "How much money
have I got in the bank?
I've saved on my work;
I've got 100,000 dollars in the
bank.
 
Please tell me what the value
today is of my future Social
Security benefits.
 
If those are 8 million dollars,
then I know that my 100,000
dollars,
I don't want to waste too much
time trying to accumulate money
out of my savings,
because I'll never catch up to
8 million dollars.
If it's 50,000 dollars,
today's market value of my
future Social Security benefits,
I know that I'd better be
putting in a lot of money today.
 
And I know how much money today
is, how big my savings are,
relative to what the market
value is of my Social Security
benefits."
 
So the Republicans say people
just don't have any idea what
the value of their benefits are,
even if they happen to know the
formula I just explained,
nobody really can calculate
what it is.
 
Then thirdly,
the rich are giving money to
the poor.
 
Everybody knows Social Security
is doing that.
Can you tell me,
what's the effective tax rate?
Let's say I'm in the top tax
bracket.
What is my effective tax rate
on Social Security?
What fraction of my taxes are
being taken away from me because
my benefits are going to be less
good, because I was one of the
highest earners?
 
There's virtually no one in the
country who's able to answer
that question.
 
A Republican would say,
"What kind of a program is
this if nobody knows?
 
Okay," they'll say,
"we may sign on to the
idea that the rich should give
some of their money to the poor,
but at least tell us how much
of our money we're giving to the
poor.
 
We don't even know."
 
And then the Republicans say,
"We'd like equity-like
returns.
 
You know, why is it--"
This is what George Bush said.
"Why is it that our
returns are going to be 2
percent?
 
I'd like to know that my money
is being invested in the stock
market and earning what I could
get in the stock market."
Anyway, Republicans,
savvy investors like to think
that the money that they're
being forced to save can get the
same rate of return as they
could get for themselves.
Why should they be cheated in a
government--never mind that they
have to give away part of the
money.
The part that they're not
giving away at least ought to
earn equity returns.
 
And then Republicans tend to
think that choice is a good
thing,
not a bad thing,
and so if you let people decide
how to invest,
it'll be better for them than
if you--
even if some of the people make
mistakes.
Okay, so those are the
two--maybe some of you can add
some other criticisms.
 
Yeah?
 
Student:
Wouldn't any system that
insures against living longer
than expected,
that annuity type system,
have that problem in terms of
caring
>?
You'd be unable to calculate
the present value,
precisely because you're unable
to predict how long you live.
So any system that successfully
>
is supposed to perform,
that's just an inherent issue.
Prof: Yes.
 
So no, I don't think so,
because--so his question is,
since we don't know how long
we're going to live,
and the program continues to
insure you for your entire life
and pay you for your entire
life,
how can you figure out what the
market value of that is?
Well, the fact is,
there is no general market.
So you're right,
there is no general market you
can look at now today,
that will tell you,
suppose we pay a fixed amount
of money for the average person
in the economy,
what's the present value of
that?
 
However, that doesn't mean we
couldn't have a market like
that.
 
And so my solution is going to
involve precisely a market like
that.
 
So to answer his question,
it's not inherently impossible
to attach a market price to
paying somebody for the rest of
his life.
 
After all, you could imagine
Social Security now,
paying, let's say 50 million
people,
the people who are now retired,
each of them is going to be
paid for the rest of his life
according to a rule,
which we all understand.
 
It just goes up with inflation.
 
So you could say,
suppose you owned 1 percent of
all those payments,
what would the value of that
be?
 
You could trade a security like
that.
Somebody could say,
"I want to buy today a
security that gives me 1 percent
of all the payments everybody's
going to get,"
or it could be 1 percent of all
of the payments every 70 year
old today is going to get from
Social Security.
 
That's a well-defined thing and
it could trade in the market.
You're going to see that the
market,
as soon as we start talking
about this,
there is an incredible number
of derivative instruments,
they're called,
that trade in the market.
That could be a new one,
and then there would be a
market price.
 
You're going to see,
when I propose my plan,
that it involves something like
that.
Any other questions about the
rules of Social Security or
whether you think they're bad or
good for some other reason?
I've tried to list the ones
that struck me as the most
important.
 
Yeah?
 
Student:
What does it mean by a return?
Does it mean that you invest in
government bonds and then you
get back taxes from another part
of the government?
Prof: Equity-like
returns?
Is this what you're referring
to?
Student:
>
define the return.
 
Isn't the interest you're
getting just taxes from another
part of government?
 
