Friday, November 21, 2014

Social democracy / social security is the fiscally responsible choice

Image: The fiscally responsible save for a rainy day. (source)


UPDATED--see below [in brackets]



It should go without saying that budget deficits aren't a result of government spending, but rather the balance of government spending and government income. This becomes obvious when we look at budget deficits of the social democracies, which have far greater government spending per capita than the United States. The United States' budget deficits were 7% of GDP in 2012 (and 10.1% in 2009 at the height of the Great Recession), while Denmark's were 4%, Austria's were 3.1%; Finland's were 2.1%; Iceland, 1.9%; Sweden, 0.3%; and Norway actually ran a surplus of 13.8%. Social democracies are generally very responsible fiscally, historically running fewer budget deficits (chart 4.1) than most other OECD countries, including the United States (Austria being the exception) (click for unobscured graph):


It's important to remember that this 35 year period includes is an incredibly severe recession that affected only Scandinavia in the 1990's; for Finland, this recession was arguably worse than their experiences during the Great Depression. Despite having an extra recession, the social democracies managed to be more fiscally responsible as a whole than the rest of the developed world.

[Update, 02/19/2016: Simply tallying the number of years of budget deficits can be misleading, since a single year may have a greater deficit than the cumulative effect of many years of very small deficits. So, here's a graph of government financial net worth (government assets minus liabilities) with datapoints for 2007, 2009, 2013, and 2014--so before, during, and after the Great Recession. I've marked the social democracies in red and the United States in blue:



Clearly, the social democracies are very fiscally responsible by this measure as well.]

Not only have the Scandinavian social democracies had fewer years of budget deficits, but their rock bottom borrowing costs indicate that investors have utmost confidence in the finances of the social democracies. Markets do err, but the market for the debt of social democratic countries proves that no one seriously thinks that large social democratic welfare states pose a threat to a country's fiscal footing--simply because nobody is willing to bet their money against it.

This adds up to a compelling case that social democracy is fiscally responsible.

It would be easy to assume that this fiscal responsibility is due to the inherent cultural superiority of the social democratic countries, a common assumption that is quite easily debunked. Rather, social democratic programs are fiscally responsible for two main reasons. First--and by far most importantly--the design of social democratic programs ensures widespread popularity among voters. Politicians unwilling to find the welfare state can expect to be quickly fired by angry voters; unsurprisingly, there is no serious party opposing the enormously popular welfare state. Second, social democratic programs are administratively very simple. This simplicity makes drafting a budget easier and more transparent. It's little wonder the social democracies can turn in responsible budgets year after year, even in times of economic recession.

The fiscal responsibility of America's social democratic programs
The United States has two social democratic programs--Medicare and Social Security. Medicare provides health care for roughly half the cost of private insurance; there's no question that Medicare is the fiscally responsible choice.

I've spilled much ink on this blog about how Social Security "reforms" are not motivated by concerns of fiscal responsibility. I've also assembled evidence showing that Social Security is the most efficient retirement model. If Social Security isn't fiscally responsible, then nothing else is either. Because Social Security is the cheapest way to ensure retirement security for so many people, if you don't think Social Security is affordable, then you think that retirement should be accessible only to the wealthy, with the poor condemned work until they die.

However, I've never actually tackled Social Security's finances directly, and this seems like a pretty good place to do it.

The Social Security Trust Fund is the piggy bank of the Social Security program. All Social Security taxes paid to the federal government are added directly into the Social Security Trust Fund, and all Social Security benefits are withdrawn directly from the Social Security Trust Fund.

Currently, the Social Security Trust Fund has a mammoth $2.7 trillion surplus. In 2013 alone, Social Security ran a surplus of $64.3 billion (see see the last two lines of table III.A1). Clearly, this is not a program that is coming off the rails.*

The Social Security Trust Fund developed such huge surpluses in part because of the unusually high birth rates that created the Baby Boom generation. For decades, there were so many Baby Boomers paying into the Social Security Trust Fund and comparatively few of their parents and grandparents drawing benefits from the Social Security Trust Fund, that the Social Security Trust Fund developed its massive surplus. It's possible that this surplus will be sufficient to pay for the Baby Boomers' retirement, but it might not. Currently, Social Security's actuaries believe that it is most likely that the Social Security Trust Fund will run out of money around 2030 (see table IV.B3). However, there is a reasonable chance that Social Security never runs out of money.

