Monday, April 28, 2008

Paranoic Newtonian Low Cost

In science a theory does not have to be 100% true to be useful. It turns out that 19th Century physicists were not nearly as close to the limits of science as they thought as first Einstein and latter the Quantum folk set those limits far, far back. But within the limits of normal every day reality you never really need to build in adjustments for either relativistic or quantum effects, Newton is plenty good for ordinary purposes.

So I propose to use my Paranoia theory as a reasonable Newtonian tool for analysis and ask the question 'What if?'

What if Low Cost really had been constrained to a particular limit, a limit that had it produce a fully funded system going forward? Well considered as such Low Cost would represent the answer to this question: 'what level of economic and demographic growth would fix Social Security without any changes in tax, benefits, or retirement age?' Which is an excellent policy question, it allows us to look at the various assumptions and draw conclusions, this data column maybe looks too optimistic, that one too pessimistic and so measure the respective effects on ultimate solvency. But whatever our conclusion Low Cost is always out there competing with every other proposal for reform or fix, it sets a barrier against the use of two sets of books, one that shows crisis and another that solves it. This sets out the fundamental challenge to privatizers, they constantly point to historic rates of returns on stocks while ignoring that those rates depend on long stretches of years of better growth performance than fully funded Low Cost, instead they need to show that they can get better than Intermediate Cost results and yet still stay under the limit established by the Low Cost model.

Now if Low Cost is a limit what is Intermediate Cost? Well it too establishes a limit, it puts privatizers on a budget. People often claim that 'We can't tax our way out of Social Security crisis'. Well of course we can, it just depends on how much pain we are willing to take. Each year the Trustees tell us exactly what the payroll gap is given Intermediate Cost assumptions, which is to say what amount of immediate tax hike would be needed to place the system in Long Term Actuarial Balance, which is to say fully funded with a constant reserve. In the 2008 Report that gap is 1.7% of payroll on wages up to the current limit of $102,000. Whether that is a lot or not is up for discussion, what isn't is that any privatization plan that costs more than an additional 1.7% of payroll isn't worth doing if it doesn't return a better result for most workers. Which gets us to the other limit of Intermediate Cost, that of percentage of payable benefits at Trust Fund Depletion.

People often talk about Depletion is terms like 'broke' and 'bankrupt' and conclude 'Social Security just won't be there for me'. Well as long as we have a payroll tax we can pay out some level of benefits, the dollar flow nevers go to zero. The proper questions would be 'How much will benefits need to be cut?' and 'What would be the net result in real terms to what retirees get today and in all years between now and projected Depletion?'. And we know the answers to both. The scheduled benefit right before Depletion has been calculated to be around 160% compared to a similarly situated retiree today (that is not my number but I trust the Professor who supplied it). The Trustees tell us that the cut in 2041 will be to 78% of the schedule. Well if we take 78% of 160% we get 125%, crisis in context means retirees starting 33 years out get cut back to a benefit only 25% better than the one my Mom gets today. Doesn't add up to 'crisis' to me. What it does is put up another benchmark for privatizers, if their plan builds in benefit cuts in excess of 22% at Depletion then the plan is just not worth doing, nobody comes out ahead net and almost everyone would benefit in the mean time by not taking whatever phased in changes between now and Depletion.

Which brings up another limit. On balance Depletion has been receding into the future and since 1997 at a rate of more than a year per year, even if that rate slows down any movement outwards discounts that date more and more particularly for Boomers, mortality tables suggest that half of us will be gone by 2041, asking people over fifty to undergo any sacrifice simply to avoid some kid only getting a 25% better check than our parents do today seems a bit much.

So there is a whole set of limits set here. Low Cost establishes growth numbers. Intermediate Cost establishes payroll gap, benefit cut at depletion and date of benefit cut. It also sets a base set of economic numbers. An honest privatizing plan needs either to work with IC numbers or rescore Social Security under their own assumptions. All those numbers are moving. Low Cost numbers seem reasonable by historical standards, the payroll gap has on overage been shrinking (down from 2.23% in 1997 to 1.7% today), the amount of the projected benefit cut has been shrinking (down from 25% in 2007 to 22%) today. The progress is admittedly incremental but it is pretty steady and every bit of improvement makes the cost/benefit analysis of any given privatization plan that much more difficult to sell. When privatizers tell you 'We can't afford to wait' what they really mean is 'The numbers are killing my plan'.

