Krugman, Hennessey skeptical of deficit commission

As the Washington Post reports, the Obama administration is set to sign an executive order establishing a bipartisan commission to look at ways to reduce the budget deficit. Both Keith Hennessey on the right and Paul Krugman on the left are skeptical.

Hennessey does a terrific side-by-side of the Obama administration's plan for a commission versus the Conrad-Gregg commission proposal. One of Keith's strongest points is with regard to the goals of the relative commissions: most commission proposals have focused on the long run, in particular the growth of entitlements. While the Obama commission would be able to make recommendations in these areas, their specific goal is to reduce the deficit to 3 percent of GDP by 2015. Not only does that tend to ignore the longer-run problems, it seems to me that the short run deficit really is the business of Congress. I'm fine on a fast track procedure by which a commission can recommend longer-term reforms, but if we also need a commission to balance the budget year-in and year-out then we might as well send Congress home.

Krugman argues that the Greenspan Commission that led to the 1983 Social Security reforms was just a ruse to raise taxes on working people to fund tax cuts for the rich. I'm not sure how well that really holds up, since it's pretty clear that the Greenspan Commission didn't know that its proposal would lead to short term surpluses, and if it didn't, it's hard to argue that it intended to use those short-term surpluses to offset deficits driven by tax cuts elsewhere. In any case, I somehow suspect that's not how an Obama commission would end up. If anything, there's a reasonable fear of the contrary: that it would push to increase taxes in ways that Democrats alone would like to do but politically couldn't accomplish.

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Hubbard (Not Mankiw!) on Social Security Accounts and the Public Option

Update: An unfortunate attribution error led to me treat Bush CEA chairs as interchangable. My apologies to all involved.

Glenn Hubbard writes in the New York Times, hitting a point that's occurred to me at various times during the health debate: the "public option" is to liberals today what Social Security personal accounts were to conservatives back in 2005, when President Bush promoted Social Security reform. From one point of view, neither the public option nor personal account are really all that important: many of the health reforms people wish to accomplish, such as broadening coverage or cutting waste, can be done without the public option; likewise, personal accounts don't reduce the need to raise taxes or cut benefits as part of Social Security reform.

At the same time, the public and personal accounts are the most important elements for many of the most energetic proponents of reform. The liberal base strongly desires the public option just as the conservative base desired personal accounts. Liberals have a philosophical belief that health care is a right that shouldn't be subject to markets and profit motives. Likewise, conservatives believe that individuals should have more control over their retirement savings, and government less. This "ownership society" viewpoint was a strong motivator for President Bush and others, including myself.

Glenn argues that for the good of reform, President Bush should have put aside personal accounts if doing so would have allowed him to accomplish reform of the rest of the Social Security program. Likewise, he says, Democrats should set aside the public option in order to accomplish health care reform. Despite my strong support for accounts over the years, I think Glenn is right on both counts.

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Retirees who work must return $250 stimulus check

Donald Lambro reports for the Washington Times that

Seniors who also work and qualify for Mr. Obama's $400 Making Work Pay middle-class tax cuts may find themselves forced to give back some or all of the Social Security bonus come tax-filing time in 2010.

The basic story is that Obama's making work pay tax credit – which is, in effect, a cut in the employee share of the Social Security tax – benefit only those with earned income. Retirees squealed, as you'd expect, that they hadn't gotten their share of the stimulus loot and so a $250 check was added for everyone receiving Social Security benefits.

The hitch is that many people both work and receive benefits at the same time. Those folks probably expect that they'd get to keep both checks, which isn't unreasonable given that they fulfill the criteria for both. According to Lambro, that's not how it works.

Congressional and IRS officials say taxpayers cannot double-dip into both programs. If you are getting extra Social Security money and benefit from a lower withholding in your paycheck, the two will have to be reconciled when you file your 2009 tax returns next year.

While I'm not a huge fan of either the Making Work Pay credit or the $250 retiree checks, the administration should at least have been more forthcoming with details regarding how the program worked. According the SSA's Income of the Population Aged 55 and Over, 46% of beneficiaries aged 62-64 (1.13 million people) have earnings; 22% of beneficiaries aged 65 and older (5.4 million people) have earned income. These folks may not be too pleased come tax time.

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Judd Gregg role on entitlement reform?

One reason Republicans regretted New Hampshire Sen. Judd Gregg's acceptance of President Obama's nomination as Commerce Secretary is that the Senate would lose one of its strongest voices for long-term budget and entitlement reforms. Gregg was a leading sponsor of the so-called Gregg-Breaux Social Security Reform Act, which was co-sponsored by Sens. John Breaux (D-LA), Chuck Grassley (R-IA), Bob Kerrey (D-NE), Chuck Robb (D-VA), Craig Thomas (R-WY) and Fred Thompson (R-TN). More recently, Gregg has teamed up with Budget Committee chairman Sen. Kent Conrad to sponsor a commission to take on long-term tax and spending challenges, including entitlement reforms. These are big shoes to fill.

But it appears all is not lost. A story in Politico today contains the following note:

In something of a surprise, the fiscally conservative Gregg noted that Obama selected him "especially" for his work on entitlement reform. "If our credit is going to be good and our dollar is going to be strong, we have to address entitlement reforms," the Republican said.

While the Commerce Department has not before played a strong role on entitlement reform, Gregg's will be a strong voice within the administration for restraining the growth of entitlement spending and putting the nation's long-term books in order.

Update: The Manchester Union Leader weighs in here.

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Samuelsson: Obama in a box

Newsweek's Robert Samuelson writes on the challenges of programs for the aged, both at the federal and state level, and the difficulties politicians face in addressing them:

What looms is a huge transfer of income from younger workers to older retirees. Ideally, we would consciously decide how large the transfer should be. But in practice, the choice occurs semiautomatically. Social Security, Medicare and pension benefits are set by law. Unless the laws are changed, the payments go out, and the pressures on taxes and other government programs are inescapable.