Prof: Okay,
so you can always do this
calculation,
which has historically been
done, and I'm going to show you
those numbers in a second.
You can always look at how many
tax--let's take someone my
father's age.
 
My father actually died,
but a couple of years ago,
my father, he could look back
at his whole life,
and he could look at how much
money he paid in Social Security
taxes when he was young.
 
Then he could look at what
benefits he got every year until
that point.
 
Let's say it was the day after
he died.
I could look at what he got
every year until he died.
So then I could just--that's
just a sequence of cash flows.
We know how to calculate the
internal rate of return of that
sequence.
 
That's his rate of return.
 
And I showed you in the graph a
long time ago that that was
actually done historically.
 
We've done that.
 
Leamer did that here.
 
He did that for every
generation.
Every birth cohort,
the average person,
what their return was,
and you see,
it was very high to begin with
and it become pitiful.
If you forecast the future for
you, it's going to be less than
2 percent.
 
So Bush is saying,
"Why should you,
young Yale undergraduate,
why should you be satisfied
with less than 2 percent?
 
Instead of paying those taxes
to Social Security,
you put them in the stock
market, you get lots more than 2
percent probably,
so why be satisfied with 2
percent?"
 
And Gore would say, "Well,
now we've got this pay as you
go system,
you can't possibly put it in
the stock market,
because then the old people
aren't going to get it."
 
Okay, any other questions?
 
Any other reasons you think the
program is good or bad,
Social Security.
 
What's your feeling about
whether we should get rid of it
or not or privatize it or change
it?
Yeah.
 
Student:
It discriminates against people
who are predisposed to die
early.
It favors couples whose ages
are really far apart.
It's extremely
>
Prof: Yes.
 
He's saying other problems with
Social Security is that it
discriminates.
 
It doesn't treat everybody
equally.
His first example was,
people who you can reasonably
expect to die sooner are going
to get a less good deal than
people you can reasonably expect
to live longer.
So what is the most basic class
that's being discriminated
against, therefore?
 
Who among you can you predict
are going to live less long than
others among you,
at least historically?
Presumably that will stay true.
 
Student: Men.
 
Prof: Men.
 
Okay, so men live 6 years less
long than women,
so men are getting a bad deal.
 
Now black men,
historically--although this is
rapidly changing,
but black men lived even less
long,
even worse by a considerable
degree,
so you'd think it discriminated
against black men.
 
Black men also tended to be
poorer on average though,
so they were getting a better
return per year than rich white
men.
 
But anyway, a black man with
the same earnings got a much
worse deal historically on
Social Security than a white man
with the same earnings,
because on average,
the black man died before the
white man.
That probably had a lot to do
with healthcare and nutrition
and stuff like that,
and this is rapidly changing.
But anyway, certainly it seems
like men are going to get a
worse deal than women.
 
So yeah, there are all kinds of
little problems with Social
Security like that.
 
Anything else?
 
He mentioned a couple of others
too.
I regard those as less critical
though, than the problem of the
thing going broke,
and these things which have
split the country.
 
It's been impossible--so
basically, everybody thinks this
is a logical contradiction.
 
You can't do what the
Republicans want,
at the same time,
do what the Democrats want.
So what should you do?
 
Anything else anyone wants to
say?
Someone else had their hand up
before.
All right.
 
So why did the system become
such a mess?
How did it go broke?
 
How should we have expected it
to go broke?
Did it all happen because there
was the baby boom?
All right, so I want to tell a
little parable.
It has nothing to do with the
baby boom.
Okay, so imagine that--and I'm
saying it in terms of fathers
and sons, but I could say
mothers and daughters.
So historically,
it was men working most of the
time, but let's do mothers and
daughters.
So suppose a mother is old now
and sick and she needs an
incredibly expensive operation,
a million dollars to save her
or to extend her life.
 
She doesn't have the money,
so she goes to her daughter and
she says, "I need a million
dollars."
And of course,
the daughter who loves her
wants to come up with the
million dollars to pay for her.
But, you know,
that's a lot for her to pay.
So she thinks to herself,
"My mother not only gave
me life,
but let's face it,
without her,
my daughter wouldn't have any
life and her daughter wouldn't
have any life and her
granddaughter wouldn't have any
life.
My mother's responsible for not
just me, but for all these
generations after me.
 
Why should I be the one to pay
the entire benefit of my
mother's operation?
 
So you know what I'm going to
do?
I'll give her the million
dollars, but when I get old,
I'm going to go to my daughter
and say,
'Daughter of mine,
I sacrificed for your
grandmother,
my mother.
I put up a million dollars to
save her.
I'm broke now.
 