Viewed this way Intermediate and Low Cost serve as a vice. If the gap ever closes completely then obviously crisis is over but even if it doesn't it leaves increasingly little room for privatizers to operate in. My private estimation is that the vice will be tight enough by 2010 to make this debate moot, given a prolonged recession you might have to bump that back to 2012. But the day of reckoning is coming. Because they just don't have the numbers.

Paranoic Empiricism or Empirical Paranoia?

This post will take some time to develop, consider this installment one.

In 1997 I finally got my hands on the Annual Report of the Trustees of Social Security to find out why reported dates of Trust Fund depletion seemed to be moving. Well I found that answer, in short better than expected economic growth was driving that date out in time. But it was the numbers behind the numbers that provided the real surprises.

First I learned that the Social Security Trustees actually produce three different economic and demographic projections purporting to cover the full range of possible economic outcomes. The standard projection, the one always cited in the papers is officially called Intermediate Cost. It is accompanied by a more optimistic model called Low Cost and a more pessimistic model called High Cost. In looking at Low Cost two things jumped out. First its outcome was better than most people would have thought possible, if those numbers came home Social Security would be fully funded through the 75 year actuarial window. The second was even more interesting, the numbers needed going forward were not much different than the actual numbers of 1996, if the near to medium future looked like the near to medium past then we were essentially home free. Now in point of fact 1996 was at the time considered to be a pretty good year, having essentially identical numbers representing the top of a possible range of economic outcomes did not seem odd.

But then the 1998 Report came out and instead of the 2.5% Real GDP projected by Intermediate Cost (hereafter IC) or the 3.2% of Low Cost (LC) the actual number came in at 3.8%. Which was interesting enough in that it showed the short term model was too conservative, what the Trustees saw as the top end of the range clearly wasn't. But what was really interesting was the outcome of Low Cost. Other things being equal a better than expected first year number should have the mathematical effect of moving the curve up, 1998 Low Cost should have shown a better end result than 1997, fully funded should have yielded to somewhat over funded. But it didn't. While IC showed a full 3 year improvement with Trust Fund Depletion moving out from 2029 to 2032, LC stayed static at fully funded yet not overfunded.
Why was this? Well on examination in the face of a better than expected 1997 the reaction of the Social Security Trustees (or actually the staff actuaries in the Off of the Chief Actuary) was to adjust future growth numbers down, including a slightly lower number for the current year. It seemed a little odd that the net effect was equilibrium but odder things have happened.

But when lightning strikes twice you start to get jittery. Because in 1999 it happened again, growth numbers came in not only in advance of IC but also of LC, in fact strongly so with much the same result as in the 1998 Report, depletion moving out 2 years to 2034. But once again the outcome of Low Cost didn't budge, it still showed fully but not overfunded Social Security through the 75 year window. And on inspection you could see a further downward adjustment in future numbers. I began to smell a rat. In the face of two years of much better than expected numbers what would make you more pessimistic about the future?

Third time is a charm, the 2000 Report came out and the pattern was confirmed. Much better growth than even the 'optimistic' LC projected, Trust Fund depletion moving out in time by another 3 years to 2037 but LC stubbornly staying at its same equilibrium result.

Which is where the paranoia part comes in. Empirically the simplest explanation of the number series varying outside what would appear to be your confidence interval without a change to your upper limit is that it is in fact a deliberate limit, that the data was being fit to the curve. Now in a policy context this wasn't necessarily a bad thing, in fact it established Low Cost as a useful touchstone, outcomes closer to LC showing less need to address Social Security at all while any outcome better than IC at a minimum lowering the risk of doing Nothing short term. The problem is that the Trustees insisted this was not what was happening at all, instead these numbers were simply the best available information as analyzed by the career staff at the Social Security Administration. Moreover these numbers were examined and utilized by many other agencies including OMB and CBO, deliberate manipulation would imply a government wide conspiracy to conceal the true financial situation facing Social Security. And all of this mind you within a presumedly Social Security friendly Clinton Administration.