Beyond reassuring speeches, Obama hasn't confronted the conflicts. He's been all things to all people. Rhetorically, he's for the children. But he's also for the elderly. In the campaign, he opposed proposals for reducing the future costs of Social Security and Medicare through higher eligibility ages and lower benefits. Obama is in a box of his own making; he cannot fulfill his promises to children without repudiating some promises to the elderly.

As a society, America is in the same box. The conflicts between generations may or may not incite open political warfare, but either by design or default, we will be making decisions about America's future. The old are well organized and highly protective of promised benefits, while the young are politically passionate and unfocused. For the young, the odds look lousy.

Click here for the whole article.

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Obama to take on Social Security?

The papers are full of stories today indicating that President-elect Obama looks to address entitlement spending as he takes office amidst record federal budget deficits. The New York Times reports on a press even Obama conducted yesterday, saying that "Obama Promises Bid to Overhaul Retiree Spending," saying that

"President-elect Barack Obama said Wednesday that overhauling Social Security and Medicare would be 'a central part' of his administration's efforts to contain federal spending, signaling for the first time that he would wade into the thorny politics of entitlement programs."

Obama provided no details of his plans for entitlements, but said his proposed budget in February would have more to say on the subject.

This could be pretty significant. On one hand, I and many others were critical of Obama's policy stand on Social Security during the election, as his proposed "solution" – a 2 to 4 percent payroll surtax on earnings over $250,000 – would address only around 15 percent of the long-term deficit. Meanwhile, Obama had ruled out any other changes to benefits, taxes, or the retirement age. This didn't give him much room to put together a plausible reform plan.

But the current and projected fiscal situation, with multi-trillion dollar deficit leading into the crush of Baby Boom entitlement spending increases, should mean that past positions should be reconsidered. If Obama and has staff – which includes Social Security experts Peter Orszag and Jason Furman – are rethinking how to address Social Security and looking to move it toward the front burner, that's to be commended. They may have a challenge in convincing Congressional Democrats to go along, but projected deficits are so large that their chances of doing so may be improved.

The challenge for Republicans will be to resist the temptation to demagogue and attack rather than to work together toward a solution. This temptation understandably will be strong, given that demagoguery and attacks were produced in spades by many Congressional Democrats during the 2005 reform debate. But the goal here is solutions. If President Obama is willing to do his part, those on the right should do theirs.

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Peter Orszag, Social Security Benefit Cutter? Not really.

A short article in The Progressive caught my eye through its headline "Obama's OMB Head Would Cut Social Security," which refers to the CBO director Peter Orszag who will soon take up a post in the Obama administration. The article reads:

“On Tuesday, Obama picked Peter Orszag to direct the Office of Management and Budget (OMB). Orszag believes that Social Security benefits should be cut back to help balance the Social Security Trust Fund over the next 75 years.”

This is potentially interesting, in that Orszag's Social Security reform proposal – developed with MIT Prof. Peter Diamond – took what they called a "balanced approach" between tax increases and benefit reductions. This would seemingly put Orszag at odds with President-elect Obama, whose idea of a balanced approach is apparently 100 percent tax increases, zero percent benefit reductions or increases in the retirement age. (Think I'm joking? I'm not.)

This says something about the popular left, where even being open to some benefit reductions for high earners is considered heresy. In any case, though, there's a lot less to this than meets the eye. The reason is that the Diamond-Orszag proposal was actually much less balanced regarding tax increases and benefit cuts than you'd think.

The following table is derived from the SSA actuaries analysis of the Diamond-Orszag proposal, with some additional cost breakdown by me. It divides the effects on the program's actuarial balance of the different components of the plan. In total, the plan improved the system's 75-year actuarial balance by 2.46 percent of payroll, which is equal to 128 percent of the total deficit. The Diamond-Orszag plan seemingly "overshoots" but in fact this is because, like many other plans, it aims to be "sustainably solvent" beyond 75 years.

Diamond-Orszag Provision	Effect on actuarial balance	Type	Percent of 75-year deficit
Legacy tax above cap	0.550	Tax increase	29%
Legacy benefit reduction	0.323	Benefit reduction	17%
Legacy tax rate increase	0.323	Tax increase	17%
Legacy tax rate increase above cap	0.323	Tax increase	17%
Benefit reduction for longevity	0.297	Benefit reduction	15%
Rate increase for longevity	0.253	Tax increase	13%
Raise taxable maximum	0.250	Tax increase	13%
Interactions between provisions	0.200	N/A	10%
Add state/local workers	0.190	Tax increase	10%
Reduce top bend point factor	0.180	Benefit reduction	9%
Inflation adjustment near retirement	0.000	Neutral	0%
Widows benefit enhancement	-0.080	Benefit increase	-4%
Low earner enhancement	-0.140	Benefit increase	-7%
Disabled benefit provisions	-0.210	Benefit increase	-11%
Total	2.460		128%

I've categorized each provision as either a tax increase or a benefit reduction. One provision is neutral with regard to cost, while interactions between different provisions improve the actuarial balance by around 0.2 percent of payroll. Since interactions can't easily be attributed to either tax increases or benefit cuts, I've ignored them here.

Around 84 percent of the Diamond-Orszag plan's 2.26 percent attributable improvement in the actuarial balance can be ascribed to tax increases and 16 percent to net benefit reductions. In other words, "balanced" doesn't imply 50-50, or really anything even close to that. The tax increases by themselves are almost enough to fix the 75-year shortfall. While certain people get benefit cuts, there are also a lot of benefit increases in the plan as well.

