Tuesday, September 30, 2008

Social Security: Hard Solvency vs Soft Solvency vs Sustainable Solvency

'Sustainable solvency' is a new buzz phrase floating around with 'intergenerational equity' and 'unfunded liability'. But before exposing how the term blurs the real issue we need to examine the concepts of what I call 'hard solvency' vs 'soft solvency'.

'Hard solvency' is used here to describe a Social Security system that can pay 100% of all scheduled benefits over the seventy-five year actuarial window with no changes to current law in the form of tax increases or increases in retirement age. If and when we ever achieve it supporters of Social Security can clearly call 'game over, and we won'. But we are not there, instead the most recent Report would have us being able to pay out full benefits until 2041 and 78% after that. These numbers are subject to change and on balance have been improving (the 2007 Report had a 75% payout at Trust Fund depletion). Still as long as the numbers continue to improve supporters have a good case for pushing a plan consisting of 'Nothing'.

Now 'soft solvency' is conceptually a little more difficult. The current schedule of benefits is set up so that future generations of retirees get a fair share of real wage increases over their working lives, that is it provides improvements in standard of living equivalent to those of people still in the work force. Per Prof. Rosser of JMU this improvement means a benefit in real terms of 160% of what similarly situated retirees get today. And if we use what I call Rosser's Equation we see that 78% of 160% = 125%. Which is to say that after TF depletion future retirees will be able to buy a basket of goods 25% better on average than my mom can today. Now it might be that the future basket will pale somewhat when compared to people still in the workforce or to the basket that retiree was collecting in 2040 but it can hardly be described as some huge crisis. By this standard any time Rosser's equation delivers a result of 100% or better we can say that the overall system is in 'soft solvency'. Another way of describing this would be in terms of 'intergenerational equity'. If the Gen-X retiree of 2041 is still getting a real benefit as good or better than his grandmother did in 2008 there can hardly be any equity issues to resolve.

If we establish soft solvency as a floor and hard solvency as a goal we can say that currently we are 40% of our way home. Whether we really need to take positive steps in the short run to boost the result of Rosser's Equation is a question of policy preference and a balance between current utility of dollars for workers today against future utility for retirees thirty years down the road. And by the way not forgetting that these two populations largely overlap. That is it may be more efficient to hope to close the gap between 125% and 160% by mechanisms outside of Social Security itself.

But in any event both hard and soft solvency look at the outlook from the standpoint of the beneficiary for whom results closer to hard are on balance better than results closer to soft, but not necessarily so much so as to simply accept higher payroll taxes to achieve 'hard', 'soft-plus' might be perfectly acceptable if need be.

When critics of Social Security use language like 'dead broke' and 'bankrupt' all they are really saying is that Social Security is not currently passing the test of hard solvency. Which is fair enough, but it also suggests that any fixes should move the needle away from current levels of soft solvency towards hard, that is getting that 78% number up. Instead they pivot and invoke the concept of 'sustainable solvency'.

'Sustainable solvency' in practice means eliminating 'unfunded liability' which in our terms is the difference between the current projections of soft solvency (78% of 160% = 125%) and hard solvency (100% of 160%), that is it is a gap in benefits. But in their terms 'unfunded liability' is a pure burden on future taxpayers and so seen as a gap in future income vs cost. From that perspective it doesn't matter whether you address the gap on the income side or the cost side, instead the focus is on eliminating it one way or another. What this implicitly does is to kick hard solvency to the curb. Even though in a real sense 'crisis' starts out as a failure to achieve hard solvency, the solutions simply accept that some version of soft solvency is in fact good enough, if that is if it can be used to introduce a system based on Personal Retirement Accounts (PRAs).

So the task for supporters of Social Security as currently configured is to put the privatizers' feet to the fire. Does their solution give a better result then the current level of soft solvency projected? If not why should current workers and near retirees buy in? The system as currently configured is projected to deliver a minimum of soft solvency plus and is trending more and more towards hard solvency. Why should we accept a result that doesn't deliver more solvency at equivalent cost?

15 comments:

Arne said...