Maybe I don't need an
operation, but I'm basically
totally broke because I spent so
much money rescuing my mother.
Why don't you do the same for
me that I did for my mother and
give me a million dollars?
 
And by the way,
you could use the same argument
with your daughter,
and so it's really not so bad,
because you're going to get the
money back when you're
old.'"
And so the granddaughter agrees
and pays the daughter,
and then when she gets old,
she does the same thing.
 
It goes on for generation after
generation.
Now let's say it went on
forever.
How did this happen?
 
Did nobody lose anything and we
paid for the operation to begin
with?
 
Is this some kind of Ponzi
scheme or something?
Where did the million-dollar
operation get financed?
How did that happen?
 
Who paid for it?
 
Yes?
 
Student:
Don't you pay the opportunity
cost >
 
million dollars and
>
individual lifetime when the
money could have gone and made
money itself rather than
spending on the operation?
Prof: Well,
you got a million dollars back,
remember, when you were old.
 
Student:
>
nothing more than a million
dollars
>
 
Prof: Okay, exactly.
 
So that's the whole point.
 
The point is that the
daughter--just to repeat what he
said.
 
The first daughter paid a
million dollars when she was
young.
 
Yes, she got the million
dollars back,
but when she was old,
and that's a long time later.
So for that whole time,
she made a 0 percent interest.
Now maybe the interest rate
was, let's say,
over that many years,
we're talking about 30 years or
40 years, a large amount of
time.
So the interest rate could
easily, over 40 years,
you divide 40 into 72,
you know, it's like 1 and 3
quarters or something.
 
So if the real interest rate
was 1 and 3 quarters,
something like that,
you could easily imagine,
that was the doubling rule,
that 100 dollars could have
been turned into 200.
 
So the first daughter who took
her 100 dollars could have had
200 by the time she was old.
 
She only got 100 when she was
old.
So in present value terms,
she gave up 100 when she was
young.
 
She got, in present value
terms, 50 dollars when she was
old.
 
So she gave away 50 dollars.
 
She paid for half the operation.
 
Now where did the rest of the
50 dollars come from?
Well, the granddaughter gave
100 when she was young,
got 100 when she was old,
so in present value terms,
she also lost 50 dollars,
exactly the same amount as the
first daughter.
 
She gave up the same thing.
 
Her contribution was just as
big.
Of course, it came a lot later,
so in present value terms,
at the time of the operation,
the granddaughter's
contribution is discounted
twice,
so it's 1 half of 1 half.
 
So she only contributed in
present value terms 25 dollars
to the operation.
 
And then the great
granddaughter,
she herself looks at it as a 50
dollar contribution,
but from the point of view of
the original operation,
it's discounted 3 times,
so by 8, so it's 12 and 1 half.
So 50 25 12 and 1 half 6 and 1
quarter, blah,
blah, blah, forever,
adds up to the 100.
So basically,
this parable shows how a
daughter could share the cost of
her mother's operation among all
the descendants,
pay completely for the
operation with each generation
making the same contribution,
the same sacrifice.
 
Of course, the generations who
make it earlier are helping the
mother more,
but the point is,
every generation has made
exactly the same sacrifice and
that's how the original mother's
operation got paid for.
Now what happens in generation
10,
the great great great great
great great granddaughter is
going to say,
"You know,
I never even heard of this
original mother.
I couldn't care less about her
operation.
It wasn't a very good operation
anyway, because she died three
years later, because medicine
was so bad at the time.
So why should I be paying my
contribution to that original
mother's operation?
 
Yes, I know that she's
responsible for my life,
but you know,
I don't know anything about
her.
 
I don't even know her name any
more.
How come I have to keep paying
for it?
So I just want to stop."
 
Now why is it going to be
actually difficult for that
generation to stop?
 
"I just don't want to give
my money to that first
generation.
 
I couldn't care less.
 
Let's stop right now."
 
Yes?
 
Student:
She's not giving the money to
her great great grandmother;
she's giving it to her own
mother.
 
Prof: Her own mother,
exactly.
So you can't stop just in the
middle because it's like the
gift is being re-enacted every
generation.
So the new generation that
stops, even if they understand
where the whole thing began,
they're not going to screw the
original mother.
 
They're going to screw their
own mother, which they probably
don't want to do,
so they're not going to want to
stop the thing.
 
So to say the parable very
shortly,
the first generation that got
taxes--
got benefits without
contributing anything,
that was a huge amount of money
that they got.
Every generation after that
lost money,
but that was all a way to pay
the first generation,
and you can't stop the cycle
without screwing your own
parents.
 
