Thursday, February 28, 2008

Gene Sperling on Bob Ball

Former Clinton national economic adviser Gene Sperling dedicates his Bloomberg column to former Social Security Commissioner Bob Ball, who passed away recently at the age of 93. Ball served as Social Security Commissioner from 1962 to 1973, under both Democratic and Republican administrations. Sperling discusses Ball's influence on the Clinton administration's discussions of Social Security reform and the role Ball played in the debate over personal retirement accounts.

In addition to his career at SSA, Ball was also a member of the so-called Greenspan Social Security commission in 1983, which drafted the most recent major reforms to the program.

Ball remained active in the Social Security debate, including a Washington Post op-ed outlining his own plan to keep the program solvent. Ball proposed several steps to improve the program's finances (an actuarial memorandum from SSA is available here). These include:

  • Increase the taxable maximum wage (currently around $100,000);
  • Invest part of the trust fund in stocks; and
  • Dedicate part of the estate tax to Social Security.
These three steps would address about three-quarters of the 75-year actuarial deficit, assuming stock returns were as projected.

To address the remaining 75-year deficit the plan would:
  • Reduce annual COLA payments by around 0.22 percentage points by switching from the CPI-W to the chain-weighted CPI;
  • Include all state and local workers in the Social Security program.
To achieve "sustainable solvency" -- defined as maintaining a stable trust fund balance relative to annual benefit payments -- the Ball plan would automatically enact a balancing tax rate increase of 1 percentage point at the time at which the Social Security trust fund ratio was projected to begin declining. Under current Trustees projections, this would take place in the year 2023. This tax rate could be adjusted in future years if needed.

More details on Bob Ball's long career are available at this page maintained by the SSA historian. Read more!

Gadgets: How will Social Security fare under different economic or demographic assumptions?

From scanning blogs and news stories, it's clear that a number of people believe the Social Security Trustees projections are overly pessimistic. They might be. (They also might be overly optimistic -- there's a great deal of uncertainty involved here.)

Leaving aside the question of whether the Trustees projections are reasonable -- I believe they are -- it's important to understand how differences in those projections might change outcomes for the system. In other words, if the Trustees ARE pessimistic, how much better will Social Security's finances be?

It's possible to estimate this using the Sensitivity Analysis contained in each year's Social Security Trustees Report. It reports high and low estimates for each demographic variable and how a high or low value for any given variable would by itself affect system financing. If all the variables are set to their high or low cost value, we get the overall high or low cost scenarios for the system.

To make this process easier, I created a simple spreadsheet that estimates how different values for a few of the major economic/ demographic variables affect Social Security's annual cash flows and trust fund ratio (the ratio of trust fund assets to benefit costs in a given year). I used the Policy Simulation Group's SSASIM model to estimate cash flows for the high/low cost values of four different variables: the total fertility rate (children per woman); net immigration; improvements in mortality; and real wage growth. These are the biggies in affecting annual cash flows. Other factors have smaller effects, and changes to interest rates affect only the trust fund ratio.

Using the SSASIM output, I calculated a simple linear function for each variable, which allowed me to estimate the change in annual cash flows for each variable. I then net these out so a number of changes can be combined to estimate the effects on the total system.

Please note: this simple model is designed for illustrative, educational purposes, to give a ballpark estimate of how different demographic/economic assumptions affect
Social Security's financings. So it's a crude tool.

But it's also a useful tool. Consider that many people argue that the Trustees' economic assumptions are overly pessimistic. Well, the principal economic assumption is real wage growth; that's how productivity filters through to the program. What if we increase real wage growth from 1.1 percent, which is about its average over the past 40 years, to 1.7 percent?

The chart below shows the change in cash flows. The red line is the Trustees' intermediate projections, while the blue line is adjusted for higher wage growth. The difference is significant -- deficits are delayed for a few years past 2017 and are always smaller than under the lower-growth assumption. However, is higher wage growth -- 50% higher than projected or seen over the past four decades -- enough to fix the system, such that we don't need to bother with reform? No. By the 75th year the deficit is around 3.75% of payroll rather than 5.3%. In other words, economic growth -- while certainly helpful -- won't plausibly be high enough that we can safely ignore the problem.

You can play with other variables as well. Fertility is a big factor: if we can increase our fertility rate significantly then Social Security's problems really do become a lot easier. But if fertility falls to European levels, we're in big trouble. I hope this little tool is interesting. You can download the spreadsheet here.

Read more!

Wednesday, February 27, 2008

Taking the personal out of personal accounts

Given my comments on Magin's argument that personal accounts essentially offer a free lunch, why do I favor personal accounts as part of Social Security? While arguments for accounts focus on the "personal" -- can I get a better rate of return? Can I leave the money to my kids? etc. -- the main argument of personal accounts has very little to do with what they can do for individuals and a lot to do with helping out the government.

