10 Truths About Entitlements

The U.S. Chamber of Commerce has launched a new initiative on entitlement reform, highlighting the growing costs of entitlement programs and pushing the need to fix Social Security and Medicare promptly.

Their whole page is worth checking out, especially for more details on these 10 truths about entitlements:

Truth #1: Entitlement programs are huge, expensive, and reach into every corner of American life. 

Truth #2: Entitlement programs are not self-funding and are a main driver of deficits.

Truth #3: Entitlement costs are growing at an alarming rate.

Truth #4: Longer life expectancies, changing demographics, and soaring costs explain why entitlements as we know them today are unsustainable.

Truth #5: Not a single major entitlement program is projected to be financially solvent 20 years from now.

Truth #6: The cost to make these programs financially solvent for the next 75 years is almost $40 trillion.

Truth #7: Mandatory spending—entitlement programs and interest on the debt—are already squeezing out important investments in other essential programs.

Truth #8: We have nothing to fear from carefully crafted, phased-in adjustments to our entitlement programs.

Truth #9: We can reform entitlements without baseline cuts and without breaking our commitment to the nation’s seniors, disabled, and poor.

Truth #10: The biggest threat imaginable to Medicare or Social Security as we know them will be if we do nothing at all.

 

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Shiller: Pay COLAs that are larger than inflation

Economist Robert Shiller writes in the New York Times that Cost of Living Adjustments, rather than being indexed to the ‘chained CPI’, should instead rise at the faster rate of GDP growth. I make a similar argument in my new National Affairs article, albeit for somewhat different reasons.

Well worth a look.

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A New Vision for Social Security

I have a long article in the new issue of National Affairs that pretty much sums up the work I’ve done on Social Security over the past several years. The article (ungated!) outlines both what I would do to reform the program and, more importantly, why.

One of the themes of the piece is that reformers focus excessively on the details of the tax and benefit formulas without thinking enough about the big picture goals of reform: why we have a Social Security program in the first place and how we want it to accomplish its goals. I don’t expect anyone to adopt these ideas en masse, but that’s not the point. The goal is to encourage people to think about the program and reform in a slightly different way, to focus more on the ends of reform and less on then means.

Some of the proposals are pretty far out, but that’s the luxury of working at a think tank. Enjoy!

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Why the Government Needs to Budget over the Infinite Horizon

From the NCPA’s daily policy digest.

 

Why the Government Needs to Budget over the Infinite Horizon

June 19, 2013

How far into the future should governments budget? Economic theory has a clear and rigid answer. But it's not one economists like to give, because it's not one people easily comprehend and it's not one that politicians, whose attention most economists covet, like to hear. The answer is that governments need to budget out to infinity, says Laurence Kotlikoff, a senior fellow with the National Center for Policy Analysis and economist at Boston University.

Infinity is a very long time. But economic theory also tells us that in budgeting out to infinity, we should place less weight on distant government expenditures and tax receipts. Specifically, we should include in our budgeting not actual future expenditures and taxes, but their present values.

• Present value stands for the value right now, in the present. And the value right now of getting $1 in the future is smaller the longer you have to wait for it.
• Take the just-released 2013 Trustees Report on Social Security's long-run finances. They claim an infinite horizon fiscal gap of $23.1 trillion separating the system's projected costs and taxes net of its trust fund.
• This massive shortfall, which grew a whopping 8 percent last year, is 50 percent larger than U.S. gross domestic product and almost twice the federal debt held by the public.
• Social Security began reporting its infinite horizon fiscal gap 2003. Back then it was $10.5 trillion. On an inflation-adjusted basis, the gap's risen 74 percent leaving the system in far worse shape than when the 1983 Greenspan Commission "fixed" it.

The Greenspan Commission, like the current Trustees, looked out only 75 years. In so doing, it ignored not just the 30 years between 2057 and 2087 now in the current 75-year window, but all the years after 2087, when today's and tomorrow's children will be alive.

• For the U.S. government as a whole, the infinite horizon fiscal gap is a whopping $222 trillion.
• Its elimination requires not a 32 percent immediate and permanent tax hike in Social Security FICA taxes or a 22 percent immediate and permanent cut in Social Security benefits, but either a 64 percent immediate and permanent tax hike in all federal taxes or a 40 percent immediate and permanent cut in all expenditures apart from servicing official debt.

