Wednesday, April 9, 2008

Nancy Altman on reform (with editorial comments)

In today's Los Angeles Times, Nancy Altman outlines her proposal for Social Security reform, modeled after the plan put forward by the late SSA Commissioner Robert Ball. (Click here for more details on Ball's plan and here for the actuaries' analysis.)

Following her piece, I've pasted in a letter to the editor I wrote this morning which argues that her proposal appears easy simply because she lowers the bar on what is considered success in reforming Social Security. While due to space restrictions the letter confines itself to the core criticism, I do believe that anyone who argues that Social Security needs prompt action and who is willing to put concrete reform options on the tables deserves credit. Following the letter is some additional detail on what it means for a reform plan to be "solvent."

The right fixes for Social Security

Along with baseball and cherry blossoms, spring in the nation's capital brings a ritualized dance over Social Security. Every year for the last two decades, Social Security's trustees have issued a report alerting Congress that action is needed to keep the program solvent. And every year, Congress answers with silence.

It was not always this way. In 1973, the trustees projected a deficit. By 1977, Congress had responded with corrective legislation. In 1981, when that action proved insufficient, Congress began work on a new solution. President Reagan announced his own set of reforms, including a proposal to cut benefits sharply for people about to retire early. That set off a firestorm of protests. To quell the uproar, Reagan quietly dropped the plan and called for the formation of a bipartisan commission. The commission developed a package that Congress passed and Reagan signed into law in 1983. Subsequent trustees' reports again showed Social Security in balance.

Beginning in 1989, however, the trustees again started alerting Congress to deficits caused mainly by changing assumptions, including those about the economy and disability rates. Why didn't President George H.W. Bush, President Clinton or Congress offer serious solutions? Why did President George W. Bush promote a privatization proposal that would have made Social Security's deficit larger? Where did the political courage go?

In fact, political courage was in no greater supply in the 1970s and early 1980s than it is today. The circumstances were simply different. Back then, Social Security faced a short-term deficit: inadequate funding to pay full benefits by the early 1980s. Congress and the White House were willing to make some hard decisions to avert the political catastrophe of millions of beneficiaries not receiving their promised benefits, perhaps just before the next election. Today, there is no such danger on the near horizon.

Social Security will run a surplus until 2027, when it will have accumulated $5.5 trillion. At that point, if no action is taken, the trust fund will begin to cash out the Treasury obligations it holds. That will allow all benefits to be paid until 2041, according to the latest trustees' report.

Despite the long time frame, the trustees are right to alert Congress, which should act without delay so changes can be modest and phased in. Moreover, the quicker Congress acts, the sooner it will restore an intangible benefit. As its name suggests, Social Security is intended to provide security -- peace of mind -- in addition to cash benefits. Peace of mind is lost when politicians and pundits make alarmist statements like "Social Security is going broke" or "it's unsustainable." Eliminating the projected deficit would end those frightening, hyperbolic claims.

But without an imminent crisis to force some action, what would give Congress and the president the backbone to make the necessary changes? Fortunately, it would take only three reforms and not much backbone to put the program back in balance.

First, instead of repealing the estate tax, as President Bush wants to do, Congress should dedicate its revenue to Social Security. The accumulation of huge fortunes depends, in part, on the productivity and infrastructure of the nation. Requiring heirs to contribute to the basic security of all Americans seems a reasonable minimum to ask of those who have benefited so greatly from the common wealth.

Second, Congress should restore the practice of subjecting 90% of aggregated wages nationwide (i.e., the sum of all wages, taken together, of corporate executives, janitors and everyone else) to Social Security taxes. Because the wages of the highest-paid workers have increased much more rapidly than average wages over the last several decades, only about 84% of all wages is currently subject to Social Security taxes, resulting in billions of dollars of lost revenue every year. Restoring the 90% level, by gradually increasing the maximum amount of earnings subject to taxing, would have no effect on workers earning less than the maximum -- currently $102,000 a year. If this proposal were now law, those earning more than $102,000 -- just 6% of the workforce -- would have paid a mere $120.90 in additional contributions this year.

