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.

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.

Trust Fund Operations 2008-2085

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.

2007 Report: Trust Fund Operations 2007-2085

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.

(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.

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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.

http://www.youtube.com/watch?v=2eMkth8FWno

For the more masochistically inclined you can review the entire exchange at http://TheBruceWebBruceWebb.blogtownhall.com

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?

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.
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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.

Lid Blown off Low Cost

One of my very first posts here was What is the Low Cost Alternative which I put up on November 20th, 2004. In it I made the observation that since 1997 Low Cost, purportedly the upper end of a possible range of economic outcomes, in fact always gave the same result: fully funded Social Security through the 75 year actuarial window with a steady reserve. It consistently returned what I call Baby Bear results, the porridge never being too hot or too cold. I discussed the implications of this in my 2006 Post Goldilocks and the Three Social Security Bears.

Well this held up excellently through the 2005, 2006, and 2007 Reports each of which gave the same basic Baby Bear outcome. Which made 2008 kind of a shock. For the first time the Trustees present a Low Cost model that would officially have Social Security over funded after mid century. Low Cost is outcome I in the following figure Figure II.D6.—Long-Range OASDI Trust Fund Ratios Under Alternative Assumptions [Assets as a percentage of annual cost] A constantly rising Trust Fund is a long range menace to Social Security, there is a point when having too much in reserve becomes a bad thing, something I expand on some in Interest on Interest: a Threat.

(I finally figured out how to upload images. II.D6 now displays at the top of this post.)

There is only one way to flatten the tail after 2041 to get Social Security back to long term Baby Bear status. And that is some combination of cutting revenues or increasing future benefits. Which is to say exactly 180 degrees reversed from pretty much universal policy positions. To say the least not at all the kind of crisis people are envisioning.

Reality vs Intermediate Cost vs Low Cost

This table (which looks a lot nicer in edit mode-oh well) shows projected Real GDP figures for both Intermediate Cost and Low Cost from the last eleven Social Security Reports along with actual Real GDP numbers. The 1997 numbers make some sense, in the face of a 1996 2.5% number Intermediate Cost projected a repeat at 2.5% with a more optimistic Low Cost number of 3.2%. But oddly each model predicted a sharp downturn in the second year. In the event the economy returned 3.8%. Now one would think this result would tug at the model and at a minimum establish a new ceiling since obviously 3.8% was a possible outcome. Instead the 1998 Report stuck with 2.5% as a median IC number and set LC at 3.1%. That is they suggested that the very best the economy could be expected to do was a 20% slowdown in the rate of growth of GDP. Well the real economy returned 3.9%. What was the response? The Trustees stayed with their slowdown narrative. Why did the Trustees not concede that growth above 3% was the new median? Well the answer appears in the post above this one. Or will when I write it.

Report Year Prev Year IC Current Year IC Second Year LC Current LC Second Year Actual Result
1997 2.5 % 2.5% 2.0% 3.2% 2.7% 3.8%
1998 3.8% 2.5% 2.0% 3.1% 2.5% 3.9%
1999 3.9% 2.6% 2.0% 3.4% 2.5% 4.0%
2000 4.0% 3.5% 2.7% 3.9% 3.1% 5.1%
2001 5.1% 3.1% 3.1% 3.5% 3.5% 1.0%
2002 1.0% .7% 3.8% 1.6% 4.6% 2.4%
2003 2.4% 2.9% 3.6% 3.8% 4.1% 3.1%
2004 3.1% 4.4% 3.6% 4.9% 3.9% 4.4%
2005 4.4% 3.6% 3.5% 3.9% 3.8% 3.6%
2006 3.6% 3.4% 3.3% 3.8% 3.5% 4.7%
2007 4.7% 2.6% 3.0% 3.4% 3.4% 2.2% (prelim BEA)

2008 Report

Entry page
Table of Contents
List of Tables
List of Figures

Economic Assumptions under the Three Alternatives
Trust Fund Ratio under the Three Alternatives

(Near) Year End Balances 2007

(Actual balances are in and I will need to edit this post. Short version OAS ended up at $2.024 trillion or $3.3 billion behind Intermediate Cost projections. DI came in at $215 billion or about $6 billion ahead of IC projections (but unchanged for the month). Combined OASDI came in at $2.239 trillion beating IC projections but slightly lagging Low Cost. Most interesting note? 2007 Real GDP came in at 2.2% against a projected 2.6% yet receipts overall managed to come out ahead. This is the third year in a row that Real GDP came in at or below expectations and yet receipts held up.)

Well it's near the end of the year but the Bureau of Public Debt reports with a lag time of a month. So these are the totals as of Nov. 30th.

From the Bureau of Public Debt Nov. 30 Report

OAS Old Age Survivors:$2,014,006,866,559.62
DI Disability $215,535,461,216.24

Total: $2,229.5 billion

Low Cost projection for OAS: $2,030.5 billion
Low Cost projection for DI: $210.8 billion
Total Low Cost projection for OASDI: $2,241.3 billion

Intermediate Cost projection for OAS : $2.027.7 billion
Intermediate Cost projection for DI: $208.9 billion
Intermediate Cost projection for OASDI: $2236.6 billion

Well in a couple of places I posted that back of the envelope calculations showed that OASDI surpassed year end projections about week two of November. Didn't seem to happen. On the other hand the change from October to November was plus $10 billion for OAS and almost $1 billion for DI so we are looking at a total projection of about $2,240.3 billion by years end, which is to say comfortably above Intermediate Cost and slightly below Low Cost. Which btw is in line with reported GDP and productivity numbers. I am still in the comfort zone.

Update: Well the December job numbers were pretty lousy, then again most of those paychecks wouldn't come until January anyway so shouldn't impact December receipts. 2008 is not shaping up well at all on the Social Security front. On the other hand it is kind of hard to sell private accounts when the country is in a recession. Which of course is the overall point of this whole blog, Social Security solvency tracks the economy much as the stock market does. There just is not enough margin to exploit to give materially better outcomes for private accounts.

Visit to the Dark Side: What if the Fed is right

(Note this has not had its final edit. It is meant to make a point about how robust the system is even when it takes a large hit)
Some people are predicting that the next four quarters are going to be totally flat. What happens to our model if we assume a sequence of 2007. 2.6%; 2008 1% then sustained growth at 2.6% while maintaining a pretty pessimistic view of growth in the outyears. Note that 2008 was projected as being the only year at 3.0% in the whole projection, replacing that with a zero is going to hurt. But how much? As it turns out surprising little.

