What are the Policy Consequences of Delaying Social Security Reform?

Filed Under (Retirement Policy, U.S. Fiscal Policy) by Jeffrey Brown on Mar 28, 2011

Much has been written about the financial consequences of delaying action on Social Security reform (click here for one such report, notable for the fact that it is genuinely bipartisan).  Most of what has been written deals with the straightforward “mathematics” of delay.  In short, the longer we delay, the bigger the changes that will be required when Congress finally does act.  Regardless of whether you prefer that we return Social Security to financial sustainability via benefit reductions or tax increases, the point is that the longer we wait to do so, the bigger those benefit reductions or tax increases will have to be.  This is well-documented by policy experts across the political spectrum (even if the facts are somehow ignored by many of those that must run for re-election).

Today, though, I want to focus not on the simple mathematics of delay, but rather on what delay means for the politics, and what those politics, in turn, mean for the policy outcome.  In recent years, I have heard two very different views on the subject.  I am not sure which will prove to be correct, so let me just set them out here and invite comments if you have strong feelings on the subject.

The first view, which I first heard in a conversation that I had with a well-known and well-respected policy expert on the Democratic side of the debate (whose name I will not use simply out of respect for the fact that this was a private conversation) who pointed out that the longer we wait to address Social Security, the more likely it was that solvency would be restored through tax increases.  His political calculus was that the bigger the benefit cuts required, the less likely that the political will would exist to make such cuts, particularly given the clout of organizations like the AARP.  This particular individual viewed this as a desirable outcome, as it made it more likely we would keep the current benefit structure in place. 

The second view was explained last week in an op-ed published in the Washington Post.  Chuck Blahous, who is one of two Public Trustees for Social Security (he is the Republican trustee who spent 8 years in the Bush White House, although he was nominated to this current post by President Obama), argues that delay could result in the undoing of the program.  He says:

“Faced with a choice between wrenching benefit cuts and/or payroll tax increases vs. tearing down the wall between Social Security and the rest of the budget, legislators will tear it down. And that would be the end of Social Security as we know it. No more special parliamentary protections. No longer would benefit payments be shielded from the chopping block by the rationale that they were funded by separate payroll tax contributions. Social Security would be financed from the general revenue pool, and its benefits would thereafter have to compete with every other federal spending priority. The irony would be that the program was done in by its supposed defenders.”

These are two very different views from two highly respected experts on Social Security politics and policy.  Sadly, given the reluctance of Congress and the Obama administration to make Social Security reform a priority, we may be given the “opportunity” to find out which view is right.  That is unfortunate, as the better outcome would be to fix the program sooner rather than later, and leave the “what ifs” as a purely intellectual exercise.    

I’d be interested in what the readers think (and you can post your comment by clicking the link below) — does delay make it more likely that we will shore up the program by raising payroll taxes, or does it make it more likely that we will have to desert the 75+ year history of having the program financed by a payroll tax, or does it make it more likely we will have to cut benefits?  Or something else?  Thoughts welcomed …

Here we go again, …

Filed Under (Environmental Policy, Health Care, Retirement Policy, U.S. Fiscal Policy) by Don Fullerton on Feb 25, 2011

Yes, I’ve written about the budget before, and perhaps I’m getting repetitive.  But it’s important, and surprising, so I’ll give it another go.  But nevermind President Obama’s recent release of a proposed budget for next year.  That document is already irrelevant!  Let’s start with the current budget. 

Current federal spending now is over  $3 trillion per year.  The deficit is $1.6 trillion.  The U.S. House of Representatives approved a plan to cut spending by $60 billion.  The Republicans chose not to change spending on defense and homeland security, nor entitlement programs like Social Security, Medicare, and Medicaid.  The problem is that then other discretionary spending must be cut for some government agencies by as much as 40%.  And yet that total $60 billion cut is only a drop in the bucket.  It cuts the annual deficit only from $1.6 trillion to 1.54 trillion!

My point is that you can’t get there from here.  First of all, it’s not wise to cast such a wide net, without thinking, making cuts of 40% or more to discretionary programs simply because they are called discretionary.  It means cuts to national parks, environmental programs, and federal employees who provide many public services people want.

Second, who says we need to leave defense and entitlements untouched?   Within just a few years, Medicaid will cost about $300 billion per year, Medicare will cost $500 billion, and Social Security will cost $800 billion, and defense $800 billion.  ALL of domestic discretionary spending will be only $400 billion.  By those round numbers, $60 billion from that last category is a 15% cut.   The same $60 billion cut proportionally from all of those categories would be only a 2% cut.  That’s what I mean by a drop in the bucket.

