We’ve finally “stopped the raid” on Social Security…

For years, politicians and members of the public have decried the so-called "raid" on the Social Security trust fund, in which surpluses generated by Social Security were spent on other programs. For instance, back in 1990, Sen. Harry Reid asked, "Are we as a country violating a trust by spending Social Security trust fund monies for some purpose other than for which they were intended? The obvious answer is yes."

Now, there was nothing illegal about this practice; since Social Security was required by law to invest it surpluses in Treasury securities that pretty much means the Treasury was required to borrow the money. That said, Sen. Reid assured us, as a lawyer, that someone doing this outside of government would be prosecuted.

More importantly, there's good reason to believe that borrowing from Social Security encouraged the rest of the government to spend more and tax less than it otherwise would have, since the deficits and debt involved were effectively "off the books." The Social Security trust fund still has meaning in an accounting sense, but it doesn't represent any true saving in a budget-wide or economy-wide sense.

Personal accounts were proposed as one means of "saving the surplus," though they ran into problems when it became clear that a lot of people – both in Washington and elsewhere – didn't particularly want the surplus to be saved. They liked their spending higher and taxes lower. Former Vice President Gore proposed the much-derided "lock box" to save the surplus, although even to Social Security specialists it was never quite clear how that would work. Seemingly, the Social Security raid was an unsolvable problem.

But some problems solve themselves. According to the Congressional Budget Office's most recent projections, released this week, Social Security is running cash deficits and will continue running cash deficits, well, pretty much forever. Last year, both CBO and the Social Security Trustees projected that Social Security – while currently running deficits due to the recession – would return to surpluses again for several years before making a final turn South in 2016. The new projections show deficits every year from 2011 through 2021, totaling $593 billion over that period.

So breathe easy, America, the "raid" on Social Security has finally been stopped. Now we just need to think about repaying the trust fund and making the rest of the program sound. But all we heard from President Obama on that subject in the State of the Union address was the sound of a ball being punted.

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Social Security in permanent deficits

According to the CBO. The Associated Press gives the details. Read more!

Disability insolvency in 2018 – what will Congress do?

Investors Business Daily's Jed Graham reports on a seemingly small but important fact: Social Security's Old and Survivors (OASI) program is legally distinct from its Disability Insurance (DI) program, even if their finances are generally lumped together. The DI program is in far worse financial shape than OASI, such that its trust fund is currently projected to be exhausted in 2018. At that point, Congress must do something to keep checks flowing, even if that something is merely to allow for cross subsidization between the OASI and DI trust funds.

It would be nice, though, if we looked at real reforms. On one hand, I'm more open to tax increases for disability than retirement, since on the retirement end people can easily "tax themselves" simply by saving more. That's tougher to do with regarding to private disability insurance. At the same time, though, I'm worried about the increase in disability applicants coming from categories – particularly depression and musculoskeletal problems (read: back pain) – that are hard for SSA to confirm or disprove. My trade-off would be to allow for some higher taxes in exchange for tightened eligibility, but it's hard to predict whether Congress can make the tough choices.

Click here to read the whole story.

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Social Security in Deficit; Will It Ever Rebound?

The New York Times reports that the Congressional Budget Office (CBO) projects that Social Security will run a cash deficit of around $29 billion this year, something that hadn't previously been predicted to occur until 2016. This isn't huge news, as the program was only barely in surplus this past year and the demographics aren't getting any better.

But here's one thing I wonder about: will the program ever come out of deficit again, or is this it? The CBO projects that Social Security will return to small surpluses (in blue) of $5 billion in 2014 and $4 billion in 2015, before again going into deficits—this time permanently—in 2016.

But as far as I know, the CBO's "current law" projections assume that the Bush tax cuts are repealed in their entirety when they expire at the end of 2010. If, however, the cuts are retained for low- and middle-income households—as President Obama has promised—then Social Security revenues from income taxation may be slightly reduced. This could be enough to tip the balance.

In 2014, for instance, Social Security's own actuaries predict that the program will receive around $31 billion in revenues from income taxes levied on retirement benefits. If that amount is reduced slightly, then the chances of a surplus are reduced.

In the end, the difference between a small surplus and a small deficit isn't a big deal substantively. Over the next 10 years, CBO projects that Social Security will run a total cash deficit exceeding $200 billion.

But it may be a big deal in influencing if and when Americans and their representatives in Washington come to terms with the fact that Social Security and other entitlement programs aren't going to fix themselves. As long as Social Security has been in surplus, it has been easier for policy makers to forget that fact.

Update: Marc Goldwein over at the Committee for a Responsible Federal Budget caught this first -- I'm losing my edge as I get older...

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Me on Fox Business talking about Social Security

For some reason I can't embed it, but here's a link. The focus is on the CBO's projection that for the first time since the 1980s Social Security will run a cash deficit this year. CBO projects a deficit of around $28 billion, moving back toward balance over the next few years and then back into deficit again.
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Cross posting from NASI blog

I left an extended comment to former SSA chief actuary Haeworth Robertson's post on the Social Security Trust Fund over at the National Academy of Social Insurance's blog.


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CBO presentation on decline in Social Security surplus

The Congressional Budget Office yesterday made a presentation to the Social Security Advisory Board regarding the recession-induced decline in the Social Security surplus. I don't believe the presentation is available online, but I've uploaded a copy here.

The viewer below shows the charts, which focus on tax revenues and costs, the total Social Security surplus (including interest) and the primary surplus (which does not include interest payments) and the trust fund balance. Each chart tells the same story in a different way: that Social Security's finances have received a pretty significant hit from the recession. Cash flow-wise, it puts the program three to four years behind where it otherwise would have been. The impact on trust fund solvency will depend upon a combination of these reduced cash flows and changes in interest rates going forward.

