Debate density . . . and vacuum

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The debate about whether and how to allow young people to invest part of their Social Security taxes in personal accounts is off to a fascinating start.

Some initial rhetoric and legislative action have been informative and constructive, and some deceptive and destructive. Unfortunately, it is hard to find any middle ground between insightful candor and devious fraud. So, I thought it might be annoyingly useful to take on the role of a grumpy old professor and start handing out grades.

On this list (there will be others), President Bush gets the only "A" -- for daring to push hard for dealing with a festering problem before it gets really nasty. But not just any Social Security reform bill will do, and most I've seen will earn low grades for a few quirky features. So, the president's grade may yet slip by the time something is signed into law.

• Ignoring incentives and markets: D. Los Angeles Times editor Michael Kinsley recently wrote that "to work, privatization must generate more money for retirees than current arrangements. ... Where does this bonus come from? There are only two possibilities -- from greater economic growth or from other people."

The latter "other people" theme was superfluous, but sure to be garbled once he called privatization "the notion of putting Social Security money into stocks, instead of government bonds, because stocks have a better long-term return." Social Security money is not invested in "government bonds." Ninety-five percent of Social Security money, soon to exceed 100 percent, is but a transfer payment from Social Security taxpayers (many over age 65) to retirees (many under 65).

In any event, Mr. Kinsley envisioned no chance of greater economic growth because, he theorized, "Increased growth can come only from higher private investment or smarter private investment." Economists would describe that as a production function with only one factor of production -- privately owned buildings and machines (public schools and highways must be even worse than I thought). There are no workers, managers, students or entrepreneurs in Mr. Kinsley's growth model, or their behavior doesn't matter. If that made sense, it would not matter to the economy if all U.S. workers, managers, students and entrepreneurs were suddenly replaced with a random assortment of illiterate peasants from Bangladesh or Chad.

By contrast, Nobel Prize laureate Ed Prescott finds "promises of payments to the current and future ... can be honored by reducing the effective marginal tax rate on labor and moving toward retirement systems with the property that benefits on margin increase proportionally to contributions."

Putting 12.4 percent of your paycheck into the Social Security slush fund to be redistributed by political whim is far more demoralizing to lifetime work incentives than letting folks put some of that money into assets they really own.

Mr. Kinsley also imagines privatization "can't possibly work, even in theory" because he theorizes the return on investments must fall whenever there are more investors. "The money newly available for private investment," he says, "would bid up the price of (and thus lower the return on) stocks." If so, the return on stocks should have been falling continually since at least 1980, when IRS Section 401(k) first became effective and the Dow was around 900. In fact, "money newly available for private investment" has been growing since about 1933. Yet stocks continue to do quite well.

The value of stocks is not determined by the volume traded, but by their expected return (capital gains and dividends) in comparison to many alternative investments. Besides, nobody says personal accounts must be invested in stocks.