Simon Johnson's Blog, page 29

January 16, 2013

More Bad Software

By James Kwak


Last week BATS admitted that its software suffered from systematic problems for four years, failing to obtain the best execution price for about 250 customers and costing them about $400,000. That should be a giveaway: no self-respecting company would break the law just to steal $400,000 from its customers. This was a programming error, pure and simple.


Also last week, a RAND study revealed that, despite billions of dollars of investment, electronic medical records have done little to reduce costs for healthcare providers. This is more complicated than a simple programming error. The issue here is that projected savings of this kind are typically based on some model of how operations will be done in the future, and that model depends on perfectly-designed software functioning perfectly. Medical records systems apparently fall far short of this ideal: as the Times summarized, “The recent analysis was sharply critical of the commercial systems now in place, many of which are hard to use and do not allow doctors and patients to share medical information across systems.”


The common feature to these stories, however, is that big, complex, business software is really, really important—and a lot of it is bad. In many niches, it’s bad because there aren’t that many companies that serve that niche, it’s hard for customers to evaluate software that hasn’t been delivered and installed yet, and there are all sorts of legacy problems, particularly with integration to decades-old back-end systems. And most of the incentives favor closing the sale first rather than making sure the software works the way it should.


I don’t have much to add that I didn’t put in my Atlantic column on a similar topic last summer. Nothing has changed since then. So I’ll stop there.





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Published on January 16, 2013 18:26

January 14, 2013

A Weak “Defense of the CEO”

By James Kwak


I finally bit the bullet and read “In Defense of the CEO,” Ray Fisman and Tim Sullivan’s article on the cover of the “Review” section of Saturday’s WSJ. The inside continuation page is headlined “When CEOs Are Worth a Fortune.” In fact, I read it twice. But nowhere could I find any evidence or even an argument that any CEOs are worth a fortune—just a lot of implying, assuming, and asserting that they are.


Fisman and Sullivan discuss what CEOs do: they go to meetings, which is no surprise. They cite one study saying that CEOs who spend more time meeting with employees run companies that are more profitable than CEOs who spend more time meeting with external parties. But they don’t discuss which way the causality runs, or whether the latter companies would do better with the former CEOs. They make the conceptual argument that “a slight edge in ability can translate into enormous payoffs,” which might justify high CEO pay—if only they provided any evidence that ex ante higher pay packages actually correlate with ex post higher shareholder returns. And they repeat the stock argument that golden parachutes give CEOs an incentive to sell out at high prices rather than dig in and fight off takeovers—but the only study they cite argues that golden parachutes are associated with lower company valuations.


Mainly what they do is name-drop CEOs of successful companies (or at least with successful tenures)—Amazon, Apple, Zappos, EasyJet, Ford—without bothering to argue that those CEOs were responsible for their companies’ success. In a couple of cases it’s hard to argue with the importance of the CEO, but simply repeating Steve Jobs’s name over and over is not going to convince anyone that the average CEO is Steve Jobs.  Three of their five examples, by the way, founded their companies, which makes them far different from the typical hired mercenary with an obscene employment agreement.


This is the best the WSJ can find as an argument for paying oodles of money to CEOs?





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Published on January 14, 2013 19:08

January 4, 2013

If Only

By James Kwak


Paul Krugman describes the battle lines this way:


“Democrats want to preserve the legacy of the New Deal and the Great Society — Social Security, Medicare and Medicaid — and add to them what every other advanced country has: a more or less universal guarantee of essential health care. Republicans want to roll all of that back, making room for drastically lower taxes on the wealthy.”


I think he’s right about the Republicans. But I don’t think he’s right about the Democrats.


If you want to preserve Social Security, Medicare, and Medicaid, in a world where the population is aging and health care costs are going up, then it’s obvious that your top priority should be higher tax revenues. Without a reasonable level of federal tax revenues, there’s no way we’ll be able to pay for those programs in the future.


Instead, President Obama chose tax cuts for the “middle class.” That doesn’t make him a bad person: those tax cuts help the middle class, at least in the short term. (The one thing that I always found indefensible about his position, however, is defining the middle class up to $250,000 in annual income per household, which was his threshold before the compromise at $450,000.)


But those tax cuts came at the expense of future federal tax revenues, which means they came at the expense of—you guessed it—Social Security, Medicare, and Medicaid. In other words, Obama and the vast majority of the Democrats in Congress chose goodies for low-, middle-, upper-, and very-upper-income families today (the only people not getting goodies are the super-upper-income families that make more than $450,000*) over the fiscal capacity required to preserve our social insurance and safety net programs.