SSAB Presentation - 2009 04 - Trust Fund Charts

Publish at Scribd or explore others: Research fund funds

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USA Today: Recession adds urgency to Social Security fix

USA Today editorializes on the need for Social Security reform:

Our view on retirement: Recession adds urgency to Social Security fix

Vanishing surplus underscores need to ensure long-term solvency.

With 401(k)s and pension funds taking a hit recently, perhaps it should come as no surprise that Social Security is hurting as well. While the program is not invested in the stock market (as privatizers wanted to do), it is dependent on a steady stream of payroll tax revenue, which drops in times like these when large numbers of workers lose their jobs or see their income decline.

Preliminary damage estimates by the Congressional Budget Office aren't pretty. Projected Social Security surpluses over the next decade have all but disappeared. Next year's operating surplus, previously estimated at $86 billion, is now $3 billion. Ten years of cumulative surpluses, once seen at about $703 billion, are now projected at $83 billion.

In short, the long-predicted Social Security crisis is arriving sooner than expected, underscoring the need to ensure the program's long-term solvency now. The global recession, and the losses in other forms of retirement savings, may appear to provide a reason for delaying unpleasant reforms yet again, but this is actually an ideal time to act.

Each year that the U.S. government fails to address its massive retirement and health care obligations raises the prospects of it defaulting on its debts, inflating its way out of them, or imposing punitive taxes to pay them off — any of which would cause greater misery than the changes needed to stabilize the system. A commitment to shore up Social Security would serve as a clarion statement that the U.S. economy is a sound long-term investment.

It would also give confidence to ordinary Americans that Social Security will be around when today's young and middle-aged workers retire.

For all the talk about "trust funds," Social Security essentially operates on a cash-in, cash-out basis. And once the amount being paid out in benefits exceeds the amount coming in — now expected in 2017 — the government will have to borrow billions of dollars to cover the difference.

Compared with solving the health care problem, Social Security should be a walk in the park. As a program it works just fine, but it is unsustainable as the result of increasing life spans, rising benefits, and the aging of Baby Boomers. In 1935 the average retiree lived about 13 years after the age of 65. Today the average is 19.5 years.

Preserving Social Security for the long term isn't that complicated. It can be done by gradually raising the retirement age for able-bodied workers, curbing growth in benefits and making high-income workers pay more payroll taxes. The longer a solution is delayed, the more painful it will become.

Early this year President Obama signaled an interest in addressing the problem. And a bipartisan group of senators began discussing a plan to fix the program, largely by enticing people to stay in the workforce longer.

House Democrats shot this effort down. In addition to the normal reluctance to taking a tough but necessary stand, they reasoned that responsible action would undermine some of the political gains they made after President Bush's unpopular bid to partially privatize the program in 2005.

Maybe so, but the numbers don't lie. Social Security is in trouble. The recession is a reason to fix it now, not an excuse for further delaying the inevitable.

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Wexler reintroduces Social Security (almost) Forever Act

Florida Rep. Robert Wexler reintroduced his "Social Security Forever Act," which would impose a 6 percent surtax on earnings above the taxable maximum of $106,800. The tax would be split evenly between employers and employees, and no additional benefits would be paid based on the extra taxes. Off the top of my head, this would increase Social Security's revenues by around 1 percent of payroll, since around 16 percent of total earnings are above the current wage ceiling and Wexler would tax 6 percent of them, which equals 0.96 percent of payroll.

Using the GEMINI microsimulation model I simulated the effects of Wexler's plan on Social Security solvency. The chart below shows both the system's net cash flows and its trust fund ratio (the trust fund balance divided by that year's benefit payments), both compared to current law.

Trust fund solvency is clearly what Wexler was aiming at here, as the trust fund ratio would remain positive throughout 75 years but become insolvent soon thereafter. However, this plan doesn't approach so-called "sustainable solvency" in which the trust fund would remain healthy after 75 years.

Moreover, the plan depends on building new trust fund surpluses today to help finance deficits in the future, the same philosophy taken in the 1983 reforms. There's not much point in belaboring the problems with that approach. Annual cash flows, while better in every than under current law, still run pretty significant deficits beginning in around 2022, versus (we think) 2017 under current law.

I'm not sure a trust fund-based approach is going to be that effective in truly prefunding future cash flow deficits, but at least Rep. Wexler has the guts to put his plan on the table – which is more than can be said about most Members of Congress, Republicans or Democrats.

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What is the debt-to-GDP ratio if we include the Social Security and Medicare trust funds?

As deficits rise and the Baby Boomers retire, the burdens of government spending on the economy are becoming more obvious. The most common measure of where we are and where may be going is the ratio of debt to gross domestic product. This ratio, more so than the simple dollar value of the debt, indicates the economy's capacity to support government borrowing.

But an important question is how to measure the debt to GDP ratio. All measures include the publicly held government debt, which means Treasury bonds held by everyone from Wall Street investors to ordinary folks saving for retirement. However, it's not clear whether we should includes intragovernmental debt, which is primarily composed of the Social Security and Medicare trust funds.

Many on the left don't like to count the Social Security and Medicare unfunded obligations – which total in the tens of trillions of dollars – as true "debt." That's fine. As some have correctly pointed out, future Social Security and Medicare benefits in excess of what the trust funds can finance are obligations, not liabilities, and can be changed at any time. (It's ironic that many on the left don't wish to change them, but that's another story.) That is, implicit debt isn't the same explicit debt.

But folks on the left are also adamant that the Social Security and Medicare trust funds are true debt – as good as any debt issued to Wall Street, as (say) Dean Baker argues. Ok, that's fine.

