It is possible to fix the bankrupt Social Security System and the Federal Reserve’s failure to achieve its inflation target painlessly. Yes, really.
The Fed has failed to raise inflation to its 2 percent target because over-regulated banks can’t find over-regulated firms wanting to borrow and invest. As a result, the increases in the Fed’s base money from its Quantitative Easing and other efforts to stimulate the economy has piled up as bank excess reserve deposits at the Federal Reserve Banks.1
If the Fed pushes too hard (e.g., by lowering the interest it pays on these bank reserves, potentially even to negative levels) it feeds asset price bubbles (stock and housing prices), which do great damage when they burst.2
If the Fed just printed more money and sprinkled it around to the general public—what Milton Friedman called helicopter money—there is no doubt that the public would spend more and drive up prices.
Leaving aside whether it is really a good idea to create a steady 2 percent rate of inflation, there is an easy way of doing it that would also facilitate badly needed reform of the government’s retirement system. Contrary to the myth that our Social Security pensions reflect what we paid in (saved) to the system, Social Security pension payments are now fully pay as you go. This means that the revenue from payroll taxes approximately matches the outflow for current pensions, i.e. nothing is being saved for the future. As our population continues to age and the number of retired pensioners increases relative to the shrinking number of workers paying into the system, the modest amounts that have been accumulated in the Social Security “Trust Fund” will be drawn down to zero in about 15 years, at which time the government will not be able to meet existing promises.3
The following proposal combines helicopter money sufficient to bring the inflation rate to its target with badly needed reform of our government pension system. Under this proposal all individuals will receive a minimum government guaranteed pension for life whether they paid in anything or not. This might be implemented as part of a Friedman-like negative income tax and other badly needed tax reforms,4 or stand-alone.
Before retirement, individuals who are working, but with incomes below the poverty level (to be politically established), will not pay a wage tax as they do now. The subsequent pensions of such people will be paid with helicopter money, meaning the Federal Reserve will print the money to buy government bonds sufficient to finance these expenditures. All workers with incomes above the poverty level will be required, as they are now, to set aside the amount of income needed to finance their minimum guaranteed pension on a fully-funded basis. They are free to save more if they would like a higher pension. The funds set aside must be invested in government-licensed-and-approved private pension funds chosen by each worker rather than in the almost fictitious Social Security Trust Fund.
This would establish the three pillars of good pension policy proposed by the World Bank in 1998: a means-tested minimum pension financed by the government’s general revenue; a mandatory minimum pension paid for and privately invested by all working individuals; and additional, optionally, supplemental retirement saving privately invested.
Such a model was first adopted in Chile over 35 years ago with great success. Central and Eastern European countries have adopted similar models as part of their transition from centrally-planned to market-based economies. Financing income subsidies to the poor from general revenues (via printing money), and a user-fee approach to mandatory saving (mandatory saving matched to the actuarial value of the pension received), conforms more closely to the principles of good tax policy.5
The alternative sometimes proposed of raising the income cap on the payroll tax is closer to general revenue financing, if the government guaranteed minimum is only paid to the poor, but leaves out non-wage income and thus fails the good tax criteria.
As new workers would be truly saving for retirement, their savings would not be available to finance those currently retired, as is now the case with our pay-as-you-go system. Thus transitional arrangements will be needed for several decades to deal with existing unfunded promises.
If the promises remain unchanged, the money to pay for them will have to come from somewhere, either in higher taxes or reduced defense or other expenditures. Usually, in such cases the government spreads the burden around.
Two simple and sensible changes to the current promises would absorb the greater part of the shortfall. The first is to adjust the pensionable retirement age to the fact that the average person lives much longer than when the current retirement ages were fixed. People are living longer and can – and most would like to and do – work longer.
The other is to change the index to people’s pensions from a wage index, which generally increases pensions in real terms over time, to the cost of living, which would preserve their real value against any inflation over time.
For today, this means that the wage tax on the poor would be abolished and paid for with new Fed money that would thus be put in the hands of those who would spend it, increasing employment (though we are really at full employment now) and/or wages and prices. It would both raise inflation a bit and launch a genuine, long-overdue pension reform.
- “US Monetary Policy–QE3” Cayman Financial Review, January 2013
- “The D E Fs of the Financial Markets Crisis” CATO Institute, September 26, 2008.