That’s the problem with the tax deal—not the fact that the threshold was set at $450,000 rather than $250,000, which Krugman correctly notes doesn’t make much of a difference. And you can’t say the tax cuts were a necessary choice to keep the economy from slipping into recession. If that were the case, they should have been temporary, not permanent, and Obama has been trying to make them permanent since 2010.


The Democratic Party today, as I’ve said countless times over the past year, has become the party of smallish government and tax cuts for most people, while the Republican Party is the party of tiny government and tax cuts for everyone. There is no party dedicated to the New Deal and the Great Society. We need one.


* And even they are getting goodies. First, they benefit from the lower marginal tax rates on income up to the $450,000 threshold; second, they benefit from the treatment of dividends as capital gains, not as ordinary income; and third, they benefit from the $5 million estate tax exemption.





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Published on January 04, 2013 16:54

December 31, 2012

It’s Not That Complicated

By James Kwak


Of course the tax bill couldn’t have passed today, even if the two sides reached a compromise. Today it would have been a tax “increase.” Tomorrow it will be a tax “cut.” As my daughter would say, “Duh.”


Grover Norquist’s Taxpayer Protection Pledge will remain technically inviolate, which was not terribly hard to predict. And it will have done its most important work: making a small and obvious policy change—allowing moderately higher taxes for the rich—seem like an enormous, gut-wrenching concession by Republicans.


See you next year!





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Published on December 31, 2012 17:49

December 11, 2012

Nationalization Works

By James Kwak


The Treasury Department today announced that it has sold off the rest of its stake in A.I.G. Treasury will focus on the claim that taxpayers made a profit on the deal. As I’ve written before, the story is a bit more complicated.


But that’s a sideshow. The point of nationalizing A.I.G. (what else do you call it when the government buys 80% of a company?) wasn’t to make money; it was supposedly to save the global economy. In any case, things have worked out pretty well: the global economy is intact, though still not healthy, and A.I.G. is a private company again.


Which brings up what, to me, is the bigger question: Why were we so afraid of nationalizing Citigroup and Bank of America four years ago? And isn’t A.I.G. looking like a better company today than those two?





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Published on December 11, 2012 08:24

December 10, 2012

Yet More CEO Hypocrisy

By James Kwak


Several weeks ago, I wrote a column criticizing the “Fix the Debt” CEOs for saying that we should raise taxes while not mentioning the one tax break that means the most to them as individuals—the preferential rate for capital gains—and, in many cases, giving money to the presidential candidate who promised to protect that tax break for them.


A friend pointed out another glaring example of these CEOs’ hypocrisy. Of the CEOs in Fix the Debt, 71 lead public companies; of those, 41 have employee pension funds. Of those, only two pensions are fully funded; the other pensions are underfunded by an average of $2.5 billion, according to the Institute for Policy Studies.


More generally, according to the same source (see full report), S&P 500 companies’ pensions are only 72 percent funded. Social Security, by contrast, will pay full benefits for the next twenty-some years, and will pay about 75 percent of scheduled benefits thereafter even if nothing is changed. And those company pension funds benefit from the lax standards of private pension accounting, which allow them to assume optimistic rates of return. Social Security’s funding estimates have much less risk because it is paid for by interest on Treasury bonds and by payroll taxes, which are much less volatile than the stock market.*


So when anyone tells you that we should listen to so-and-so because of his success in the business world, run far, far away. Luckily we learned that lesson in time for November 6.


*Someone is sure to point out that company pensions are underfunded relative to being pre-funded, while Social Security is a pay-as-you-go system. But that’s beside the point. The federal government has the power to collect payroll taxes, which is why we can count on future program revenues. Corporations do not have the power to unilaterally raise prices on their customers (without losing sales), so they can’t reliably increase revenues in the future; that’s why they are supposed to be setting aside money today.





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Published on December 10, 2012 11:56

December 3, 2012

Entitlements Scare Tactics

By James Kwak


A friend asked me about last week’s WSJ op-ed by Christopher Cox and Bill Archer claiming that the government’s true liabilities exceed $86 trillion—not the  $16 trillion national debt that people usually talk about. There’s something to it, but there’s also a huge scary story in there that’s purely meant to frighten people.