But if so, shouldn't we count Social Security and Medicare debt when we calculate debt-to-GDP ratios? I can't see why not. And when we do, it tells a very different picture about the evolution of public finance in the U.S. The chart below is drawn from OMB historical data from 1940 through 2007. It shows both publicly held debt – the kind we usually think about – as well as intragovernmental debt, which includes the Social Security and Medicare trust funds as well as other government trust funds (the highway trust fund, etc.).

As of 2007, publicly held debt equaled 37 percent of GDP. Not a problem, except that CBO projects that the recession and financial crisis coupled with President Obama's spending plans, by 2018 the publicly held debt could more than double, to 82.4 percent of GDP. Most people would consider that a problem.

But then add to that the intragovernmental debt that many people insist must be treated as just as "real" as publicly-held debt. There don't seem to be good projections of future intragovernmental debt, but let's just assume that the ratio to GDP remains the same. (This isn't implausible; while the Medicare trust fund is winding down, the larger Social Security trust fund is projected to peak in the 2020s.)

In that case, by 2018 total government debt will reach 111 percent of GDP. That level would put us somewhere between where Sudan and Jamaica are today, and fifth from highest globally. While there isn't a strict threshold at which debt becomes unsustainable – what matters is the growth rate of nominal debt relative to the growth of nominal GDP – even the IMF and World Bank's debt sustainability framework adjusted for a strong country like the U.S. would frown on debt at that level.

Moreover, the total debt level as of 2018 would be only slightly lower than the historical peak of 121 percent in 1946, when we had just finished fighting a war around the globe. But unlike the debt issued to fight World War Two, this debt won't be incurred in the cause of freedom but in the cause of political convenience – a fight not to defeat foreign enemies, but political opponents who say that long-term spending must be reined in.

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Recession could cut life of Social Security trust fund by five years

I was asked yesterday how the current recession, which has significantly reduced the Social Security surplus, might affect the life of the trust fund. I put together some back-of-the-envelope numbers that at least guestimate the effects. These are necessarily approximations and mix CBO and SSA projections together (CBO, because they have they latest data available; SSA, because the Trustees projections for solvency remain the most prominent and well-understood). Take them with a grain of salt, but qualitatively I believe they should get in the ballpark.

Here's how CBO summarizes the differences in Social Security cash flow – meaning tax income (payroll tax revenues plus income taxes levied on retirement benefits) minus benefits and administrative costs – between their March 2008 budget projections, which also formed the basis for their August 2008 long-term Social Security projections, and their current March 2009 projections:

Even as of 2018, cash flow is almost $50 billion per year lower than was previously projected. I'm assuming this difference declines to zero within 10 years following 2018, although it's possible that the effect is permanent.

Next I calculate the present value of these new-found losses to tax income. Discounted at a nominal interest rate of 5.4 percent, which is a rough average of the 10-year Treasury bond rate from CBO's latest economic projections, this produces a present value as of 2009 of $621 billion. In other words, these future declines in payroll tax revenues are roughly equivalent to the trust fund balance simply being $621 billion lower as of today.

Next, I compound this present value forward to the year 2040 at a 5.2% interest rate, which is closer to the longer-term rates used in CBO's August 2008 Social Security update. This produces a value as of 2040 of $2.99 trillion. This shows the rough lost value to the trust at the point in which the fund is near exhaustion. In CBO's projections, the program is running annual nominal deficits of around $550 billion at that point (that's around $300 billion in today's dollars, for anyone interested).

Now, I simply divide $2.99 trillion by $550 billion, which gives me a value of 5.45. This indicates that the lost income to the trust fund today is worth around five and one half years of solvency in the 2040s. The Social Security Trustees currently project the program will become insolvent in the year 2041, so the current recession could push that insolvency date forward to around 2036.

Bear in mind that these numbers are approximate – you wouldn't want to do brain surgery this way. We will know more when the next Trustees Report is released. Moreover, lower wages today due to the recession can lead to lower promised benefits in the future, although I suspect the offset won't be on anything close to a one-to-one basis. (Losing a year of earnings due to unemployment would reduce benefits only if that year were among the worker's highest 35 and if he doesn't make it up by extending his work life later. In addition, if unemployment is concentrated among low earners, their benefits may become more progressive and partially make up for any losses.)

In any event, though, this gives a rough feeling for the scale of the effects of the recession on long-term Social Security financing.

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The Social Security trust fund is a safe, dependable return. Right?

With the stock market crash, many have pointed to the safety and security of Social Security relative to 401(k) plans and the idea of adding personal accounts to Social Security. There is certainly merit to these arguments, and having a diversified portfolio of safe and risky investments makes sense.

At the same time, it's worth checking into how Social Security's investments have done over time. Surplus taxes paid into Social Security are invested in the Old Age, Survivors and Disability Trust Funds (OASDI), which hold special-issue government bonds whose interest rates are based on average Treasury bond interest rates at the time. The idea here is investments which provide safe, if modest, returns for the long-term.

But not many people have considered how modest. Effective annual interest rates on the trust funds are available through the Social Security actuaries' web site (see here). To calculate real returns I subtracted the annual rate of growth of the consumer price index (CPI), available here. A couple charts tell an interesting story. First is a fairly conventional comparison: how did the trust funds' returns compare to a mixed portfolio of 50 percent stocks and 50 percent bonds? The first chart shows average annual returns by decade and shows a couple interesting things. First, the mixed portfolio returns exceeded the trust fund's returns in all decades except for the truncated 2000-2008 period, by an average of around 2.9 percent. Second, both the stock-bond portfolio and the trust funds lost money in two decades, although only the trust funds had a truly terrible decade, losing 3.5 percent annually during the 1940s.

