Wednesday, June 4, 2014

Kotlikoff: Why Social Security Lowballs Benefit Estimates

PBS has a nice story featuring Boston University economist Larry Kotlikoff on the benefit estimates that are provided to working-age individuals through the Social Security Statement.

The Social Security Administration’s benefit online calculators aren’t to be trusted for use for people under age 60, even for someone who is single and was never married and will never marry. The reason is that unless you change their assumptions, they assume (in contradiction to the Social Security Trustees’ Report’s own assumptions) that the economy will experience zero economy-wide average real wage growth and zero inflation between now and the end of time. That’s an odd assumption for an economy that’s experienced positive average real wage growth rates as well as inflation for each of almost all the postwar years.

There’s another way to understand the issue, which I’ve outlined in a Christian Science Monitor op-ed and a longer research piece for RAND. In this reading, which is mathematically equivalent to what Kotlikoff describes, the SSA estimates benefits using reasonable assumptions regarding wage growth and inflation and generates a decent estimate of the nominal benefits a person will be entitled to.

But the SSA then indexes that future benefit to the present using, not the Consumer Price Index, but the Average Wage Index. So while SSA sometimes claims that benefit estimates are in today’s dollars, or adjusted for the cost of living, they’re actually not.

The scale of the difference is meaningful. For instance, a typical worker retiring 30 years from today will receive a nominal Social Security benefit of about $64,750 per year. Adjusted for inflation, that future benefit will be $27,683 in today’s dollars. But that’s not the figure he’ll see on his Social Security Statement. Rather, because the SSA wage-indexes his future benefits, the figure he would see on his Statement will be just $17,982, which is 35 percent lower than the true purchasing power of his benefits is expected to be.

1 comment:

WilliamLarsen said...

Andrew is this not what I wrote about decades ago? As I recall we spoke about wage indexing in the late 90's and wage growth created a mathematical divergent series. The spread between replacement rates (wage indexing and US Treasury Rates) were the key to future benefits. Higher wage growth without corresponding higher US treasury Rates would cause SS-OASI to implode faster due to a constant OASI tax rate.

I stressed then that OASI forecast was way off because of the way SSA calculated future benefits. This is why in 1984 I projected SS-OASI would be unable to pay full scheduled benefits in 2036-2037 while the SSA projected 2063.

Underestimating future benefits, underestimates the size of the problem as well. I seriously doubt those born after 1950 will come out ahead with Social Security based on a theoretical cash flow what their contributions using the "ACTUAL" US Treasury rates paid to OASI could have been. It is tough to come out ahead when the payroll tax is already a good 30% too high on an actuarial basis.

If you truly believe that future beneficiaries will still come out ahead, how do you reconcile the legacy debt let alone the 75 year solvency period shortfall? Every cohort cannot get back more than what they contributed.