Author: Andrew Samwick

In response to my last post about Social Security reform, Max Sawicky asks:

[I]sn't it radically inconsistent to say (cash-flow) deficits matter, but that a long-term in-go (e.g., lower projected Social Security benefit payments) washes out a short-term out-go (a payroll tax diversion to individual accounts, replaced by additional borrowing)? Haven't we heard in the past that some current added borrowing will pay for itself with some gain in the future? If you think that, for instance, the returns to pre-natal care are subject to dispute, what about the two-thirds of the Social Security Trust Fund shortfall derived from years beyond the next 75, lo unto eternity?

I don't see any inconsistency. Let me try to address all the pieces of Max's post. (If casual readers feel their interest starting to wane in all of these details, feel free to skip down to the last three paragraphs to see where I would like the debate to go next.)

1) Do deficits matter?

Yes. Every dollar that the government borrows today must be repaid, with interest, in some later period. The deficits matter today because they imply a repayment next period, and resources have to be found to make that repayment. All deficits matter--whether they are on-budget or off-budget, whether they are run in the current year or future years. (The question, "Do deficits matter?" is often asked in the context of whether they increase interest rates. This is an interesting but, for the purpose of this discussion, less relevant consideration than the simple fact that they matter to the people who have to repay them, regardless of what they did to interest rates in the interim.)

2) Can a long-term in-go wash out a short-term out-go covered by borrowing?

Yes. The interest rate tells us the amount of in-go we would need in the future to cover a dollar of out-go this year. If we run a $1 deficit this year, and the interest rate is 3%, then we need $1.03 next year to balance the books. Or we would need 1.03*1.03= $1.0609 in two years, or 1.03^30 = $2.43 in thirty years, etc.

3) Haven't we heard in the past that some current added borrowing will pay for itself with some gain in the future?

I cannot stipulate to everything that Max has heard, so I'll give this a qualified "not on my blog." I discussed something that might be confused with this assertion in the context of Senator Kerry's campaign statements about the reform plan analyzed in Chapter 6 of the Economic Report of the President. That reform plan--Commission Model 2 under the assumption that 100 percent of eligible workers opt for the personal accounts and that debt is issued where needed to cover expenses--does generate some current added borrowing. It also gets repaid, as part of the reform, but in no way is it "paying for itself." It gets repaid, as in #1 and #2 above, precisely because individuals who opt for the personal accounts while working agree to receive lower benefits from the pay-as-you-go system later in life and because the reform plan includes reductions in benefits for future retirees relative to current law quite apart from the personal accounts.

4) If you think that, for instance, the returns to pre-natal care are subject to dispute, ...

I confess that I'm not sure what Max means by the reference to the returns to pre-natal care, so I'll just state for the record that I strongly believe in spending money to encourage pre-natal care. Also, breastfeeding and doulas, but those are topics for a different post.

5) ... what about the two-thirds of the Social Security Trust Fund shortfall derived from years beyond the next 75, lo unto eternity?

I have referred a couple of times to the $10.4 trillion shortfall in the Social Security system. This is the present value of the excess of projected benefits less projected revenues, and it is estimated in this table of the 2004 Trustees Report. The table shows that, evaluated only through 2078, the present value of the excess of projected benefits less projected revenues is $3.7 trillion, or about 1/3 of the $10.4 trillion. Max is referring to the roughly 2/3 of this $10.4 trillion that is due to deficits incurred more than 75 years into the future.

Well, what about them? Is Max suggesting that it would be inappropriate to consider the deficits that are incurred during the lifetimes of our youngest citizens? I don't think so. Is Max suggesting that it is appropriate to count the taxes that people pay on their earnings in, say, 2040, without also counting the benefits that they earn as a result, to be paid in, say, 2080? I certainly hope not. I favor the $10.4 trillion measure because it is the most comprehensive summary of the program.