The second chart shows a running average return on the trust funds, beginning in 1940. The return value for each year represents the average of returns from 1940 through that years. Here's something I found pretty interesting: from the program's inception through 1986, the average annual return on the trust funds was negative. To repeat, through the first four and one half decades, the trust fund's investments lost money on average each year. Following 1986 the running average of annual returns was positive, but barely so: even extending through 2008, the average annual return on trust fund investments, adjusted for inflation, was only 1.38 percent above inflation. These returns are safe, to be sure, but far lower than the 4.4 percent real annual return on the stock-bond portfolio.

So here's a question: if the trust fund's returns have been so low, how did Social Security manage to pay such high benefit returns to early retirees? (The benefit return is a function of taxes paid and benefits received, with the trust fund's investment return having an only indirect effect on benefits.) We've talked here several times about the high returns paid to early retirees; here's a chart showing average annual returns paid to beneficiaries. The answer is that while a sustainable Social Security program would have built up a significant trust fund balance over time to help pay future benefits, the trust fund balance was kept very low and the extra funds paid out as benefits. When Social Security was begun, the idea was for it to become a "funded program" carrying a large trust fund balance. Congress soon acted to delay scheduled tax increases and move up the payment of benefits, in addition to making benefits more generous. (Lesson: past Congresses were pretty much like present ones in terms of catering to current voters over future ones.) High benefits were paid, at the expense of the trust fund balance that could help the system fund itself in perpetuity. This was, in effect, like eating your seed corn: things look good in the short-term, but you don't have the means necessary to keep things going for the long run.

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NBER Summer Institute: Papers available online

Last week I attended the Social Security section of the NBER's annual summer institute up in Boston. A number of interesting papers were presented, some of which are available online. The links are available below. A couple of quick comments on a few of the papers:

• The Auerbach/Lee paper covers much of the same ground as the working paper on resiliency of Social Security financing I put out through AEI a few weeks ago, though they take the extra step of evaluating how the reduction in uncertainty affects the welfare of different cohorts.
  
• The Liebman/Luttmer/Seif paper looks at how well people understand the fact that their Social Security benefits are linked to the taxes they pay, and how this understanding may affect their behavior. They concluded that we can reject the idea that people have no understanding of the benefit formula, but couldn't conclude how firm an understanding they actually do have. This has policy implications, in that one argument for personal accounts has been that it would encourage work by making the tax/benefit link clearer. (In most personal account plans to date that actually wouldn't be the case, since they're built on top of the current benefit formula, but it could be relevant for certain types of reform plans.)
  
• The Delavande/Rohwedder presentation (unfortunately not available online) looked at an experimental online poll in which individuals were asked how they would react to a Social Security benefit reduction, by saving more, working longer, delaying claiming, etc. A very interesting exercise.
  

WEDNESDAY, JULY 23:

JOINT SESSION WITH AGING AND PUBLIC ECONOMICS

ENRICO PEROTTI, University of Amsterdam; The Political Origin of Pension Funding and State Ownership

JUSTINE HASTINGS, Yale University and NBER, LYDIA TEJEDA-ASHTON, Yale University; Financial Literacy, Information, and Demand Elasticity: Survey and Experimental Evidence from Mexico

ALAN AUERBACH and RONALD LEE, UC, Berkeley and NBER; Welfare and Generational Equity in Sustainable Unfunded Pension Systems

GIOVANNI MASTROBUONI, Collegio Carlo Alberto; Labor Supply Effects of the Recent Social Security Benefit Cuts: Empirical Estimates Using Cohort Discontinuities

ERZO LUTTMER and JEFFREY LIEBMAN, Harvard University and NBER, DAVID SEIF, Harvard University; Labor Supply Response to the Social Security Tax-Benefit Linkage

ADELINE DELAVANDE and SUSANN ROHWEDDER, RAND; Individuals' Responses to Social Security Reform

GAOBO PANG and MARK WARSHAWSKY, Watson Wyatt Worldwide; Optimizing the Equity-Bond-Annuity Portfolio in Retirement: The Impact of Uncertain Health Expenses

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Saving the Surplus, or What’s Left of It…

Jack Kemp has a new op-ed promoting a book by Denny Smith and Peter Ferrara entitled "Stop the Raid," which promotes personal retirement accounts as way to keep Congress from "raiding" the Social Security surplus to spend on other things. As Kemp explains,

[I]n 2007, 88 percent of total Social Security tax income was spent immediately for current benefits and expenses, leaving a surplus at $80.3 billion. What happened to that surplus money? The federal government borrowed it and spent it on general budget expenditures. In return, Social Security got Federal IOUs, which promise to pay the money back, with interest. Over the next five years, from 2008 to 2012, the federal government will continue to raid (borrow) another $410 billion from the Social Security trust funds.

Using personal accounts to "save the surplus" is a very attractive – perhaps the most attractive – argument for them, as they could stop a practice most Americans agree is dishonest and harmful to their future retirement security. Saving the surplus, far more than potentially higher rates of return or even a simple ownership argument, is probably the best way to sell personal accounts to typical Americans.

I've used that argument myself, and in the past I think there was a lot of substance to it. Had we saved the Social Security surpluses generated since the 1980s, we would be sitting on a $2.5 trillion pool of assets with which to pay Social Security benefits rather than merely a stock of government bonds that will be repaid by raising taxes on ourselves in the future.

That said, it's a basic rule of economics that we make decisions at the margin: what matters is what we can do going forward, not what we could have done in the past. And the sad truth is that we've put off Social Security reform for so long that there's really not much of a surplus left to save.

Between 2008 and 2016 – the last year in which Social Security is projected to be in positive cash flow – cash surpluses will total around $462 billion in present value (assuming a 2.7% real interest rate). That's a good chunk of change, no doubt.