You have set up a moving definition of soft solvency. If results follow IC, then the year that the value of benefits exceeds 125% (or so) of current value you will no longer have soft solvency. When you are forced to cut benefits it will be to below what is the then current value.

Of course, if you cut the benefits immediately to rise a CPI instead of AWI, you will still have the trust fund and its interest that woudl allow you to keep raising it at a slower rate. Unfortunately, the report does not lend itself to figuring out whether you would be at a sustainable level from there out.

Anonymous said...

your point is worth making if only to give some perspective to the "social security is broke" crowd.

but this low end worker would be more than happy to have my payroll tax raised a dollar a week each year while my income is going up ten dollars a week each year in order to maintain my relative standard of living when i retire.

now if it is really true that my dollar a week is secretly going to maintain the living standards of some current greedy granny retiree.. i can't say i really care as long as it counts toward my benefit check when it gets to be my turn.

because while you are heading them off at "ain't broke pass," you are conceding them the "use CPI instead of wage indexing, and committing yourself to a view that we are too poor to afford a decent retirement.

you might have observed that while that future pension may be worth 160% of today's, it will still only be 40% of the average wage then. or a lot less for the people with below average earnings.

and by the way, that dollar per week tax raise... that's for the average worker. the worker at half the average wage (around 20k/yr) would see a tax raise of about 50 cents per week per year.

somewhat less than he spends on lottery tickets.

coberly

Bruce Webb said...

Arne I may not have made myself clear. While soft solvency is indeed a moving target it tracks at the 100% of current benefit level and not the 125%. For example per the 2007 Report Rosser's Formula yielded '75% of 160% = 120%'. If the 2009 Report shows us dropping back to that point I would not concede that we have lost 'soft solvency', this isn't a concept that only ratchets upwards (though of course that is our hope and goal).

Bruce Webb said...

Coberly.

At no point did I "conced(e) them the "use CPI instead of wage indexing," formulation. Read again. And your contention that I am committing myself to the view that we cannot afford a decent retirement suggests that you have not quite grasped the concept of 'soft solvency' to begin with. I wish my Mom's Social Security benefit as it exists today was as good as her great-granddaughter's benefit is projected to be. Which doesn't mean that she or I begrudges Natalie collecting 160% or more when she retires in 2070, you want your kids and grandkids and great-grandkids to do better than you did. Which doesn't equate to taking unlimited current sacrifices to maintain what is in fact a fairly arbitrary future target. The schedule of benefits did not in fact come down on a third tablet from Sinai, if we only hit 155% or even 140% I am not willing to say that means poor Natalie eating cat food. It just ain't so. It still represents a better absolute standard of living than Mom would get today if she was totally reliant on Social Security.

"you might have observed that while that future pension may be worth 160% of today's, it will still only be 40% of the average wage then. or a lot less for the people with below average earnings."

So what? That is true today. If you work minimum wage or near that and end up relying on Social Security alone there is no doubt that you will be living hand to mouth and probably making some visits to the food bank at the end of each month. Which is an argument for a Social Democratic National Pension system that rewards a lifetime of work without necessarily offsetting that by the market assessment of what that work was worth. But that is not the question at hand.

Anonymous said...

Bruce

I don't want to argue with you because we are, or should be, on the same side. And this could easily become a clash of personalities and egos.

But you need to be careful when you find yourself saying "taking unlimited current sacrifices.."

The "sacrifices" are not unlimited. They appear to amount to about 2% of payroll, money which you get back in the form of a higher standard of living when you retire.

If you really see this as a conflict between generations... lowering the staggering social security tax on current workers vs unlimited benefits to greedy grannies... well, i need to stop there.

the schedule of benefits did not come down from Sinai, but it was calculated fairly closely to be a good compromise between subtracting from current income and providing a minimum survival level in retirement.

oddly enough "retirement at half pay" has been sort of a standard for the past two hundred years amont those institutions which offered retirement beneftis (the British navy...for officers), But that was before Boskin showed us all how "inflation" was really a measure of how much better off we are.

I don't think turning Social Security into welfare will work out in the long run, especially if those who advocate it don't seem to care very much about the standard of living of the pensioners.

Bruce Webb said...