The vertical axis has the Intermediate Cost alternative projections given in the 2007 Report for the years from 2007 to 2024. The horizontal axis represents the numbers as they would have to be adjusted for posited GDP over that same period.
------2008--09--10--11--12--13--14--15--16--17--2024

2007 2.6
2008 3.0--3.0
2009 2.8--2.8--2.9
2010 2.6--2.6--2.8--2.8
2011 2.6--2.5--2.8--2.8--2.7
2012 2.4--2.4--2.7--2.7--2.7--2.7
2013 2.2--2.2--2.7--2.7--2.7--2.7--2.7
2014 2.1--2.1--2.6--2.6--2.6--2.7--2.7--2.6
2015 2.2--2.2--2.5--2.6--2.7--2.6--2.6--2.6--2.5
2016 2.2--2.2--2.5--2.5--2.5--2.5--2.5--2.5--2.5--2.5
2017 2.2--2.2--2.4--2.4--2.4--2.5--2.5--2.5--2.5--2.5--2.5
2018 2.2--2.2--2.3--2.3--2.4--2.4--2.4--2.5--2.4--2.4--2.4--2.5
2019 2.1--2.2--2.2--2.3--2.3--2.3--2.4--2.4--2.4--2.4--2.4--2.4--2.4
2020 2.1--2.1--2.2--2.2--2.3--2.3--2.3--2.3--2.4--2.4--2.3--2.3--2.3--2.3
2021 2.1--2.1--2.2--2.2--2.2--2.2--2.3--2.3--2.3--2.3--2.3--2.3--2.3--2.2-2.2
2022 2.1--2.1--2.1--2.2--2.2--2.2--2.2--2.3--2.3--2.3--2.3--2.3--2.2--2.2-2.1-2.0
2023 2.1--2.1--2.1--2.1--2.2--2.2--2.2--2.2--2.3--2.3--2.3--2.2--2.2--2.2-2.1-2.0-1.9
2024 2.1--2.1--2.1--2.1--2.1--2.2--2.2--2.2--2.2--2.2--2.2--2.2--2.2--2.1-2.0-1.9-1.9

2.6% is a pretty pessimistic number but even in the face of a terrible 0% hit in 2008 would put the system on track to solvency by 2014. It just takes some minor adjustments to growth numbers in the outyears.

Crisis Maintenance at 3.0% GDP (historic trend)

The following three posts try to make an attempt to show how the Intermediate Cost alternative would have to be adjusted to keep Social Security 'Crisis' constant, that is to not have the current 2041 date recede further into the future. The methodology assumes that greater than expected growth in any give year can be offset one for one by subtracting equivalent points from future years. In fact due to compounding on the interest on a greater than expected surplus the effect would actually be greater than depicted here, though not significantly over the period presented.

From 1985 to 2006 Real GDP increased on average a shade over 3.0% 2007 Report Table V.B2.-Additional Economic Factors . This table shows how Intermediate Cost responds to trend growth over the short run.

The vertical axis has the Intermediate Cost alternative projections given in the 2007 Report for the years from 2007 to 2016. The horizontal axis represents the numbers as they would have to be adjusted for 3.0% GDP over the period 2007-2012.
--------------2008----2009----2010----2011----2012

2007 2.6
2008 3.0-----2.9
2009 2.8-----2.7-----2.7
2010 2.6-----2.6-----2.6-----2.5
2011 2.6-----2.5-----2.4-----2.4-----2.3
2012 2.4-----2.3-----2.3-----2.2-----2.1-----2.0
2013 2.2-----2.2-----2.2-----2.2-----2.1-----1.9
2014 2.1-----2.1-----2.1-----2.1-----2.1-----1.9
2015 2.2-----2.2-----2.2-----2.1-----2.0-----1.9
2016 2.2-----2.2-----2.1-----2.1-----2.0-----1.9

There has been exactly one five year period since 1960 with average Real GDP of 2.4. Two years of growth at trend would put us at a point where all future five year periods were bleaker than anything in the past. Now current forecasts generally call for a dismal 2008 so this process might not kick in right away. But whether you start in 2009 or 2010 growth at historic trend grinds crisis down to nothing in a short period of time.

Crisis Maintenance at 2.8% GDP

There have been three five year periods below 2.8% since 1960, and six above with a range from 2.4% to 5.0%. This would have to represent a fairly pessimistic outcome, particularly coming off a 3.3% 2006 number

The vertical axis has the Intermediate Cost alternative projections given in the 2007 Report for the years from 2007 to 2016. The horizontal axis represents the numbers as they would have to be adjusted for 2.8% GDP over the period 2007-2012.
--------------2008----2009----2010----2011----2012

2007 2.6
2008 3.0-----2.9
2009 2.8-----2.7-----2.8
2010 2.6-----2.6-----2.6-----2.6
2011 2.6-----2.6-----2.6-----2.6-----2.5
2012 2.4-----2.4-----2.4-----2.4-----2.3-----2.3
2013 2.2-----2.2-----2.2-----2.2-----2.2-----2.1
2014 2.1-----2.1-----2.1-----2.1-----2.1-----2.1
2015 2.2-----2.2-----2.2-----2.2-----2.2-----2.0
2016 2.2-----2.2-----2.2-----2.2-----2.2-----2.0

At 2.8% average Real GDP we leave crisis behind by at latest 2010

Crisis Maintenance at 3.3% GDP

Okay nobody is currently projecting 3.3% GDP growth in the short term. On the other hand this is in fact just under the 3.4% Real GDP average of 2004-2006. It is not crazy talk.

The vertical axis has the Intermediate Cost alternative projections given in the 2007 Report for the years from 2007 to 2016. The horizontal axis represents the numbers as they would have to be adjusted for 3.3% GDP over the period 2007-2012.
--------------2008----2009----2010----2011----2012

2007 2.6
2008 3.0-----2.9
2009 2.8-----2.7-----2.6
2010 2.6-----2.6-----2.5-----2.4
2011 2.6-----2.5-----2.4-----2.2-----2.1
2012 2.4-----2.3-----2.2-----2.1-----2.0-----1.9
2013 2.2-----2.1-----2.1-----2.1-----1.9-----1.9
2014 2.1-----2.1-----2.1-----2.0-----1.9-----1.9
2015 2.2-----2.1-----2.1-----2.0-----1.9-----1.9
2016 2.2-----2.1-----2.1-----2.0-----1.9-----1.9


At 3.3% Real GDP we hit ultimate numbers by 2012. In fact I only subtracted six out of nine points from the 2010 column, this would actually take 2017 from 2.2% to 1.9% as well.

