Wednesday, October 28, 2009

Fall newsletter from Michigan RRC

The University of Michigan's Retirement Research Center has released its fall newsletter. Here are links to the main stories – check 'em out, wonks (and others).

Top of Form

Director's Corner
The August Retirement Research Consortium (RRC) conference at the National Press Club was well-attended and provided a stimulating exchange of ideas on retirement benefits, disability, Medicare, and health insurance in general...

2009 RRC Conference
The Retirement Research Consortium (RRC) held its 11th annual conference August 10-11, 2009, focusing on "Issues for Retirement Security" at the National Press Club in Washington, DC...

RRC Conference Photo Gallery
Photos of the August RRC conference presenters and attendees...

How Older Americans Are Faring in the Recession
Older Americans have weathered the financial crisis relatively well, although many now expect to work longer than they did just a year ago...

Using Matched Survey and Administrative Data
The July 2009 Social Security Bulletin includes an article titled "Measurement Issues Associated with Using Survey Data Matched with Administrative Data from the Social Security Administration"...

IRS Site Helps Employers Manage Retirement Plan Options
The Internal Revenue Service has launched a site to help employers navigate through tax-favored retirement plan options...

Did You Know?
SSA paid benefits to about 55.8 million people in 2008...

2009 Working Papers Available
The 2009 MRRC Working Papers are now available on our website with Key Findings...

Social Security Holds Compassionate Allowances Hearing on Early-Onset Alzheimer's Disease
On Wednesday, July 29, 2009, Michael J. Astrue, Commissioner of Social Security, hosted the agency's fourth public hearing on Compassionate Allowances...

AARP Offers 'Doughnut Hole' Calculator
Each year, an estimated three million-plus older Americans fall into the "doughnut hole" -- a coverage gap in Medicare's prescription drug program...

MRRC's New Awards
The University of Michigan Retirement Research Center is pleased to announce its research awards for 2009-2010..

Bottom of Form

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Bad signs on entitlements

Over at AEI's Enterprise Blog

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Why is there so much waste in health care?

My short answer: too many incentives point in that direction. My longer answer is over at the Washington Examiner.

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Thursday, October 22, 2009

New paper: “Obama’s $250 Bonus Turns Social Security into Welfare”

The Heritage Foundation has released a new paper by Senior Fellow David John titled "Obama's $250 Bonus Turns Social Security into Welfare." Here's a taste:

Since Social Security recipients will get no cost-of-living adjustment (COLA) next year, President Obama wants to give each of them $250, a move supported in principle by the Republican House and Senate leadership. However, this move is not only unjustified; it makes a fundamental change to Social Security's structure and starts the process of converting the program from an earned benefit funded by a worker's own contributions to a welfare program.

While there will be no Social Security COLA, benefits will not decrease, despite the fact that the cost of living has gone down, thus increasing the amount that recipients can buy with their existing benefits. And the benefit would mean even larger spending in a year with record deficits. This new $250 payment would follow the earlier $250 payment that each Social Security recipient was paid through the stimulus package this year.

Check out the whole paper here.

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Savings and Retirement Forum Featuring Mark Warshawsky

On Monday, October 26th, 2009 the Savings and Retirement Forum will be held at The Brookings Institute: 1775 Massachusetts Ave, NW, Washington, DC 20036, at 8:30am. Mark J. Warshawsky, Ph.D., Director of Retirement Research Watson Wyatt Worldwide will be discussing "TDF Assett Allocations Risk vs Reward Tradeoffs"

The purpose of the Forum is to bring together academics, interested industry professionals, policy wonks, and government staffers who work on issues related to Social Security, pensions, savings, and general retirement issues for a monthly seminar and an annual half-day conference. Our website,   contains the dates of future meetings, links to relevant papers, and a few miscellaneous links that people doing research on these issues may find useful.

If you plan on coming please RSVP. Coffee, juice, and pastries will be served.

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NASI event: Fixing Social Security: Adequate Benefits, Adequate Financing

Security will be the next big issue in the political forefront. Be ready for the debate. This event will bring you up to speed with policy options from NASI's new report addressing adequacy and solvency of the U.S. Social Security system as well as poll findings on Americans' views on Social Security from the Benenson Strategy Group.

Copies of the reports will be available at the event.

Friday, October 30, 2009, 9:30 – 11:00 am

H-137 Capitol Building, E Capitol St, NE & 1st St, NE, Washington, DC

(Use the Independence Avenue Entrance)

Coffee and Snacks Provided


  • Janice M. Gregory, National Academy of Social Insurance
  • Kenneth Apfel, Former Commissioner of the Social Security Administration
  • Danny Franklin, Benenson Strategy Group
  • Virginia Reno, National Academy of Social Insurance

For more information and to register, please visit the event page on our website.

Register Now

National Academy of Social Insurance
1776 Massachusetts Avenue, NW • Suite 615 • Washington, DC 20036
Phone: (202) 452-8097 • Fax: (202) 452-8111

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Watch the Fiscal Wake-Up Tour Online

Concerned About America's Fiscal Future?
Watch a Live Webcast of the Fiscal Wake-Up Tour

The Fiscal Wake-Up Tour

The Fiscal Wake-Up Tour is rolling into Denver tomorrow, October 22, and you are welcome to watch as national experts discuss how the country can plan for a better economic future in the face of skyrocketing federal debt, an aging population and rapidly rising health care costs. The Wake-Up Tour, which is making its second stop in Denver, has been profiled in "60 Minutes" and the highly acclaimed documentary I.O.U.S.A.. David Walker, President and CEO of the Peter G. Peterson Foundation and the former U.S. Comptroller General, and Robert Bixby, executive director of the Concord Coalition are set to speak — view other speakers and the agenda here.