Coberly while 'unlimited' may not have been the best choice of words you might want to consider what should be our response to a multi-year meltdown in the economy with 10% unemployment and high inflation. That combination it would seem to me would start to reverse Rosser's Equation and make the projected payroll gap bigger and sooner. What level of payroll gap would cause you to reconsider your position? 2.5%, 3.0%, 3.5%?

The implied notion that the optimal fix for Social Security is always an increase in payroll tax of whatever level needed is I think too narrow a view.

Arne said...

Bruce,

In 15 years (2023) the equation will become 75% of 133% = 100%. If IC happened and benefits dropped in 2041, then benefits would become less valuable than the benefits that people got retiring between 2023 and 2041. If you attempt to apply your definition of soft solvency to the situation under IC in 2024, you will find it fails unless you start making changes.

(The probability of being on the IC curve 15 years from now seems rather remote to me, but that is how the math would come out).

Bruce Webb said...

Frankly Arne I never understood the origin of that 160% in 2041, I just trusted that Prof. Rosser knew what he was talking about. And I think I know where you are coming from.

But your 133% in 2023 would only seem to be a product of then Income against then Cost and not include the cash value of the principal in the Trust Fund. That the Trust Fund acts between 2024 and 2041 to boost that 75% payout to a 100% payout of the scheduled benefit is a feature not a bug. I'll take your word that the initial payment under the schedule equates to 133% in 2023 and then ramps up to 160% by 2040 only then to be discounted by 22%. But either way it seems that everyone retiring in the near to medium term still gets a better benefit than the baseline my Mom gets today and for that matter as good or better than the person retiring a few years before that.

Which is to say of course the benefits received between 2023 and 2040 are more valuable than the ones projected after, that is inherent in the 22% cut in benefits needed to offset the fact that the TF has gone to depletion, if of course it ever does.

Anonymous said...

Bruce

I think you and Arne can seriously mislead yourself if you keep talking in percents without bringing it down to dollars per week out paycheck vs dollars per week out of a benefit check.

As for the 3% or 5% "implied tax increase", i think we can wait to see if it develops and then make a decision as to whether it is better to cut benefits or raise taxes. That will depend upon conditions at the time, but my guess is that the required increase can never be more than about 3 and a half percent and that it would always be better to take the tax increase.

what would change that would be pretty good evidence that the great majority of retirees had an adequate standard of living from other sources, and the benefit structure could be jiggered to make the insurance function a bigger part of the payout... in other words more of your "tax" goes to a premium against real poverty.

frankly this is an argument we ought not to be having (my fault) as there are too many "if's" to make any "logic" meaningful.

but i have a very hard time figuring out what exactly your position on Social Security is if you accept a priori the idea that the "old" are stealing from the "young."

or that some actuarial "fairness" means very much when stacked up against reasonable human needs.

Anonymous said...

Bruce

the 160% in 2040 comes from a projection of the increase in real wages by then.

As long as benefits are wage adjusted, their real value will go up parallel to real wages.

the question remains whether moving from 40% of real wages to 30% of real then wages would leave the retiree with the elements of a decint standard of living.

i say no. and i repeat the example you all have gotten tired of without understanding: my grandmother worked her whole life in an economy that did not depend on the automobile. having an automobile represents an increase in the real standard of living. she retired into an economy that assumed the automobile. tring to live in an economy that expects an automobile with being able to afford one is a real hardship, however the Professors define "real."

Arne said...

Bruce,

The 160% comes from the growth of the difference between CPI and AWI. It has nothing to do with actual SS income or costs.

With AWI at 3.45% and CPI at 2.0%, next year's retirees get a benefit 1.4% better than this year's. By 2041 this grows to 60% better than this year's. But 2041 retirees are still 1.4% better off than 2040 retirees. (Note: I picked 3.45% to make it come out to 160% in 2041.)

If SS folows IC, complete with the (call it) 25% decrease in benefits in 2041, then 2041 retirees will be 20% better off than 2008 retirees, but they will be worse off than retirees from 2022 to 2040. (Note correction to year because I wrongly used 25% better.)

I believe that to correctly apply your definition, you need to move the baseline up each year, so in 2022 (using IC projections) you will fail to have 'soft solvency' because future retirees (2041) will get less value than current (2022) retirees.

