McCain, disgrace, etc.

This morning's news is that in an event Monday Sen. John McCain used the words "Social Security" and "disgrace" in the same paragraph, thereby prompting headlines such as "McCain Says Social Security Is 'A Disgrace'" on the probably non-entirely-unbiased AFL-CIO blog.

Here's video of the McCain statement via You Tube so you can judge for yourself:

A couple points:

First, McCain said that, unless Social Security is fixed, younger Americans won't receive the benefits that present-day retirees have. In one sense, this is wrong – real, inflation adjusted retirement benefits for future cohorts will be just at least as high as for today. However, in another sense – and, to be blunt, the sense that most of the left interprets "benefit cuts" – McCain was correct: future retirees won't receive the full promised benefits that current retirees are, and thus won't receive the same replacement rates (benefits relative to pre-retirement earnings) that current retirees do.

Second, it's clear that what McCain calls a disgrace isn't Social Security itself, but the way it has been financed. Pay-as-you-go financing – transferring taxes from workers to beneficiaries – combined with changing demographics is the principal reason that future beneficiaries won't receive their full scheduled benefits (that's the "disgrace" part). A pre-funded system, in which each cohort puts aside savings to fund its own retirement, isn't nearly as subject to demographic pressures as a pay-as-you-go program. (Two ways in which it is subject: rising life expectancies, which account for Social Security's cost growth from mid-century on, affect funded and pay-as-you-go programs identically. Also, demographic pressures can affect interest rates, which would affect funded programs through the returns on their assets.)

Third, this is really pretty silly stuff.

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Estimated financing effects of (potential) Obama proposal

Yesterday's Washington Post provided some additional details on Sen. Obama's proposals for Social Security. The campaign is looking at applying a tax of 2 to 4 percent total between employers and employees on earnings over $250,000. The campaign does not say whether additional benefits will be paid based on those taxes.

My educated guess is that it's highly improbable that additional benefits would be paid. If benefits were paid based on the current benefit formula the provision would lose money, simply because a 2-4 percent tax isn't sufficient to finance benefits even under the 15 percent replacement factor in the Social Security benefit formula. Moreover, even if additional earned benefits were scaled down, which is possible, the net savings to Social Security would be extremely small. So for these purposes, I'm assuming a 2-4 percent surtax on wages over $250,000, very similar to the surtax used in the Diamond-Orszag proposal from a few years back.

I've simulated a 4 percent surtax using the GEMINI microsimulation model developed by the Policy Simulation Group, assuming the tax increase is imposed as of 2015. Results are relative to the baseline estimates of the 2007 Trustees Report, which projected that Social Security would begin running cash deficits in 2017, face trust fund insolvency in 2041, and run a 75-year shortfall equal to 1.95 percent of taxable wages.

Compared to the 2007 baseline, a 4 percent surtax above $250,000 would delay cash deficits from 2017 to 2018, trust fund insolvency from 2041 to 2045, and reduce the 75-year deficit from 1.95 percent to 1.68 percent of payroll.

In the 2008 Social Security Trustees Report, the projected 75-year shortfall was reduced from 1.95 percent to 1.70 percent of payroll, principally based on changes in methodology for modeling the effects of immigration on system financing. Therefore, it can be expected that the 75-year shortfall under Sen. Obama's proposal would be lower than calculated above – somewhere in the range of 1.5 percent of payroll.

That said, even based on the reduced 2008 deficit, the Obama proposal would come nowhere close to restoring long-run solvency. Sen. Obama advertized his original plan as a means for avoiding benefit reductions or increases in the Social Security retirement age, but these calculations make clear that these steps would be needed in addition to the tax increase on individuals earning over $250,000. While these numbers are based only on educated speculation regarding the final form of Sen. Obama's proposal, it is unlikely the net results would differ significantly.

