The cost of "sitting on" Social Security

In a Seattle Times column by Froma Harrop, Dean Baker is quoted regarding his preferred plan for Social Security: wait and see how big a problem it turns out to be.

What should we do about Social Security? "I would just say, 'Let's sit on this,' " Baker answers. If come 2030 Americans see problems looming, he adds, "we can do something."

Here is the Social Security Trustees best guess of what "sitting on it" until 2030 would mean. The current 75-year Social Security deficit is 1.7% of payroll, meaning that and immediate and permanent increase of 1.7% in the payroll tax, from 12.4% to 14.1%, would be sufficient to restore solvency for 75 years. (An equivalent immediate and permanent benefit reduction would do the same.)

With each passing year, an additional year of deficits is added to the 75 year calculation, thereby increasing the size of the deficit. This tends to increase the shortfall by around 0.06% of payroll each year. Therefore, our best guess of the 75-year actuarial deficit in 2030 would be around 1.32% of payroll higher than today's, for a total of around 3% of payroll. This would require an immediate tax increase of 3%, to 15.4%, or equivalent reduction in benefits.

Moreover, while there is a great deal of uncertainty regarding Social Security's future finances, this uncertainty isn't a reason for delaying action. Remember that things could turn out worse than the Trustees project, not only better than projected, and people would be willing to act sooner or even over-balance the program in order to avoid this unlikely but adverse outcome.

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Paul Krugman on trust fund, with comments from Andrew Samwick

Paul Krugman comments on the latest Trustees Report while Andrew Samwick, from his new blogging location, puts Krugman's claims to the test.

Krugman's basic argument -- which I believe really originated with Dean Baker -- is that however we characterize the trust fund, calling Social Security a "crisis" is incorrect. If we believe there is a trust fund, Krugman says, then the program is solvent until 2041, making it a significant but not-so-pressing problem. If we don't believe there is a trust fund, then Social Security is just a part of the federal government and so is funded in perpetuity.

Clever, but limited for several reasons. For once, consider that much of Medicare is not financed through a trust fund, being paid entirely through general revenues, but that doesn't mean we don't consider its cost growth a problem. (It's the only problem, some would argue.) Likewise, Social Security's costs are projected to rise from 4.3% of GDP today to 6% of GDP in 2030. Those costs must be paid, whether we consider trust fund real or not. Whether we consider the trust fund real may influence how we think they should be paid, but the cost increase is real and significant.

Samwick takes on this quote from Krugman:

"As Kevin Drum, Brad DeLong, and others have pointed out, the SSA estimates are very conservative, and quite moderate projections of economic growth push the exhaustion date into the indefinite future."

Samwick points out, much as I have (see here and here), that this claim isn't particularly plausible:

You can look at the sensitivity analysis for the growth in real wages in Table VI.D4 and see that increasing the projected rate of growth in real wages by 0.5 percentage points (around the baseline growth rate of 1.1% per year) shrinks the 75-year actuarial deficit from 1.70% to 1.12% of taxable payroll. That gets us about a third of the way toward a zero balance over 75 years and is a necessary but not sufficient condition to support Krugman's claim. If continued linear extrapolation is valid, then we would need to add about 1.5 percentage points to the real wage growth rate--over 75 years--to get the balance to zero. That's sustained real wage growth of 2.6% per year for 75 years. Krugman should come out and say that such a number is "quite moderate" if that's what he means. Seems pretty optimistic to me.

For a fairly lengthy alternate take on what it means for the trust fund to be "real", see here. Read more!

2008 Trustees Report released

Today the Social Security Trustees released the 2008 Report on the program's finances. The report is available here. The summary of the Social Security and Medicare Trustees Reports is available here.

The short story is that the short- and medium-term forecast is about the same, while the long (and extra long) term forecast is improved. The date at which social security begins to run cash deficits remains the same at 2017, as does the date when the trust fund is projected to become insolvent (2041).

However, the 75-year actuarial deficit improves significantly, from 1.95 percent of taxable payroll to only 1.7 percent of payroll. One way to think about this is that an immediate and permanent payroll tax increase of 1.7 percentage points -- from 12.4 percent to 14.1 percent -- would be sufficient to keep the program solvent for 75 years, though not beyond.