But many people act as if saving the surplus would be sufficient to fix Social Security, or at least make a good sized "down payment on reform." Social Security's total long-term shortfall equals roughly $13.6 trillion in present value, meaning that even if we saved every penny of the surpluses going forward it would amount to only around 3 percent of the total shortfall. Not much of a down payment. Moreover, given the political economy of things, it's likely that even if that surplus were saved in personal accounts through 2017, the government would make up most of it through increased borrowing. So the net take would likely be less than 3 percent.

Now, 3 percent is better than nothing, and a lot further than Social Security reform has gone to date. But even accounts to save that modest amount would demand vast amounts of political capital, almost surely more than the reform movement has at this point. While accounts have a role to play – an important one, in my view – to be viable that role, and how the accounts would be financed, should be fleshed out in more detail than in a simple "save the surplus" approach.

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How long is forever?

Philosophers may ask the question, 'How long is forever?' Rep. Robert Wexler (D-FL) has provided his own answer to that question: 75 years, but not longer.

The Sun Sentinel reports on the reintroduction of Rep. Wexler's "Social Security Forever Act." To begin, here's how the Congressman's press release describes the bill:

Today, Congressman Robert Wexler (D-FL) reintroduced his plan to save Social Security – the Social Security Forever Act of 2008. Wexler’s legislation closes the Social Security gap, without cutting benefits or raising the retirement age, by imposing a 3 percent hike on payroll taxes for incomes above $102,000 a year. Currently, individuals do not pay any taxes for Social Security purposes on earnings above $102,000. By raising the cap on Social Security taxes, the Social Security Forever Act not only ensures the solvency of this vital program but restores tax fairness in America at a time when income inequality is sharply on the rise.

“Social Security is a fundamentally sound program; however, its future solvency is endangered because not all wages and salaries are subject to Social Security taxes,” said Congressman Wexler. “There is a simple and fair way to solve this problem. By lifting the Social Security earnings cap, Congress can ensure the long term solvency of a program that keeps millions of seniors out of poverty each year. At a time when our economy is struggling, my plan protects Social Security without raising the retirement age or slashing benefits.”

A couple comments:

First, if you go to the actual text of the legislation (available here), it also includes a 3% surtax applied to employers. This seems worth mentioning. Since the employee bears the full burden of the payroll tax, this is effectively a 6% surtax on earnings over the cap, currently $102,000. While not as high as Senator Obama's plan to eliminate the taxable maximum, this would increase the top marginal tax on earned income from 37.9% to 43.9%.

This surtax is equivalent in size (if not incidence) to an increase in the current payroll tax from 12.4% to around 13.7%, an increase of around 1.3% of payroll in the steady state. Since the Social Security actuarial deficit is 1.7% of payroll, and even higher under the 2005 Report when the plan was first constructed, this tells me Wexler's plan would probably not be solvent for 75 years under Trustees' assumptions. (More likely, Wexler constructed his plan around CBO projections, which then showed a much smaller deficit although the current gap between CBO and Trustees projections is fairly small.) This chart shows the annual income and cost rates for the Wexler plan:


Second, the plan wouldn't actually fix Social Security forever. In fact, it actually wouldn't quite make it to 75 years. The chart below shows the trust fund ratio (trust fund assets divided by the annual cost of paying benefits) for the Wexler plan compared to current law.
The Wexler plan is very much like the 1983 reform plan, which changed taxes and benefits only enough to reach 75-year solvency but made no effort to assure solvency thereafter. You can see that the trust fund ratio peaks in 2018 and declines thereafter, a clear sign of unsustainable financing. To achieve sustainable solvency, in which the trust fund ratio is stable or rising at the end of the period, requires that you raise the surtax rate up to around 12%. (This is basically equivalent to eliminating the payroll tax ceiling.)

This highlights why experts have promoted the idea of sustainable solvency. This report from the Social Security Advisory Board's 1999 Technical panel says:

When reformers aim only for 75-year balance, therefore, they usually end up in a situation where their reforms only last a year before being shown out of 75-year balance again. The 1994-96 Advisory Council wisely tried to accept only reforms that produced sustainability over the longer term— sustainability defined in a way that would ensure that taxes and benefits were more or less in line after the 75th year.

75 years is precisely what Rep. Wexler aimed for, and precisely what he got. If your plan is solvent only for the years 2008-2083, once the time period shifts to 2009-2084 you're no longer solvent. Put another way, without the unexpected improvement in solvency in the 2007 Trustees Report, Wexler's "Social Security Forever" plan would already be significantly out of balance since it was constructed to fix only the 2005 actuarial deficit, forgetting that deficits tend to rise as time passes. Some people don't care about this; I do.

Third, the plan would entail a larger build-up of the trust fund followed by a spend-down. If you don't believe the trust fund build-up has improved the unified budget deficit or added to national saving (here's why I don't), then this doesn't make much sense.

For anyone interested, here's the excel file I used in putting these numbers together.

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David Francis on the latest Trustees Report

If only for completeness (and because I'm quoted), here's the latest from Christian Science Monitor columnist David France on the 2008 Social Security Trustees Report. The article is available online here. While I don't agree with Francis's views, he is correct that the improvement in Social Security's long-term financing was generally missed in press reports. The reason, I believe, is that the press focuses on the years in which the program begins to run cash deficits (2017) and the year of trust fund exhaustion (2041), neither of which changed in this year's Report. The total 75-year deficit, however, did fall significantly, but this improvement was largely overlooked.

Social Security sounder than you might think:The latest report from the trustees of the system show improvement in its finances, despite some grim coverage.

By David R. Francis | columnist

from the April 7, 2008 edition

The 1 in 4 American families who receive some form of Social Security benefits should be cheered by the latest annual report of the system's trustees.

That report, issued March 25, shows "a really significant improvement" in the finances of the system, says Andrew Biggs, who helped draft the report while serving as deputy commissioner of the Social Security Administration (SSA).