$16 trillion is the amount of Treasury debt outstanding at the moment. The more relevant figure is the amount of debt the federal government owes to people and institutions other than itself. If, for some reason, I lent money to my wife and she promised to pay it back to me, we wouldn’t count that as part of the debt owed by our household. The debt owed to the public is about $10 trillion these days.


So where do Cox and Archer get $86 trillion? They are counting the present value of future unfunded liabilities. To take one example, if you add up all the money that Medicare Part A is expected to pay out over the next 75 years and figure out how much it would be worth today, you get a total of $21.2 trillion. If you add up all the money that Medicare Part A will bring in from payroll taxes and do the same, you get $15.6 trillion. So to make Medicare Part A balance over seventy-five years, the government would have to have $5.6 trillion that it doesn’t have today. Do the same for all of Medicare and you get a total of $38.6 trillion. This is all from Table V.F2 on page 238 of the latest trustees’ report on the Medicare trust funds. (Cox and Archer, who claim to be citing the same source, have $42.8 trillion in their op-ed; maybe they’re using an infinite time horizon instead of a 75-year timeframe.)


Now, this is a meaningful exercise. It provides information that isn’t captured in the annual deficit figures and the current national debt, neither of which says anything about how spending and tax revenues are likely to evolve in the future. When we make decisions about taxes and spending, we should consider what we know about the future. In this case, we know that Medicare spending, under current law, is likely to increase faster than tax revenues because of demographic changes and health care inflation.


But what does $86 trillion mean? Is it a lot or a little? And this is where Cox and Archer start telling silly stories meant to scare people. They claim that “to collect enough tax revenue just to avoid going deeper into debt would require over $8 trillion in tax collections annually.” This is wrong on two levels.


First, if you did your calculations properly, you don’t “go deeper into debt” each year. You already estimated the amount that you will have to pay out and the amount that you will collect. The present value of your future unfunded liabilities shouldn’t be changing significantly from year to year unless those estimates change. For example, your discount rate might change, or your estimate of health care inflation might go up, or something like that. But these estimates can change in either direction.*


Second, the source they cite already tells us how much we would have to raise taxes (p. 239):


“From the 75-year budget perspective, the present value of the additional resources that would be necessary to meet projected expenditures, at current-law levels for the three programs combined, is $38.6 trillion. To put this very large figure in perspective, it would represent 4.3 percent of the present value of projected GDP over the same period ($907 trillion).”


The appropriate number to compare $86 trillion to is the present value of all future GDP. The Medicare trustees give us the present value of GDP over the next seventy-five years, which is $907 trillion. So $86 trillion is a big number (and I’m still not sure where Cox and Archer got it), but $907 trillion is a much bigger number.


Looking just at Medicare, we would need to increase taxes by 4.3 percent of GDP over the levels set by current law. Today, it would be about $600 billion. That is a lot, but it is certainly doable—and it’s a lot less than $8 trillion.


Why do Cox and Archer mangle their estimates so much?


“Some public officials and pundits claim we can dig our way out through tax increases on upper-income earners, or even all taxpayers. In reality, that would amount to bailing out the Pacific Ocean with a teaspoon. Only by addressing these unsustainable spending commitments can the nation’s debt and deficit problems be solved.”


This is a standard, “we can’t afford it” attack on social insurance programs. But they only arrive at this conclusion by being an order of magnitude wrong about the actual size of the funding gap.


Being bad at math is one thing. But Cox and Archer didn’t even have to do the math; they just had to keep reading until they got to the point where the Medicare trustees did the math for them.


* There’s one exception: Since the most recent year has slipped from the future into the past, it’s no longer part of the calculation. If that was a surplus year, then the present value of your future unfunded liabilities will go up by a bit. But the surplus should have improved your balance sheet by an offsetting amount, so you’re no worse off.





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Published on December 03, 2012 07:39

November 29, 2012

New (Free) Book About U.S. Government Debt

By James Kwak


I contributed a chapter to Is U.S. Government Debt Different?a book published by the Financial Institutions Center of Wharton. It includes chapters by many people more distinguished than I, such as William Bratton, Peter Fisher, James Hines, Howell Jackson, Deborah Lucas, Steven Schwarcz, Richard Sylla, and others. You can download the whole thing for free at the link above. Enjoy.