Now, I'd guess that Orszag would be open to reasonable compromises that differ from his preferred approach, and I'd hope that President Obama would listen to the advice that Orszag gives to him. But the good news for readers of the Progressive and others of that inclination is that Peter isn't nearly as gung-ho on benefit cuts as the article would imply.

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Obama: Tax cuts or welfare?

There's been a fair amount of ink spilled on whether Sen. Obama's claim that he would give tax cuts to 95 percent of Americans is legit. The key point is whether a transfer made to an individual who does not currently pay income taxes can be counted as a "tax cut."

The core component of Sen. Obama's tax cut plan is called "Making Work Pay." I've discussed it elsewhere, but the key claim is that it provides a $500 refundable income tax credit for each worker, for a maximum of $1000 per couple. The Tax Policy Center estimates its 10-year cost at $710 billion, so it's obviously a big-ticket item in Obama's tax agenda.

So here's the question: how should we categorize these policies?

The Tax Foundation reports that 33 percent of filers currently pay no net income taxes, which means that 67 percent of filers do. Since 95 percent is larger than 67 percent, it's seemingly hard for Sen. Obama to argue that 95 of Americans will receive a tax cut when only 67 percent are paying taxes in the first place. The Wall Street Journal editorial page relies on this argument in calling Obama's claims an "illusion."

But note that the references above are to the percentage of Americans paying income taxes. Most or all of the tax filers who do not pay income taxes do pay payroll taxes for Social Security and Medicare. Obama's plan is clearly designed to compensate workers for the employee share of the Social Security payroll tax, which is 6.2 percent of all wages under $102,000. Under Obama's plan, workers would receive a refundable tax credit equal to 6.2% of wages up to $8,000, with a maximum credit of $500 per worker and $1,000 per couple. In effect, workers earning $8,000 would receive a full rebate of their Social Security payroll taxes while those earning more would receive a partial rebate. Obama economic advisor Jason Furman says, "Senator Obama believes that the tens of millions of families working hard and paying payroll taxes do not think that tax cuts are a form of 'welfare' or 'redistribution' - they think it is only fair to reward work."

Having laid that out, a few points seem relevant:

• In a purely technical sense, Sen. Obama's plan is not giving tax cuts to people who don't pay taxes; it's giving refundable income tax credits to compensate low earners for their Social Security payroll taxes. So score one for Obama, I guess.
  
• However, Obama's proposal ignores what's really going on: cutting Social Security payroll taxes for low earners, who already receive more in benefits than they pay in taxes – that is, their "net taxes" are negative – and filling the gap in Social Security's funding using income tax revenues. That's the clearest explanation of what's going on and would be the simplest way to structure what Obama wants to accomplish. If Obama wants to cut payroll taxes, he should cut payroll taxes – without obscuring the effects of his plan on both Social Security progressivity and solvency.
  
• The only problem is that, viewed transparently, almost no one would agree that it's particularly good policy – certainly not a policy worth $710 billion over 10 years, given everything else on our plate. His plan would make Social Security much more progressive and move it toward a "welfare program." And if we didn't fill the gap with income tax revenues, Social Security's long-term deficit would be increased by almost 60 percent.

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New article: “What does the turbulent stock market tell us about Social Security personal accounts?”

I've written about this before, but I have an article today on National Review Online that looks at how Social Security personal accounts would have fared under today's market conditions. The motivation behind the piece was a question from Sen. Obama, asking how you would have felt had you invested part of your Social Security taxes in an account. Presumably it was a rhetorical question, but I took it seriously and was surprised at what I found: assuming a full career with a personal account, even a person retiring today would have increased their total Social Security benefits.

A note on titles: last week I had a piece with Kent Smetters in the Wall Street Journal, which was given the title "The Rich Pay Their Fair Share"; what we actually argued was that you couldn't even judge whether the rich pay their fair share given the type of information on tax policy generally reported in the press. The title here – "Still a Good Idea" – is a bit similar: my analysis doesn't prove that accounts are a good idea, but it disproves one argument for why they'd be a bad idea. So I guess you could have called it "Personal accounts: No worse an idea than before" or something along those lines. (My career prospects as a headline writer are probably very limited – although I always thought that "Headless body in Topless Bar" was a classic.)

In any case, here's the piece followed by an added chart.

Still a Good Idea
What does the turbulent stock market tell us about Social Security personal accounts?

By Andrew G. Biggs

The recent financial crisis and ensuing stock-market gyrations have drawn renewed attention to Social Security reform, in particular proposals to establish personal retirement accounts investing in stocks and bonds. Sensing a political opening, Sen. Barack Obama tells campaign audiences, "If my opponent had his way millions of Americans would have had their Social Security tied to stock market this week. Millions would have watched as the market tumbled and their nest egg disappeared before their eyes… Imagine if you had some of your Social Security money in the stock market right now. How would you be feeling about the prospects for your retirement?"

Well, let's imagine that: if Social Security included personal accounts, how would an American retiring today have fared? Despite recent market downturns — the S&P 500 index is down 24 percent for the year as this article is written — the answer is not at all what you would think.

Consider a simple personal account plan similar to those introduced in Congress. Workers could voluntarily invest 4 percentage points of the 12.4 percent Social Security payroll tax in a "life cycle portfolio," which would shift from holding 85 percent stocks through age 29 to only 15 percent stocks by age 55. At retirement, the account balance would be converted to pay a monthly annuity benefit.

However, workers who chose to divert a portion of their payroll taxes to a personal account would also receive a reduced traditional benefit. Traditional Social Security benefits for account holders would be reduced by the amount they contributed to the account, plus interest at the rate earned by government bonds held in the Social Security trust fund. This would keep the current system's finances roughly neutral.