So, Social Security's enormous fiscal problem is just a molehill in front of a mountain of horrendous obligations our politicians and their "trustees" are ignoring with their careful choice of words and their finite budgeting horizons.

Source: Laurence Kotlikoff, "Why the Government Needs to Budget over the Infinite Horizon," Yahoo! Finance, June 13, 2013.

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New paper: “The Impact of Interest Rates on the National Retirement Risk Index”

The Center for Retirement Research at Boston College has released “The Impact of Interest Rates on the National Retirement Risk Index,” by Alicia H. Munnell, Anthony Webb, and Rebecca Cannon Fraenkel.

The brief’s key findings are:

• The National Retirement Risk Index shows that changes in interest rates have only a modest effect on retirement preparedness for three reasons:
  • Most households have relatively little financial wealth to annuitize.
  • The effect on annuity income is muted, because the principal portion of the annuity payout is unaffected by interest rates.
  • Changes in the annuity income from a reverse mortgage are partly offset by changes in the amount that can be borrowed.

This brief is available here. Read more!

Is the Social Security shortfall overstated?

PBS’s Paul Solmon talks to Boston College economists Alicia Munell. With video! Check it out here.

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New papers from the Social Science Research Network

"The Relationship between Job Characteristics and Retirement Savings in Defined Contribution Plans During the 2007-2009 Recession"
Monthly Labor Review, 136(5), pp.3-16, 2013

CHRISTOPHER R. TAMBORINI, U.S. Social Security Administration
Email: Chris.Tamborini@ssa.gov
PATRICK PURCELL, Government of the United States of America - Social Security Administration
Email: patrick.purcell@ssa.gov
HOWARD IAMS, U.S. Social Security Administration
Email: Howard.m.iams@ssa.gov

Pension trends in the United States, marked by the movement toward defined contribution (DC) plans, raise questions about the individual characteristics that influence retirement saving behavior. This study examines how DC participants’ industry and employer characteristics relate to the prevalence of reduced retirement account contributions in a time of severe recession (2007-2009). Data come from a restricted-use file that matches workers in the 2008 Survey of Income and Program Participation (SIPP) to their W-2 tax records received by the Social Security Administration. Multivariate probit models indicate several job-related factors, most notably a decline in real earnings, were linked to declines in participants’ contributions to defined contribution retirement plans during the recession of 2007–2009; employer size, occupation, and industry-specific employment losses, among other characteristics, were also associated with changes in retirement plan contributions.

"Sharing High Growth across Generations: Pensions and Demographic Transition in China"
UBS Center Working Paper Series, Working Paper No. 1, November 2012

ZHENG MICHAEL SONG, Fudan University - School of Economics
Email: zsong@fudan.edu.cn
KJETIL STORESLETTEN, Stockholm University - Institute for International Economic Studies (IIES), University of Oslo - Department of Economics, Centre for Economic Policy Research (CEPR)
Email: KJETIL@IIES.SU.SE
YIKAI WANG, University of Zurich
Email: yikai.wang@iew.uzh.ch
FABRIZIO ZILIBOTTI, University of Zurich, Centre for Economic Policy Research (CEPR), CESifo (Center for Economic Studies and Ifo Institute for Economic Research)
Email: zilibott@iew.uzh.ch

Intergenerational inequality and old-age poverty are salient issues in contemporary China. China’s aging population threatens the fiscal sustainability of its pension system, a key vehicle for intergenerational redistribution. We analyze the positive and normative effects of alternative pension reforms, using a dynamic general equilibrium model that incorporates population dynamics and productivity growth. Although a reform is necessary, delaying its implementation implies large welfare gains for the (poorer) current generations, imposing only small costs on (richer) future generations. In contrast, a fully funded reform harms current generations, with small gains to future generations. High wage growth is key for these results.

