Virtually participating

As I noted in my last post, today I was supposed to be in Milan, Italy, participating in a panel at a conference entitled "Tax Policy and the Financial Crisis," held by Econpubblica, the Center for Research on the Economics of the Public Sector at Milan's Universita Bocconi. Lots of excellent people, mainly European economists, officials, and businesspeople, were also there, and I was looking forward to meeting many of them for the first time, as much as to seeing The Last Supper and sampling the local cuisine. Severe though transient back pain forced me to cancel, but this morning I was able to participate from my desk, courtesy of the remote video conferencing wizardry of Skype, along with the help of kind people on both ends.

My talk was entitled "The 2008-09 Financial Crisis: Implications for Tax Reform." It's briefly described here. You can also, if interested, access a pdf version of my PowerPoint slides for the talk, either at the previous link or here.

Ouch

The semester is now over, and I was supposed to be (at this very hour) headed to JFK Airport to fly to Milan, where I'm scheduled to appear on Thursday, April 30 at an Econpubblica, Universita Bocconi conference entitled "Tax Policy and the Financial Crisis." Good food, a viewing of Leonardo's The Last Supper, and getting to meet a number of leading European tax policy economists and lawyers, were also part of my plans for my expected 48+ hours in Milan.

Severe though (I hope) transient back pain forced me to cancel, and I'll instead be attempting remote video participation via Skype. Have PowerPoint slides, will travel, even if only virtually.

Final NYU Tax Policy Colloquium of 2009

Yesterday we had our final session, featuring Tom Brennan's Certainty and Uncertainty in the Taxation of Risky Returns.

Tom's article, still in early draft form, is a contribution to the extensive Domar-Musgrave literature on the treatment of risk in an income or consumption tax. It's well-established in that literature that, with a uniform tax rate (including loss refundability) and complete financial markets, neither an income tax nor a consumption tax affects the after-tax return available to taxpayers on their investment portfolios, except that the income tax hits the entire portfolio at the tax rate times the risk-free rate. That rendering may sound esoteric, but the key point is that taxpayers can undo the tax system's mandatory insurance by suitably adjusting their pre-tax portfolios, again assuming that financial markets are complete.

While the Domar-Musgrave reasoning notoriously requires all sorts of strong assumptions, these help to focus (as I put it at the session) on the "income-ness" of the tax base. In other words, there's no claim that the actual tax system has no effect on risk; rather, its being an income tax has no effect that wouldn't generally be the same (e.g., due to incomplete markets) if it were instead a consumption tax.

One feature of the actual tax system actually having a huge effect on risk-bearing is the lack of full proportionate rates. Rates on positive income are graduated (though for large corporations this is relatively insignificant), and net losses are non-refundable except insofar as one has net income in other years permitting the use of net operating losses (NOLs).

Tom Brennan, who has a math PhD, aims in his paper to give us a new way of looking at the tax rate effect on risk. Taking the simple case of an investment that will either gain $X (taxable at the statutory rate) or lose $Y (assumed to be non-recoverable despite the possibility of other taxable income in the same or a different year), he models nonrefundability as equivalent to a government call option on the value of the asset, based on the statutory rate.

His analysis used investments changing value over time, but I thought it could be made simpler through an example involving an instantaneous coin toss bet. E.g., suppose if it's heads you win $100, tails you lose $100, and the tax rate is 50%.

The standard Domar-Musgrave point (leaving out time and thus income taxation) could be illustrated by noting that, if there's a 50% tax with full loss offsets, all you have to do is double the bet to $200 pre-tax to end up in exactly the same place as if there were no tax.

Tom proposes to look at the case where the gain is still taxable at 50% but the loss is disallowed. Now, to restore after-tax the $200 dispersion in outcomes that you had in the non-tax world (since you'd either gain or lose $100), the amount bet has to be jumped up to $133.33. This will leave you, after-tax, either plus $66.67 or minus $133.33. Only, this is not very satisfying despite restoration of the prior level of dispersion, since the expected after-tax return is now minus 25%. So in fact you'd refuse to bet if you demand at least the 0 expected return that you could have gotten by doing nothing.

