I have a short article in Financial Planning Magazine which addresses some of the rules people use to decide when to claim Social Security benefits. I argue that the so-called 'break even age' approach that's often used by financial planners and the Social Security Administration isn't the best way to think about when to claim benefits. Some highlights: The break-even approach is easy to understand. But it has three main flaws: First, clients may live longer than they think. A 2005 British study found that retirement-age individuals typically underestimated their true life expectancies by three to five years. If the break-even age approach is used, it must be coupled with a realistic view of the probabilities of survival. Second, the break-even age ignores benefits for a surviving spouse. Increased survivors' benefits are one of the best reasons to delay claiming, since widows have among the highest poverty rates of retirees. The break-even age approach makes what should be a household decision a purely individual one. Third, and most important, the break-even approach treats delaying benefits as a gamble, when it should be seen as insurance against outliving assets. By focusing on average life expectancy, you ignore the significant chance of living longer than expected. While the typical 65-year-old will live to around age 83, one in four will survive to 90 and one in 10 to 95. There is a nearly 5% chance one member of a 65-year-old married couple will live to age 100. Click here to read the whole article.
Sunday, August 31, 2008
Financial Planning: When should you claim benefits?
Two views on Social Security reform
From the Indianapolis Star, June Lyle of AARP and Michael Tanner of the Cato Institute present their views on how to fix Social Security for the future.
Re Krugman on “How Important is Social Security?”
Paul Krugman discusses the importance of Social Security to total retirement income. He cites SSA data and concludes that for the typical retiree, Social Security benefits make up around two-thirds of total retirement income. However, for reasons discussed here, those numbers tend to overstate the importance of Social Security benefits. (Short story: a) the SSA data Krugman cites effectively counts couples as individuals; since couples are less dependent on Social Security and singles more, this weighting makes the overall population appear more dependent; b ) the SSA data derives from a survey that doesn't do a good job of counting asset income, such as draw-downs from IRAs and 401ks. I'd have to double check, but I don't believe that IRA or 401k income would be counted at all in this data. As people rely more on these accounts, this undercounting will make it seem as if they are more dependent on Social Security even if they aren't.) To give some context, I've pasted in a table from a paper co-written with Glenn Springstead of SSA that's forthcoming in the Social Security Bulletin. It's based on the SSA's MINT (Modeling Income in the Near Term) model, which is the state of the art in modeling retirement income. The table breaks down sources of retirement income for individuals age 64-66 in the year 2005. Table 6: Composition of total retirement income for retired beneficiaries age 64-66 in 2005 Lifetime earnings quintile All Lowest 2nd 3rd 4th Highest Social Security 39% 47% 43% 41% 35% 29% Earnings 20% 16% 22% 19% 20% 25% DB pensions 10% 8% 9% 11% 11% 12% Asset income 25% 19% 20% 25% 31% 31% Co-resident income 5% 9% 6% 4% 3% 3% SSI 0% 1% 0% 0% 0% 0% Total 100% 100% 100% 100% 100% 100% Source: Authors' calculations, MINT model. % total 39% 47% 43% 41% 35% 29% % non-earned income 49% 57% 55% 51% 44% 39% I've added two rows below the table that show Social Security as a percentage of total retirement income, either including or excluding earnings (since as people age their earned income will decline). Overall, Social Security accounts for around 39 percent of total retirement income for this group, or around 49 percent of income excluding earnings. Social Security is obviously a very important source of retirement income, but still lower than the 65 percent total than Krugman argues for.
Friday, August 29, 2008
More on how the future deficit is caused by over-generosity to past participants
This is a long post, so be sure to hit the 'read more' link to see the whole thing.
We’ve talked a bit here (and here, over at Angry Bear) about how Social Security’s large future shortfalls are a function not of over-generosity to future retirees, but to over-generosity to past ones. This sounds strange and it’s been a bit hard to explain given the data available. But I’ve spent a bit of time converting data in this paper by SSA economist Dean Leimer into a form that might help things make some more sense.
To start, this table shows the program’s deficit over the infinite horizon, measured in the 2008 Trustees Report as $13.6 trillion, or 3.2 percent of taxable payroll over that period. Folks who think the infinite horizon figure is crazy often focus on the, well, infinite part; how can we know, and why should we care, what will happen in the infinite future?
Those of us who think the infinite horizon measure has merit sometimes point out that the deficit isn’t a function of what we project will happen in the way off future, but of what happened in the past. Early participants received much, much more in benefits than they paid in taxes. As a result, the trust fund balance is much lower than it would have been had these early cohorts received only an actuarially fair return (defined as their benefits being equal in present value to their taxes; put another way, it means they would receive a return on their taxes equal to the interest rate paid on bonds on the trust fund).
To back this view, we sometimes point to this table, which breaks the infinite horizon shortfall down more finely. It shows that the $13.6 trillion deficit through the infinite horizon is fully accounted for by the fact that past and present participants received $15.2 trillion more in benefits than they paid in taxes. Future participants are projected to receive $1.5 trillion less in benefits than they’ll pay in taxes, even if Social Security were fully solvent. Add those two numbers together, subtract the current value of the trust fund ($2.2 trillion) and you have the $13.6 trillion deficit.
One question that’s been raised, however, is that the figures for past and present participants includes everyone currently over the age of 16. This means that the earliest participants are lumped together with people just entering the system now, so it’s not clear whether the $15.2 net transfer is really a function of over-generosity to past cohorts or to future ones.
I requested from the Social Security actuaries a cohort-by-cohort breakdown of the figures above, but they weren’t able to provide it. So alternately, I worked with data from Dean Leimer’s paper to convert it to a form more comparable to that show in Table IV.B7. Dean is probably the leading expert on how different cohorts have been treated under the Social Security program and he constructed his figures from SSA data, so I fully trust they’re technically correct. The issues was simply converting them for comparability, which I did.