Thursday, October 22, 2009

7:00 p.m. - 9:00 p.m. MDT (9:00 p.m. - 11:00 p.m. EDT)

To join the live webcast tomorrow, visit


Paying for America - A Student Summit on the Fiscal Health of America

Also featured in the live webcast is "Paying for America," a student summit presented by the University of Denver and The Concord Coalition as part of Concord's Fiscal Stewardship Project. The summit will give college students an opportunity to learn more about our nation's fiscal and economic difficulties. There will be panel discussions on the causes of these problems, how they could affect the students for the rest of their lives, and potential solutions.

Thursday, October 22, 2009

9:00 a.m. - 4:30 p.m. MDT (11:00 a.m. - 6:30 p.m. EDT)

To join the live webcast tomorrow, visit

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Tuesday, October 20, 2009

More on the “new Social Security notch”

I've been meaning to flesh out what I wrote last week in Forbes regarding a new "Social Security notch," in which individuals who turned 62 in 2009 are disadvantaged because – while they did not receive the over-large 5.8 percent COLA paid in January of this year – they will be subject to the "no COLA" years in 2010 and 2011. (See this new AEI paper for details on the COLA.)

This seems to be a good time to discuss it more, since SSA's Chief Actuary Steve Goss has circulated a memo on the Hill (available here) discussing the notch issue. (Steve's been very helpful to me in understanding a really tricky issue.) Since the memo is short I'll paste in the text and then give a quick response.

Social Security Benefits for Those Born in 1947

October 14, 2009

Andrew Biggs recently noted (Forbes Commentary, October 9, 2009) that retired workers who were born in 1947, and will reach age 62 in 2009, did not receive the 5.8 percent cost of living adjustment (COLA) awarded to Social Security beneficiaries eligible in December 2008. This is true. However, the workers born in 1947 did receive a 4.54 percent increase in their benefits through the wage-indexed benefit formula. And this increase will not be applied for retirees born before 1947. Therefore, the difference of about 1.2 percent is the amount by which benefits will be lower for life for a worker 62 in 2009, compared to a similar worker reaching 62 in 2008.

Is this a "notch", and is it unusual? Unfortunately, consumer prices and the average wage level do not rise smoothly over time. The increase in the CPI that caused the 5.8-percent COLA for December 2008 just happened to be bigger than the 4.54-percent increase in the average wage that retired workers age 62 in 2009 will receive instead of the COLA. So yes, this is a small "notch". Is this unusual? Actually, the COLA received by existing beneficiaries has been larger than the average wage increase applied for newly-eligible beneficiaries in 9 of the 30 prior years. And in 5 of these years the difference was greater than it is for 2009. So the 1.2-percent difference between benefits for those age 62 in 2008 and those age 62 in 2009 is neither very large nor very unusual.

Steve Goss, Chief Actuary

Social Security Administration

The first thing to remember is that I didn't argue that a notch existed because individuals in the 1947 cohort would receive lower dollar benefits than individuals in the 1946 cohort (although they may). I argued that unusual changes in prices over the course of 2008, interacting with the benefit formula, mean that individuals aged 61 in 2008 will receive lower benefits than they otherwise would have.

However, comparing two cohorts may nevertheless be useful so long as we bear in mind how Social Security intends benefits to change between cohorts. Social Security is a wage-indexed program, meaning that initial benefits rise from cohort-to-cohort along with average wages. This maintains a roughly constant replacement rate – the ratio of initial benefits to average pre-retirement earnings. (Social Security calculates pre-retirement earnings as the wage-indexed average of the highest 35 earning years.) As a result, we'd expect the 1947 cohort to receive higher benefits than the 1946 cohort, assuming they had higher average lifetime earnings. The fact that benefits are lower is notable.

Typically the replacement rate for a medium wage earner is around 40 percent; since the retirement age isn't currently increasing, let's assume the replacement rate would ordinarily be 40 percent for both the 1946 and 1947 birth cohorts. To make things simpler still, let's think of the numerator and the denominator of the replacement rate separately; in other words, imagine as if a person received a benefit of $40 (say, per day) and had pre-retirement earnings of $100 (again, per day).

OACT's memo points out that a typical person in the 1947 birth cohort received benefits 1.2 percent lower than a similar person in the 1946 birth cohort. So, using our simplified formula, that $40 daily benefit falls to $39.52. The memo also notes average wage growth of 4.54 percent in 2007, the year the 1947 birth cohort turned 60. This, in turn, increases the wage-indexed average of lifetime earnings by around 4.54 percent, since the Social Security benefit formula indexes past earnings to wage growth through age 60. So that $100 daily pre-retirement earnings for the 1946 birth cohort increases to around $104.54 for the 1947 cohort. Divide it out and you get a replacement rate of 37.8 percent.

Now calculate the percentage differences in replacement rates: 1 – 37.8%/40% = 5.5%. In dollar terms, benefits for the 1947 cohort are around 5.5 percent lower than needed to maintain the same replacement rate received by the 1946 cohort. This was the point I attempted to make in the Forbes article.

Now, there are many possible "notches" that can be created by the benefit formula and there are other things going on that might reduce the cut for the 1947 cohort a little. I'll get into them as I write on this more.

Read more!

Monday, October 19, 2009

Would the Baucus health plan “raid” Social Security?

I say yes, over at National Review Online.

Baucus Plan Would Raid Social Security   


The health legislation sponsored by Senate Finance Committee chairman Max Baucus (D., Mont.) received an apparent boost when the Congressional Budget Office stated it would reduce the budget deficit by $81 billion over the next ten years. Obama administration budget director Peter Orszag crowed that the CBO scoring "demonstrates that we can expand coverage and improve quality while being fiscally responsible."

