Wednesday, November 10, 2004

Social Security Reform in the Blogosphere

Beginning with this post, I explained why I think Social Security should have been an important campaign issue and why I believe that the President and Congress must work to reform it. The thrust of the argument is that there is currently a $10.4 trillion hole in the system's finances, and, by not reforming the system, that hole grows bigger each year.

In a post yesterday, Max Sawicky writes:

What would I do, supposing 2042 approached and circumstances were as they are currently projected? I would do a combination of payroll tax increases, increases in the retirement age (ideally voluntary, and with adequate advance notice), a slowdown in benefit indexing, and some general revenue infusions. There is no need to do any of this for some time. (There will be a need for tax increases over the next ten years to redeem debts to the Trust Fund.).
I commend the whole post to your attention, not because I agree with all of it, but because it does clearly state (in this paragraph most of all) the rationale that many on the political left (like Congressmen Matsui and Rangel) have used to delay reform.

The part that is disagreeable to me is that I think Max doesn't fully appreciate (or, at the very least, articulate) what he would find in 2042 if he waited to reform the system. (He says 2042 "approached" rather than "arrived," but for the sake of argument, I'll assume he does in fact wait until 2042.) Here are two ways to characterize the circumstances projected for 2042:

1. The annual cash flow deficits. According to the 2004 Trustees Report, Social Security is projected to run annual deficits of 4.5 percent of taxable payroll in 2042. Over the subsequent four decades, those deficits are projected to widen to 6.0 percent of taxable payroll. So if Max waits, this is the problem he faces in 2042. (To put these in perspective, note that in 2004, taxable payroll is $4.522 trillion, these deficits would be $203 and $271 billion, respectively, if we were running them today.)

2. The unfunded obligations. The 2004 Trustees Report also tells us that the present value of unfunded obligations is $10.4 trillion, using a long-term real interest rate of 3 percent (based on a nominal interest rate of 5.8 percent and a CPI inflation rate of 2.8 percent). If Max waits to reform the system, then the unfunded obligations compound at about 3 percent for 38 years, leading to unfunded obligations of roughly 10.4 x (1.03^38) = $32.0 trillion in 2042.

As I have stated before, the Diamond and Orszag plan is a much better strategy for people on the political left to adopt. They do several things that Max discusses, except that the Diamond and Orszag plan starts doing them sooner rather than later. This is a substantially fairer way to spread the burden of plugging the $10.4 trillion hole, while it is 90 percent of GDP, before it gets to be a $32 trillion hole (141 percent of a much larger GDP). How would you feel if, with the foresight that we have about the demographic factors that will cause the future deficits, policy makers 38 years ago decided to punt on reform, causing you to now have to pay payroll taxes of 16.9-18.4 percent rather than 12.4 percent?

The trouble in this debate is that the people on the political right seem to want to lead with the personal accounts rather than the solvency issue (even though Commission Model 2 achieves both). My fear is that, in the process of making this an issue, we'll get the personal accounts without restoring solvency. The people on the political left are so terrified of personal accounts that they refuse to enter any debate constructively. The Diamond and Orszag plan now stands out as an exception, but, as I noted in the original post on that plan, no Democrats on the Hill have mustered the political courage to advance it legislatively. More typically, we find the attitude that Max has expressed--we can cross that bridge when we come to it. I think that argument does not adequately consider how the size of the problem grows if we wait to address it. Maybe Max will favor us with the magnitudes of the various changes he would suggest as 2042 approaches.

Elsewhere in the blogosphere, Brad DeLong has posted on the circumstances under which he might "accept" personal accounts as part of reform, commented on the post by Max, and linked to some posts by Duncan Black at Eschaton that show some of the political left's misgivings about personal accounts per se.

Some loose ends that I have yet to tie together on this issue, and thus hope to address in future posts: some measures that could be imposed on the personal accounts that might allay the political left's fears of including them in Social Security reform, the relationship between the tax cuts and the underfunding of entitlement programs, and the even more serious problems with Medicare (including the new prescription drug benefit).


