Thursday, February 27, 2014

Should we shift Social Security’s “start-up costs” to the rich?

Boston College economist Alicia Munnell, writing for MarketWatch, discusses the so-called “start-up costs” involved with Social Security, which are often referred to as the system’s “legacy debt.” This represents the extra benefits paid to early participants in the program over and above what they paid in taxes. This amount – which is somewhere north of $20 trillion – is the main reason Social Security is underfunded going into the future.

Munnell argues that these costs should be shifted from Social Security to the general Treasury. In other words, they should be financed by income taxes, which are predominantly paid by high earners, rather than payroll taxes. She argues that doing so would “produce a more equitable tax system.”

I can understand making this kind of change and I might even support something like it. But I’m not sure why shifting Social Security costs from a tax that is more or less proportional to income to one that is paid predominantly by a very few high earners is more “equitable.”


Arne said...

The fact that the "legacy debt" continues to increase into the infinite future should be a clue that policies based on the level of legacy debt don't make sense. It will continue to be that way as long as SS is PAYGO. I understand preferring not to have PAYGO because you believe that higher savings is inherently better (although I find the evidence weak), but disliking PAYGO because it has "legacy debt" is circular reasoning.

Andrew G. Biggs said...

I think the legacy debt only increases with interest; in present value terms it stays the same.

Arne said...

Legacy debt is the difference between what beneficiaries paid in and what they receive. It grows every year as the number of beneficiaries grows. It also grows with the growth of benefits which is based on AWI.

Since neither factor has anything to do with any particular discount rate, its present value is not analytically defined. (You can calculate the change in present value just as you could the present value of the fruit in your lunch even though one day it is an apple and the next it is an orange.)

Andrew G. Biggs said...

But since present and future participants are likely to pay in more than they'll receive, the net actuarial deficit is smaller than the legacy debt. There's a section in the TR that explains this.

Arne said...

The TR is dealing with scheduled benefits. A PAYGO program (which SS cannot exceed by law) is dealing with payable benefits. On the basis of payable benefits, the net actuarial deficit is zero. There is, however, still a "legacy debt".

Reducing the legacy debt is not, in and of itself, a particularly meaningful policy goal. It is the same thing as not wanting a PAYGO system.

WilliamLarsen said...

In 1943 the unfunded liability of OASI was $16 Billion. Less than a half million beneficiaries while more than 29 million workers paying social security taxes with nearly that many worker who were not covered.

Since the payroll tax never reached the acturial rate until around 1968, some 31 cohorts did not pay anywhere near enough. When you look at the total payroll taxes paid and the total benefits paid, less than 5% of payroll taxes have ever been set aside.

Saving 5% of net payroll taxes does not produce anywhere near enough to fund SS. The trust fund is shrinking while liabilities are growing due to SSA wage base growth. These two diverging growth rates mean that real liabilities are accuring at more than $1 Trillion a year.

This disproves the statement;

"I think the legacy debt only increases with interest; in present value terms it stays the same."

When the trust fund to expense ratio reaches 20%, the ponzi scheme is up. With each following year a portion of the payroll taxes will be required to be deposited in the trust fund to maintain the 20% ratio requirement of 1984. This means not only will 4% less than the total payroll be available for benefits, but with each year more beneficiaries will want to collect, thus decreasing the 75% payable benefit to 60% around 2065. Keep in mind that under COLA, COLA will be zero as well.

Is there any solution? Bernie Maddoff and the guy form Texas are great examples of what happens when a ponzi scheme fails. Detroit may also be a good example, but they seem to have much more assets in relation to liabilities.

Arne said...

"The Social Security Act does not stipulate
what would happen to benefit payments if the trust funds ran out."

I can find no link between COLA and TF status.

Social Security is PAYGO, which seems like a Ponzi scheme to some people. It certainly did pay more to the first generation, a feature that was needed since they were wiped out by the Depression. It requires adjusting because people are living longer and Congress has to figure that out again (and again).

