Saturday, December 11, 2004

Chilean Retirement System and BUSH!

So on LiquidBlur, I posted a message entitled Chilean Retirement System, Bush, and Political Capital. I include most of that post here:


So we've been talking a lot about Bush and social security lately, and there has been a lot stirring in the news lately.

The Ideal Chilean Retirement System
Ideally, Bush would like to implement the Chilean Retirement System here in the United States. This isn't necessarily a bad idea. The Chilean Retirement System charges a 10% tax to all workers in Chile. All but a fraction of that money is invested in a private interest-bearing retirement account. There are restrictions on the type of private account this can be. In short, the government will not put your money in a high-risk account. After retiring (at an age around 70), everyone draws money from their own private interest-bearing accounts. Now, keep in mind that not all of that 10% went into those accounts. A fraction of that went into a program like the present social security. This fraction of the 10% tax will gaurantee some minimal retirement benefit for thsoe who are not drawing more than that minimal retirement benefit. In other words, everyone draws from their own money, and those who do not draw enough draw from a social-security-like benefit gaurantee service.

Now, in this system, every worker also has the choice to pay up to an additional 10% into their own government pension plans. This money will go directly into those private accounts.

Note that all of the money that goes into these accounts goes in tax free. It only gets taxed when it is taken out, and by the time it is taken out, it is taxed at a far lower rate. (this is like a traditional IRA)

Now, first note that this is NOT the plan that Bush is actually proposing, but I'll get into that in a moment.

The Present Social Security System
In another LiquidBlur post, mathking has already explained the basics of social security. Right now, approximately 7.7% of a worker's income goes into pay for social security. The employer actually has to also pay a matching 7.7% for every employee. This combined effective 15.4% of each salary goes into paying for social security. Based on the amount of money paid into social security, when a person retires (at age 65?), she is entitled to a certain amount of social security money directly proportional (though not necessarily linearly) to how much money she paid in. (oh, and additionally if someone makes over $85,000/year, they pay into social security as if she made $85,000/year) (also note that self-employed workers have to pay the full 15.4% themselves)

Because social security is not a "pay as you go" type plan, it will run out of money to support itself at the current tax levels sometime in the "near" future. Some project this as far out as 2042. In order to support the current social security system, taxes would have to be raised, that $85,000 cap would have be raised, and/or the retirement age would have to be extended. However, eventually, as the population continues to grow, there's a good chance this will happen again. Right now the current problem has to do with the retirement of the baby boomers.

Differences Between the Two... Pros and Cons of the Chilean System
With all that being said, note that in the Chilean system employers do not have to perform any sort of matching. Employees, self-employed or otherwise, all are required to pay that 10% tax, and they all can add an additional 10% voluntarily.

The Chilean system has had a number of good reviews. It was adapted circa 1980 (as an alternative plan, actually), and in a very short amount of time, 95% of all Chilean workers had signed-up for the plan. The trouble is that it does not prevent old-aged poverty, and it carries with it an administrative cost (probably not too much greater than the social security administrative cost). Plus, it's not convincing that it doesn't have the same problems that social security has. If, for example, 5% of the population needs that gauranteed social-security-like money, as the population grows, the cost of that 5% of people grows. That cost is less than the social security cost, but it's growth rate may be greater than the growth rate of social security cost. These are all questions beyond me and beyond most public documents on the subject. Regardless though, this system seems to work fairly well in Chile, despite these downsides.

The Transition Cost to the Chilean System
The trouble is that it would cost $2 trillion to convert our current system to the Chilean system. In other words, if you switched from our system to their system tomorrow, then people would stop paying into social security and all of the people who have not been on this new system for all their lives but ARE currently retired will need $2 trillion to maintain their current retirement payments. After some transient period when people started drawing retirement money out of the new system, this cost would stop accruing, and at that point, it would have cost a total of approximateily $2 trillion.

So experts say that changing from our system to the Chilean system would require raising taxes or cutting programs (or raising retirement age) or both, but this isn't popular with the Bush administration.

The Bush Administration, The Iraq War, and Something That is NOT the Chilean System
So this brings us to the Bush administration. Here is an administration that would like the Chilean retirement system. When Bush talked about his "political capital" that he will spend in the next four years, many speculate that he was talking about social security reform. He ideally would like a major part of the Bush legacy to be social security reform.

The trouble is the cost of the war he started in his first four years may have "borrowed" more "political capital" than he has left to spend in these next four years. The tremendous cost of the Iraq war has put us so far in debt that there's no way we can afford changing to a better social security system.

But Bush still wants to reform social security, so he's trying to make compromises. His compromise is to gradually move toward the Chilean retirement system. The current plan is to give people the choice to pay into social security exactly as they always have or move to a plan where they still pay exactly as they always have, but a fraction of the money that they pay does not go into social security but goes into a private interest-bearing account.

Note that this is not the Chilean system at all. Note that this change alone just makes the social security problem worse. All it does is undercut social security funds. It is something that looks like a transition, but it pays no additional transition cost, and will thus incur a greater cost later on in the future when a REAL transition has to occur.

Conclusions: Iraq, Retirement, and Bush Hoping for Some Luck
So right now analysists say that if the Iraq war did not happen, we could have the Chilean system. But we now have so much debt that there just is no way that we can fund a realistic transition.

So Bush is taking a risk. If his plan works by some weird twist of luck, then he's done a good thing. However, none of the experts predict that this is going to happen. Most experts say the best case scenerio is that things only get worse, and they get worse a lot quicker.

So anyway... what do other people think? Take a look at:

  • The Chilean System
  • Other contries using a similar system (Australia?)
  • Bush's "compromise"
  • How long we have until social security crashes
  • The Cost of the Iraq War and how it ties our hands now....

Thoughts? Feelings?

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