Center for Business and Public Policy
at the University of Illinois, Urbana-Champaign

Today is Labor Day in the United States, a holiday started over a century ago as a  “yearly national tribute to the contributions workers have made to the strength, prosperity, and well-being of our country” (U.S. Dept of Labor).

Unfortunately, this year’s Labor Day celebration comes at a time when the employment situation in the U.S. is rather dismal.  Last Friday, the BLS (Bureau of Labor Statistics) put out its jobs report for August.  The official word is that “nonfarm payroll employment changed little (-54,000) in August, and the unemployment rate was about unchanged at 9.6 percent.”

Here is the problem - I have always been mildly dissatisfied with our use of the unemployment rate as the key indicator of the health of the jobs market.  Why?  Because of the “discouraged worker effect.”  In essence, if you are so discouraged by the job market that you have given up looking for a job, you are no longer even considered part of the labor market.  Therefore, you are not counted in either the numerator or the denominator of the unemployment statistics.

An alternative is to look at broader measures.  One such measure was discussed last Friday by Henry Olsen of the AEI in an article posted at AEI Online.  I will refer you to his bog to see the graphic, but the bottom line is that he looks at the ratio of civilian employment to the total population, and finds these numbers much less rosy.  For example, he notes:

“The import of the employment rate is clearer when one compares it and the unemployment rate to data from last August. America’s adult population has risen by 2 million people since then, but the number of adults with jobs has dropped by 180,000.  The unemployment rate declined slightly despite these numbers, from 9.7 percent to 9.6 percent, because over 2.3 million people have left the labor force entirely, so discouraged they are no longer even looking for work.  The employment rate more accurately reflects that despair, sliding down from 59.1 percent to 58.5 percent.”

So, unfortunately, we celebrate Labor Day this year at a time when the outlook for labor is not ideal.  Let’s hope it gets better next year.

Earlier this year, the University of Illinois instituted a “Voluntary Separation Incentive Program” for academic professionals and civil service employees.  It also instituted a Voluntary Retirement Program for tenured faculty and some other academic employees.  Both of these programs were implemented to help downsize the university in order to cope with both temporary and longer-term budget problems.  In an email to faculty, the Chancellor of the Urbana-Champaign campus noted on 8/27/10 that:

“more than 500 employees took advantage of our Voluntary Separation Incentive Program, and some 90 tenured faculty members and 16 adjunct professors and lecturers will leave the University under the Voluntary Retirement Incentive Program. Achieving this reduction in staff through voluntary programs minimized the dislocation and disruption that would have resulted from more drastic measures.”

Over the past 6 months, I have heard a lot of discussion among university colleagues and members of the community as to whether these incentive programs are really a good thing or not.  Concerns seems to focus on two aspects. 

1. Are these programs really cost effective?  For example, how do we know that we are not just subsidizing retirement that would have happened anyway?  If 50% of the people who retired under this program were planning to retire this year anyway, this would essentially doubles the per-incremental-retirement.

2. How do we know that the “right” people are retiring?  For example, might it be the case that the most productive employees are the ones accepting these packages, because they are the ones with the best non-University alternatives for producing income?

I do not have the administrative data from Illinois that one would ideally like to have to answer these questions in our case.  But I did find a wonderful 2004 paper by John Pencavel of Stanford University, entitled “Faculty Retirement Incentives by Colleges and Universities” in which he discusses these and other topics.  I encourage you to read the whole paper if you have the time.  But here is my brief summary of some of his findings (based on his own research and that of other economists):

He examines the early retirement programs used by the University of California for tenured faculty in the first half of the 1990s and finds that:

1. Faculty are indeed responsive to monetary incentives.  He finds that an incentive equal to a one percent increase in a pension replacement rate is associated with a 3.7 percent increase in the acceptance of the early retirement incentive.

2. He shows that it is exceedingly difficult to accurately forecast who accepts such a package, which in turn makes it very difficult to accurately predict behavior in advance.  In the paper (around pages 30 and 31, he explains the reasons in detail).
3. Contrary to the concern raised in my question #2 above about the “best” faculty being most likely to retire, he finds that after controlling for age, length of service, academic discipline, and campus, one can treat salary as a proxy for the “quality” of a faculty member (i.e., if we compare two 60 year old professors in the same department who have been on the same campus for the same number of years, the more highly paid one is, on average, “better.”)  He finds that “those individuals with higher salaries were less inclined to accept the buyout program, a finding that is commonly found in studies of the relationship between pay and quit rates.”  In other words – on average – the better employees (as proxied by salary) were less, not more, likely to accept early retirement.     