That's not the way some in the press saw this report. One headline used the word "grim." That description would be true in regard to the report of the Medicare trust fund that pays hospital benefits. While the four trustees signing the report foresaw "enormous challenges" for both programs, they expected Medicare's financial difficulties to come sooner and be "much more severe" than any problems tied to Social Security.

What perhaps caused some confusion among the public is that the report calculated that benefits paid would exceed revenues from taxes on payrolls in 2017, same as last year's report. That prospect is based on the fact that the nation's 80 million baby boomers have now begun to retire.

But the reserves of special Treasury bonds in the system's trust fund will not be exhausted until 2041, as was also stated last year. Yet any fix for the Social Security system should be financially easier, the report indicates.

The system's actuaries now project that an increase in immigrants and their children mean that the number of tax-paying workers in relation to retirees will be higher after 2041 than previously estimated. More immigrants paying taxes means that the actuarial deficit over the next 75 years has dropped from $4.7 trillion in last year's report to $4.3 trillion in the 2008 report.

Those numbers may seem huge, but they are "manageable," says Paul Van de Water, an economist with the National Academy of Social Insurance (NASI) in Washington. "Social Security is structurally sound and does not require drastic changes."

It would take a permanent boost in the payroll tax from 12.4 percent of wages to 14.1 percent (half paid by the employee, half by the employer) to keep the program fully solvent for the next 75 years. Or benefits could be cut a little.

But the important message here is that the system is not bankrupt. Tax revenues will still be rolling in after 2041. If Congress fails to pass remedial legislation and the long-term forecasts of the SSA are correct, the system will still have enough revenue to pay 78 percent of the benefits promised in 2041.

Because of rising productivity over the decades, retirees in 2041 would reap greater Social Security benefits in real terms than the average $1,081 per month that today's retirees receive.

But some analysts hold that the most relevant number for future retirees is the replacement rate – what typical workers would receive in Social Security benefits relative to what they had earned before retiring. That rate would drop from 36 percent today to 28 percent in 2041.

Alicia Munnell, director of Boston College's Center for Retirement Research, finds that drop troubling, especially since many corporations are replacing standard pension plans that carry fixed benefits with 401(k) plans, in which benefits often hang on trends in the stock market or other financial markets.

As of 2004, the typical 401(k) or Individual Retirement Account for a male, head of household age 55 to 64, had only $60,000 in assets. That sum would do little to improve the living standard of most Americans over many years of retirement.

In any case, the analysts interviewed agree that current declines in stock and home prices have enhanced the perceived value of Social Security. Only half of American workers are covered by pensions of any kind outside of Social Security.

Moreover, the recent stock market and real estate woes have further diminished any possibility for privatization of Social Security. The Bush administration proposed partial privatization of Social Security (or private accounts), but public reaction and the last federal congressional election decidedly shot down that plan.

Even Mr. Biggs, who several years back worked for a leading advocate of privatization, the Cato Institute, concedes that the only feasible political possibility at present would be government-encouraged private accounts on top of the existing Social Security system, not carved out of it. That, plus a cut in benefits, might be a "reasonable compromise" between Republicans and Democrats, suggests Biggs, now at the American Enterprise Institute, a conservative think tank in Washington.

Republican presidential candidate Sen. John McCain of Arizona ducks the Social Security privatization issue by proposing a commission led by former Federal Reserve Commission Chairman Alan Greenspan. His somewhat ambiguous words suggest he might support an add-on system of private accounts.

The Democratic candidates oppose privatization. But no action on Social Security is likely until after the November election.

Read more!

Nancy Altman on reform (with editorial comments)

In today's Los Angeles Times, Nancy Altman outlines her proposal for Social Security reform, modeled after the plan put forward by the late SSA Commissioner Robert Ball. (Click here for more details on Ball's plan and here for the actuaries' analysis.)

Following her piece, I've pasted in a letter to the editor I wrote this morning which argues that her proposal appears easy simply because she lowers the bar on what is considered success in reforming Social Security. While due to space restrictions the letter confines itself to the core criticism, I do believe that anyone who argues that Social Security needs prompt action and who is willing to put concrete reform options on the tables deserves credit. Following the letter is some additional detail on what it means for a reform plan to be "solvent."

The right fixes for Social Security

Along with baseball and cherry blossoms, spring in the nation's capital brings a ritualized dance over Social Security. Every year for the last two decades, Social Security's trustees have issued a report alerting Congress that action is needed to keep the program solvent. And every year, Congress answers with silence.

It was not always this way. In 1973, the trustees projected a deficit. By 1977, Congress had responded with corrective legislation. In 1981, when that action proved insufficient, Congress began work on a new solution. President Reagan announced his own set of reforms, including a proposal to cut benefits sharply for people about to retire early. That set off a firestorm of protests. To quell the uproar, Reagan quietly dropped the plan and called for the formation of a bipartisan commission. The commission developed a package that Congress passed and Reagan signed into law in 1983. Subsequent trustees' reports again showed Social Security in balance.

Beginning in 1989, however, the trustees again started alerting Congress to deficits caused mainly by changing assumptions, including those about the economy and disability rates. Why didn't President George H.W. Bush, President Clinton or Congress offer serious solutions? Why did President George W. Bush promote a privatization proposal that would have made Social Security's deficit larger? Where did the political courage go?

In fact, political courage was in no greater supply in the 1970s and early 1980s than it is today. The circumstances were simply different. Back then, Social Security faced a short-term deficit: inadequate funding to pay full benefits by the early 1980s. Congress and the White House were willing to make some hard decisions to avert the political catastrophe of millions of beneficiaries not receiving their promised benefits, perhaps just before the next election. Today, there is no such danger on the near horizon.

