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January 23, 2005

Roger Lowenstein on Social Security

I failed to link last week to Roger Lowenstein's excellent New York Times Magazine article on Social Security:

The New York Times > Magazine > A Question of Numbers: ...many, and perhaps most, people today think the program is in serious financial trouble.

But is it? After Bush's re-election, I carefully read the 225-page annual report of the Social Security trustees. I also talked to actuaries and economists, inside and outside the agency, who are expert in the peculiar science of long-term Social Security forecasting. The actuarial view is that the system is probably in need of a small adjustment of the sort that Congress has approved in the past. But there is a strong argument, which the agency acknowledges as a possibility, that the system is solvent as is.

Although prudence argues for making a fix sooner rather than later, the program is not in crisis, nor is its potential shortfall irresolvable....

About 47 million people... receive a check from Social Security every month. The money... comes from a payroll tax on current workers and on their employers. The program is a model of efficiency; expenses are low, as pension plans go, and participation is near universal. Benefits rise with the level of earnings, but they are tilted toward progressivity, so that those at the bottom get more in proportion to their earnings and those at the top get less. Social Security also delivers a considerable nonmonetary benefit: people who have contributed throughout their working lives know that, regardless of the ebb and flow of their careers and, indeed, of the stock market, a guaranteed pension awaits them.

Currently, Social Security is running a hefty surplus; the payroll tax brings in more dollars than what goes out in benefits. By law, Social Security invests that surplus in Treasury securities, which it deposits into a reserve known as a trust fund, which now holds more than one and a half trillion dollars. But by 2018, as baby boomers retire en masse, the system will go into deficit. At that point, in order to pay benefits, it will begin to draw on the assets in the trust fund.

The debate over Social Security's solvency is really two debates. The first is over how long the trust fund will last.... Joshua Bolten, head of Bush's Office of Management and Budget, said of Social Security last month, ''The one thing I can say for sure is that if left unattended, the system will be unable to make good on its promises.'' But the Social Security Administration itself pretends to no such certainty. Its actuaries (about 40 are on staff) frankly admit that the level of, say, immigration in 2020, or of wages in 2040, is impossible to forecast. ''The only thing we are sure of is that it won't happen precisely as we project,'' says Stephen Goss, the chief actuary at the agency. And the trustees' annual report, which is based on the actuaries' analysis, takes pains to say that it is not making a prediction. It makes a projection -- three different ones, actually -- that amount to informed but very rough guesses. The agency's best guess, labeled its ''intermediate'' case, is that the system will exhaust its reserves in 2042. At that point, as payroll taxes continue to roll in, it would be able to pay just over 70 percent of scheduled benefits.... David Langer, an independent actuary who made a study of Social Security's previous projections compared with the actual results in 2003, thinks the ''optimistic'' case is its most accurate....

The second debate concerning solvency is over whether the securities in the trust fund will be honored.... This seems an odd preoccupation. Social Security does not own junk bonds or third-world debt; it invests in U.S. Treasuries, considered the safest investment on the planet. Since 1970 there have been 11 years in which Social Security has operated at a deficit; each time, it redeemed bonds from the trust fund without a fuss. Goss, the agency's actuary, says he has no doubt it will be able to do so again. ''Absolutely,'' he said when asked if the trust-fund bonds are sound....

In a recent position paper, Tanner wrote that Social Security faces a horrendous unfinanced liability of $26 trillion over 75 years. In a footnote, he cited the 2003 trustees' annual report. Actually, the trustees' intermediate projection is for a deficit, over 75 years, of $3.7 trillion.... When I asked Tanner about the footnote, he admitted that the trustees didn't actually say $26 trillion; Tanner derived the figure by counting the cash-flow deficits that the trustees project from 2019 on out. In other words, he ignores the next 15 years or so, during which time Social Security will be running a surplus. And he assumes that the assets in the trust fund, which should be accruing interest into the 2040's, won't exist, either. Tanner counts only the bad years and only the bad numbers....