Anyway, that plan would still cut the deficit only from $1.6 trillion to $1.54 trillion.  The ONLY way to make any sizeable dent in the huge $1.6 trillion deficit is to look at all the current spending, not just at $400 billion of domestic discretionary spending, but at the $800 billion of defense spending, $800 billion of social  security, $500 billion of Medicare, and/or $300 billion of Medicaid.

And who says taxes are sacrosanct?  A $1.6 trillion deficit means we are spending more than our income, so one just MIGHT think that problem can be approached from both ends.

Social Security, Medicare, Medicaid: One of these things is not like the others

Filed Under (Health Care, Retirement Policy, U.S. Fiscal Policy) by Nolan Miller on Feb 17, 2011

Interesting goings on in the world of government budgets these days.  I’ve written in the past about the problems of increasing health care costs in the U.S. and how this is a problem that, at this point, we just don’t know how to solve.  Social Security, on the other hand is another matter.  Despite the gloom and doom about the coming insolvency of the system, things aren’t really all that bad.  (Of course, that statement should be interpreted relative to health care entitlements, but still …)  I’m relatively uninformed on the subject, but it seems like, if we wanted to “fix” social security, we could (i) raise taxes, (ii) reduce benefits, (iii) increase the retirement age, or (iv) some combination of these.  None of these options is great, but any would work.

President Obama raised a similar point in his Tuesday press conference.  Asked about the “long-term crushing costs of Social Security, Medicare [and] Medicaid” which his budget proposal did not address, he responded:

Now, you talked about Social Security, Medicare and Medicaid.  The truth is Social Security is not the huge contributor to the deficit that the other two entitlements are.  …  Medicare and Medicaid are huge problems because health care costs are rising even as the population is getting older.

So, just how bad does the future look for Social Security?  Well, bad, but not that bad.  Take this excerpt from the Summary of the 2010 Annual Reports on the Status of the Social Security and Medicare Programs:

Social Security expenditures are expected to exceed tax receipts this year for the first time since 1983. The projected deficit of $41 billion this year (excluding interest income) is attributable to the recession and to an expected $25 billion downward adjustment to 2010 income that corrects for excess payroll tax revenue credited to the trust funds in earlier years. This deficit is expected to shrink substantially for 2011 and to return to small surpluses for years 2012-2014 due to the improving economy. After 2014 deficits are expected to grow rapidly as the baby boom generation’s retirement causes the number of beneficiaries to grow substantially more rapidly than the number of covered workers. The annual deficits will be made up by redeeming trust fund assets in amounts less than interest earnings through 2024, and then by redeeming trust fund assets until reserves are exhausted in 2037, at which point tax income would be sufficient to pay about 75 percent of scheduled benefits through 2084. The projected exhaustion date for the combined OASI and DI Trust Funds is unchanged from last year’s report.

So, even if NOTHING were done, Social Security would be able to pay at least 75 percent of scheduled benefits through 2084.  Like I said, that’s bad, but it could be worse.

What about health care?  For that, let’s turn to a new working paper by Kate Baicker and Jon Skinner entitled “Health Care Spending Growth and the Future of U.S. Tax Rates.”  Not exactly beach reading.  They note that health care spending currently accounts for 17.6 percent of GDP and health care expenditures currently grow, on average, about 2.5 percentage points faster per year than GDP.  If this trend continues, health care expenditures are expected to account for 26 percent of GDP by 2035.  Of course, escalating health care costs are expected to reduce GDP, so the future might actually be worse.  According to the CBO (reported by Newhouse here), if health care cost growth exceeds GDP growth by 1 percentage point (on average) until 2050, this will lead to a 3 – 16% decrease in GDP over what would have happened if there were no gap.  Things will be substantially worse if the 2 percentage point gap continues.

What about government revenues?  Here’s where it gets really scary.  Suppose that health care costs continue to grow at a rate 2.5 percentage points faster than GDP grows.  In 2007 (too lazy to look up this year’s number), spending on Medicare and Medicaid was about 4.5 percent of GDP.  If the 2.5 percentage point gap continues, CBO estimates that by 2050 spending on Medicare and Medicaid will account for approximately 20 percent of GDP.  If this increased expenditure were financed by increasing income taxes and rates for all income groups were increased proportionately, CBO says:

Before any economic feedbacks are taken into account, and again assuming that raising marginal tax rates was the only mechanism used to balance the budget, the tax rate in the lowest tax bracket would have to be increased from 10 percent to 26 percent; the tax rate on incomes in the current 25 percent bracket would have to be increased to 66 percent; and the tax rate in the highest bracket would have to be raised from 35 percent to 92 percent. The top corporate income tax rate would also increase from 35 percent to 92 percent. Such tax rates would significantly reduce economic activity and would create serious problems with tax avoidance and tax evasion. Revenues could fall significantly short of the amount needed to finance the growth of spending, and thus tax rates at this level may not be economically feasible.

