Edward Prescott on Social Security

Edward Prescott, 2004 Nobel Prize co-winner, is putting forward a plan to help reform Social Security, or more accurately to augment the current program. One of the notable parts of the article is that Prescott comes out in support of the “No Crisis” view of Social Security insolvency.

“I don’t think there’s a crisis,” he told me in a recent interview. “But the sooner we do this (reconstruction), the sooner we can improve benefits.”

Basically, Prescott favors augmenting Social Security with forced savings plan that would put the savings into something like the Federal Thrift Savings Plan. The plan would institute graduated payroll taxes with the money going into these private accounts. The rates would look something like,

  • Prior to age 25 the tax is set to zero to allow workers to use the money for aquiring human capital, a mortgage or even car payments.
  • At age 25 the tax rate would be 3%.
  • At age 30 the rate would increase to 6.1%.
  • At 35 the rate would move up to 12.4%

The benefits is that since the workers taxes really aren’t taxes, but forced savings the negative impact of higher taxes is minimized or even eliminated. In fact, labor force participation might increase and savings should increase as well, according to Prescott.

My only issue, is that a forced savings plan might be offset savings by people who are currently saving via 401ks. However, those workers who do not have access to such retirement accounts would now be saving. So on the whole I’d say that savings would probably increase.

Also, the increased savings would mean higher investment and capital, which could very well translate into higher wages. Also, more productive capital will mean a more productive economy, which is also good for the current Social Security system.

Hopefully Prescott’s proposal will be written up and put on the web for people to read.

Cross posted at Deinychus antirrhopus.

FILED UNDER: Economics and Business
Steve Verdon
About Steve Verdon
Steve has a B.A. in Economics from the University of California, Los Angeles and attended graduate school at The George Washington University, leaving school shortly before staring work on his dissertation when his first child was born. He works in the energy industry and prior to that worked at the Bureau of Labor Statistics in the Division of Price Index and Number Research. He joined the staff at OTB in November 2004.

Comments

  1. Jem says:

    While I see the value of simplicity from having only three brackets, I wonder about the unintended consequences of the tax rate “bumps”. The impact of this proposal would seem, at least in part, to: (1) effectively eliminate raises for folks hitting each “gate”–especially the one at age 35 (a change from 6.1% to 12.4% tax rate on one’s thirty-fifth birthday would effectively eliminate about two year’s worth of “average” raises) or (2) make the employee suddenly much more “costly” to employ, if the employer elects not to diminish the employee’s take-home wages in comparison to inflation.

    So, do we make employees effectively poorer just at the time where they enter the most productive phases of their careers (likely when their children are young and they might be making sacrifices anyway to fund education), or do we increase the market incentives to push these folks out of their employment (via layoffs or other means) so that employers avoid a sudden and substantial increase in employment costs?

  2. Steve says:

    Jem,

    Part of the tax hit could be offset by a reduction in 401k contributions. But, there would be those who’s current (disposable) income would decline. That is part of the problem of a forced savings program. While without the program some individuals would elect to spend their income, the forced saving program prevents them from doing so.

    There really is no painless way out of the Social Security problem.