A empirical conclusion that seemed obvious based on pure examination of the number series crashed into political reality, there was no way to pull this off, it all just had to be a coincidence. Until it happened again, and again, and again. In all Reports from 2001-2007, now produced by the Social Security unfriendly Bush Administration, the result of LC remained constant: fully funded but not overfunded. It would appear that statistical lightning could strike the same effective point eleven years in a row. Yeah and I could let the money ride and hit 11 sevens in a row at a Craps table in Vegas, the smart money is against that happening.

Finally the pattern broke in 2008 with results to be seen below:
Shape of Low Cost This year Low Cost for the first time ever shows what an overfunded Trust Fund would look like, I can finally ditch paranoia and using the Trustees own numbers begin to explain the risks of an over funded system, an outcome that until 2007 had officially been deemed impossible by two Administrations. Just excuse me if I hold onto some of my paranoia, I formed a conclusion in 2000, openly posted it in Nov 2004 under What is the Low Cost Alternative and had it stand up to test with the 2005, 2006 and 2007 Report. I may have been wrong but I wasn't crazy, or at least not much, Occam's Razor suggested that Low Cost was being artificially constrained, careful examination of the numbers year over year showed clear signs of under motivated changes in data points for future years and it beggers belief that everything just happened to return the exact same equilibrium result.

My belief anyway.

Wednesday, April 16, 2008

100/100 in action

In the post below this one I argue that high Trust Fund ratios present a threat to Social Security by transferring it from worker paid insurance to general fund paid welfare. This was specifically a political calculation, under our current situation the Economic Right has successfully been able to separate federal spending into two categories: one of spending that we can't NOT afford which includes all things military, and the other of spending we CAN'T afford which includes most social spending. That the stuff that we can't NOT afford comes with prices starting with 'b's and the stuff we CAN'T afford comes with prices typically starting with 'm's never seems to register. (The Administration practically wet itself announcing $200 million in world food aid yesterday, which works out to 8 hours of the current costs of waging war in Iraq). It is important to keep Social Security from being lumped in with all those other programs, the Right hates it and always has. That is not hyperbole, if they can kill they will, Alf Landon explicitly ran against it in 1936 and the Republicans never really stopped.

A Trust Fund Ratio of 100 is not only a reasonable target, it is in fact the legal test of Short Term Actuarial Balance for the Trustees. Now one way of getting there is to use the brute force method of simply not collecting FICA at all for the next two and a half years and so drive the TF ratio down from its current level of 360 to 100. But that would mean taking a combined $800 billion annual hit to the General Fund over that period. Not only is that not going to happen, it is not necessary. Instead we need to craft a new model that will deliver us to sustainable solvency after 2040.

We know what level of tax increase we would need under Intermediate Cost assumptions: 1.7% of payroll. We know the growth numbers that will return an overfunded system along the lines of Low Cost: 2.9% Real GDP in the years after 2013. So lets go target shooting.

For political reasons our first target point is 2011. We can start with Intermediate Cost assumptions and assume we will need to start phasing in that 1.7% with an initial increase of .4% of payroll. If between now and 2011 we beat IC numbers we simply shave that initial increase down to compensate. If we do enough better to make it unnecessary we can make an adjustment in the next target point of 2015 or whatever interval we choose but always with the goal of delivering 100% of benefits while keeping the TF tail from going long term significantly over a ratio of 100.

It is my personal opinion that subsequent adjustments in the targets will be more likely in the direction of cutting the rates rather than raising them, but in this case opinions don't matter, economic performance does. Rather than quarrel about 75 year windows instead we can just settle on a policy outcome and adjust the FICA rate as needed to hit it.

This is not to say that the current schedule is perfect or that adjustments to benefits are totally off the table, we might agree to settle on a 95/100 solution. But the points are one, we need to be proactive and not reactive, and two there are significant dangers to allowing the Trust Fund ratio from getting out of hand, we are in fact called to thread the economic needle.

