## Tuesday, January 04, 2005

### Victor Does the Heavy Lifting

In a comment on a recent post, and in more detail on The Dead Parrot Society, Victor tries to answer this request:

Matthew Yglesias asks, "The first thing that would be nice to calculate if someone can figure out how to do it is the exact average productivity growth over the next 75 years that we need to make sure that the Trust Fund is never exhausted."

In his search for an answer, and as a critique of a rough answer at Brad DeLong's blog, he finds the sensitivity analysis in the 2004 Trustees Report (Table VI.D4):

A far superior approach would be to do what the Social Security Trustees did: let the real-wage differential vary, keep all the other assumptions constant, and see how the results changed. They found that a 0.5%-points increase in the real-wage differential, improved actuarial balance by .54%-points of taxable payroll, from a 1.89% deficit to 1.35% deficit. Assuming the SSA truly held all other factors constant, this would be equivalent to increasing productivity from their baseline of 1.6% to 2.1%. That's a whopping increase in productivity, and a pretty good improvement in the actuarial balance, but you are still far from 75-year solvency. (which, recall, is only one of the issues that many are concerned about)

Victor just stops too early in his calculation. If one were to use the linear approximation in the text of the report, (0.54 percentage point of imbalance per 0.5 percentage point improvement in the real wage differential), then we would need to boost the differential by 1.89/0.54 = 3.5 units of 0.5, or by 1.75 percentage points up to 2.85 percent to go from the intermediate projections to 75-year balance.

If we wanted to be a bit fancier, we would note that the change over the three scenarios is not quite linear. The table gives us three pairs of numbers on {real wage differential, 75-year imbalance}: {0.6, -2.42}, {1.1, -1.89}, {1.6, -1.35}. With three pairs, we can fit a quadratic to do the extrapolation. When we do, we get [omitting the gratuitous algebra] about 2.81 percent for the real wage differential. Let's call it 2.8 percent, or an increase of 1.7 percentage points.

If we maintain the Trustees' other economic assumptions in Table V.B1 (earnings as a percent of compensation, average hours worked, and the wedge between CPI and the GDP price index) and Table V.B2 (total employment growth), this translates into long-term growth rates of 3.3 percent for productivity and 3.5 percent for real GDP. That productivity growth rate strikes me as too high.

However, these rough calculations were made without regard to what happens in the years after the 75-year window. In this case, there may be surpluses in the years near the end of that projection period, and so 2.8 percent for the real wage differential is too high for a longer projection period. We would need the actuaries to run the numbers themselves to be sure.

In addition, the "If we maintain ..." is a very big "if." It is not satisfied, for example, in the Brookings Paper by Robert J. Gordon that Victor cites in an earlier post as the basis of what Kevin Drum has been blogging about. It looks like, yet again, I've got more reading to do before I can make a more definitive statement.

And most importantly, it is hardly sensible to treat the Trustees' assumptions as if they are independent of each other, particularly the ones that work together to go from GDP growth to the real wage differential. If one of them changes, it is likely to be offset by changes in the others. For example, note from the historical series of Tables V.B1 and V.B2 that we have had high productivity growth in the past couple of years, but this has been associated with negative real wage differentials largely because of the decline in average hours worked. Using the last couple of years as evidence that productivity can be much higher than the Trustees have assumed is an incomplete argument. It is not evidence that productivity can be much higher, everything else equal.

Other blogs commenting on this post

Anonymous said...

Andrew,

Imagine that you are alive at the exact moment when the Social Security Trust Fund becomes exhausted.

Just before exhaustion, a \$1000 payment is funded by \$800 in payroll tax receipts and a new Treasury public borrowing of \$200 to redeem the last non-marketable special Treasury security held in the Social Security Trust Fund.

Just after exhaustion, the next \$1000 payment is funded by \$800 in payroll tax receipts and a new Treasury public borrowing of \$200 to directly make up the shortfall.

What is the error, if any, in the above that doesn't indicate that the exhaustion of the Social Security Trust Fund is of no practical significance, and therefore, the Social Security Trust Fund itself is of no real importance?

TIA, Don Lloyd
dlloyd@catallarchy.net

JG said...

I am at something of a loss as to why anybody cares like this about the trust fund.