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New info on Obama proposal

The Washington Post's Perry Bacon Jr. reports this morning on how Senators McCain and Obama are looking at Social Security reform. Not too much new information on the McCain approach, but new details added on Sen. Obama's plan. Will return to the subject later with more info.

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NCPA compares candidates on Social Security reform

Sadly, there's not a ton of source material to work with, but the National Center for Policy Analysis puts together a side-by-side on McCain vs. Obama on Social Security reform:

	John McCain	Barack Obama
Social Security Reform	Partial Privatization - Provide younger workers the option of putting a portion of their earnings into personal savings accounts in return for reduced future benefits from the Social Security system	Keep current system but with changes to funding and taxes as stated below Opposes privatization
Raising Retirement Age	Unstated	No
Savings	Unstated For younger workers, use of personal savings accounts to accrue retirement income in addition to Social Security (see Social Security Reform above)	Expand the Saver's Credit to households earning up to $75,000 Automatically enroll workers in a workplace retirement plan (Employers will be required to enroll their employees in a direct-deposit IRA account if no retirement plan currently exists)
Payroll Taxes	Rules out higher payroll taxes to pay for Social Security	Raise payroll taxes on incomes over $250,000 Those making $102,000 - $250,000 would not see any changes
Benefits	Require the government to keep its full entitlement obligation to seniors	Require the government to keep its full entitlement obligation to seniors
Benefits Taxes	Eliminate the tax on Social Security benefits	Eliminate income taxes on senior citizens making under $50,000 (This applies to general income; not Social Security benefits)
Medicare	Lower Medicare premiums for seniors while also reducing the growth of Medicare	Reduce waste in the Medicare system

 

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McCain steering clear of entitlements?

The Politico
reports that McCain campaign's economic focus has so far stayed far away from entitlement reform, but advisor Doug Holtz-Eakin hinted that a President McCain would reach out to Democrats:

McCain adviser steers clear of entitlements

Asked on a conference call with reporters just how John McCain would balance the budget by 2013, his top economic adviser offered the usual recipe. "Broad-based efforts at controlling discretionary spending, keeping growth rapid and reviewing programs for their effectiveness." Of course, with McCain's proposed tax cuts, that still may not get the country to a balanced budget.

Which is where Holtz-Eakin's next statements come in. McCain, noted his adviser, "has a long history of being someone who can reach across the aisle" to address policy issues. He'll "solve big problems and provide leadership," Holtz-Eakin said, staying vague. 

Don't get what he's talking about? It's the issue that dare not speak its name during a campaign -- what to do about those entitlements that take up a much larger slice of the federal budget than any earmarks McCain wants to cut.

What Holtz-Eakin was suggesting, of course, is that McCain would work with Democratic leaders in Congress to address the increasingly heavy fiscal load that will come when baby boomers retire and start drawing Social Security, Medicare and Medicaid.  The political challenge is saying during the course of a campaign just how you'd balance the budget by addressing this looming challenge.   McCain dares not propose increasing taxes on Social Security for fear of offending his tax-averse GOP base.  But he also, wisely, fears the wrath of seniors in such key elderly-heavy states such as Florida and Pennsylvania that would come were he to propose cutting benefits.

So instead it's mostly a wink and a nod -- the suggestion, if not outright proposal, that McCain will work and compromise with Democrats on the Hill to offer the needed harsh medicine that can't be unsealed until after Election Day. 

At the same time, however, a McCain document obtained by the very same newspaper had this to say on Social Security:

Reform Social Security: John McCain will fight to save the future of Social Security, and he believes that we may meet our obligations to the retirees of today and the future without raising taxes. John McCain supports supplementing the current Social Security system with personal accounts – but not as a substitute for addressing benefit promises that cannot be kept. John McCain will reach across the aisle to address these challenges, but if the Democrats do not act, he will. No problem is in more need of honesty than the looming financial challenges of entitlement programs. Americans have the right to know the truth and John McCain will not leave office without fixing the problems that threatens our future prosperity and power.