I should note, however, that the numbers don’t exactly match up because Leimer’s projections of future taxes and benefits was based on the 2002 Trustees Report, which showed a significantly larger deficit than the 2008 Report. I discounted future dollar amounts based on the interest rates in the 2008 Report to keep things as comparable as possible, but the overall deficit is larger in Leimer’s figures due to his matching an older set of Trustees projections. Also note that all individuals born prior to 1900 are lumped together in Leimer’s data.
In any case, first here’s a chart showing real internal rates of return from Social Security for different birth cohorts. As you can see, early cohorts received very high returns while later cohorts received lower ones. Once a cohort is receiving a return below the trust fund interest rate (around 3 percent) the present value of that cohort’s taxes will exceed their benefits. These later cohorts will be net contributors to the system, meaning that they actually help keep the system solvent even if they’ll be the ones holding the bag when it’s going broke.
You may notice that for later cohorts returns tend to rise. Why is this? It’s because these figures are shown under scheduled taxes and benefits, which assumes (unrealistically) that full benefits can be paid at all times. As future cohorts will live longer and longer in retirement, they’ll receive more benefits and so returns will rise. But again, this is unrealistic; in real life, returns will inevitably stabilize.
Now here’s the second chart. It shows net transfers from Social Security by cohort, expressed in present value dollars to make them comparable to the numbers in Table IV.B7. If the dollar figure is positive that means that a given birth cohort received more in benefits than it paid in taxes (all in present value form); if the number is negative, it means they pay more in taxes than they’ll receive in benefits. Again, all this is under scheduled benefits, so solvency doesn’t come into play here.
What the table shows is that early cohorts – particularly those born prior to 1900 – received much more in benefits than they paid in taxes. For the pre-1900 cohorts, the bonus was around $14 trillion. The bonuses decline over time until they’re actually negative beginning with people retiring in the late 1990s. They stay negative for quite a while, and then some distant cohorts are actually slightly positive again (also due to the assumption that they live longer and collect more benefits).
If you add all the cohort figures up, they total around $22 trillion in present value. If you then subtract the current value of the trust fund, the total is around $20 trillion. This is larger than the current infinite horizon shortfall of $13.6 trillion, because the 2002 Trustees projections were more pessimistic.
But I think this basically shows the point we were discussing earlier. The so-called “infinite horizon” deficit has very little to do with what will happen hundreds of years from now and everything to do with what happened in the first 25 years or so that the Social Security program was running. Participants, rich and poor alike, were paid much more in benefits than they contributed in taxes. As a result, the trust fund balance – which should be somewhere around $16 trillion – is only around $2 trillion. This is what drives the long-term deficit.
I think in a way this makes reform easier to understand and resolve. We’ve inherited a ‘legacy debt’ due to over-generosity to prior generations. Whether this over-generosity was justified is an academic question. (Some say yes, to help reduce poverty; I agree there, but much of the legacy debt is due to over-generosity to high income participants, which is harder to justify.) In any case, though, it’s a done deal: the shortfall is what it is, and our only choices are how to deal with it. My argument, which I’ll expand on more fully in the future, is to treat this legacy debt more like a real debt: find the best, fairest and least economically damaging way to pay it off, which may be a way outside of the current Social Security financing structure. But that’s a question for another day.
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New paper: “Social Security increases poverty”
Following on our conversation from a week or so ago, here's a new paper published by the Independent Institute that argues that Social Security increases poverty. (Even I didn't go that far…) Here's some background below via the NCPA, followed by a quick comment from me: Social Security is often touted as a crucial safety net that protects American retirees from abject poverty. In reality, Social Security has made it harder for retirees to grow wealthier by reducing their ability to save and thus has contributed to poverty in old age, argues Texas A&M economist and Independent Institute Research Fellow Edgar K. Browning. For those retiring in 2008: Moreover, the yield from Social Security looks even worse when considering that savings fuel investment and economic growth, adds Browning. It is likely that we would have fewer poor among the elderly had they been free to invest their taxes in private assets. Once Social Security's rate of return drops to below two percent, it will only continue to aggravate poverty in the future. Policymakers are left with the decision to cut benefits or double the tax rates. Neither option is attractive, but the longer we wait, the harder it is to implement change and the more likely we will be forced to accept substantially higher taxes, concludes Browning. Browning seems to be arguing almost fully through the equity premium, the idea that by investing in stocks one can get a higher return – and thus, a higher benefit – than a low-risk, low-return "investment" like Social Security. There's some truth in this: for a low earner without any other savings, Social Security constrains them to a retirement savings portfolio without any equity exposure. That said, the higher return on equities is compensation for increased risk, which the paper doesn't appear to account for. Moreover, Social Security's progressivity means that low earners receive higher average returns, which helps compensate for the lack of equity exposure. So I don't really buy the larger argument, but worth checking out in an case.
Monday, August 25, 2008
Upcoming event: Is it time for the U.S. to engage in real pension reform?
The Urban Institute and the Peter G. Peterson Foundation. IS IT TIME FOR THE U.S. TO ENGAGE IN REAL PENSION REFORM? Wednesday, September 10, 2008 8:45-10:30 a.m. ET Despite decades of significant tax subsidies for pensions and retirement accounts, most Americans retire with little or no pension saving. Washington will give out more than $750 billion in tax subsidies for pension plans between 2007 and 2011, and, yet, many low- to middle-income families lack the financial assets needed to afford retirement. The United Kingdom moved boldly this year to reform its private pension system by encouraging significantly greater accumulation of pension assets and protections in old age. A new Urban Institute paper (http://www.urban.org/url.cfm?ID=411676) details a "Super Simple" saving plan that would provide a basic, low-cost, easily administrable scheme that could boost the retirement assets of low- and middle-income individuals. "Super Simple"—the most substantive reform since the Employee Retirement Income Security Act of 1974—resembles the U.K. reform, but puts the changes, such as streamlining today's multiple 401(k)-type plans through a design attractive to employers and employees alike, within a U.S. context. Join the discussion as our panel of experts explores Panelists: To attend, RSVP at http://www.urban.org/events/other2/rsvp.cfm, e-mail paffairs@urban.org, or call (202) 261-5709. At the Urban Institute 2100 M Street N.W., 5th Floor, Washington, D.C. Light breakfast will be provided at 8:30 a.m. The forum begins promptly at 8:45 a.m.