Anonymous said...

wipe that trust fund right out of your mind.

it was always designed to go to depletion.

for whatever reasons it has actually outlived its purpose. the expected reason for the 2040 shortfall is that by then the number of retired... because of longer life expectancy... will be greater than can be supported at the 12% tax level by the then number of workers at the then expected level of income.

the simple and obvious answer is to gradually raise the tax rate... because we are paying for our own longer life expectancy, a damned shame, but there it is...about one tenth percent per year starting in 2030, while incomes are increasing at a rate of more than 1% per year.

at the end of the day everyone has more money in their pocket "today" plus they have paid for a longer retirement at a replacement rate that is the same as it is today, however much of an increase in standard of living that may arguably be.

absent actual starvation, "standard of living" is always measured relative to the prevailing community standard, not what they got by on back in the stone age.

Anonymous said...

Bruce said

"you might want to consider what should be our response to a multi-year meltdown in the economy with 10% unemployment"

set aside the inflation for a moment. assume there is no Trust Fund... that SS is at pay as you go and can maintain benefits at, say 5% unemployment.

now a 10% unemployment would be 5% less employment than SS could pay full benefits at. this would either reduce benefits 5% or require a 5% tax increase. but that is a 5% of a 6% tax, or about 0.3% tax increase on those still working.

in today's terms that would be about a 2 dollar a week increase in the tax on average wages, or about a dollar a week on low wage workers. if that was considered too heavy a burden to bear for the emergency, some kind of graduated benefit cut might be negotiated... but note that this would imply rather than about a 50 dollar a month cut in an average pension, something like a hundred dollar a month or more cut from above average pensions in order to hold the 500 dollar a month pensions harmless.

no doubt if you projected this great unemployment emergency far into the Rosserian future, those 500 dollar a month pensions would be 800 dollar a month pensions in real terms and those people could easily get by with a 5% cut to 740 dollars a month.

which brings me back to the Rosser question: what is so sacred about the value of the pension today. since today's pensions are easily worth 160% in real value of what pensions were worth in 1950, we could cut the payroll tax just be reducing the real value of pensions today to what they were in 1950.

William Larsen said...

Social Security is relatively easy to model. The reason is that most of the variables depend on each other.

Benefit formula is dependent on wages subjected to SS and US average wage growth.

Benefits are indexed by inflation.

The US Treasury Rate determines the income SS receives.

I was provided the SSA population file listing ages 0 to 100 (1 year increments) by male and female (single, married, divorced and widowed).

The SS-OASI expense is the sum total of all beneficiaries while the income is the sum total of all wages subjected to SS-OASI tax plus income from the trust fund.

The Average benefit is easily and accurately calculated by using the US average wage at 60 and applying the benefit formula and bend points. This method actually under estimates the actual average by about 1/4 of 1%.

The bend points are adjusted by the average wage you assume. I like to use a 20 to 25 year moving average. This method I used in 1984projected SS-OASI's inability to pay full benefits in late 2037. Today it is pointing to early 2038.

Using this model I have also calculated the rate of return for all cohorts. The last cohort born to break even with SS was born in 1938. Those born after 1985 can expect 29 cents in benefits for each $1 paid in taxes and interest credited at the US Treasury Rate.

For those who would rather pay $1 more, please think again. We are already paying 10.6% of our wages to SS and the return is terrible. To get a larger benefit, means your return on the next dollar paid is also a terrible return. You would do better to take your extra dollars and buy US savings bonds.

One more thing, the total potential voters 46 and under outnumber the boomers and seniors combined by a hefty percent. At what point do you think the young will simply say enough is enough?

Bruce Webb said...

US bonds are currently in negative territory. And the CBO predicts Social Security is solvent until 2049.

Your 'accurate calculations' would be advanced by actually supplying same.

And we are not paying "10.6% of our wages to SS". Under standard economic theory we are actually contributing 12.4% (including the employer match) or we are contributing 10.6% including our contribution to Medicare (absent employer match). Your attempt to confuse these two is not convincing to anyone actually following the debate and using real numbers.