Beyond 75 years, the infinite horizon actuarial deficit also declined, from 3.5 percent of payroll in the 2007 Report to only 3.2 percent of payroll in the current Report.

These long-term deficit reductions reflect not changes in the Trustees' assumptions, but improvements in the methods the SSA actuaries use to project the program's finances. Specifically, the actuaries improved their modeling of immigration, particularly of individuals who immigrate to the United States but later emigrate, generally to their country of origin. These individuals would work and pay taxes into Social Security, but generally not collect retirement benefits. As a result, they are a net plus to system financing.

Commentary: While these new methods for modeling immigration clearly correct a shortcoming in previous methods, more remains to be done in modeling the earnings, fertility and mortality of immigrants, who often differ in all these respects from the native born. In general, the earnings, fertility and mortality of immigrants are not modeled distinctly from the native born. Lower earnings and lower mortality means that immigrants generally receive a higher return from Social Security. Lower earnings also means that individuals who work in the U.S. but return home are a smaller windfall, since their taxes would be lower than average American workers. However, higher fertility could mean that future population growth would increase, which would improve Social Security's finances. I believe these issues can best be analyzed using a microsimulation model in which individuals are modeled distinctly, rather than in the semi-aggregated cell-based model the SSA actuaries use for most of their analysis. Read more!

Life expectancy gap between rich and poor widens

The New York Times reports that while average life expectancies are increasing, they are rising at different rates for Americans of different incomes. The gap in life expectancies between rich and poor is growing. The Times story highlights a number of potential causes, ranging from different risk factors, different levels of medical treatment, and differences in long-range planning for individual health. All likely play a role.

A factor the Times article does not mention is that causation between income and health runs both ways. While those with lower incomes can’t afford as good health care, it’s also the case that those with poorer health tend to earn less, simply because they cannot work as much. If poor health has a stronger negative effect on income today than in the past, this could help explain the trend.

Differential mortality by income has been an issue for Social Security policy for many years. Milton Friedman argued decades ago that Social Security’s formal progressivity was reduced due to the different life spans of the rich and poor. (This is true, though the program remains progressive overall.)

More recently, Peter Orszag and Peter Diamond argued that the Social Security benefit formula should be adjusted to account for rising differential mortality by income. Their reform plan indexed all Social Security benefits to account for rising average life expectancies, but also increased the progressivity of the benefit formula to account that longevity was rising faster for the rich than for the poor.

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Social Security Trustees Report Tuesday

This coming Tuesday the Social Security Trustees will release their annual Report on the financial status of the program. When the Report is released it should be available here.

During the almost five years I spent at the Social Security Administration I was involved with the preparation of the Trustees Report. By the time I became Deputy Commissioner I led the SSA staff who took part in the Trustees working group, which is the day-to-day staff level group that effectively prepares the Report. As I left the agency only in February I was involved in the preparation of the 2008 Report, but like current staff will not discuss the results of the Report prior to its release.

However, this might be a good opportunity to briefly discuss the Trustees process, which I never understood particularly well before I became involved with it. Several issues may be of interest.

First, the White House is almost totally insulated from the process of producing the Trustees Report. White House staff are not involved with the Trustees working group in any way and do not attend Trustees meetings. The White House is not told of changes in the Trustees assumptions and does not know the overall results until the Report itself is released. This is designed to limit political influence on the Trustees Report.

Second, there are often questions of whether the Trustees themselves attempt to exaggerate the size of the problem, either to accomplish political goals or simply to push the public toward action. In the time I spent working on the Trustees Report I never witnessed anything at all along those lines. In fact, it is refreshing how professionally the staff, both political appointees and career, go about their business. I have on several occasions witnessed political appointees arguing for changes in assumptions, purely on the merits, that would make the actuarial deficit smaller. Likewise, I have seen career staff arguing for changes in assumptions that would tend to make the measured deficit larger. The are obviously disagreements about both assumptions and methods, and how these disagreements are resolved would tend to affect the size the of deficit. But among the individuals involved, I have found that these disagreements tend to be normally distributed – that is to say, the fact that a given person holds a certain view that would make the measured deficit larger does not mean that all of his/her views would do so. In short, in my experience issues tend to be examined on the merits.