But the CBO analysis actually leads to a very different conclusion: that in a classic "raid" on Social Security, Baucus's ostensible fiscal responsibility depends on raising Social Security taxes today to paper over new health spending, ignoring that those increased Social Security taxes imply higher benefit costs down the road. This marks yet another gimmick in a health-reform debate defined by contrivances.

Orszag recently outlined the Obama administration's standards for health-care financing, saying that "health care reform must be deficit neutral over the next decade (as well as being deficit neutral in the tenth year alone)." Balancing revenues and costs over the next ten years purportedly addresses short-term deficit concerns, while balancing in the tenth year signals that a plan won't generate longer-term shortfalls. President Obama says he will not sign legislation that fails these tests.

Unlike other congressional proposals, the Baucus legislation appears to meet Obama's criteria. Baucus's plan purportedly would improve the budget balance by $81 billion from 2010 through 2019, and in 2019 itself would cut the deficit by $12 billion. It's no surprise the media treats Baucus's plan as if it belongs to Obama himself.

But the devil is in the details of the CBO memo. CBO breaks down the Baucus plan's budgetary effects into those occurring "on budget" (where the substantive policy changes are) and those "off budget" (meaning through the Social Security program). The Baucus plan's on-budget provisions would reduce the ten-year budget deficit by a tiny $1 billion and in 2019 would increase borrowing by $6 billion. In the real world, where entitlement costs rise faster than projected and Congress fails to implement promised cuts to Medicare spending, the Baucus plan will doubtless generate significant deficits.

Meanwhile, the Baucus plan's fiscal skullduggery takes place off-budget. Social Security revenues would increase by $80 billion over ten years, with an $18 billon increase in 2019 alone. Around 3 million individuals would leave employer-sponsored health coverage — which is exempt from taxes — to purchase insurance through a subsidized "exchange." Leaving employer-sponsored coverage would raise workers' taxable wages and thereby boost Social Security revenues. Millions more would trade a portion of their insurance benefits for higher wages to avoid a new tax on high-cost policies. By skimming the new Social Security taxes, the Baucus plan appears to significantly cut the deficit when, in truth, it balances only by the skin of its teeth.

This is perhaps the clearest example of "raiding the trust fund" on record. Democrats and Republicans have long believed that Social Security surpluses encourage the rest of the budget to run larger deficits, as borrowing from Social Security does not increase the measured budget deficit or the publicly-held national debt. But it's difficult to tell whether any particular legislation comprises a "raid," since the legislation might be passed even in the absence of Social Security surpluses.

In the case of the Baucus proposal, however, it is incontrovertible. The plan does not simply rely on existing Social Security surpluses but creates new ones to offset higher spending on health coverage. Without new Social Security revenues the plan would not balance and, if the president is to be believed, would face a presidential veto. It's that simple: no new Social Security taxes, no new spending.

A health debate that began with earnest claims that we could "bend the cost curve" to cut costs while increasing quality has devolved to a farce in which vastly increased government spending is papered over with implausible spending cuts and dubious bookkeeping.

— Andrew G. Biggs is a resident scholar at the American Enterprise Institute and former principal deputy commissioner of the Social Security Administration.


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John Berry on Social Security Politics

John M. Berry comments for Reuters on the politics of the Social Security COLA:

The White House's knee-jerk reaction to the news that inflation was so low that Social Security beneficiaries won't get a cost-of-living increase next year was a seriously bad omen for long-term control of federal spending.

The problem wasn't the $13 billion cost of another one-time $250 payment to each retiree proposed by President Barack Obama. No, it was the utter disregard of the discipline inherent in indexing payments to changes in consumer prices.

Click here to read the whole article – it's a good history of the policy and politics of COLAs.

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How different is inflation for seniors versus working age Americans?

Over at AEI's The American online magazine.

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Sunday, October 18, 2009

Now I know why I don’t watch CBS News…

For what little it's worth, here's how CBS News reported on the COLA controversy.

What's striking is that in a two-and-a-half minute segment – which is in-depth journalism by today's standards – CBS interviewed precisely no one who opposed paying an ad hoc COLA this year, despite ample reason to believe it's unjustified (when both the Wall Street Journal and the Washington Post editorialize against it, you can be pretty sure something's gone wrong).

Come on, people – at least pretend to get both sides of the story.

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Do seniors deserve higher Social Security benefits?

Peter Grier of the Christian Science Monitor weighs in.

US seniors will be able to buy more with their Social Security checks this year, even though they won't be getting extra cash via a cost of living adjustment (COLA), according to some analysts.

That is because the price of goods and services in America has fallen significantly since the period on which the last Social Security benefit increase was based. In addition, for most Social Security recipients, Medicare Part B premiums – which are deducted from their government checks – will be frozen.

The bottom line? The purchasing power of a typical retiree will jump by about $725 next year, according to Andrew Biggs, a former deputy commissioner of Social Security.

That calls into question the necessity of Congress voting seniors a one-time $250 payment, as President Obama has proposed, writes Mr. Biggs, now a scholar at the American Enterprise Institute, in a new analysis.

"An ad hoc COLA payment is unnecessary and could lead to larger costs down the road," writes Biggs.

Check out the whole article.

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Saturday, October 17, 2009

Social Security benefits haven’t risen in generations. Really?

A friend brings to my attention an otherwise-interesting post by Kevin Drum discussing the recent Social Security COLA imbroglio. Drum makes the interesting point that annual COLAs give the impression of rising benefits even when the real buying power of benefits stays the same. (Economists call this "money illusion" and it's the source of a number of problems.)

But Drum takes things a bit far. He says that

Technical arguments about CPI calculations aside, the fact is that seniors haven't gotten a benefit increase for decades. It's just not the way the program works. But the fact that their checks keep going up makes it seem like they have.