Tom notes that one could look at the government's tax claim as akin to its having gotten a free call option permitting it to claim half of the betting outcome. Win and the government takes half of your risky outcome for the strike price of zero; lose and the government lets the option expire as it's out of the money (a negative return being worth less than zero). Under these facts, the government's option was worth ex ante 25% of the amount bet.

Final step in restoring Domar-Musgrave style equivalence, if you happen to have an aesthetic taste for going there, is that, if the government compensated the TP for the value of the option, we'd end up (as in the standard Domar-Musgrave scenario). Specifically, the TP would bet $133.33, the government would hand him $33.33 in cash to make up for the option that it's taken, and the taxpayer would end up after resolution of this bet with either $66.67 or minus $133.33, in either case plus the cash that the government handed him.

The point not being that this is either a policy recommendation or a prediction of any kind; it just closes the circle so we can square our accounts (so to speak). Or, a bit more pertinently, if the government doesn't compensate the TP for the value of the option (and why would it, if it evidently wants to impose the asymmetric tax), the value of the option that's been taken tells us something about the burden being imposed through the asymmetric rates.

All this may sound a bit esoteric, but it was a good last PM session, as we were able to help clarify what the paper says (it's math-heavy and tough reading for lawyers). Question to be answered down the road is how much the model helps us in advancing our understanding of the real world impact of asymmetric rates. While this particular way of parsing them is new, experts have certainly long understood that loss nonrefundability is potentially important to risk-taking, as are graduated marginal rates.

More on this from me in a few days and in a different setting. I will be in Milan, Italy for a couple of days next week, to speak on April 30 at a conference entitled "Tax Policy and the Financial Crisis," to be held at Econpubblica, Universita Bocconi. I'll be on a panel addressing the financial crisis's long-term implications for tax reform, and one of the topics I plan to address is the interplay between loss nonrefundability and excessive risk-taking, AIG-style.

Torture revelations

I've been staying away from the Bush Administration torture controversy as it really isn't anywhere near my area of expertise, but I must say, the new revelations that one motivation for torture may have been to generate "evidence" of al Qaeda-Saddam ties truly takes it to a new level.

It's Curry Time!!

My basketball-playing, basketball-fan son and I had been watching some Knicks games during the season, are now watching the NBA playoffs, and have developed a new phrase: "It's Curry Time!"™

(Based on the overweight, unmotivated, perpetually injured and indifferent Knicks player, Eddie Curry, who has about an $18 million annual salary but who played only about 5 minutes this year, during which time the Knicks were badly outscored.)

He's a big center, only he can't or won't run, jump, pass, catch a pass, rebound, or play defense. He can shoot from 5 feet away when he's healthy, but getting him the ball there is another question unless he's being defended by Ferdinand the Bull (as distinct from, say, Joakim Noah the Bull).

Curry Time!™ used to be the moment when a game was enough of a blowout that you would voluntarily put Curry in if you were the Knicks coach, just to showcase him (as if that could help) and rest someone else. Meaning, garbage time to the nth degree.

It's been redefined to mean the point in a game when the team with the lead could put in Curry if they had him, keep him in for the rest of the game, and still win.

At the end of the third quarter tonight, the Cavaliers were beating the Pistons by 27 points. I asked my son: "Is it Curry Time!™ yet?"

He thought it was still a bit too soon. Even with a 27 point lead, even with LeBron, the Cavs might not be able to hold this lead against a mediocre 8th seed with Curry in the game.

Turned out he was right. Even without Curry, though also without LeBron (whose presence would be a wash at best for Curry's), it's down to 11 points with 8 minutes to play.

Chicken game

Considering the shape that Chrysler is in, it would be amusing, if it weren't so contemptible, that the company opted for expensive private financing in lieu of cheaper bailout financing, in order to avoid limits on executive compensation.

