Wednesday, January 30, 2013

What the Squirrels Taught Me


This post is a response to Matt Bruenig's response to my piece in Bloomberg about generational inequities in the financing of social-insurance programs. You should probably read them both first.

Bruening: "In his argument, Soltas groups Medicare and Social Security to make a point about old-age entitlement costs. That’s a terrible thing to do as their budget impacts are majorly different."

I agree completely that the two programs have very different budget problems. I agree that the magnitude of Social Security's problems is comparatively small, and that Medicare's is comparatively large. The reason I group them, however, is that they are both underfunded old-age transfer programs where policy fixes necessarily entail choices about generational equity.

I attempt no deception.

Let's deal with the meat of your argument. Here I propose a different model of the economy, which we'll assume is populated by squirrels who hoard non-spoiling acorns in a vast public store. And let's assume two totally separate squirrel populations.

In the first squirrel population, there's a store of acorns under a tree. The lifetime consumption cycle of a squirrel goes like this. When young, the squirrel eats 80 percent of the acorns he finds and deposits 20 percent of them in the public store. When old, the squirrel consumes an amount of acorns commensurate with the amount he deposited in youth. Then the squirrel dies. They're not the exact same acorns -- no pre-funding individual acorn accounts -- such that acorns are always flowing through the store from young to old. But over the lifetime of the squirrel, his net contribution to publicly-held capital is zero. An equivalent statement of this is that the squirrel's net tax burden for social-insurance is zero, or also that there is no net transfer of acorns from one squirrel to another.

Now let's visit the other population of squirrels. Their lifetime cycle is initially the same, except they contribute only 10 percent of their acorns when young and and therefore eat twice as many as the acorns they deposited when old.

What happens to this community? If you concede that we are in a different situation than the first squirrel population, then I have won every part of this argument I have set out to prove. Without corrective action, the public store of acorns will diminish to zero.

When it does, there are two broad-brush correctives, assuming that we will not attempt to replenish the public stock, and merely maintain a zero steady state:

(1) Tell the old squirrels to halve acorn consumption.

(2) Tell the young squirrels to double their acorn contribution.

For the generation that shifts from young to old at the instant the acorn store goes to zero, option (1) will render their net consumption of public acorns zero. Option (2) will make their net consumption of public acorns positive. Option (2) will, by extension, increase the total consumption of acorns for this generation.

So the first problem we're dealing with between the two squirrel populations is not merely a problem of money. It's a shifting of real consumption.

And the reason your argument is flawed is because this shifting of real consumption occurs even without the change in the percentage of total acorns consumed in any unit of time by the elderly squirrels. That's important, so I'm going to write it again: A constant fraction of consumption going to the elderly does not equal zero generational transfers.

The reason why is because the elderly squirrels spent down the public store of acorns. This is easily seen by adjusting option (2) such that the tax is increased sufficiently as to restore the acorn inventory to its prior level within a given time frame. This version of option (2) also renders the net public acorn consumption of young squirrels within that time frame negative and depresses their total lifetime acorn consumption.

So what does this all mean? It's simply not true that generational inequities are irrelevant as a distinction between what I want and what exists -- i.e. between the first and second squirrel populations. There is a shifting of real consumption and a reduction  in the capital stock of the second population which does not occur in the first.

We can suppose that any solution will leave the young, then, with some reduction in lifetime real consumption and some reduction in the capital stock. The point of my op-ed was to argue that either one is a really rotten deal for the young squirrels.

Let's also consider what I object to in the behavior of the older squirrels. Basically, it's granting themselves the right to deplete the capital stock to finance their current consumption -- and then to shift other squirrels' consumption. The adjustment to their behavior I would have made would have been to either raise their contribution rate, such that they eat fewer of their acorns and increase the capital stock instead -- or they should just not have promised themselves as much in the future, such that they do not reduce the capital stock on net.

Let me also talk about why I think this is a normative wrong. I would apply a contract test of normative wrong in transfers. If we could bring all of the squirrels in any population together from the beginning of time until the day of judgement, would such a scenario be judged as acceptable in advance by all members of the community? I think the first population would, whereas the second population would not. I think the receiving of net transfers of public acorns between generations bears the burden of justification. And I do not think it can be, assuming that no generation is less able to earn. (Suppose that half the squirrels in one generation were maimed by owls but were still alive and hungry. I believe in a sufficiently robust welfare state as to say that net transfers would be justified to those squirrels, and therefore that would be to me an acceptable case for an generational net transfer of public acorns.)

