Wednesday, May 24, 2006

Cost of Inactivity 3: Response to Karlsfini (and apologies)

(Karlsfini did not authorize me to repost his question from MaxSpeak.)

Bruce, what version of spell check are you using that tags "Regan" and not "Reagan"?

Also, why not just say what's on your mind here where the comments are turned on, rather than try to move the party somewhere else?

A free an open discussion -- that's what we like.
Karlsfini | 05.24.06 - 9:53 am | #

Well I usually start with the only Spell Checker they had when I was a kid, the one inside my head. And "Spell Check is your Friend" is snark for "You are not going to be taken seriously if you repeatedly misspell the name of a recent President" particularly one who is practically a God to the economic Right.

As to your underlying question I would respond forever to this thread if engaged by serious thinkers addressing the issue. It just looked like between Pinky, Bob and Bill a certain amount of "je ne sais quoi" had left this thread.

But I am playing with a mental gambling game I call "Social Security: the Cost of Inaction". It starts with this formula:

A=Social Security payroll gap from year one report times year one payroll income:

Y1Gap x I. Using 2005 as year one and me as example this works out to 1.89% x $50,000.

B=Difference in payroll gap from year two report time year two payroll income times years to retirement.

Y2Gap-Y1Gap x I x Y. Using 2006 as year two (1.92% gap) and me as example this works out to .03% x $51,000 x 17.

The Price of Inaction is B - A.

Now when Bruce is playing this game we get $50,000 x 1.89% = $945. And then $51,000 x .03% = $15.30 x 17 years to retirement = $260.10

Cost of inaction to Bruce in 2005 $260.10 - $945 = -$684.9. That is $685 2005 dollars left in my pocket. Given that both interest and inflation work in my favor here that is the rock bottom cost to me of doing nothing.

Now take somebody we will call "Andy". Andy just graduated from Wharton at 24 in 2004 with an MBA that enables him to take a job on the Street which pays close to the maximum for 2005. How does Andy fare. Well $90,000 x 1.89% = $1701. And $1701 x .03 = $27.30 x 42 = $1146.60. Cost of inaction to Andy in 2005. $1146.60 - $1701 = -$554.40. Now given that interest and inflation are working a lot better for Andy than they are for Bruce, not taking action in 2005 on Social Security put real 2005 dollars in everybody's pocket.

Those who claim that the cost of inaction is $600 billion or $160 billion would be well served to play this game. If you believe that the economic numbers will produce better results than 2006 Intermediate Cost and so lower payroll gap next year than doing nothing is a dead pipe cinch. The 2006 dollars left in your pocket clearly were not needed after all and can be invested or spent. If the payroll gap ticks up than you need to play the game. Are your immediate savings in not taking the tax hit outweighed by your increased tax burden between now and retirement?

Crisismongers insist that if Intermediate Cost holds true payroll gap goes to 12% at depletion. Well fine. I won't be paying payroll tax at currently projected depletion. Some of you will. Well play the game. If there is no increase in payroll gap, i.e. if it stays at 1.92% inaction costs you literally less than nothing. Only if the increase in payroll gap times your income going forward times your years to retirement exceed the dollars left in your pocket (even ignoring the postive effects of interest and inflation on those pocketed dollars) is action even needed.

It would take some pretty sharp spikes in payroll gap year to year to make Inaction a bad bet. .0003 x your 2006 income (.03%) is not much of a bite compared to keeping .0192 x your 2006 income (1.92%) in your pocket.

Take it year by year. Ignore the 75 year or Infinite Future projections. Are you going to have more or less dollars in your pocket this year by doing nothing? Understanding that doing nothing is going to cost you no more, and probably less, going forward than doing something?

Privatizers don't want you to do the math. I'll be glad to respond here, there and everywhere, but Karlsfini just between you and me I think this is likely a dead thread.

But thanks for letting me organize my thoughts. And thank you Max

Tuesday, May 23, 2006

Cost of Inactivity 2: Lets get Historical

Revert to the last post:
Cost of Inactivity I and look at the numbers from the past Reports.

Let's say someone actually started paying attention to the numbers back in 1997, downloading the Reports and looking at the numbers. Well in that Report the price of inactivity was 2.23% of payroll. People paying attention would have to admit that keeping 2.23% of payroll in pocket that year would have to be offset by increased payouts in years forward. Well lets say I was making $32,000 back then compared to $50,000 now. My cost for a permanent fix? $713 dollars a year plus whatever increases in income I gained between then and now. Which at $50,000 would be $1150 a year.

Well I could do the arithmetic and maybe will but I am looking at roughly $8000 plus accumulated interest as the cost of doing nothing and what is the cost of my not accepting a 2.23% boost in payroll back in 1997? 1.92% going forward.

Crisis mongers who insisted that we would pay and pay for doing nothing back then need to return to their abacuses. Thousands left in my pocket since then and a smaller bite going forward.

The math continues in Part 3 of Cost of Inactivity.

The Cost of Inactivity: Nothing as a Plan for Soc Sec

This will be a work in progress for a while, but I will publish it anyway. e-mail criticism and commentary to are welcome.