"Don't Raise Social Security Taxes: But If It's Necessary, Here's How"
American Enterprise Institute for Public Policy Research, No. 1, January 2013

ANDREW G. BIGGS, American Enterprise Institute
Email: andrew.biggs@aei.org

As the debt-ceiling debate begins, congressional Republicans will demand spending cuts to counter any increase in the debt limit. These spending cuts are likely to include entitlement reforms, with Social Security, particularly, as a prime target. Most congressional Democrats might favor payroll tax increases to make Social Security solvent. But higher taxes discourage work and personal saving and encourage early retirement, with negative consequences for the economy. Although these increases clearly are not the best way to solve America’s overall entitlement problem, they may be necessary to consider if an agreement is to be reached. If so, payroll tax increases should be levied across the board, not merely on high earners, to reduce the economic impact and make all Americans aware of the costs of the benefits they all receive.

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A guide to the 2013 Social Security Trustees Report

From public trustee Chuck Blahous, over at e21. Including one chart I particularly like, for those who downplay the need for action.  Check out the whole article.

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Does retirement hurt your health? Or are the unhealthy more likely to retire?

Peter Orszag’s new Bloomberg column explores whether working longer will make you healthier. Interesting stuff.

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New papers from the Social Science Research Network

SOCIAL SECURITY, PENSIONS & RETIREMENT INCOME eJOURNAL

"Limited Computational Ability and Social Security"
International Tax and Public Finance, 20(3), 414-433 (2013)

FRANK CALIENDO, Utah State University
Email: frank.caliendo@usu.edu
T. SCOTT FINDLEY, Utah State University
Email: tscott.findley@usu.edu

We revisit the role of social security in countering inadequate saving for retirement. We compute the optimal social security tax rate for households who lack the computational ability to solve dynamic optimization problems. Instead, they follow the simple rule of thumb of consuming and saving a fixed fraction of disposable income. This departs from the tradition of computing the optimal tax rate when households suffer from some type of behavioral bias yet possess the ability to solve dynamic optimization problems. Our general equilibrium model is calibrated to the moments of the distribution of saving rates in the US, and our results are generally supportive of a social security program as large as the one in the US.

"Subjective Life Expectancy and Private Pensions"
MEA Discussion Paper No. 265-12

TABEA BUCHER-KOENEN, Munich Center for the Economics of Aging, Max Planck Society for the Advancement of the Sciences - Max Planck Institute for Social Law and Social Policy
Email: bucher-koenen@mea.mpisoc.mpg.de
SEBASTIAN KLUTH, Max Planck Society for the Advancement of the Sciences - Max Planck Institute for Social Law and Social Policy
Email: kluth@mea.mpisoc.mpg.de

One important parameter in the decision process when buying a private annuity is individuals´ subjective life expectancy, because it directly influences the expected rate of return. We examine the market for private annuities in Germany and evaluate potential selection effects based on subjective life expectancy. First individuals are pessimistic about their life span compared to the official life tables. Second we find a significant selection effect based on subjective life expectancy for women who invest in private annuity contracts - so called Riester pensions. For men there seems to be no difference in subjective life expectancy by Riester ownership. Comparing the size of this selection effect with the underlying loading in life expectancy charged by the insurance industry shows that the latter appears to be in line for women but very high for men. Our findings have strong policy implications. On the one hand misperceptions about longevity risk might prevent individuals from providing sufficiently for retirement. On the other hand mandated unisex tariffs might especially discourade men from investing in Riester pensions, for them premiums in life expectancy are particularly high compared to subjective expectations.

"Backing Out of Private Pension Provision - Lessons from Germany"
MEA Discussion Paper No. 262-12

MICHAEL ZIEGELMEYER, Banque centrale du Luxembourg, Max Planck Society for the Advancement of the Sciences - Max Planck Institute for Social Law and Social Policy
Email: michael.ziegelmeyer@bcl.lu
JULIUS NICK, University of Mainz
Email: junick@mail.uni-mannheim.de

Financing pensions in the EU is a challenge. Many EU countries introduced private pensions schemes to compensate declining public pensions levels due to reforms made necessary by demographic change. In 2001, Germany introduced the Riester pension. Ten years after introduction the prevalence rate of this voluntary private pension scheme approximates 37%. However, numerous criticisms raise doubts that the market for Riester products is transparent. Using 2010 German SAVE survey, this paper investigates for the first time terminated and dormant Riester contracts on a houshold level. Respectively 14,5% and 12,5% of households who own or have owned a Riester contract terminated it or stopped paying contributions. We find that around 45% of terminated or dormant Riester contracts are caused at least partly by product-related reasons, which is significantly higher than for endowment life insurance contracts. Uptake of a new contract after a termination is more likely if termination is product-related. Nevertheless, after termination 73% of households do not sign a new contract, which can have serious long-term consequences for old-age income. Households with low income, low financial wealth or low pension literacy are more likely to have terminated or dormant contracts. Low income and low financial wealth households also have the lowest prevalence rate of Riester contracts and are higher risk of old-age poverty.