Not that they need to, but in the longer term, things are even worse.  Chernew, Hirth and Cutler project the meaning of a 2 percentage point health expenditure-GDP gap until 2083 and find that, on average, 118 percent of all real income growth between now and 2083 will be devoted to health expenditures.  The Newhouse study illustrates this point with a graph showing that if a household has about $40,000 to spend on everything other than health care in 2008, under the current projections it will have about $30,000 to spend on everything else in 2084.

So, the comparison between Social Security and health care is pretty clear.  If nothing is done, Social Security will be able to pay at least 75% of benefits through 2084.  If nothing is done on the health care front, (according to the CBO report) “if health care costs per beneficiary grew an average of 2.5 percentage points faster than GDP per capita each year, as they have over the past four decades, and the spending was financed solely with a proportional increase in income tax rates, the economic costs would be significant and the circumstance probably impossible to sustain through 2050.”

What are President Obama’s Plans for Social Security? What We Learned (and did not Learn) from the SOTU

Filed Under (Retirement Policy, U.S. Fiscal Policy) by Jeffrey Brown on Jan 26, 2011

There is a bipartisan consensus among scholars and analysts of the Social Security system that the program is fiscally unsustainable.  As I, and others, have pointed out many times, there are only two solutions to this problem.  Either we reduce the lifetime benefits that people receive (e.g., by raising the retirement age, changing the benefit formula, etc), or we raise taxes.  To find a bipartisan solution, we will almost surely have to do some of both.

Last night in the State of the Union Address, President Obama said:

“To put us on solid ground, we should also find a bipartisan solution to strengthen Social Security for future generations. We must do it without putting at risk current retirees, the most vulnerable, or people with disabilities; without slashing benefits for future generations and without subjecting Americans’ guaranteed retirement income to the whims of the stock market.”

What to make of this statement?  One must read the key phrases carefully …

Let’s start with the easy one – the last one:

“without subjecting Americans’ guaranteed retirement income to the whims of the stock market” – no surprises here.  The President – like nearly every elected Democrat in Congress -  is opposed to personal accounts as part of Social security.  It would have been big news if he had not said this.  The fact that he said it just “checks the box” on what we already knew.

Now on to reading between the lines …

“without putting at risk” — notice that he is placing a priority on protecting benefits of 3 groups: (1) current retirees, (2) low income households, and (3) those receiving disability benefits from Social Security.  This is not surprising, and in fact is the “norm” in many recent reform proposals – including President Bush’s plan for “progressive price indexation” which would have protected both (1) and (2) and might have protected (3) depending on whether the new indexation would have been made to apply to the Disability Insurance program.  There are good economic and policy reasons – and even stronger political ones – to protect these groups.  So the President’s choice of protected groups is not surprising.

But notice what he did NOT say.  He did not say we could not reduce benefits, only that we cannot put these groups “at risk.”  So, now comes the debate over whether we can have any reductions without putting these groups “at risk.”  For example, if we made a technical change in the way we calculated the cost-of-living-adjustment, such as using a different version of the consumer price index (CPI) that is thought to be more accurate (relative to the current one that is thought to over-state inflation), would that qualify?  Even though such a change would result- over the years – in very large reductions in expenditures relative to current projections?

“without slashing benefits for future generations” – hmmmmm.  There are two problems interpreting this statement.  First, what does “slashing” mean?  Can we “trim” benefits, so long as we don’t “slash?”  What constitutes a benefit “slash” – a 25% cut?  A 5% cut?  A 0.01% cut?

Second, even if we define  “slash,” we have to ask, “slash relative to what?” Relative to currently scheduled benefits, or relative to what today’s retirees receive?  This matters enormously, since each successive generation of retirees sees average starting benefits rise with average wage growth.  If we interpret the President’s statement about Social Security benefits as being “relative to what today’s retirees” receive, we have a lot of room for meaningful changes to the benefit formula.  After all, President Bush’s progressive price indexation plan would meet this criteria.   In contrast, if President Obama’s statement is relative to currently scheduled Social Security benefits, then he has just promised us a huge tax increase.

Representative Paul Ryan (R) of Wisconsin gave the rebuttal to the speech.  The fact that he did not mention Social Security has raised some eyebrows (here and here), in large part because he has specific ideas about entitlement reform that he outlined in the Roadmap that has made him an emerging star in the Republican party.

Unfortunately, I predict that we may not learn much anytime soon about where this debate is heading.  After all, the President has to start running for re-election soon, so now may not be the time to tackle such a politically divisive issue.  Which is really too bad for future generations …

If It’s Difficult, Then Let’s Just Not Do It?