Urban Institute
New paper: Macroeconomic Effects of Pension Reform in Russia
The IMF released a new working paper, "Macroeconomic Effects of Pension Reform in Russia," by David Hauner. Here's the abstract, which would warm the hearts of most U.S. conservatives: Putting the pension system on a sustainable footing arguably remains the biggest challenge in Russia's economic policies. The debate about the policy options was hitherto constrained by the absence of general equilibrium analysis. This paper fills this gap by simulating their macroeconomic effects in a [drink stochastic general equilibrium] model calibrated to Russia's economy—the first of its kind to the best of our knowledge. The results suggest that a minimum benefit level in the public system should optimally be financed through lower government consumption, while higher taxation of labor and capital should be avoided. Reducing public investment spending is superior to increasing consumption taxes unless investment generates high rates of return. The whole paper is available here.
Fact-checking Dean Baker
Dean Baker has an article in the Guardian online this morning. Given that the article is entitled "The truth about Social Security" and accuses Republicans of "scare tactics" on Social Security, one would expect that the article itself would be free of less-than-truthful scare tactics. Not so, it seems. I'll just point out two examples. First, Dean says that For those who have forgotten that nightmare, Bush's plan would have reduced benefits by approximately 1% a year for many workers. Workers who retire 10 years after the plan was put in place would have seen a 10% reduction in benefits compared with the currently projected levels. Workers who retire 20 years after the plan is implemented would see approximately a 20% cut in benefits, and workers who retire 40 years later would see their benefits cut by close to 40%. Well, the truth is that President Bush's plan wouldn't have reduced promised benefits by 1% a year for "many workers." It would have made those reductions only for the very highest earning workers, those who earned at or above the maximum taxable wage every year of their lives. It's very thoughtful of Dean to look out for the interests of the rich, but he also might want to point out that a) all retirees under Bush's plan would have received higher benefits than today's retirees; b) most retirees would see much smaller reductions versus promised benefits than the 1% per year he illustrates; and c) retirees in the bottom 30% of the earnings distribution wouldn't see any reductions at all. That's actually the truth about the Bush plan. Second, Dean likewise warns that these benefit reductions from the very rich would flow into the hands of, well, the very rich. The losses to retired workers could mean big benefits for the financial industry. Under some versions of the plan, the financial industry would rake in hundreds of billions of dollars in fees and commissions over the next 40 years. According to a recent World Bank analysis, the financial industry pocketed 15-20% of the money paid into the privatised social security system in Chile, which has often been held up as a model by privatisers in the US. Dean knows, as would anyone who reads the SSA and CBO analyses of reform plans, that the President's plan and almost all others would use a very different account management structure than was used in Chile. Almost all plans would use an administrative structure modeled after the Federal Thrift Savings plan, which differs greatly from that used in Chile, and in most cases administrative costs would between 15 and 25 basis points (meaning, 0.15% and 0.25% of assets under management). Admin costs of 15 basis points would reduce the final balance by around 3% while admin costs of 25 basis points would reduce it by around 5%. There are plenty of reasons people can honestly oppose personal accounts as part of Social Security – transition costs, market risk, etc. But these are simply deceptive scare tactics. Dean, you can do better than this.
Washington Post: Social Security on Ice
The Washington Post MAYBE IT'S just not possible to have anything approaching a serious discussion about Social Security in the midst of a presidential campaign. Maybe the best that can be achieved is do-no-harm Social Security detente, in which neither candidate so boxes himself in that his choices in office would be even more constrained by politics. That, at least, is where the 2008 candidates seem to be settling. The last few weeks have featured John McCain putting tax increases on and off the table quicker than a newlywed trying out china patterns, while Barack Obama, having proclaimed himself the truth-teller about making tough choices, proceeded to duck them. In February, Mr. McCain seemed to be following in the "no new taxes" footsteps of the first President Bush, who lived to rue that pledge. Asked by ABC's George Stephanopoulos if he was a "read my lips" candidate, Mr. McCain obliged: "No new taxes," he said. Then, back on the same show last month, Mr. McCain sounded different -- and, to our ears, much more responsible -- when asked if he would rule out a payroll tax increase as part of a larger Social Security fix: "There is nothing I would take off the table," he said. Naturally, that got him clobbered by anti-tax conservatives. It didn't take long for Mr. McCain's own spokesman to repudiate Mr. McCain. "There is no imaginable circumstance where John McCain would raise payroll taxes," said spokesman Tucker Bounds. "It's absolutely out of the question." Except that it might not be. "Sen. McCain believes you can solve Social Security without raising taxes, but he also believes you can't start a negotiation with an ultimatum," said spokesman Taylor Griffin. Switch to Mr. Obama, who got some credit from us during the primary campaign for at least acknowledging that dealing with Social Security would entail some difficult choices. Last November, Mr. Obama was saying, on NBC's "Meet the Press" that "we're going to have to make some decisions, and it's not sufficient for us to just finesse the issue because we're worried that, well, we might be attacked for the various options we present." Of course, Mr. Obama was promptly attacked, including by Hillary Clinton, for presenting one option -- an increase in the payroll tax for taxpayers making more than $250,000 a year. Now, Mr. Obama has refined the details of that proposal, and to call his approach finessing would be awfully generous. As laid out in a Wall Street Journal op-ed by economic advisers Jason Furman and Austan Goolsbee, Mr. Obama's tax increase would not take effect until 2018 -- yes, after both terms of an Obama presidency. One argument for this delay is that raising Social Security taxes now would just allow lawmakers to spend more of the existing surplus on other things; it's not until 2018 that the income from payroll taxes would fall short of paying promised benefits. But surely President Obama could find some way to bring in money sooner without letting Congress fritter it away on other needs. Meanwhile, under the revised Obama plan, additional Social Security taxes on the top earners would be between 2 and 4 percent. That's only sensible: Soaking the richest taxpayers with the full tax would push marginal tax rates to dangerously high levels. Meanwhile, the Obama campaign has been deliberately obscure about whether the tax would apply to all income (including investment earnings could raise significantly more revenue) and whether those paying more taxes would receive extra benefits (in which case much less of the shortfall would be filled in). What's clear is that, however the Obama plan is crafted, it would not come close to solving the fundamental problem that Social Security revenue will not be able to pay promised benefits. Even assuming that Mr. Obama would tax all income and would not increase benefits, he would make up one-third of the projected 75-year shortfall. So does Mr. Obama get credit for being brave -- or foolhardy -- enough to put out a tax proposal that is sure to be used against him? Does he get demerits for failing to be more specific, and more honest, about what will be required? Or does it turn out, sadly, that the "textbook Washington campaign" he derided Clinton for running, in which "you don't present tough choices directly to the American people for fear that your answers might not be popular, you might make yourself a target for Republicans in the general election," has something to recommend it after all. A few quick points: First, the final paragraph hits on some serious issues. As good-government types we'd all like a detailed, high-minded discussion of reform options in a presidential campaign, but it's not clear our political system and culture can handle that. Might it be better – not just for the candidates, but for the prospects of reform – for the campaigns to stay quiet? Possibly, and both candidates this year seem to have come to believe that. Second, I discussed a potential Obama plan to apply the 2-4 percent surtax to all incomes, not just earnings, here.
