Tuesday, December 28, 2004

Max Speaks, and He Clarifies

In response to my last post, Max has clarified his remarks in a subsequent post. No need to go through it in its entirety. On his main point, he now accurately characterizes my views as to what gets worse over time:

What he means if I understand him correctly is that from the standpoint of future generations -- retirees and taxpayers -- the problem of the unfunded ten trillion dollar liability (as of 2004) gets worse because preceding cohorts of retirees are let off the hook ("held harmless" in his words) by having the good fortune of receiving their SS benefits and meeting their Maker before the bill comes due.

I'll add two additional remarks to further clarify the discussion:

First, Max makes the following statement:

Concerning Andrew's 3.5 percent of GDP, I assume this reflects another one of those calculations out to perpetuity, since the Trustees report shows the gap to be only slighly over two percent of GDP at the end of the 75 year planning period (in 2080). The increase in the cash gap relative to GDP has to take some time to rise much beyond two percent of GDP.
Yes and no. The "3.5 percent" to which I often refer is the 3.5 percent of taxable payroll that would be required immediately and in all future years to close the projected $10.4 trillion financial shortfall. It is shown here in the 2004 Trustees Report and is equivalent to about 1.2 percent of GDP. I cite this figure to put the present value calculation in the context of the traditional revenue base for the program. It is an infinite horizon measure, but it is scaled by taxable payroll not GDP.

Second, Max concludes his post with a discussion of whether "pre-funding" this unfunded obligation is good policy. This is an interesting question. As I have noted, my first choice would be not to pre-fund the unfunded obligation but instead to reduce the growth of future benefits (via increases in the retirement ages, not the replacement rate at the age of normal retirement) so that the unfunded part of the obligations is reduced to zero. Reformers to the left of me ideologically--like Diamond and Orszag--have also designed plans that do not entail substantial pre-funding. They do it with tax increases and no reduction in projected aggregate benefits for about five decades. This is a sensible distinction between right and left--smaller versus larger public spheres. I'd like to see it become the template for Congressional debate.

Without pre-funding, there is no need to work through the thorny issues of how those funds are to be accumulated and invested--centrally (via a Trust Fund with a hands off management and a "lockbox") or in a decentralized system of personal accounts. I favor the latter and prefer it to a Diamond-Orszag approach. Earlier this week, Brad DeLong commented in two posts on why he would prefer the former. Some of the difference may be the scale of the investments that we are each envisioning. Clearly, there is some size of the system's aggregate investment in equities below which even I would concede that it would be fine for the government to control the investments. I don't have a specific threshold in mind, but I'm pretty sure that it's sufficiently small (e.g., less than a hundred billion dollars) that it would do little in the way of restoring solvency. Presumably, there is some size of the system's aggregate investment that is sufficiently large that Brad would say is appropriate for a decentralized system of personal accounts. But maybe not, and I'll be the last one to put words in someone else's blog.

Other blogs commenting on this post


JG said...

Two notes:

1) I see that the Treasury now is publishing accrual-basis (as per GAAP) financial statements for the government (though I haven't seen any publicity for them).

They present some real "hold on to your seat"-type numbers. E.g.: While the official budget deficit for 2004 was a mere $412 billion, on an accrual basis the government's net liabilities increased by $11.078 trillion. In just one year. For perspective, total national income was $10.3 trillion.

The big three liability increase items (as per page 11) were: federal debt held by the public, $385 billion; net Social Security liabilities $810 billion; and Medicare ... ahem ... $9.61 trillion (with a "t").

For SS and Medicare these are 75-year numbers: "The social insurance projections in the table above are based on a 75-year period and include expenditures for scheduled future benefits over scheduled revenue for current participants, including those who have reached the eligibility age."

I submit that the government's increasing its implicit debt each year by more than 100% of national income is a course that might be described as "not sustainable".

Over on Max's site their are a lot of commenters of the opinion that the government simply should not break its promises as to entitlement benefits. Well, it's sure as heck going to be breaking *some* promises, so they'd better get used to the idea, and might want to start listing priorities.

2) Oh ... I'll save this for later. In the meantime, Happy New Year.

BTW, what's with changing the name of the General Accounting Office to the Government Accountability Office ... or should I guess?

Anonymous said...

By evading the question of prefunding I think you're avoiding the a criticially important question in the Social Security debate: what commitments did our government enter into as a result of the early 1980s (Greenspan-led) Social Security reform and what obligations should they entail for future policy? Those who argue that the Social Security trust fund does not contain "real assets" are ignoring the implied obligations of the 1980s reform. That the General Fund borrowed from the trust fund to finance current operations might have been regrettable economic policy, but it was something that has been done and doesn't (in my opinion) change the status of the assets in the trust fund. They are still obligations of the federal government that must be redeemed. If they are not, then, as others have commented, the 1980s-era reform was class warfare of a particularly deceptive kind (and, in which case, my preferred Social Security reform would be to uncap FICA for Social Security revenue purposes, but leave the benefit formulas in terms of capped contributions - since that would have approximately the same effect as the progressive income tax increases that would be required to repay the bonds in the trust fund).

Roland Patrick said...

"Those who argue that the Social Security trust fund does not contain "real assets" are ignoring the implied obligations of the 1980s reform."

Which includes, among others, former Treasury Sec'y Larry Summers. However, whatever was 'implied', the reality is that the SS 'trust fund' is both an asset and a liability--in exactly equal amounts--of the federal government. Meaning the 'trust fund' balances to $ 0.00.

That is economic reality, those who argue it isn't, ain't doin' economics.