Comment to Washington Monthly

(This comment was blocked, perhaps on grounds it was too HTML heavy)

If you want to restore progressivity to the overall tax system you do it by raising top marginal income tax rates and taxing capital gains as regular income. There is absolutely no reason to launder the money through a Social Security system that is scheduled to deliver a $200 billion per year surplus on average for the next ten years.

The payroll tax is only regressive if you regard Social Security as a government program like any other, as if it were in fact a welfare plan that should be funded by wealth transfers. But the fundamental strength of Social Security is that it is worker funded insurance that benefits workers. It draws nothing from capital and so owes nothing to capital, particularly nothing in the form of direct political control. The cap serves as political insulation, it is almost the only thing that prevents Social Security being relegated to the 'spending we cannot afford' category (think SCIPS) as opposed to the 'spending we can't NOT afford (anything military). Leave the cap alone, the cap is our friend. If you really think you have the political strength to simply extract another 6.2% (or 12.4%) from the wealthy then take marginal rates back to 39%, don't tinker with the cap.

If Social Security was actually facing some serious funding crisis we might consider tinkering with the cap. But it isn't. Once you actually put numbers to those dates like 2017 ($30 billion) and examine the growth numbers that produce them (2.2% Real GDP in 2015 - a 33% slowdown from 2006) you realize there is a reason they never talk dollars in articles that talk about Social Security. Instead it is always adjectives like 'looming'. The reason for this are pretty clear, 95% of America has fallen for a deliberate con game. Dean Baker and colleague Mark Weisbrot spotted the con in the 1990s and responded by writing Social Security: the Phony Crisis in 1999. The link is to the introduction in which Dean and Mark describe the situation as follows

We have a chance, said President Clinton, to “fix the roof while the sun is still shining.” He was talking about dealing with Social Security immediately, while the economy is growing and the federal budget is balanced. The audience was a regional conference on Social Security, in Kansas City, Missouri, that the White House had helped bring together.
The roof analogy is illuminating, but we can make it more accurate. Imagine that it’s not going to rain for more than 30 years. And the rain, when it does arrive (and it might not), will be pretty light. And imagine that the average household will have a lot more income for roof repair by the time the rain approaches.
Now add this: most of the people who say they want to fix the roof actually want to knock holes in it.
This is the situation facing Social Security, and it is well known to those who have looked at the numbers. The program will take in enough revenue to keep all of its promises for over 30 years, without any changes at all. Thirty years is a long time—it’s hard to think of any other program that can claim to be secure for that long. Furthermore, the forecast of a shortfall in 2034 is based on the economy limping along at less than a 1.7 percent annual rate of growth—about half the rate of the previous three decades. If the economy were to grow at 1998’s rate, for example, the system would never run short of money.

Well the economy actually outperformed 1998 for a number of years and has now and has settled back in a glide path for total solvency.

This is going to sound pretty harsh to a pretty politically sophisticated group, but unless you are familiar with what Baker and Krugman have written on the topic of Social Security your knowledge base is more likely than not to be negative.

Here are some questions for you. In 1997 the Social Security Trustees said the Trust Fund would go to depletion in 2029. In 2007 they now project it to go to depletion in 2041. What are the implications of having a future date recede in time at a rate of more than a year per year? Obviously if Social Security continues to improve at that same rate then we need to do nothing, and certainly not right away. Two what caused the date to move out so steadily in the first place? What is the causal explanation for the trend seen in this table? EPI: Changes in the Trustees Projections over Time Those are the questions we should have been discussing over the last ten years, not listening to the scary stories of people who have always hated Social Security to start with.

Take Dean Baker's advice. Take a look at the numbers for yourselves. You will probably be amazed at what you will find. The Reports are available at http://www.ssa.gov/OACT/TR/index.html or via my website.

2007 Report

Entry page
Table of Contents
List of Tables
List of Figures

Economic Assumptions under the Three Alternatives
Trust Fund Ratio under the Three Alternatives

2006 Year End Balances

From the Bureau of Public Debt Dec 2006 Report

OAS Old Age Survivors:$1,845,338,897,223.25
DI Disability $203,922,695,075.07

Total: $2.0492 trillion

Low Cost projection: $2.0380 trillion
Intermediate Cost: $2.0353 trillion

The first year difference between fully funded Low Cost and an Intermediate Cost that goes to zero in 2041 is $2.7 billion. Not only did we hit Low Cost, we beat it by $11.2 billion.

The Trust Fund just isn't broke. By the numbers.

Guide to the Bruce Webb

This blog started as a convenient place to put links to the various Reports of the Trustees of Social Security along with some commentary. Well its original main purpose has been obscured so let me restore that a bit:

The Reports

2007 Report
2006 Report
2005 Report
2004 Report
2003 Report
2002 Report
2001 Report
2000 Report

The Fundamentals

Social Security is not Broke: by the Numbers
Social Security: is it about Solvency or about Ayn Rand


Social Security After 'Crisis'

Cost of Inactivity: 'Nothing' as a Plan for Social Security
Goldilocks and the Three Social Security Bears
Interest on Interest: a Threat
Invest or Divert? Lets do Both
Unleash your Inner FDR: Social Security as Political Opportunity

Cost of Inactivity 3: Response to Karlsfini (and apologies)

(Karlsfini did not authorize me to repost his question from MaxSpeak.)

Bruce, what version of spell check are you using that tags "Regan" and not "Reagan"?

Also, why not just say what's on your mind here where the comments are turned on, rather than try to move the party somewhere else?

A free an open discussion -- that's what we like.
Karlsfini | 05.24.06 - 9:53 am | #

Well I usually start with the only Spell Checker they had when I was a kid, the one inside my head. And "Spell Check is your Friend" is snark for "You are not going to be taken seriously if you repeatedly misspell the name of a recent President" particularly one who is practically a God to the economic Right.

As to your underlying question I would respond forever to this thread if engaged by serious thinkers addressing the issue. It just looked like between Pinky, Bob and Bill a certain amount of "je ne sais quoi" had left this thread.

But I am playing with a mental gambling game I call "Social Security: the Cost of Inaction". It starts with this formula:

A=Social Security payroll gap from year one report times year one payroll income:

Y1Gap x I. Using 2005 as year one and me as example this works out to 1.89% x $50,000.

B=Difference in payroll gap from year two report time year two payroll income times years to retirement.

Y2Gap-Y1Gap x I x Y. Using 2006 as year two (1.92% gap) and me as example this works out to .03% x $51,000 x 17.

The Price of Inaction is B - A.