Third, Congress should permit Social Security to improve earnings by diversifying its portfolio and investing some of its assets in equities, as just about all other public and private pension plans do.

These reforms would restore Social Security to balance -- without benefit cuts, without raising the retirement age and with only a very modest tax increase on 6% of the workforce. Politicians should leap at the opportunity to do so much good and reap so much political gain at such little cost.

Nancy Altman is the author of "The Battle for Social Security: From FDR's Vision to Bush's Gamble."

Following is a letter to the editor I drafted this morning:

Re. “The right fixes for Social Security,” by Nancy Altman; April 9, 2008

To the editor:

Nancy Altman endorses three steps to fix Social Security’s financing shortfalls: first, dedicate estate tax revenues to Social Security; second, increase the wages on which payroll taxes are applied from $102,000 to around $185,000; and third, invest part of the trust fund in stocks.

These steps would not come, as Ms. Altman believes, at “little cost.” Dedicating estate tax revenues to Social Security would break the historical link between taxes paid by workers and benefits received by them – a link that differentiates Social Security from so-called “welfare” programs. Increasing the maximum taxable wage would raise the top marginal tax rate by 12.4 percentage points, and, while it would hit only around 6% of workers each year, would affect over 20% of workers over their lifetimes. Investing the trust fund in stocks would involve so-called “transition costs” and the risk of market downturns in the same way as President Bush’s plan to introduce personal retirement accounts.

While Ms. Altman claims these steps would “restore Social Security to balance,” the Social Security actuaries found these three steps would leave around one-quarter of the program’s 75-year deficit unaddressed. To reach “sustainable solvency,” meaning that Social Security would be solvent through 75 years and financially healthy thereafter, would require changes roughly twice as large as those proposed by Ms. Altman.

Sustainable solvency has been a bipartisan goal of Social Security reformers for the last decade. Thus, Ms. Altman’s solution appears attractive relative to other reform plans only because it fixes much less of the problem. Fixing Social Security will depend on insight, compromise, and the ability to make difficult choices, not on lowering the bar for success.


Andrew G. Biggs

The American Enterprise Institute, Washington DC

Here is some more background on the three measures of "success" for a reform plan:
  • Sustainable solvency: Almost all current reformers aim to restore Social Security to "sustainable solvency." This means that the program is solvent through 75 years and ends the period on strong financial footing. Sustainable solvency was a standard devised by SSA's actuaries which enables plan designers to avoid the shortfalls of the 1983 reforms, in which the program was solvency for 75 years but fell off a financial cliff in the 76th year. Sustainable solvency has been a standard since the 1994-96 Advisory Council and reform plans across the spectrum have met this standard. Reaching sustainable solvency would require improvements in the actuarial balance of somewhere around 3 percent of payroll.
  • 75-year solvency: Prior to the mid-1990s, reformers aimed to keep the program solvency for 75 years, but didn't pay much attention to whether the program ended the 75-year period on strong financial footing. This is a significant shortfall, since many of the individuals who paid taxes during the 75 years, and thus contribute to 75-year solvency, would be retired after the 75th year and thus face benefit cuts if the program were not sustainably solvent. Based on current projections, reaching 75-year solvency requires an improvement in the actuarial balance of around 1.7 percent of payroll.
  • Close actuarial balance: Roughly speaking, this standard is met if the 75-year actuarial deficit is less than 5% of total 75 year costs. (The definition is available here.) Since the 75-year summarized cost rate is equal to 15.63% of payroll, 5% of which equals 0.78% of payroll, any reform plan with a 75-year deficit of less than that amount would meet the test of close actuarial balance. Thus, a plan could improve the 75-year balance by less than 1% of payroll and still meet this test.
To my knowledge, only Altman and the late Robert Ball have applied this standard to a reform plan. In short, success by Altman's standards can require as little as one-third the tax increases or benefit reductions of a plan that aims to reach sustainable solvency. This seems, to me at least, to not move the debate in the right direction.