I read some speculation that this was to make it easier for Chrysler to conclude the Fiat deal - although Fiat presumably doesn't care about current Chrysler executives' compensation levels (so the argument would have to be about people it brings in). But I would guess the Chrysler execs are simply gambling that the more they keep over-paying themselves, even if they needlessly increase the company's financial burdens (which are not their problem any more), the more they will end up taking home in the end given U.S. government reluctance to pull the plug and let them go. They are playing a chicken game with the federal government, and I would guess they're winning.

Moral hazard indeed.

This is the most "it figures, business as usual" story I've seen since FASB, responding to Congressional bullying, eased the mark-to-market rules for financial institutions in a manner that invites abuse of discretion, evidently reasoning that the markets have simply been plagued by too much transparency lately. (Yes, I know the argument for the change, but don't like either the short-term effects on rightfully skittish investors' confidence or the long-term effects on financial statements' reliability.)

Interesting new development

According to the Daily Tax Report (subscribers only, so this link may not work for all users):

"Edward Kleinbard is leaving the Joint Committee on Taxation after nearly 20 months as its chief of staff, lobbyists and congressional staffers said April 21.

"Kleinbard is expected to leave his post May 15. It is not clear who will serve as acting chief of staff. Last time there was a vacancy, Deputy Chief of Staff Thomas Barthold served as acting chief of staff for nearly two years.

"Prior to coming to Washington, Kleinbard was a partner with Cleary Gottlieb Steen & Hamilton LLP in Manhattan. Sources said Kleinbard will join the faculty of the University of Southern California Gould School of Law."

I personally wouldn't be surprised if Barthold becomes the permanent Chief, and that would certainly be a good outcome. I doubt that many outsiders of Kleinbard's or his predecessor George Yin's stature, be they leading practitioners or academics, would want the job at this point.

Some readers may know that I am a big fan of Kleinbard's scholarship and work, as well as a friend. At the JCT, he did a great job of advancing the ball on tax expenditures and in generally making the JCT issue pamphlets more serious intellectual contributions that merited broad reading.

Obviously the current political environment, even post-2006 and indeed post-2008, makes it hard for the JCT to play the substantive political role that it had decades ago, before the committee and member staffs got to their current size. Even the institutional independence that, say, the CBO chief but not the JCT chief currently has would be welcome from a policy standpoint, but it's hard to see why Congress would ever choose to grant it.

I anticipate that Kleinbard will be an outstanding academic success - smart move by USC Law School in signing him up.

NYU Tax Policy Colloquium on Mitchell Kane's Taxation and Global Cap and Trade

Neither I personally nor the colloquium have focused as much in the past as we are likely to in the future on the carbon taxes/cap and trade set of issues. (I've never written about these issues because I don't as yet see the angle or intellectual arbitrage opportunities using my skill set.) But yesterday Mitch Kane's paper provided a welcome step in the direction of focusing on them more.

Mitch's paper takes as given that we'd be doing cap and trade not a carbon tax, this being his assigned topic for a forthcoming NYU conference in Abu Dhabi. (Not to mention that current political noises center on cap and trade.) But every time one reads the papers or thinks about the issues it becomes clearer that, even though in principle the two approaches (with suitable ongoing adjustment to each) are interchangeable, in practice it's insane to go the Rube Goldbergesque cap and trade rather than carbon tax route.

My preferred way of thinking about the interchangeability is as follows. Under a carbon tax polluters pay as they go. With cap and trade, they prepay the tax before engaging in the polluting activities, and then use it up by doing the now-permitted carbon-emitting activity. Only, they can sell the taxes-paid voucher to someone else, and, if they want to pay more to emit more, they can't unless the government is willing to sell more prepaid tax vouchers. (Whereas in the carbon tax model you automatically can pay more to pollute more.)

There's a theoretical literature suggesting that the relative merits depend on whether one is more uncertain about the social cost of emissions (which the carbon tax ideally would reflect) or about supply and demand responses (which get reined in by cap and trade if the government keeps the permit supply fixed). But if you keep adjusting the carbon tax to control output levels, or the number of outstanding permits to keep their prices relatively constant, they start to look like each other. In terms of the political frictions if there are adjustment lags, I'd tend to think it makes more sense to take a stab at the social costs and set a carbon tax than to posit something about desired emission levels when the inputs, such as cost of abatement, have such a big effect (which one may not understand) on the optimal reduction in emissions for a given period.