Now when Bruce is playing this game we get $50,000 x 1.89% = $945. And then $51,000 x .03% = $15.30 x 17 years to retirement = $260.10

Cost of inaction to Bruce in 2005 $260.10 - $945 = -$684.9. That is $685 2005 dollars left in my pocket. Given that both interest and inflation work in my favor here that is the rock bottom cost to me of doing nothing.

Now take somebody we will call "Andy". Andy just graduated from Wharton at 24 in 2004 with an MBA that enables him to take a job on the Street which pays close to the maximum for 2005. How does Andy fare. Well $90,000 x 1.89% = $1701. And $1701 x .03 = $27.30 x 42 = $1146.60. Cost of inaction to Andy in 2005. $1146.60 - $1701 = -$554.40. Now given that interest and inflation are working a lot better for Andy than they are for Bruce, not taking action in 2005 on Social Security put real 2005 dollars in everybody's pocket.

Those who claim that the cost of inaction is $600 billion or $160 billion would be well served to play this game. If you believe that the economic numbers will produce better results than 2006 Intermediate Cost and so lower payroll gap next year than doing nothing is a dead pipe cinch. The 2006 dollars left in your pocket clearly were not needed after all and can be invested or spent. If the payroll gap ticks up than you need to play the game. Are your immediate savings in not taking the tax hit outweighed by your increased tax burden between now and retirement?

Crisismongers insist that if Intermediate Cost holds true payroll gap goes to 12% at depletion. Well fine. I won't be paying payroll tax at currently projected depletion. Some of you will. Well play the game. If there is no increase in payroll gap, i.e. if it stays at 1.92% inaction costs you literally less than nothing. Only if the increase in payroll gap times your income going forward times your years to retirement exceed the dollars left in your pocket (even ignoring the postive effects of interest and inflation on those pocketed dollars) is action even needed.

It would take some pretty sharp spikes in payroll gap year to year to make Inaction a bad bet. .0003 x your 2006 income (.03%) is not much of a bite compared to keeping .0192 x your 2006 income (1.92%) in your pocket.

Take it year by year. Ignore the 75 year or Infinite Future projections. Are you going to have more or less dollars in your pocket this year by doing nothing? Understanding that doing nothing is going to cost you no more, and probably less, going forward than doing something?

Privatizers don't want you to do the math. I'll be glad to respond here, there and everywhere, but Karlsfini just between you and me I think this is likely a dead thread.

But thanks for letting me organize my thoughts. And thank you Max

Cost of Inactivity 2: Lets get Historical

Revert to the last post:
Cost of Inactivity I and look at the numbers from the past Reports.

Let's say someone actually started paying attention to the numbers back in 1997, downloading the Reports and looking at the numbers. Well in that Report the price of inactivity was 2.23% of payroll. People paying attention would have to admit that keeping 2.23% of payroll in pocket that year would have to be offset by increased payouts in years forward. Well lets say I was making $32,000 back then compared to $50,000 now. My cost for a permanent fix? $713 dollars a year plus whatever increases in income I gained between then and now. Which at $50,000 would be $1150 a year.

Well I could do the arithmetic and maybe will but I am looking at roughly $8000 plus accumulated interest as the cost of doing nothing and what is the cost of my not accepting a 2.23% boost in payroll back in 1997? 1.92% going forward.

Crisis mongers who insisted that we would pay and pay for doing nothing back then need to return to their abacuses. Thousands left in my pocket since then and a smaller bite going forward.

The math continues in Part 3 of Cost of Inactivity.

The Cost of Inactivity: Nothing as a Plan for Soc Sec

This will be a work in progress for a while, but I will publish it anyway. e-mail criticism and commentary to mailto:bruce.webb2@verizon.net are welcome.

Can we quantify the price of inaction on Social Security? My starting point is this table from EPI Changes in Trustees Projections Over Time.
Note these are not EPI numbers, these are official numbers from the Annual Reports: "Source: Annual Reports of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds, 1996-2004."

Trustee report date
1996 1997 1998 1999 2000 2004
Year when tax revenue falls short of benefits
2012 2012 2013 2014 2015 2018
Year when trust fund income falls below expenditures
2019 2019 2021 2022 2024 2028
Trust fund depletion date
2029 2029 2032 2034 2037 2042
Shortfall as a share of taxable payroll
2.19% 2.23% 2.19% 2.07% 1.89% 1.89%

Now let the fun begin. My oh my plenty of numeric fun to be added.

What is the cost of doing nothing? I mean real cost in terms of dollars and cents to a particular worker in postponing Social Security reform by a year? Now there has been some learned talk at MaxSpeak and DeLong on May 22 and 23 about what are the costs of inaction, but they all assume that the current economic and demographic model of Social Security is valid and the proper focus point is the outcomes five, ten, seventy-five and God Help Us, Infinite Future out. Well no I propose to put this whole discussion on the Short Term. What is the cost of postponing action this year given what we know about the year just past and the year now ongoing?

Lets start with a real example. The 2004 Report declared that an immediate increase of 1.89% of payroll would be enough to fully fund Social Security with no changes in benefits or retirement age. This under the Intermediate Cost assumptions. Now the 2005 Report declared that the gap is now 1.92%. Worrisome? Well lets whip out the calculator.

Per the Trustees NOT taking action in 2004 in the face of a 1.89% payroll gap left the $50,000 earner with $945 in his pocket. What were the negative consequences? Well the 2005 Report gives us 1.92% payroll gap. Well translate this into dollars. I have $945 left with every opportunity to invest or spend with whatever utility I would get from that spending and what is my downside? Well it is an additional .03% of payroll taxes going forward. Which for our $50,000 earner is $15 a year going forward. Well I have 17 years to retirement which means my total actual cost going forward for pocketing that $945 is 17 x $15 which equals $255. Not doing anything, and discounting for inflation and interest I could earn on that $945 over the next 17 years and I am still $690 ahead in current dollars.

If the payroll gap stays steady, as it did from 2000 to 2005, then you are ahead by exactly the amount of the payroll gap multiplied by your income plus whatever current and future interest you would earn on that amount.

2006 Report: Live

These links now work. I created them in February anticipating the release of the Report by March 31st, instead they delayed the Report until May 1 and then released the key data point with an asterix. Did 2005 productivity grow at 2.0% or somewhere North of that?

Entry page
Table of Contents
List of Tables
List of Figures

Economic Assumptions under the Three Alternatives
Trust Fund Ratio under the Three Alternatives

Invest or Divert

Let's do both.