With any projection, there are two important concerns. The first is whether it is biased. Is it systematically over- or understating future deficits? Have the actuaries made defensible assumptions about the key underlying parameters? Interested readers can go to Section V of the 2004 Trustees Report for the detailed explanations. I served on a 1999 technical panel of the Social Security Advisory Board to offer guidance on assumptions and methods used by the actuaries. From that experience, my general view is that improvements in mortality are understated in the projections and productivity growth is probably a bit too low. (The latter depends on how permanent we believe the post-1995 uptick in productivity will be. It is looking more permanent as time goes by.) These two deviations tend to offset each other. The 2003 technical panel made similar recommendations. So I am inclined to take the $10.4 trillion number as a reasonable starting point.

The second concern is that a projection, even if unbiased or right on average, may be imprecise. This concern gets more important as the projections are made for more and more distant years (and I think this is Max's broader point here). The 2004 Trustees Report addresses this imprecision in an appendix, in which simulations are presented that attempt to account for the historical variation in the key parameters (like the fertility rate, the mortality rate, and productivity growth). The end result is this figure, which shows that there is a 97.5 percent probability that the annual deficit will be greater than 1 percent of payroll in the 75th year (with larger deficits in prior years). It also shows a 10 percent probability of an annual deficit of greater than 11 percent of taxable payroll in that year. To me, reasonable attempts to take the imprecision of the central projection into account suggest more, not less, of a reason to address this problem as soon as possible.

In the interest of moving the debate along, I'll say that I am not wedded to the infinite horizon estimate of a $10.4 trillion shortfall as the only metric for gauging reform. Here's an alternative criterion that Max and other folks who are "going to the mattresses" might find more constructive.

Choose a projection period over which you feel confident in the accuracy of the underlying economic and demographic assumptions, subject to the constraint that it is long enough to cover the retirement of the baby boom generation. Provide specific reforms to the system such that the Social Security trust fund is positive and trending upward in the last years of that projection period. Do not use any gimmicks related to benefits or costs in those last few years.

I have seen exactly one such plan [from people who criticize personal accounts], and the Democrats in Congress refuse to endorse it. I would be happy to see another from Max, and even happier still to see his commitment to use the reputation of his organization among Democrats to move it in Congress.

David Altig at Macroblog dissects the article in today's New York Times on Social Security, "Bush's Social Security Plan Is Said to Require Vast Borrowing." I commend the whole post to your attention, but here's the concluding paragraph, which is right on the money:

The deficit is, pure and simple, a pretty poor basis on which to evaluate the pros and cons of any fiscal policy. What matters is how much we spend and what we spend on, how we collect the revenues and who we collect them from, over the long haul. Debate about the short-run deficit is a diversion from the important business.

All deficits matter, but trying to evaluate a change in an intergenerational transfer program based on the surpluses or deficits that occur during a five- or ten-year window is not particularly constructive. I posted about the inadequacies of the budget framework last week.

The NYT article contains more evidence that the issue is not being framed properly in Washington. Consider this paragraph:

The main Republican players in Congress on the issue say they expect to endorse an increase in borrowing to finance the transition to a new system. But they remain split over whether to back plans that would include larger investment accounts and few painful trade-offs like benefit cuts and tax increases - and therefore require more borrowing - or to limit borrowing and include more steps that would be politically unpopular.

This is almost entirely a false tradeoff. The system has projected obligations that exceed projected revenues by $10.4 trillion in present value. This is the amount of "politically unpopular" measures that must be taken to restore the system to solvency. This figure has nothing to do with the size of the personal accounts that may also be carved out of the system, except insofar as a greater opportunity to make private investments in personal accounts makes the whole reform package easier to pass.

I laid out my reform suggestions for Social Security here and here about a month ago (and offered plenty of criticism of the way Democrats in the Congress and on the campaign were discussing the issue). With the election behind us, my biggest fear in this process is that we will get debt-financed personal accounts without the necessary measures to restore solvency.