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February 01, 2005

Oh No! Not Again!

So I surf on over to the Project for Social Security Choice (which hasn't yet gotten the memo that Bushies are supposed to say not "Social Security choice" but "Social Security personalization") and find myself once again confronted by the Stupidest Man Alive:

Donald Luskin: Krugman betrays a fundamental misunderstanding of the economics of Social Security itself. He write, "we don't need to worry about Social Security's future: if the economy grows fast enough to generate a rate of return that makes privatization work, it will also yield a bonanza of payroll tax revenue that will keep the current system sound for generations to come." Krugman has forgotten -- or chosen to ignore -- that under current law Social Security benefits are indexed to wage growth. If the economy grows like Krugman is talking about, yes, payroll tax revenues will grow too -- but so will benefits, nearly perfectly proportionately. The sensitivity tables given by the Trustees of the Social Security Trust Funds don't show this -- because they arbitrarily cut off the calculation after 75 years. But the reality is that the early benefits of increased tax revenues are eventually offset by the higher cost of benefits. Gee -- think how good Krugman could make that look if he reduced the window of analysis to just 10 years...

Merciful God in Heaven! Is there no end to the stupidity?

Needless to say, Donald Luskin is wrong--completely wrong. Faster productivity growth improves the finances of the Social Security system. And the 75-year horizon has nothing to do with it: the financial benefits to the trust fund from faster productivity growth are in fact much smaller in the next decade than they are further out.

Once again, it's a mistake that only a real idiot could make.

I've already analyzed it--in my defense of Irwin Stelzer:

Brad DeLong's Semi-Daily Journal: A Weblog: Why Oh Why Can't We Have a Better Press Corps? (Why Haven't National Review's Funders Pulled the Plug? Edition): Irwin Stelzer knows what he is talking about. He is a real economist. He is correct when he says that faster economic growth has a powerful positive effect on the finances of the current Social Security system over any horizon, and that with sufficiently faster growth it might prove capable of meeting all of its obligations.

Consider a person who retires at 62 under the current system and lives to age 84. Her initial benefit payment is tied to the general trend in wages in the economy. Thereafter, under the current system, her benefit payment is indexed by the growth in prices.

Let's think about the resources available to the Social Security system to pay these price-indexed post-retirement benefits. The Social Security system has at its disposal pay-as-you-go taxes which rise with wages. And the difference between the growth of wages and the growth of prices is the growth of productivity.

Now let's consider two alternative worlds--one with zero and one with two percent per year productivity growth--and look at the situation halfway through her retirement, when she reaches 73. And let's suppose that in alternative world 1, the world with zero percent productivity growth, her share of the taxes that Social Security collects cover only 90% of her benefits: with zero percent productivity growth, the Social Security system is running a deficit.

Now let's look at what happens in alternative world 2, the world with two percent per year productivity growth. The economy has been growing 2% faster for 11 years. That means that wages and the Social Security tax base are 22% (actually 24%--compound interest you know) higher than in alternative world 1. Instead of collecting revenues that cover only 90% of her benefits, the Social Security system collects revenues that cover 112% of her benefits: no Social Security deficit. No Social Security problem. Faster productivity growth affects the cost of Social Security (initial benefits go up faster the faster is productivity growth) and it affects the revenues of Social Security (a richer economy pays more in Social Security taxes) but it affects revenues more.

The key is that the current price indexation of benefits after retirement adds a wedge between Social Security's costs and its resources roughly equal to half of life expectancy at retirement times the trend productivity growth rate...

I can't say that the Club for Growth is on the fast track to the laugh track because it arrived there long ago. But things like this remind us of why it is such a laughingstock.

Posted by DeLong at February 1, 2005 04:12 PM