(As a side note, when we introduce features to the model such as interest, all of the squirrels can increase their lifetime acorn consumption by saving, i.e. they can all have positive lifetime net public acorn consumption. But the net present value of their acorn consumption at birth must always be zero for this to work.)

All this should make it clear why I object to a payroll tax fix -- whether you raise the rate or lift the cap -- for Social Security or Medicare.

13 comments:

  1. Evan,

    You are not thinking about the squirrels as a whole group. You should, because it will show your argument to be incomplete because of the notion of a ‘capital stock’ which simply doesn’t exist in the squirrel economy.

    Your model doesn't explain how the capital stock got there, who put it there, or what it might represent in reality.

    In your model squirrel economy, the young work 50% of their life and consume 80% of their acorns during working age. They consume the remaining 20% of their previous collection efforts during their 50% of lifetime retirement years.

    Let’s make it easy and have 2 squirrels per society where they live one year as young and one as old. They collect 100 acorns in their first year, consume 80 that year, and 20 the next year. In each year the society (the two squirrels) as a whole collects and consumes 100 acorns between 2 squirrels.

    However, there is actually never a ‘vast public store’ of acorns in this equilibrium. Every time the young squirrel puts in an acorn, the old squirrel takes out that acorn. The balance is always zero. It is simply a transfer at every period. As I said, you assume a 'vast public store' without having any mechanism for it to get there.

    What about your underfunding society?

    We must assume that society has gone from a situation where the young squirrel gives the old squirrel 10 acorns per year, to a situation where the old squirrel consumes 20 acorns per year.

    Lets look at this change with 4 squirrels (numbered in brackets) over a few periods.

    Period 1. Young 90 (2) Old 10 (1)
    Period 2. Young 80 (3) Old 20 (2)
    Period 3. Young 80 (4) Old 20 (3)

    If the Period 1 equilibrium continued, then all squirrels would collect and consume 100 acorns over their lifetime. However, because in Period 2 the old squirrel consumes 20, the young must consume 80. They must, because there is no stock of acorns to run down. In this sequence of events, squirrel 2 consumes 110 acorns over their lifetime but only contributes 100.

    Where did this come from? The young squirrel in period 2. However this young squirrel gets it back when they are older. Who loses? No one really. Except if you want to reverse the changes to regulations and go back to the previous equilibrium. In that case, one generation of squirrel gets screwed by collecting 100 and consuming 90 over their lifetime.

    You get close to acknowledging the lack of capital stock when you say that “acorns are always flowing through the store from young to old”.

    In sum, consumption by non-contributors in society is always funded in the current period by those who do. You are mislead by the idea of having some kind of capital stock that can be run down to pay for consumption by the old. This stock doesn’t exist in the model squirrel economy nor real life. Consumption of goods by retirees must be produced in the period it is consumed. And even in a society with a capital stock, that stock is not acorns (but, say the oak tree). My views on this same issue with a capital stock is here

    http://www.macrobusiness.com.au/2013/01/the-pre-saving-myth-of-superannuation/

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    1. Cameron,

      I've taken some time to read carefully through this.

      Where I don't agree is that you're effectively implementing option (2) in my post in your period 2. That's why the young consumption falls from 90 to 80. I agree that's a plausible solution to the problem. But note that if you don't assume option (2) is taken, then we're back at my premise -- that something has got to give. If you assume that the young continue to consume 90, then you will be 10 acorns short of the desired consumption.

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    2. I agree. Something has to give. But we can choose which ever way - force retirees to live on less or work longer, or force current workers to consume less. Either way, if the retirees are allowed to continue consuming it must come from the current generation's production, whether through inflation, taxation or some other means.

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  2. While there is an intergenerational transfer, it would not be from the second generation to the first, but from the last generation to the first, assuming there is ever a last. In raising the rate to 20%, the transfer is merely being maintained from the next to current. And there never is a capital stock among the second population but what they saved themselves (I am assuming the two populations are independent). It may be the second population only planned on half the retirement of the first or miscalculated their required saving rate or simply had the bad fortune of bad crops but discover this in their retirement, but the next generation must save 20% if they expect to consume it in retirement. In this, it is not so much transfer as smoothing and returns will never be what one expects. You expect too much if you expect clairvoyance, and life will never be as fair as you demand. There are risks in transferring consumption from the present to the future that can never be eliminated.