Social Security Low Cost & the 100/100 Target

100% of scheduled benefits plus sustainable solvency with a 100 Trust Fund Ratio.

The current system of reporting Social Security solvency depends on a projection model. The Trustees ask the Office of the Chief Actuary to come up with a range of possible economic and demographic outcomes and score solvency under models that purport to represent the median (Intermediate Cost), the top (Low Cost), and the bottom (High Cost) of that range. This has led to a certain amount of controversy with one camp arguing that Intermediate Cost by coincidence or design has been too pessimistic, while another camp argues that it is in fact carefully constructed in light of best available information. Well that is not getting us anywhere, quarreling over which 75 year economic model is superior is kind of laughable considering that we don't have consensus over what happened over the last 75 days. (Are we in recession yet?) I suggest a new approach.

Instead of projecting why don't we try targeting? And a good starting point is the current schedule of benefits. To recap the situation. Social Security benefits are adjusted to capture the changes in real wages over a workers lifetime. What this means in practice is that historically Social Security has been a better deal for each generation, offset by some increases in payroll taxes along the way. Under the current schedule benefits in 2041 are set to be about 160% compared to the benefits a similarly situated retiree gets today. However under Intermediate Cost Assumptions the accumulated surplus in the Trust Funds is scheduled to run out in that year resulting in an immediate reset in benefits to 78% of the schedule. Now one way to look at this is to apply Rosser's Equation (after Prof. Rosser of JMU who pointed me to these numbers) and see that 78% of 160% = 125% and call the deal done. Because a benefit 25% better than my Mom gets today guaranteed until I am 84 doesn't exactly rise to the level of personal crisis. Then again the world doesn't revolve around me.

So lets just assume that we want to target 100%. But what about the other 100? What is this Trust Fund Ratio you talk of?

The Trust Fund Ratio is simply a measure of the trust fund balances expressed as a function of time with 1 year = 100. If Social Security income from all sources continues to track total cost you end up with a stable Trust Fund Ratio. More income than cost ratio goes up, less income than cost ratio goes down. By law the Trustees are mandated to keep a minimum Trust Fund Ratio of 100. This allows for a certain degree of short term fluctuation in employment and hence payroll receipts to occur with creating financing gaps, keeping the TF ratio above 100 is a reasonable policy outcome. But there are limits, at some point a high TF ratio becomes actually a threat to the health of Social Security itself. Oddly enough you can really be too rich.

It works like this. Social Security surpluses are currently invested in Special Treasuries. Despite some hysteria these bonds perform just like any other Treasury, they carry specific interest rates and specific terms and are backed by the Full Faith and Credit of the United States. They are just as real as that dollar bill in your wallet. But is exactly because these bonds are real that they can become a problem. To see why you have to examine the past and present projection of the Low Cost Alternative.

From 1997 to 2007 Low Cost always returned the same outcome, a fully funded Social Security system with a flat TF ratio through the 75 year actuarial window meaning that total income tracked total costs putting the whole system in long term equilibrium. Now while this is a perfectly adequate outcome it would not in fact be an ideal outcome, the TF ratio settled out at high enough levels that the cost of paying the interest starts representing an appreciable burden on the General Fund. Not a big burden but enough of one to get noticed, under 2007 Low Cost the General Fund would be required to pay out about 10% of the interest owed in years after mid-century or about 2% of total system cost. Now there is nothing particularly unfair about a 98%/2% split between payroll tax and general fund, on the other hand the obligation never stops even while the original utility of the excess borrowing fades away. Table VI.F8.-Operations of the Combined OASI and DI Trust Funds, in Current Dollars, Calendar Years 2007-85

The 2008 Report tossed us an entirely different complication, under the newest Low Cost projection the system never settles into equilibrium, instead you get outcome I in the figure in this post Shape of Low Cost the tail doesn't flatten and the TF ratio rockets up to 650 in 2085 and rising from there. To see why this is a problem you have to take this process to its logical end. A TF ratio of 2000 at an interest rate of 5% would require General Fund transfers equal to 100% of overall system cost to restore equilibrium. Which is to say that Social Security would lose all semblance of being a worker financed insurance system and simply be transformed to welfare. In fact I would argue that any TF ratio above 1000 is a longterm danger, restoring the system to equilibrium requiring a transfer of more than 50% of total cost and so making SS into at least a partial welfare program. But by a really cruel mathematical irony the only way to drive the TF ratio down is by cutting the revenue from the payroll tax and so in the short term INCREASING the share borne by the General Fund. Instead you need to get this particular tiger's tail under control before the acceleration sets in.

