Wednesday, October 10, 2007

Add-on v Carve-out

Hillary Clinton's proposal to fund individual 401(K)'s is fairly standard moderately liberal Democratic policy wonkery. Here is how MSNBC describes the plan:
Under her "American Retirement Accounts" plan, everyone would have access to a portable 401(k) and the government would offer matching tax cuts of up to $500 to $1,000 to help middle class and working families save. The campaign estimates it would cost $20 billion to $25 billion a year to provide the matching tax cuts and said she would pay for it by freezing the estate tax at 2009 levels....

Clinton said that like her health care plan, no one would be forced to set up these accounts and that people who like their current retirement accounts could keep them. She said the current government was subsidizing those who need it least, using about half of the nearly $200 billion spent yearly to encourage retirement savings to help the top 10% of earners and spending only 10% of that money to help the bottom 60% of earners.

Her plan would provide a matching refundable tax credit for 100% of the first $1,000 in savings for every married couple making up to $60,000 and would provide a 50% match on the first $1,000 of savings for couples making between $60,000 and $100,000 a year. The accounts would allow individuals to contribute up to $5,000 per year on a tax-deferred basis.
I am not totally thrilled with the tax expenditure feature as that distorts incentives, but I am glad that she is implicitly adapting PAYGO. But this is a fairly good and generic Democratic retirement income add-on plan.

And what is the base upon which this is being added onto? Why Social Security is the base. Private accounts as an add-on feature has been a standard Democratic policy prescription since at least 1998, and it was a common one during the 2005 Social Security fight.

Ed at the Captain's Quarter does not understand the distinction between an add-on program and a carve out program:
In the first place, Hillary fought against privatization when the Bush administration applied the concept to retirement in 2005. Bush proposed allowing Social Security taxes to partially go into private accounts similar to 401Ks, and the Democrats still campaign against it. Hillary has said a month ago that "privatization never works," and now she's reversing herself in order to hand out subsidies for savings account.
The Bush proposal in 2005, as fleshed out as the corpse of his legacy, was a carve-out. Guaranteed defined benefits would be substantially cut from roughly 40% income replacement to 20% income replacement with some lesser cut for the lowest income groups, and some of the future cash flow value would be diverted to an array of private accounts. The risk of sudden market drops the week of retirement, of long term sideways trends in the market, of significant interest volatility would all be borne by the private individual who does not have the cyclical hedging and smoothing capacity of the federal government. An add-on account with a federal contribution makes very few people any worse off and makes most people better off.

The risk transfer and the gutting of guaranteed income replacement levels was the core of the ideological fight on Social Security. If Bush had proposed an add-on account with indepedent funding sources, there would be Democratic scuffles on the details --- levels of subsidies, choice of investment vehicles, opt-in v. opt-out --- but the bill would have passed with healthy majorities in both chambers. That was not what he proposed and he lost massively. Hillary Clinton is proposing a completely different beast which is consistent with her opposition to the Bush Social Security plan.

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