Tuesday, January 26, 2010

A Good Time to Revive Social Security Reform?

Cross-posted from the Enterprise Blog:

The Cato Institute's Mike Tanner—my former boss and a great guy—writes in the Washington Times that now may be the time to revive Social Security reform. Social Security's financial problems have worsened over the past year due to the recession. And, perhaps more importantly, the apparent healthcare overhaul—and its always-dubious promise of fixing the budget by lowering health costs—means that policy makers must look elsewhere for budget savings. Social Security has to be addressed sooner or later, and with healthcare on the back burner, now is as good a time as any.

But it's also worth revisiting what made Social Security reform so hard the last time it was tried in 2005. Tanner writes:

If Social Security's problems haven't changed since the Bush years, neither have the possible ways to fix those problems: Raise taxes (the Social Security payroll tax would have to be nearly doubled to keep the program afloat), cut benefits by as much as 25 percent or allow younger workers to invest privately.

Here's where I differ a bit with my more libertarian brethren.

Back when I was on the staff of President Bush's 2001 Social Security reform commission, we wrote in our interim report that once Social Security begins to run cash deficits in 2016 we face the ugly choices to "raise taxes, reduce benefits, decrease other government spending, or increase borrowing from the public."

Wise guy that I was—a habit that I assure you I've given up—I remarked to one of the other staffers that with personal accounts we face the same choices, only sooner. That is, when you divert payroll taxes that currently fund today's benefits to private investments, you've got to find money to fill that gap. Funding these so-called "transition costs" involves the same choices as before: raise taxes, cut spending, reduce benefits, or borrow.

And this is one place where reform fell down in 2005. No one was willing to raise taxes or cut spending, and President Bush's plan already would have reduced benefits just to fix the program's solvency. As a result, the accounts would be funded entirely by borrowing. This all but eliminates the economic case for accounts, which relied on increased national saving to boost the economy's ability to support larger populations of retirees with smaller populations of workers. Funding accounts with debt is like borrowing from your 401(k) to invest in your IRA—total saving doesn't change.

Politically speaking, the debt associated with these transition costs was a loser. It was hard to convince the public you were taking the fiscally responsible route—which, overall, President Bush was—when the plan involved a few trillion in new borrowing.

I'm not sure how a Social Security reform plan today addresses these problems any better than plans in 2005 did, which is why I'm skeptical of the success of accounts funded out of the payroll tax. I support them, but unless people are willing to make tougher choices than they've shown themselves to be, I don't see how it happens.

But when Social Security reform does come up, personal accounts still have a role to play. The Left will favor fixing Social Security the way we've generally fixed it in the past, by raising taxes. But if we need more money to fund Social Security benefits—which isn't illogical, given that people are living longer—then people should have the option to save those extra contributions in their own accounts rather than paying to a system that may or may not save them in the "trust fund" and may or may not pay them back in the future. That's a place where personal accounts have a real role to play, and an argument that account supporters can win.


Bruce Webb said...

With all respect to your old boss at Cato a FICA increase of 2.01% (SSA) or 1.3% (CBO) is not "almost doubling" and a 25% cut would be the effect of doing nothing until Trust Fund Depletion and not the immediate cost as Tanner seems to suggest.

Those are simply not honest numbers. Perhaps there is a context in which they become honest numbers but as stated they are not.

Andrew know it or not people with a lot bigger credentials than me are looking over your shoulder and exchanging notes. And are not impressed by your willingness to spin Lori Montgomery and the WaPo to sell the AEI/Cato line.

Andrew G. Biggs said...

I think what Mike Tanner is referring to is the annual cost rate, which (if you don't believe int the trust fund, which I'm quite confident he doesn't) reflects the implicit tax rate of supporting the program. Today the cost rate is right around 12.4 percent of payroll, assuming no significant cash surplus this year. By 2025 you're looking at a cost rate of 15.86 percent (a 28% increase) and by 2040 you're looking at a 16.99 percent cost rate (a 37% increase). Hate to say it, but I think I have to call this for Mr. Webb.

WilliamLarsen said...

The problem with Social Security today is the exact same problem it had in 1937 when it began. Funding SS-OASI had problems during the 50’s, 60’s and between 1970 and 1983 SS-OASI spent more money than it collected in tax revenue each and every year. Finally in 1983 it borrowed $11 Billion from the Medicare Trust fund and SS-DI trust fund which was repaid using the increase in tax rate, base, taxation of SS-OASI benefits.