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Published on November 29, 2012 11:56

High-Frequency Trading and High Returns

This guest post is contributed by Ricardo Fernholz, a professor of economics at Claremont McKenna College. Some of his other work was profiled on this blog here


The rise of high-frequency trading (HFT) in the U.S. and around the world has been rapid and well-documented in the media. According to a report by the Bank of England, by 2010 HFT accounted for 70% of all trading volume in US equities and 30-40% of all trading volume in European equities. This rapid rise in volume has been accompanied by extraordinary performance among some prominent hedge funds that use these trading techniques. A 2010 report from Barron’s, for example, estimates that Renaissance Technology’s Medallion hedge fund – a quantitative HFT fund – achieved a 62.8% annual compound return in the three years prior to the report.


Despite the growing presence of HFT, little is known about how such trading strategies work and why some appear to consistently achieve high returns. The purpose of this post is to shed some light on these questions and discuss some of the possible implications of the rapid spread of HFT. Although much attention has been given to the potentially destabilizing effects of HFT, the focus here instead is on the basic theory behind such strategies and their implications for the efficiency of markets. How are some HFT funds such as Medallion apparently able to consistently achieve high returns? It is natural to suspect that such excellent performance is perhaps an anomaly or simply the result of taking significant risks that are somehow hidden or obscured. Indeed, this is surely the case sometimes. However, it turns out that there are good reasons to believe that many HFT strategies are in fact able to consistently earn these high returns without being exposed to major risks.


To understand how this works, let’s consider the S&P 500 U.S. stock index. Suppose that we wish to invest some money in S&P 500 stocks for one year. Currently, Apple has a total market capitalization of roughly $500 billion, making it the largest stock in the S&P 500 and equal to approximately 4% of the total capitalization of the entire index. Suppose that we believe it is very unlikely or impossible that either Apple or any other corporation’s capitalization will be equal to more than 99% of the total S&P 500 capitalization for this entire year during which we plan to invest. As long as this turns out to be true, then it is actually pretty simple to construct a portfolio containing S&P 500 stocks that is guaranteed to outperform the S&P 500 index over the course of the year and that has a limited downside relative to this index. In essence, we can construct a portfolio that will never fall below the value of the S&P 500 index by more than, say, 5% and that is guaranteed to achieve a higher value than the S&P 500 index by the end of the year.[1]


This is not a trivial proposition. If we combine a long position in this outperforming portfolio together with a short position in the S&P 500 index, then we have a trading strategy that requires no initial investment, has a limited downside, and is guaranteed to produce positive wealth by the end of the year. According to standard financial theory, this should not be possible.[2] Furthermore, the assumptions that guarantee that our portfolio will outperform the S&P 500 index appear entirely reasonable. After all, not for one day in the more than 50-year history of the S&P 500 has one corporation’s market capitalization come anywhere close to equaling even 50% of the total capitalization of the market. A 99% share of total market capitalization would essentially amount to there being only one corporation in the entire U. S. for an entire year. This seems like neither a likely outcome nor one that investors should take seriously when constructing their portfolios.


What does a portfolio made up of S&P 500 stocks that is guaranteed to outperform the S&P 500 index look like? There are many different ways in which such a portfolio can be constructed, but one feature common to all such portfolios is that relative to the S&P 500 index itself, they place more weight on those stocks with small total market capitalizations and less weight on those stocks with large total market capitalizations. The weight that an index such as the S&P 500 places on each individual stock is equal to the ratio of that stock’s total market capitalization relative to all stocks’ total market capitalizations taken together. In the case of Apple, then, the S&P 500 index would place a weight of roughly 4% in this individual stock while those portfolios that use HFT to outperform this index would instead place a weight of less than 4% in Apple stock.


The second key feature of these outperforming portfolios is that they must be constantly rebalanced to maintain the chosen weights for each stock. This implies that any time the price of one stock increases relative to the price of other stocks, some of this stock must immediately be sold to maintain that stock’s prescribed weight. This constant rebalancing is what makes these trading strategies part of HFT. Consider, for example, an equal-weighted portfolio that invests the same dollar amount in each of the 500 stocks that make up the S&P 500 index.[3] If the price of one of those stocks increases relative to the others, it is necessary to sell some of that stock and purchase a small amount of the other 499 stocks in order to rebalance the portfolio and maintain the equal weights for all stocks. Trading frequently in order to rebalance the portfolio in this way plays a crucial role in outperforming the market.