Filed Under (U.S. Fiscal Policy) by Don Fullerton on Dec 17, 2010

Last week, when President Obama announced his compromise with Republicans over the Bush era tax cuts, the general perception throughout the media left one feeling like the Democrats just had their milk money stolen.  All the talk of being taken hostage by the Republicans did little to ease that feeling.  After working through all the talking points, politicking, and pandering, however, this much is clear: the debate has no obvious winners and losers.  Both sides are getting watered down versions of what they really wanted. The basic premise of the deal is as follows:

  1. The Bush era tax cuts are extended for everyone for the next two years. 
  2. Unemployment benefits are extended for 13 months. 
  3. The estate tax is back, in modified form. 
  4. Social Security taxes are cut for one year.

 The tax cut at the top may help the rich more than desired by Democrats, but then the extra Social  Security tax cut will help low-income families, and ALL those cuts will help stimulate the moribund economy.

The crux of the Republicans argument is that we are in danger of a double dip recession if the tax cuts expire, a talking point the White House has not been shy about echoing in recent days.  Interesting to note is a perceived contradiction by Republicans whereby they refuse to approve anything that might add to the national debt, such as the 9/11 Emergency Responders bill.  Yet, extending the tax cuts implies 3.9 trillion dollars in lost revenue over the next ten years.  The GOP counters that since the cuts are currently in effect, it’s not technically adding to the deficit. 

 What is missing from the equation here is any viable long term plan agreed upon by both parties.  Yes, we get to do it all again, in just two years!   The long term deficit can still be cut, but any meaningful cuts will have to include Medicaid, Social Security, and the military.  God speed the politician brave enough to raise those issues.  Our elected officials are really doing little more than pushing these problems off for the next 24 months, as one party attempts to out-politic the other.  It’s a Ponzi Scheme, as pointed out in my earlier blog!

 If the American Congress could tackle as many issues every month as they are through the month of December, American politics would look a lot different.  We have seen critical votes attempting to resolve critical issues ranging from the 9/11 Responders health care, Don’t Ask, Don’t Tell, and now the Bush era tax cuts, the estate tax, unemployment benefits extension, and more, all rolled into one.  If only Congress could exist as a permanent lame duck!

Top Ten Myths of Social Security: Myth #2 – Economic Growth will Save Social Security

Filed Under (Retirement Policy, U.S. Fiscal Policy) by Jeffrey Brown on Dec 6, 2010

A few weeks ago, I posted the first in a series of myths about Social Security (click here for the first one). Today, I want to tackle a second major myth concerning Social Security, namely, that we need not concern ourselves about Social Security’s shortfalls, because the problem will go away thanks to economic growth.

Some Social Security analysts and commentators argue that the economic growth assumptions in the Social Security Trustees’ Report are too pessimistic, and that with higher economic growth, Social Security’s finances will remain strong for the foreseeable future. One of the highest profile supporters of this view is Paul Krugman, who wrote in a 2005 editorial that “faster growth will yield a bonanza of payroll tax revenue that will keep the current system sound for generations to come.”

If only it were so easy! Unfortunately, this myth sounds plausible to many, especially when the statement is being made by a Nobel Laureate (although I should hasten to add that Krugman won his Nobel prize for research completely unrelated to Social Security, a topic on which he has no particular academic expertise).

The basis for this myth is that the Social Security Trustees’ Report assumes a rate of economic growth over the next 75 years that is lower than the historical growth rate over the past several decades. If one were to simply increase the assumed rate of economic growth to this historical level, Social Security’s financial woes would appear much less severe.

Importantly, the assumed low rate of economic growth does not arise from a pessimistic view about future productivity growth. Indeed, the long-run rate of productivity growth assumed in the 2010 Trustees Report for the next seventy-five years is 1.7%, which is in-line with total productivity growth over the past five economic cycles (covering the period 1966-2007) (see p. 93 of 2010 Trustees Report) Rather, the low rate of economic growth stems from the assumed reduction in total employment growth On pages 100-101, the Trustees discuss their assumptions in detail, noting that this growth slow-down is attributable to the slowing of growth of the working age population, a “natural consequence of the baby-boom generation approaching retirement and succeeding lower-birth-rate cohorts reaching working age.” While one might argue that their specific assumptions are pessimistic, it seems hard to argue with the basic logic that some reduction in the growth rate of total employment is justified, given that the entire baby boom generation will move from being part of the labor force to being entirely out of the labor force over the next seventy-five years.