Account holders' total Social Security benefits would increase if their account returned more than the interest rate on government bonds. This makes analyzing how account holders would have fared a relatively simple task.

Using historical stock and bond returns since 1965, I simulated an individual who held a personal account his entire career and retired in September 2008. A typical retiree in 2008 would be entitled to a traditional Social Security benefit of around $15,700 per year. For workers who chose personal accounts, this traditional benefit would be reduced by around $7,800. However, the worker's personal account balance of $161,500 would pay an annual annuity benefit of around $10,100. This $2,300 net benefit increase would raise total Social Security benefits by around 15 percent.

While today's retiree would have faced the subprime crisis and the tech bubble earlier in the decade, he also would have benefited from the bull markets of the 1980s and 1990s. The average return on his account — 4.9 percent above inflation — would more than compensate for a reduced traditional benefit.

While this is an isolated case, it is telling that the very example Sen. Obama uses to illustrate the dangers of personal accounts in fact refutes the point he is attempting to make. Even workers retiring today would have increased their Social Security benefits by choosing a personal account.

But we can go further. Using stock and bond data from 1871 through 2008 I simulated 95 separate cohorts of account holders retiring from 1915 through 2008. Despite the ups and downs of the stock market, every single group of retirees would have increased their benefits by investing in personal accounts. Total benefits would have increased by between 6 and 23 percent, with an average increase of 15 percent.

The point here isn't that stock investments are a free lunch. In an efficient market the higher returns paid to stocks are nothing more than compensation for their higher risk, and we don't know that future market returns will be as good as those in the past. But accounts do provide a valuable tool to prefund future retirement benefits and reduce cost burdens on tomorrow's workers. And these numbers put the lie to Sen. Obama's exaggerations of the risks of investing in the market.

— Andrew G. Biggs is a resident scholar at the American Enterprise Institute in Washington, D.C.

Here's a chart comparing the real internal rates of return on personal accounts holding a life cycle fund versus an all-bond account, for individuals retiring from 1915 through today.

I have a longer paper (hopefully) coming out soon from AEI that will look into this issue in more detail and show why my results differ from those of Robert Shiller. When that comes out I'll post the data and calculations showing where the numbers came from.

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Obama advisor: “Ask high earners to pay more into Social Security”

Jason Furman, chief economic advisor to the Obama campaign, writes on Social Security in the DesMoines Register:

Sen. Barack Obama is committed to protecting retirement security, strengthening seniors' health-care coverage and treating all seniors with a respect that dignifies their many contributions to our country.

He understands that the challenges facing Social Security and Medicare are very different. Despite the cries of privatization proponents, Social Security is not in crisis - it has a manageable cash-flow issue that we can ably solve over the upcoming years and decades.

Obama is confident that we can come together to find a workable solution. He believes that one strong option to improve Social Security's long-term solvency is asking people who earn more than $250,000 to pay a little more into the system. But Obama will not raise the retirement age or reduce Social Security benefits.

Even more important, Obama strongly opposes the privatization schemes that George Bush championed; Americans' retirements should not be subject to the whims of the stock market. Social Security is one of the most successful government programs in our nation's history. As president, Obama will keep Social Security strong for future generations.

Ensuring the future solvency of the Medicare trust fund may be our toughest fiscal challenge. Forty-two million Americans currently rely on Medicare, and Obama is fundamentally committed to Medicare's long-term strength. Washington is broken, and it has failed to overcome the special interests and pass health-care reform that expands coverage and lower costs, which would keep Medicare strong and affordable for America's seniors. As president, Obama will reduce costs in the Medicare program by enacting reforms to lower the price of prescription drugs, end the subsidies for private insurers in the Medicare Advantage program and focus resources on prevention and effective chronic-disease management.

Obama will also bring Democrats and Republicans together to provide every single American with affordable, available health care that reduces health-care costs by $2,500 per family. By investing in proven measures to improve the health of all Americans and reduce health-care costs across the economy, we can ensure that the Medicare program remains strong for future generations.

Obama is serious about his commitment to America's seniors: He will protect Social Security, strengthen Medicare and work to make sure Americans are able to enjoy a healthy, secure retirement.

All reasonable stuff, as far as it goes. But one question: If Sen. Obama wants to "ask" high earners to pay more, doesn't that imply they get the option to say "no"? I didn't think so…

Ok, one other question: if Obama wants to apply a new tax to people earning over $250,000 -- which we know will fix at most around 16% of the 75-year deficit -- and if Obama has ruled out raising the retirement age or cutting benefits, what else is left? You guessed it: higher taxes on people earning less than $250,000. Even assuming Obama imposes a 4% tax on all earnings above $250,000 and pays no extra benefits -- a double first for Social Security -- the trust fund would remain solvent only around 3 extra years. The numbers just don't work -- mathematically, Obama can't keep his promise not to cut benefits or raise the retirement age unless he's got another source of tax income. A very big source.

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How Obama would change effective payroll tax rates and Social Security progressivity?

This hadn't gotten much discussion to date, but Sen. Obama has a component of his tax plan – called "Making Work Pay" – that would introduce significant progressivity into the tax side of Social Security. His plan is designed to partially or fully compensate workers for the employee share of the Social Security payroll tax – 6.2 percent of the 12.4 percent total tax. Workers would receive a refundable tax credit equal to 6.2% of wages up to $8,000, with a maximum credit of $500 per worker and $1,000 per couple. This is the source of the "tax cuts" Obama references for lower and middle income households. The Tax Policy Center assumes the credit phases out at 5 cents for each dollar of earnings above $75,000, meaning it declines to zero at $85,000.

