Responses to Mssrs. Santorum, Shaw, Gregg, and Stenholm

["Steven H. Johnson" <info@sscommonsense.org>]

I have a few more issues to raise, and I'll break them out into 
separate postings.

But first, some notes of appreciation.  What a lively forum!

I'd like to thank Sen. Santorum for his response on the issue 
of real rates of return in the stock market.  In his reply, 
the Senator focused on price appreciation, and noted that, 
if it's tied to the GDP growth rate, we shouldn't be pessimistic.
Even if population growth slows down, our economy's potential 
for strong productivity growth remains solid.  I can't argue 
with that.  

On stock returns, though, it's important to note that two-thirds 
of the well-known seven percent number were actually derived 
from reinvested dividends, only one-third from price appreciation.  
And Sen. Santorum didn't comment on the issue of whether dividend 
yield rates can be sustained.  There, I think, the evidence is
fairly indisputable.  Dividend yields are quite low now, and the
prospects that they'll return to their historic levels aren't great.
I'll return to this issue in a later posting.

Thanks also to Rep. Shaw for his very clear reply to my questions on the 
Archer-Shaw plan.  I'd like to raise the issue of real rates of 
return with him as well.  He makes his stock return assumptions 
quite explicit, which I appreciate.  He expects 7% returns, and 
he also expects to see stock-rich personal account portfolios, 
with a weighted average return, after fees, of 5.35 percent.  

A close examination of the empirical evidence on historical 
seven percent returns suggests that the same factors which 
produced seven percent returns in the past are now poised to 
produce somewhat lower returns in the future.  A more prudent 
forecast for the Archer-Shaw proposal, therefore, might be a 
weighted average portfolio return of only 4 percent.

Thanks also to Sen. Gregg for his comments on the issue of 
whether the process of paying off Social Security debt, 
commencing about 2014 or 2015, constitutes new spending or 
merely a refinancing.  I brought up the issue in the context of 
his earlier point about how to figure rates of return on Social 
Security taxes paid.  After I wrote my posting on refinancing, 
it occurred to me that perhaps the real issue is one of double-
counting.  

In figuring the rate of return on Social Security tax dollars 
paid, Sen. Gregg seemed to me to be suggesting that one should count 
both the payroll tax dollar initially paid, say in 1988, even 
if it went into the Social Security surplus, to be then loaned 
to the Treasury, and then the income tax dollar paid in much 
later, say in 2016, to redeem Treasury's debt to Social Security.  
In figuring the rate of return on the taxes paid in, that 
produce a dollar paid to a beneficiary in 2016, my question is:  
do we count both dollars?  The 1988 payroll tax dollar?  And the 
2016 income tax dollar?  If we do, that would lower the rate of 
return, wouldn't it?  But it's double-counting to count them 
both, so we probably shouldn't.  If the 1988 dollar counts, then 
the 2016 dollar doesn't.  Or, if the 2016 dollar counts, then the
1988 dollar doesn't.

To get off this technicality, though, and back to one of the 
broader point on which Senator Gregg raised some very important 
issues.  One was the issue about the tough situation that Social 
Security's debt places the Treasury in, when the time comes to 
redeem the debt.

I think I'd favor having the Treasury redeem all of Social 
Security's debt as fast as possible, without waiting till 2015 
or so.  Why?  Because we need a marker event, that makes a break 
between the past and the future.  Social Security's past is a 
pay-as-you-go past.  In the past, it didn't matter that it was 
treated as just another program.  Money in, money out, just like 
hundreds of other programs.

But now we're stepping into a new future.  In which Social 
Security needs to be regarded as a funded pension program, with 
fiduciary responsibilities to retirees.  (Partially-funded, not 
fully-funded, but still funded.)  Its assets could well be 
sizeable.  They shouldn't be commingled in any way shape or form 
with Treasury funds.  They should be banked and managed separately.  
And Social Security should at least be given the freedom to 
invest in non-federal government bonds.

Do this, and what happens?  Treasury owes roughly $5.4 trillion 
to its creditors.  $3.8 trillion of that is to outside creditors, 
$1.6 trillion to trust funds within the government.  Redeem the 
$800 billion it owes Social Security, and its debt still remains 
at $5.4 trillion.  Only now, $4.6 trillion is owed outside, and 
$0.8 trillion is owed inside.  It truly is a refinancing, and 
better to do it now than later, I say.

Then the $2.8 trillion subsidy that the President has proposed 
becomes a true subsidy, not just a funny money game.  $2.8 
trillion in real cash has to flow, over time, from the Treasury 
to Social Security.  Which, in turn, invests that cash in a range 
of securities, so as to build up its capital pool to a level 
that ultimately results in lasting solvency for Social Security.

The President's subsidy, by the way, is probably no greater, in 
the long run, than the subsidy that will be needed if a personal 
account system is created as an add-on to the current system, 
and financed through tax credits, as the Archer-Shaw proposal 
suggests.  In fact, if the Archer-Shaw credit system becomes a 
permanent feature of the federal budget, it will undoubtedly 
turn out to be a much more expensive subsidy than the President's 
proposed subsidy.

Thanks also to Rep. Stenholm for his comments on the issues I 
raised about Ron Gebhardtsbauer's chart.  He noted that he didn't 
like the idea of building up a large Trust Fund, because it would 
represent nothing but an even larger obligation for the federal 
government.  I agree on that.  While I do like the idea of a large 
Trust Fund, because I think it's part of the solution for long-term 
solvency, I don't like the idea of the Trust Fund being 
filled up with federal government bonds.  That wouldn't be a 
healthy practice, either from Social Security's perspective, or 
from Treasury's perspective.  Better, in fact, to repeat the 
point I just made, to allow Social Security to invest elsewhere, 
and for Treasury to redeem its existing debt to Social Security 
as rapidly as is feasible.

On the issue of the Kolbe-Stenholm bill itself, this is clearly
a judgment call.  If long-run real returns to stocks are lower than
the bill's authors anticipate, there's a fairly significant cut
in the aggregate benefit stream built into this proposal.  Ten 
percent?  Fifteen percent?  Maybe even twenty percent?  Which, I
think, the bill's authors understand, probably better than any
of the rest of us.  Can we do better?  Even if we take a more
pessimistic view about long-run real returns in the stock market?
I think we can.

One final thought - a general point.  The issue of the unfunded $9
trillion liability has come up a number of times.  I believe Martin
Feldstein may have been the first to quantify the value of the 
money owed to current and future retirees in those terms.

If Social Security is on the verge of becoming a funded retirement
program (partially funded), then how much of that $9 trillion 
needs to be funded?  All of it?  Or only the portion that can't 
be covered by the current pay-as-you-go tax rate?  It seems to
me that the amount which needs to be funded is the amount that
pay-as-you-go won't be adequate to finance.  $3 trillion, perhaps, or
$4 trillion.  Roughly 50% of GDP, perhaps, to put the number in
GDP terms.  If that's a reasonable way to look at it, then that 
helps us think about our bogey.  We want a pool of capital, either
in the Trust Fund, or in PRA's, or in both, that's equal to at
least 50% of GDP.  (I actually think the real bogey, if we don't
want to cut benefits, is more like 65% of GDP.)  Thoughts on this, 
anyone?

And now to a focused set of postings aimed at identifying some of the
key issues still open, and then framing an option that's aimed 
at resolving the toughest and most vital issues.

-Steve Johnson