Thursday, February 03, 2005

Social Security in the SOTU

I read, but didn't get a chance to watch, the State of the Union address last evening. I had a few reactions to what the President said about Social Security:

1) I liked the sequencing of the statements. The discussion of restoring solvency came first, followed by the discussion of personal accounts. I hope that reflects the way the folks in the White House are thinking about the issue.

2) The President specifically said that, to restore solvency, a range of options are on the table, including raising the retirement age, which is my preferred option.

3) He also excluded the possibility of raising the payroll tax to restore solvency. That will make it more difficult--I hope it does not necessary exclude an out-of-pocket contribution to support the personal accounts, but I believe it does. I have a feeling that this will be one of the places where a compromise can be reached--higher revenues coming into the system, but in an amount smaller than the revenues flowing to the personal accounts. Just a guess.

4) I did not like the statement, "By the year 2042, the entire system would be exhausted and bankrupt." We've been down this road before. A reasonable definition of bankrupt includes the system not being able to pay all of its obligations. However, this does not mean that the system will be exhausted in 2042. What is projected is that the trust fund will be exhausted in 2042. The system will still have an income rate (payroll tax plus income tax on benefits) of 13.28 percent of taxable payroll, which is 4.51 percentage points short of the projected 17.79 percent cost rate. (The figures come from this table.) In the SOTU address, every word must be carefully chosen. The folks inside the White House working on this language absolutely have to get it exactly right.

5) Then the President moves to the following paragraph about personal accounts:

Here's why the personal accounts are a better deal. Your money will grow, over time, at a greater rate than anything the current system can deliver -- and your account will provide money for retirement over and above the check you will receive from Social Security. In addition, you'll be able to pass along the money that accumulates in your personal account, if you wish, to your children and -- or grandchildren. And best of all, the money in the account is yours, and the government can never take it away.
A couple of issues here:
  • There is a vagueness about the "greater than anything the current system can deliver" phrase that is troubling. It doesn't mention the risk associated with obtaining those returns. It also suggests that rates of return are the way to make the case for reform. Not so. It's the fact that, if you are prefunding, you need to do it outside the current system so that saving actually goes up. I would support personal accounts even if the rates of return where no better than Treasury bond returns, if we are bringing new money into the system.
  • The issue of bequests is completely unnecessary. Social Security exists to provide insurance against outliving one's means. Nothing prevents people from leaving bequests currently if they so desire. I am not aware of any failures in the life insurance market that need government attention.
  • It is a stretch to say that the government "cannot take these accounts away." I agree that it would (probably) be more difficult for the government to impose a surtax on the accounts than it would be to cut benefits coming from the pay-as-you-go system, but "cannot" is too strong. I also believe that, once the objective of making sure that elderly are not poverty is met, there is no compelling reason to have the benefits paid out of the traditional system rather than a system of personal accounts.
6) Some other items that were discussed. The President was clear that everyone 55 and over is in the traditional system with benefits as specified by current law. Good. He was also clear about a gradual phase-in. Good. He explicitly mentions the Federal Thrift Savings Program as a guide for the sort of investment options available. Very good. He then said that, eventually, everyone would get to put 4 percentage points of their payroll tax payments (of 12.4 percentage points total) into the personal accounts. Not 4 percent up to a limit, like the Commission said, but 4 percent. I'm not sure whether that was intentional.

7) An item not discussed--exactly how progressive the reductions in future benefits from the current system would be. I expect this to be another area for compromise--make the traditional system that continues even more progressive, to make sure that the lowest-income people, who are less able to bear financial risk, are depending less on the personal accounts than other workers.

I haven't checked what others have been writing around the blogosphere and the MSM, so maybe more later.

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15 comments:

PGL said...

Thanks for the summary - and especially thanks for the editorial comments, all of which I agree with. I found this notion that those 55 and older will not see any benefit cuts interesting. Since Bush is ruling out increases in the payroll tax as well, the oft heard notion that delaying will only raise the cost of reform makes no mathematical sense. Any alleged shortfall equal the difference between payouts and payins. Since Bush is saying no new payins, reducing the cost of reform means reducing payouts. But if we implement a plan in 2015 or we devise a plan now that rules out cuts for those over 55, there is no (material) difference in the payouts. So what is all this babbling about delay meaning higher costs?

Andrew Samwick said...