Saturday, April 12, 2008

Trust Fund Depletion: Crisis? or Tax Cut?

Social Security 'Crisis' comes in two forms: shortfall and depletion. 'Shortfall' is that time when receipts from payroll tax and tax on benefits fall short of cost and so Trust Fund assets first need to be tapped. Shortfall currently is projected for 2017 under Intermediate Cost projections. But in this post I propose to examine 'Depletion', the date when all Trust Fund assets are depleted, currently projected for 2041.

Whether Depletion constitutes crisis depends on where you are sitting. Under current law at Depletion benefits are automatically reduced to whatever level then current Social Security income sustains, a level that currently projects at 78% of the scheduled benefit. On the other hand the current benefit schedule would have a 2040 benefit 160% in real terms of what a similarly situated retiree gets today and by application of Rosser's Equation we have 78% of 160% = 125%. So 'crisis' is here defined as '25% better check than my Mom gets today'. While it is a nice feature of Social Security that each generation gets a better outcome you have to ask whether the difference between 25% better and 60% better rises to the level of national priority when we have 47 million people uninsured. As an example a person scheduled to retire in 2041 would be 33 today and likely to have young children and moreover have plenty of time to plan for retirement. Telling that young parent that his retirement check 33 years out is more important than funding his childrens' education or health care is on examination kind of absurd. And yet that is where 'crisis' takes us.

Now lets move up the age scale and see what a 2041 crisis means to someone currently 66, or 55, or 44. If I am 66 and preparing for full retirement next year the prospect of a benefit cut 31 years out isn't exactly scary and even less so if the proposed cures include phased in cuts in between (as most 'reform' plans do). I'll be very lucky to still be kicking at 97. Similar considerations hit for the 55 year old, mortality tables suggest that half of his cohort will be dead and most of the rest on the way out, any 'reform' plan that carries some combination of tax increases and benefit cuts is just going to hit you twice. Now a 44 year old is on the cusp, she is likely to still be drawing benefits in 2041, but on the other hand she is looking at a potential of 23 years of higher taxes until retirement in 2031 coupled with ten years of whatever phased in benefits cuts might be required to 'save' Social Security. On balance none of these people have a reason to move on Social Security, 'crisis' in numeric context is no crisis at all.

But now let's move down the age scale and see what a 2041 depletion crisis means to someone 22, 11, and 1 years old. Time to bring in some numbers.

Under Intermediate Cost assumptions, Social Security starts drawing on the General Fund in 2017 as income from taxation lags total cost. Initially this just takes a portion of the interest due but mounts until in the mid 2020s all accrued interest is needed at which time it becomes necessary to start redeeming the principal. Eventually by 2040 this transfer from the General Fund reaches $806 billion. (Which is a lot of money but when adjusted for inflation works out to $335 billion in inflation adjusted constant dollars or less than they typical Bush deficit.) But then the obligation effectively ceases, after an additional transfer of  $267 billion in 2041 the legal obligation on the General Fund simply stops. Result? $806 billion tax dollars suddenly freed up.

Which gives the taxpayers of 2041 some choices. They can examine Rosser's Equation and figure that 78% of 160% = 125% is just not that bad a deal for Grandpa and so use that $806 billion somewhere else, say to shore up Grandpa's Medicare, or maybe they will just take it back in the form of a tax cut, or some combination of spending and tax cuts.

