Monday, November 12, 2012

Thoreau on Entitlement Reform

Over the weekend my daughter and her husband visited us and as often happens we had a couple of discussions about politics.  My daughter and her husband are strong supporters of the president.   As readers of this blog have already found out I begin my thoughts of government subscribing the the notion first advanced by Thoreau in Civil Disobedience in which he said in part -
"I HEARTILY ACCEPT the motto, — "That government is best which governs least";(1) and I should like to see it acted up to more rapidly and systematically. Carried out, it finally amounts to this, which also I believe, — "That government is best which governs not at all"; and when men are prepared for it, that will be the kind of government which they will have. Government is at best but an expedient; but most governments are usually, and all governments are sometimes, inexpedient."  (Emphasis added)

I am not against government for a very limited number of things, just skeptical that if we get too exuberant in figuring out how much more government can do, we risk profound unintended consequences (although I suspect some of the consequences are intended by those who would extend governmental power).    

My daughter and her husband base their expressions of support for government on two premises.  First, is an assumption about improving equity in society.   While my wife and I have been relatively successful in life, there are those in society that have not and in a just society we need to as Dickens says in a Christmas Carol "it is more than usually desirable that we should make some slight provision for the Poor and Destitute, who suffer greatly at the present time.  Many thousands are in want of common necessaries; hundreds of thousands are in want of common comforts, sir."  Who could be against that?   Well, me for instance.

A just society should make provision for the poor and destitute, but there are what economists call moral hazards when you err too much in one direction.   People react to incentives and if you diminish the benefits of prudent behavior people may be less prepared to make provisions for themselves.   Social security is a prime example where a well intentioned program distorted individual choices ending up eliminating possibilities for some benefits to society and even reducing the possible individual benefits that most people could expect to receive.

I am an advocate of privatizing Social Security, in much the way that Jose Pinéra did in Chile and which many other countries have proposed.   The privatized system has a couple of benefits for society.   First, it creates a capital pool which the existing paygo method does not.   Those assets could also create a larger benefit and a legacy to ones heirs.     Over my working life between employer and employee contributions to Social Security I contributed more than $330,000.   That produces a monthly "benefit" of about $2500.   Had that money been invested in a conservatively managed pool of stocks and bonds (similar to the options in programs like tuition savings plans or IRAs) the value of those contributions would have tripled.   At a payout rate of 4% my monthly benefit would increase by more than $800 per month.  Even if I agreed that we would make a payment to others that might amount to 10% to cover the needs of people in society who make poor choices, I would still have a much better result by having government set the rules rather than running the program.   From any reasonable interpretation, the current system (where benefits are reduced and there is no residual) is a sucker's bet.   The chart at the left shows inflation adjusted returns for the Dow Jones Industrial Average.    If you begin at 1900 that increase is 100 times the 1900 amount - even if you adjust for inflation (which is about 28X) the return is still huge.   Retirement savings have a very long time to grow because our cycle of work is a very long time.  

There are plenty of ways to make provision for people who are either unable to invest for themselves or who are simply unlucky.   But the bottom line is that the private alternative would provide greater security while at the same time producing a huge capital pool for investments that society needs.  IF you do not believe it, simply look at the transformation in places like Chile.

But there is a second argument raised by both my daughter and her husband.   There are a lot of people who receive government assistance, even me and my wife.   And indeed we do receive payments.    But again lets look at the facts. My return on the Old Age Survivors and Disability Insurance have been mildly negative when compared to a reasonably diversified portfolio of investments. As demographics continue to turn against the younger participants in the system, they believe they will never receive benefits.   That is a bad deal for all.

There is also the question of Medicare.   And indeed the math here is also negative.   Over my working life I paid in just under $100,000 in tax payments to the health insurance part of Social Security. (Again remember to at least double the amount paid in based on an assumption that had the money been invested to term we would have a capital pool that would at least match some reasonable investment index.)   But Medicare is not free to recipients.   My wife and I now pay a monthly premium for parts A-D and advantage coverage of about $1000 per month.   When I left my last full time employer, my health insurance coverage was costing my employer (for covering both of us) a bit more than $1500 per month.  Add in the money already paid in and the cost of coverage is at best about equal to what I would pay in a market based solution.

Market based solutions need not be harsh to the less fortunate.  I come back to my original point, the risk of relying too much on government is that in the words of Thoreau government run solutions can be "inexpedient" for both the individuals and society.

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