The two portfolio characteristics described above – more weight on smaller stocks and high-frequency rebalancing in order to maintain those weights – are not particularly complex and do not rely on information that is not readily available to the public. Of course, the true strategies behind most HFT are more sophisticated and must address real-world issues such as trading costs.[4] Despite its simplicity, however, this discussion describes a valid method of investing that achieves very high returns without major exposure to risk. This point is clearly demonstrated in Figure 1. The figure plots the log return of a portfolio that combines long positions in stocks that decrease in value with short positions in stocks that increase in value and that is rebalanced every minute and a half, much like in the previous discussion.[5]Based on a simulation that uses data from U.S. stock prices in 2005, this portfolio earns a compound return of more than 100% over the course of the year.Surely, the ability of HFT strategies to achieve high returns by exploiting the relative movement that is natural among stock prices in this way explains much of both the rapid spread of HFT and the consistent success of prominent HFT funds such as Medallion. Barring a significant change in financial regulation, then, there is little reason to think that the spread of HFT will reverse itself.



Figure 1: The  compound return of a portfolio that combines long positions in stocks that decrease in value with short positions in stocks that increase in value and that is rebalanced every minute and a half.


Nothing about our discussion of HFT strategies and high returns is inconsistent with a market that is efficient in the sense that stock prices reflect the public’s full knowledge about fundamentals. According to standard financial theory, anytime an individual stock price does not reflect that stock’s fundamentals, rational investors will buy or sell that stock and earn high returns until the stock price shifts to a value that does reflect fundamentals so that such returns are no longer possible. The HFT strategies that achieve high returns with limited risk, however, do not rely on deviations between prices and fundamentals. Indeed, as long as fundamentals are such that no one stock dominates the entire market for a full year, investors are able to consistently earn these returns without any knowledge of fundamentals and their deviations from prices. In this case, there is neither a contradiction between market efficiency and the ability of HFT to consistently outperform the market nor is there necessarily anything about HFT that makes markets more efficient.


The fact that HFT represents a highly effective investment strategy that has little to do with market fundamentals raises several challenging questions. How is it possible for HFT to consistently earn high returns with limited risk in an efficient market? What happens as more and more people pursue these high returns with HFT? How does HFT on a large scale like this affect stock prices? These are difficult “general equilibrium” questions that have yet to be answered satisfactorily by financial economists. There is little doubt, however, that a deeper understanding of these issues is likely to yield important theoretical and practical insights about the true workings of financial markets.


Footnotes


1. For these portfolios, there is a tradeoff between the extent to which the portfolio will outperform the index, the length of time before this outperformance is to occur, the maximum possible underperformance during this period, and the upper bound on the relative capitalization of the largest stock in the index. See Fernholz, Karatzas, and Kardaras (2005) for details.


2. A discussion of some of these “equilibrium’’ issues is provided by Karatzas and Kardaras (2007).


3.  In fact, this simple equal-weighted portfolio is, under slightly stronger assumptions, guaranteed to outperform the S&P 500 over a sufficiently long time period.


4. For example, high-frequency traders are often broker/dealers in order to reduce potentially significant trading costs.


5. In addition to combining long and short positions in this way, the portfolio also closes all of its outstanding positions at the end of each day. This helps to reduce the volatility of the portfolio’s return. For a more detailed description of how this portfolio works, see Fernholz and Maguire (2007).


References


Fernholz, R., I. Karatzas, and C. Kardaras (2005, January). Diversity and relative arbitrage in equity markets. Finance and Stochastics 9(1), 1-27.


Fernholz, R. and C. Maguire, Jr. (2007, September/October). The statistics of statistical arbitrage. Financial Analytics Journal 63(5), 46-52.


Karatzas, I. and C. Kardaras (2007, October). The numeraire portfolio in semimartingale financial models. Finance and Stochastics 11(4), 447-493





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Published on November 29, 2012 10:55

November 28, 2012

Social Security and the National Debt

By James Kwak


In this season of fiscal brinksmanship, the topic of Social Security has once again come to the fore. Republicans are generally in favor of cutting benefits, although they are bit afraid to say so after the demise of George W. Bush’s privatization “plan”; Democrats are generally in favor of not cutting benefits. But many liberals have another argument: Social Security is irrelevant to the whole issue of deficits and the debt, since the program cannot have any impact on either.


I generally count myself as a liberal, but I think this is a misleading argument. This could take some time to explain, as I’ll try to go through it carefully.


The standard liberal argument goes like this: Social Security has its own funding scheme that is walled off from the rest of the federal government. Employees pay payroll taxes into the Social Security trust funds, and benefits are paid out of those trust funds. The crux of the argument is that Social Security, by law, may not spend money that it does not have in its trust funds.  It is impossible for Social Security to incur a deficit over the long term, since it can only spend money it already collected. In the words of Dean Baker:


“Social Security is prohibited from spending any money beyond what it has in its trust fund. This means that it cannot lawfully contribute to the federal budget deficit, since every penny that it pays out must have come from taxes raised through the program or the interest garnered from the bonds held by the trust fund.”