Social Security financing projected forward is complicated by a confusion of first and second order income streams. Now Cost is pretty fixed, it varies depending on your assumptions about Real Wages, CPI and various demographic figures but is conceptually easy. Each month a certain number of checks in certain amounts have to be mailed out. But income is conceptually more difficult and requires some breakdown.

The simplest component is Payroll Tax. 12.4% of every paycheck up to about $90,000 flows to the Treasury each pay period. No one questions that this is real money really extracted from the real economy. A lesser known component is taxation on benefits. In some cases higher earning beneficiaries pay tax on their benefits. This gets a little murkier. If this tax was applied across the board as a simple reduction in benefits at the top end of recipients this would not show as an economic extraction from the real economy at all. It is only because it is applied to checks actually mailed out that it even appears as an extraction from the real economy. A third component is interest on excess payroll tax invested in Special Treasuries. This money is pretty real as well. To the extent that borrowing from the Trust Fund just replaces other borrowing (a question for another day), these are just dollars the Treasury would have been paying out to some other investor. But then comes the dread Interest on Interest

Now there are Papa Bear scenarios which would have payroll tax and taxation of benefits fully capable of covering costs forever, and then some. See Goldilocks and the Three Social Security Bears. If this happens our conceptual course forward is pretty simple. We invest the interest on the existing bonds and any principal payment in alternative economic vehicles (my choice would be Municipal and School bonds) and then direct the returns from that back into the income stream. But if payroll is more than handling cost what do we do with the overage? One answer is to split it in thirds: one third to be reinvested, one third in payroll tax cuts, and another third diverted to Medicare (others might balance the ratios otherwise). Now given that the General Fund under this scenario is gamefully kicking in its $100,000,000,000 in interest owed, or even making additional payments on the principal, we end up with a portfolio that is not only steadily reducing payroll tax but kicking in substantial amounts to Medicare besides. All while capping the General Funds responsibility to actual interest owed.

There are other Papa Bear scenarios that are not so rosy. But they all have the same end benefit to the General Fund. If we just started paying out interest in full in the form of buying alternative instruments for the Trust Fund and keep economic productivity anywhere above Baby Bear's 2.1% ultimately we just dig ourselves out of the hole. Depending on how close we get to Baby Bear we may end up having to tap some proportion of the Alternative Portfolio. But in each case we evade the Interest on Interest trap.

Sounds like a fairy tale? Put on your green eyeshades and run the numbers.

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.

Interest on Interest: a threat

The Treasury Bonds in the Trust Fund are real. At least those purchased by current payroll tax dollars. They are the product of actual payroll dollars extracted from real paychecks. And in turn the interest earned on those Bonds is real. The General Fund would have had to pay those same dollars to a bond investor if they didn't have the Trust Fund to borrow from instead.

But the Interest on the Interest is more troubling. It is second order. The General Fund is simply assuming an obligation for the convenience of not reducing the current payroll tax to make it a real pay-go system. Now the decision to raise payroll taxes in 1983 was perfectly necessary, for the most part it just restored paygo, the amount of excess payroll tax over cost actually collected is vastly overestimated by just about eveyone, the Trust Fund did not break the $100 billion mark until 1988. And investing the suplus in Special Treasuries was equally sensible, why set up any elaborate system when the whole Fund would be depleted by 2023 anyway.

But 2023 has now turned into 2041, and given not very extraordinary numbers may begin to stretch out even farther. Now the effect of reinvesting the interest in the Special Treasuries back into Special Treasures starts to bite. The General Fund starts assuming an unfunded liability, one that compounds over time as interest on interest starts to pile up. Now no one who believes in the Full Faith and Credit of the United States (and I certainly do) doesn't agree that that money is owed, the question is whether this is the best way to do it in the interests of all taxpayers in the future.

And the answer is 'No'. Given that the Trust Fund will likely be in surplus well past 2041 and perhaps forever we need to reexamine how we manage it. And the answer is pretty clear: stop reinvesting interest into Treasuries. It doesn't produce real cash flow into the Treasury, it just masks the cost of borrowing. The solution is obvious, interest on existing Treasuries and any excess of income excluding interest over current cost needs to be invested in an alternative economic vehicle. In the short term this means some borrowing pain, in the long term it shifts the reponsibility for redeeming those assets off of the General Fund. Moreover it offers the opportunity for the General Fund to eliminate any responsibility long term. If in addition to taking all interest on the current Trust Fund into other vehicles, it actually start to pay down the current principal it gradually reduces its interest burdens overall.

But given the actual financing of Social Security this means reducing the flow of other income into the system. Which means cutting the tax on Social Security benefits that applies to more affluent recipients (a relatively small amount of income) or cutting or diverting a portion of the payroll tax.

Unleash your Inner FDR: Social Security as Opportunity

Time for Politics.

Social Security offers the opportunity to reverse a whole generation of political defensivism on the part of Democrats. We have the unique chance of changing the entire narrative.

Because Social Security "crisis" is not a matter of numbers, not really, it is a story in support of an ideology which can be boiled down to "Markets Good, Government Bad". This story has been carefully crafted for seventy years and finally got its opportunity to be put in play in 1980 with the election of Ronald "Government is not the solution, government is the problem" Reagan.

As it turns out Reagan was forced to compromise on Social Security in 1983 and accept an increase in payroll tax. The response of the Social Security haters was then laid out in the Fall 1983 issue of the Cato Journal Social Security: Continuing Crisis or Real Reform? Particularly illuminating is the article by Butler and Germanis "Achieving Social Security Reform: A “Leninist” Strategy". They laid out a careful, long term strategy that would allow them to kill Social Security at the next crisis point, which point was projected to coincide with the retirement of the first Boomers, which would start as early as 2008. According to the story the impact of Boomer Retirement would send the whole edifice crashing leaving Private Accounts standing triumphant.

But history and the economy did not play nice. They conspired to return economic numbers that started to push shortfall and depletion back. This trend accelerated in the nineties and can be inspected here Economics Policy Institute: Changes in Trustees Projections over time. A Trust Fund that was projected to run dry in 2023 was over a period of years adjusted to a Trust Fund projected to run out in 2041, and that date was being pushed back more than 1.3 years per year.

Privatizers panicked. Their carefully generated narrative began to lose its punch. In 2041 the youngest Boomer (born in 1964) will be seventy four, the oldest (born in 1946) ninety-six. It would be pretty hard to argue that they in fact had not fully paid for their Social Security themselves. So privatizers began to tweak the numbers and move the goalposts. In doing so they had to cast doubt on the very existence of the Trust Fund. Hence the talk of "worthless IOUs". But even this new story is losing its impact.