Now, it's true that for current beneficiaries benefits haven't gone up, unless one pays attention to technical arguments regarding whether the current CPI overstates the rate of inflation. (Of course, if you do pay attention to those technical arguments, then – at least according to Northwester economist professor Robert Gordon – it's possible the that real value of benefits has been rising by 1 percent or more above the rate of inflation.)

But that ignores another point: the real value of benefits for new retirees has been rising consistently. That is, a new retiree this year doesn't get the same benefits as a new retiree last year; rather, he or she receives higher benefits. (Or at least they should; if I'm right about the new Social Security "notch" then they actually get lower benefits, but that's another story…). The chart below shows the real benefit level for new, medium wage retirees in years from 1998 through 2018.

As you can see, benefits increase pretty significantly: a new retiree in 2018 receive benefits around 29 percent higher in real terms than a new retiree in 1998. A prominent reform proposal "price indexing" would arrest this increase: rather than having benefits rise with wages from cohort to cohort, they would rise only with inflation. In effect, price indexing would be an inflation-adjusted freeze on future benefit growth. While this has been proposed, however, it's definitely not what we've seen over the past several decades.

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Friday, October 16, 2009

In Semi-Semi-Defense of Obama’s Social Security Pandering

I discuss Matt Yglesias's semi-defense of President Obama's COLA plan over at AEI's Enterprise Blog.

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Republican proposes alternative $250 COLA payment

A friend informs me that Rep. Ginny Brown-Waite (R-FL) has proposed legislation to make a $250 lump sum payment to all Social Security beneficiaries and veterans, with the payments funded out of unused funds from this year's stimulus legislation. The bill is cosponsored by Reps. Patrick Tiberi (R-OH) and Dave Reichert (R-WA).

My usual objections apply: seniors haven't been disadvantaged by not receiving a COLA; seniors haven't been the hardest hit by the recession; and lump sum payments to retirees probably aren't the best way to stimulate the economy. That said, assuming the legislation is funded out of existing stimulus funds, the lump sum payments are probably better than more cash for clunkers, bike paths and museums of organized crime. For what that's worth.

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Thursday, October 15, 2009

Obama Nominates Blahous as Social Security Trustee

In one of his best moves to date, President Obama nominated Chuck Blahous to be one of Social Security's public trustees. Here's the announcement:


Office of the Press Secretary
For Immediate Release October 14, 2009

President Obama Announces Intent to Nominate
Charles Blahous as Member of the Board of Trustees
of the Social Security Trust Funds

WASHINGTON – Today, President Barack Obama announced his intent to nominate Charles Blahous as Member of The Board of Trustees of the Social Security Trust Funds.

President Obama announced his intent to nominate the following individual today:

Charles Blahous, Nominee for Member, Board of Trustees of the Social Security Trust Funds

Chuck Blahous is a Senior Fellow at the Hudson Institute, specializing in domestic economic policy. Prior to joining the Hudson Institute, Blahous served as Deputy Director of President Bush's National Economic Council. From 2001-2007, Blahous served as a Special Assistant to the President for Economic Policy, first covering retirement security issues and later also encompassing energy policy. In 2001, Blahous served as the Executive Director of the bipartisan President's Commission to Strengthen Social Security, co-chaired by Dick Parsons and the late U.S. Senator Daniel P. Moynihan (D-NY), which submitted a unanimous report to President Bush in December, 2001. From 2000-01, Blahous led the Alliance for Worker Retirement Security. From 1996-2000, he served as Policy Director for U.S. Senator Judd Gregg (R-NH), staffing the Senator's co-chairmanship of the National Commission on Retirement Policy, as well as the Senator's initiatives in retirement and health care reform. From 1989-96, Blahous served in the office of Senator Alan Simpson (R-WY), first as a Congressional Science Fellow sponsored by the American Physical Society, and in 1994-96 as the Senator's Legislative Director. There, Blahous staffed the Senator on the bipartisan Commission on Entitlement and Tax Reform. Blahous has a Ph.D. in computational quantum chemistry from the University of California/Berkeley, and an A.B. from Princeton University, where he won the McKay Prize in Physical Chemistry.

One small comment: As much as White House officials are often accused of controlling the Social Security Trustees process, this may be the first time that Chuck – perhaps the longest serving economic policy staffer in the Bush White House – will attend a Trustees meeting or truly get involved in the process. It's a very interesting and important process, though, and one which Chuck is suited for and will enjoy.

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It’s official: No COLA (justified) next year, but you’ll probably get one anyway…

The Social Security Administration today officially announced what had long been suspected: that no Cost of Living Adjustment to retirement, disability and survivors benefits will be paid next year. As has been discussed here ad nauseum, the Consumer Price Index dropped rapidly after the last COLA was calculated in October of 2008, so overall prices today are still below that level. Instead of paying a negative COLA, Social Security simply will pay no COLAs until prices rise to match the level as of the fall of last year. Sounds fair to me, but apparently not to others.

Some links and thoughts:

  • Here's SSA's fact sheet with details of the COLA and other benefit amounts that may or may not change based on the lack of a COLA.
  • But don't worry, seniors, it seems that President Obama has endorsed proposals to give all seniors a $250 ad hoc payment this year. Wisely, the Obama administration stuck to a theme of helping those in need and stimulating the economy rather than trying to make a substantive inflation-based case for the payment. (That said, seniors are hardly the most in need in the current recession and it's not clear how well these payments work as stimulus. I didn't say it was a good argument, just better than the alternative.)
  • The payments would cost around $13 billion; no talk of finding ways to actually pay for this, but when you're already $1.4 trillion in the hole I guess they figure there's not much point in being coy.
  • The Obama policy is less bad than the Republican alternatives from Reps. Walter Jones (NC) and Rodney Alexander (LA). These would have given all beneficiaries a 3 percent increase (2.9 percent in Alexander's proposal; got to be fiscally responsible these days…) but then build future COLAs on top so that benefits would always be 3 percent higher. My guestimate is that these plans could cost close to $200 billion over the long run, so I guess we dodge a bullet on that one.
  • Interestingly, the SSA itself has endorsed the administration's proposal. It's a little out of the ordinary for the agency to get involved in these things, but since it's probably going to happen anyway probably no harm in jumping on the bandwagon.
Read more!