editorializes this morning on the McCain and Obama campaign's strategies with regard to Social Security reform. Their conclusion: despite talk of handling the issue differently, both campaigns are being
Saturday, August 23, 2008
When is a cut not a cut?
The Economic Policy Institute released a short report on the latest CBO Social Security projections, highlighting (as does the CBO report) that even if Social Security were forced to cut benefits when the trust fund became insolvent that real benefit levels would be higher than those paid to today's retirees. (Hat tip to Ramesh at The Corner.) "The fact that future retirees will receive higher benefits than current retirees, even if no changes are made to the program, is common knowledge among Social Security experts, but may come as a surprise to the average American, and even to many policy makers. This may be why the CBO, headed by respected economist Peter Orszag, decided to make that point in the first page of the new report." This is one reason EPI argues that Social Security's shortfalls aren't a particularly big deal. But if we rewind back to when reformers proposed price indexing initial benefits – a step that would restore long-term solvency while paying all future retirees higher benefits than today's – EPI wasn't nearly so keen. "Proposed Social Security price indexing would slash benefits," they said. In that document, EPI never compares benefits under price indexing to current benefit levels, but always to the much higher benefits that Social Security promises to pay. In other words, if Social Security became insolvent but future retirees would still receive higher benefits than today's, that's proof that Social Security isn't really a big problem. But if someone actually proposes fixing solvency in a way that still pays future retirees more than today, well, that would "slash" benefits. The bigger point is that there are two ways you can talk about "benefit cuts." One is whether future beneficiaries would receive less than today's. We can see that even in a worst case – Social Security goes insolvent – that these types of cuts are unlikely. The second type of "cut" is relative to scheduled benefits, or more broadly, cuts in replacement rates (initial benefits as a percent of pre-retirement earnings). In downplaying the Social Security funding shortfall EPI refers to the first kind of cut, but in attacking reforms like price indexing it refers to the second. Update: Paul Krugman's gotten the talking points as well...
Friday, August 22, 2008
EconomistMom on new CBO projections
EconomistMom has a very interesting post on the new CBO Social Security numbers. She focuses on how individuals are treated under Social Security, which I hadn't really commented on yesterday. I included a comment with a technical disagreement regarding how the Bush tax cuts affect Social Security financing (short story: neither the CBO numbers nor the Trustees actually model the Bush tax cuts; CBO assumes more revenues than we'd collect if we extended the Bush tax cuts, the Trustees assume less).
Thursday, August 21, 2008
Would Obama apply Social Security tax to non-wage income?
I've been hearing that the Obama campaign is keeping open the option of applying their proposed surtax on earnings over $250,000 to all income, not just wage and salary income that have until now been the object of Social Security taxes. A few quick thoughts on this: First, this would be a reversal of previous campaign statements. In this story from June 13, "Campaign aides said the additional tax, like the current one, would apply only to wages and salaries and not to other forms of income such as investments." There may be a political price to pay for this, but campaign flip flops aren't unusual. Second, this would increase the size of the tax increase, but also increase the policy's effect on Social Security financing. None of the existing Social Security models (CBO, SSA, etc.) can easily handle non-wage income, so I can only guestimate this on a (very) rough basis. According to the Census, in 2006 there were 2.24 million households with incomes exceeding $250,000 and their average income was $448,687. If you hit the average household with a 4% tax that produces $17,947 in additional revenue, which multiplied by 2.24 million equals around $40.2 billion. That's equal to around 0.69 percent of payroll. If the tax increase were implemented immediately and everything else stayed the same it would fix around 41 percent of the 75-year deficit (1.7 percent of payroll). Now, that's the high end of what it would solve; the Obama campaign has recently said that the tax increase wouldn't be implemented for another decade, plus households' taxable earnings are lower than their total earnings. The delay alone would reduce the improvement to around 38 percent of the 75-year deficit, and the tax base issue would probably pull off another few percent. I'm also assuming that no extra benefits would be paid, although Obama's folks have kept this option open. So my guess is that the plan would fix around 1/3 of the 75-year deficit, tops, assuming no behavioral effects or increase in evasion. So even with the most, uh, liberal application of the surtax it would not be possible to avoid other tax increases, reductions in benefits or increases in the retirement age, as Sen. Obama has promised. Third, this would explain some recent statements on taxes from the Obama campaign that struck me as odd. Consider this statement from Sen. Obama at an event in Springfield, MO on July 30: "Let me be clear: if you're a family making less than $250,000, my plan will not raise your taxes - not your income taxes, not your payroll taxes, not your capital gains taxes, not any of your taxes." Why does this matter? Because payroll taxes are levied on an individual basis, most observers had previously assumed that the Obama surtax would apply only to individuals earning over $250,000. Income taxes, however, are levied on a household basis, and the Census income data cited above is based upon households. The July 30 statement could be a hint that the Obama campaign is thinking about applying their surtax on a family basis. If so, Social Security taxes could be increased in individuals earning as little as $125,000 – only slightly above the current cap of $102,000. This would render some of Sen. Obama's previous discussions of the Social Security tax structure inaccurate (e.g., see the final Democratic primary debate). It might also play into Obama's pledges regarding the capital gains tax rate, though I'll leave that to the tax folks to sort out.