So it's very difficult for the
thing to be stopped.
Now you could make it a little
bit more realistic by saying
every generation,
wages grow every generation,
say between 1 and 2 percent in
real terms.
That's the historical rate of
growth.
By the way, it hasn't been so
great lately,
but anyway, historically,
say 1 to 2 percent real growth
of wages.
 
So on an annualized basis,
if you did the same thing with
each generation paying 12
percent of their youthful wages,
you would find that--now we're
coming closer to reality--
that every generation was going
to get between 1 and 2 percent
return on their contributions,
because the young would
contribute 12 dollars out of 100
say,
but their daughter,
that lady's daughter,
30 years later,
the wages would have grown by 1
to 2 percent every year for
those 30 years.
So 12 percent of that bigger
number would go to that
daughter, and so there would be
a rate of return between 1 and 2
percent.
 
And that's exactly what Bush
and everybody else is
predicting.
 
So now you understand where the
1 to 2 percent comes from that
you're going to get.
 
If the population is stable,
the ratio of young to old,
the rate of return on Social
Security is going to be equal to
the rate of growth of wages.
 
So it's not 0 as in the first
parable, because wages are
actually growing.
 
It's between 1 and 2 percent,
which is a bad return compared
to the rate of interest,
and that's why every generation
is losing.
 
Okay, so let's do one more
thing.
So the baby boom,
does the baby boom make things
worse or better?
 
How can you think about it?
 
It's so simple minded to think
this way.
It's amazing;
the public is so confused about
this.
 
Suppose you have a baby boom
generation.
So you're going on with all
these mothers,
we're back to the mother and
the daughter with 1 million.
So let's say there's one
mother, one daughter,
one person in every generation.
 
All of a sudden,
there's a baby boom generation,
but of course,
to be old, you have to be young
first.
 
So let's say in some generation
after a bunch of times,
there are 2 daughters instead
of 1 daughter.
Each of them is not going to
pay--if the tax rate stays the
same and the young daughters now
each pay 1,
the mother who's alive then
only needs 1 when she gets old.
So 2 daughters now have 1 to
contribute, so half of their
money goes to paying off the
mother when she's old,
just like would have usually
happened.
But the baby generation,
because it's young first,
that means when I was young,
my generation was making a huge
amount of money.
 
We're doing it now.
 
That's why there's a surplus.
 
There's this gigantic surplus
being put in to Social Security,
and so when my generation gets
old,
the dollar that didn't have to
go to the mother,
because there was an extra
dollar there,
that could be earning the rate
of interest.
And so at the end,
when we get old,
there are going to be 2 of us,
and there's only going to be 1
child next generation to
contribute 1,
and we're going to be expecting
1.
But see, the 1 that was put in
when we were young has now grown
to 2.
 
You've got 2 there,
plus another 1,
that's 3, so there actually
should be a surplus,
not a deficit.
 
Did you follow that?
 
Did that go too fast?
 
So I'm saying that every
generation, you give 1,
you get 1, you give 1,
you get 1, you give 1,
you get 1.
 
All of a sudden,
there are 2 people,
so they're each giving 1,
so none of them is worse off
than before.
 
When they get old,
they're going to need 2.
You've only got 1 person
contributing.
So here's the baby boom,
double the size of all the
other generations.
 
When they're old,
it looks like a problem.
Who's going to take care of
these people?
There're not enough young
people to take care of them.
But remember,
they were young before they
were old.
 
So since this mother only needs
1 and there are 2 of these
daughters,
the extra 1 could be invested
and the 1 that's invested is
going to make a rate of return
and become more than 1,
like close to 2.
And so you'll have the 1 from
the new daughter,
plus almost 2 that was saved,
that was in the Social Security
trust fund and earning interest.
 
So you'll actually have 3
dollars to make up for the 2,
and so it's not a problem at
all that you have this baby
boom.
 
In fact, it's a benefit that we
had the baby boom.
So basically,
what did the baby boom do?
It staved off the original
problem.
So let's just think about this
one more time.
Suppose that you have a
slightly more realistic example,
the kind you're going to do in
the problem set.
Suppose that you've got--people
live from 20 to 80 and they pay
taxes and work from 20 to 60 and
they retire from 60 to 80.
Everybody's paying 12 dollars
in Social Security taxes when
working,
and there's a 0 rate of
interest, and they're getting
24--
maybe I have a rate--they're
getting 24 dollars when they're
retired,
in benefits.
Okay, so the system balances
every year,
because in every generation,
these are the birth years,
the thing started in 1938,
and then they collected taxes
for a little while.
 
