Soc Sec XXVI: Social Security Low Cost & the 100/100 Target

I had thought the following had been published as part of this series, but in the course of comments on XXIV see that it wasn’t. Instead it was written in the month before I got privileges here. But it dovetails neatly into discussion of the newly released Issue Brief No. 5: Social Security Reform: Strategies for Progressive Benefit Adjustments. The Issue Brief starts from Intermediate Cost assumptions and so assumes that a 100% payout of scheduled benefits is impossible. In response they propose a plan where lower income workers’ initial benefit remains tied to real wages increases but that upper income workers have theirs tied to price indexing. Good friend Coberly looks at this and concludes (in my words) “Same shit, different bag”. I don’t disagree entirely, it all depends on your assumptions, but in this case it might well end up with us getting tossed into an apparent briar patch and coming out with a dozen roses. Warning serious wonkery ahead, since the piece was originally written for my blog (which has a typical readership of one, if I get around to it), it assumes a pretty good understanding of the concepts. But then again I will be happy to answer questions in comments.

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.

Well that was part one. In a follow up I posted the mechanics under the title “100/100 in action”

In the post (above) this one I argue that high Trust Fund ratios present a threat to Social Security by transferring it from worker paid insurance to general fund paid welfare. This was specifically a political calculation, under our current situation the Economic Right has successfully been able to separate federal spending into two categories: one of spending that we can’t NOT afford which includes all things military, and the other of spending we CAN’T afford which includes most social spending. That the stuff that we can’t NOT afford comes with prices starting with ‘b’s and the stuff we CAN’T afford comes with prices typically starting with ‘m’s never seems to register. (The Administration practically wet itself announcing $200 million in world food aid yesterday {ed. last April}, which works out to 8 hours of the current costs of waging war in Iraq). It is important to keep Social Security from being lumped in with all those other programs, the Right hates it and always has. That is not hyperbole, if they can kill they will, Alf Landon explicitly ran against it in 1936 and the Republicans never really stopped.

A Trust Fund Ratio of 100 is not only a reasonable target, it is in fact the legal test of Short Term Actuarial Balance for the Trustees. Now one way of getting there is to use the brute force method of simply not collecting FICA at all for the next two and a half years and so drive the TF ratio down from its current level of 360 to 100. But that would mean taking a combined $800 billion annual hit to the General Fund over that period. Not only is that not going to happen, it is not necessary. Instead we need to craft a new model that will deliver us to sustainable solvency after 2040.
We know what level of tax increase we would need under Intermediate Cost assumptions: 1.7% of payroll. We know the growth numbers that will return an overfunded system along the lines of Low Cost: 2.9% Real GDP in the years after 2013. So lets go target shooting.
For political reasons our first target point is 2011. We can start with Intermediate Cost assumptions and assume we will need to start phasing in that 1.7% with an initial increase of .4% of payroll. If between now and 2011 we beat IC numbers we simply shave that initial increase down to compensate. If we do enough better to make it unnecessary we can make an adjustment in the next target point of 2015 or whatever interval we choose but always with the goal of delivering 100% of benefits while keeping the TF tail from going long term significantly over a ratio of 100.
It is my personal opinion that subsequent adjustments in the targets will be more likely in the direction of cutting the rates rather than raising them, but in this case opinions don’t matter, economic performance does. Rather than quarrel about 75 year windows instead we can just settle on a policy outcome and adjust the FICA rate as needed to hit it.
This is not to say that the current schedule is perfect or that adjustments to benefits are totally off the table, we might agree to settle on a 95/100 solution. But the points are one, we need to be proactive and not reactive, and two there are significant dangers to allowing the Trust Fund ratio from getting out of hand, we are in fact called to thread the economic needle.