Third, many people don't understand how strong is the role of the SSA actuaries (who are career staff) within the Trustees Report process. Technically, the Trustees and their staff decide on the assumptions while the actuaries run the numbers to determine what outcomes those assumptions would produce. In practice, however, the actuaries have a very strong influence on the assumptions – both the "headline" assumptions as well as numerous sub-assumptions needed to model the Social Security program. The actuaries first present their own preferred assumptions, that the working group takes as a starting point for their own discussions. The actuaries' assumptions can and are changed, but they are not a silent voice in the process. This has both pros and cons. On the pro side, the "political" influence on the Trustees Report is very small compared to reports from any other executive agency. This lends (or should lend) credibility to their findings. On the other hand, it is intended that the Trustees have a strong role in producing the Report, and it can be questioned whether that role is strong enough.

 

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How dependent are retirees on Social Security?

Warning: This post is long.

In discussions of the role Social Security plays in providing retirement income, one will often hear some variant of the following: Social Security

“is the major source of income (providing 50% or more of total income) for 66% of the beneficiaries. It contributes 90% or more of income for one-third of the beneficiaries and is the only source of income for 22% of them.”

These are official SSA statistics. Perceptions of Americans' dependence on the Social Security program help influence views regarding the shape of possible reforms. For that reason, as well as others, it is important to have a clear idea what these statistics mean.

The interpretation of these statistics, and their sensitivity to alternate formulations, are the subjects of an important series of papers in the Social Security Bulletin by Lynn Fisher, an economist at the Social Security Administration.

Fisher shows that commonly used figures regarding seniors' dependency on Social Security rely on a series of measurement decisions, any of which could reasonably be decided in other ways. Using plausible alternate methodologies, the percentage of seniors entirely dependent on Social Security – around one-in-five, by the standard measure – could be as low as 3.5 percent.

Fisher examines four potential sources of bias in how we measure dependence on Social Security benefits:

• Unit of measurement: do we count "elderly units" or individuals?
• Benefit reporting: do we use self-reported benefit levels or rely on government data?
• Asset income: do we include only regular income payments, irregular payments such as IRA or 401(k) withdrawals, or even assets that can be liquidated to produce income?
• Non-cash benefits: Should we include non-cash benefits such as energy, food or housing assistance?

Any number of reasonable answers can be made to these questions. What is important is that people understand these choices when they ask "How dependent are retirees on Social Security?"

Unit of measurement: The SSA measures of dependence are expressed in terms of “aged units.” Aged units treat each marital unit (married couple or nonmarried individual) as one unit. A non-married individual has only his or her own income and demographic attributes.

How can this affect measured levels of dependence on Social Security? In two ways. First, single individuals tend to have lower incomes, and therefore be more dependent on Social Security, than do married couples. However, since both a single individual and a married couple count as one unit, this can overstate the percentage of individuals who are dependent on Social Security. For instance, if a single person was entirely dependent on Social Security while a married couple was not, on a ‘aged unit’ basis 50% would be wholly dependent on Social Security while on an individual basis only 33% would be.

Second, a non-married individual may share a household with other individuals, but the aged unit does not include the resources of these non-married cohabitants. (Thus, the ‘aged unit’ measure is not as broad as a ‘household’ measure.) If non-married cohabitants share incomes and costs, this can cause overstatement of unmarried individuals’ dependence on Social Security.

Using the individual as the unit of reporting and assuming that family income is shared, the percentage of seniors wholly dependent on Social Security drops from around one-fifth to around 13%.

Asset income: As the pension world shifts from traditional defined benefit plans to defined contribution plans, in which individuals would draw down their account balances to fund retirement expenses, one would expect that the share of seniors reporting asset income would increase. The measured percentage has actually decreased from 1991-2000, but this may be due to the limitations of the CPS survey data SSA uses in its calculations of Social Security dependency. Fisher turns to another survey – the Federal Reserve’s Survey of Consumer Finances, which emphasizes measures of asset holdings, to supplement existing data.