[T]here is a serious issue at the heart of what worries critics. It isn't that the trust fund is broken; it's that the existence of the fund is seducing the government to spend more than it otherwise would, thus brooking larger deficits in the future. Since Social Security lends its surplus to the Treasury (that's what it means to be investing in Treasuries), it is parking its surplus cash with the government. And just as lending money to a child outside a candy store may impose an impossible temptation, so the government may feel tempted while it holds onto Social Security's purse....

[...]

The crunch came, as actuaries had predicted, in the late 1970's.... The actuaries had assumed that from 1978 to 1982 inflation would total 28 percent; the actual figure would be 60 percent. And they had predicted that wages would grow by 13 percent after inflation, whereas, in fact, real wages didn't rise at all; they declined.... Once Reagan was in the Oval Office, he allowed his budget director, David Stockman, to handle the crisis.... Reagan, like F.D.R., bounced the problem to a commission, this time led by a well-known economic consultant, Alan Greenspan. The 15-member commission got nowhere until December 1982. Then, with default only months away, an unofficial subgroup began to meet in secret. Robert Ball, a former Social Security commissioner, and Senator Daniel Patrick Moynihan negotiated for the Democrats opposite Baker for the White House.

In the end, they compromised on a combination of benefit cuts and tax hikes. The payroll tax, then 10.16 percent, was already scheduled to rise, but the negotiators sped up the implementation of the increase. (Today the rate is 12.4 percent.) Moreover, Congress agreed to hike the retirement age from 65 to 67. This change, which is being phased in very slowly (the retirement age is now 65 and 6 months) had the same effect as cutting benefits. Greenspan and company now calculated that Social Security would build a giant reserve, sufficient to see it through the middle decades of the 21st century....

Social Security's key long-range projection is that, over 75 years, it will come up short by an average of 1.89 percent of payroll.... [T]ny swings in any of these or other factors could improve -- or worsen -- the program's balances. If a few of them lean in the direction of the optimistic forecast, the trust fund will cover benefits through 2080, or close to it. Would such a program, which appears to be solvent or near solvent until the limit of what is humanly forecastable, be improved upon by the various schemes for privatization?...

It's important to stress that the savings result from cuts, not from the decision to privatize....

Social Security could capture the return on stocks, without putting individuals at risk, by investing in equities directly. This would also achieve another frequently stated objective: keeping the government's hands off the Social Security trust fund. That option would be far more efficient, in economic terms, than separating the money into 150 million disparate accounts. Costs are much lower for one big investor. And more important, in a system of individual accounts, benefits will vary with individual choices, and some people will make poor ones. In Sweden, where the retirement system has included private accounts since 2000, the majority of Swedes made excessively risky investment choices by putting money into stocks at the market top, according to Richard Thaler, a University of Chicago behavioral economist. Finally, pooling the investment pools the risk, and thus reduces the danger of retiring at the wrong time. In a system of personal accounts, someone who retired after a market crash would be out of luck.

So it is notable that all the current proposals to privatize involve the economically inferior option of individual accounts. But privatization advocates aren't motivated solely, and perhaps not even primarily, by economics. Glenn Hubbard, Bush's former top economic adviser, wrote in Newsweek that an ''obvious objective'' of privatization is ''to advance the president's ownership society agenda.'' Such pro-free-market sentiment has a long lineage. Remember Senator Vandenberg, who fretted in the 30's that public ownership of private securities would amount to socialism? Even though state pension funds and some U.S. agencies, including the Federal Reserve, put some pension money in stock-index funds, conservatives still react as if such a solution for Social Security were akin to turning it over to the Kremlin....

[O]nly a real crisis would dictate undoing an institution that has provided a safety net for retirees, that has helped to preserve in the social fabric some minimum of shared responsibility and that has been supported by workers in good faith. And, in looking at Social Security today, the crisis is yet to be found.

People should also go read Lowenstein's excellent Origins of the Crash.

Posted by DeLong at January 23, 2005 11:36 AM