Treatment of uncertainty in new CBO Social Security projections
There is a great deal of uncertainty in projecting Social Security’s finances out over 75 years or more. We know the basic economic and demographic building blocks that determine Social Security’s finances, but we can’t know for sure the value of each over coming decades. In the Social Security Trustees Report, this uncertainty has traditionally been primarily addressed using “high cost” and “low cost” scenarios to complement the best-guess “intermediate cost” projections. For a number of reasons, I think these high/low cost scenarios aren’t particularly helpful. (The recent Technical Panel agreed.)
CBO doesn’t use high/low cost scenarios. Instead, they illustrate uncertainty using a “stochastic” or “Monte Carlo” simulation which assigns probability distributions to each of the main economic or demographic variables and then illustrates the range of outcomes we could expect. (The Trustees also use a stochastic model, but unfortunately it’s not yet the primary descriptor of uncertainty in the Report.)
But even given a model that can calculate the range of possible outcomes, there’s the important question of how you describe this range. You can’t simply do a data dump, you need to find ways that are easily understandable. The new CBO report has a number of very effective ways of portraying uncertainty in Social Security financing. I’ll run through them here.
CBO's Figure 1 shows the 80 percent probability range for Social Security's annual income and costs. The dark lines indicate the median outcomes for each, while the shaded areas denote the range of outcomes. Only 20 percent of outcomes would fall above or below these shaded ranges.
CBO's Figure 3 is similar, except that it focuses on uncertainty in the value of the trust fund ratio (the ratio of the trust fund's balance in a given year to the system's costs in that year). The dark line indicates the median outcome; it hits zero in the year in which the trust fund is projected to become insolvent. The advantage of Figure 3 over Figure 2 is that it also accounts for uncertainty in interest rates, which do not affect annual income and costs. However, many believe that annual cash flows have more substantive importance than the trust fund balance.
Figure 4 is a new chart that I believe is very helpful. It shows the probability that the trust fund will have been exhausted by a given year. Up through the mid-2020s there is almost a zero chance of the fund being exhausted. By the mid-2040s, the likelihood is around 50 percentg. This probability rises until by the 2070s there is only around a 15 percent chance of the trust fund not having been exhausted. One advantage of this chart is that allows an easy comparison of how much a reform plan might improve Social Security's finances. We could say, for instance, that under current law there is a 50 percent chance of the trust fund being exhausted by 2049, but under the reform plan this drops to 25 percent, etc.
Table 3 is also a new addition to the CBO report. It focuses on the probability of the program running deficits of a given size in a given year. For instance, the chart shows that in the year 2050 there is an 87 percent chance that Social Security will be running a cash deficit, a 53 percent chance that the deficit will exceed 1 percent of GDP, and a 16 percent chance it will exceed 2 percent of GDP.
These figures all derive from the same underlying model, but show different ways of describing different aspects of the model's output. I believe the two new figures constitute a significant improvement to how uncertainty is described and should be considered for inclusion in the Socail Security Trustees Report.
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Hubbard: We Can't Tax Our Way Out of the Entitlement Crisis
Columbia University professor Glenn Hubbard has an op-ed in today's Wall Street Journal regarding Sen. Obama's plans for entitlement reform. Here are the highlights with regard to Social Security reform: In their op-ed on this page, Obama economic advisers Jason Furman and Austan Goolsbee noted that taxpayers whose incomes exceeded $250,000 would face an additional Social Security payroll tax increase of four percentage points (in addition to a five-percentage-point increase in the top marginal income tax rate). This new payroll tax plan would affect the top 3% of earners. The new payroll tax hike is more modest than the one Mr. Obama hinted at last fall, which might have uncapped the payroll tax entirely. But it would also do very little to shore up Social Security, since it means that no more than 15% of Social Security's long-term funding gap would be closed. Thus, if Mr. Obama is indeed opposed to reductions in Social Security spending growth, he is necessarily committed to large future payroll-tax or general income-tax increases. This last is a point I've probably overstressed: Obama's proposed tax increase isn't sufficient to honor his promises not to reduce benefits or raise the retirement age, meaning that other even larger tax increases would be needed.
New CBO projections of Social Security financing
The Congressional Budget Office today released new projections of future Social Security financing, similar to those done in the annual Social Security Transferred Report. Also see Peter Orzag's blog on the new report, plus the report's data in Excel format (something which endears CBO to the wonky set). The headline deficit figure – 1.06% of payroll over the next 75 years – is significantly lower than the Trustees 2008 projection of 1.70% of payroll, which was itself a big reduction from the 2007 projection of 1.95%. This post will focus on the source of changes in the CBO projections and as well as how they differ from the Trustees' Report. There are three principal differences in assumptions between the CBO projections and those from the Social Security Trustees: There are other differences in assumptions between CBO and the Trustees, plus CBO's model uses somewhat different methods than the SSA actuaries, but the above three factors account for most of the differences between the two reports. I will have additional posts on other topics, in particular new and helpful ways in which the CBO report presents uncertainty regarding future Social Security financing.
Tuesday, August 19, 2008
WSJ: David Walker interview on “IOUSA”
The Wall Street Journal has an article and interview with former GAO head David Walker regarding the new documentary IOUSA, which follows the Fiscal Wake Up Tour's efforts to raise awareness about the government's long-term fiscal imbalance. Worth reading.