Frances Perkins got in action
and so they decided to go to pay
as you go.
 
To--let's just assume it
started pay as you go from the
very beginning.
 
So in 1940, you see in 1940,
the people who are 60,
the 1880 generation,
would have two decades to live.
So these guys--oh,
I'm sorry, I never put this.
Not that it mattered,
but it would have been a little
better.
 
So these guys,
the 60 year olds here,
and these 70 year olds,
the 70 year olds and the 60
year olds are collecting money.
 
Now the original start of
Social Security was a little
fuzzy.
 
They didn't want to pay people
who had never contributed,
so these 70 year olds weren't
really getting anything.
Okay, let's just keep for the
simple, steady state.
So the point is,
the 60 year olds are collecting
24 dollars.
 
The 70 year olds are collecting
24 dollars, and each of these
generations, the 50,40,
30s and 20s,
they're all paying 12 dollars.
 
So the contributions are
exactly matching the benefits.
So the system is perfectly in
balance.
Now what happens the next
decade?
You've got the new 70 year olds.
 
It's this next generation,
plus these guys,
who have now turned 70,
who had been contributing
before.
 
Now they're in their 60s,
sorry, they're in these 60s.
These guys in their 70s,
these guys in their 60s,
and then here are the
contributors.
This new generation has now
come on board to contribute.
So again, there's balance every
generation.
Okay, but now who are the
winners and the losers?
Well, you know,
it's much worse than it sounded
at first glance,
because people live longer than
1 year.
 
So you see these people,
in the '40s,
all these guys were gaining.
 
So this generation of 1870,
they have almost an infinite
rate of return.
 
They made no contributions.
 
These guys, they also made no
contributions and they're
getting huge returns,
because they're getting them,
you know, 20 years of returns.
 
But it's worse than that,
because when we go to the next
generation,
these guys, they actually
contributed when they were in
their 50s,
but that wasn't very long
before they retired and they got
24 dollars of benefits and 24
dollars of benefits,
having paid only 12 dollars of
taxes.
Of course, this came later,
but 48 compared to 12,
they got a gigantic rate of
return.
You go to the next generation,
and they're making out like
bandits too, because they only
contributed twice.
Okay so in the '40s,
a bunch of people were making
money, getting benefits,
who didn't make any
contributions.
 
In the '50s,
a bunch of people were
making--getting benefits who
made no contributions.
In the '60s,
there are still people getting
benefits who made no
contributions.
It's not till you get to the
'80s, once people are fully
retired, having made 40 years of
contributions.
So from 40 to 80,
it's not until the '80s that
the people who are getting
benefits were all people who
fully contributed.
 
Okay, so all these people were
getting an incredibly good deal.
We had 40 years of people
getting extra returns.
If you just do the distributive
law of arithmetic,
and you realize that all these
things go off to infinity
because they're discounted,
you can sum them in either
direction.
 
You can sum down the columns,
and that's always 0.
The benefits and the
contributions always net to 0,
but therefore,
if you add up the rows,
which is what each generation
gets,
they also have to add up to 0.
 
But you see,
there's so many original
generations.
 
This one got a huge benefit.
 
This one got huge benefits.
 
The present value of their
contributions relative to their
benefits is incredibly positive
for that generation.
For this generation,
it's still incredibly positive.
Remember, this is 12,12,
and this is 24,24.
For this generation,
it's probably still positive.
Not till you get to here has it
become--well,
not till you get to here does
something change.
So this is a positive number,
this is a big positive number.
This is a gigantic positive
number.
This is a huge positive number.
 
You add up over all these
things positive.
The rest of these generations
have to be negative to just
balance the thing at 0.
 
So that's why every generation
from here down to here is going
to have to earn a negative
return,
basically in steady state,
they'd all earn the same
negative present value,
or the same bad rate of return.
And there were so many
generations that got positive
amounts of money.
 
So in today's dollars,
can you tell me how much money
that we gave away to these early
generations?
Can you take a guess,
just order of magnitude?
So I'm asking in today's
dollars, today's present value
dollars.
 
Whatever the number is,
you have to assume it grew at
the rate of interest since then.
 
So what do you think that is?
 
Student: Couple trillion.
 
Prof: Couple trillion.
 
Does someone want to guess?
 
Reasonable guess,
but someone want to make
another guess?
 
Just so you get an idea of the
size of the program.
Does anybody know what GNP is
in the country?
Student: $15 trillion.
 
Prof: Okay,
$14 trillion,
something like that is GNP.
 