Bruce Webb said...

"but fell off a financial cliff in the 76th year"

Come on. If this was true we should have seen a substantial fall off between the 2006 Report whose 76th year excluded 2082 and the 2008 Report which included both 2082 and 2083 within its 75 year actuarial window. Only by redefining '76th year' to mean 'every year from the 76th to the Infinite Future Horizon' does language about financial cliffs even begin to make sense. The effect you claim did not in fact show up.

By your own figures the change in the actuarial window adds .06% annually to the payroll gap under Intermediate Cost assumptions, an amount that can and has typically been more than offset by improved outcomes and/or changes in assumptions and methods. These same 'cliff' claims have been repeated over and over since the introduction of Infinite Future Horizon with the 2003 Report. And shown to be alarmist in the Reports since (with the possible exception of the 2007 Report which did show an increase in the payroll gap due mostly to a change in assumed interest).

For those of us who have been following along this year after year attempt to just reset the clock and resume the narrative as if the numbers were not moving under our feet would be amusing if we thought the story tellers didn't have an agenda that included killing Social Security outright. But as it is we are not laughing.

"This is a significant shortfall, since many of the individuals who paid taxes during the 75 years, and thus contribute to 75-year solvency, would be retired after the 75th year and thus face benefit cuts if the program were not sustainably solvent."

Very, very few of those individuals are in the workforce today and while I feel the pain for that 21 year old who will still be alive and kicking at age 96 in 2085 and have some feelings of responsibility for workers unborn for a couple of decades who will be retirement and so Medicare eligible in 2085, I am thinking the each would gain more benefit from guaranteed medical coverage say over that same 75 years. This whole 'think about the children!' attempt to sell privatization fails the laugh test in light of conservative opposition to SCHIPS. Why retirement security for a baby that will not be born until 2018 somehow becomes a huge national priority simply escapes me. Which leads me to believe that none of this is in the end about retirement security at all.

Andrew G. Biggs said...

I was referring to a 1983 type reform, in which the system is solvent for 75 years but only 75; as a result, from the 75th year to the 76th people face a very large tax increase or benefit reduction. That's not optimal policy - it's better to smooth changes over as many cohorts as possible. So we'd benefit from system measures, like sustainable solvency or the infinite horizon actuarial balance, that reduce the chances of precipitous policy changes.

Bruce Webb said...

Which is to dodge the point. There is in fact no magical fracture at that 76th year, instead you just have changes at the margin. I'll freely admit that you would get slightly different outlooks using a 65 year window or an 85 year window but frankly Infinite Future looks like a gimmick introduced to allow the substitution of '$14 trillion plus' for '$4 trillion plus' to forestall the possibility of someone amortizing $4 trillion over 75 years and adjusting it for inflation.

Andrew G. Biggs said...

Well, actually there is: if you are solvent only for 75 years -- as we were in the 1983 reforms -- you go from full scheduled benefits in the 75th year to payable benefits in the 76th year. Payable benefits are around 25% less than scheduled, so I suspect many people would call that a fracture.

This is probably worth a separate post, but people really misunderstand the infinite horizon, but it helps to compare it to the sustainable solvency measure. For sustainable solvency, you need to be solvent over 75 years plus have a stable or rising trust fund ratio at the end of the period. This latter criterion is simply a test of the system's financial health going forward (you could also use cash flows instead).

So the sustainable solvency measure doesn't demand information on anything beyond 75 years, much less the infinite horizon. But how much would we have to raise taxes today in order to achieve sustainable solvency? (I.e., what is the 'sustainable solvency actuarial deficit,' so to speak.) Last I checked, it was around 3.2%, at a time when the infinite horizon deficit was 3.5%.

So the vast majority of the changes required to fill the infinite horizon deficit are simply those required to get Social Security through 75 years and have it financial healthy, rather than falling off a cliff, at the end of 75 years. Maybe the sustainable solvency measure would be a better thing to stress since it doesn't demand reference to the infinite future. But in any case, they're functionally the same.