More generally, while it is correct that higher rates of economic growth lead to higher tax revenues in the future, it is important to understand that in a wage-indexed system such as ours, future benefit obligations also grow when wages rise. Specifically, the current Social Security benefit formula is designed to hold benefits constant relative to a retiree’s average (wage indexed) lifetime income. As average earnings rise, therefore, so do promised benefits. Thus, while economic growth does improve the long-run sustainability of the system (a point made by Brad DeLong, among others), under most reasonable assumptions the need for policy changes is not eliminated. Indeed, if the economic growth rate were increased to historic levels, this would only postpone the onset of cash flow deficits by a few years.

More generally, analysts are no doubt correct to assert that the actuarial and economic assumptions used to evaluate the future cash flow problems of Social Security are, in fact, just assumptions. It is certainly true that any set of projections will, ex post, likely turn out to be wrong. But uncertainty about the future cuts both ways, suggesting that while Social Security’s future cash flow may turn out to be better than expected, they could also be worse than expected. Prudent planning for the future should actually place more weight on the downside risk than on the upside potential.

The bottom line is that, yes, future projections are subject to considerable uncertainty. But to avoid making politically difficult policy corrections based on the fact that the future might turn out better than expected strikes me as unwise. Rather than using the existence of uncertainty as an excuse to avoid responsible policy actions, policymakers should look for ways to reform the Social Security system so that it is more resilient to unexpected demographic and economic shocks.

Reflections of a Conservative, Lefty, Right Wing, Do-Nothing, Liberal, Moderate, Tea-Partying Privatizer

Filed Under (Health Care, Retirement Policy, U.S. Fiscal Policy) by Jeffrey Brown on Nov 29, 2010

In American politics, individuals who advocate a move in the direction of more limited government, greater reliance on market force, and who emphasize the role of individual choice are often labeled as conservatives, neo-cons, right-wingers, privatizers, or, in the last election cycle, tea partiers. Those who advocate a greater government role, restrictions on individual choice, and more regulation are labeled as liberals, progressives, left-wingers, and socialists.

Lately, however, I have been thinking about how meaningless some of these phrases can be when describing specific policies reforms relative to the status quo. The reason is that U.S. economic policy as a whole lacks ideological consistency. This reflects, in part, the fact that our existing set of laws and regulations are often creatures of the time period in which they were passed.

As an example, I want to focus on a broad issue on which I have spent much of my professional life as a researcher and policy adviser. Namely, how we as a nation choose to handle risk. In particular, how we allocate risk – and insurance for risks – across the public and private sectors.

If you think about it, the allocation of risk is one of the primary roles of government in the modern era. Indeed, I once heard the U.S. government described as “a very large insurance company with an army.” This is not a bad description. The U.S. government runs the world’s largest life- annuity and disability programs (Social Security), some of the largest health insurance programs (e.g., Medicare, Medicaid, the VA system), a pension default insurance program (the PBGC), a deposit insurance program (the FDIC), an unemployment insurance program, a crop insurance program, a terrorism risk insurance program, and many more.

There is tremendous scope for reasonable and intelligent debate about the appropriate role of government when it comes to intervening in private insurance markets. I do not pretend to have the only “correct” view – how could I, when some of the economists I most respect in this world have come to different conclusions than I have?

But I do believe that I have developed a world-view about what constitutes a sensible and appropriate division of responsibility between the public and private markets that is informed by economic theory, empirical evidence, a dose of experience in how the government operates, and my own ideological predisposition towards individual freedom over government control. The world view that I have developed is one that believes that when it comes to the allocation of risk, we should find the least intrusive role possible for the government that is consistent with providing citizens with adequate opportunities for insuring against risks when doing so enhances societal well-being.

Yes, that is a mouthful. So let me briefly explain. I first note, however, that you need not agree with this world-view to agree with the main point of this blog. But allow me to – very briefly – explain my rationale. Basically, for nearly any economic policy, I go through the following thought process:

1. Can the private market achieve an efficient outcome without government intervention? Here, I define efficiency is the usual economist way of “1st best” outcome that would be generated by Adam Smith’s ideal of a perfectly competitive market without market failures. If the answer is “yes” – as I feel is typically the case with most markets for goods and services, then my belief is that the government should stay out of the way and let markets work their magic.

2. If the answer to question 1 is “no” because of the existence of a market failure (such as adverse selection or moral hazard in insurance markets, the existence of externalities, etc.), then I ask whether the government is capable of over-coming the market failure. Importantly, the answer is often “no.” In many cases, the government faces the same problem as private markets. For example, if there is moral hazard in insurance markets (e.g., if people behave in inefficiently more risky ways when they are insured), then there is very little the government can do about it. The answer is sometimes also “no” because of “government failure,” that is, a political process that leads to even good ideas being poorly implemented due to policy being influenced by special interests or policies being poorly implemented by an inefficient bureaucracy. Whatever the reason, if the answer to this question is “no,” then I will again favor the private market solution, even with its flaws.