The political reason for cap and trade, of course, is that it isn't called a tax. Only, everyone knows it's a tax (which obviously is what you need to make polluters internalize the social costs of their activities), so one doesn't really gain very much. Plus you get the insane and apparently irresistible political incentive to shower money on polluters by giving them permits for free rather than through auction. This reflects a failure to recognize that we are giving them prepaid tax vouchers without requiring them actually to pay the taxes first. The optics of carbon taxes would be unlikely to yield this result. And, as Alan Auerbach noted at the session, their profits are likely to go up in the post-permits because the reduced output enables them to raise prices. It's as if we organized them into a cartel by charging a tax to reduce output and letting them keep all the revenue. Only mingled corruption and confusion could produce such a result, but evidently they are not in short supply.

Mitch's paper discusses several of the tax issues in handling a cap and trade system. He argues that there is an essentially arbitrary choice between "pre-regulatory" and "post-regulatory" baselines in determining tax basis for permits that were granted for free, but we argued that this is better conceived of as a standard transition issue. (For handy reading on transitions, I suppose one could take a look at this.)

Mitch also focuses on the question of how to minimize inefficiency in the choice between permits and abatement, and offers two alternative approaches that he dubs "no clienteles" and "harmonious clienteles." Alan Auerbach argued, to my view entirely persuasively, that essentially what one needs is income tax neutrality (i.e., permits and alternative abatement methods all are taxed the same for each taxpayer), with marginal rate differences between taxpayers not distorting anything other than via the general work and savings effects of an income tax. This was related to but more demanding than the requirements for satisfying Mitch's "harmonious clienteles" scenario.

Tomorrow may rain so, I'll follow the sun

As you can perhaps see, Shadow (left) and Ursula (center) are doing a lot better these days, though Shadow remains a bit creaky. He's been scoring Passover gefilte fish lately. Buddy (right) spends his days proving that there's nothing like high spirits (and limited calories, despite his best efforts) to keep the mind clear and the body healthy.

Tax Policy Colloquium on Desai & Dharmapala, Investor Taxation in Open Economies

This past Thursday we discussed the above paper proposing "global portfolio neutrality," or GPN, as a new entry in the alphabet soup of proposed international tax norms (joining CEN, CIN, CON, NN, and NON). GPN holds that national as well as worldwide efficiency is maximized by causing individuals to face the same tax rate on their portfolio holdings no matter where they invest. It would be satisfied by purely residence-based taxation of individuals on their portfolio holdings. Given source-based taxation of passive income, such as withholding taxes on dividends, the authors argue for granting unlimited foreign tax credits (FTCs), including refundable FTCs for tax-exempts. They also apply GPN to inbound investment, and suggest, therefore, that we not tax sovereign wealth funds (SWFs) that are not otherwise taxable outside the U.S. on their worldwide holdings.

The paper is partly a response to an earlier paper by Michael Graetz and Itai Grinberg, which - at least as interpreted by Desai and Dharmapala, although Graetz, attending the session, did not entirely accept this interpretation - argues that the US should merely allow deductions for withholding taxes paid abroad. The Graetz-Grinberg argument, at least as reported, was as follows. As per the Desai-Hines norm of capital ownership neutrality (CON), who owns a given business actually may matter a lot, in the sense of affecting profitability, in the case of conducting an active business. But for portfolio holdings there presumably is no effect, since the holder is assumed to be passive and to play no operating role in the business. Hence, while merely allowing a deduction rather than an FTC for foreign withholding taxes would distort ownership decisions - discouraging the holding of foreign stock - this doesn't matter since ownership is irrelevant here.

Desai and Dharmapala respond that ownership does so matter, for reasons of optimal diversification. People in a given country who are already "long" the national macro-economy because their human capital is tied up in it should be eager to diversify via exposure to foreign macro-economy risks (which are somewhat but not perfectly correlated with our own) by holding foreign stock. (BTW, the "home bias" that we continue to observe in stock ownership patterns, though it is declining, arguably shows irrational under-diversification although there also are some rational proposed explanations for it.)