Wednesday, October 14, 2009

New paper: “Case For a Social Security Cost-Of-Living Adjustment in 2010 Is Weak”

From the Department of Strange Bedfellows, the Center on Budget and Policy Priorities today released an issue brief titled "Case For a Social Security Cost-Of-Living Adjustment in 2010 Is Weak" that examines argument for paying an ad hoc COLA next year.

Under current law, there will be no cost-of-living adjustment (COLA) in Social Security in 2010 — the first time that has happened since automatic cost-of-living adjustments began in 1975. Several bills before Congress would grant a special increase in Social Security payments for 2010.

The inflation data, however, do not support an increase: overall consumer prices have fallen significantly in the past year and are not expected to return to their earlier peak until mid-2011. In addition, when no Social Security COLA is provided, Medicare Part B premiums — which are deducted from Social Security checks — are frozen for most beneficiaries so that the Social Security checks do not drop (see the box on page 5).

If policymakers nevertheless choose to act, they should grant a flat, one-time payment as an economic stimulus measure rather than an across-the-board percentage increase that undermines the mechanics and purpose of Social Security's indexing provisions

Couldn't have said it better myself. It's a very well presented paper.

My own AEI paper on the COLA came to very similar conclusions.


Read more!

Tuesday, October 13, 2009

New paper: “A diet COLA for Social Security? Not really.”

Heading into SSA's expected announcement on Thursday of the 2010 Cost of Living Adjustment, I have a new paper in AEI's Retirement Policy Outlook series titled "A diet COLA for Social Security? Not really" that examines whether current beneficiaries are truly being hurt by not receiving COLAs over the next several years. The answer, in my view, is pretty clearly no. The 2009 COLA paid in January of this year inadvertently increased the real purchasing power of Social Security benefits by around 5 percent. As a result, Social Security will not pay COLAs until prices rise by around 5 percent, bringing the real value of benefits back to their intended level. In the meantime, however, real benefit levels will be above last year's, increasing the typical senior's buying power by around $1,000 before COLAs resume.

I've inserted a chart below showing the CPI-W over the last year or so. In mid-2008 there was a rapid increase in prices, such that a 5.8 percent COLA was granted in October of 2008. By the time the COLA began being paid in January of 2009, however, prices had dropped back below their 2008 levels. Once the CPI rises back to it's level at the 3rd quarter of 2008 – a value of around 216 – COLAs will again start being paid.

While current retirees aren't being hurt, as I argued here, new beneficiaries – principally people aged 62 today, but also including new applicants for disability and survivors benefits – will be hurt, as they will be penalized by not receiving COLAs over the next two years but didn't receive the large 5.8 percent 2009 COLA. These folks deserve some help.

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Sunday, October 11, 2009

The real problem with public employee pensions

Cross-posted from The Enterprise blog.

The Washington Post
reports today on the sorry state of funding in state and local employee pensions, focusing on the impact of recent poor stock returns. While a poor investment climate certainly hasn't helped, it's not the biggest reason public employee funds are in bad shape. A bigger reason public pension plans are underfund is that, in effect, we told them they can be. State and local pension plans use different and far less demanding accounting rules than do corporate pensions, even though public employee benefits are guaranteed by law while corporate pension benefits are not.

The key issue is how to "discount" future benefit obligations to the present, which tells us how much plans must have on hand today to fund their future liabilities. A high discount rate lowers the present value of a future obligation, while a low discount rate implies a higher present value.

Corporate pension plans must discount their future benefit liabilities at the low interest rates earned by high-quality corporate bonds, while public pension plans are allowed to use the much higher expected return on their assets, which include a high proportion of stocks and, more recently, hedge funds and private equity. The effects can be startling.

For simplicity, imagine a pension plan that owed a lump sum of $1 million 15 years from now. Discounting at a 6.25 percent interest rate – which is typical for corporate bonds today, although higher than several years ago – the present value of that obligation would be approximately $403,000.

Using an 8 percent return, which is not uncommon for public pension funds, the present value of that $1 million future obligation would be only $315,000. Plans that have at investments worth at least $315,000 would consider themselves fully funded and, in some cases, use this status to justify increasing benefits.

Defenders of current actuarial practice argue that public pension funds are different, since governments can't go bankrupt – a proposition that may well be tested soon – and because they can always raise taxes to fund deficits. The latter may be true, but surely the point of pension accounting is to give taxpayers some idea of the contingent liabilities hanging over them – which current methods do not.

Moreover, there is a good case that public pension funds should use lower discount rates than corporate pensions because public pension benefits are a safer asset for the beneficiary and thus a more binding obligation on the pension plan. Corporate pension benefits are not fully guaranteed if the sponsor goes bankrupt, while in most states accrued public pension benefits are treated as a binding obligation. In many states these benefits are guaranteed in state constitutions.

If these pension obligations are as binding as state government bonds, it makes sense to discount them at the same rates. Nationally, the yield on a state government bond with a maturity of 15 years averages around 3 percent. Discounted at that rate, a $1 million future obligation requires $642,000 in assets today – over twice as much as the funds themselves would consider necessary.

Moreover, while public pensions discount their future obligations at the "expected return" on their investments, this doesn't mean we can actually expect those assets to meet their goals. The reason is that funds take as the expected return the average return on the asset classes they hold, and the average return is always higher than the median or typical return. Imagine that a public pension fund invested $315,000 in assets with an expected return of 8 percent and a standard deviation of returns of 13 percent. Using a Monte Carlo simulation we can check how often this portfolio is likely to exceed $1,000,000 in 15 years time. The answer is a little over 40 percent, meaning that there's an almost 60 percent likelihood that even a "fully funded" public pension plan won't be able to meet its obligations.