4. For those that object to the use of salary (conditional on age, campus, dept and years of service) as a proxy for quality, he also reports results of another study that found that in the years before the early retirement programs, “those faculty with lower research output were more inclined to accept the severance incentives than other faculty.”  Again, this suggests that the most productive faculty are less likely to retire under an incentive program than are less productive faculty.

On net, I confess that reading this research makes me feel better about the program that the University implemented.  However, Pencavel concludes by cautioning against declaring an early retirement program a success simply based on the reduction in payrolls and the absence of adverse selection in who retires.  A full cost-benefit analysis would require an analysis of a much broader range of implications – including the overall impact on the quality of teaching and scholarly output.

In short, only time will tell …

One of the most despised provisions of the Social Security regulations is known as the WEP – an acronym for the “Windfall Elimination Provision.”  This provision is poorly named, poorly designed, and poorly understood.  But that does not mean it should be eliminated.  While the Social Security Administration does a truly horrible job of communicating it, the WEP (or something like it) has a legitimate reason for existing.

What is the WEP?  It is a provision in the law that alters the way Social Security benefits are calculated for individuals who work for state and local employers who do not participate in the U.S. Social Security system.  For example, the earnings of employees of public universities and public schools in Illinois – who participate in Illinois SURS and Illinois TRS – are not covered by Social Security. 

Illinois is not alone.  Approximately one fourth of all public employees in the U.S. do not pay Social Security taxes on the earnings from their government job according to the U.S. Government Accountability Office (GAO).  This includes approximately 5.25 million state and local workers, as well as approximately 1 million federal employees hired before 1984. 

However, many of these public employees – including the author of this blog – will still qualify for Social Security benefits, either as a result of switching between covered and uncovered employment at some point in their career or because they simultaneously work two or more jobs that span both covered and uncovered employment.  For example, a teacher in the State of Illinois may spend his summers working in covered employment.  Alternatively, a professor may spend part of her career working at a private university covered by Social Security, and part of her career working for a state university that is not covered. 

If Social Security benefits were calculated as a simple “linear” function of lifetime earnings, this would not present any problems.  If you earned 50% of your lifetime income in Social Security, you would just get 50% of the benefit that you would have earned had all your earnings been covered.  The only thing Social Security would need to know is how much you paid into Social Security.  Whether you have other “uncovered” earnings would be irrelevant.

But Social Security does not have a “linear” benefit formula.  Rather, it is explicitly designed to offer a higher ratio of benefits-to-taxes-paid for low income workers than it offers to higher income workers.  It is designed this way in an attempt to redistribute income from the rich to the poor.

And therein lies the problem.  If Social Security only observes part of a person’s total earnings (e.g., they know someone’s earnings from a summer job, but not their university salary), then they might mistakenly classify this person as a low-income individual, even though they might be a high income individual who just had a small part of their earnings covered by Social Security.  As a result, blindly applying the same benefit formula to this person gives them a benefit that is too high relative to other individuals who have the same total lifetime earnings!  In essence, we would be paying too much to people who only worked a small part of their career under Social Security.      

In order to adjust for this, the Windfall Elimination Provision (WEP) was enacted as part of the 1983 Social Security Amendments.  This provision is meant to downward-adjust the Social Security benefits of affected workers in order to eliminate the “windfall” (a poor choice of words, I am the first to admit!) that arises when, for example, an individual with high lifetime earnings (based on both covered and uncovered earnings) would appear as if he or she were a low earner when evaluated solely based on covered earnings. 