So far, so good. But the trickier part, for me, is their argument that GPN establishes, as a matter of unilateral national self-interest, providing FTCs for foreign withholding taxes so long as our withholding tax rate is about the same as those applying abroad.

They have a logical and internally consistent argument for this, which would take too long to explain here but can be found at pages 23-24 of their paper (available here under April 9). But I was skeptical on the grounds that:

(a) It isn't actually unilateral if withholding tax rates have to be about the same.

(b) FTCs create bad incentives, from the U.S. standpoint, both for our taxpayers (who need not seek to economize on foreign taxes in deciding where to invest if we'll offer a credit anyway) and for foreign governments (who can think of the tax cost as passed on to the U.S. Treasury).

(c) The reason D&D require that withholding taxes be about the same is that foreign inbound investment will replace the outbound (e.g., if Americans sell U.S. stocks to hold foreign stocks, then someone else has to buy the U.S. stocks). Hence, we automatically pick up withholding tax revenues to replace the lost revenues from offering FTCs. But Alan Auerbach and I argued that this amounted to assuming that capital flows must be symmetric by asset class, which isn't necessary even if symmetry holds overall.

A further issue I raised is that investors care about true diversification as to underlying economic characteristics. But the determination of source for dividends received is essentially formal - under U.S. law, depending almost purely on where the issuer is incorporated. Does selling GE stock to hold Siemens stock have anything to do with diversification if both companies are active in the same places to the same degree? Diversification by source, as determined by the tax system with respect to passive income, could at the limit be no more meaningful than making sure you hold both stocks that are printed on red paper and those that are printed on blue paper.

A final criticism I offered on these issues (although actually, at the session, I stated it first) is that GPN, like all of the alphabet soup norms, addresses only one margin (portfolio diversification) whereas there are many. For example, can one really discuss the tax treatment of passive income held by U.S. taxpayers without considering U.S. corporations, the outbound passive investment of which is taxable without deferral under subpart F.

Despite these criticisms, this was one of the best papers and sessions of the semester. Among its virtues was addressing the significance of tax rate differences among investors within a jurisdiction. But here, although I largely sympathized with the analytical bottom line, I of course found a way to carp and cavil all the same.

With respect to refundable FTCs for tax-exempts, my main critique was that, since FTCs create incentive problems from the national welfare standpoint, it's logical to limit them. The way we actually do so, by offering a 100% marginal reimbursement rate (MRR) until one hits the credit limit and then 0% thereafter, seems a bit arbitrary and unlikely to be optimal. But it's hard to say if, overall, we are too generous or not generous enough. Hence, in any given case (such as the tax-exempts) in which one proposes to scrap the limit and permit more FTCs to be claimed, it is hard to be sure whether we are going in the right direction or not.

Finally, with respect to sovereign wealth funds (SWFs), I agreed that it is likely to be in the U.S. national self-interest not to tax them on inbound investment IF we are effectively a small open economy without the market power to impose some of the burden of the tax on them. They're distinctive in that, for various other inbound investors, the withholding taxes we impose might (a) not exceed the tax rate they would face anyway, and/or (b) be creditable by their home governments. But SWFs can't take advantage of FTCs because, effectively, they ARE the home governments that would be providing the credit.

But it seemed odd to me to call this GPN, given that (a) from a national welfare standpoint we don't care about affording them better diversification, and (b) we'd be quite happy to tax them and distort their portfolio choices insofar as we have enough market power to stick them with some of the economic incidence of the tax.

Dismaying encounter

Earlier this week I had coffee with a former colleague, now eminent outside the legal academy, who was in town for a few days. He's very much to the right of me politically, but someone I've always respected as intelligent, thoughtful, and intellectually honest. Not a law and economics person, by the way.

The financial crisis came up and, while it's not his area of expertise, I must admit to being startled by what I heard. First off, he noted that the whole thing resulted from a regulatory failure. I agreed, but then it turned out that what each of us meant was rather different. He believes the entire thing was caused by the Community Reinvestment Act (apparently burrowing underground since 1976 until it finally exploded to deadly effect), with an assist from Fannie and Freddie.