So what do you guess this
number is?
Okay, it's $17 trillion.
 
He guessed $2 trillion.
 
It's $17 trillion.
 
So we made a staggering
transfer of income to these
people at the beginning,
and now somebody's got to pay
for that and it's not a trivial
thing to pay for,
because $17 trillion,
if everybody gave,
every corporation,
every person in the whole
country gave away all the money
they made for a year,
we still wouldn't pay it down.
 
So that's a big amount that's
hanging over everybody,
and that's what the Social
Security problem is.
We gave away so much money at
the beginning,
if we keep the system in
balance, we have to gradually
give all the money back.
 
And we can't stop it,
because then some old guys are
going to get screwed.
 
So there's no way of stopping
the thing and each generation
has to lose.
 
So the reason why you're
getting such low rates of return
is because the system was
designed--Frances Perkins knew
what she was doing.
 
She wanted to help all those
old people in the '40s.
Now she was out of power in the
'50s and '60s,
you know, when we were still
helping all those people.
But the point is,
there was a tremendous transfer
of wealth,
so there were entire
generations of that era,
and that's the reason why
everybody's getting such a bad
rate of return now.
It's not because the money's
being lost or thrown away.
So what I'm telling you now is
not controversial.
I don't think many people
understand it,
but everyone who does
understand it agrees with it.
When come to my solution,
they're not going to agree.
But anyway, so what I'm telling
you, just to compute,
in the problem set you have to
compute an example.
So let's just see how this
would work.
So suppose from the point of
view of a 10 year old,
just doing the example I did,
suppose there's a 15 percent
rate of interest,
and you're going to contribute
in your 20s,
12 dollars, 12 percent,
so no growth in the economy.
 
So it's 12 dollars all the time
when you're in your 20s,
30s, 40s and 50s.
 
So what would you do from the
point of view age 10?
That's 10 years before your 20s.
 
You're going to contribute 12
dollars in your 20s.
You discount it at the 15
percent rate of interest.
You're going to be contributing
12 dollars in your 30s,
so you discount it at 15
percent twice,
and in your 40s,
you're giving up 12 dollars,
you're discounting it to 15
percent 3 times,
and in your 50s,
you're doing it,
12 dollars,
so you're discounting it 4
times.
 
So that's the present value.
 
From the point of view of a
young girl,
looking at what you're going to
be forced to contribute over
your life,
those are the taxes you can
expect to pay in present value
terms.
Now of course,
when you get old,
in your 60s and 70s,
you're going to get benefits,
24 dollars, much higher than
the taxes you paid.
But by then,
it's 5 decades later,
so you're discounting it 5
times, and when you're in your
70s, you're discounting it 6
times.
So you have to discount by 6,
so the present value of that is
way less than the present value
of this.
So you see that the loss in
present value terms is going to
be 11 dollars,
11 dollars out of 34,
which is what your benefits
were.
So your loss is something like
34 percent.
So this is just--I made up
these numbers.
The actual loss,
which I computed for the real
economy, is around 25 percent.
 
So that's how big each
generation, 1 quarter of the
typical--so here it's 34
percent.
1 quarter to 1 third in this
example of each generation's
Social Security taxes are simply
being lost,
frittered away,
and basically used to pay off
the debt from the original
generation.
Now if you want to look at the
total present value loss,
starting in the 1930s,
for people born in the 1930s,
you have to look at every
generation's losing the same
11.95 and so you take the
infinite future of generations,
and they're losing 79.68,
if you add up to infinity,
and of course,
that's the gain that was given
to the original generations.
 
Okay, so that's the kind of
example you're going to work
out, except for with realistic
numbers.
Okay, and so I just do--you're
going to do that anyway.
All right, so that's it.
 
So now, if you look at which
generation's got the most money,
at the beginning,
there weren't many people in
Social Security,
and so the amount of money that
they got,
the benefits that the really
old got,
there were so few of them that
if you add it up,
it wasn't that big.
So the generation that
benefited the most was my
father's generation and James
Tobin's generation.
Tobin, as we'll see in a
second, he used to tell me all
the time--
he was Yale's most famous
economist,
and I happen to be the James
Tobin professor,
so I have quite a fondness for
him.
 
I also went to the same high
school he went to in Illinois.
Anyway, he used to tell me that
the problem with Social Security
was,
we didn't have enough--I didn't
have enough children,
and I would tell him the
problem with Social Security was
we gave him,
his birth date,
too much money,
and that's why we're all
suffering now.
So you can see all the
generations and which ones,
which generation got the most
amount of money.
So that I also calculated.
 