So where does that 22 year old fit in this picture? Well he is not retirement eligible until 2053 and so has a full 12 years of an effective tax cut in exchange for potentially having to take a somewhat lower retirement. At worst it is a near wash. And the 11 year old of today? In 2041 he will only be 44 and maybe more inclined to take his chances funding his IRA than continuing to pay General Fund taxes to bolster Social Security. 

When you sum it all up there is only a narrow band of people on either side of 30 for whom a crisis defined as a minor cut in real benefits 32 years out even makes sense, and that would have to be weighed against other uses for that current payroll dollar. As for Boomer's and Millennials both there is exactly zero reason to move on this front.

Low Cost is out There & Why that could be a bad thing

People who follow Social Security issues understand that in addition to the Intermediate Cost Alternative whose dates and numbers are universally reported in the press that the Trustees also present two other models called Low Cost and High Cost. Low Cost is typically depicted as being more 'optimistic' while High Cost being more 'pessimistic'. But that depends on your perspective. In reality Low Cost is better depicted as 'hotter' in economic terms and High Cost as 'cooler'. Now for most purposes the a relatively hotter economy than current Intermediate Cost assumes would be a good thing, all kinds of things are possible given higher levels of productivity and GDP, but for the specific purposes of Social Security it is possible that you can get too much of a good thing.

The post above explains why for most people a crisis defined by a minor benefit cut starting in 2041 for most cohorts is offset by the tax savings to everyone else after Depletion. Social Security 'crisis' in context being just a run of years in the 2030's when General Fund transfers to redeem the principal in the Trust Fund approaches current levels of deficits but then resets to zero for 2042.

But what happens under Low Cost? Well until the 2007 Report the Low Cost alternative always returned the same result: fully funded Social Security with flat Trust Fund ratio (reserves expressed as a function of time). While at first glance this seems like an ideal outcome a look at the numbers reveals a little different story.
Under 2007 Low Cost Income excluding Interest continues to exceed cost until 2023 at which time a portion of the interest accrued needs to be tapped. The amount needed never exceeds more than about a fourth of the actual interest earned and doesn't amount to a whole lot once you adjust the total for inflation, in constant dollars it works out to about $120 billion a year. But it never stops. Generation after generation ends up paying interest on a debt piled up by people paying excess taxes from 1983 to 2023 even after all utility of that borrowing has been exhausted and the people who paid in the actual extra dollars have all moved on. This isn't a terrible outcome but it does hack away at the fundamental strength of Social Security as a worker funded insurance plan for workers, under 2007 Low Cost the General Fund subsidy, though certainly legally obligated, starts making it take on aspects of a welfare system.

With the 2008 Report we entered into a whole new world. Rather than Low Cost showing an outcome with a Trust Fund ratio in equilibrium we have Outcome I in the figure at the top of the post, a Trust Fund ratio that bottoms out around 2040 and then accelerates upwards after about 2060. This is a bad outcome. If the assets in the Trust Fund are real, and they are legal obligations, why should workers continue to pay into a system with trillions of dollars of accumulated surpluses? But flattening out that tail becomes more and more difficult, the only way to do it is to slash away at FICA taxes so that enough interest has to be drawn from the Trust Fund to get it back to equilibrium. The mathematical result is that the balance between Income and Interest in relation to Cost starts skewing. At an extreme a Trust Fund Ratio of 2000 with an assumed interest rate of 5% can only go to equilibrium by paying 100% of benefits from the General Fund in the form of Interest (5% of 2000 = 100% of Cost). At a Ratio of 1000 you end up at the crossing point where fully half of Social Security is being paid out of the General Fund by taxpayers that never benefited directly from the early 21st century borrowing to start with. Operationally Social Security starts looking like just another Federally funded social program, in a word welfare.

What is the solution? Well first we need to have a plan to flatten the tail of Low Cost, perhaps combined with some reexamination of what the long term Trust Fund Ratio should be. Under the law the Trustees are mandated to maintain a Trust Fund Ratio of at least 100 and that seems to be a reasonable target, that would deliver a total system where 95% of benefits are being paid from payroll tax and 5% by transfers to pay the accruing interest. And it would be nice to have as a goal meeting the benefit levels of the current schedule. Which is why I want to call this the 100/100 Plan. 100% of scheduled benefits and a Trust Fund with a consistent 100 TF Ratio.

