Saturday, April 12, 2008

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.

1 comment:

Anonymous said...


just checking your comments box. I think you should post this on angry bear.

i have begun suggesting to people that SS might be overfunded. of course they don't pay any more attention to that than they do to deconstructiong the trillions and trillions of unfunded debt myth.

but angry bear seems to have an audience.

btw, i don't know how to sign this.