Now this parable is not exactly
accurate.
So you know,
in the parable,
we should have had a crisis in
1970, it should have been,
or 1980.
 
I told you the people in 1980
should already have realized--
the generation starting to work
in 1980,
so born in 1960,
a lot younger than you are,
they should already have
realized that they're getting a
bad deal in Social Security,
and so we should have had all
this come much sooner.
 
So what kept the problem from
manifesting itself until now?
Well, what kept the problem
from manifesting itself until
now is actually quite easy to
see,
is there were a lot more young
people per old in the historical
generations.
 
Now we're leveling off and
everybody thinks we're going to
be 2 young people for every old.
 
The story I sort of told,
working from 40 to 60 and
retired from 60 to 80 in a
stable population,
that's coming close to what
we're converging to.
So there are going to be 2
young for every old,
where there used to be 3,4 and
5.
Now how could there have been
so many young for all the old?
Well, you know,
women at the beginning,
in this period,
they were working.
Women were surging into the
labor force.
There were a huge number of
young women working,
but their mothers actually
weren't working.
They had not worked and so they
were getting half their
husband's benefits,
not the full benefit that these
daughters who were working their
whole lives are going to get.
They're not going to take half
their husband's benefits.
They're going to take all their
own benefits,
which are going to be a lot
higher.
So then there was the baby boom
generation.
The baby boom generation,
far from causing the problem,
has deferred the problem.
 
There are all these surpluses,
because we were working so
long.
 
I don't want to get into all
the details.
People are living longer now
too, so that's another problem.
Too much complication here.
 
Okay, so what can you do about
this?
Well, there are obvious things
to do, which are bad.
So one thing you could do is,
you could say,
if we're supposed to be paying
the average young [correction:
old]
person 40 percent of the new
generation's wages,
and there are only going to be
2 young people for every old
person,
we could maybe shave the 40
percent down a little bit.
Let's make the Social Security
tax 18 percent instead of 12
percent.
 
So you could raise it by 6
percent.
Nobody wants to actually do
that, because an increase of 6
percent in a tax rate is an
astronomical increase and you
can read in the newspapers how
loath Congress is to raising
taxes.
 
Another obvious thing you could
do is, you could raise
retirement age.
 
So instead of saying it's 65,
because people will live till
80,
make it start at 67,
so you'll only have to pay them
for 13 years instead of 15
years.
 
In this example,
18 years instead of 20 years.
So you could keep raising the
retirement age.
The problem with that is--not
the retirement age,
the age you start collecting
Social Security.
The problem with that of course
is that people are retiring not
later and later,
even younger and younger,
believe it or not,
and so you're getting this huge
gap between when people retire
and when they start getting
Social Security.
 
So there's a limit to
how--obviously you should do a
little bit of that,
but there's a limit of how much
of that you can do.
 
So you need to make not just a
parametric reform,
you know, like adjusting a
number, changing the tax rate a
little bit,
but I believe you need a
fundamental reform,
and the Republicans have
proposed one.
 
They've said,
"Let's privatize.
Let's change the whole
system."
Okay, so what does it mean to
privatize?
How are they going to do that?
 
So what Bush had in mind was
the following:
he said, "What is
privatization?
It involves three things.
 
It's the creation of individual
accounts, so your name goes on
it.
 
So it's your account,
your money and no one can take
it from you.
 
It's your money and your
money's what's going to pay for
your own benefits,
so it's prefunded.
So it's individual accounts and
prefunded, and it's
diversification.
 
You're supposed to invest not
just in government bonds,
but in the stock market,
whatever else you want."
So those are the three
cornerstones,
at least the way I've explained
them, of privatization.
Three things that it
accomplishes.
It gives you your name on the
money.
It's your money.
 
That's the money that's going
to pay you when you get old,
prefunding, and you can invest
in a wider range of assets,
especially the stock market,
which is what everybody seems
to want to put their money in,
or at least used to,
until we had this last crash.
 
On the other hand,
the stock market's going up a
lot, so people are getting less
nervous about it.
So those things are different,
they're not the same.
So how is Bush going to handle
this?
How would you think he was
going to do this?
How could you possibly--so Bush
said, "I want to privatize.
I want the 12 percent that you
pay in Social Security taxes,
I want 4 percent of that for
you to be able to put that in
your private account in the
stock market with your name on
it."
 
So Gore said,
"Well, that's ridiculous.
If it's only 8 percent then,
left to give to the old people,
the old people are going to get
cheated,
so how is Bush going to handle
that?"
What did you think he was going
to do?
Student:
Borrow the
>
 
Prof: Could you say that
again?
It sounds right,
but I couldn't--
Student:
Borrow to make up the
shortfall.
 