How does this change the effective Social Security payroll tax rate? The chart below shows the net payroll tax as a percentage of earnings for a single worker, with earnings levels from zero to $102,000 (the current cap on payroll taxes). The net tax rate is 6.2 percent of wages up to $8,000, gradually increasing to the statutory rate of 12.4 percent of wages by $85,000 and remaining constant up to the cap.

How would this affect the progressivity of the Social Security program taken as a whole? Remember, while the Social Security payroll tax may be regressive – a fact those on the left often cite – Social Security benefits are progressive. So you need to look at both taxes and benefits together to understand the progressivity of both current law Social Security and the program net of Sen. Obama's new tax credit.

Commonly Social Security progressivity is described through what is called the "money's worth ratio," which is the ratio of lifetime benefit received by a given individual to lifetime taxes paid. Both taxes and benefits are expressed in present value form, by discounting them at the government bond rate. To put things in terms of rates of return, a money's worth ratio of 1, in which lifetime benefits are equal to lifetime taxes, implies that the individual earned a rate of return on their payroll taxes equal to the return on government bonds.

Social Security's actuaries periodically calculate money's worth ratios for stylized workers at different earnings levels. The data used here come from a 2007 publication and are for single earners retiring in 2008. The SSA actuaries use four stylized lifetime earnings levels. They are:

Very low: Earns around 25 percent of the average wage, or around $10,500 per year. Around 20 percent of workers are in this group (meaning that this is the closest descriptor of their average earnings).

Low: Earns around 45 percent of the average wage, or around $18,900 per year. Around 22 percent of workers are in this group.

Medium: Earns around 100 percent of the average wage, or around $42,000 per year. Around 28 percent of workers are in this group.

High: Earns around 160 percent of the average wage, or around $67,000 per year. Around 21 percent of workers are in this group.

Maximum: Earns the maximum taxable wage each year, or around $102,000. Around 10 percent of workers are in this group.

The following table compares the money's worth ratios for each worker type, assuming retirement at age 65 in 2008, to what they would have been under the Obama proposal.

	Net money's worth ratio
Earnings level	Current law	Obama payroll tax rebate
Very low	1.19	1.88
Low	0.87	1.1
Medium	0.64	0.71
High	0.53	0.56
Maximum	0.47	0.47
Assumes single male worker, retiring in 2008 at age 65

For instance, under current law a very low earner could expect to receive 1.19 times more in lifetime benefits than they pay in lifetime taxes. Since this comparisons are made to present values, discounted at the government bond rate of return (around 3 percent above inflation), this implies a rate of return on payroll taxes of around 4 percent above inflation. Under the Obama proposal, the net money's worth ratio for a very low earner would increase to around 1.88; total benefits would be the same, but lifetime taxes would be significantly lower. While comparisons are not straightforward, this implies an annual return on taxes of around 6.1 percent above inflation. Over a lifetime, the differences are significant.

The chart below uses the data above shows the "slant" of the Social Security program's progressivity under the Obama proposal. As can be seen visually, the system would be significantly more progressive than under current law. This may or may not be a good thing, according to your perspective, but it seems not to be something that should go undiscussed.

Now, what would the effect of the Obama plan be on Social Security's financing? After all, it effectively rebates part or all of the employee share of the Social Security payroll tax. The answer is that technically it would not affect Social Security's financing at all. These rebates, while based on the Social Security payroll tax, would be paid from general tax revenues – broadly speaking, income taxes. The total general revenue cost of the Obama proposal over 10 years is $728 billion, according to the Tax Policy Center.

That said, it's worth comparing the cost of Obama's proposal to those for personal retirement accounts, whose "transition costs" would also would be funded out of general revenue. The last detailed analysis of President Bush's personal accounts proposal I've seen was for the 2007 budget, which forecast a 10-year total cost of around $779 billion. In other words, the two policies cost around the same in the short term. Over the long-term, however, the Bush plan was designed to save those early contributions to help reduce Social Security costs. In other words, almost every dollar of costs in the near term was recouped in later years. The Obama plan, however, is simply an effective reduction in payroll taxes which would have increased costs over the long term.

Note that these numbers omit any reference to Sen. Obama's formal Social Security plan, which would also increase progressivity by imposing a surtax of 2 to 4 percent on all earnings above $250,000. Together, these policies would significantly alter Social Security's progressivity and – some might argue – shift it closer to a welfare-type program.

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Obama Ad Hits McCain on Social Security

Barack Obama has a new ad criticizing John McCain for his support for adding personal retirement accounts to Social Security – an effective attack given the backdrop of the past several weeks. Take a look:

The claim 'cutting benefits in half' is a big stretch. President Bush's proposal for 'progressive indexing' would have addressed about half the long-term deficit – that's a lot different than cutting benefits in half. But we're in an election year so these kinds of claims by either side shouldn't be all that surprising.

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More on Social Security and poverty…

It seems one of my comments from yesterday struck a nerve, both here and over at Arnold Kling's blog. Here's the offending passage:

Sen. Obama says, "Social Security has lifted millions of seniors and their families out of poverty. Without it, nearly 50 percent of seniors would live below the poverty line." This is a common talking point, but let's be clear on what it means: if we forced people to pay Social Security taxes all their lives but didn't pay them any benefits, yes, nearly 50 percent of seniors would live below the poverty line. But this is a silly standard. If we were truly "without" Social Security, we would also be without Social Security taxes, which individuals could then save on their own for retirement. So the better question would be, "Without Social Security taxes and benefits, what would the poverty rate among seniors be?" The answer is, about the same as the current rate.

I made two points:

First, saying that a system that collects an eighth of people's wages all their lives and pays them a benefit at retirement reduces poverty versus an alternate system that collects the same amount of taxes but doesn't pay them a dime at retirement is a silly comparison. This was my main point, but it's also one that you either accept or you don't. To me, it seems so obviously a silly comparison that if you don't understand that I'm not sure what else I can do.

