Saturday, November 20, 2004

The Three Alternatives

To understand Social Security you have to understand the three Alternatives: the Low Cost, the Intermediate Cost, and the High Cost. Each is a set of economic and demographic assumptions that purport to show "a range of possible outcomes" with the Intermediate set "designated as alternative II, reflects the Trustees' best estimate of the trust funds' future financial outlook." (2004 Report p.1). Note that there is no suggestion that this estimate is conservative, biased by the natural caution of actuaries, this is supposed to be the midpoint estimate, attested to by the political masters of Social Security.

Interestingly the Intermediate Cost Alternative is the only one that is ever cited in the media, and is generally presented as a firm prediction: The Trust Fund "will" start running out in year X and will be totally depleted by year Y. There is nary a suggestion that it is just the mid-point of a range and that the Trustee's allow that the economy might outperform those numbers and no conversation about the future state of the Trust Fund if it does.

The biggest driver for the Trust Fund is Productivity Growth. If the economy grows more than projected the date of Trust Fund exhaustion gets pushed back. Moreover early years are more important than later years. And now the data. (2004 Report p.88) Economic Assumptions

Productivity Growth Under the Intermediate Cost Alternative
2004 2.7% 2005 1.8% 2006 1.9% 2007 1.9% 2008 1.8% 2009 1.8% 2010 1.7% 2011 1.7% 2012 and years forward 1.6%.
At first glance these are pretty pessimistic, at second glance they are ridiculous. The best guess of the Trustees is that productivity will shrink from the 3.4% it achieved in 2003 to an ultimate rate half of that? Is there a single other model out there that shares these numbers? (And a little challenge to would be privatizers: how are you going to return 7% on stocks with these anemic economic numbers.)

Productivity Growth Under the Low Cost Alternative
2004 2.8% 2005 2.1% 2006 2.2% 2007 2.2% 2008 2.1% 2009 2.0% 2010 2.0% 2011 1.9% 2012 and years forward 1.9%
For guys that are pushing Tax Cuts as the engine to drive a roaring economy, this belief that 1.9% is the best we can expect longterm seems to go against every other prediction I have seen. We can do better than that, though as we will see, to save Social Security we don't have to.

And no matter how you slice it, we already beat the 2004 number in both models.