1) We know the trust fund provides zero (\$0) in financing for future SS benefits. To quote the _Analytical Perspectives on the 2005 Budget_ on the subject of the trust fund bonds....

"At the time Social Security ... redeems these instruments to pay future benefits not covered by future income, the Treasury will have to turn to the public capital markets to raise the funds to finance the benefits just as if the trust funds had never existed.

"From the standpoint of overall Government finances, the trust funds do not reduce the future burden of financing Social Security."

http://www.whitehouse.gov/omb/budget/fy2005/pdf/spec.pdf

That seems clear enough. And we also know that ...

2) The trust fund also does zero – rather, less than zero – towards its actual intended purpose, which was to increase national savings. To wit:

_Is the Social Security Trust Fund Worth Anything?_, by Kent Smetters,

“We find that there is no empirical evidence supporting the claim that trust fund assets have reduced the level of debt held by the public. In fact, the evidence suggests just the opposite: trust fund assets have probably increased the level of debt held by the public....

”... each dollar of Social Security surplus appears to have actually increased the debt held by the public in the past by \$1.76.”

http://irm.wharton.upenn.edu/WP-security-Smetters.pdf

So why all this concern about and work over the trust fund?

Why is it not just a total red herring?

Anonymous said...

[MaxSpeak] If the Trust Fund is meaningless, it cannot go broke. You could also argue that in this case the program imbalance (present value of contributions minus expenses) is undefined because one cannot include historic program in-go and out-go. That throws you into overall budget imbalance. Tax increases, anyone?

Roland Patrick said...

Jim is correct, the 'trust fund' is a red herring.

When the first of the Baby Boomers (born in 1946) begin to retire, the SS surplus will begin to be reduced. Meaning the govt will need to find another source of funds for spending that had been covered by the SS surplus. The problem increases with each year.

The effect could be felt as early as about 2009. It's only about 2018 that the surplus disappears COMPLETELY.

JG said...

The Anonymous version of Maxspeak wrote:

"If the Trust Fund is meaningless ... Tax increases, anyone?"

Well, of course, that would be half the point – the other half being that "tax increases = benefit cuts".

Politics and precedent says there is going to be *no* such increase of general revenue income taxes post-2020 to fund SS (\$5 trillion worth, corresponding to the notional trust fund balance -- on top of the much bigger increases for Medicare at the same time) without a political deal that reduces benefits by a corresponding amount.

We’ve already seen this in our own time. When SS benefit promises overran the tax revenue needed to pay them in the 1980s the gap was closed with a political deal that was half tax increases and half *benefit cuts* -- which is why today’s young workers are going to be the first to get back less from SS than they put into it.

And conditions for tax increases for SS were far better in 1983 than they will be when the Medicare crunch hits.

The only answer the denialists have ever put up to say this won’t happen is that voters wouldn’t stand for it and Congress wouldn’t be so heartless as to cut the benefits of dependent seniors.

But of course taxpaying voters will insist on it, as they did in 1983, and Congress won’t be cruel to retirees – it will do exactly what it did in 1983, cut benefits *further* for the young, and expand the means-testing that began in 1983 (carefully disguised as it was then).

Voters will insist. And will progressives object? Will Krugman and Maxspeak and friends say: "We insist that income taxes be raised first to fund transfer payments to Warren Buffett, Bill Gates, & Co. just as we promised, because that’s *progressive* -- even if we then run short of funds for the medical care that everyone wants!"?

I don’t see it.

So a generation from now, thanks to throwing FDR’s promise of "intergenerational equity" overboard in 1983, and stomping on it after that, support for SS from the young, already plunging, will be through the floor – and it will be means-tested too.

What will be SS’s political future after that?

AndrewB said...

A couple small points:

If wage growth doubled it seems unlikely the whole gain would be taken as wages rather than leisure. If the number of hours worked declined, then the necessery productivity/wage growth for solvency would rise.

Also, the Trustees' sensitivity analysis is based on trust fund solvency, which some view to be less important than annual cash flows. While higher wage growth would increase present surpluses, delay the date of cash deficits (currently 2018) and reduce annual deficits thereafter, for most of the 75-year period scheduled benefits would be paid only through transfers of general tax revenues to redeem trust fund assets. Depending on your view of the political economy of trust fund financing, this may or may not be a good thing.