Second, I said that in the absence of Social Security the senior poverty rate today would be around the same. This I'm willing to concede is too strongly stated, though it's worth considering the range of issues pro and con (see below). That said, what I'm conceding is that the elderly poverty rate would be higher than the current rate (officially around 9.5 percent), not that "nearly 50 percent of seniors would live below the poverty line." That I believe is simply wrong. In any case, here are some things to think about:

Individual saving: Would people most at risk of poverty in retirement save as much in the absence of Social Security? Probably not, which is the strongest reason to believe Social Security reduces poverty (if not by 50 percent…). That said, I'm not convinced that run of the mill low earners (meaning low skilled, versus due to health or social reasons) simply wouldn't or couldn't save.

Progressivity: The Social Security benefit formula is progressive, such that low earners get higher replacement rate than higher earners. This will reduce poverty rates versus an un-weighted scheme, though I wouldn't over estimate the effects of progressivity. Redistribution in practice is often quite haphazard; while Social Security likely reduces poverty versus an otherwise identical program with no redistribution, it would be quite easy to design a system with better poverty protections than the current program.

Average rates of return from Social Security: Social Security pays a below-market average rate of return today because it paid an above-market rate of return to early participants. In the absence of Social Security, past retirees would have been poorer and current retirees, on average, richer. This would reduce poverty in retirement.

Total saving rates: Fuchs, Krueger, and Poterba surveyed public finance economists, asking what the personal saving rate would have been if Social Security had never been enacted. The median response was that the saving rate would have been 60 percent higher. If so, output per worker today would be around 20 percent higher. Presumably this would drag more than a few low earners out of poverty.

Labor force participation: Social Security contributions are viewed by many workers as a pure tax, meaning that (accurately or not) they don't expect to receive anything in return for them. This will tend to reduce labor force participation. Moreover, Social Security benefit rules tend to encourage earlier retirement, which would also reduce lifetime earnings.

Portfolio allocation: Social Security is in many ways equivalent to mandatory saving in an all-bond portfolio: low risk, but low return. For higher earning individuals this doesn't make much difference since we can alter our non-Social Security savings portfolio to get the mix of risk and return we like (this is one reason why personal accounts wouldn't be a "better deal" for higher earners; if we want more stocks we can already do it). For lower earners, though, Social Security constrains their portfolio to one that is probably lower risk than they'd prefer.

Additionally, Arnold Kling makes the point that the reduction in elderly poverty over time is as much attributable to the growth of the economy than to Social Security. Per capita national income today is far higher than it was in the 1930s, so even assuming no Social Security program we should expect to see poverty declining over time.

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Tax Policy Center Blog on Obama's Empty Social Security Fix

Ouch. I thought I'd been tough on Sen. Obama's Social Security reform plan. But Howard Gleckman, writing for the Tax Policy center's TaxVox blog, really sticks it to him today.

The thing about a donut hole is that it is empty. There is nothing. And that, it seems, is what is left of Barack Obama's plan to fix Social Security.

The Obama people now tell us that his proposal, which is built on a tax hike for those earning more than $250,000, won't take effect until at least 2018. You heard right: 2018.

That would not be in Obama's first term. It would not be in his second term. It would not happen until two years after his successor is elected, even if he serves a full 8 years. It would also, conveniently, be outside the budget window, allowing Obama to scale back the official size of his proposed tax hike for the wealthy.

Do the political math. Take the likelihood of any politician keeping any given promise. Discount for the time he says it will take to fulfill that pledge. Then discount it again if the effective date is scheduled for roughly the time of his post-Presidential book tour. The credibility factor is infinitesimally low. It is as if George Bush had promised in 2003 that he'd withdraw from Iraq in 2013.

Make no mistake, what Obama is really saying is that, at least for the campaign, he is walking away from Social Security and all of its problems.

Click here to read the whole post.

I'd noted the reduced improvement to system financing from putting off the tax increase for a few more years, but Gleckman hits on a further political dynamic. But Obama's folks have a viable defense, if they want to make it: most people on both sides agree that the Social Security trust fund hasn't been too effective at actually increasing saving. (Click here to read why.) If so, it doesn't make much sense to increase taxes before 2017, when the system is projected to start running deficits. Otherwise, we'd simply be putting more cookies in the cookie jar for Congress to spend. If Obama made that argument I think most people would find it plausible. The problem is that once you acknowledge the trust fund isn't "real" saving, the Social Security problem looks a lot bigger and a lot closer, and solutions for prefunding move more toward personal accounts. I don't think Obama wants to admit either of those right away.

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NY Times on Social Security in Campaign ‘08

The New York Times has a story today on how the McCain and Obama campaigns are treating Social Security reform. It's a good story overall and it's great to see some attention paid to the policy details rather than just the politics.

However, I think the story's title --"Social Security Too Hot to Touch? Not in 2008" – misses the point a bit. What the story shows is that for both Sen. McCain and Sen. Obama Social Security has been a politically difficult issue to address. McCain has had trouble with his conservative base over his willingness to put everything "on the table" (Obama had the same problem when he made a similar statement) while the vagueness of Obama's own proposal is clearly designed for purposes of political protection.

One section is worth highlighting (and not simply because I'm quoted in it):

To begin to attack the problem now, Mr. Obama would subject all wages above $250,000 a year to the payroll tax. That concept has been nicknamed the "doughnut hole" because it would exempt wages between $102,000 a year, the current ceiling for contributions, and $250,000.

"What Barack Obama is doing is different from what people running for president traditionally have done," Jason Furman, Mr. Obama's chief economic adviser, said in an interview. "He's putting an option on the table, not just saying he wants to work with Congress, but also saying what he wants to work on."