Allowing public pension funds to discount their benefit obligations at the expected return on their investments doesn't just lower the amount of funding they must undertake, it also encourages them to take more risk with their investments. Were a fund to hold only safe investments like Treasury bonds it could discount its benefits only at a low interest rate. But the riskier the investments they make the higher discount rate they can use. It's easy to see where this leads. For instance, the expected return on the Profunds "Ultrabull," which doubles the returns on the S&P 500 would be, well, double the expected return on the S&P 500 – or around 20 percent per year. This would solve plans' funding problems on paper, but it's hard to believe this is the most sensible investment strategy to take.

Accounting is a boring subject and so it's not surprising that it doesn't get much attention in the press or by lawmakers. But it's hugely important.

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Friday, October 9, 2009

US News on Social Security reform

US News & World Report's Luke Mullins has a nice article on prospects for Social Security reform. One point I made in it is (I think, anyway) worth repeating:

Andrew Biggs, a former deputy commissioner of the Social Security Administration, expects President Obama to try and tackle reform later in his term. "It's a big issue, but it's relatively fixable in the sense that it is much more of a mature policy issue than something like healthcare," says Biggs, a resident scholar at the conservative American Enterprise Institute. "We know the pros and cons. We just have to make our decisions."

I think the course of the health care reform debate has shown the merits of a mature policy issue. We started health care talking about "bending the cost curve" but it became clear that we either had little idea how to really do it – think of health IT, comparative effectiveness research and disease management – or we weren't willing to take the steps that most experts think will cut costs, like repealing the tax exemption for health coverage. Social Security may be the smaller problem, but we can be more confident that common reforms will actually get the job done.


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More on health care profits

I have an article co-authored with Kent Smetters of Wharton looking at whether high profits earned by health insurers and drug manufacturers are the reason why health care is so expensive in the U.S. The short story is that health insurers' profits aren't particularly high at all and drug makers' profits, while high, aren't necessarily outrageous. Check it out here.

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The new Social Security notch

I have an article in Forbes outlining what could be a new "notch" for Social Security recipients. The original notch affected people born in the years 1917-21 and was due to a number of changes in the Social Security benefit formula during the 1970s. (See here for a Congressional report on the notch.)

The second notch affects mostly people who are 62 today and could result in an around 5 percent reduction in their Social Security benefits, which over time can end up as a lot of money. Put simply, the notch comes about because Social Security won't be paying Cost of Living Adjustments over the next two years. Here's the article, followed by a few comments:

Old-timers in Washington remember the Social Security "notch" as a quirk in the program's benefit formula that reduced payments for retirees born from 1917 to 1921. Eventually, a bipartisan Congressional commission concluded that the notch's effects were modest and did not require compensation. But not before members of Congress entered over 100 pieces of legislation to address the notch and senior advocacy groups, often under very dubious pretenses, reaped millions in contributions by claiming they could secure compensation for affected retirees.

A new Social Security notch coming soon should generate interest in Congress as it presents a much stronger case for help. Quirks in Social Security's formula for granting Cost of Living Adjustments (COLAs), interacting with a spike in inflation during 2008, could cause a typical 62-year-old couple to lose almost $25,000 in benefits over their lifetimes.

Social Security COLAs are calculated every October by comparing the third-quarter data of the Consumer Price Index for Urban Workers (CPI-W) with the previous year's numbers. An increase in the CPI results in a COLA the following January for retirees and other Social Security beneficiaries. Rising energy prices caused a 5.8% COLA to be ordered in the fall of 2008. However, plummeting prices between the fall of 2008 and the beginning of COLA payments in January 2009 caused the CPI as a whole to drop by around 5%. In effect, the 2009 Social Security COLA compensated retirees for inflation that no longer existed.

To make up for this overpayment, Social Security will pay no COLAs until prices rise back to their previous fall 2008 levels, which, according to the Congressional Budget Office, won't be until 2012. While seniors are upset by the lack of a COLA in the coming year, they actually benefited from the original overpayment. The overly large January 2009 COLA increased Social Security benefits purchasing power by around 5% above 2008 levels. For a typical retiree this is equivalent to an annual benefit increase of almost $700. Given that COLAs are designed merely to keep purchasing power constant, this is a large gain. Moreover, for all but the richest retirees, Medicare Part B premiums are not allowed to increase in a year without a COLA. This will save the typical senior almost $100 next year.

There is, however, one class of Americans who will lose big: people who turned 62 this year. 62 is the first age at which Social Security retirement benefits can be claimed, which means that individuals born in 1947 did not receive the 5.8% "windfall COLA" paid in January of this year. Like current retirees, however, today's 62-year-olds will not receive COLAs for the next two years. Inflation over the next two years will reduce the purchasing power of benefits for today's 62-year-olds by around 5% before COLAs resume in 2012. If today's 62-year-olds had received the "windfall COLA" of 2009, the lack of COLAs over the next two years would simply return their benefits to the proper level. But since today's 62-year-olds did not receive the 2009 COLA, the lack of COLA payments in 2010 and 2011 will have a significant negative impact on their lifetime benefits.

In addition, due to details of the Social Security benefit formula, this financial loss can't be avoided by delaying retirement until after COLAs resume in 2012. For a typical newly retired couple with a monthly benefit of $2,235, this penalty will cost them around $1,340 per year, for every year of their retirement. If they survive to a typical age of 83, these couples will lose almost $25,000 in lifetime benefits. While high-income households may shrug off a 5% cut in their Social Security benefits, for low earners every penny counts.