Can we quantify the price of inaction on Social Security? My starting point is this table from EPI Changes in Trustees Projections Over Time.
Note these are not EPI numbers, these are official numbers from the Annual Reports: "Source: Annual Reports of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds, 1996-2004."

Trustee report date
1996 1997 1998 1999 2000 2004
Year when tax revenue falls short of benefits
2012 2012 2013 2014 2015 2018
Year when trust fund income falls below expenditures
2019 2019 2021 2022 2024 2028
Trust fund depletion date
2029 2029 2032 2034 2037 2042
Shortfall as a share of taxable payroll
2.19% 2.23% 2.19% 2.07% 1.89% 1.89%

Now let the fun begin. My oh my plenty of numeric fun to be added.

What is the cost of doing nothing? I mean real cost in terms of dollars and cents to a particular worker in postponing Social Security reform by a year? Now there has been some learned talk at MaxSpeak and DeLong on May 22 and 23 about what are the costs of inaction, but they all assume that the current economic and demographic model of Social Security is valid and the proper focus point is the outcomes five, ten, seventy-five and God Help Us, Infinite Future out. Well no I propose to put this whole discussion on the Short Term. What is the cost of postponing action this year given what we know about the year just past and the year now ongoing?

Lets start with a real example. The 2004 Report declared that an immediate increase of 1.89% of payroll would be enough to fully fund Social Security with no changes in benefits or retirement age. This under the Intermediate Cost assumptions. Now the 2005 Report declared that the gap is now 1.92%. Worrisome? Well lets whip out the calculator.

Per the Trustees NOT taking action in 2004 in the face of a 1.89% payroll gap left the $50,000 earner with $945 in his pocket. What were the negative consequences? Well the 2005 Report gives us 1.92% payroll gap. Well translate this into dollars. I have $945 left with every opportunity to invest or spend with whatever utility I would get from that spending and what is my downside? Well it is an additional .03% of payroll taxes going forward. Which for our $50,000 earner is $15 a year going forward. Well I have 17 years to retirement which means my total actual cost going forward for pocketing that $945 is 17 x $15 which equals $255. Not doing anything, and discounting for inflation and interest I could earn on that $945 over the next 17 years and I am still $690 ahead in current dollars.

If the payroll gap stays steady, as it did from 2000 to 2005, then you are ahead by exactly the amount of the payroll gap multiplied by your income plus whatever current and future interest you would earn on that amount.

Monday, February 13, 2006

2006 Report: Live

These links now work. I created them in February anticipating the release of the Report by March 31st, instead they delayed the Report until May 1 and then released the key data point with an asterix. Did 2005 productivity grow at 2.0% or somewhere North of that?

Entry page
Table of Contents
List of Tables
List of Figures

Economic Assumptions under the Three Alternatives
Trust Fund Ratio under the Three Alternatives

Sunday, January 08, 2006

Invest or Divert

Let's do both.

Social Security financing projected forward is complicated by a confusion of first and second order income streams. Now Cost is pretty fixed, it varies depending on your assumptions about Real Wages, CPI and various demographic figures but is conceptually easy. Each month a certain number of checks in certain amounts have to be mailed out. But income is conceptually more difficult and requires some breakdown.

The simplest component is Payroll Tax. 12.4% of every paycheck up to about $90,000 flows to the Treasury each pay period. No one questions that this is real money really extracted from the real economy. A lesser known component is taxation on benefits. In some cases higher earning beneficiaries pay tax on their benefits. This gets a little murkier. If this tax was applied across the board as a simple reduction in benefits at the top end of recipients this would not show as an economic extraction from the real economy at all. It is only because it is applied to checks actually mailed out that it even appears as an extraction from the real economy. A third component is interest on excess payroll tax invested in Special Treasuries. This money is pretty real as well. To the extent that borrowing from the Trust Fund just replaces other borrowing (a question for another day), these are just dollars the Treasury would have been paying out to some other investor. But then comes the dread Interest on Interest

Now there are Papa Bear scenarios which would have payroll tax and taxation of benefits fully capable of covering costs forever, and then some. See Goldilocks and the Three Social Security Bears. If this happens our conceptual course forward is pretty simple. We invest the interest on the existing bonds and any principal payment in alternative economic vehicles (my choice would be Municipal and School bonds) and then direct the returns from that back into the income stream. But if payroll is more than handling cost what do we do with the overage? One answer is to split it in thirds: one third to be reinvested, one third in payroll tax cuts, and another third diverted to Medicare (others might balance the ratios otherwise). Now given that the General Fund under this scenario is gamefully kicking in its $100,000,000,000 in interest owed, or even making additional payments on the principal, we end up with a portfolio that is not only steadily reducing payroll tax but kicking in substantial amounts to Medicare besides. All while capping the General Funds responsibility to actual interest owed.