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    1. I need not assume clairvoyance. It'd be insignificant if the problem was merely one of intergenerational smoothing. This is a deliberate and massive underfunding.

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    2. The other flaw in this is saving is equated to investment and the alternative is consumption, but while some will save, some will invest, plant their acorns, and grow more oak trees. They will have "consumed" their acorn in doing so, but under favorable conditions, have many more to collect in the future. Their failure to store it only caused a transfer in the narrow sense of the store, not in the broader sense of the population, which if anything would be a transfer in the other direction. Those investments may come to nought despite our best efforts or they may be foolish from the start, but they may be enormously successful too. It does matter what is done with the acorns, but saving is not the same as investment and investment consumes up front before producing. We shouldn't slide into the simplistic, production good, consumption bad frame that the elderly are parasites on society. They built it and rebuilt it as well. While we should do our best to rationalize our programs, we also need to recognize they do not exist in isolation.

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    3. Let's deal with this:

      "While there is an intergenerational transfer, it would not be from the second generation to the first, but from the last generation to the first, assuming there is ever a last"

      That would be true if only the first cohort to pass through the system took positive NPV benefits. (They get benefits but didn't pay in over their lifetime.) It's a plausible scenario. And that would be a small problem if that was what was happening. But it isn't. What's happening is that intermediate generations are promising themselves very large NPVs of benefits.

      Now we'll deal with this:

      "The other flaw in this is saving is equated to investment and the alternative is consumption, but while some will save, some will invest, plant their acorns, and grow more oak trees."

      The answer to this is simple, and I noted it towards the end of the post: assume interest on the acorns. You can pretend whatever fraction of the store is in saving, and then the remainder is simply "acorn certificates" akin to stock in squirrel corporations which increase lifetime harvesting productivity. So no need to assume S=I for the model to work. All this does is allow for a positive net lifetime consumption of public acorns such that the NPV is zero.

      We can connect this back to the main point by observing that the results of such investments are really part of the capital stock. To the extent that the capital stock grows from such returns, this works.

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    4. Sorry, what can't go on, can't go on. We can all promise ourselves to stay forever young and never die, but it isn't going to happen. You can't claim we are headed for disaster but will never get there. We either are and it happens or we aren't and it doesn't. The longer it takes, the less the problem was all along. Yes, you can assume interest on acorns. You cannot assume a constant interest or a positive interest on acorns though.

      The biggest problem with your position is it offers no solution. Any solution must offer a compromise better than the default, which is to cut benefits when the store is exhausted. Such a compromise would necessarily include some rise in taxes, caps or rate, with some cut in benefits. By excluding the former, you eliminate the latter, which is just as fine with me. The default is not a bad solution, and a 22% cut in 25 years is better than anything you can offer.

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  3. The squirrel metaphor is deeply dishonest. The Social Security reforms passed by Congress in the 1980s raised payroll taxes to a level where the current working age population was paying a lot more than what was necessary finance the then-current Social Security program. The idea was that the Social Security Trust Fund would build up treasury bills that could then be used to help pay for the retirement of the baby boomers. So the baby boomers paid extra into the system, and now they are going to retire and need those benefits, and you're saying that they didn't save enough acorns! What hogwash! How dare you suggest that current retirees didn't save enough, that was the whole point of the reforms that were passed back in the 80s! I hope when you get old, you are taken care of by someone as dishonest and cruel as you are.

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    1. You must be new to the blog. This comment does not meet the civility standards regular visitors know I request of them. Here's my challenge to you, nonetheless. Find me evidence that the current working-age population has a zero NPV of net benefits.

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    2. Why did people overpay for Social Security according to the arrangement recommended by the Greenspan Commission? Do you dispute that this was meant to finance the retirement of the baby boomers, or are you simply arguing that this arrangement is not enough to support the Baby Boomers in retirement?

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  4. You do realize the program has always functioned that way? I think I misunderstood and thought you had a problem with the system today, rather than the system in principle.

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