It is easiest to see the problem that would be created if there were no WEP provision in place through an example.  Consider the three individuals shown in the table below.  “Larry” is a very low income worker who works his entire life under Social Security, with an average lifetime monthly earnings of only $500 per month.  Using the 2008 benefit formula, Larry would have a full benefit $450, or 90% of his pre-retirement income.  “Mo” is a higher income worker with all of his earnings covered under Social Security, thus having an average monthly income while working of $5,000.  Under the benefit rules, Mo would have a full benefit of $1891.34, or a 38% of their working life income.  Thus far, this example simply illustrates the “redistributive” nature of the benefit formula, as Larry receives a higher replacement rate than does Mo, owing to the fact that Larry has lower lifetime earnings.

Social Security Primary Insurance Amount If No WEP Adjustment Applied

Now consider Curly, a public employee.  Curly’s total lifetime earnings of $5000 are identical to Mo’s.  Had all of Curly’s earnings been covered by Social Security, Curly would have the same 38%replacement rate as Mo.  However, only 1/10^th of Curly’s earnings were in employment covered by Social Security; the rest were in non-covered public employment.  If Social Security applied the standard benefit formula to Curly’s covered earnings without any WEP adjustment, Curly would receive a monthly benefit of $450, equivalent to Larry.  This provides Curly with a ratio of benefits to (covered) earnings of 90%, which is substantially more generous than the 38% ratio provided to Mo, even though Mo and Curly have identical lifetime earnings.  To use the language of the provision designed to address this issue, Curly would receive a “windfall.”  The WEP adjustment is designed to calculate Curly’s benefits differently, so that they end up looking more like Mo’s, since they both have similar lifetime incomes.    

In short, because Social Security is a redistributive program, there is a real need for something like the WEP.  Most people affected by it, however, hate it.  And who can blame them given that SSA does a terrible job of explaining it?  In essence, instead of telling a retiree that “your benefit will be $800,” SSA tells them “your benefit would be $1100, but because of the WEP, it is only $800.”  But for the individual in question, the $1100 benefit is a red herring.  In no way, shape or form is the $1100 benefit a relevant amount to start with.  So SSA’s poor communication and negative framing raises a lot of hackles unnecessarily.  As a result, thousands of letters are written to elected officials every year demanding that it be repealed.  And, every year, bills are introduced in Congress to eliminate it.  And every year, those bills fail as they should.

This is not to say that the WEP is perfect.  Far from it.  I have written more extensively elsewhere that the WEP calculation may be close to correct on average, but it is almost certainly wrong for each individual.  Sadly, it hits lower income individuals harder than it should, and does not hit most high income individuals hard enough.  There is a “right” way to calculate the WEP, but implementing it requires that SSA have a full history of both covered and uncovered earnings, but they did not collect the uncovered earnings in a systematic way until the early 1980s.  As such, we probably have to wait another 10 years before they can implement the fix.  In the meantime, SSA could do themselves and a lot of elected officials a huge favor by taking the time to adequately educate affected individuals on the rationale for this program.

As an economist, I often get annoyed when lawyers with no training in economics try to act as if they are experts in economic policy.  As such, all the lawyers out there should be equally annoyed with this blog post, because I – an economist with no legal training – am about to make an observation about state constitutional law. 

Several readers have emailed me the Chicago Tribune op-ed on August 10, 2010 entitled “Pension check may not be in the mail.”   In it, Dennis Byrne states that “if the pension funds go bust, the state has no obligation to step in to pay the benefits.”  This was based on a legal opinion provided by the Chicago law firm Sidley Austin.

According to this legal opinion, the contractual agreement is between the workers and the pension fund, rather than the workers and the state.  I find this a rather odd interpretation. 

In the 1998 “Sklodoswski” decision by the Illinois Supreme Court, “beneficiaries in various state employee pension systems brought suit seeking to compel the state and its officials to appropriate monies necessary to meet statutory funding obligations contained in the Illinois Pension Code.”

Essentially, Supreme Court ruled that while beneficiaries do have a contractual right to benefits, the Illinois constitution does not require that the state pre-fund those benefits. 

The court ruled that:

“allegations of underfunding are insufficient as a matter of law to constitute an impairment of benefits.  Plaintiffs … have alleged only an opinion that present funding levels are insufficient, from a prudential standpoint, to meet the accrued future obligations of the funds.  These claims have no factual allegations that would support a finding that the funds at issue are ‘on the verge of default or imminent bankruptcy’ such that benefits are in immediate danger of being diminished.”