As every year passes, another birth cohort crosses over the "55 and over" threshold and is thus held harmless by the reform. Wait 10 years, and the burden of plugging the whole in the system goes up on everyone but those 10 birth cohorts. To me, that's one very real cost of delay.

The burden also goes up in present value (measured next year) because even implicit debt accrues interest. See this post for examples. If the riskfree rate exceeds the growth rate of the economy, then the burden will also go up as measured as a share of GDP.

Anonymous said...

With regard to your #4, I think that the wording has been chosen very carefully. The administration wants people to believe that the system is much closer to financial trouble than is the case. The word 'Bankrupt' may be technically correct, but to the general audience the impression is left (as it is intended to) that Social Security will have no money left. This is a lie.

In your number 5 you say bringing new money into the system is the reason for the reform, rather than the higher rates of return. But the administration has pretty explicitly ruled out any mechanism by which new money could enter the system. The improved rates of return are the rationale behind the Administrations position.

Lastly you mention the issue of bequests. This is interesting. Isn't this a way that money will leave the system? Has anyone looked at what the effect on Social Security would be if the system had to pay out the full promised benefits to the heirs of those due to receive benefits? In other words, the current system gets to 'keep' some of the money it does not pay to those who die before receiving some or all of their promised benefits. The system of private accounts does not. What is the effect of this?

Kent said...

He also excluded the possibility of raising the payroll tax to restore solvency.I hope the inevitable compromise takes the form of raising the cutoff income. I am not a fan of excessively progressive income tax, but I despise regressive income taxes, which is what the Social Security tax has amounted to.

Max said...

You said:

"It also suggests that rates of return are the way to make the case for reform. Not so. It's the fact that, if you are prefunding, you need to do it outside the current system so that saving actually goes up."

I think I know what you mean, but I'd appreciate it if you could elaborate on it yourself. The idea is out there that the individual accounts provide some kind of arbitrage gain -- found money -- relative to riskless returns from bonds or SS itself.

PGL said...

Andrew: the comparison I was suggesting is: (a) Bush plan - pass it now and exempt the 55+cohort; (b) my plan - pass it in 10 years and exempt the 65+cohert. No difference.

Anonymous said...

However, this does not mean that the system will be exhausted in 2042. I am exhausted now.

Tom MaguireP.S. Re equity arbitrage returns, the White House was pretty diligent about distancing themeselves from this. Here is the LA Times:

In a significant shift in his rationale for the accounts, Bush dropped his claim that they would help solve Social Security's fiscal problems — a link he sometimes made during last year's presidential campaign. Instead, he said the individual accounts were desirable because they would be "a better deal," providing workers what he said would be a higher rate of return and "greater security in retirement."

A Bush aide, briefing reporters on the condition of anonymity, was more explicit, saying that the individual accounts would do nothing to solve the system's long-term financial problems.
This is old news to NY Times readers.

Max said...

That's not what I'm referring to. If the extra returns on a PRA were used to fully offset benefits, then the individual is no better off but the system's solvency is marginally improved. But if the individual keeps the premium on his PRA and his benefit is only offset by some riskless return, then the individual benefits and the system is no better off. Andrew seems to be saying that in the latter case there is no real net benefit to the individual.

Anonymous said...

(GT)

You say you've been down this road before, in reference to SS bankruptcy. Do you agree that SS, having no debt, cannot go bankrupt?

Cent21 said...

Acturary table suggests that 98% that reach the workforce at age 20, and 82% reach retirement age.

Thus, a real cost is that about 18% of revenue going into the system would be lost. No, less than that. Something north of 10%.

I think personal accounts that divert revenues should have to pay a "legacy benefits" fee that covers the transition cost. Otherwise, those costs are borne by other SS beneficiaries, and by the general public. If it is a good enough idea to divert revenues to personal accounts, then it is a good enough idea that they should be "revenue neutral" rather than being subsidized.

JG said...

"You say you've been down this road before, in reference to SS bankruptcy. Do you agree that SS, having no debt, cannot go bankrupt?"

The one and only reason SS cannot go bankrupt is that it is the *government* and the government is not subject to its own bankruptcy laws.

Any other party in this great nation that can't pay all its liabilities can be put into bankruptcy by those to whom they are owed.

Social Security will still be able to pay 75% of its legally established liabilities in the out years, so it won't be bankrupt?

Heck, Studebacker could have gone on forever paying everybody 75% of what it owed.