Social Security will run a surplus until 2027, when it will have accumulated $5.5 trillion. At that point, if no action is taken, the trust fund will begin to cash out the Treasury obligations it holds. That will allow all benefits to be paid until 2041, according to the latest trustees' report.

Despite the long time frame, the trustees are right to alert Congress, which should act without delay so changes can be modest and phased in. Moreover, the quicker Congress acts, the sooner it will restore an intangible benefit. As its name suggests, Social Security is intended to provide security -- peace of mind -- in addition to cash benefits. Peace of mind is lost when politicians and pundits make alarmist statements like "Social Security is going broke" or "it's unsustainable." Eliminating the projected deficit would end those frightening, hyperbolic claims.

But without an imminent crisis to force some action, what would give Congress and the president the backbone to make the necessary changes? Fortunately, it would take only three reforms and not much backbone to put the program back in balance.

First, instead of repealing the estate tax, as President Bush wants to do, Congress should dedicate its revenue to Social Security. The accumulation of huge fortunes depends, in part, on the productivity and infrastructure of the nation. Requiring heirs to contribute to the basic security of all Americans seems a reasonable minimum to ask of those who have benefited so greatly from the common wealth.

Second, Congress should restore the practice of subjecting 90% of aggregated wages nationwide (i.e., the sum of all wages, taken together, of corporate executives, janitors and everyone else) to Social Security taxes. Because the wages of the highest-paid workers have increased much more rapidly than average wages over the last several decades, only about 84% of all wages is currently subject to Social Security taxes, resulting in billions of dollars of lost revenue every year. Restoring the 90% level, by gradually increasing the maximum amount of earnings subject to taxing, would have no effect on workers earning less than the maximum -- currently $102,000 a year. If this proposal were now law, those earning more than $102,000 -- just 6% of the workforce -- would have paid a mere $120.90 in additional contributions this year.

Third, Congress should permit Social Security to improve earnings by diversifying its portfolio and investing some of its assets in equities, as just about all other public and private pension plans do.

These reforms would restore Social Security to balance -- without benefit cuts, without raising the retirement age and with only a very modest tax increase on 6% of the workforce. Politicians should leap at the opportunity to do so much good and reap so much political gain at such little cost.

Nancy Altman is the author of "The Battle for Social Security: From FDR's Vision to Bush's Gamble."

Following is a letter to the editor I drafted this morning:

Re. “The right fixes for Social Security,” by Nancy Altman; April 9, 2008

To the editor:

Nancy Altman endorses three steps to fix Social Security’s financing shortfalls: first, dedicate estate tax revenues to Social Security; second, increase the wages on which payroll taxes are applied from $102,000 to around $185,000; and third, invest part of the trust fund in stocks.

These steps would not come, as Ms. Altman believes, at “little cost.” Dedicating estate tax revenues to Social Security would break the historical link between taxes paid by workers and benefits received by them – a link that differentiates Social Security from so-called “welfare” programs. Increasing the maximum taxable wage would raise the top marginal tax rate by 12.4 percentage points, and, while it would hit only around 6% of workers each year, would affect over 20% of workers over their lifetimes. Investing the trust fund in stocks would involve so-called “transition costs” and the risk of market downturns in the same way as President Bush’s plan to introduce personal retirement accounts.

While Ms. Altman claims these steps would “restore Social Security to balance,” the Social Security actuaries found these three steps would leave around one-quarter of the program’s 75-year deficit unaddressed. To reach “sustainable solvency,” meaning that Social Security would be solvent through 75 years and financially healthy thereafter, would require changes roughly twice as large as those proposed by Ms. Altman.

Sustainable solvency has been a bipartisan goal of Social Security reformers for the last decade. Thus, Ms. Altman’s solution appears attractive relative to other reform plans only because it fixes much less of the problem. Fixing Social Security will depend on insight, compromise, and the ability to make difficult choices, not on lowering the bar for success.

Yours,

Andrew G. Biggs

The American Enterprise Institute, Washington DC

Here is some more background on the three measures of "success" for a reform plan:

• Sustainable solvency: Almost all current reformers aim to restore Social Security to "sustainable solvency." This means that the program is solvent through 75 years and ends the period on strong financial footing. Sustainable solvency was a standard devised by SSA's actuaries which enables plan designers to avoid the shortfalls of the 1983 reforms, in which the program was solvency for 75 years but fell off a financial cliff in the 76th year. Sustainable solvency has been a standard since the 1994-96 Advisory Council and reform plans across the spectrum have met this standard. Reaching sustainable solvency would require improvements in the actuarial balance of somewhere around 3 percent of payroll.
• 75-year solvency: Prior to the mid-1990s, reformers aimed to keep the program solvency for 75 years, but didn't pay much attention to whether the program ended the 75-year period on strong financial footing. This is a significant shortfall, since many of the individuals who paid taxes during the 75 years, and thus contribute to 75-year solvency, would be retired after the 75th year and thus face benefit cuts if the program were not sustainably solvent. Based on current projections, reaching 75-year solvency requires an improvement in the actuarial balance of around 1.7 percent of payroll.
• Close actuarial balance: Roughly speaking, this standard is met if the 75-year actuarial deficit is less than 5% of total 75 year costs. (The definition is available here.) Since the 75-year summarized cost rate is equal to 15.63% of payroll, 5% of which equals 0.78% of payroll, any reform plan with a 75-year deficit of less than that amount would meet the test of close actuarial balance. Thus, a plan could improve the 75-year balance by less than 1% of payroll and still meet this test.

To my knowledge, only Altman and the late Robert Ball have applied this standard to a reform plan. In short, success by Altman's standards can require as little as one-third the tax increases or benefit reductions of a plan that aims to reach sustainable solvency. This seems, to me at least, to not move the debate in the right direction. Read more!