The Court seems to have come awfully close to saying that if the level of funding reached a point where it was “on the verge of default or imminent bankruptcy,” such that the funds were no longer able to pay benefits, then this would constitute an impairment, and the state would have to pony up the funds.  The Court was simply observing that being actuarially under-funded is not sufficient to impair benefits.  And the Court is right on this point – since true impairment comes when the fund runs dry, not when there is an actuarial imbalance.  But once the funds run dry, the unspoken implication is that benefits would indeed be impaired and that the state would have to step in at that point. 

If you don’t believe these hypothetical discussions, then let’s look at some history.  As I noted in my 2009 paper in the American Economic Review (co-authored with David Wilcox):

“Perhaps the most reliable evidence on the riskiness of public pension benefits comes from instances when a public pension plan sponsor suffers from severe financial distress. For example, during the 1970s, the fiscal position of New York City deteriorated so greatly that, by March 1975, it was unable to complete a $912 million offering of short-term notes (Attiat F. Ott and Jang H. Yoo, 1975).  In response to the ensuing crisis, the city negotiated a one-year wage deferral and, over the period to 1978, cut 61,000 jobs from its payrolls, among other steps (David Lewin, 1977).  City pension funds became important sources of financing for the city.  Nonetheless, the city never reneged on accrued benefits under any of its five DB plans.  This protection of pensioners during a period of losses for other parties reflected the non-impairment provision in the state constitution.” 

“Another notorious case study occurred in the early 1990s, when Orange County’s Treasurer, Robert Citron, invested heavily in derivatives and long-term bonds, betting that short-term interest rates would remain low.  In December 1994, Orange County filed the largest municipal bankruptcy in U.S. history, following nearly $1.7 billion in losses sustained in Citron’s fund.  In response, the county chief executive officer proposed a 40 percent reduction in the county’s general fund budget, layoffs of more than 1,000 people, and the elimination of more than 500 other vacant positions (Matt Lait, 1995).  In spite of these financial difficulties, however, defined-benefit obligations were met in full.  In part, beneficiaries were protected by the fact that the pension fund was over-funded.  However, they were also protected by a constitutional provision stating that “the assets of a public pension … system are trust funds and shall be held for the exclusive purposes of providing benefits to participants in the pension or retirement system…” (Article XVI §17(a)).  Attempts by the county to use the surplus assets in the trust fund were rebuffed.”

In short, there has never been a case to my knowledge where a pensioner residing in a state with a constitutional guarantee against impairment was denied his or her benefits.

If I were a participant in a state DB plan (which I am not), I would still be pretty comfortable with my pension guarantee.  For perspective, it remains a substantially stronger guarantee than what the other 95% of America gets from Social Security which (a) is intentionally structured as an unfunded, pay-as-you-go system, and (b) which can be changed by Congress and the President at any time.

This coming Saturday, August 14, marks the 75^th birthday of the U.S. Social Security system. Specifically, it marks the date that President Roosevelt signed the Act into law, famously stating:

“We can never insure one hundred percent of the population against one hundred percent of the hazards and vicissitudes of life, but we have tried to frame a law which will give some measure of protection to the average citizen and to his family …”

The original Act specified that benefits were to be paid only to primary workers when they retired at age 65.  The Act established that benefits would be based on payroll tax contributions made during the working years.  Of course, the program has been modified many times over the years (e.g., allowing benefits to be taken at 62, expanding coverage to spouses, disabled workers, and others, dramatic increases in tax rates, changes in benefits, etc). 

Initially, benefits were paid as a lump-sum.  While Ida May Fuller is best known as the first recipient of Social Security benefits, SSA’s historian indicates that the first benefits were paid as a lump-sum, and that:

“The earliest reported applicant for a lump-sum benefit was a retired Cleveland motorman named Ernest Ackerman, who retired one day after the Social Security program began. During his one day of participation in the program, a nickel was withheld from Mr. Ackerman’s pay for Social Security, and, upon retiring, he received a lump-sum payment of 17 cents.”

It was not uncommon for early recipients to receive much more than they put in.  Indeed, it has been estimated that the net transfers to early generations of recipients is well in excess of $10 trillion.  In other words, for most of the last 75 years, the majority of Social Security recipients received far more in payments than they paid into the system (and, yes, this is true even if one accounts for inflation and implied interest on those contributions.)