3. In the relatively small subset of cases where the private market does not work, where the government has the ability to overcome the market failure, and where the government solution is likely to be designed and implemented in a sensible manner, then I am entirely willing to back such a policy. Even then, however, I will favor the most limited form of government intervention necessary to overcome the market failure. Thus, for example, I have no problem mandating that drivers carry collision insurance because a government mandate can overcome the adverse selection problem that might cripple a purely voluntary market.

Because my approach starts with a belief in the power of free markets and a healthy dose of skepticism about the political process and the skills of bureaucracies, my view is definitely “right-of-center.” But it is clearly not an unabashed “free markets all the time” view because it does recognize a need for limited government intervention in some cases. You may not agree with this view – but it is an ideologically and economically coherent and internally-consistent approach to economic policy.

But now, let us return to the how my views would be labeled by the political process in America today. In practice, application of my world-view to policy means that I often favor having the government encourage insurance through automatic enrollment or even a mandate (in order to overcome adverse selection), but then allowing competitive private market to actually provide the insurance.

But the U.S. is all over the map when it comes to how we treat insurance programs. Consider two dimensions of the problem:
1. Is insurance mandatory or voluntary?
2. Is insurance provided by the government or the private sector?

There are 4 possible combinations of answers, and we have programs in each. Here are a few examples:

Voluntary/Private – dental insurance, 401(k) plans
Voluntary/government – long-term care under the new CLASS Act
Mandatory/private – automobile insurance
Mandatory/government – Social Security, Medicare, PBGC, FDIC

My view is that we ought to have lots of programs in the mandatory/private, when in fact this is one of the least used approaches. What is interesting, however, is how advocating movement towards mandatory/private is viewed relative to the status quo. Over the years I have publicly advocated the use of personal accounts as a supplement or partial replacement for Social Security, and I would be perfectly happy to make them mandatory (or at least the default option). I have also publicly advocated replacing the PBGC with mandatory private pension insurance. I’d also like to see our public sector defined benefit plans reformed so that they have a defined contribution component. In all of these cases, I am advocating a move from mandatory/public to mandatory/private. As a result, I have been labeled a “conservative” or “neocon,” a “right-winger” and a “privatizer.”

In recent years I have also advocated that we consider making annuities the default distribution option from 401(k) plans, and in a blog in October I suggested that we considering mandating that people buy long-term care insurance in order to eliminate dependence on the inefficient Medicaid program. In these cases, where I am trying to move from voluntary/private to mandatory/private, some people labeled me a “lefty” and “liberal.”

Now, let’s take my view about automobile insurance. In essence, I think we have a reasonable approach – namely, that we mandate coverage but allow private insurance providers to provide it. This has not been a major policy issue in recent years. So I can be fairly characterized as having a “do nothing” or “status quo” approach to this policy issue.

At the other extreme, I cannot help but point out that the recent CLASS Act is precisely the opposite of what I would design. It is voluntary, so fails to overcome the main problem in the market but is provided by the government, despite the fact that the private market is fully capable of providing it! Here I just get labeled as a critic.

So, where does this leave me? Am I a right-wing, small government, neo-con intent on privatizing major government programs? Or am I a left-wing advocated who wants to take away individual choice? Or am I a defender of the status quo? Or am I just a critic of government policies?

The answer to all of these questions is “yes.” But this does not mean that I am a flip-flopper or ideologically inconsistent. To the contrary, it means that I am applying an ideologically consistent world-view to a wildly inconsistent set of existing public policies.

At the end of the day, I believe that much of our political rhetoric has become vacuous, school-yard name-calling that does little to illuminate our policy discussions. I find it frustrating – even sad – that we so often mindlessly label and name-call instead of engaging in well-reasoned, analytical discussions of important policy issues.

Ten Myths About Social Security (Part 1)

Filed Under (Finance, Retirement Policy, U.S. Fiscal Policy) by Jeffrey Brown on Nov 15, 2010

The Social Security Administration was established during the Great Depression by President Roosevelt and has been an enormously successful safety net for the people of the United States.  It has undoubtedly kept millions from poverty in the event of retirement, disability or death of the primary breadwinner.  In the 75 years since the program’s inception, however, times and circumstances have changed, and the system’s financial structure has become unsustainable.  Under the current system, there are two primary options for closing the large financing gap that exists: either increase the revenue dedicated to the system (i.e., increase taxes) or reduce expenditures from it (i.e., cut benefits).  Beginning today, I will bring to the CBPP blog what I consider to be the top ten myths (in no particular order) of Social Security reform, in my best attempt to add some clarity to this debate.  These myths are adapted from a paper I wrote along with Kevin Hassett and Kent Smetters that appeared in the Elder Law Journal.  I will begin by looking at whether the system really needs to be reformed at all.