He in turn was startled by my suggestion that failures in corporate governance, particularly in the financial sector, reflecting managerial opportunism and lack of transparency, could reasonably be thought by anyone to have had anything to do with the crisis. The only problem he could see in the financial and general corporate sectors that markets weren't completely able to handle was the "too big to fail" problem of government rescue.

He also believes that it is logically impossible for Keynesian stimulus to have any effect whatsoever, since what you spend here doesn't get spent there, and that there is absolutely no need to worry about the banks. If they all fail and money can be made by lending, then of course businesses will spring up right away and start doing it.

I have to confess that this exchange diminished my enjoyment of the meeting, but it was also more broadly dismaying. Level one is realizing the degree to which even intelligent people on the right can be completely divorced from reality on these matters. They go to trusted information sources, which have been making absurd and easily falsifiable claims about the current situation and the underlying issues. Level two is realizing how everyone does this to a degree. Because we all get our information from sources we have pre-coded as trustworthy and simpatico, we all may have a difficult time seeing what's right in front of our eyes.

One more reason to despair about public policy, even leaving aside all of the incentive and interest group problems that even by themselves are so crippling.

2010 NYU Tax Policy Colloquium - great news

I'm pleased to be able to announce that my co-teacher for the 2010 Tax Policy Colloquium will be Mihir Desai.

Sessions at U Va and NYU

I'll often blog about my talks or conference appearances and such, but have lately been too busy and backed up at work to spare the time. But at a certain point it gets so bad that it really doesn't matter any more at the margin if you ignore your main responsibilities for a bit. It can't get any worse, and is very far from getting noticeably better. So here goes.

Last Friday, I traveled to Charlottesville, VA to discuss Decoding the Corporate Tax at a Virginia Tax Study Group panel, kindly arranged by Michael Doran (who is leaving Virginia for Georgetown). My co-panelists were Ethan Yale (who is leaving Georgetown for Virginia) and Michael Schler. Nice discussion, and to my shock I actually succeeded in personally selling 11 of the books afterwards to people who I hope are now satisfied customers.

Ethan presented his own paper, describing a corporate tax reform proposal to tax corporate dividends like share repurchases (i.e., with basis recovery). I find this an interesting proposal to add to the existing menu, and think its merits depend in part on the significance of the corporate governance issues that might make the dividend vs. repurchase choice important. Then I described my book (overview plus brief description of policy proposals at the end) and Mike S. commented on both of our proposals.

I do like the policy proposals in my book, which are (1) lowering the corporate tax rate but with offsetting adjustments, (2) ceasefire-in-place international tax simplification, and (3) addressing corporate governance problems via the gap between taxable and financial accounting income. But I agree with the other two discussants that the book's main contribution over a long-term perspective is expositional, relating to the rich yet inconclusive economics literature and how to think about the subject, rather than to the proposals themselves.

So there we are, a nice and reasonably productive day in Charlottesville, VA; it's Friday at 4 pm, and I've just arrived at the airport to fly back to NYC. I need to fly back promptly as I have no overnight bag, no place to stay, and a commitment to appear the next morning, back in NYC, at an NYU Alumni Reunions panel with a couple of hundred scheduled attendees. The panelists are supposed to discuss tax policy in the Obama Administration, and as an added complication we have been too busy to finalize what we're actually doing.

In the Charlottesville airport at 4 pm, I learn that my flight to NYC has been cancelled, a victim of the East Coast storms last Friday, and indeed that the Charlottesville Airport (a very small one) is done for the day apart from (1) a couple of flights headed to points further south, plus just maybe (2) a flight to Philadelphia that was supposed to leave at 3:30 but is now tentatively scheduled for 7:15.

Lots of options at this point. Drive to NYC? Drive to Washington (2 hours) and take a shuttle in the morning? Airport hotel? Ask my hosts to find lodging? (They were very willing to help.) I chose Door Number 5, the flight to Philadelphia, and hoped for the best. Good call, as it transpired - it left earlier than expected and via 3 separate trains I made it the rest of the way back home only 3 hours late overall.