Prof: Exactly.
 
So I don't know what Gore was
thinking, especially since I was
supposedly advising Gore about
Social Security.
But he just said in the debate,
"That's impossible.
You'll just screw all the old
people."
Okay, so you're supposed to be
giving 12 percent,
you know, 12 here,
-12 here, and then getting some
return over here.
 
And now Bush is saying,
"I only want to give you 8
dollars,
and the other 4 you put in your
Social Security account,
and then you're going to get
maybe a much bigger return
here--
sorry, in your stock market
account,
in Social Security,
so you can't take it out."
So Bush would say,
"Yes, let people put their
names on it, force them to save
and contribute the whole 12
dollars."
 
Bush agrees that you've got to
force young people to save,
because they're not going to do
it otherwise.
So you put the 4 dollars in
their private account,
but it's their name on it,
and then it grows to some huge
number,
you know, 20 instead of just
doubling by the time they get
old.
And so that huge account is
their money.
So that's what Bush would say.
 
So Gore would say,
"If you take these 4
dollars and give it to them,
how are you going to pay the
old people who need the 12 right
up here?
The old people are supposed to
get 12.
How are you going to give them
their 12 when the young aren't
handing over the 12 anymore?
 
They're only handing over
8."
Well, it's not like Bush and
his advisors didn't think about
that.
 
That would be a colossal
blunder.
Of course they thought about
that.
So what were they going to do?
 
They were going to have the
government go out and borrow the
other 4, so the government
contributes 4 that it borrows.
And now of course over here,
the government's going to have
to owe 8,
because it's got to pay back
the 4 it owed in 30 years,
at we're assuming,
100 percent interest over 30
years,
has got to pay back the 8.
 
You're all with me.
 
So where are they going to get
the 8?
Who are they going to get the 8
from?
What?
 
Student: Taxpayers.
 
Prof: Which taxpayer?
 
Student: All of them.
 
Prof: Everybody.
 
Really?
 
Student:
The same people who are paying
the Social Security.
 
Prof: Okay, these people.
 
So if you chose to take 4 of
your dollars out of Social
Security and put it into your
Social Security stock market
trust fund,
your personal trust fund,
the deal is,
you have to pay the interest at
the end of 30 years.
 
So this 8 comes out of your 20.
 
So these people pay back the 8.
 
So basically,
to say it in a different way,
the way you get to invest in
the stock market,
according to the Bush
privatization rules,
is these people effectively,
they're giving the 12 dollars
anyway to the old,
but they get to borrow 4
dollars and put it in their
private stock market account.
And then they have to pay back
the amount they borrowed with
interest, which is 8.
 
But if the stock market does
better than the interest rate,
then of course they make out
better.
They get 20 - 8, which is 12.
 
Okay, so is that clear how he
did it?
So it's not a logical
impossibility.
The problem with the Bush plan,
of course,
is that if the money you put in
the stock market earns the same
rate of return that you would
have gotten anyway,
if the stock market earns the
same rate of return,
100 percent over all those
years as the bond market,
then this private stash you
have just goes back to paying
off the government debt and you
haven't gained anything in the
stock market.
 
You get the same Social
Security benefits you would have
had anyway.
 
So these guys who opt into the
privatization program,
let me repeat the Bush plan.
 
If you opt into the
privatization program,
you effectively do everything
you did before in Social
Security.
 
You pay your taxes that go to
the old people.
You get the benefits just like
you did before,
but on top of it,
you have the right to borrow 4
dollars from the government,
invest it in stocks,
and then at the end,
you have to pay back the
government out of your stock
market return.
So you're betting on whether
the stock market is going to do
better than the bond market.
 
That's effectively what the
plan was.
Okay, so it's not a logical
impossibility like Gore said.
On the other hand,
if you don't think the stock
market's going to do better than
the bond market,
you could end up being worse
off.
You could put in 4 dollars
here, get only 6,
and then you'd have to owe the
government 8.
Where's the government going to
get the other 2 dollars from?
It's going to reduce your
Social Security contributions
[correction: benefits]
by 2.
So that's the government plan.
 
So in the problem set,
I gave you three problems.
You can only do two of them now.
 
The last one I didn't get far
enough to have you do.
So just do two of them,
and I'm going to give my own
plan next time and also do a
little mathematics.
It's going to turn out that
it's quite interesting to math
this up a little bit.
 
 
 
