Can Economic Growth Save Social Security?

Filed Under (U.S. Fiscal Policy) by Jeffrey Brown on Jul 9, 2010

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.”

An Idea for Safeguarding Pensioners and Taxpayers

Filed Under (Retirement Policy) by Jeffrey Brown on Dec 10, 2009

In at least one previous post, as well as in other research papers and articles, I have discussed the enormous problems facing the Pension Benefit Guarantee Corporation (PBGC), the government corporation that insures private defined benefit pension plans.  This week, a very talented MBA student at Illinois – Gagan Bhatia – reminded me of a terrific idea that would go a very long way toward providing plan sponsors with economically appropriate incentives for funding their plans.  Right now, plan sponsors lack appropriate and sufficient incentives to fully fund their plan or to choose a portfolio that immunizes the plan funding from market risk.  Sure, the government imposes funding requirements, but they have proven woefully inadequate.

In fairness, while Gagan Bhatia came up with this idea on his own and independently, it is an idea that has been out there, including in some work by Doug Elliot of the Center on Federal Financial Institutions.  Regardless of who gets credit, I think it is a terrific idea.

In a nutshell, the idea is to increase the seniority of pension claims in the event of a bankruptcy.  When a company files for Chapter 11 bankruptcy, the company’s creditors and claimants fall into different pools as per their priority over the company’s assets. PBGC’s obligations fall into the Unsecured Creditors pool which are paid after the Secured Creditors.   

Under this proposal, the PBGC would be moved up the line and be considered a senior, secured claim.  In essence, it would allow the PBGC to get paid first (or at least earlier than under current law) from any assets that the plan sponsor has remaining.

Why does this help?  Currently, creditors have insufficient incentive to consider the funding status of a firm’s pension plan when the firm is issuing debt.  If creditors knew that the PBGC’s claim on the firm’s assets was senior to that of the creditors, then creditors and potential creditors would become powerful enforcers of economically appropriate funding behavior.  Plan sponsors that failed to adequately fund their pension or plan sponsors who failed to engage in asset-liability matching would be considered – appropriately – to be a higher credit risk.  Thus, the firm would have to pay more to borrow.  Firms that funded their pensions and invested them in a manner that mitigated future funding risk would benefit from lower borrowing rates. 

In essence, this approach would harness market forces to achieve a worthwhile public policy goal.  Along the way, both pensioners and taxpayers would benefit. 

 

 

 

So you don’t know how long you will live? Perhaps its time for an “auto-annuity”

Filed Under (Retirement Policy) by Jeffrey Brown on Sep 14, 2009

I don’t know about you, but I have no idea how long I will live.  In most ways, this is a blessing – given how much I like to quantify things, I don’t think I could help myself from starting the grand count-down if I knew my death date for certain.  But in at least one respect – financial planning for retirement – this uncertainty is a real nuisance. 

Fortunately, there are financial products – known by the unsexy name of “life annuities” – that help solve this problem by converting  wealth into a stream of income that will last as long as you do.   There is plenty of research out there showing why annuitization can improve individual well-being by providing a higher level of consumption in retirement.  The problem is that most 401(k) plan sponsors don’t offer them in their plans, and thus most retirees or soon-to-be-retirees don’t have the option to convert their wealth into a guaranteed income stream.

Last Friday, I presented a new policy proposal at a conference sponsored by the American Council of Life Insurers, the AARP, the American Benefits Council, and WISER (apologies if I missed any sponsors!)  The gist of the proposal is to encourage 401(k) and 403(b) plan sponsors to adopt life annuities as the default distribution option from their plans.  The policy steps suggested to encourage it include fiduciary relief and the easing of some administrative burdens associated with qualified joint and survivor annuity rules.  If I may say so myself, the proposal was very well received – including by officials at Treasury, Labor and most of the Congressional staffers present.

Using “automatic enrollment” has proven very successful at increasing 401(k) participation rates, and I believe that “automatic annuitization” could help do the same for increasing annuitization in the payout phase.  This seems a worthwhile goal.  After all, saving assets is not enough to ensure retirement security – you also need a way to ensure that you have enough to live on no matter how long you live. 

I know that this will not make the most scintillating reading for the masses, but you might want to check out the paper anyway.  Whether or not this proposal is ever enacted, I am pretty confident that the future of private sector retirement plans in this country is going to include a greater role for annuitization.  So you may as well start learning about it now … here is the link to the paper.