Pension and Social Security Systems

As people age, they eventually reach a state where they cannot produce as much as they consume.  Many poor societies used to encourage the elderly to commit suicide at that point, but modern societies are wealthy enough to afford to support vast numbers of elderly in their dotage.  This means that working-age people must somehow transfer resources to the elderly.  There are several mechanisms for accomplishing this:
1. Private savings.  Working-age people consume less than they earn and accumulate claims on future goods and services that they can consume in their dotage.
2. Government transfer programs.  The government requires that working age people consume less than they earn so that the elderly can have more. These come in two forms:
a) Individual forced savings accounts.
b) Pay-as-you-go transfers like Social Security (which is partly savings too).
3. Traditional social norms.  Usually descendents are expected to consume less than they earn during their working age so that they can transfer resources to their elderly parents or relatives. 

In every case, if each system achieves the same level of retirement in a year, then working-age people must transfer the same amount of real resources to retired people during that particular year.  The effect on real resources is exactly the same.  However, some systems create a higher stock of savings than others.  Imagine societies that live on wheat alone.  A system that required each individual to save for his own retirement would have vast storehouses of wheat whereas a system that used a pay-as-you go system might have zero storage.  Assuming zero spoilage in storage, the total amount of wheat produced every year would be exactly the same over an infinite horizon.  If there is spoilage, then the system with savings would actually need to produce more wheat than the pay-as-you-go system.   To avoid the expense of storage (and spoilage), the savings system could create paper commodity money which is worth a certain amount of grain.  Then people could produce extra wheat and trade it to their elders for paper money and store paper money rather than grain.  Money turns the savings system into something akin to the pay-as-you-go system.  

What system works best?
1. People do not save enough for the future because we are myopic.
2a. This is like #1, except that people are forced to save more than they otherwise would do.  One problem is that it can be politically manipulated by the finance industry to yield them extra profits.  Another problem is that some people cannot manage where to keep their savings and if people put their savings into risky investments, they may not have anything left at retirement.
2b. This is essentially an income tax and transfer program and has the same effect as an income tax except that it also reduces the incentive to save.
3. This can encourage people to have too many kids which can reduce per-capita income.  Also, children are even less reliable than financial markets. It is unfair due to random chances leading to wide differences in outcomes that are difficult to insure against.  An only child whose parents both get Alzheimer's disease must transfer a lot more resources than a family of six children whose parents remain healthy and productive their entire lives.   A parent of six children would get a much better retirement than a parent whose children all died in a tragic bus accident.

This issue was raised by Samuelson's "An exact consumption-loan model of interest with or without the social contrivance of money" JPE 1958 and critiqued by Lerner (1959) on the left and Meckling (1960) on the right.  They are all bothered that perfect competition does not accomplish the optimal result and give varying alternatives.  Also see: Feldstein, Martin S. “Induced Retirement and Aggregate Capital Accumulation.” JPE, 1974, 82(5).

Mortgage Interest Deduction

Leonhardt at NYT:

The mortgage interest deduction, for example, saves more than $5,000 a year for the typical household in the top 1 percent of earners. Most middle-income households don’t benefit from the deduction at all, because they instead claim the standard income tax deduction. And the mortgage deduction is the second-largest tax break for individuals, costing about $80 billion a year, more than the budgets for the Education Department and Justice Department combined. ...

The truth is, closing loopholes has much stronger support among economists and columnists than it does among voters. Only 23 percent of Americans benefit from the mortgage deduction, but 93 percent support it. ...
So what kind of tax increases do Americans support? The old-fashioned kind. Seventy-two percent support raising taxes on income above $250,000, according to a recent New York Times/CBS poll, and a large majority likewise favor raising Social Security taxes on the affluent.
In the end, the most likely tax increase may be the one that’s already on the books. On Jan. 1, 2013, all the Bush tax cuts — on the affluent and nonaffluent alike — are set to expire, which would solve roughly one-quarter of our long-term deficit problem. If Republicans have their way, all the tax cuts will be extended. If the Democrats have their way, most of them will be.

Voters Love The Military

ThinkProgress:

Gallup came out with the latest version of its confidence in institutions poll, the kind of survey that I think sheds more light on real public opinion dynamics than do polls on “the issues”:

This kind of thing is why it’s hard to cut the defense budget, even though voters seem relatively friendly to the idea of cutting the defense budget. No member of Congress in a tough race wants to be in a fight with a general in a country where people have enormous confidence in generals and almost no confidence in Congress. I also think it’s interesting that people have much more confidence in the U.S. Supreme Court than they do in other branches of government that are sometimes said to have more democratic legitimacy. The hurly-burly of active participation in actual politics may, in practice, serve to be delegitimizing. Operating in secret, wearing uniforms or robes, and staying above the fray seems to be the road to respect.

If we need taxes, why not pollution taxes?

