Thursday, May 26, 2005

An over-long comment responding to a post by Andrew Samwick on Social Security.

Prof. Andrew Samwick has resumed covering the Social Security debate with a number of interesting posts, one of which I started to write a comment for, which -- unsurprisingly considering my tendency towards logorrhea -- ran on far, far too long to fit appropriately in a blog comment box.

What to do? Kill all those words?? Nah, I have space to fill here.

So, FWIW, here is a blog comment meant for there. If this has any interest for you, go read the original post then come back. If not ... have a nice day!

...For me, the debate is becoming less and less about philosophy or efficiency, and more about the inequity of passing such large burdens off to future generations of taxpayers.
Yes, which points out the pointlessness of the “trust fund” mechanism as brought back to life via the ‘83 law changes, to preserve the high positive returns from Social Security to the retirees of that generation, in spite of Social Security then being broke.

The Trustees now project that just servicing the trust funds (including the Medicare one that everyone overlooks) that have been consuming everybody’s 15.3% payroll tax bill since then, will require a 35% income tax increase (or equivalent) by 2030 – effectively making the 50-year-olds of the era pay for their benefits twice, first through 3o years of payroll tax payments, then through income taxes for the rest of their lives to reimburse themselves for all their past payroll taxes that went to the trust funds.

This while their Social Security benefits will have negative value relative to payroll taxes paid alone – and will still be 27% underfunded. Talk of intergenerational equity!

Now, I recently watched the video of the polite and even friendly (it’s possible!) Shoven/Orszag debate on Social Security.

In it Orszag shot down Pozen’s graduated indexing idea on the political grounds that Congress simply will never adopt a benefit cut without a matching tax increase – as indeed it did when closing the funding gap in 1983, 50% with benefit cuts (for the then young) and 50% with tax increases. Splitting-the-baby is SOP for Congress, compromise, a fundamental political necessity.

Yet Orszag blithely assumes this new, big, 35% income tax increase will be adopted by Congress (simultaneously with even larger increases for Medicare) with no corresponding compromise benefit cut. Suddenly the very same basic political incentives and SOPs won’t apply, for some unstated reason.

But it's hard for me to see how anyone can believe such huge tax increases for Social Security will just sail through. Not merely because the voters of 2030 won’t want to pay them, but also because once Social Security goes on general revenue in an era when there won’t be near enough to go around and deficits will be surging, every other interest group that relies of general revenue (Agriculuture, Defense, Education, HEW, Medicare, you-name-it) will have licence, and feel a duty, to go after that same money. Social Security will be sacrosanct, “a third rail of politics”, no more. The lobbyists of every other group will have the knives out for it.

In that world, I just can’t imagine that Congress will blithely raise taxes so much on working people to pay unreduced benefits to Bill Gates, the Walton family and all the other wealthy, at the expense of all other programs -- least of all at the insistence of liberals and “progressives”. Their lobbyists won’t stand for it!

It follows that what happened in ’83, and what Orszag predicted about graduated indexing, will happen by 2030 if the status quo remains. Means testing was brought into Social Security in a small, hidden way in ’83 – and split-the-baby legislation coming by 2030 will make it open and a whole lot larger.

Now, we all know what the left is saying today about means testing – but they are just bringing it on themselves, with a vengence, more so later by denying it now.

In other words, the problem with abusing "intergenerational equity" is not merely that it is "unfair", but that the actors of the future will very rationally respond to the abuse by changing the system in ways that we profess we don't want to see. How anyone can endorse this course with the goal of "saving" or "perserving" Social Security is beyond me.

And, if any of the above is true, then the "trust fund" means nothing.

Congress operates on a current cash-flow basis, all political incentives are driven by current cash flow, because that’s what constituents and taxpayers actually feel and respond to. “Actuarial soundness” means nothing to it (as opposed to to accountants and economists).

The trust fund is nothing but a vestigial form whose function has been lost to history. For two years, under FDR’s original funded Social Security scheme, it had a function. But when in 1939 Congress changed Social Security to paygo to seize the current cash flow of the payroll taxes, that function was lost forever – though the form remains, actuaries and economist insist on parsing it for 75 years, and politicians worship it (as some primitive remote Pacific-island tribe might worship the vestigial leg bones of a whale.)

But the trust fund has zero ($0) effect on cash flow – and when the 35% income tax increase for it arrives by 2030, and people see themselves paying twice for the same benefits, it’s going to have zero effect on preserving Social Security as we know it today, compared to if it didn’t exist. (Maybe less than zero, considering how many people then are likely to feel they have been misled by all the prior claims regarding it.)

A sensible fiscal policy would have the on-budget deficit sum to zero over the business cycle and all long-term entitlement programs to have zero projected long-term actuarial deficits.
Yes, indeed -- but these are two separate propositions. Good luck on the first!

As to the second, the only way to actually have zero projected long-term actuarial deficits in benefit programs is by funding them with real economic savings, in private accounts or otherwise, as private sector qualified retirement plans do (or are supposed to do).

But this is unattractive to politicians because it has cash flow cost to them, makes the expense of promised benefits clear, and destroys the illusion that they are "giving" voters something – as opposed to voters paying for it themselves.

So politicians much prefer funding with lockboxes (Social Security) or, best of all, nothing at all! (Medicare parts B & D).

Imagine if Ted Kennedy had tried to get Medicare enacted by saying: “And this is the tax bill we are going to hit you with right now to fully advance fund the benefits you won’t receive for many years on an actuarially sound basis, and this is how much the bill will go up every year in the future, look and see…"

Medicare today probably would hardly be the same! ;-)