"The 'Defined Ambition' Pension Plan: A Dutch Interpretation"
Rotman International Journal of Pension Management, Vol. 6, No. 1, 2013

NIELS KORTLEVE, PGGM Investments
Email: Niels.Kortleve@pggm.nl

As in many other countries, recent developments in demographics and financial markets are having a serious impact on pension systems and contracts in the Netherlands. For example, people living longer and being in good health is a major joint achievement of our welfare states and of medical science. However, these achievements demand a new approach to pension provision when tackling both longevity and aging societies. Traditional occupational DB pension provision has become too expensive for plan sponsors, and new solutions need to be found. On top of these trends we see an increasing individualization in European societies: people no longer participate in (mandatory) collective systems for the sake of solidarity alone; there needs to be a benefit for all. Sharing comparable risks at fair prices and costs has historically been well accepted, but redistribution of welfare in the name of inter-generational solidarity brings more discussion to the table. This article describes a new Dutch pension contract designed to address these challenges.

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CRFB Responds to New York Times on Social Security

You can check out their detailed response here – well worth a look.

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Upcoming event: Retirement & Savings Forum

Join at noon on Wednesday, June 19, 2013

For a Lunch Meeting with Guest Speaker:

Felix Reichling and   Kent Smetters

Congressional Budget Office            Wharton School

Who will discuss a new CBO paper:

“Optimal Annuitization with Stochastic Mortality Probabilities”

Wednesday, June 19, 2013

Noon-1:00 p.m.

RSVP

Location: 

Fidelity Investments

325 7^th St. NW

Washington, DC

(Lunch will be provided)

Abstract

The conventional wisdom dating back to Yaari (1965) is that households without a bequest motive should fully annuitize their investments. Various market frictions do not break this sharp result. This paper demonstrates that incomplete annuitization can be optimal in the presence of stochastic mortality probabilities, even without liquidity constraints. Moreover, stochastic mortality is a mechanism for various frictions to reduce annuity demand. Simulation evidence demonstrates that it is optimal for most households to not annuitize any wealth. Optimal aggregate net annuity holdings is likely even negative.

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NY Times: “What’s next for Social Security?”

Not benefit cuts, if the Times editorial board has its way. While they make some solid points, they also rely on some dubious evidence.

For instance, most reform plans would reduce the growth of benefits over decades. The fact that Americans today have been battered by a recession doesn’t speak against changes over long periods.

Likewise, while a rising retirement age will reduce replacement rates – the ratio of benefits to pre-retirement income – that’s not irrational when life spans are rising. Despite what the Times says, benefits aren’t being reduced in real terms.

Likewise, while Medicare Part B premiums are rising – thus reducing net Social Security benefits – that’s because Medicare provides ever-more generous benefits each year. And since premiums pay only 25 percent of Part B costs,  total payments to seniors are rising a lot faster than they’re being cut.

All that said, Social Security should remain strong for the people who need it. But part of “strong” is financially strong, and we need to figure out how to make that happen.

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Goldwein: Reforming Social Security is easy — but it won't be for long

Writing in The Hill, Marc Goldwein of the Committee for a Responsible Federal Budget argues that we can fix Social Security easily – if we act today – and points to a new online tool that lets you see how you would fix the program.

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Social Security risks on the horizon

Jason Fichtner and Frederick Kilbourne write in Investors Business Daily that the Social Security Trustees should watch for unexpected but important risks to the program’s finances. Check it out here.