Because amazingly enough we may not even need to tap the Trust Fund principal, we may need at worst to tap a fraction of the interest due. Because we are soundly beating the productivity numbers required by Low Cost.What is the Low Cost Alternative: What does it mean and Low Cost predicts just that: a minor shortfall in income less interest against cost in 2023 which is more than offset by interest earned. Absent some future government proving themselves to be Crooks and Liars in abrograting Trust Fund bonds issued with the Full Trust and Credit of the United States beating Low Cost means we are home free.

But it might well be better than that. The economy is returning productivity numbers close to double what Low Cost requires, and minor changes in productivity in the early years have outsized impacts on the Trust Fund in the outyears. As it sits we may have a Trust Fund that is actually overfunded going forward. And that is our opportunity.

Imagine a March 2006 Report that announces that not only will Social Security not be going broke, it will be a net lender forever. That shows that privatizers pushing "Crisis" were not just alarmists but outright liars trying to sabotage the legacy of Roosevelt. Do you think we could run with that? Do you think we could run ON that? Well I do.

Principal Economic Assumptions: What are they?

I constantly talk about "Productivity", but of course it is not the only number series involved. If we take Tables V.B1 Principal Economic Assumptions and V.B2 Additional Economic Factors we see a total of 11 columns:
Productivity
Earnings as a percent of Compensation
Average Hours Worked
GDP Price Index
Average annual wage in covered employment
Consumer price index
Real wage differential

Average annual unemployment rate
Average increase in Labor Force
Average increase in Total Employment
Average increase in Real GDP
Average annual interest rate

I focus on Productivity for a few reasons. One the Trustee's front it in their discussion, they talk about it in section B.1, they put it in the left hand column of the table. And they characterize it so "The rate of change in total productivity is a major determinant in the growth of average earnings." No they don't say "the major", but "a major" suggests that we should place close attention.

Two, the effects of Productivity on Trust Fund exhaustion are direct: a bigger future economy will have an easier time financing a fixed pool of boomers. This is true however we structure the financing and the payout.

Three, the effects of the other number series are harder to understand. The problem we have is that wage increases and inflation work on the Trust Fund in different ways. Wage increases boost contributions. Inflation increases boost cost. And the interaction is pretty complex. It works this way. Your ultimate initial retirement check depends on a combination of your income history and the overall rate of real wage increases. If workers as a whole do better you do better. But there the linkage stops, adjustments to your retirement check after that are determined by CPI: consumer price inflation. Okay lets unravel this a bit.

Higher inflation means higher payouts both short and long term. So all things being equal a jump in projected inflation is an immediate drag on the Trust Fund via increased payouts. Bad for Solvency (but oddly due to the disconnect from CPI and medical inflation not necessarily bad for current retirees. Topic for another time).

Increases in hours worked and average wage will increase contributions and so inject money into the Trust Fund. On the other hand they will increase your retirement check when the time comes and so increase costs. I have had posters elsewhere claim that this offsets itself, but I don't think so. The time shift between contribution and retirement check should make this a net gain for Solvency in a paygo system and the effect should roll forward. Like I said the effect some of these other number series are harder to understand. But people are free to bring numbers.

From the standpoint of solvency is seems clear that inflation is bad and real wage differential is good. But without a lot of study and more numeric skills than I have it is difficult to determine the significance of any particular number. But what I do know is that if productivity year in and year out comes in above both the Intermediate Cost and Low Cost projection Solvency is increasingly likely. And if we convince ourselves it will permanently come in above those points we are justified in asking skeptics to identify the particular number series that will offset that, and how they specifically work on Trust Fund balances.

Because I just don't think the long-range trends in this table are reversible EPI: Changes in Trustees Projections over time

The differences between projected 2004 and real 2004 (that is from the 2005 Report Table V.B1)
Productivity 2.7% 3.3% Earnings -.3 -.5 Hours worked (increase) .0 .0 GDP Price 1.6% 2.2%
Average wage 3.6% 3.8% CPI 1.2% 2.6% Real Wage Differential 2.4% 1.2%

Productivity is the Loneliest Number but still no. 1

I had an interesting e-mail from an economist who wanted to remain anonymous. He/she pointed out that Productivity is only one variable and that the Trustees had a stochastic analysis that validated the current exhaustion date. Let me make a couple of points here.

One, Productivity is shorthand for the whole range of economic numbers. It is true that the other numbers can vary, but many of them, like real-wage growth, have been tied to Productivity. True there are rumblings that this linkage is breaking down but it is incumbant on others to show how that offsets the huge gap between projected and actual Productivity. If Productivity was coming in at 2.2%, barely above the 2.1% used by Low Cost, I would still have a good case that we were on the road to solvency under the "if this goes on" theory, but I wouldn't be so cocky. My advice would still be to do nothing, if we are beating the model we are beating the model. But in the real world Productivity is coming in above 3.0% and now we are entering "what if" territory. "What if" 2005 ends up with a number over 3.0%? My answer is Solvency. Others can knock me off that mountain, but just pointing out that the other numbers of Low Cost are similarly optimistic compared to Intermediate Cost doesn't buy anything. Show me that they are being undershot by enough to offset the dominant variable. I am open to argument.

Two, I have never claimed to be an economist. But embedded in that stochastic analysis (which is studded by so many qualifiers and warnings about methods and reliability of projections to start with) is this sentence: "Each time-series equation is designed such that, in the absence of random variation, the value of the variable would equal the value assumed under the intermediate set of assumptions" (2005 Report p. 159). Near as I can tell all this analysis is doing is allowing variation around the assumed ultimate numbers under Intermediate Cost for the out years and seeing what happens. Given that in past years the Trustees have asserted that variations in the out years have little influence of ultimate results, it is not surprising that the results of this admittedly experimental model validate that. This is a relatively new part of the Report, introduced in 2003, and in this humble bloggers opinion is more intended to confuse and give some greater validity to Intermediate Cost than is warranted. You assume Intermediate Cost numbers as your point of departure and you would expect the outcome to vary around the projected result.

But it is near term numbers that are the big drivers, small changes at the beginning of a curve have outsize effects on its ultimate values. I have been begging professionals to weigh in from day one. Show me reasons why I should not just take Low Cost at face value. This was a nice, if private first step. Not entirely persuasive, but welcome.

Scoop just ate my homework: MyDD diary

I have been taking up too much space at Economist's View (but Mark Thoma should be a daily stop for anyone discussing Social Security.) So I want to return to the topic of my previous diaries: Life After Solvency.