There are other Papa Bear scenarios that are not so rosy. But they all have the same end benefit to the General Fund. If we just started paying out interest in full in the form of buying alternative instruments for the Trust Fund and keep economic productivity anywhere above Baby Bear's 2.1% ultimately we just dig ourselves out of the hole. Depending on how close we get to Baby Bear we may end up having to tap some proportion of the Alternative Portfolio. But in each case we evade the Interest on Interest trap.

Sounds like a fairy tale? Put on your green eyeshades and run the numbers.

Goldilocks and the Three Social Security Bears

I just updated a new diary at MyDD with the above title Goldilocks rather than repost it here, I would refer you there where if you wanted you could login (or set up a Scoop account if you are not already a member) and comment.

To summarize: the current model used by the Social Security Trustees, that of presenting Low Cost, Intermediate Cost, and High Cost as a range of economic outcomes has broken down and it has become necessary to reformulate the models. Which process becomes easier by renaming them. I use the Three Bears.

Baby Bear replaces Low Cost. Baby Bear is a model that produces a fully funded Trust Fund with a flat Trust Fund Ratio. This is in practice what Low Cost has produced for the last decade What is the Low Cost Alternative. Rather than argue whether it is an optimistic number or not, or likely to come to pass or not, we can take it for the question it answers: "What set of economic and demographic numbers gives us fully funded Social Security with a flat Trust Fund Ratio?". Which is to say which is the perfect porridge, not too hot and not too cold.

Mama Bear replaces both Intermediate and High Cost. Take Baby Bear and assume the economy performs worse. Once again we need not worry too much about whether this is realistic or not. It is just a model that projects the effects of an economy whose porridge is too cold.

Papa Bear is new on the scene. Papa relies on the economy producing a better result than Low Cost. Now where you set Papa could set off endless debate. I suggest a simple mechanism: just replace the previously projected second year numbers with the numbers just in. For example the 2005 Report projected a set of numbers for 2005 and another for 2006 and then more for the out years. Leaving the numbers for the out years alone, simply substitute real world 2005 for originally projected 2006 and then do the math. Now this porridge is not particularly hot, the assumption that the economy will perform for a single year pretty much as it did in the past year and then dive back down to the numbers of Baby Bear is not optimistic at all. But it does produce a computable surplus above and beyond what is needed to fully fund Social Security. At least it does this year.

The diary goes on to propose a complicated and not totally thought out mechanism for diverting this one year surplus to other uses, either as a rebate or to Medicare. The key is that we avoid the debate about whether we can predict the economy three years, ten years or seventy five years out. Baby Bear is a model which produces a specific desired result. Papa Bear is a testable model: by the end of the very next year you can determine whether you were correct or not. And in between is a mechanism that regulates the flow of income excluding interest into the Trust Fund.

There is another component. Baby Bear assumes that the Trust Fund is real, that the interest on the Trust Fund is real, and most importantly that the interest on the interest of the Trust Fund is real. The latter is the problem. See the post below.

Interest on Interest: a threat

The Treasury Bonds in the Trust Fund are real. At least those purchased by current payroll tax dollars. They are the product of actual payroll dollars extracted from real paychecks. And in turn the interest earned on those Bonds is real. The General Fund would have had to pay those same dollars to a bond investor if they didn't have the Trust Fund to borrow from instead.

But the Interest on the Interest is more troubling. It is second order. The General Fund is simply assuming an obligation for the convenience of not reducing the current payroll tax to make it a real pay-go system. Now the decision to raise payroll taxes in 1983 was perfectly necessary, for the most part it just restored paygo, the amount of excess payroll tax over cost actually collected is vastly overestimated by just about eveyone, the Trust Fund did not break the $100 billion mark until 1988. And investing the suplus in Special Treasuries was equally sensible, why set up any elaborate system when the whole Fund would be depleted by 2023 anyway.

But 2023 has now turned into 2041, and given not very extraordinary numbers may begin to stretch out even farther. Now the effect of reinvesting the interest in the Special Treasuries back into Special Treasures starts to bite. The General Fund starts assuming an unfunded liability, one that compounds over time as interest on interest starts to pile up. Now no one who believes in the Full Faith and Credit of the United States (and I certainly do) doesn't agree that that money is owed, the question is whether this is the best way to do it in the interests of all taxpayers in the future.

And the answer is 'No'. Given that the Trust Fund will likely be in surplus well past 2041 and perhaps forever we need to reexamine how we manage it. And the answer is pretty clear: stop reinvesting interest into Treasuries. It doesn't produce real cash flow into the Treasury, it just masks the cost of borrowing. The solution is obvious, interest on existing Treasuries and any excess of income excluding interest over current cost needs to be invested in an alternative economic vehicle. In the short term this means some borrowing pain, in the long term it shifts the reponsibility for redeeming those assets off of the General Fund. Moreover it offers the opportunity for the General Fund to eliminate any responsibility long term. If in addition to taking all interest on the current Trust Fund into other vehicles, it actually start to pay down the current principal it gradually reduces its interest burdens overall.

But given the actual financing of Social Security this means reducing the flow of other income into the system. Which means cutting the tax on Social Security benefits that applies to more affluent recipients (a relatively small amount of income) or cutting or diverting a portion of the payroll tax.