Myth 1:  Social Security is Financially Sound for “Decades to Come”

A leading argument against reform of the Social Security system is that “Social Security is financially strong and will remain strong for decades to come.” Implicit in this statement is that it is okay to follow a “do nothing” approach to reform Social Security.  Defenders of the “do nothing” approach point to the fact that the Social Security Trust Fund[1] is projected to have sufficient resources to pay full retirement benefits through the year 2037 (according to the Social Security Trustees) or the year 2039 (according to the Congressional Budget Office). While it is true that the data of Trust Fund exhaustion is several decades away, this fact is not a particularly salient one when it comes to analyzing the broader economic or budget implications of the Social Security system.

To understand this debate from a broad economic perspective, it is important to understand how the Social Security system is financed.  For most of its history, Social Security has been financed primarily on a “pay-as-you-go” basis.  What this means is that in a given year, the taxes paid by workers in that year are immediately spent to provide benefits to individuals who are receiving benefit payments in that year. In other words, Social Security is primarily an income transfer system, not a savings program.

One implication of this financing structure is that the required balance between tax rates and benefit payments is sensitive to the ratio of the number of workers, who pay the taxes, to the number of beneficiaries, to whom payments are made.  To put this relation in very simple mathematical terms, the following relation will hold in an annually balanced, pure pay-as-you go system:

For example, in 2006, the average Social Security benefit was approximately 36% of the average worker’s wage.  In that year, there were 3.3 workers paying into Social Security system for each beneficiary.  Thus, the cost to each worker to support each beneficiary was around 10.9% of earnings (36 / 3.3 » 10.9).  Because the payroll tax rate is set at 12.4% of covered earnings, Social Security ran a surplus in that year.  Indeed, if the ratio of workers-to-beneficiaries were projected to stay constant at 3.3 for the indefinite future, then we would have the pleasant option of reducing payroll taxes from 12.4% to 10.9%, or increasing benefits from 36% of an average worker’s earnings to 42%.

Unfortunately, the worker-to-beneficiary ratio is not constant.  Back in 1950, there were over 16 workers per beneficiary.  Today we are down to a ratio of about 3.0.  By the year 2030, as a result of lengthening life expectancies and declining fertility rates, this ratio will decline to only 2.1.  To put this into perspective, with a worker-to-beneficiary ratio of only 2, then a Social Security program that pays benefits equal to 36% of the average worker’s earnings would require a payroll tax rate of 18%, or 45% ((18-12.4)/12.4) higher than today’s rate.  Alternatively, to live within the existing 12.4% payroll tax, benefits would need to decline to under 25% (a 30% reduction) of the average worker’s earnings.  In short, the pay-as-you-go structure of the existing Social Security system, when combined with a declining ratio of workers-to-beneficiaries, requires either that tax rates rise or that benefits fall by a substantial amount over time.

This stylized example closely mirrors actual cash flow projections prepared by both the non-partisan Social Security actuaries as well as the Congressional Budget Office (CBO).  Although we have been running Social Security surpluses in recent decades, in a few years these surpluses will changes to deficits, and the deficits will grow every year thereafter.  Indeed, by the time today’s college senior reaches their normal retirement age of 67 in the year 2055, the annual cash flow deficits will amount to 3.14% of covered wages (according to intermediate projections by the Social Security trustees).  This means that in order for the system to be in annual cash flow balance, taxes would have to be quite a bit higher, or benefits substantially lower, than scheduled under current law.

Some point out that even though they system will start running cash flow deficits in just a few years, we have nothing to worry about because the Social Security trust funds will not be exhausted for another three decades.  This is technically true from a narrow, government accounting perspective, but it is not true from a broader economic perspective.  While the bonds in the Trust Fund are an asset to the Social Security system, they also represent an equally large liability to the U.S. Treasury.  Thus, from the perspective of the federal government as a whole, the Trust Fund asset is exactly cancelled by a corresponding Treasury liability.  It is roughly akin to an individual borrowing money from himself – because he creates an asset and a liability of equal size, his net worth is unaffected.  As a result, when these bonds are redeemed, the Treasury must come up with the resources to fulfill those obligations.  Ultimately, this money can only come from one of three sources: i) higher taxes, ii) reduced government spending, or iii) issuing additional debt to the public, which simply means higher taxes or reduced spending at some point in the future.