Making this happen requires changing our conceptual Social Security model from one of projections to one of explicit targeting. First we need to provide a Baby Bear model, which is to say that combination of growth outcomes and taxation adjustments needed to achieve 100/100 equilibrium and then pair that with a truly median economic and demographic projection (because Intermediate Cost is not cutting it). If the actual economy performs better than Baby Bear in the current year than you calibrate the tax adjustment down, if the actual economy underperforms Baby Bear you set the future adjustment up. If we put the actual adjustment on a schedule with minimal political influence, say in the third year of every Presidential term, you would end up with a system of minor tweaks starting in 2011.

My bet is that the first tweak would likely be a relatively small cut in FICA, but with an extended recession it might be a somewhat larger boost but in any event in the range of plus/minus .2% of payroll. But in any event we need to plan for outcomes enough better than Intermediate Cost to risk the runaway Trust Fund we see under Low Cost.

Friday, April 04, 2008

(draft) Social Security borrowing

This post will take a lot of refinement. It originated in a reply to an e-mail exchange and so lacks a certain amount of context, but I didn't want to waste the content. Feel free to criticize in the comments.

Well 'a lot' may be an understatement. I seem to have doofed on the math, so I am going to return this one to draft mode until I can check the data better.

Plus I managed to delete the entire text in the process.

Tears of a Clown

Regular readers of the econoblogs Economist's View and Beat the Press will be familiar with commenter Brooks. A few days ago I put up a post inviting him to make his actual case as opposed to trying to sustain a tiring and trying meta-narrative of who said what when with what motives. Well he failed the test, instead endlessly posting self-justifying bleats. Well I took that post down, it advanced nothing. In response Brooks thoughtlessly mirrored the entire thread over at ClownHall, oops I mean TownHall not understanding it just revealed him as being a doof. Which is his right. But all I can say is better their bandwidth than mine. Anyone who thinks I am simply running away in the face of a superior line of argument might need to review the YouTube of the Black Knight in Monty Python and the Holy Grail:  'Come back you coward!' After being delimbed by Arthur.
For the more masochistically inclined you can review the entire exchange at

Wednesday, April 02, 2008

The Shape of Low Cost

This figure shows in graphic form the outcomes of Intermediate Cost (II) vs High Cost (III) vs Low Cost (I)

Outcome II shows the standard narrative. A Trust Fund Ratio rising to a peak in 2017  then a more or less rapid falloff to zero as the first the interest is tapped and then the principal is redeemed with the result of total Trust Fund Depletion in 2041.

Outcome III or High Cost shows the same process only accelerated.

But Outcome I or Low Cost shows a much different picture. The Trust Fund ratio peaks at about 450 about 2020 then dips to 390 by around 2040 as a portion of the interest is tapped but after a period of plateau sharply increases through the remainder of the 75 year actuarial window. This is quite literally the picture of a potentially overfunded Social Security system. Is a Low Cost outcome guaranteed? Well no. Is it possible? Certainly the numbers are not at all outlandish and perfectly in line with economic performance over the last fifteen years.

Can we at least talk about the implications of this?

Tuesday, April 01, 2008

Interest on Interest: an Intergenerational Fable

Cross posted at AB
"I'm not sure that "interest on interest" means very much if the government would be borrowing the same amount from somewhere else."

The following fable shows the potential problem of just letting Interest compound if we get outcomes close to Low Cost.
Follow the cash flow and its magnitudes over time. Who paid extra when, who pays less or draws out more later. Let me try a story.

Generation A pays into Social Security on a PayGo basis but also pays in extra to build up a cushion.
Generation B pays into Social Security on a PayGo basis but neither pays in extra or draws on the cushion which meanwhile grows through compound interest.
Generation C pays into Social Security on a mostly PayGo basis but on retirement draws down on the interest on the accumulated cushion in moderate way but not enough to keep it growing pretty fast.
Generation D pays into Social Security on a still mostly PayGo way but on retirement draws down on the cushion all of the interest being accrued on a Trust Fund now with a seven year reserve.
Generation E pays into Social Security on a still mostly PayGo way but is stuck with a huge annual interest bill to pay benefits by Generation D and remaining Generation C's. A bill that doesn't go away.

