Later On

A blog written for those whose interests more or less match mine.

More complete explanation of Social Security

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And why its finances are in good shape. Paul Krugman:

Some commenters have asked for more about Social Security’s role in the long-run budget problem, and in particular an explanation of my assertion that the Beltway obsession with Social Security reflects ignorance. So here’s a quick, informal explanation.

Start with the current position. Last year, federal spending on Social Security, Medicare, and Medicaid was 8.5 percent of GDP, equally divided between Social Security and the health care programs. Dismal long-run projections, like those of the GAO, have this total rising by 10 percentage points of GDP by mid-century.

So, how much of this is a Social Security problem? Pundits like Tim Russert love to point out that in its early days Social Security had 16 workers paying in for every retiree receiving benefits. But this is irrelevant; looking forward, we’ll see the worker-beneficiary ratio fall from about 3 to 2 as the baby boomers retire. This will raise the percentage of GDP spent on Social Security from about 4 to 6 — that is, a rise of about 2 percentage points of GDP, which is a small fraction of the entitlements problem. See, for example, this chart from my NY Review of Books piece on the subject.

What’s more, Social Security has already been strengthened to deal with this rise. In 1983 the payroll tax was increased and adjustments made to the retirement age, so as to build up a trust fund. According to the “intermediate” projection of the Social Security trustees, this trust fund will be exhausted in 2041 — but they also present a more optimistic scenario, based on economic assumptions that don’t seem at all outlandish, in which the trust fund goes on forever.

This brings us to the claim that the trust fund doesn’t exist, because it’s invested in government bonds. The full explanation of why this is sophistry is here.

The bottom line is that Social Security is just not the major problem.

Now, part of the projected rise in Medicare and Medicaid costs represents the effects of an aging population. But as a new report from the CBO explains, demography is only a minor factor — mainly it’s rising health care costs. What’s more, the proposed “solutions” for the Social Security problem have no relevance to the issue of rising Medicare costs — even if privatization were a good idea, which it isn’t, it would do nothing to solve the problem of rising medical bills.

The Beltway obsession with Social Security is a classic case of a little knowledge being a dangerous thing. People have picked up a few facts about demography, and think they understand the long run budget problem. They don’t.

PS: OK, from some communications I see that 2017 — the projected date at which payroll taxes no longer cover benefit payments — has raised its ugly head. But there is no interpretation under which 2017 matters. Social Security legally has its own dedicated funding; if you believe the government will honor the law, the surpluses the system is now running are building up a trust fund, which will finance the system for decades after 2017, and maybe forever. If you think the law will be ignored, then Social Security doesn’t really have its own budget — the payroll tax is just one of many taxes, and SS benefits are just one of many government costs. In that case the relationship between payroll taxes and benefits is irrelevant.

The only way to make 2017 matter is to change the rules midway: when SS runs surpluses they don’t count, but when it runs deficits they do.

Written by Leisureguy

17 November 2007 at 12:37 pm

Posted in Government

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  1. Correcting all the errors in Mr. Krugman’s piece would take more space and time than it justifies, so this comment will just focus on a couple of them.

    He makes one correct statement — that by mid-century, Medicare and Medicaid are projected to contribute far more to the overall fiscal imbalance than is Social Security.

    But this does not mean that Social Security doesn’t have a huge imbalance of its own, a conclusion he reaches based on several fallacies. Among them:

    He writes that Social Security has already been strengthened to deal with its projected cost increase, specifically saying that “In 1983 the payroll tax was increased and adjustments made to the retirement age, so as to build up a trust fund.” This is a common misperception, but it is a misperception nevertheless. The crafters of the 1983 agreement did not intend to build up a big Trust Fund, nor did anyone assert then that pre-funding of future liabilities could be accomplished by building up a big Trust Fund. There is ample documentary evidence of this reality, including:

    — The Greenspan Commission couldn’t have known their solvency package was predicated on a big Trust Fund buildup, because they didn’t present Congress with a complete package and thus couldn’t themselves analyze it. They presented it with provisions that added up to about 2/3 of actuarial balance on average over 75 years. Congress filled in the remaining 1/3. The materials seen by the commission and the authorizing committees did not include an analysis of annual cash flows that would show a big Trust Fund buildup followed by a drawdown. These materials only showed what each provision did, on average, over 75 years.

    — The Commission’s Executive Director Bob Myers has testified repeatedly that no such belief ever existed. Senator Pat Moynihan, once he realized that the big surpluses were accumulating, actually moved to cut the payroll tax, realizing that the so-called “solvency” for several decades would be wholly illusory if achieved by this method, as the money would never be saved. Jake Pickle, chairman of the subcommittee that pushed through the legislation, wrote at the time that they were going to stick with pay-as-you-go, that the public could never be sold on a big Trust Fund buildup.

    — The final proof of the pudding is that the Greenspan Commission didn’t use the actuarial method that the Social Security Trustees now use. The current methodology implicitly assumes that the Trust Fund is “real,” and discounts future deficits by the rate of interest it “earns.” But that method wasn’t adopted until 1988. The Greenspan Commission used a different method that assumed the system was pay-as-you-go, and which basically tried to balance the system’s finances as a % of taxable wages, over 75 years. The method the Greenspan Commission used is completely incompatible with a view that the Trust Fund is meaningful advance funding. In fact, one of the reasons that the methodology was switched in 1988 was that by then people realized the big Trust Fund was building up, and there was a disconnect between Trust Fund accounting, and the then-used measure of the actuarial deficit. The fact that they had to change the method simply to keep the books self-consistent in 1988, was a demonstration that in 1983, they never anticipated that big Trust Fund buildup, nor believed that such a thing could be a legitimate basis for solvency.

    The bottom line is that the system’s actuarial balance calculation is predicated on the idea that surpluses run in one year in some way can balance deficits run decades later. Not only have those surpluses not been saved, and not only has nothing been done in practical fact to finance the deficits that begin in 2017, the historical fact is that no one in 1983 ever thought such a thing was possible or desirable via the Trust Fund. That’s a myth — a common myth, but a myth.

    Mr. Krugman might be forgiven for holding this widely held misconception, but other statements in his piece are sloppier. He further writes that “According to the “intermediate” projection of the Social Security trustees, this trust fund will be exhausted in 2041 — but they also present a more optimistic scenario, based on economic assumptions that don’t seem at all outlandish, in which the trust fund goes on forever.” This shows almost no familiarity at all with the Trutees’ report and its assumptions. A couple of factual points about that:

    1) The “optimistic” scenario he refers to isn’t one in which only the economic assumptions are rosier, but the demographic factors as well are tilted in the direction of extended solvency. This is important, because it’s the demographic variables in that projection that drive the result, more than the economic variables.

    2) That scenario doesn’t have solvency lasting “forever,” just through the 75-year period. In fact, if he’d bothered to look at the report, he could see that even that scenario was clearly not permanently sustainable, because the permanent cash deficits in that scenario begin midway through the 75-year period and it’s clearly in a downslide by the end.

    3) He may not consider the economic variables “outlandish,” but one of them is a projection that real wage growth over the next 75 years will be more than 75% higher than it’s been over the last 40.

    4) A stochastic analysis shows that this scenario has less than a 2.5% chance of coming to pass.

    5) Despite some mythmaking to the contrary, this optimistic scenario of the Trustees has a terrible track record. In the majority of the Trustees’ reports going back to 1983, it has been the least accurate projection they’ve provided.

    One could go on, but Mr. Krugman is extremely careless with his facts, so it is not surprising that he reaches a misguided conclusion.

    Like

    Jed Thorwin

    17 November 2007 at 3:23 pm


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