But, you may ask, what happened to those surpluses in the year they were generated?  From an economic perspective, the Social Security surpluses of the past two decades helped to reduce the burden on future generations only to the extent that they increased national saving over this period.  Holding constant the level of private saving as well as all other government revenues and spending, adding one dollar to the Social Security surplus adds one dollar to government saving and thus to national saving.  However, many analysts believe that the very existence of the Social Security surpluses over the past twenty-five years have made it easier for Congress to run larger deficits in the non-Social Security portion of the budget, essentially using the Social Security surpluses to “hide” larger deficits in the rest of government.  To the extent that this is true, the net increment to national saving of the Social Security surpluses is reduced.  Indeed, work by Wharton Professor Kent Smetters has provided empirical time series evidence suggesting that the Social Security surpluses net contribution to national saving has been close to zero. If so, then the balance in the Social Security Trust Fund is little more than an accounting fiction.

For these reasons, it is incorrect to assert that Social Security is “financially strong and will remain strong for decades to come.” To argue that we can ignore the problem for several decades simply because we have an accounting balance in the Trust Fund is fiscally and economically irresponsible.  It is worth noting that two of the leading economists who strongly opposed President Bush’s reform plans – Peter Orszag (who went on to become President Obama’s budget director) and Peter Diamond (who won the 2010 Nobel prize in economics and was nominated by President Obama to become a governor of the Federal Reserve system) agreed that the fiscal problem facing Social Security is quite real, and that acting sooner rather than later is good public policy. A constructive debate about the future of Social Security should accept that a problem exists, and focus on alternative methods of restoring long-run, sustainable fiscal balance to the program.  Simply denying that the problem exists will not make it go away.

[1] Technically, there are separate trust funds for the Old Age, Survivors Insurance program (OASI) and the Disability Insurance program (DI).  For the rest of this blog, I will refer to the combined balances of these funds as the Social Security “Trust Fund.”

Three Cheers for the Simpson-Bowles Deficit Commission

Filed Under (Retirement Policy, U.S. Fiscal Policy) by Jeffrey Brown on Nov 11, 2010

The deficit commission, chaired by Democrat Erskine Bowles and Republican Alan Simpson, has started to release details of their proposals. As someone who has been an active participant in the Social Security policy debate over the past decade, I am particularly interested in their proposals regarding this program. I am pleased to say that this Commission is producing well-reasoned, sensible, balanced, and politically courageous proposals. Whether or not your or I agree with every detail is irrelevant. The important fact is that they are putting forward serious proposals to deal with a serious issue.

My good friend Chuck Blahous, who served at the National Economic Council in the Bush Administration for 8 years, and who now serves as one of the two Public Trustees for Social Security and Medicare, has done an excellent job of describing these proposals. Rather than repeating what he says, let me just provide a link to his article on the subject. I highly recommend it …

You can read it by clicking HERE.

Raising the Retirement Age and Other Needed Reforms

Filed Under (Retirement Policy, U.S. Fiscal Policy) by Jeffrey Brown on Nov 8, 2010

Last week I posted a short piece about the retirement age debate in France. Later in the week, I was interviewed by the public radio show “MarketPlace” about this topic. It is a short piece, that I recommend even if you skip over my few-second quote. You can find it by clicking here.

In preparing for that interview, I ran across a useful summary of the fiscal implications of raising the retirement age put out by the Social Security actuaries.

I continue to believe that raising the retirement age ought to be part of any Social Security reform package. But even if we continued to raise the NRA to age 70, given the desire to phase it in slowly (most discussions talk about a month every two years), it will be the start of the 22nd century before we would actually reach age 70. As such, the savings are a bit slow to build. Roughly speaking, taking it all the way to 70 on this time path would eliminate about 1/3 of the 75-year actuarial deficit as well as shave the annual deficits in the long-run by about 1/3. That is a non-trivial cost saving. But it does also mean that even if we do this, we need to find ways to fill the other 2/3 of the financing gap. In short, we will need additional reforms on top of raising the NRA.

Some of my favorite reform pieces include:
- increasing the number of years of earnings that we average into the benefit calculation. This not only reduces average benefits, but it does so in a manner that provides additional incentives for labor supply
- slowing the growth rate of initial benefits for high income earners (technically, this can be done by indexing the upper parts of the benefit formula by an amount that is less than wage growth)
- basing the annual cost-of-living adjustment (COLA) on a superlative price index, or perhaps the current index minus a bit to reflect its overstatement of inflation
- capping the spousal benefit at 50% of the median household’s benefit (technically, the PIA) so as to avoid paying high spousal benefits to someone just because their husband or wife was a high earner

Together, these changes would go a long way toward restoring fiscal balance to the program. It would be nice if our political leaders would hurry up and do some of this, so that we can then turn our attention to the much harder question of how to fix Medicare.