Americans turning 61 this year will also receive reduced benefits, though their cut will be around half that of 62-year-olds. Effects on younger individuals should generally be small, making this a true notch that affects only a small portion of retirees. While a Congressional ad hoc COLA for current beneficiaries is unjustified, given that the real purchasing power of today's benefits has increased, redress for new retirees over the next several years makes sense. Their reduced benefits stem from an unintended quirk in the benefit formula and restoring lost benefits will not make Social Security's precarious financing any worse. While Social Security benefits will need to be reduced as part of any reform, unintended cuts focused on a small group of near-retirees, rich and poor alike, make no sense.

It is time for Congress to adjust the Social Security benefit formula to make sure that neither unintended windfalls nor penalties take place.

I'm writing something now outlining the sources of the notch in more technical terms, but it mostly derives from the fact that Social Security benefits are based upon your average "indexed" wages. Indexing converts past earnings to make them comparable to earnings levels as of age 60. (For instance, if you earned half the economy-wide average wage when you were age 20, the indexed value would equal half the economy-wide wage as of age 60.) However, earnings after age 60 aren't indexed. This means that an increase in inflation that is later "revoked," as the 2008 increase was, would produce only a small increase in initial benefits but the lack of COLAs later would significantly reduce them. Current retirees aren't affected, as they first received an overly large COLA and later receive no COLAs, leaving their end benefits pretty much where they should be.

Here's one way to think about this: imagine that a bank inadvertently credited each of its customers accounts with an extra $1,000. It then discovered the error and said that it would deduct $500 from each customer's account over each of the next two years. In the meantime, though, bank customers could keep the interest on their accidentally higher balances. Now, current customers clearly aren't badly treated -- they got a bit extra today and will have it deducted over time. But now imagine if the bank made similar $500 per year deductions to the accounts of new customers, who hadn't received the initial $1,000 accidental credit. These new customers would obviously come out behind. In the Social Security world, current beneficiaries are the existing customers; they may gripe, but it's hard to say they've been badly treated. But today's 62 year olds are like the new customers, who have to pay back a credit they never received.

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Wednesday, October 7, 2009

How much would markets charge to cover the Social Security shortfall?

Over at Columbia University Business School's Ideas at Work blog, Columbia professor Stephen Zeldes discusses joint work with John Geanakoplos of Yale in which they calculate a market price for Social Security's expected shortfalls. Because Social Security benefits are tied to wages and wage growth is uncertain, there is risk regarding the program's future finances. Zeldes and Geanakoplos try to price this uncertainty by first calculating the price of a bond whose return would be indexed to wages, then applying this price to Social Security benefits.

The Social Security Administration (SSA) measures the financial health of the system by estimating future cash flows (benefit payments and worker and employer contributions) and discounting them into today's dollars, to arrive at a measure of present value. But what discount rate should be used? The government currently uses a rate that makes no adjustment for risk: the yield on riskless Treasury bonds. But Social Security cash flows are not riskless, says professor Stephen Zeldes. Ignoring that risk leads the SSA to use too low a discount rate, producing an inaccurate measure of Social Security's present value — and of its long-run health.

Social Security benefits are wage-indexed: payments are based on an individual's earnings history and the average national wage in the year that the individual turns 60 years old. Those who have the good fortune of turning 60 in a year in which wages are high will have higher benefits. In subsequent years, benefits are adjusted for inflation, but not for wage growth. Because the average wage fluctuates over time, any valuation of future benefits should account for this risk, Zeldes argues.

Zeldes and John Geanakoplos of Yale University have proposed a way to account for market and wage risks. They first ask, if cash flows were traded as securities on financial markets, what would their market prices be? To determine this, they first propose creating a wage bond, a security tied to the average national wage that when it matures would pay an amount equal to the average national wage that year. They use asset pricing methodology to determine what the discount rate and market value of these bonds would be. Since Social Security cash flows are closely related to those of wage bonds, the prices of the wage bonds can be used to compute the market value of Social Security cash flows.

Pricing wage bonds is not an easy exercise. Research has shown a positive long-term correlation between average wages and stocks. "This means that distant payoffs on wage bonds will tend to be low if the stock market has performed poorly and high if the market has done well," Zeldes says. To price wage bonds, Zeldes and Geanakoplos developed a model that links wages, dividends and stock prices. The model accounts for specific behaviors of the economy and markets, and also draws on common techniques used to price derivatives. Using this model, the researchers came up with an appropriate discount rate for valuing future cash flows.

"It's fine to use close to a risk-free bond rate to discount Social Security benefits that will be received in a couple of years, because the short-run riskiness of wages is low," Zeldes says. "But for benefits in the distant future, the discount rate should be much higher than the one now used by the SSA. Our model shows that the rate should be much closer to the rate that would be applied to stocks."

The researchers apply their methodology to estimate the maximum transition cost. This equals the present value of all benefits that have been accrued to date, minus the current value of the Social Security trust fund. In other words, the maximum transition cost indicates how much extra money the trust fund would need, if the Social Security system were shut down today, in order to ensure payment of all benefits already accrued as a result of past earnings. Applying the SSA methodology that ignores risk yields an estimated gap of about $11.1 trillion. "But we find that the risk-adjusted market value of this gap is about 23 percent smaller than this, i.e., only about $8.6 trillion," Zeldes says. "This means that the cost in today's dollars of paying future benefits is not as high as most people perceive it to be."  

Click here to read the whole article. As I've noted in this post, attempts to ascribe market prices to Social Security financing are in their early stages and it's not even clear at this point whether the market price would be higher or lower than the expected cost that's reported in the annual Trustees Report.

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Tuesday, October 6, 2009

How will demography and entitlement spending affect future interest rates and investment returns?