SS has low administrative expenses, so it is a good deal as insurance goes. It would have lower costs if people still died at the rate they did in the 50s, but I find it hard to think of that as better.

JoeTheEconomist said...

Andrew, Check page 66 of the Trustees report. It explains that the unfunded liability grows every year - as though it had an interest cost.

Munnell's solution is flawed. Once SS is funded by the general taxpayer, all of the uncovered people will expect to join.

WilliamLarsen said...


Check out these statutes:

United States Code Title 42, Chapter7, Subchapter VII, Sec. 911 (a),

United States Code Title 42, Chapter7, Subchapter VII, Sec. 910 (a),

(a) Terms and conditions of recommendations
If the Board of Trustees of the Federal Old-Age and Survivors Insurance Trust Fund and the Federal Disability Insurance Trust Fund, the Federal Hospital Insurance Trust Fund, or the Federal Supplementary Medical Insurance Trust Fund determines at any time that the balance ratio of any such Trust Fund for any calendar year may become less than 20 percent, the Board shall promptly submit to each House of the Congress a report setting forth its recommendations for statutory adjustments affecting the receipts and disbursements of such Trust Fund necessary to maintain the balance ratio of such Trust Fund at not less than 20 percent, with due regard to the economic conditions which created such inadequacy in the balance ratio and the amount of time necessary to alleviate such inadequacy in a prudent manner. The report shall set forth specifically the extent to which benefits would have to be reduced, taxes under section 1401, 3101, or 3111 of the Internal Revenue Code of 1986 would have to be increased, or a combination thereof, in order to obtain the objectives referred to in the preceding sentence.

As for a link for COLA I believe the federal statute is
42 USC 415 (2)(A)(i)

Here is a link.

Andrew G. Biggs said...

But this doesn't require that the recommendations be acted upon.

WilliamLarsen said...

Social Security by law cannot borrow money. It has statutory authority to spend only those funds received from the dedicated social security tax on wages, tax on benefits and funds in the trust fund. Federal Law prohibits transferring general revenues to any trust fund.

United States Code Title 42, Chapter7, Subchapter VII, Sec. 911 (a)

Let us assume that the trust fund is exhausted. SSA Trustees do not raise the payroll tax. The referenced statute does not allow Social Security to borrow funds and general revenue funds cannot be used to pay social security benefits. What will happen? SSA will not print money. The US Treasury cannot print checks on SSA trust fund because it is empty. The Treasury can print checks for benefits based on payroll taxes as they come in. In simple terms, either across the board cuts take place or some receive full benefits while others get none. In any event OASI can pay at most 76% of scheduled benefits in the first year.

We might also deduce from the previous referenced statue that SSA is non compliant with reporting to congress changes necessary to maintain the 20% ratio based on the plain and literal language used by congress

"determines at any time that the balance ratio of any such Trust Fund for any calendar year may become less than 20 percent, the Board shall promptly submit to each House of the Congress a report..."

You are correct that require the recommendation be acted upon. But it does require a report identifying actions to be submitted promptly to congress. I have not see any such report that maintains the OASI trust fund at 20% of any year into the future.

The point of this statute is simple. After decades of patches, congress wanted something that would address the problem. Neither SSA nor any commission has ever come to grips with the reality of Social Security's design. The need for this was to maintain the ability to pay some perception of cash flow.

In any event there is no painless solution. Who are we trying to save social security for? Are we trying to let politicians save face? Are we trying to let the SSA save face? Are we trying to let those who have led commissions save face? A. J. Altmeyer was 100% correct back in 1943 and yet no one in congress or the SSA have taken the time to simply state the obvious. Social Security is not going broke, it is broke! When did Enron finally go broke; when it filed for bankruptcy or when it began to use accounting gimiks years before?

Every single proposal every presented on Social Security has losers and winners. The problem today is at 10.6% payroll tax everyone is a loser; low, average and high wage earners and the economy as a whole.

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