How is this possible?  Actually, it is quite simple.  Social Security is not a funded pension system.  It is a “pay-as-you-go” transfer system in which the funds paid out to current beneficiaries are provided by current taxpayers.  Such a system can work quite well so long as we have wage growth and so long as the ratio of workers-to-retirees is stable or growing. 

But therein lies the crux of Social Security’s financing problems.  Unlike what many citizens believe, the true problem facing Social Security has very little to do with Congress’ penchant for “spending the Social Security surpluses” of the past 25 years.  It has far more to do with the basic financing structure of the program.

In the 1950s, there were 16 workers paying taxes to support each Social Security beneficiary.  By the time JFK was elected President, it was about 5 workers per beneficiary.  Today we have a bit more than 3 workers for each beneficiary.  In my lifetime, that will fall to 2 workers per beneficiary.

So do the math.  If you want to replace 40% of the average workers income upon retirement, and you have 16 workers supporting each retiree, you only need to collect taxes from each worker equal to 2.5% of their income (2.5 x 16 = 40).  With only 5 workers per retiree, you need to tax them at a rate of 8%.  When there are only 3.3 workers (today’s ratio), you need a tax rate of 12.1%.  (Today’s combined tax rate is about 12.4%).  As the ratio falls to 2-to-1, tax rates need to climb to 20% to keep the system in balance.

(I am simplifying a bit here, but it is remarkable how closely this very simple calculation mirrors the Social Security Trustees’ long-term financial outlook!)

So, as we celebrate the birthday of the Social Security system, we have to ask ourselves some difficult questions.  Can we afford the system we have?  If not, whose benefits do we cut? High income retirees ?  Low income retirees?  Today’s retirees?  Today’s workers?  Alternatively, whose taxes do we raise?  Everyone?  Only high income households?

Just as most members of the human race who are fortunate enough to live to age 75 begin to notice varying degrees of health declines due to aging, so too must we deal with the unhealthy economic consequences of an aging Social Security system. 

I was stunned to hear the news today that the Senate rejected Peter Diamond for a post at the Federal Reserve Board.  News stories are suggesting that the Republicans were uncomfortable with his supposed lack of expertise in monetary policy. 

Those of us who know Peter well (full disclosure - he was on my dissertation committee at MIT) know that either (a) this is just a  smoke-screen and that the real motivation was something altogether different or (b) the members of the Senate do not know enough economics themselves to know a brilliant economist when they see one. 

Let me be clear - while Peter and I are friends, we rarely agree on issues of public policy.  But to question his expertise in monetary matters is would be laughable if it were not so sad.  He is quite possibly the smartest person I have ever met (and the set of people that I have met includes numerous Nobel Laureates).  More to the point, he is certainly more qualified for the Fed than many of its past Governors.  And more qualified to speak with authority on monetary matters than any member of the Senate. 

If Senators want to reject a nominee for political reasons, that is certainly their right (although I wish it were otherwise for positions like the Fed).  But I sure wish they would be more forthright about their true objections.

The Social Security Disability Insurance (SSDI) program is an important part of the social safety net in the U.S.  If ever there were a risk that ought to be insured, it is the possibility of experiencing a physical or mental disability that brings one’s working-life to an end.  Those of us that have loved ones who rely on the SSDI program as a major source of household income understand how important it can be to financially sustaining those who are unable to continue working.

But the program can also be criticized in many ways.  First, the backlog of cases is very high – meaning that those who are disabled must often a very long time – sometimes even years – before they receive their first check.  There has also been a tremendous rise in the SSDI program caseload, which is placing enormous financial strain on the program as well as on the Social Security Administration’s already stretched field offices.

Nearly all of these problems trace to one root cause – that there is no simple test for determining who is truly disabled, and who is just trying to pass themselves off as disabled so that they can receive monthly checks for the rest of their lives without working. 

I know, some of you are going to say, “who would possibly do that?”  Indeed, some are offended by the notion that any undeserving individual would attempt to “act” disabled when they are not. 

