Sunday, January 08, 2006

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.

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