from Follow the Money

Undisputed Unaffordability

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Budget, Debt, and Deficits

That is a phrase from the Washington Post’s oped on Social Security.

I think it goes a bit too far, so I want to dispute the "undisputed unaffordability" of Social Security.

I do not dispute that there is a gap between projected Social Security benefits and projected Social Security revenues after 2050 or so. Revenues are around 5% of GDP, expenditures around 6.5% of GDP, give or take a bit.

That is a gap of 1.5% of GDP.

What I dispute is the notion that the US as a country could not afford to spend an extra 1.5% of GDP, or a total of 6.5% of GDP, on Social Security if it wanted to. Some might prefer to spend less than we do now on Social Security (about 5% of GDP), others might prefer a bit more. Some might prefer a mix of modest benefit cuts (say a slightly higher retirement age) and more revenues.

But it is a choice. The demographics do not make Social Security, as it is currently structured, clearly unaffordable. Yes, benefits rise from a bit more than 4% of GDP to well over 6% of GDP as a result of the baby boom’s retirement. But we raised payroll taxes preemptively, and at around 5% of GDP they are now well above what they need to be to pay current benefits. That limits the need to raise payroll taxes in the future. Social Security’s problems don’t start with the baby boom; they start when the savings (the trust fund) built up to pay for the baby boom’s retirement run out.

What is more clearly unaffordable, unless we do something, is our medical system. Why? In part, because the US is aging. But even more so because health care costs are rising faster than GDP, for the young as well as the old. Right now we are paying about 15% of GDP on health care. That is lot more than the roughly 6.5% of GDP the US is forecast to spend on Social Security in 2050. And, unless something changes, the US will be spending lots more than 15% of GDP on health care in 2050. Now, you can make a case that in order to afford to provide more medical care to an aging population, the minimum income support in retirement now provided by Social Security needs to be reduced. But I did not see the Washington Post making quite that case.

Incidentally, Richard Berner of Morgan Stanley argues today that the Medicaid and the Pension Benefit Guarantee Corporation both are in need of more urgent attention than Social Security.

And while we are talking about unaffordability, I can not resist noting (again) that the 1.5% of GDP gap between projected Social Security revenues and projected benefits is smaller than the roughly 5% of GDP current gap between non-Social Security revenues (11-12% of GDP) and non-Social Security expenditures (16-17% of GDP). Look at the off budget deficit projected by the CBO. Do the math in terms of the percentage change in revenues needed to pay for projected expenditures, and the gap between say 11% revenues and 16% of GDP expenditures is bigger than the forecast gap between Social Security’s 5% of GDP revenues and 6.5% of GDP expenditures in 2050.

One final note: given the Washington Post oped page’s spirited championing of free trade, I am surprised that they have not noted that Social Security is designed in such a way that it allows lets the winners from trade to help out those who lose from trade. That should help make trade more politically palatable. Social Security, unlike many traditional corporate pensions, vests immediately and is fully portable, so "job churn" doesn’t reduce retirement benefits. Some people end up with slightly lower lifetime earnings as a result of the dislocations associated with trade, just as others end up with higher life-time earnings. Suppose you happen to work in a plant that is shut when you are 55 or so. Lots of your human capital probably is tied up in a set of skills specific to that plant, or maybe that industry. And, given your age, you have relatively limited opportunities to earn back the costs of investing in your own "retraining." One of the risks Social Security insures against is the possibility that someone "who works hard and plays by the rules" but happens to end up in the wrong industry at the wrong time will end up with slightly lower than expected lifetime earnings. It helps compensate for an economy that is otherwise increasing the amount of risk (see Peter Gosselin’s excellent work on this) most individuals are assuming. That, to me, is no bad thing.

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Budget, Debt, and Deficits