But let’s be honest.  If it were easy to determine who was disabled and who was not – if there were some simple and fool-proof blood test or lie-detector test – then there would be no need for a huge bureaucracy of SSA claims reps, no need for 50+ state disability determination units, no complex layers of case reconsiderations and appeals, no need for hundreds of Administrative Law Judges, and no delays in processing checks.  There would be no backlog of cases.  And, frankly, there would probably be a lot more willingness among the general public and elected officials to generously support the program. 

But it is not that easy.  When a person argues that their back pain or mental condition means that they will no longer be able to work, the law requires that Social Security determine whether the person is indeed unable to earn more than the “Substantial Gainful Activity” amount each month – not just in their prior job, but in any job.  They must also determine whether the disability is permanent and/or likely to result in their death.  No easy task.

Ultimately, however, it is an empirical question whether there are people who apply for benefits but do not truly qualify.  And economists have researched this topic for years.

One recent paper by researchers at Columbia University, the Social Security Administration and the Congressional Budget Office (http://www.columbia.edu/~vw2112/papers/dissa_vwjsjm_final.pdf) finds that “younger rejected mail applicants to the Disability Insurance (DI) program exhibit substantial labor force attachment.  Similarly, a significant fraction of rejected applicants with low-mortality impairments such as back pain and mental health problems is employed.” 

In other words, there are a lot of people who apply for SSDI benefits, thus explicitly claiming that they have a work-ending disability, who return to work after being rejected.  Pretty clear evidence that they were not actually disabled, at least according to the SSDI definition.  But they applied for benefits anyway.  Maybe they really are hurt, maybe they really think they deserve the benefits.  But the fact that they can work after being rejected indicates that they did not suffer a work-ending disability. 

And as long as it remains the case that non-disabled people apply for disability benefits, the disability determination process will continue to be difficult, complex, long and extremely frustrating for everyone involved.  Those who suffer the most are those who truly are disabled.

When the financial crisis hit last year, a lot of news sources started speculating that people would be forced to work longer to make up for the losses in their 401(k) plans.  Yet there seemed to be some puzzlement when data started indicating that more people were retiring earlier.  What happened here?

Some new research sheds a bit of light on this.  The answer to the puzzle is essentially that there are different groups out there who were affected differently.  Higher income individuals with large 401(k) balances were indeed likely to postpone retirement as a result of the negative wealth shock.

However, the financial crisis was also accompanied by a deep and prolonged recession that significantly increased unemployment, or more broadly, joblessness.  A study by Courtney Coile and Phil Levine of Wellesley College shows that a rise in unemployment during a recession leads to earlier retirement.  In essence, older individuals choose to retire rather than try to find another job. 

In aggregate, it appears that the unemployment-induced increase in retirement outweighs the 401(k)-loss-induced delay in retirement.  The net result is the average person retiring earlier, not working longer.

Of course, the most important point of all is that both effects are likely to reduce retirement security.  Whether forced out of the labor force early due to job loss or forced to stay in the labor force longer due to a negative wealth shock, individuals are made worse off.  And that, ultimately, is the real story.

Several recent news reports have indicated that Illinois is planning on selling pension obligation bonds in order to come up with the cash to make its contributions to the five state public retirement systems for the next fiscal year.  This is by no means the first time that the state has used POBs: In 2009 it issued just under $3.5 billion of bonds to fund its pension contributions for 2010.  Back in 2003, it issued about $10 billion in bonds for the same purpose.

So, are issuing such bonds a good idea or not?  The answer depends on who you are, and what you are trying to achieve.

If you are a participant in one of the five public plans, the issuance of these bonds sure beats another year of having the state fail to make its contributions.  While I have written before that public employees have little to worry about given the nature of the constitution benefit protections that are in place, any lingering concerns about the state’s inability to make good on pension promises ought to be at least partially mitigated by having additional contributions made into the pension funds.  This is true regardless of whether the funds came from higher taxes, reduced spending, or borrowed funds.

If you are a politician, this is really a good plan because it allows you to – once again – avoid behaving like a responsible adult and making the difficult fiscal choices that ultimately need to be made.