Btad Plumer:

So why not do that through a tax on carbon pollution or other assorted environmental unpleasantries? After all, if we have to raise revenue, we may as well slap higher taxes on behavior we'd like to discourage (like pollution and congestion) rather than, say, labor, no?

At least in rarefied think-tank circles, that idea's gaining favor. Four of the six groups that recently sketched out deficit-reduction plans for the Peter G. Peterson Solutions Initiative ended up advocating a new carbon tax as part of their proposals — including, note, the conservative American Enterprise Institute. And here's another reason to consider a shift: According to a new IMF paper with the irresistible title, "Reforming the Tax System to Promote Environmental Objectives: An Application to Mauritius," the United States gets, by far, the lowest percentage of revenue from environmental taxation of any OECD country:

In case that graph's too tiny, America's way over there on the far left, getting slightly less than 3 percent of its revenue from measures to discourage pollution. The average industrialized country gets about 6 percent. That's mainly due to the fact that many European countries put higher levies on gasoline. Still, compared with the rest of the world, we vastly undertax pollution. And changing this doesn't have to cripple the economy: Congress could always do things in a revenue-neutral manner, swapping in higher taxes on greenhouse gases (say) in exchange for lower payroll taxes.

The IMF paper, by the way, notes that there are a whole slew of different tax schemes to try to remedy dirty air, urban congestion, and greenhouse gases. If you want to deal with global warming directly, then a cap-and-trade system or carbon tax that affects the entire economy is your best bet. (This is different from a simple gas tax: Since a carbon tax is spread out evenly among the transportation, industrial and electric sectors, it tends to have a very modest effect on pump prices.)

If governments wanted to address externalities from cars directly (or try to curb oil use), there's the always-unpopular gas tax, sure, but there still are other options. Congestion pricing — charging people who drive during rush hour and take up valuable space — can unclog the roads. Feebates — extra fees on gas-guzzlers combined with rebates for, say, electric cars — can steer people toward more efficient vehicles. Then there's the old Dean Baker favorite, tax incentives to promote pay-as-you-drive insurance, in which your insurance premiums are set based on how many miles you travel in a year. (That last one doesn't necessarily raise revenue, but it does give people motivation to drive less if they can, which might push gas prices down a smidge.)

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The Failure of Prison Privatization

Yglesias:

The genius of the real private economy is that firms that are really poorly run go out of business. It’s not that some magic private sector fairy dust makes the firms all be runs soundly. Lots of bad businesses are out there. But they tend to lose money and close. Meanwhile, well-run firms tend to earn profits and expand. The public sector doesn’t have this feature. Just because a public agency is inept is no guarantee that it will go out of business. Resources are allocating according to political clout rather than any criteria of merit. It’s a problem. But it’s not a problem that “privatizing” public services actually solves. There’s no magic private sector fairy dust.

That’s not to say government services should never be contracted out. As an extreme example, public agencies don’t manufacture their own printer toner.

Eight facts and three thoughts about Social Security - Ezra Klein - The Washington Post

Eight facts and three thoughts about Social Security - Ezra Klein - The Washington Post:
1) Over the next 75 years, Social Security’s shortfall is equal to about 0.7 percent of GDP. Source (PDF).

2) For the average 65-year-old retiring in 2010, Social Security replaced about 40 percent of working-age earnings. That “replacement rate” is scheduled to fall to 31 percent in the coming decades. Source.

3) Social Security’s replacement rate puts it 26th among 30 Organization for Economic Cooperation and Development nations for workers with average earnings. Source.

4) Without Social Security, 45 percent of seniors would be under the poverty line. With Social Security, 10 percent of seniors are under the poverty line. Source.

5) People can start receiving Social Security benefits at age 62. But the longer they wait, up until age 70, the larger their checks. Waiting to 66 means checks that are 33 percent larger. Waiting to 70 means checks that are 76 percent larger. But most people start claiming benefits at 62, and 95 percent start by 66. Source.

6) Raising the retirement age by one year amounts to roughly a 6.66 percent cut in benefits. Source.

7) In 1935, a white male at age 60 could expect to live to 75. Today, a white male at age 60 can expect to live to 80. Source.

8) In 1972, a 60-year-old male worker in the bottom half of the income distribution had a life expectancy of 78 years. Today, it’s around 80 years. Male workers in the top half of the income distribution, by contrast, have gone from 79 years to 85 years. Source.

The conclusions I draw from these numbers are:

1) Social Security’s 75-year shortfall is manageable. In fact, it’d be almost completely erased by applying the payroll tax to income over $106,000. Source (PDF).

Opposition To Spending Cuts Makes Taxes Higher Than They Otherwise Would Be

Yglesias: "taxes are irrelevant—money that’s spent will be paid for out of taxes. Spending cuts are both necessary and sufficient to reduce the long-term level of taxation. And since once spent money has to be repaid with interest, delay induces higher taxes."