While more specific than Mr. McCain's plan, the Obama proposal raises questions. The tax rate Mr. Obama would apply to wages over $250,000 has not been established, but it would be lower than the combined 12.4 percent that employees and employers now jointly pay. "We've studied a range of plans with combined employer and employee rates between 2 and 4 percent," Mr. Furman said.

By itself, the Obama proposal will not guarantee the solvency of Social Security. Andrew Biggs, a Social Security expert at the conservative American Enterprise Institute, calculates that the plan would reduce the gap by 15 percent to 43 percent, depending on the level of the surtax, which he complains "is being fuzzed up to prevent people like me from running the numbers."

It is also not clear whether those paying the additional payroll tax would receive more benefits, as the system now mandates. Mr. Furman said "it is factually inaccurate to say that a decision has been made to de-link taxes from benefits," because "that is something you'd want to work out with Congress."

While Sen. Obama deserves credit for putting an option on the table – something Sen. McCain hasn't done to date – as it currently stands Obama's option is barely a policy. We know people earning over $250,000 will pay more, but we don't know how much and we don't know whether they'd earn any extra benefits. This forces people (like me) to make the best assumptions we can about how things would work.

Here I estimated the effects of a 4 percent surtax on earnings over $250,000, on which no extra benefits would be paid. This would improve the 75-year actuarial balance by around 0.27 percent of payroll, reducing the total 1.7 percent deficit by around 15 percent. This is about the most the Obama approach could get. If benefits were not delinked from taxes, the improvements would be smaller (by around one-fifth, I believe). If the tax rate were 2 percent rather than 4 percent, the gains would be cut in half. You get the drift.

The point here is that under a reasonable range of assumptions, Sen. Obama's plan doesn't get you very far – certainly not far enough that you could rule out raising the retirement age or reducing benefits.

Update: See today's Wall Street Journal op-ed by Jason Furman and Austan Goolsbee for a few more details on the Social Security side of things. One new detail is that the tax increase would not begin until "a decade or more from now." The numbers I cite above assume a 2015 start date, so the solvency improvements would be a tiny bit smaller than before.

Another key point: Goolsbee and Furman argue that Obama's plan is similar to one floated by Sen. Lindsey Graham several years ago, which Sen. McCain at the time said he could support. This is a valid point, but several key differences should be pointed out. First, under Graham's plan any tax increases would be used to fund personal retirement accounts, not finance the curent program or build the trust fund. Second, Graham's proposal included a surtax along with a number of other policies. Obama proposes a surtax but rejects any other changes, putting him on the wrong side of the mathematical divide.

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Academy of actuaries: Raise the retirement age

On Monday the Academy of Actuaries will hold a press conference at the National Press Club to release a new paper on Social Security reform. The sneak preview, via the Associated Press's Jesse J. Holland, is that the actuaries favor raising the retirement age as part of a larger Social Security deal.

Want to keep Social Security from going bankrupt? Make future recipients wait longer for their first benefit check because they probably will live longer anyway, an influential group of actuaries says.

The next president and a new Congress will come under increasing pressure to act to fix the Social Security system. Democratic presidential candidate Barack Obama rejects any increase in the retirement age while his GOP rival John McCain opposes tax increases as a possible fix.

The American Academy of Actuaries, which advises policymakers on risk and financial security issues, wants any potential solution the White House and lawmakers might consider to include raising the retirement age from the current range of 65-to-67-years-old. The group provided The Associated Press with an advance look Thursday of its recommendations.

Current benefits are supplied by payroll taxes from today's workers, all of whom pay a 6.2 percent Social Security payroll tax on income up to $102,000. Their employers match it, for a total tax of 12.4 percent. The tax applies only to earned income, not to passive income such as dividends and interest.

Benefits are projected to exceed the Social Security system's tax revenues in about nine years. The program's trustees have said the Social Security trust fund will be depleted by 2041 without changes.

A major problem, the actuaries say, is that people are living longer. That means they are drawing more money from the program.

When Social Security started in 1935, the average American's life expectancy was just under 60 years, according to the Social Security Administration. By comparison, people now eligible for Social Security can expect to live on average a little past 76, the agency says, "meaning workers have more time for retirement and more time to collect Social Security."

For many years, 65 has been the retirement age to receive full benefits. But under changes in 1983, only people born before Jan. 2, 1938, can collect full benefits at 65. Those born after that date face a gradually rising retirement age for full benefits until it reaches 67.

Current estimates show that by 2040, 65-year-old men and women could live at least 18 more years after becoming eligible for full Social Security benefits.

"You just can't have people living longer and longer and longer, and have the program with a frozen normal retirement age of 67. It just doesn't make sense," said Bruce Schobel, the chairman of an academy task force on retirement security principles. "Eventually people will have a larger and larger proportion of their lives spent in retirement until you reach the point where we just can't afford it."

The academy is not staking out a position on when people should retire and acknowledges that saving Social Security will take more than just raising the retirement age.

"All that we're suggesting is that some increase in the retirement age should be part of any package," Schobel said.

Obama already has rejected such advice. "We will not raise the retirement age," Obama said in June at a campaign event in North Carolina.

Obama has, however, called for a Social Security payroll tax on incomes above $250,000 a year, compared with the current $102,000 threshold.

"Barack Obama is opposed to raising the retirement age. He believes we should strengthen Social Security while protecting the middle-class families that rely on it," said Jason Furman, Obama's campaign economic policy director. "To that end, he would like to work with Congress on a plan to ensure that people making over $250,000 pay a little more to strengthen this vital program for generations to come."