I won’t tell you what investments to pick if you won’t…

Marketwatch’s Irwin Kellner comments on the latest Social Security Trustees Report. You can read the entire column for yourself, but here I’ve pulled some key excerpts followed by commentary.

Kellner's comments are indented:

In 2000, the system’s actuaries thought the assets of this fund would be exhausted by 2032. Two years later it was 2037. Now the projected exhaustion date is 2041. Meanwhile, the Congressional Budget Office, which makes these projections as well, recently thought the system will remain solvent until at least 2052.

Two thoughts: First, the trust fund exhaustion date, while important, is also a volatile measure, since even a small change in assumptions can shift it by a year or two. Second, while CBO “recently thought the system will remain solvent until at least 2052,” they more recently amended that projection to 2046. Given that CBO uses slightly more optimistic assumptions and that their model tends to show smaller shortfalls even with constant assumptions, this is a relatively small difference.

Judging by past history, assumptions underlying the intermediate projection are very conservative -- especially when it comes to economic growth…. The intermediate projection assumes that the economy will grow by an annual rate of 2.3% per year between now and 2085… well below the 3.4% that the economy grew on average between 1960 and 2005.

Please, I’m begging you, stop these comparisons of past to projected GDP – they just miss the point. As far as Social Security is concerned, “GDP” doesn’t matter. The closest thing to GDP growth that matters for Social Security is the sum of real wage growth and labor force growth. The Trustees projected rate of real wage growth (1.1% annually) is – cue the music – slightly higher than the average from 1960-2007. What’s lower is the rate of labor force growth, but this makes total sense: from 1960-2007, labor force growth grew rapidly (around 1.7%) principally due to Baby Boom birth rates and rising female labor force participation. But birth rates have fallen significantly, meaning fewer new workers, and female labor force participation isn’t going to get much higher than it is today. As a result, total GDP growth is projected to slow, even if output per worker – a better measure of the economy’s health – continues along just fine.

And as you might imagine, the speed at which the economy grows has a lot to do with the other variables -- including the interest the fund earns from investing its surplus in Treasuries.

Actually, GDP growth is the product of the other variables, not an input to them. Moreover, the correlation between real GDP growth and real interest rates on the trust fund – around 0.18 – while positive, isn’t terribly strong.

You might ask the question why this more realistic [low cost] projection has escaped politicians from both major parties. I don't know why, but I can only theorize that it's because they haven't taken the time to read the entire report.

Alternately, it may be because they have read the entire report. The arguments here are typical of those you read in the press and see on the web, not what you hear from people who really spend a lot of time with this material. Read more!

Myths of Entitlement Reform, and a Call to Action

The Washington Post reports on a joint document signed by analysts at a number of think tanks urging a more disciplined approach by Congress on entitlement reform. Specifically, the joint document – signed by analysts from the Brookings Institution, the Heritage Foundation, the Urban Institute, the American Enterprise Institute and other organizations – calls for Congress to set 30-year budgets for Social Security, Medicare and Medicaid.

The report also outlines a number of myths regarding entitlement reform:

Myth: We can grow our way out of difficult budget choices.

Reality: Strong economic growth will make the choices somewhat easier. Hence, it is important to resolve the budget problem and reform social insurance in ways that enhance growth. However, we cannot grow our way to a sustainable budget outlook. The Government Accountability Office calculates that—if present trends and policies continue— it would take decades of “double digit” growth rates to eliminate the deficit. But, because of the structure of Social Security, that growth in productivity and wages automatically translates into higher future benefits, offsetting a significant portion of the fiscal gains from a larger economy. In short, if the status quo continues and entitlement programs are not reformed, there is no feasible growth rate of the economy that will produce a sustainable budget path.

Myth: Eliminating waste in government programs will solve the deficit problem.

Reality: Improving the efficiency of government programs is important as a matter of fiscal responsibility and restoring trust in government, but it will not significantly reduce future deficits. It is an illusion to think that eliminating waste in government programs will come anywhere near closing the projected gap between spending and revenues. In fact, if present trends and policies continue—and the growth of entitlement programs is not restrained—even entirely eliminating all non-entitlement spending will not close the budget gap.

Myth: The deficit problem can be solved by delivering health care more efficiently.

Reality: Making the health system more efficient can slow the rate of growth of medical care spending and reduce the gap between federal spending and revenues. High priority should be given to eliminating wasteful health spending and increasing value obtained for

public and private health spending. However, even if these efforts are successful, medical care spending is almost certain to grow faster than the economy, and federal health spending will still grow faster than federal revenues.

Myth: We just need to raise taxes starting with rolling back some or all of the Bush tax cuts.

Reality: Higher taxes could contribute to paying part of the rising social insurance bill, but we cannot simply tax our way out of the problem. Even restoring tax rates to pre-2001 levels will not close the gap between spending and revenues. Raising taxes will not address the underlying forces—population aging and health care cost growth—driving spending and revenues apart in the coming decades. Even raising revenues as a percent of GDP to European levels—levels that are unprecedented in the United States—will not be sufficient. If the wedge between spending and revenues attributable to social insurance programs continues to grow, taxes would have to be raised continuously and would eventually cripple the economy. Finally, even if taxes were to be raised, it is not at all clear that Social Security, Medicare, and Medicaid should receive automatic priority for these resources over other needs such as education, homeland security, and infrastructure investments.

Myth: Cutting taxes will increase revenues.

Reality: Lowering tax rates can stimulate long-term economic growth, but at today’s rates not by enough to pay for the lost revenue. Tax cuts used to stimulate the economy during a recession are a different matter, but they should be kept temporary and ideally should be paid for once the economy recovers.

Read more!

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!