Are the Trustees too pessimistic?

In the comments, Bruce Webb raises a common argument, that Social Security’s Trustees have generally been too pessimistic about the program's finances. I wrote on this issue a long time ago, and posted my little solvency widget in part to let people play out their own scenarios. But this issue is an evergreen and deserves some more attention.

Bruce argues that the Trustees have been overly pessimistic based on their short-term forecasting record. Bruce compares GDP growth as projected in a Trustees Report with the realized figure one year later. He argues that since 1997 GDP growth has generally been understated and that the Low Cost projections have been more accurate. From here, he concludes that the Low Cost 75-year projections may be more accurate.

A couple points: First, it is hard to draw firm conclusions about the Trustees’ 75-year forecast from the accuracy of their single-year forecasts, since these are very different animals. The SSA Office the Chief Actuary is geared more toward long-term forecasting, while the Congressional Budget Office and private sector forecasters concentrate more on the short-term. Moreover, in many ways long-term forecasts are easier than short-term forecasts, since the long term relies more on underlying fundamentals and less on year-to-year fluctuations. For instance, I cannot say with accuracy whether the weather one week from now will be cooler or hotter than today’s, but I can say with great accuracy that the weather six months from will be hotter simply because of the fundamentals.

Second, Bruce uses one method for assessing the Trustees’ accuracy, but others – perhaps better ones – are available. Here I turn to Chuck Blahous, the number two at the White House National Economic Council and the Bush administration’s chief policy man on Social Security. In a paper presented last year at the American Enterprise Institute, Chuck applied a rigorous test to the Trustees accuracy.

First, he devised two benchmarks of Social Security’s financing health: a), the annual cash balance (surplus or deficit) as a percentage of payroll; and b), the trust fund ratio – the trust fund balance as a percentage of annual costs. At any given time, these are good measures of how well Social Security is funded, clearly more so than GDP growth alone. In 2005, the last year for which data was available when the paper was being written, the annual Social Security cash surplus was 1.55% of taxable wages, and the Trust Fund ratio was 318%.

Next, Chuck looked back over the previous Trustees Reports ranging back to 1983 and analyzed how accurately they projected these outcomes for 2005. Specifically, he asked which set of projections – Low Cost, High Cost, or Intermediate – was the most accurate in projecting the cash balance and trust fund ratio for 2005.

Figure 1 details the Trustees projections of the annual cash flows. Of the 22 Reports, the Low Cost was most accurate in only 4, the Intermediate Cost in 7, and the High Cost in between 8 and 11 Reports (this is due to changes in how the Reports were structured).

Figure 2 repeats the process for the Trust Fund ratio. Here the Intermediate Cost projections have been most accurate, being the best projections in 12 of 22 Reports. The Low Cost projections were most accurate in 6 years, and the High Cost in 4 years.

Clearly other tests could be applied. But one test – summing the squared errors of the different methods, then discounting to control for the difficulty of prediction as time increases – shows the summed errors for the Intermediate Cost projections were only one-fourth the size of those of the Low or High Cost scenarios.

Chuck summarizes the results in this way:

A reasonable summary of the 1983-2004 projections’ accuracy is that the Trustees’ Intermediate projections most accurately predicted the cumulative value of the Social Security surpluses over the totality of the 1983-2004 period. With respect to predicting the balance of annual system operations in 2005, the High-Cost projections were the most accurate in the highest number of reports, although the Intermediate projections exhibited the lowest total error. On balance, by both standards taken together, the Intermediate projections have been the most accurate, and the Low-Cost projections have been the least. Though this does not necessarily mean that the superiority to date of the Intermediate projections is significant for the future, the data clearly contradict the widespread misconception that the Low-Cost projections have in the past been best.

Anyone considering the argument that the Trustees are overly pessimistic must account for the arguments and evidence Chuck Blahous presents in this paper.

In addition to the paper itself, PowerPoints from Chuck and discussants Steve Goss (SSA) and John Sabelhaus (CBO) and video of the entire event are available here at the AEI website.