BTW, it's interesting that Social Security liabilities that are legally accrued under the law are not considered "debt" by some.

It's fun being a government. Your legal liabilities aren't debt. ;-)

But try telling a bunch of 64-year-olds that they aren't *owed* them. ;-(

JG said...

"'It also suggests that rates of return are the way to make the case for reform. Not so.'"

Oh ... Yes so!

When rates of return were *high* they were the whole political and economic justification for SS, especially for liberals. They were the whole game.

Here's Paul Samuelson on that, back then:
http://www.scrivener.net/2005/02/beauty-of-social-security-by-paul.html

But now that returns have plunged, and even today's low-to-negative ones are unsustainable, they suddenly aren't supposed to count??

For conservatives this is naive. For liberals this is first disingenuous, then naive.

"I think I know what you mean, but I'd appreciate it if you could elaborate on it yourself. The idea is out there that the individual accounts provide some kind of arbitrage gain -- found money -- relative to riskless returns from bonds or SS itself."

There may be a little gain, but private accounts are not about closing the funding gap -- and it has been very poor politics for the White House to try to sell them as that, as it has to date. Though on the record of the recent press briefing that may be changing for the better.

Look, the whole issue of the funding gap is right here:

Congress in its great wisdom made $10 trillion of backward transfers to pre-2000 SS participants to **increase their returns on contributions** -- colloquially, "hand out free money".

This $10 trillion in payouts over the bond rate, of course, is the entire reason why SS has always been such a success and so popular. As per Samuelson.

But now, post-2000 taxpayers have to pony up this $10 trillion to close the gap.

The SS status quo does this by collecting from wage earners, upping their payroll taxes and slashing their benefits -- a process started in 1983 and not done yet. From now on this will make workers *poorer* on a lifetime basis. This is *regressive*.

OTOH, to the extent workers' contributions are saved for themselves in private accounts they are protected from this fate, and can continue to be enriched by the system.

Then the cost of the $10 T is shifted to *richer* folks, who will pay via progressive income taxes, maybe a VAT, and having *the rich* means tested out of SS (do Warren Buffett and Bill Gates really need it, on top of their Medicare benefits?). This is *progressive*.

The exact same $10 trillion shortfall must be financed either way. One way or the other.

Why "progressives" want to drop it on the backs of labor is beyond me.

If one believes what they always claim about wanting to help workers, shouldn't *they* be the ones who want to preserve the actual historical objective and substance of SS with private accounts?

To help labor, and stick it to the rich?

Max said...

I am glad to see Jim Glass fighting with Andrew, and I still hope Andrew answers my question and fights with Jim Glass.

My comment on JG is that his last comment goes off the rails after the acronym OTOH. If you acknowledge that solvency is unaffected by private accounts, then switching to them can't address solvency. Solvency aside, it has already been shown that the value of the PRAs will be vulnerable to the intricacies of the benefit offset mechanism.

The simplest progressive basis for dealing with any program shortfall is progressive tax revenue. All the tricky stuff -- borrowing to pay for diversion to accounts that generate a benefit offset, etc. -- is grist for alternative outcomes.

Cent21 said...

The legally established liabilities of SS are clearly spelled out by the enabling statutes.

If the trust fund ratio drops below .20, indexing uses the lower of wage or price index. A notice gets sent to congress explaining the upcoming dilemma.

The legal obligation is to pay benefits from a schedule, as long as there are trust fund assets to back that up, or to pay from available revenues, if there are insufficient trust fund assets.

You don't say a corporation is bankrupt if it cuts its dividend.

If SS cuts benefits by 22% 45 years from now, after having raised benefits by about 40% plus the inflation rate from current levels, that would be similar to a company cutting its dividend once after 75 straight years of raising its dividend.

Clearly, any company that raises its dividend every year for 75 years in a row would prefer not to ever cut its dividend. But it wouldn't be "bankrupt" just because it cut its dividend. In fact, it would simply be prudent.

Social Security can't go "bankrupt" or "flat bust" unless something much worse than the problems projected by the SSA actuaries and CBO come to pass.

Roland Patrick said...

"If SS cuts benefits by 22% 45 years from now, after having raised benefits by about 40% plus the inflation rate from current levels, that would be similar to a company cutting its dividend once after 75 straight years of raising its dividend."

Oh, so SS revenues are already invested in equity.