Which sets up the conflict. Generation A whether they drew any direct benefit from the cushion still knew it was there if needed by Generation B.

Generation B is held harmless here. Aware and grateful for the cushion but knowing their own contributions over a lifetime balanced their average return.

Generation C starts getting a free ride. They did not pay in their full fare, instead they are veritable Trust Fund Babies thanks to that partial interest drawdown.

Generation D gets a pretty good ride. Drawing the full value of interest on the Trust Fund gives them a pretty nice standard of living, and all originally paid for by great granddad A. Thanks G G A!

Generation E gets kind of a bumpy ride. Now that all the interest is being paid out the Trust Fund balance is frozen and so starts getting eaten away by inflation. Meanwhile they are paying in still mostly PayGo but are also stuck with a large and growing bill for interest all of which goes for the benefit of Generation D and remaining C's who when you think about it never paid their full fare ('almost PayGo' not being 'PayGo') to say nothing of not having had to kick in the extra to start with. Moreover most of the balance in the Trust Fund is just interest on interest accumulated during Generation B and C's lifetime. Meanwhile I got to find some way to pay college for Generation F!!!

Makes for a testy Thanksgiving when Grandpa and Grandma D fly in from their winter place in Arizona to find Son E working two jobs to try to get something, anything in the college fund for Daughter F while still having to pay $600 billion a year in interest on money mostly contributed by Great-Great Grandpa A. But whose actual cash was borrowed and spent on weapons systems now only seen in museums.

E is in a trap here. The Trust Fund is there, it has tens of trillions in securities, it has more years of reserves than it really needs. But the only way to actually get it to shrink in size is to cut income flowing to it. Which means a nice little FICA tax cut for those earning below the median. But E makes 3 x the cap, the tax cut doesn't mean much to him. Moreover paying down the principal in the Trust Fund to get the TF ratio down to a reasonable level and with it the annual interest accrual means paying an even higher level of income tax than before! And F still needs to go to college!!

Nice recipe for intergenerational warfare there. But it gets worse. Lets say Generation D is still not drawing down the total interest and the Trust Fund has ballooned to the point where annual interest would pay 110% of cost. E can never get ahead of the game at all. FICA could go to zero and he is still stuck with the bill. While all those people making wages at a level that doesn't trigger substantial income tax get a nice tax free 6.2% boost to put in their F's college fund and a paid retirement-'Thank you Mr. Man and of course Great-Great-Great Grandpa A!!!'

Mr. Man, aka E is not going to be happy here. He ends up with an income tax funded retirement system whose benefits flow disproportionately to lower income workers. 'Why it is nothing more than god damn welfare, and I don't give a crap that my Boomer Great Great Granddad A paid in extra all his working life. He didn't see a penny of that extra money back! And neither did Great Grandpa B, that old coot paid his way. Heck Grandpa Charlie hardly tapped into the pot and at least he remembers G G Granddad A. That guy is just an old hologram to me. Meanwhile Pop's got his place in Phoenix and every store clerk in the country is getting both their kid's college fund and their retirement paid by ME!!'

Mix in a little class warfare with the intergenerational piece and it makes for an ugly picture. Hopefully Marek won't get ahold of this story, the whole idea would give him a stroke.

It is not that Pop D or Cashier E did anything wrong here, that Pop paid in a lot less then he would have had this truly been PayGo from the start, that Cashier E is the beneficiary of monetary sacrifices of earlier generation of workers, none of them are to blame. But how do you explain that to E? or the Congressman to whom he is a big supporter?

The danger of interest on interest is that over time it converts Social Security from a worker funded insurance plan to a Welfare plan paid largely by the middle and upper classes, that is assuming the upper classes still pay any taxes at all by that point. What is more you can't get out of the trap by cutting benefits, that actually just makes the paper problem worse.