Monday, March 30, 2009

New article: Full Faith and Overextended Credit

I have an article in AEI's online magazine The American thinking about how the budget deficit might resolve itself over the long-term (or the short-term, if we're not careful).

Who do you think is more reliable—the full faith and credit of the United States backing up Treasury bonds, or the McDonald's Corporation, backed only by "billions and billions served"? By some market measures it is the latter, and for good reason. The price of credit defaults swaps guaranteeing payment on 10-year Treasury bonds has risen by 1000 percent since December 2007, with an implied 12 percent probability of default on government debt over the next decade. In the view of the markets, this makes U.S. government bonds a more risky proposition than debt issued by McDonald's.

Why? Trillion dollar annual short-term budget deficits due to the recession and financial crisis will soon merge with even larger deficits generated by government entitlement programs like Social Security, Medicare, and Medicaid. While a large short-term deficit to stimulate the economy can be absorbed, large deficits running for decades simply cannot be. Over the next decade, the combined costs of the big three entitlement programs will rise by 2.1 percent of gross domestic product; over the following decade, entitlement costs will increase by an additional 3.1 percent of GDP, with costs continuing to grow thereafter.

Click here to read the whole article.


Bruce Webb said...

Hassett seems to be using some apples and oranges here. But it is hard to tell because he doesn't give the key links that would allow us to check his work.

He provides links to CBER, to the 2008 Report, the AEI 2007 event, Blahous's 'compelling case' at that event, and rather oddly to President Bush (I doubt anyone has forgotten who he was). But he doesn't bother to link to either the CBO estimate or the data of the OACT (or OCA is you will). Why I don't know.

Luckily you supplied both the link to the latter and a data excerpt with:
which allows us to see that almost all of the damage was on the DI side. Now although DI was projected to run a small surplus this year under IC projections it was proposed to go into deficit by 2012 anyway
So really we are not seeing a 2017 event moving up to 2009, we are seeing a 2012 one moving up in response to what probably is an early-early retirement movement among disabled workers being displaced from the workforce during a hopefully temporary spike in unemployment. Which in turn makes the following statement not really fully operational.
"Second, many individuals who retire early or go on disability in this crisis may not return to the workforce once the recession ends, so the higher payments are probably with us forever."
People who take early retirement have their benefits reduced in a way that is actuarially neutral, higher outlays from ages 62-66 being offset by lower ones later. Similarly people who take DI are probably reducing their ultimate OAS check at full retirement age, and even if not are not going to be collecting DI 'forever'. That is Trust Fund balances are taking a hit today but with effects that should smooth out over time.

Hassett may or may not understand these operational details but either way the piece is unnecessarily alarmist. In addressing DI it may well be that "the time to act is now" or maybe even a few years back when it fell out of Short Term Actuarial Balance. But since a fix for DI can really only come in the two forms of tightening eligibility (when approval times are already scandalous) or raising that portion of FICA dedicated to DI I can see why fixing what is actually broken not being attractive to the tax-averse people at AEI.

From where I sit this just seems to be another move to use an acknowledged crisis (Medicare and now DI) to sell a fix to OAS that may not ever be needed.

Plus Hassett in mentioning the 5.8% boost from COLA last year and claiming "that adjustment jacks up benefits payments permanently" doesn't mention that a prolonged period of flat to declining inflation numbers reduces those same payments permanently compared to projections. This brief paragraph should probably have been left out altogether.

(BTW something that could well have applied to Hassett's hook about the mother in the freezer. It is not surprising that there is little in the news in the week prior to the release of the Report (if it comes out on time). Because one nice thing you can say about the professional staff at SSA is that they aren't much for leaking advance numbers to the press, generally the first hint I get is when the links I set up on my blog go live.)

Andrew G. Biggs said...

A spike in DI applicants due to a recession hits both DI and OASI. DI today, for obvious reasons, but OASI in the future because DI beneficiaries transferring to OASI at the full retirement age don't have their benefits reduced for early claiming. The aggregate effect obviously depends on how many extra DI applicants we get this year, but it doesn't all come out in the wash.

John Bailey said...

According to the CBO projection, the public debt will increase around $5 trillion over the next 2-3 years.

What I would like to see is for someone to offer a theory as to where that money will come from.

That would allow us to assess the consequences of whatever that mechanism is.

Jim Glass said...

I like the line "The US will become a pension plan with an army".

It's good enough to steal! But I'll change it to "A retiree health benefit and pension plan with an army", to avoid copyright problems.

Though whether we'll still be able to afford the army ... ?

WilliamLarsen said...

High deficits in the future make it difficult to pay social security benefits
Social Security by law cannot borrow money. It has statutory authority to spend only those funds received from the dedicated social security tax on wages, tax on benefits and funds in the trust fund. Federal Law prohibits transferring general revenues to any trust fund.[4]

By law the trust fund cannot be drawn down to zero. The trustees must submit a report promptly to congress detailing benefit cuts or tax increases when in any given year the trust fund is projected to fall below 20% of that given years expenses. Social Security's ability to pay future promised benefits is dependent solely on the ability to raise social security taxes.[5]

For over twenty years the Social Security Trustees have projected and reported the trust fund to be exhausted anywhere between 2019 and 2042 which is decades before its original projection of 2060. Where is their report detailing benefit cuts and/or tax increases to rectify the inadequacy?

[4] United States Code Title 42, Chapter7, Subchapter VII, Sec. 911 (a),
[5] United States Code Title 42, Chapter7, Subchapter VII, Sec. 910 (a),

Let us think about current law and the implications of SS-OASI and Medicare. It is clear that SS-OASI is limited in spending and if nothing is done, across the board cuts take place. This means that it can never exceed the burden it is today. For Medicare, it too has statutory limits. Medicare is funded by a formula. This formula curtails spending or another way to look at it curtails taxes. Medicare is funded 50% by payroll tax (2.9%), beneficiaries (1.45%) and by federal general revenues (1.45%). By law it cannot exceed the revenues from payroll, which is limited to 2.9%. Therefore, the maximum spending allowed for Medicare is 5.8% of payroll. There cannot be unlimited growth in either Social Security nor Medicare because Congress legislated in 1984 maximum limits on spending.

Jim Glass said...

There cannot be unlimited growth in either Social Security nor Medicare because Congress legislated in 1984 maximum limits on spending.

Of course that law superceded the law in place the prior year, and the next law will supercede that law, and then the law after that...

Are really saying that you fully expect Medicare benefits to be slashed in 2019 when the Medicare trust fund bonds run out?