New paper: Distributional Effects of Increasing the Benefit Computation Period
The Social Security Administration has released a new paper by Mark Sarney analyzing how an increase the benefit computation period – the number of years of earnings upon which Social Security retirement benefits are calculated – would affect the progressivity of the program. A number of reform plans have included a provision to increase the benefit computation period from the highest 35 years of earnings to the highest 38 or 40 years, but to date there hasn't been a detailed analysis of how this would affect the distribution of benefits. Here's the abstract: The computation period is the number of highest earning years, currently 35, that are used to compute the career average earnings on which Social Security benefits are based. The brief uses MINT model projections to compare the distributional effects of two policy options discussed by the Social Security Advisory Board; one extends the 35-year computation period 3 years and the second one extends it 5 years. Both would reduce benefits; by 2.5 percent for the 3-year extension and 4 percent for the 5-year extension. About one out of five beneficiaries are not affected, even after full implementation in 2070. Workers with the lowest lifetime average earnings would face the largest proportional benefit reductions because they generally would have more years of zero earnings in their computation period than other workers. Social Security's progressivity would not change substantially. This is the first in a series of papers analyzing the distributional effects of common Social Security reform provisions. Mark Sarney heads the MINT modeling analysis team in the Office of Retirement Policy at SSA (where I spent most of my time) and is a great guy to work with.
New paper: Adjusting Government Policies for Age Inflation
The NBER has released a new working paper by John Shoven of Stanford and Gopi Shah Goda of Harvard entitled Adjusting Government Policies for Age Inflation. Here' the abstract, followed by a link: Government policies that are based on age do not adjust to the fact that a given age is associated with a higher remaining life expectancy and lower mortality risk relative to earlier time periods due to improvements in mortality. We examine four possible methods for adjusting the eligibility ages for Social Security, Medicare, and Individual Retirement Accounts to determine what eligibility ages would be today and in 2050 if adjustments for mortality improvement were taken into account. We find that historical adjustment of eligibility ages for age inflation would have increased ages of eligibility by approximately 0.15 years annually. Failure to adjust for mortality improvement implies the percent of the population eligible to receive full Social Security benefits and Medicare will increase substantially relative to the share eligible under a policy of age adjustment. http://papers.nber.org/papers/W14231 Update: The Wall Street Journal has a story on this paper.
Monday, August 18, 2008
More on Social Security and poverty…
It seems one of my comments from yesterday struck a nerve, both here and over at Arnold Kling's blog. Here's the offending passage: Sen. Obama says, "Social Security has lifted millions of seniors and their families out of poverty. Without it, nearly 50 percent of seniors would live below the poverty line." This is a common talking point, but let's be clear on what it means: if we forced people to pay Social Security taxes all their lives but didn't pay them any benefits, yes, nearly 50 percent of seniors would live below the poverty line. But this is a silly standard. If we were truly "without" Social Security, we would also be without Social Security taxes, which individuals could then save on their own for retirement. So the better question would be, "Without Social Security taxes and benefits, what would the poverty rate among seniors be?" The answer is, about the same as the current rate. I made two points: First, saying that a system that collects an eighth of people's wages all their lives and pays them a benefit at retirement reduces poverty versus an alternate system that collects the same amount of taxes but doesn't pay them a dime at retirement is a silly comparison. This was my main point, but it's also one that you either accept or you don't. To me, it seems so obviously a silly comparison that if you don't understand that I'm not sure what else I can do. Second, I said that in the absence of Social Security the senior poverty rate today would be around the same. This I'm willing to concede is too strongly stated, though it's worth considering the range of issues pro and con (see below). That said, what I'm conceding is that the elderly poverty rate would be higher than the current rate (officially around 9.5 percent), not that "nearly 50 percent of seniors would live below the poverty line." That I believe is simply wrong. In any case, here are some things to think about: Individual saving: Would people most at risk of poverty in retirement save as much in the absence of Social Security? Probably not, which is the strongest reason to believe Social Security reduces poverty (if not by 50 percent…). That said, I'm not convinced that run of the mill low earners (meaning low skilled, versus due to health or social reasons) simply wouldn't or couldn't save. Progressivity: The Social Security benefit formula is progressive, such that low earners get higher replacement rate than higher earners. This will reduce poverty rates versus an un-weighted scheme, though I wouldn't over estimate the effects of progressivity. Redistribution in practice is often quite haphazard; while Social Security likely reduces poverty versus an otherwise identical program with no redistribution, it would be quite easy to design a system with better poverty protections than the current program. Average rates of return from Social Security: Social Security pays a below-market average rate of return today because it paid an above-market rate of return to early participants. In the absence of Social Security, past retirees would have been poorer and current retirees, on average, richer. This would reduce poverty in retirement. Total saving rates: Fuchs, Krueger, and Poterba surveyed public finance economists, asking what the personal saving rate would have been if Social Security had never been enacted. The median response was that the saving rate would have been 60 percent higher. If so, output per worker today would be around 20 percent higher. Presumably this would drag more than a few low earners out of poverty. Labor force participation: Social Security contributions are viewed by many workers as a pure tax, meaning that (accurately or not) they don't expect to receive anything in return for them. This will tend to reduce labor force participation. Moreover, Social Security benefit rules tend to encourage earlier retirement, which would also reduce lifetime earnings. Portfolio allocation: Social Security is in many ways equivalent to mandatory saving in an all-bond portfolio: low risk, but low return. For higher earning individuals this doesn't make much difference since we can alter our non-Social Security savings portfolio to get the mix of risk and return we like (this is one reason why personal accounts wouldn't be a "better deal" for higher earners; if we want more stocks we can already do it). For lower earners, though, Social Security constrains their portfolio to one that is probably lower risk than they'd prefer. Additionally, Arnold Kling makes the point that the reduction in elderly poverty over time is as much attributable to the growth of the economy than to Social Security. Per capita national income today is far higher than it was in the 1930s, so even assuming no Social Security program we should expect to see poverty declining over time.
