Sunday, February 1, 2009

David Langer must have compromising pictures of the N.Y. Times letters editor

The New York Times today published the latest of many letters from David Langer, an actuary based in New York who's made a business of sorts as a gadfly critiquing the Social Security Trustees projections of future insolvency. I really don't know how he gets so many letters published there.

To the Editor:

Your editorial portrays the "grim reality" facing retirees: an uncertain financial market, inadequate savings and employer contributions, shift of all risks to workers (investment, longevity) and so on. And the solutions are unsatisfactorily focused on patching up existing arrangements.

Fortunately, a superb answer is available: Simply expand Social Security to provide a benefit to replace 70 percent of average pay rather than the current 41 percent.

Consider: It's already set up as a national plan, does not depend on anyone's investment acumen, avoids financial chicanery, has expenses that are ridiculously low, provides longevity and cost-of-living guarantees, and has built-in job portability.

And the increase in cost may be surprisingly small; it will be offset by many factors, including raising the taxable wage base, use of a large part of the current $2.4 trillion surplus, and folding in the assets of existing plans by a reasonable trade-off. Definitely worth thinking about.

David Langer
New York, Jan. 27, 2009

The writer is a consulting actuary.

Ok, let's do a little back of the envelope math. The best projections of the Social Security actuaries are that to make Social Security permanently solvent would require an immediate and permanent tax increase of 3.2 percentage points – that is, an 26 percent increase in the 12.4 percent payroll tax – or an equivalent cut in benefits of around 21 percent. So, while Social Security current promises a replacement rate of 41 percent of pre-retirement earnings to an individual retiring at the full retirement age, with the taxes and resources we currently have it can actually afford to pay a replacement rate of around 32.3 percent. Langer proposes that Social Security instead pay a replacement rate of 70 percent – 2.17 times the current affordable rate. This would require that we roughly double the current payroll tax rate. Now eliminating the current $106,800 payroll tax ceiling could reduce this cost increase by around 15 percent, folding in private pension assets of around $900 billion might cut it by a percent or two, etc. But the main point is that Langer is proposing an effective doubling in size of the federal government's largest program, which is already significantly underfunded, in an environment of large present and projected deficits in the rest of the budget. People need to get a grip that we face a budget constraint and start thinking of ways to tackle it.


Jim Glass said...

Perhaps a tad ironically, the The NY Times itself is getting a taste of the cost of entitlements to come. At a time when its business is shriveling, its bonds have been reduced to junk status, and it has just had to borrow $250 billion form Mexican billionaire Carlos Slim, its pension fund is underfunded by $625 billion.

Joe the non-actuary said...

Our "budget constraint" is what we are willing to pay in taxes. The idea that we cannot afford more than what we pay today is not based on logic but preference.

You are unwilling to pay higher payroll taxes for ideological reasons and so you see it as a hard constraint today. In Europe they already pay twice what we pay fro more generous benefits.

These are choices that a self-governing society can and must make. But it's not like we are coming up against some immutable law of physics.

Andrew G. Biggs said...

True, but there's no reason why Social Security costs shouldn't be seen in the context of what Americans have traditionally been willing to pay for government. Over the past 50 years government has taken up around 20 percent of GDP, through periods run by Democrats and periods run by Republicans. To argue, as Langer does, for adding another 4 or 5 percent of GDP to the bill isn't mathematically wrong, but it's surely improbably.

Moreover, this also has to be seen within the context of the rest of the budget. Medicare is sure to increase significantly in size in coming years, as is Medicaid. Should we add increased Social Security costs as well?

Finally, there's a general rule in public finance that the 'deadweight loss' of a tax - effectively, the waste caused by the disincentives involved with taxation -- rise with the square of the tax rate. This implies that the economic distortions of taxing 30 percent of GDP will be a lot higher than taxing 20 percent. We're very unlikely to be able to foot that kind of bill with our current progressive tax code. To pay European levels of benefits we'd need a European type of tax system, which is generally less progressive than ours (by relying on higher payroll taxes and higher sales taxes).