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New paper: Modeling Individual Earnings in CBO’s Long-Term Microsimulation Model

Modeling Individual Earnings in CBO’s Long-Term Microsimulation Model: Working Paper 2013-04

June 4, 2013

By Jonathan A. Schwabish and Julie H. Topoleski

This paper describes the methods developed to project individual earnings in the Congressional Budget Office Long-Term (CBOLT) microsimulation model. CBOLT is used to assess the fiscal situations of the Social Security system and the federal government as a whole. Unlike many other models that project Social Security’s finances, CBOLT projects behavior at the individual level. For each individual in the model, CBOLT projects levels of educational attainment, transitions in and out of marriage, labor force participation and employment transitions, immigration and emigration, and claiming patterns for Social Security benefits. An important feature of CBOLT is that it models each worker’s annual earnings over that worker’s lifetime. Those lifetime earnings patterns are the key determinants of individual payroll taxes paid and Social Security benefits received, and thus of aggregate Social Security finances.

In CBO’s modeling, the historical pattern of rising earnings inequality continues for the next two decades, but earnings inequality generally ceases to rise by the mid-2030s. The method for projecting individuals’ earnings that was developed for CBOLT and described in this paper closely follows the method first documented by Carroll (1992), but it is also informed by the work of other researchers. In general, individual earnings are perturbed by a pair of estimated earnings “shocks.” The first shock is permanent and measures the long-run gap between a worker’s earnings and the average earnings of that worker’s group (where the group may be defined by age, sex, and education). Permanent shocks could be caused by, for example, receiving a promotion or attaining a higher level of education. The second shock is transitory and measures any additional but temporary variation in a person’s earnings. Transitory shocks could arise from, for example, receiving a bonus or missing work because of illness.

read complete document

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Upcoming event: Social Security Disability Insurance: Challenges and Opportunities

Social Security Disability Insurance: Challenges and Opportunities Friday, June 21, 2013 • 9:30 a.m. - 11:00 a.m. ET Russell Senate Office Building, Room 385 Constitution Avenue and 1st Street, NE Washington, DC 20002
To attend in person in Washington, D.C., register at: http://www.eventbrite.com/event/6949272461. (Registration is required.)
Panelists: Moderator: Howard Gleckman, Resident Fellow, Urban Institute Kenneth Apfel, Professor of Practice at University of Maryland School of Public Policy and Former Commissioner of the Social Security Administration Lisa Ekman, Director of Federal Policy, Health and Disability Advocates Melissa Favreault, Senior Fellow, Urban Institute Gina Livermore, Senior Researcher, Mathematica Policy Research Join our panel of experts as they answer such questions as: What are the economic circumstances of Disability Insurance (DI) beneficiaries?  What policies might improve these? What are the main challenges for the DI program? How should DI fit into Social Security reform discussions? How would DI beneficiaries be affected by alternate approaches to reducing Social Security’s long-range financing gap? How might the current political environment shape DI’s future?

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Was Social Security racist?

The Washington Post’s Wonkblog has a nice discussion of whether agricultural and household workers were originally excluded from Social Security by Southern Senators because these groups are predominantly black. SSA historian Larry DeWitt thinks not, but it’s an interesting story.

Racist or not, the original restrictions on Social Security coverage did mean that many low-wage workers were excluded from what was an incredible financial deal, with most participants receiving far more in benefits than they ever paid in taxes.

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My next stop: Vegas.

A friend emails that, last May, I predicted the next Social Security Trustees Report would show few changes relative to the 2012 edition. The Trustees released their latest Report on Friday and – lo and behold! – it seems I was right.

The Social Security trust fund’s exhaustion date stays unchanged at 2033. Social Security’s 75-year deficit increased from 2.67 to 2.72 percent of payroll, a small change that’s explainable just by the passage of time: each year, a new 75^th year is added to the projections and that 75^th year inevitably involves deficits, making the whole projection slightly worse. A shortfall of 2.72 percent of payroll means that a tax increase of 2.72 percentage points, from 12.4 percent of wages to 15.12, would make the system solvent for exactly 75 years, but not beyond.

The “infinite horizon” shortfall increased slightly, from 3.9 to 4.0 percent of wages. That’s the payroll tax increase needed not just to keep the system solvent through 75 years but thereafter as well. This is an important figure because the 75-year figure is premised on a lot of people paying taxes over the next 75 years but not receiving full benefits if they’re retired after the 75^th year.

Social Security faced insolvency last year and it faces insolvency this year. The only way we’ll not say the same thing a year from now is if Congress and President Obama step in and do something about it.

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