Why the uncertainty? Social Security taxes are paid as a percentage of workers' wages. Obviously, the higher workers' wages, the more money the Social Security Trust Fund will have. And, Social Security payments depend on benefits paid out; this depends on the rate of disability and how long beneficiaries live. Both income and expenditures depend additionally on birth rates, inflation, borrowing rates, and many additional factors; all of these are difficult to predict. Thus, Social Security actuaries forecast a range of plausible futures for OASDI; there's a reasonable chance that what they call the "low cost" estimate will be most accurate. If so, the Social Security will never run out of money--the Social Security Trust Fund will remain solvent indefinitely.

So, the potential problem we will face around 2030 has to do with the unusual birth rate that created the Baby Boomer generation; once this generation passes on, American demographics are such that Social Security will be solvent indefinitely.

So! There is a reasonable chance that Social Security never runs out of money, but it's more likely that it does around 2030. This is not a new problem. During the Reagan administration, the Social Security actuaries predicted that there was a reasonable chance that the Social Security Trust Fund would run out of money in the early 2000's. Ultimately, Republicans and Democrats agreed to a compromise that included a small increase in Social Security taxes, delaying a cost of living adjustment, and gradually phasing in a change to full retirement age from 65 to 67. Much of the huge surplus in the Social Security Trust Fund is owed to this mix of tax increases and benefit cuts, all of which were actually quite small.

Since we still have years to prepare, we could make similarly small changes to ensure ourselves an indefinitely solvent Social Security program. The Congressional Budget Office ran an analysis of 30 Social Security tweaks, under the reasonable assumption that the shortfall is a fairly small 0.6% of GDP (we spend 3.8% of our GDP on the military but won't commit another 0.6% to retirement security?). In Summary Figure 1, any options that sum to +0.6 mean a permanently solvent Social Security--for example, if we increased Social Security taxes 1% and reduced Cost of Living Adjustments by 0.5%, we would have an indefinitely solvent program. A 3% tax increase phased in over 60 years and an increase in the full retirement age from 67 to 68 would make the program solvent indefinitely. Alone, a tax increase somewhere between 1 and 2% would be sufficient. (Ezra Klein makes a must-read case against raising the retirement age.) Again, none of these changes are huge because there's still plenty of time to prepare.

This set-it-and-forget-it nature of universal social insurance programs makes them the fiscally responsible choice. Actuarial work can help us predict what changes need to be made to the programs decades before an actual crisis hits.

The Social Security Administration is required to publish its actuarial tables every year; it's no secret that they had been predicting possible financial difficulties between 2030 and 2040 since the 2000's. Had we acted sooner, the changes we would have needed to make to ensure indefinite solvency would have been much smaller--but our political system chose not to act and fewer people will thus have to bear more of the burden of fixing the system.

In sum, there is nothing fiscally irresponsible about Social Security. If it runs out of money, it will be because we are a little bit unlucky and we chose not to properly fund it. Again, only minor changes are needed to make the program indefinitely solvent. And--to repeat--there is no cheaper way to ensure retirement security for all Americans. Social security is at least twice as efficient as private retirement savings in 401(k)'s, 403(b)'s and IRA's. If Social Security is unaffordable, then so, too, is everything else, because every other retirement system is more expensive than Social Security. Thus, if you consider Social Security fiscally irresponsible, then you are in fact saying that you do not believe that the elderly should have retirement security. You are arguing in favor of a world where only the rich can afford to retire and the poor have to work until they die.



*The Disability Insurance program of Social Security is not doing as well as the Old Age and Survivors program, and is actually losing money. But in practice, this matters very little, since the DI program is much smaller than the OASI program, and the DI program can borrow money from the OASI program. Thus, most analyses follow the combined actuarial table for both programs.

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