Patrick Sullivan said...

Anonymous might want to Google up, "social security" and "Galveston". Or "IRA", "401k', perhaps.

Robert Eisner had some ideas about private accounts too.

Anyway, I doubt Max Sawicky is telling us his real reasons for wanting to wait 30+ years before we do anything. The actual problem comes a lot sooner; when we have to convert those "special bonds" into money. People who act as if that is a mere accounting entry, in my experience, are hoping we'll begin raising taxes at that time. Salami tactics.

Alex said...

Setting aside the issue of whether we should really accept 'unfunded obligations' predictions a half century in the future as gospel, I have yet to understand why personal accounts are a better way to take advantage of the superior return on equities than government simply investing part of the trust fund in stocks. A) 2 trillion in transition costs is no chump change B) there's no real proof the mutual fund industry would be able to or want to deal with a gazillion miniscule new accounts, and even if they do, Social Security's low administrative costs have always been one of its best features, C) why would we deliberately invite the crisis that will inevitably happen when a decade of retirees get caught during a bear market? and D) the budget is screwed enough as it is. In fact the only good argument seems to be that GOP has been getting good mileage out of the "its yer money!" line over the past couple years. If we want to debate setting aside a percentage of taxable payroll over and above that set aside for Social Security, then fine. But that should be discussed as a mandatory savings plan on its own terms, not as an offshoot of Social Security. Blurring the two only serves to confuse what should be a fairly cut and dry issue about defensively adjusting the program's formula.

Anonymous said...

To answer Andrew's question, seeing as how $271 billion or less in today's terms is in the neighborhood of the rundown in annual revenues accomplished by George W. Bush and company in just four years, I don't think it's unreasonable to imagine recouping much of that (remember I contemplated other measures as well) if we were 15 years away from 2042.

I take the point that putting the entire financing burden on the payroll tax is not the best solution. Why should workers in 2042 bear the burden of population changes that long preceded them? There will be plenty of income (or consumption) to tax by then, without precluding real rising after-tax income.

Rather than crossing that bridge when we come to it, I'd say we get ready to cross that bridge when we can see it, rather than rely on the artist's conception.

I don't get excited about measures of the present value of unfunded liabilities from now till forever because I think they are jive. It's a way of ginning up a huge number. If you want to do that, compare it to the present value of GDP.

One thing that is baffling about this whole privatization campaign is why a knowledgeable person like Andrew would prioritize the 2042 problem over the 2018 problem. The latter date is of course about when income tax revenue will be needed to redeem obligations to the Trust Fund and, by extension, Social Security beneficiaries.

As far as politics goes, you can hardly blame the Dems for declining the opportunity of leading with their chins with tax increases and benefit cuts, in the face of a hugely fiscally irresponsible Administration. As things stand, odds are that the diverted payroll taxes would be replaced by borrowed money, further ballooning the deficit. In terms of the present values from now to perpetuity this might be a wash, but should we be indifferent to the impacts of such a policy on interest rates and financial markets?

Now, was that unconstructive?

I will have more to say when I get back home, as I'm presently in the business center of the Minneapolis Marriott, at the National Tax Association conference, where Andrew is missing some fine presentations.

Max Sawicky
(posting as 'Anonymous' because I didn't feel like going through the Blogger rigamarole.)

Pcentrist said...

Matt Miller's "Two Percent Solution" ( argues that just by changing how social security is indexed by inflation to "prices" rather than "wages" would slow down benefits enough to keep the system solvent.

And "wage" indexing is overpaying current social security recepients since wages are rising faster than prices due to productivity gains. People in 2000 were getting 1.2 to 1.4 times their contribution into the system (adjusted for inflation).

I haven't seen any discussion in the blogs or major media about this theory. Perhaps it's too arcane. But if shaving just a bit of benefits solves the problem - and may be justified - why not go this route?