McCain originally said everything was on the table to fix Social Security. He recently has amended that position, saying he would not increase payroll taxes. "I want to look you in the eye: I will not raise taxes or support a tax increase," he told supporters Wednesday.

Former Texas Sen. Phil Gramm, who served as a McCain adviser until he resigned earlier this month, told The Washington Times this month that a bipartisan deal to save Social Security might include raising the retirement age to 70 over 30 years.

Sens. McCain and Obama are both in a bit of a fix here, although Obama worse than McCain. McCain can reject tax increases and still more or less fix Social Security, say through a combination of raising the retirement age and progressive benefit reductions for high earning retirees. (If you let the NRA rise to 70 by 2080 or so, you could do a benefit reduction that shielded the bottom half the earnings distribution from cuts.) The prospects for political success may be limited, but he can at least put together a plan that's plausible as policy.

Obama's in a bit deeper: his plan to hit earners making over $250,000 would fix maybe 15 percent of the long-term deficit, and he's rejected raising the retirement age or cutting benefits. Where does the other 85 percent (much less the additional fixes needed to make the system sustainable beyond 75 years ) come from? If someone has an idea how they plan on making this work, please let me know.

Update: Reader AK questioned whether raising the retirement age would be regressive, given the shorter life expectancies of low earners. The Excel file below shows that raising the normal retirement age wouldn't be regressive, since it would reduce everyone's benefits by the same amount. Raising the early eligibility age -- 62 -- would be regressive and cause larger percentage cuts for low earners.
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AP: Details missing from Obama's Social Security plan

The Associated Press's Charles Babington reports on what we currently know (and don't know) about Sen. Obama's plans for Social Security reform:

Barack Obama's bid to place a new Social Security tax on very high incomes is either a bold or foolhardy plan, depending on who critiques it. But its potential impact is almost impossible to gauge because he is providing few details on basic questions such as what the tax rate might be, what types of income would be taxed and how the taxpayers' benefits would be affected. The Democratic presidential candidate says he would work with lawmakers from both parties to resolve such matters. Voters generally applaud bipartisan cooperation, but they apparently will go to the polls this fall with only a vague notion of what Obama has in mind.

Obama made headlines June 13 when he called for a Social Security payroll tax on incomes above $250,000 a year. Currently, the tax is levied only on the first $102,000 of each worker's income. That covers the entire salary of most Americans. Obama would not apply the Social Security tax to annual incomes between $102,000 and $250,000, a move meant to avoid alienating several million upper-income voters. His proposed change would apply only to those earning more than $250,000 a year, or about 3 percent of all taxpayers.

When he outlined his idea in the battleground state of Ohio, Obama said it is unfair for middle-class earners to pay the Social Security tax "on every dime they make," while millionaires and billionaires pay it on "only a very small percentage of their income." He also said the Social Security program needs revamping to bolster its long-term viability.

With Obama offering few details, several news accounts suggested that his proposed tax on very high incomes would be applied just as the existing Social Security tax is levied on incomes up to $102,000. All workers pay a 6.2 percent Social Security payroll tax on such income. Their employers match it, for a total tax of 12.4 percent. The tax applies only to earned income, not to passive income such as dividends and interest.

In recent weeks, Obama aides have quietly indicated that the proposed tax on incomes above $250,000 might be different in key aspects. The rate probably would be about 2 percent to 4 percent, not 6.2 percent, they said. It's also possible that it would apply to more types of income, including dividends and investments. As for benefits, the campaign has not said how the proposed tax on very high incomes would translate into new retirement income, if any, for those who pay it. The campaign "has not put forth a specific plan" for Social Security, Obama economic adviser Austan Goolsbee said in an interview.

Perhaps because so many details are missing, Obama's Social Security proposal has generated relatively little debate on the campaign trail. But any change to the massive program could have far-reaching effects. Many Americans rely on Social Security for much or all of their retirement income. Some workers, meanwhile, do not realize how much is withheld from each paycheck for Social Security and, to a lesser degree, Medicare. Nearly three-fourths of all workers pay more in these payroll taxes than in federal income taxes, according to the Center on Budget and Policy Priorities. The center assumes that workers pay the full 12.4 percent in Social Security taxes, contending that employers would devote their half of the total to salaries if they did not have to make the 50-50 match.

Given the dearth of details about Obama's plans, some Republicans have criticized it, using assumptions that Democrats reject. Lawrence B. Lindsey, a former economic adviser to President Bush, argues that high earners would pay the full 12.4 percent tax rate on income above $250,000 while receiving no added benefits. "A high-income entrepreneur would see his or her federal marginal tax rate rise to 53 percent from 37.7 percent," Lindsey wrote in a June 20 Wall Street Journal op-ed column. The marginal tax rate is what a person pays on each additional dollar earned. Lindsey wrote that Obama's plans would provide a powerful incentive for the highest-earning Americans to work less, invest less and contribute less to the economy.

Former Oklahoma Sen. Don Nickles, a Republican, agreed. A person who owns two restaurants and makes $500,000 a year would have little incentive to open a third restaurant under Obama's tax plans, and might even close one, Nickles said in an interview. "He's not going to be hiring more people," Nickles said.

Obama economic adviser Jason Furman, responding to Lindsey in a letter published by The Wall Street Journal, said Obama would "work with Congress on a bipartisan basis to design the details" of his Social Security plan, "including the tax rate, how it is phased in over time, the linkage between these tax payments and benefits, and other critical design elements of this plan." Furman wrote that Obama "has not proposed a 12.4-percentage point tax increase on earnings above $250,000."

It seems that both presidential campaigns are slowly asymptoting toward the same general campaign position: pledge support for reform and a willingness to discuss different options with the opposing party in Congress, but don't offer a full reform plan that could be shot down during the campaign season.

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