The Congressional Budget Office today released an interesting and readable explanation of the ways in which demographics and government spending can affect future interest rates and returns on investments such as stocks. This is relevant to the Social Security debate as some analysts have argued that future stock returns will be much lower than in the past, thereby undercutting at least part of the rationale for reforms including personal retirement accounts.

Several points seem worth highlighting:

  • The interest rate over the long term is a function of the relative sizes of the capital stock and of the labor force. If slower population growth reduces the size of the labor force relative to the capital, each worker will have relatively more tools and machines with which to work, raising worker productivity and wages. However, more capital per worker also implies a lower marginal return to capital, and therefore a lower interest rate.
  • Using a standard economic model and reasonable assumptions for economic parameters, CBO shows that a one percentage point reduction in the growth of the labor force would produce a reduction in interest rates around 1.5 percentage points. For illustration, from 1960 through 2008 the labor force grew at annual rate of around 1.7%; over the next 75 years the projected rate of labor force growth averaged around 0.5%. All else being equal, this 1.2 percentage point reduction in the rate of labor force growth would reduce the average interest rate by around 1.8 percentage points.
  • A lower interest rate would tend to reduce returns on stocks, making personal accounts less attractive. The return paid to stocks is a function of the general interest rate paid to all investments and of the premium paid to riskier investments, such as stocks. The discussion in this CBO paper focuses on changes in the overall interest rate, not upon the size of the risk premium. All other things equal, differences in returns between safe in risky investments would remain roughly constant even if average returns rose or fell. (That said, I agree with CBO's general practice of abstracting from the equity premium so to avoid the misinterpretation that stocks produce "free money." A large equity premium doesn't necessarily imply that stocks are a "good deal"; it may just imply that they're very risky or that investors are very risk averse.)
  • At the same time, lower interest rates would make a long-term Social Security actuarial deficit larger. A reduction in the real interest rate of 1.8 percentage points would increase the 75-year Social Security deficit from 2 percent of payroll to around 2.9 percent of payroll. While a high ratio of capital to labor would also increase wages, this very likely wouldn't be enough to offset the poorer actuarial balance due to lower interest rates. (A 1 percentage point reduction in labor force growth would reduce interest rates by around 1.5 percent and increase the wage rate by around 0.6 percent. However, the wage rate differs from the growth of wages. Thus, we could see a single year in which wages grew 0.6 faster than ordinary or, more likely, a number of years with very slightly faster annual wage growth until the new equilibrium level was reached.)
  • While demographic changes are likely to reduce interest rates, budget deficits associated with financing Social Security and Medicare would tend to increase interest rates. CBO concludes that in most cases the positive effect on interest rates of rising budget deficits would outweigh the negative effect from demographic change. In other words, we're as likely to see higher interest rates and investment returns in the future as we are to see lower ones.

Overall this is a very good piece of work on an interesting and important topic – technically solid but accessible enough to be understandable to the public.



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New paper: “Changes in the Distribution of Workers’ Annual Earnings Between 1979 and 2007

The Congressional Budget Office released a new paper titled "Changes in the Distribution of Workers' Annual Earnings Between 1979 and 2007" which details the changes in average earnings, earnings mobility, in earnings gaps between men and women and between low and high earners over the last several decades. While the paper has certain limitations, in that it does not contain information on changes in the number of hours worked or changes in total compensation including fringe benefits, it includes a wealth of information on annual earnings as well as serving as a very useful primer in this area. Check it out here.

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Monday, October 5, 2009

Upcoming event: OECD Pensions at a Glance 2009: US Pensions in Light of the Crisis

Pensions at a Glance 2009

US Pensions in Light of the Crisis

Co-hosted by AARP Office of International Affairs and OECD Washington Center

Edward Whitehouse
Head of Pension Policy Analysis

OECD Social Policy Division

Janet McCubbin
Director of Economic Security
AARP Public Policy Institute

Register online at

Friday, October 9, 2009

Horace Deets Learning Center
601 E Street NW

2nd Floor, B Building

Washington DC, 20049
8:30 AM Registration, 9:00-10:00 AM Presentation

While the series is free of charge, we ask that you please register by Thursday, October 8 for security reasons.
Event Description

The financial and economic crisis has had a profound impact on retirement-income provision around the world. Where is the impact largest? What policy responses have there been? What are the options and the arguments? 

Pensions at a Glance 2009 provides a consistent framework for comparing pension policies between countries along with reliable data. This presentation looks at US retirement policies from an international perspective. 


Edward Whitehouse is a Principal Administrator in the Social Protection unit of the Social Policy Division at the OECD. A British national, Mr. Whitehouse also works on pensions and retirement-income systems. He has previously worked as editorial writer and as social affairs correspondent of the Financial Times and was co-editor of the World Bank's Pension Reform Primer program. He has taught at Oxford University and University College, London and advised numerous governments on pension reform.

Janet McCubbin is the Director of Economic Issues for the AARP Public Policy Institute. At AARP she leads a team of researchers who analyze and develop policies related to Social Security, pensions and saving, the intersection of health and retirement security, older workers, income security programs, and tax and budget issues. Janet's own research focuses on tax subsidies for health care, retirement savings and low-income workers. Prior to joining AARP Janet was chief of the Special Studies Branch, Statistics of Income Division, Internal Revenue Service and an economist in the Office of Tax Analysis of the U.S. Department of the Treasury. Janet is an affiliated professor with Georgetown University's Public Policy Institute. She received a bachelor's degree from the University of Colorado and a doctoral degree in economics from the University of Maryland.

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For more information, please contact Susan Fridy, OECD Washington Center, 202-822-3869

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Friday, October 2, 2009

Bruce Bartlett on the Medicare Part B premium

Bruce Bartlett writes in Forbes Magazine that the recently passed exemption on Medicare Part B premium increases was unjustified but that the complexity of issues like this has led even many supposedly conservative lawmakers to support the legislation.

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