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5 myths about Baby Boomer retirements

In the Washington Post, deputy assistant secretary of the Navy Russell Beland examines a number of "myths" regarding how the retirement of the Baby Boomers will affect the government and the economy. In summary, here they are:

1. As boomers quit working and ease into their golden years, they could break the backs of the younger workers who will have to support them.
   
2. We're running out of time to fix senior-citizen entitlement programs before a crisis strikes.
   
3. Boomers' retirement will be bad for the economy.
   
4. The politicians know what needs to be done; they just lack the will to do it.
   
5. Saving the budget will require either major reductions in the old-age entitlement programs or major tax increases -- or both.
   

If you want to know why they're myths – to be honest, I find some of it not totally ready for prime-time – you'll have to read the whole thing.

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New paper: Policies to reduce uncertainty in Social Security financing

I have a new working paper that examines auto-correction policies for Social Security taxes and benefits that would help adjust for uncertainty regard future demographics. (I talk a bit about adjusting for economic uncertainty, but will do some more detailed work on that in the future.) Here's the basic story, in pictures.

Figure 2 shows the probability distribution of Social Security's net cash flow (income minus outgo), programmed to match the stochastic simulations contained in the Social Security Trustees Report. The median outcome matches the Trustees intermediate projections, but there's obviously a ton of variability. There's about a 1 percent chance we'd be almost in positive cash flow in 2080, but an equal 1 percent chance of cash deficits of 12 percent of payroll. What can policy do about this?

Figure 2: Stochastic simulation of Social Security cash flows, SSASIM model

One policy option is to index initial benefits to price growth rather than wage growth. This will definitely improve expected outcomes for solvency – based on the intermediate projections, this chance alone would fix financing in perpetuity. However, price indexing also increases uncertainty regarding system financing, because benefits no longer adjust to changes in wages (higher wage growth equals higher benefits, lower wage growth equals lower benefits). Figure 4 below illustrates: the median outcome is a lot better than current law, but the level of uncertainty is actually higher.

Figure 4: Stochastic simulation of cash flows under price indexing, SSASIM model

So here's an alternate idea: index changes in taxes and benefits to changes in the ratio of workers to beneficiaries. Long-run, demographics are the biggest sources of variation in system financing (because most of the economic uncertainty gets handled through wage indexing of benefits). The worker-beneficiary ratio accounts for both changes in fertility (workers) and mortality (beneficiaries). If we index to that, we'll account for much of the uncertainty in the long run.

Figure 6 illustrates indexing of benefits to the worker-beneficiary ratio, although the paper also contains a similar chart showing tax indexing. I set things up so that the average affect of the change on solvency would equal that of price indexing – that is, sustainable solvency based on cash flows. However, the level of uncertainty is far smaller.

Figure 6: Stochastic simulation of cash flows under dependency indexing of benefits, SSASIM model

This approach has several advantages. First, it helps deal with the folks who claim the Trustees are pessimistic and there's no real problem lurking in the future. If so, there's no danger in implementing auto-correction policies, since they only make changes as needed. This might help get reform enacted sooner, which is important. Second, auto-correction policies keep financing on a stable basis, which helps smooth burdens more reliably between generations. Without auto-correction, policymakers are likely to wait until the last minute to make changes, which inevitably pushes larger burdens off onto later generations. Third, auto-correction policies give future generations the chance to change Social Security as they wish, from a baseline of solvency rather than insolvency.

There are some other issues to address, such as indexing for economic uncertainty, how to deal with uncertainty regarding how future outcomes are modeled – e.g., the large change in Social Security solvency that occurred in the 2008 Trustees Report was principally due to changes in how immigration was modeled, not to assumptions regarding immigration levels. But as a general class of reforms, I think auto-correction policies have an important role to play.

Plus, Obama policy guru Jason Furman also likes them, which means we may see them sometime in the future.

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