Fisher found that SCF data supported the view that receipt of asset income had remained roughly constant from 1991-2000. From this improved measure of asset holdings, she was able to infer receipt of asset income. This previously unreported asset income was relatively small, but concentrated among lower earners. While it does not greatly affect the average level of dependence on Social Security, it would lower the percentage wholly reliant on the program, from around 20% to around 10%.

Survey data: Fisher examines two issues dealing with data. First, how the Census Bureau’s Current Population Survey (CPS), which SSA uses to calculate its dependency statistics, compares to the Survey of Income and Program Participation (SIPP), another Census survey that can be used to calculate the income of the aged. Second, Fisher examines how results differ when survey data regarding receipt of Social Security benefits is replaced with administrative data.

Survey choice: The SSA dependency data are derived from the Census Bureau’s Current Population Survey (CPS). One advantage of the CPS is that a new survey is conducted annually, allowing for more up-to-date data. Another Census survey, the Survey of Income and Program Participation (SIPP), is conducted less frequently but asks more detailed questions. Survey subjects are asked about 70 sources of income, versus 35 in the CPS, and the survey takers check back with subjects four times per year, versus only once in the CPS. The SIPP also asks detailed questions about financial assets, while the CPS does not.

Administrative data: SSA’s figures regarding dependency on Social Security use self-reported levels of Social Security benefits contained in the CPS survey. However, researchers have matched CPS survey results to SSA administrative files to see how accurately individuals can recount their Social Security benefits. For a number of reasons, individuals misreport their Social Security benefits – confusing them with SSI or other benefits; reporting them net of Medicare Part B premiums, etc.

Taken together, using both the SIPP survey data and matching survey findings to administrative data and reduce reported dependence on Social Security benefits. Using 1996 survey data, Fisher found that the percentage 100% dependent on Social Security using the CPS with self-reported benefits was 17.9%; add administrative data to the CPS and dependence fell to 17.3%; use the SIPP survey with self-reported benefits and 100% dependence fell to 8.5%, and using SIPP matched to administrative records dependence fell to 8.4%.

Effects in combination: Fisher examines a number of different methodological questions separately, the sees how they affect measured dependence on Social Security when used in combination. Table 1 provides details: Combining all the issues discussed above and applied to 1996 data, the percentage of individuals over 65 depending on Social Security for 100% of their income declined from 17.9% to 4.8%. The percentage depending on Social Security for 90% of their income declined from 30.4% to 13.7%.

In an appendix, Fisher explores the effects of including non-cash benefits, such as food stamps or housing or energy assistance. These are not cash, but are nevertheless valuable resources. If non-cash benefits are included, the percentage wholly reliant on Social Security declines to 3.5%.

As we consider potential reforms to the Social Security program, it is important to have good information regarding the retirement incomes of current seniors, and for policymakers to understand what existing information really means. Put another way, if someone asks the qualitative question, "What percentage of seniors are totally dependent on Social Security?", the answer can range from as high as 20% to under 4%. The two different answers may well lead to two different policy conclusions.

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New paper: "How the Income Tax Treatment of Saving and Social Security Benefits May Affect Boomers’ Retirement Incomes"

The Urban Institute has released a new paper by Barbara A. Butrica, Karen E. Smith, and Eric J. Toder analyzing how four potential changes to tax law would affect retirement income. The changes simulated are:

• a) reducing contribution limits on 401(k) plans;
• b) extend tax cuts for capital gains and dividend income;
• c) index thresholds for income taxation of Social Security benefits; and
• d) Eliminate Social Security thresholds and include 85% of Social Security benefits in adjusted gross income

The authors conclude that indexing thresholds for income taxation of Social Security benefits would have the largest effects on the middle class. These individuals do not generally reach 401(k) contribution limits, so lowering them would have a smaller effect than on higher earning workers. Likewise, the middle class tends to have lower asset income relative to other income, so extending cuts in capital gains and dividend taxes would have a smaller effect. Eliminating Social Security tax thresholds would have the largest negative effect on middle earners. Read more!