Put it this way: if we wanted individuals to get higher returns (with higher risk) within Social Security, we could do that by investing the trust fund in stocks. Alternately, if we wanted individuals to be able to leave money behind we could simply increase the traditional program's survivor benefits. Most of the good things attributed to personal accounts could be accomplished through the current program.

But one thing can't: effectively saving excess contributions today to help pay benefits in the future. Magin comments on the argument first made by Smetters, then confirmed by Shoven and Nataraj and by Burtless and Bosworth, that Social Security surpluses since the 1980s have not translated into unified budget surpluses. Put another way, in a macro sense, the Social Security surplus has been "spent" rather than "saved," such that the government's net asset position and the country's capital stock are no larger than they would have been in the absence of the trust fund accumulation. So the trust fund's holdings, while assets to the program, have not been matched by an increase in the ability to repay those assets.

Given that, the choices appear to be between prefunding via accounts held outside the government or not prefunding at all. Given that Social Security reform is pretty much all about redistributing the net burdens inherited from prior generations -- the so-called "legacy debt" -- giving up on prefunding effectively means giving up on a significant part of what reform should be. Prefunding through accounts can be through a "carve out" or an "add on" -- each can be judged only in conjunction with other elements of the reform.

Now, from a given current individual's perspective, he probably doesn't care much much whether there's prefunding or not. He cares whether he's going to get what he's promised. And for current individuals, prefunding can mean a worse "deal" from Social Security rather than a better one.

But for policymakers attempting to balance the interests of both current and future generations, prefunding is an important tool and one that appears most likely to be effected through and accounts structure.

This isn't to say that accounts have no benefits for individuals. Transparency is greater, political risk is reduced, and so forth. But the major action regarding personal accounts really has very little to do with the person holding the account. Read more!

New paper: Why liberals should enthusiastically support Social Security personal retirement accounts

Konstantin Magin of U.C. Berkeley says

"...[R]oughly half of Americans have little or no stock market investments either directly or indirectly through pensions. This is too bad, because in the long run, U.S. stocks have remarkably high returns (about 6.6 percent per year even after adjusting for inflation). And, although liberals fear that these returns come at too high a risk, I will show here that that just isn’t so. Private Social Security accounts invested in long-run diversified equity portfolios promise substantial increases in the lifetime wealth of middle- and working-class Americans, at low risk."
While it's hard to argue with his math (and I've made similar arguments, with similar conclusions, in the past) a couple points are worth touching on.

First, since I favor personal accounts I agree with Magin's general conclusion. At the least, the opportunity to diversify their retirement savings portfolio has potential benefits to low earners. I half-agree with the underlying argument, which is that the equity premium is still sufficiently large that there's free money on the table for stock holders. If so, it makes sense for low earners to get their share. At the same time, the equity premium is set by the risk preferences of market participants; just because we can't explain it in the context of other risk preferences doesn't mean it comes about for no good reason.

Second, Magin is working with an equity premium of around 5.6% (assuming 6.6% real mean stock returns and a 1% bond return). Others see a more modest equity premium: The SSA actuaries project stock returns of 6.4% and a trust fund bond return of 2.9% (a higher bond return will tend to lower guarantee costs using Black-Scholes, so the overall effect is ambiguous). Trimming 50 basis points or so for a shorter-term interest rate gives you a risk premium of 4% -- still healthy, but the probability of falling short of the riskless return certainly rises. It's anyone's guess what future stock returns will look like, but many have argued for lower rather than higher than the past. (E.g., see Diamond, Shoven and Campbell here; Baker, Krugman and DeLong here; but also see Magin and DeLong here.)

Third, while Magin shows that the price of a put option guaranteeing against loss of principal is low, it's not clear why this should be the only standard. A guarantee against the lost of real principal is more expensive, and a guarantee against falling below the riskless rate more expensive still. In the policy context, it's most common to guarantee against the account purchasing an annuity smaller than current law scheduled benefits. This can get very expensive, as shown in this paper written with Kent Smetters and Clark Burdick. Read more!

Sunday, February 24, 2008

What this blog is about

Welcome to my Social Security blog. As someone who has enjoyed and benefited from scanning various blogs for news and discussion on Social Security policy, I hope this blog will be interesting and helpful to readers.

The first main purpose of this blog is to serve as a clearinghouse for information on Social Security policy and reform. One of the great merits of blogs is simply their ability to bring existing information to the attention of new readers. As someone who follows Social Security pretty closely, I may see interesting articles or papers that others have missed and can highlight them here.

The second purpose for the blog is to provide a forum where I can comment on Social Security issues and others can post their own views. Blog topics need not be of major importance, meriting a full-length research paper. Rather, if something small but interesting pops up I can post a quick note and others can discuss. Moreover, this can be done in a far shorter time frame than traditional research work.

As a vehicle for my own views, this blog inevitably bears the baggage of my biases and experiences with the issue. At the same time, I follow and learn from blogs whose authors' viewpoints differ from my own, so I am hopeful this blog will be useful regardless of readers' points of view on Social Security reform.

Again, welcome. Read more!