Sunday, August 17, 2008
Obama on Social Security in Manchester Union Leader
Sen. Barack Obama has an op-ed in today's Manchester Union Leader regarding Social Security reform. It's worth reading the whole thing, posted here, but here I'd like to dissect a few factual claims Obama makes in the piece. First, Sen. Obama says, "Social Security has lifted millions of seniors and their families out of poverty. Without it, nearly 50 percent of seniors would live below the poverty line." This is a common talking point, but let's be clear on what it means: if we forced people to pay Social Security taxes all their lives but didn't pay them any benefits, yes, nearly 50 percent of seniors would live below the poverty line. But this is a silly standard. If we were truly "without" Social Security, we would also be without Social Security taxes, which individuals could then save on their own for retirement. So the better question would be, "Without Social Security taxes and benefits, what would the poverty rate among seniors be?" The answer is, about the same as the current rate. Second, Sen. Obama also says, "The underlying system is sound and the actual problem, a projected cash shortfall over the next 75 years, is relatively small and can be readily solved. For starters, that means strengthening the program over the long-term by returning to basic fiscal responsibility, so we're not borrowing billions from the Social Security Trust Fund." This response doesn't make much sense, for two reasons. First, if the cash shortfall is small and can be readily solved, it shouldn't be difficult for Sen. Obama to propose a plan to fix the whole shortfall, not just the 15 percent of it his tax increase would fix. And second, if borrowing from the Social Security trust fund is a problem, then the problem is over $2 trillion larger than the small and readily solved one he acknowledges. That is, for the Social Security problem to be small and distant, as Sen. Obama claims, we have to assume the trust fund is "real" saving. But if one of the keys to reform is to stop borrowing from the trust funds, which we've been doing for a quarter century, then the problem isn't small and distant: it's large and begins in only around a decade. Third, Sen. Obama says, "The Bush privatization plan that Sen. McCain now embraces would tell 39,000 New Hampshire residents that they're on their own, putting them at risk of falling into poverty and costing each of them more than $235,000 over their lifetimes." Leaving aside whether Bush's plan was privatization and whether McCain embraces it, where is the math that supports the claim that it would cost people $235,000 over – this is the important part – their lifetimes? (Is $235,000 a correct number? I have no idea how it's being calculated, but here I'll focus on the bigger questions.) To balance Social Security going forward, we need to increase taxes or reduce benefits. Different plans may apportion things differently between tax increases or benefit cuts, but the total amount by which we need to raise taxes or cut benefits is the same. If we want Americans not to be hit with a $235,000 benefit cut, then they would need to be hit with a $235,000 tax increase. It appears that Sen. Obama is counting lifetime benefit reductions under President Bush's plan, but not the lifetime tax increases that would be necessary to avoid these benefit cuts. Finally, Sen. Obama says, "It means ensuring Social Security's solvency while protecting middle class families from tax increases or benefit cuts, and without raising the retirement age. What I will do is ask those making over $250,000 a year to contribute a little more as part of a bipartisan plan that would be phased in over many years starting a decade or more from now." Someone needs to show me how Sen. Obama will "ensure" solvency with the plan he outlines, one which fixes only around 15% of the long-term deficit. He can't do it, and it's irresponsible for Sen. Obama to tell Americans that he can. Right now he's only "asking" higher earners to pay more, but if he is truly to ensure solvency he will be asking others for sacrifice as well.
Thursday, August 14, 2008
New Census projections of aging population
Forbes reports on new Census Bureau projections of the U.S. population. A couple things are interesting: the underlying assumptions differ from the Social Security in several respects, such as higher fertility, longer life expectancies, and higher immigration. Yet these differences tends to offset each other, such that the final percentage of the population aged 65 and over is just slightly above that projected by the Social Security Trustees (around 20.2% vs. 19.7% in the year 2050). The Census projections, if applied to Social Security, might imply a slightly larger deficit, but I suspect the difference wouldn't be too great. But this does reinforce my view that the Trustees' underlying assumptions are at least reasonable. 
New poll data on Social Security
Rasmussen Reports released a new public opinion poll on Social Security, asking Americans their views on the current program and how it might be fixed. As always, the phrasing of the questions matters, but I think the poll is interesting in a number of areas. Here are the results: National Survey of 1,000 Likely Voters 1) How confident are you that the Social Security system will pay you all promised retirement benefits during your lifetime? 15% Very confident 2) Should working Americans be allowed to opt out of Social Security and provide for their own retirement planning? 45% Yes 3) Is Social Security a good deal for working Americans today? 46% Yes 4) Currently, people pay Social Security taxes on the first $102,000 workers earn each year. People who make more than that do not pay Social Security taxes on salary and wages above that level. Should Social Security taxes be paid on ALL OR MOST OF THE income workers earn each year? 62% Yes 5) Should people who pay more in Social Security taxes receive more Social Security benefits when they retire? 62% Yes NOTE: Margin of Sampling Error, +/- 3 percentage points with a 95% level of confidence
Conducted August 1, 2008 By Rasmussen Reports
29% Somewhat confident
28% Not very confident
25% Not at all confident
3% Not sure
41% No
13% Not sure
37% No
18% Not sure
25% No
13% Not sure
24% No
14% Not sure
Tax Policy Center Blog on Obama's Empty Social Security Fix
Ouch. I thought I'd been tough on Sen. Obama's Social Security reform plan. But Howard Gleckman, writing for the Tax Policy center's TaxVox blog, really sticks it to him today. The thing about a donut hole is that it is empty. There is nothing. And that, it seems, is what is left of Barack Obama's plan to fix Social Security. The Obama people now tell us that his proposal, which is built on a tax hike for those earning more than $250,000, won't take effect until at least 2018. You heard right: 2018. That would not be in Obama's first term. It would not be in his second term. It would not happen until two years after his successor is elected, even if he serves a full 8 years. It would also, conveniently, be outside the budget window, allowing Obama to scale back the official size of his proposed tax hike for the wealthy. Do the political math. Take the likelihood of any politician keeping any given promise. Discount for the time he says it will take to fulfill that pledge. Then discount it again if the effective date is scheduled for roughly the time of his post-Presidential book tour. The credibility factor is infinitesimally low. It is as if George Bush had promised in 2003 that he'd withdraw from Iraq in 2013. Make no mistake, what Obama is really saying is that, at least for the campaign, he is walking away from Social Security and all of its problems. Click here to read the whole post. I'd noted the reduced improvement to system financing from putting off the tax increase for a few more years, but Gleckman hits on a further political dynamic. But Obama's folks have a viable defense, if they want to make it: most people on both sides agree that the Social Security trust fund hasn't been too effective at actually increasing saving. (Click here to read why.) If so, it doesn't make much sense to increase taxes before 2017, when the system is projected to start running deficits. Otherwise, we'd simply be putting more cookies in the cookie jar for Congress to spend. If Obama made that argument I think most people would find it plausible. The problem is that once you acknowledge the trust fund isn't "real" saving, the Social Security problem looks a lot bigger and a lot closer, and solutions for prefunding move more toward personal accounts. I don't think Obama wants to admit either of those right away.