If you are a current taxpayer, it also looks pretty good.  First, we avoid raising taxes now.  Second, we are essentially converting implicit debt (money owed to pensioners) into explicit debt (money owed to bondholders), with the key difference being that it is actually somewhat easier to default on the explicit debt than it is to violate the constitutional non-impairment clause (this is precisely the opposite for Social Security, in which it is easier to reduce benefits than to default on U.S. government debt). 

If you are a beneficiary of other government spending programs, you are also pretty happy.  After all, borrowing to fund the pensions puts less pressure on politicians to cut your favorite spending program.

So far, so good.  Sounds like everyone is a winner.  So, what is the catch? 

The catch is that issuing these bonds takes the pressure off of our elected officials to exert fiscal discipline.  It is like trying to cure a spend-a-holics debt problem by giving them a credit card.    

As such, the losers are all the future generations of taxpayers and program beneficiaries who are going to be saddled with several additional billion dollars worth of debt that must be serviced because we gave today’s politicians an “easy out” from facing their responsibilities today.  This reduction in fiscal discipline is made all-the-more dangerous when these bonds are portrayed as a way to magically reduce our obligations by more than the amount of the debt issuance.  All too often, one hears proponents of these bonds make statements about how the state can borrow at a low rate and invest at a high rate, and thus make money on the difference.  Invariably, such statements ignore the risk differences in the investments, and are akin to try to create a free lunch where none exists. 

Thus, the biggest downside to the use of these bonds is that they are an “enabler” for politicians who are addicted to deficit spending.  The direct effect of this resulting debt burden will be to increase the pressure to raise future taxes and cut future spending on education, health care, roads, state police and every other spending program that people may value.

The indirect effect is that higher future taxes will turn Illinois into an unattractive place for businesses to invest or for our most talented young people to build careers, homes and families.  Who wants to invest in a state that is saddling future generations of businesses and workers with debt?

A few days ago, AFL-CIO President Richard Trumka testified before the federal budget deficit commission.  In his remarks, he essentially argued (among other points) that we should try to grow our way out our problems.  Similarly, Edward Coyle, executive director of the Alliance for Retired Americans (an organization very closely affiliated with the union movement), objected to any discussion of raising the retirement age or reducing benefits.            

Sounds pretty good, right?  If we can just stimulate economic growth, we can avoid hard choices? 

Unfortunately, as with most “no pain” solutions to our nation’s fiscal problems, this one is too good to be true.  (In the name of bipartisanship, let me be clear that both Democrats and Republicans have their own version of the free lunch when it comes to Social Security – many free lunch Democrats argue we can grow out of the problem we have, and many free lunch Republicans believe that private accounts can solve the problem without benefit cuts.  Both are wrong – I will post about the flaws of the Republican form of free lunch at some other time.)

Let me be clear – growth is undoubtedly a good thing.  Of course I am pro growth.  Faster economic growth enlarges the economic pie, increases average wages, and thus provides more revenue for the same level of tax rates.  And there is no question that faster economic growth is a net positive for Social Security’s finances.

Unfortunately, faster growth is not sufficient to solve Social Security’s financial problems.  Let me point out two of the many reasons for this:

First, let’s remember that projections of Social Security’s long-term fiscal situation already assume that our economy will grow.  It is not as if Social Security’s trustees had not thought of this possibility.  So for growth to save us, it needs to be growth in excess of the baseline assumption.

Second, while it is true that faster growth and resultant higher wages increase payroll tax revenues to Social Security, this same wage growth also increases the benefits that Social Security must pay out in the future!  This is because the Social Security benefit formula is directly indexed to growth in the “average wage index.”  You may recall that the 2001 reform commission – and, in 2005, the Bush Administration itself – came out in favor of switching from a wage-indexed system to a price-indexed system.  Part of the rationale was to break this link and allow for us to get more of a fiscal “bang-for-the-buck” out of economic growth. 

There have been a lot of analyses to back up this analysis.  Of them all, the one that is most accessible to the non-PhD economist is probably the one written in 2003 by Rudolph Penner of the Urban Institute.  Hs conclusion: “Given the pending demographic pressures on the federal budget, we face a serious problem.  Increased growth cannot save us from breaking strong historical precedent.”  And that was back in 2003.  Sadly, the situation has gotten worse, not better …

So the short answer to the question posed in the title is “no.”