To begin, let’s clear a distracting issue out of the way. The annual federal budget balance is measured two different ways. The “unified budget” balance includes cash flows associated with Social Security (that is, payroll taxes in and benefit payments out). The “on-budget” balance excludes those cash flows (and the Postal Service). Obviously, Social Security does not contribute to the “on-budget” balance but it does contribute to the “unified budget” balance. But that’s all economically irrelevant, since in this case how you measure the thing doesn’t change the thing. (This isn’t quantum physics, after all.) The important number is the amount of money that the federal government has to borrow from the public, and that number is not affected by which budget balance you look at.*


Moving on to the main course: Dean Baker is absolutely right about current law. So for illustrative purposes, let’s posit an alternate universe, in which current law includes the following General Revenues Clause (GRC): “If the Social Security trust funds are unable to pay scheduled benefits to beneficiaries, those benefits will be paid out of general revenues.”


How would the existence of the GRC affect anything? It can’t have any impact on the national debt until the GRC begins to affect actual Social Security cash flows. And that won’t happen for as long as Social Security is able to pay benefits out of its trust funds.


The real question is what happens when the trust funds run out of money, which is currently expected sometime in the 2030s. In the current law universe, benefits automatically get cut to the level of incoming payroll taxes, which will be about a 25 percent cut; Social Security has no impact on government borrowing and hence the national debt. In my alternate universe, Social Security continues to pay full scheduled benefits, which requires additional government borrowing and increases the national debt.


The first question is: Which one do you think is more likely in the real world? Do you really think that Congress will sit by and let Social Security benefits be cut by 25% overnight? Or do you think that Congress will amend the law, essentially inserting the GRC, to preserve full benefits for seniors?


Of course we can’t predict the future with certainty, but I would say that if Congress in twenty-five years is anything like Congress today, it will find a way to pay full benefits. So when we talk about the impact of Social Security on the national debt, the most likely scenario is that it will increase the national debt—exactly as if the GRC existed today. That’s the main reason why I think it makes sense to take Social Security into account when projecting future national debt levels.


But let’s say I’m wrong and that Congress will stand by as seniors’ Social Security checks get cut by 25 percent. That’s not a good thing.


In my universe (where the GRC exists), when the trust funds run out money, Congress will have choices. It could: (a) increase taxes to pay scheduled benefits; (b) reduce other spending (like on aircraft carriers) to pay scheduled benefits; (c) borrow more money to pay scheduled benefits; or (d) cut benefits by 25 percent. In the current law universe, Congress will have to choose (d). It’s not hard to see that my universe is better than the current law universe. The two are equivalent if (d) is a better choice than (a), (b), and (c), but otherwise my universe is preferable. This is especially true for liberals, who in ordinary circumstances would prefer (a), (b), and (c) to (d).


So let’s say we know with certainty that the GRC will never be inserted and benefits will have to be cut. In that case, Social Security cannot increase the national debt. But we would actually be better off if the GRC existed and Social Security could increase the national debt, because of the options that would give Congress in the mid-2030s—including the options to raise taxes on rich people or cut defense spending.


In other words, if you are right that Social Security cannot increase the national debt, you should acknowledge that that is actually a bad thing. If you care about preserving Social Security benefits, you should prefer a world with the GRC.


Put another way, if you make the argument that Social Security cannot increase the national debt, you are conceding that there should be an across-the-board benefit cut the moment that the trust funds run out of money. Is that what you want?


On its face, the statement that Social Security cannot increase the national debt, and therefore should be off the table, seems like a classical liberal position. On inspection, though, I think it is misleading, since Congress is more likely to add the GRC than not. And for traditional liberals, I think it’s actually counterproductive, since it is premised on the unavoidability of a draconian benefit cut in twenty-five years.


* There is a separate, equally confusing, debate over the implications of the fact that the Social Security trust funds are invested in a special kind of Treasury bonds. The short answer is that because Social Security exists, the Treasury Department had to borrow less money from the public in the past few decades, when Social Security was running surpluses; but in the future, the Treasury will have to borrow more money from the public, because the Social Security trust funds will be redeeming some of those special Treasury bonds.





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Published on November 28, 2012 12:35

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