Phony Optimism

Rather than comment on American Pundit's recent column at WatchBlog, I wrote the following post, syndicated on WatchBlog as well.

American Pundit writes that "mildly optimistic economic forecasts" show that Social Security is not facing a crisis. His "mildly optimistic" forecasters, however, are the liberal Century Foundation, and throw away their intellectual credibility by writing in the cited report, "Social Security is stronger today than it has been at any time in its history."

Moving beyond mildly wildly optimistic forecasts, what really is the future of Social Security?

The Social Security Administration itself writes:

The annual cost of Social Security benefits represents 4.3 percent of Gross Domestic Product (GDP) today and is projected to rise to 6.6 percent of GDP in 2078. The projected 75-year actuarial deficit in the combined Old-Age and Survivors Insurance (OASI) and Disability Insurance (DI) Trust Funds is 1.89 percent of taxable payroll, down slightly from 1.92 percent in last year's report. The program continues to fail our long-range test of close actuarial balance by a wide margin. Projected OASDI tax income will begin to fall short of outlays in 2018 and will be sufficient to finance only 73 percent of scheduled annual benefits by 2042, when the combined OASDI trust fund is projected to be exhausted.

Social Security could be brought into actuarial balance over the next 75 years in various ways, including an immediate increase in payroll taxes of 15 percent or an immediate reduction in benefits of 13 percent (or some combination of the two). To the extent that changes are delayed or phased in gradually, greater adjustments in scheduled benefits and revenues would be required. Ensuring the sustainability of the system beyond 2078 would require even larger changes.

The nonpartisan Congressional Budget Office wrote on the subject this year:

Under the laws that currently govern Social Security, spending for the program will increase from about 4.4 percent of the nation's gross domestic product (GDP) now to more than 6 percent of GDP in 2030, the Congressional Budget Office (CBO) projects. In later years, outlays will continue to grow steadily as a share of GDP, though more slowly. Over the long term, paying the Social Security benefits scheduled under current law will require economic resources totaling between 5 percent and 8 percent of GDP, CBO projects.

At the same time, the federal revenues dedicated to Social Security will remain close to their current level--about 5 percent of GDP--in the absence of changes to the program. Thus, annual outlays for Social Security are projected to exceed revenues beginning in 2019. Even if spending ends up being lower than expected and revenues higher than expected, a gap between the two is likely to remain for the indefinite future.

Any changes to Social Security will have to be made in the context of the pressures on the total federal budget. CBO projects that spending for government health programs will grow even faster than spending for Social Security because of rising health care costs. In particular, increasing outlays for Medicare and Medicaid are projected to cause long-term shortfalls in the rest of the budget that will be even greater than Social Security's. Unless taxation reaches levels that are unprecedented in the United States, current spending policies are likely to result in an ever-growing burden of federal debt held by the public, which will have a corrosive and potentially contractionary effect on the economy.

And in another document, a year old, CBO writes:

The cost of the Social Security program will rise significantly in coming decades--a change that has long been foreseen. Average benefits typically grow when the economy does (because the earnings on which those benefits are based increase). However, in the future, the total amount of Social Security benefits paid will grow faster than the economy because of changes in demographic structure. As the baby-boom generation reaches retirement age and as decreasing mortality leads to longer lives and longer retirements, a larger share of the population will draw Social Security benefits. Moreover, the number of people age 65 or older will double during the next 30 years, while the number of adults under age 65 will grow by less than 15 percent--meaning that in three decades, the older population will be more than one-third the size of the younger group, compared with one-fifth today. Consequently, the Congressional Budget Office estimates that unless changes are made to Social Security, spending for the program will rise to 4.9 percent of GDP in 2020, 5.9 percent in 2030, and 6.2 percent in 2050.

Are these warnings just the product of a Republican cabal that seeks to rob old people of their hard-earned money? Is the data cooked? Not according to congressional Democrats, whose data closely matches that of the SSA and CBO. All the way back in 1999, President Clinton talked of the need to save Social Security, using the budget surpluses he thought would last 25 years or more.

The difference is not in the data, it's in the politics. The congressional Democrats recommend... nothing. No change. They agree with the SSA's data, but don't want (or won't admit to wanting) a tax hike to address the shortfall. The one thing they are sure of is that President Bush's proposal is a bad idea.

Returning to American Pundit's wild optimists, they point out, rightly, that there is a great deal of uncertainty. We do not know what the economy will do in two years, let alone twenty. Nor do we know what populations and immigration trends will be. They also point out (again correctly) that the Social Security Trust Fund of $1,600,000,000,000 is denominated in U.S. Treasury Bills. This introduces another element of uncertainty: the dollar. While the current plunge of the dollar has only impacted foreign currency markets, analysts are becoming increasingly afraid that if China, Japan, and a few others bail out of the market that the dollar could plummet and send interest rates - and inflation - soaring at home. That would proportionally gut the SocSec Trust Fund of value, and could bring the crisis' moment of truth - when the Fund disappears - much closer than the base-case economic predictions.

The magnitude of the projected shortfalls (and hence of the attendant uncertainty) is staggering. Numbers like 1.6% of GDP sound small, until you realize that means $175,000,000,000. That means that if the expected shortfall appears and is not mitigated, we can expect to burn through the Trust Fund in a decade.

Economics (in which I have a degree) is a notoriously unpredictable sport. Optimists point to strong growth in the last fifteen years; pessimists point to weak growth in the last thirty years; optimists point to strong growth in the past fifty years, and so on. The government should do what it can to mitigate recessions and promote growth, but it should also have the humility to realize that it cannot control macroeconomic trends. Moreover, policymakers should display the wisdom to prepare for a less-than-rosy future. If the next two decades work out like the period 1973-1993, then we could be in big trouble. If they look more like 1994-2004, on the other hand, we have nothing to worry about.

President Bush's plan may not be the best way to address the Social Security dilemma. However, after years of lamenting politicians who cannot see more than 2, 4, or 6 years down the road (oh, those long-sighted senators!) I am glad to have a president who is thinking about my retirement as well as his own. As the CBO (and a basic understanding of mathematics) points out, the sooner we address the crisis, the less drastic our measures will have to be. If we wait until a few years before the shortfall breaks on us like a tidal wave, as American Pundit suggests we ought, we will experience either debt or new taxation equal to 27% of total Social Security outlays. Whatever the benefits of high taxation, sudden high taxation is a surefire way to sink the economy (c.f. Herbert Hoover).

So far I have simply argued that something needs to be done to address the Social Security crisis. Democrats may (when it becomes more obvious and impending) decide to raise taxes to pay for the new costs. This would at least be better than sitting on their hands, but as a conservative, I fundamentally differ with the congressional Democrats' inference that government income redistribution is value-neutral. I much prefer to live in George Bush's 'Society of Stakeholders'.

Any financial advisor will tell you that saving for retirement should begin as early as possible - usually forty or more years before retiring. Social Security is part of the same industry, and the same principles of saving, risk management, and decreasing final returns apply. We should act now, and our public debate on the issue should address the economic concerns - "What will work?" - and the political concerns - "What do we want our society to look like?". I want to live in a society where elder poverty remains rare and where people own themselves and their means of production and consumption.