Social Security Solvency with no changes in benefits, retirement age or payroll tax is not an impossible dream. Each year the Trustees lay out a set of economic numbers that would would produce that result. This dataset, called Low Cost never gets a bit of attention. But that doesn't make it go away. You can get a little (okay a lot) of background at my website starting with What does Low Cost mean? More below the fold.
Welcome back, if you left at all. Over the last ten years Low Cost consistently returned the same result: flat trust fund ratio. What does that mean? For a fuller explanation you can check outThe Trust Fund Ratio explained. In brief the Trust Fund is a lot closer to a checkbook than a savings account. Contributions and interest earned go in, checks go out. The Trust Fund ratio is simply your balance expressed as a function of time. For example the Trust Fund ratio at the end of 2004 stood at 305 which means 3 years 18 days Table VI.C6.—Operations of the Combined OASI and DI Trust Funds
in Fiscal Years 2000-14 That is our current reserve and the direction of the curve is headed up under all three alternatives: Intermediate, High Cost and Low Cost Figure II.D7.—Long-Range OASDI Trust Fund Ratios Under Alternative Assumptions and if you look at our old friend Intermediate Cost (II) you see familiar dates like 2017 (when the curve peaks) and 2041 (Trust Fund Depletion). But what's up with curve (1): no drawdown until 2023? a slight dip then we sail through the 75 year window with a 450 Ratio? Are the economic numbers of Low Cost so optimistic that this is just pie in the sky? Judge for yourself. Personally I think 2.1% for 2005, 2.2% for 2006 and no number higher than that in the out years is more than doable.

Payroll vs Productivity: What would it take
2005 Report: Economic Assumptions

Low Cost is doable. In my view it is already done. You plug current growth numbers into this model and that ratio just keeps on rising.

If anyone responds maybe we can talk about what this would all mean. Meanwhile you might want to check out the terrific Rock the Vote flash Social Security: Don't get played and maybe follow that up with Lee Arnold's animation Social Security: The Real Connections. Lots to chew on. Mangia.

Social Security: it it about Solvency or about Ayn Rand?

It was an odd moment. I was riding in the elevator with the Chair of my County's Democratic Party and he thanked me for my website. Taken aback I asked how he had stumbled on it and he said that people had been passing it around. So maybe it is time for me to give some sort of introduction.

This site is all about the numbers. You get links to every Social Security Report from 1942 to 2005, you get breakouts to particular tables from all Reports from 1997 to 2005, you get some explications of what those tables mean. The numbers are important, if you are going to participate in the debate over the future of Social Security you need to understand them, you need to understand their implications, you need to be able to measure them against the numbers you read in the paper every day. Because oddly enough this debate is not about numbers and in most respects it never has been.

A certain portion of the Republican Party has always hated Social Security on principle. You see it most starkly in some of the novels of Ayn Rand, but from Alf Landon to Grover Norquist large portions of the Right simply despise the very idea of collective social responsibility. They disguise it in many fashions, the current version is "The Ownership Society", but it really boils down to "I got mine, and screw Grandma Millie" (Enron- the gift that keeps giving).

Advocates of private accounts, with a few exceptions, don't care about retirement security for lower income workers. They just don't. They want to kill Social Security and with it wipe out the New Deal. They are not even particularly secretive about this, a little Googling on Grover Norquist or the Cato Instistute will open some eyes. They want to wipe the legacy of FDR right out, they want to set the clock back to McKinley and Hanna in 1898.

To most Americans this must seem like over the top hyperbole, but the Norquists, Roves and Gingriches of this world are dead serious. They not only want to repeal the entire legacy of Franklin Roosevelt, they fully intend to erase the Trust Busting legacy of Teddy Roosevelt. From a legislative point of view they would simply wipe the 20th century off the table as if it had never existed.

Social Security is target one. But it is wildly popular, taking it on head on was in practical political terms impossible, it was deemed the Third Rail of American Politics for a reason. So in 1983 the Right decided to attack it at its weakest point. The impending retirement of Baby Boomers would put considerable strain on the system, even the reforms of the 1983 Act could only defer the challenge. So the Cato Institute took that challenge head on, they confronted Solvency and cheerfully concluded "Can't happen" and so started selling private accounts and phase out as alternatives. They didn't try to advance the ideological case, they just pushed "bankruptcy".

But unfortunately the numbers bit back. The original entry point to this site is Social Security is not broke: by the numbers You don't have to buy into my political spin, but you should know the numbers in play. Hmm, Table V.B1.

Why are they so insistent? (From Brad DeLong's blog)

"What puzzles me is energy and persistence of this propaganda campaign with scant positive results."

It is not economics it is ideology. Exactly zero in this campaign has the interest of future retirees at heart. We have to talk numbers, because in the end this will be decided on numbers, but when I point at 2.0% as being the productivity number for 2005 currently used to set policy I am not making an economic case, instead I am making a forensic case that these people are simply not serious. They don't believe these numbers, they can't. Economic reality has already left Intermediate and Low Cost's numbers in the dust and surely someone in the Bush Administration understands that.

The numeric case for Social Security solvency was made by 2001. Anyone who was seriously concerned with the question of whether the American economy could meet its mid-century obligations to Social Security had only to read the 2001 Report, take its numbers seriously, and measure them against any reasonable projection going forward. It wasn't broke then and it is not broke now.
2001 Report: Economic Assumptions
These people took an economy that returned 3.2% in 2000 and put up 2.2% as their "optimistic" Low Cost number for 2001. The notion that sharp slowdown was in any sense a best case scenario was frankly bizarre then, stubbornly repeating it year in and year out when reality keeps slapping you in the face with better numbers begins to border on pathological. But only if you assume that this discussion is being carried out with economics as a backdrop.

The Right Wing case for killing Social Security is iron-clad in their own minds. It is Socialism pure and simple. And they are taking a simple page out of Goldwater's playbook: "Extremism in the pursuit of Liberty is no Vice". Small 't' truth is not going to stand in the way of capital 'T' truth.

Cato and Heritage and AEI took the lazy man's way out in 1983. Rather than making the case on the merits, rather than arguing that Social Security was a bad policy choice under any economic conditions, they chose the "It's going broke anyway" path, they put their whole weight behind "something is better than nothing". The dawning reality that "nothing" equates to full funded Social Security Trust Fund is rocking their world, they are desperately trying to play catch up with "infinite future liability" "intergenerational income transfer" "worthless IOUs", with pretending that "Full Faith and Credit of the United States" is just a meaningless catch phrase. God Damn it the numbers were supposed to be there for them, the impending wave of Boomer retirements was supposed to put an unendurable burden on Social Security. Numbers were going to be their Best Friends.