This left time the next morning to plan and then execute the panel on Tax Policy in the Obama Administration. Greg Jenner, whom I've known since we both worked on the Tax Reform Act of 1986, was my main co-discussant on the topics for our half of the panel. We ran through most of the Obama budget proposals, other than business & international (which went to our co-panelists), and although Greg is at least technically a Republican (albeit the honest and intellectually responsible kind that's all too rare these days) we agreed about a lot. Both of us either need more meds, or are rightly reading the long-term fiscal situation as extremely threatening.

Act now while supplies last

My new book, Decoding the Corporate Tax, is now available directly from both Amazon and Barnes & Noble (albeit with the wrong title).

Tax policy colloquium on Lily Batchelder's Savings Incentives with Insurance Objectives: A Bankrupt Approach?

Last Thursday we discussed Lily Batchelder's new draft paper (still a work in progress), which argues that savings incentives in the tax code are poorly designed to advance insurance objectives for poorer individuals. She notes low responsiveness to the rules in present law, and their generally providing larger incentives to higher-income individuals who arguably are saving enough already. Thus, she proposes either (a) changing defaults so people automaticallty save for retirement through their employment, but with opt-out and no tax benefit for saving, or (b) a refundable saver's credit that's phased out based on income. Absent opt-out, the savings accounts would automatically convert shortly before retirement to fixed real life annuities.

Alan Auerbach and I were more inclined than Lily to think of saving enough and having enough insurance of various kinds as very different things. Suppose you know with certainty (a) your entire future earnings profile, (b) your exact life expectancy, and (c) anything you need to know about consumer prices, your consumption preferences, and rates of return on saving until the day you die. In this scenario there's no uncertainty about any of these inputs, hence no need whatsoever for insurance so far as any of them are concerned. Yet it would still be vital to save enough to smooth your lifetime consumption path optimally, and people who were myopic or had self-control problems would fall short of optimizing. Hence, we might want to require or induce more saving in order to increase their welfare (and also to save us from having to "rescue" them later on if they depart too far from the optimal path).

Likewise, consider in these terms Social Security. In large part it is simply a device to force a minimum level of retirement saving given one's lifetime income (net of taxes and transfers, including its own). Indeed, though it is always called social insurance for purely formal reasons (e.g., its purporting to have dedicated financing, which in fact aren't much like insurance premiums), its sole insurance feature (redistribution in the program aside) is the fixed real life annuity.

Suppose that we knew everyone's exact lifespan. We'd still need Social Security, but we'd be able to substitute term annuities, equal in length for each retiree to her remaining lifespan, for the life annuities. Now it wouldn't be insurance at all, yet it would still be pretty similar to what we now have. So insurance is not really a huge part of Social Security, despite the semantic convention that supposes it to be a core case.

If we limited the "social insurance" label to programs that actually are economically insurance, and furnished by the government due either to adverse selection problems or people's under-appreciating the value of being insured, the preeminent case would be the income tax plus welfare system, which provide insurance against income risk. But these of course are the programs that no one calls insurance and that indeed were the very ones the inventors of the "social insurance" label were trying to distinguish from their favored programs. (See my Social Security book for a fuller discussion.)

Anyway, the main payoff of all this to Alan and myself was disagreeing about the extent to which savings incentives and insurance objectives should actually be considered a natural match.

The other main quibble we had pertained to the proposal for default saving with free opt-out. Lily wants the opt-out, rather than mandatory saving beyond that in Social Security, because otherwise we might be requiring someone to over-save relative to what was truly optimal for them. Our objection was that we don't really have good reason to tilt the default towards more saving unless one thinks people are otherwise likely to be saving too little. But if we think they mostly are, why allow the opt-out?

The reason for allowing it would be clear if we expected the "right" people to opt out while the ones we wanted to save more stayed at the default level. But what if it was the other way around? It's hard to know why the opt-out would be exercised primarily by those who actually would be saving too much otherwise, rather than by those who want to under-save relative to what's optimal.