Sunday, September 07, 2008

Unfunded Liability Bookended

In the last installment of this Social Security series we kind of dug into some of the details of unfunded liability, what it was and what it wasn't and most importantly where the incidence occured: in the past or in the future. Backwards Transfer is Back. In the course of that I think it became pretty clear that none of that liability really was the consequence of overpayments to what Social Security calls 'past participants' that instead it was all due to a gap between future cost and future income for 'current participants'. But in the course of that discussion the role of 'future participants' fell through the crack when instead the numbers have some surprising implications. But before getting to that I want to back up and consider Unfunded Liability more broadly.

Traditionally Social Security has judged solvency over the short term (10 years) and the long term (75 years). Which seems reasonable enough, 75 years being a period that will capture the retirement years of pretty much any current worker. The metrics of solvency were typically expressed as percentage of payroll or percentage of GDP. In 2003 the Reports introduced new measures of solvency which expressed the gap between income and cost in Present Value dollars over the 75 year window and indeed over the Infinite Future. The first set of numbers just divides this into periods: first 75 years, 75 years to Infinite Future, and total and expresses it in dollars.
2003: $3.5 trillion, $7 trillion, $10.5 trillion
2004: $3.7 trillion, $6.7 trillion, $10.4 trillion
2005: $4.0 trillion, $7.1 trillion, $11.1 trillion
2006: $4.6 trillion, $8.6 trillion, $13.4 trillion
2007: $4.7 trillion, $8.9 trillion, $13.6 trillion
2008: $4.3 trillion, $8.3 trillion, $13.6 trillion
What do these numbers tell us? Well not much really. Generally you would expect the unfunded liability over the first seventy five years to increase simply because of normal population growth, we will have more people overall in year seventy-six than we do in year one, as we drop the latter and add the former we can expect an uptick in liability which right now is about .06% of payroll. The relatively small changes from 2003 to 2004 and 2006 to 2007 can be explained in this way. On the other hand the bigger movements from 2005 to 2006 or 2007 to 2008 turn out on examination to be the result of additional changes in assumptions, in the first case in assumed interest and in the latter changes in assumptions about immigration. But other than that the numbers don't really give us much guidance except perhaps to wonder why the future numbers from year 76 on, representing as they do the Infinite Future are not even larger. To get insight into this we need to move to a more granular analysis. Which comes under the fold.

The Table numbers vary a little bit between reports with what was Tables IV.B7 and IV.B8 in earlier Reports become IV.B6 and IV.7 but all are titled Present Values of OASDI Cost Less Tax Revenue and Unfunded Obligations for Program Participants[Present values as of January 1, 2008; dollar amounts in trillions] People who read the last post may remember that the Trustees break down "Program Participants' in kind of an odd way:
'Past participants' would seem to be that group of people who formerly drew benefits but no longer do. In short the dead.
'Current participants' are defined as everyone fifteen and older and so include all current workers and current retirees.
'Future participants' are defined as everyone under fifteen plus those not yet born. The table assigns dollar figures to these groups as follows:
Row 1 = "Present value of future cost less future taxes for current participants" (Over the next 100 years)
Row 2 = "Less current trust fund"
Row 3 = "Equals unfunded obligation for past and current participants" (Note that in this case the contribution of past participants is likely positive overall)
Row 4 = "Plus present value of cost less tax for future participants for through the infinite future"
Row 5 = "Equals unfunded obligation for all participants through the infinite future"
This result can be expressed as an equation. So what does it look like over the same period as above? (Figures in trillions)
2003: $11.9 - $1.4 = $10.5 -$.0 = $10.5
2004: $12.7 - $1.5 = $11.2 -$.8 = $10.4
2005: $13.7 - $1.7 = $12.0 -$.9 = $11.1
2006: $15.1 - $1.9 = $13.3 + $.1 = $13.4
2007: $16.5 - $2.0 = $14.4 - $.8 = $13.6
2008: $17.4 - $2.2 = $15.2 - $1.5 = $13.6 (rounding is Trustees')

What does this tell us? Well actually quite a bit. The increases in column one are mostly I think to be explained by current demographics, fewer people entering the workforce compared to the large cohort of Boomers leaving. And column two is just showing the effects of a Trust Fund in current surplus with column three being the simple sum.

But it is column four that is most interesting to me. Biggs looks at that and sees future participants paying more in taxes than they are projected to get in benefits. I suggest that is the wrong way to look at it, instead turn it around. In 2003 future participants, then defined as all people born after 1988, taken as a whole could expect their benefits to be fully funded by their taxes. Which is to say that long term Social Security is projected to return to pay-go with a surplus and that all of the problem is in fact confined to the next 100 years.

This has some profound implications for policy. Under current projections Social Security is set to pay out 78% of the scheduled benefit starting in 2041, an amount that will shrink to 75% at the end of the 75 year window. But at that point the very youngest of the 'current participants' of 2008 will be 90 and the impact of that cohort will be fading rapidly and we can reasonably expect it will go to zero right at the end of the hundred year period. Meaning that any fixes we choose to put in over the next couple of decades could be reversed later on with no damage to the long, long term outlook for Social Security. In actual practice there is no way we could limit the impacts of any medium term fixes to the current batch of current participants, some of the earlier cohorts of future participants will no doubt be called to sacrifice along with existing current participants. But there is a light at the end of that long tunnel. And if over the next couple of decades we can beat the current economic projections and so reduce the growth of column one and three we can make that light brighter and brighter.

In the light of the above equations Social Security's unfunded liability is more akin to a fixed term mortgage than an infinite burden. We can and should take some efforts to pay it down quicker while knowing that given regular payments it goes away some time in the next hundred years anyway. As the post title notes, that liability is effectively bookended.


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