Well you don't go to war with the numbers you want, you go to war with the numbers you have. In this case Republicans declared War on Social Security in 1936, started drawing up War Plans in 1983, and simply assumed that they would have an unlimited Army of Numbers to back them up when push came to shove.

Well much as we have seen in the wholy tragic and unnecessary War on Iraq, Hope is not a Plan. And while most Americans will stand up and salute when you wrap yourself in the Flag and call out "Support the Troops", only a tiny minority are kneeling at the shrine of Milton Friedman and intoning "Markets".

These people are true believers and eager enlistees in the War on Social Security. Unfortunately for them they put their full trust in the Shock and Awe of Trust Fund Insolvency and they have no viable back up plan. Their "energy and persistence" is only a mask for desperation, admitting that their 70 year dream of killing Social Security is melting away before their eyes is killing them. But watch out, proverbally the dying beast always lashes out at the last moment.

(Or as the VP put it after I penned this: during its "last throes")

Solvency and the Long Bond: Economic Life after Crisis

Most discussion of Social Security Solvency has been in the context of Privatization and more narrowly on whether private accounts help or not. A certain consensus has shaken out: to the extent that "Crisis" exists it doesn't manifest itself until the 2040's and private accounts in and of themselves wouldn't help anyway. So there is a tendency to agree with the following memorable phrase: "Social Security Privatization is as dead as Bob Dole's dick, let's move on".
But it is not just about private accounts. Sure killing the 70 year dream of the Republican Party of killing Social Security by privatizing it is important for all kinds of reasons, notably 2006 midterms. But there are important macoeconomic implications to Solvency. Assessments of the impacts of Current Account deficits and the impact of Bush Tax Cuts both depend critically on the Trust Fund balance in the year 2025, Solvency will rock our world.

Supporters of Social Security have been playing defense since November, time to play offense. I am going to assume a certain familiarity with the numbers and terminology here, those who want some background can find it on these pages: The Three Alternatives and What is the Low Cost Alternative

For the purposes of this diary I am going to assume Low Cost, that is that economic productivity growth for 2005 will meet or exceed 2.1% and that growth in the outyears will meet or exceed 1.9%. Not a stretch by any means, reported 2004 came in at 3.3% and the average over the last six years has been better than that. 2005 Report: Economic Assumptions

We start with the graph 2005 Report: Trust Fund Ratios Now outcome ( II ) is our old friend Intermediate Cost, Trust Fund Ratio peaks in 2013 and sinks more or less rapidly to 2041. But Low Cost produces outcome ( I ): the Trust Fund Ratio doesn't peak until 2022, sags a minor amount and then sails through the 75 year window maintaining a 4 1/2 year reserve.

This doesn't fully capture the dollar picture, the Trust Funds continue to grow even after the ratio begins to decline. For Intermediate Cost the dollar peak occurs in 2023. Under Low Cost interestingly enough the peak never comes. Operations of the Combined OASI and DI Trust Funds, in Current Dollars, Calendar Years 2005-80 Which still doesn't capture the entire picture, as long as payroll tax exceeds benefit costs interest earned on the bonds is just bookkeeping. The crux is when benefits exceed payroll, which for Intermediate is around 2018. Ironically we start borrowing five years before the actual dollar peak.

The main point for this entry is that the markets and economic forecasts generally have outcome ( II ) built in, 99% of the market assumes that the US will be faced with replacing a $6 trillion dollar bond portfolio with public borrowing to that same tune. What if that portfolio never had to be redeemed? What if borrowing didn't start to around 2023? And never hit an inflation adjusted amount of $150 billion a year until 2060 Estimates in Constant Dollars And all of this assuming just 1.9% productivity growth?

Short answer: Social Security Solvency transforms everything. Your view of the bond market and the role of the Chinese Central Bank may be about to change.

Productivity: 2006 Budget vs Trustees' 2005 Report

They let the cat out of the bag. I did some poking around the 2006 Budget and found the following on p. 191. I have posed the question here and there: How do the Presidents' men predict productivity when they are talking tax cuts? The answer is here. "conservatively, to be 2.6% per year". How then do they get away with 2.1% as their optimistic number when talking Trust Funds?

2006 Budget: Analytical Perspectives

"Potential growth is approximately equal to the sum
of the trend rates of growth of the labor force and
of productivity. Potential GDP growth is projected to
be 3.2 percent through 2008, and then edge down to
3.1 percent during 2009–2010, primarily because of an
assumed slowing in labor force growth. The labor force
is projected to grow about 1.2 percent per year through
2008 on average, slowing to about 0.8 percent yearly
on average during 2009–2010 as increasing numbers
of baby boomers enter retirement.
Trend productivity growth is assumed, conservatively,
to be 2.6 percent per year. That pace is noticeably below
the average since the business cycle peak in the first
quarter of 2001 (4.2 percent per year). It is, however,
close to the pace during 1996–2000 (2.5 percent) and
not far from the average since the official productivity
series began in 1947 (2.3 percent)."

(Bolding mine)

The 2005 Report

(Aug 08 edit: I have left the original text untouched. But as it turns out my exuberance was a little premature, productivity in fact fell off a cliff in Q4 2005 with the result that year end productivity came in pretty much in line with Intermediate Cost projections. But it was fun while it lasted, during the interval between the release of this Report and the BLA release of Q4 it seemed that full solvency of Social Security would have to be recognized by all at latest by 2008. Well that is reality for you.)
Pardon the incoherency, I am running around the room high-fiving myself. But first the numbers:

Entry Page
Table of Contents
List of Tables
List of Figures

Economic Assumptions Under the Three Alternatives
Trust Fund Ratios Under the Three Alternatives

Social Security is not broke. Exactly no one expects the economy to perform down to the levels of Intermediate Cost. I was stunned to see that the Trustees chose to take the whole hit in 2005. They chose to stick to their guns and return a Low Cost projection that showed the Trust Fund fully funded, but not over funded, consistant with past practice What is the Low Cost Alternative? In so doing they were constrained by definition to keep Intermediate Cost somewhere below Low Cost. Which yielded the following result: productivity growth slowing to 60% of 2004 rates in the face of a strong 1st quarter 2005.

According to the Trustees' own numbers the economy returned 3.3% in 2004. Now they would have us believe that 2.1% is an optimistic number and 2.0% a realistic number for 2005. Who are they trying to kid?