Arnold Kling blogs on Aging vs Health Care
The always-interesting Arnold Kling at EconLog has a short post drawing attention to my recent AEI paper comparing how population aging and health care cost inflation will contribute to the long-term fiscal gap. (Hint: aging plays a much bigger role than many say.) Here's Arnold's thoughts: From my perspective, the health care cost issue is a bit of a red herring. If you had government out of the health care financing business, you would not worry about what health care costs are doing. If my fellow citizens choose to spend more of their money on their health care, that's not my concern. It's the prospect of my fellow citizens spending more of my money on their health care that has me worried. A good point. There are good reasons to spend more on health care – rising incomes make health care more attractive than other good, and new technologies make new treatments available – but there are also a lot of reasons we shouldn't be spending so much. While I'm not a health care expert, I do believe that if customers saw more of the bill they were paying there would be greater pressure for efficiency in the health care sector.
My birthday wish for Social Security
I have a posting at the Hill newspaper's Congress Blog on Social Security's 73rd anniversary. Short story: my wish for Social Security reform is less wishful thinking from both sides. Once they realize what's really involved in fixing the system, they'll be more likely to reach a compromise. Today is the 73rd anniversary of the Social Security program, which provides retirement, survivors and disability benefits to over 50 million Americans. While there is reason to celebrate the past, we should also focus on the future. The retirement of the baby boomers and aging of the population will put pressure on Social Security's finances. Between today and 2040, the U.S. population will add three seniors over age 65 for each American under age 20. Social Security is already the largest program of the federal government, and over the next 30 years its costs will rise by 50 percent relative to its tax base. Click here to read the rest.
NY Times on Social Security in Campaign ‘08
The New York Times has a story today on how the McCain and Obama campaigns are treating Social Security reform. It's a good story overall and it's great to see some attention paid to the policy details rather than just the politics. However, I think the story's title --"Social Security Too Hot to Touch? Not in 2008" – misses the point a bit. What the story shows is that for both Sen. McCain and Sen. Obama Social Security has been a politically difficult issue to address. McCain has had trouble with his conservative base over his willingness to put everything "on the table" (Obama had the same problem when he made a similar statement) while the vagueness of Obama's own proposal is clearly designed for purposes of political protection. One section is worth highlighting (and not simply because I'm quoted in it): To begin to attack the problem now, Mr. Obama would subject all wages above $250,000 a year to the payroll tax. That concept has been nicknamed the "doughnut hole" because it would exempt wages between $102,000 a year, the current ceiling for contributions, and $250,000. "What Barack Obama is doing is different from what people running for president traditionally have done," Jason Furman, Mr. Obama's chief economic adviser, said in an interview. "He's putting an option on the table, not just saying he wants to work with Congress, but also saying what he wants to work on." While more specific than Mr. McCain's plan, the Obama proposal raises questions. The tax rate Mr. Obama would apply to wages over $250,000 has not been established, but it would be lower than the combined 12.4 percent that employees and employers now jointly pay. "We've studied a range of plans with combined employer and employee rates between 2 and 4 percent," Mr. Furman said. By itself, the Obama proposal will not guarantee the solvency of Social Security. Andrew Biggs, a Social Security expert at the conservative American Enterprise Institute, calculates that the plan would reduce the gap by 15 percent to 43 percent, depending on the level of the surtax, which he complains "is being fuzzed up to prevent people like me from running the numbers." It is also not clear whether those paying the additional payroll tax would receive more benefits, as the system now mandates. Mr. Furman said "it is factually inaccurate to say that a decision has been made to de-link taxes from benefits," because "that is something you'd want to work out with Congress." While Sen. Obama deserves credit for putting an option on the table – something Sen. McCain hasn't done to date – as it currently stands Obama's option is barely a policy. We know people earning over $250,000 will pay more, but we don't know how much and we don't know whether they'd earn any extra benefits. This forces people (like me) to make the best assumptions we can about how things would work. Here I estimated the effects of a 4 percent surtax on earnings over $250,000, on which no extra benefits would be paid. This would improve the 75-year actuarial balance by around 0.27 percent of payroll, reducing the total 1.7 percent deficit by around 15 percent. This is about the most the Obama approach could get. If benefits were not delinked from taxes, the improvements would be smaller (by around one-fifth, I believe). If the tax rate were 2 percent rather than 4 percent, the gains would be cut in half. You get the drift. The point here is that under a reasonable range of assumptions, Sen. Obama's plan doesn't get you very far – certainly not far enough that you could rule out raising the retirement age or reducing benefits. Update: See today's Wall Street Journal op-ed by Jason Furman and Austan Goolsbee for a few more details on the Social Security side of things. One new detail is that the tax increase would not begin until "a decade or more from now." The numbers I cite above assume a 2015 start date, so the solvency improvements would be a tiny bit smaller than before. Another key point: Goolsbee and Furman argue that Obama's plan is similar to one floated by Sen. Lindsey Graham several years ago, which Sen. McCain at the time said he could support. This is a valid point, but several key differences should be pointed out. First, under Graham's plan any tax increases would be used to fund personal retirement accounts, not finance the curent program or build the trust fund. Second, Graham's proposal included a surtax along with a number of other policies. Obama proposes a surtax but rejects any other changes, putting him on the wrong side of the mathematical divide.
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