Looking out 75 years ignores what happens in years 76 and after. It is a cliff. SS-OASI consumes the contributions of all workers to pay benefits even though a large fraction of these workers will be under age 67 in year 75, thus saying to them Thanks for your contributions, now you need to fix Social Security. This has been the problem with SS-OASI since year zero. Early on it was pretty easy to add works who were not covered (military in 1957, farmers in 1955, lawyers and Doctors in 1963, Congress in 1983), but when you run out of people who are not enrolled in Social Security, they looked to three of the four the choices left; raising tax rate, base and retirement age. In other words they continued the ponzi scheme.

Sure each cohort is living slightly longer than the cohort before them. However the rate of change is slowing. This year a baby born will live about 18 days longer than a baby last year. This is a far change from the rate of increase in 1910 when it was fie timed larger. Is living longer an actuarial problem for SS-OASI, no? The reason is that inflation which is zero right now has average about 3% a year. Looking at benefit costs over 20 years for a beneficiary shows a dramatic rise. However, this cohort will live just 18 days longer than the previous cohort 18 days divided by (20 years times 365). We are looking at ¼% increase in overall benefit cost per cohort. Relative to inflation, life expectancy cannot even be seen on the chart. Inflation is 80 has a impact 80 times that of life expectancy.

The increase in retirement age from 65 to 67 that was passed in 1983 to take affect recently took care of any and all increase in life span from 1937 to today. For every yearly increment in retirement age, the worker pays an additional year, delays payment by one year (time value) and reduces total years of benefits by one year. In actuarial terms for each additional year of delay, the beneficiary must live nearly 3 years to recoup the cost. The increase was 2 years; the actuarial equivalent is 5.3 years.

WilliamLarsen said...

What can be done about SS-OASI? Raise taxes – this means you pay more for the benefit. Raise retirement age – pay more years for fewer benefit years for the same promised yearly benefit. Reduce benefits – pay the same tax and get lower promised benefits. When all is said and done, no matter how you slice it, dice it, cut it or look at it, the end result is exactly the same. A person born after 1984 can expect to receive 29 cents in benefits for each dollar paid to SS-OASI. This cannot change unless the birth rate changes significantly. If the birth rate changes significantly now, it will produce a short term blip in revenues only to create a huge blip later on in benefit costs. Pay me now or pay me more later.

Private accounts do nothing for SS-OASI. The allow diverting a portion to private accounts only to have a claw back feature. This claw back calculates the theoretical value of the diverted amount based on the US Treasury rate plus 1%, determines theoretical annuity these diverted amounts would pay and subtracts it from your reduced SS-OASI benefit. Theoretically diverting more than 3 percentage points of the 10.6 percent paid to SS-OASI reduces the SS-OASI benefit to zero, thus making your private account your sole retirement source.

Private accounts would divert current revenues to pay current beneficiaries, creating a huge funding gap. This is called the transition cost. The transition cost is equivalent to the unfunded liability of SS-OASI.

Andrew wrote

“The Left will favor fixing Social Security the way we've generally fixed it in the past, by raising taxes. But if we need more money to fund Social Security benefits—which isn't illogical, given that people are living longer—then people should have the option to save those extra contributions in their own accounts rather than paying to a system that may or may not save them in the "trust fund" and may or may not pay them back in the future.”

My question is how is this different from the outcome with private accounts? SS-OASI still runs short of money, the extra contributions are not made available to SS-OASI to pay current beneficiaries, thus requiring benefit cuts. To me there is no difference.

The only option I see is to repeal the Social Security Act and cut everyone’s loses now. The only way for this to be accomplished is for the workers to actually understand how SS-OASI works, the ramifications it has had on artificially stimulating the US Economy over 60 years which we are now paying for and last, vote in large numbers. Is it doable to vote Social Security out, yes? Social Security in 1935 did not have over whelming support. If it was up for a vote today, would it pass, look at healthcare reform, no?
The seniors are the fewest among voters, yet they vote 90% of the time. The largest voting block are those under age 46 which outnumber boomers and seniors combined.

Social Security is doomed. The longer it stays in place, the more it will take from workers pockets and the less they will have for retirement.