The Dean and Max Show

Dean Baker of the Center for Economic and Policy Research makes a guest appearance on MaxSpeak to continue the discussion about using the infinite horizon measure of Social Security's unfunded obligations. Dean is a frequent visitor to Capitol Hill and carries quite a bit of influence with people who are not interested in adding personal accounts to Social Security, so I am happy to have him along. His post is also provided as a comment on my last post on Social Security below.

First, Dean lays out the problem as he sees it:

Suppose that we write down a schedule of taxes and benefits in which the taxes stay constant as a share of GDP and the benefits rise at the rate of 0.1 percentage point a decade. Obviously this system will eventually run a deficit, and at some point a very large deficit.

This is effectively what we have done with Social Security. The reason the benefits keep rising through time is that life-spans are projected to increase for the indefinite future.

So far, we agree (see this post from October). Dean continues:

The question is, how do we think about a deficit over the indefinite future. The Social Security trustees give us projections over the program's 75 year planning period, which we know to be 0.73 percent of GDP over this period.

Andrew prefers the dollar measure (@ $3 trillion) and would have us look over an infinite horizon, which takes it to more than $10 trillion. The question is, how concerned should we be about the deficit that is projected beyond the 75-year projection period.

This is where we start to disagree. I would not refer to the 75 years as a "planning period." Here's how the 2004 Trustees Report defines its "long range" projections:

Long range
The next 75 years. Long-range actuarial estimates are made for this period because it is approximately the maximum remaining lifetime of current Social Security participants.

This definition has nothing to do with solvency or the accuracy of the projection. In fact, the Trustees are quite clear about whether we should be concerned about what happens after the 75 years. In Section II.D, they write:

Even a 75-year period is not long enough to provide a complete picture of Social Security's financial condition. Figures II.D4, II.D5, and II.D6 show that the program's financial condition continues to worsen at the end of the period. Overemphasis on summary measures for a 75-year period can lead to incorrect perceptions and to policy prescriptions that do not move toward a sustainable system. Thus, careful consideration of the trends in annual deficits and unfunded obligations toward the end of the 75-year period is important. In order to provide a more complete description of Social Security's very long-run financial condition, this report also includes summary measures for a time period that extends to the infinite horizon. These calculations show that extending the horizon beyond 75 years continues to increase the unfunded obligation, indicating that much larger changes would be required to achieve solvency over the infinite future as compared to changes needed to balance 75-year period summary measures.

This is why I prefer the infinite horizon measure. One should never use an average over a fixed period to summarize a series that has a trend over that period. The required increase in the payroll tax to restore solvency only over the first 75 years is 1.89 percentage points. Acknowleding the continued widening of the annual deficits over that period, the required increase is 3.5 percentage points over the infinite horizon. (See this table for the comparison.)

In my last post, I tried to give Max a way to be specific about a reform plan without relying on the specific calculation of the $10.4 trillion infinite horizon present value or the full 75-year horizon. I put the challenge this way:

Choose a projection period over which you feel confident in the accuracy of the underlying economic and demographic assumptions, subject to the constraint that it is long enough to cover the retirement of the baby boom generation. Provide specific reforms to the system such that the Social Security trust fund is positive and trending upward in the last years of that projection period. Do not use any gimmicks related to benefits or costs in those last few years.

This is very similar to what the Trustees suggest in the fourth paragraph of the Report:

In recent years the Trustees Report has characterized sustainable solvency as maintaining a trust fund balance that is positive and either level or increasing as a percent of the annual cost of the program at the end of the 75-year period. The report also provides measures of the financial status over the infinite future.

Why the difference in wording? As the Trustees acknowledge, all of the key economic and demographic assumptions reach their ultimate assumptions within the first 5 to 25 years of the projection period. For all practical purposes, they could define sustainable solvency as a postive and increasing trust fund at any year after the 25th.

And now Dean gets the same challenge as I put to Max. I'll look forward to seeing the specific proposals from both of them in their next posts on this topic.