Ronald Rutherford's  Instablog

This post is a continuation of discussions on Social Security with the last one at Paul Krugman Wrong Again. There, I discussed the Old-Age and Survivors Insurance Trust Fund {Social Security} and what the report from 1945 said about projections going out to the year 2000. Along the way we saw that Paul Krugman skimmed over the material to confirm that they had a very good prediction on percentage of population 65 and over to population aged 20 to 64, but failed to notice that they assumed less percentage receiving benefits in the older category. This goes to the heart of the Social Security's Demographic Challenge. The following graphically shows the ratio of "covered workers" (i.e. payroll tax payers) to beneficiaries.

From the last post, we saw that up to a third of people over 65 were not expected to receive benefits, and adding in the fact that over a quarter of new "reward" recipients is based on disability, then it seems clear that the ratio above would not be nearly as hard on younger taxpayers without these two factors added to their burden.

In this post, I want to further explore his main points from Paul Krugman's blog post at Live Long And Prosper.

This is a really terrible idea, for at least three reasons.
1. The retirement age has already been increased to 66, and is scheduled to rise to 67. So any further increase would mean pushing retirement back to unprecedented ages. Yes, a lot of people live to 70; how many of them are really able, easily, to work that late into life?
2. While life expectancy is rising, life expectancy at age 65 — which is what is relevant here — isn’t rising nearly as fast.
3. Finally, disparities in life expectancy have been rising sharply, with much smaller gains for disadvantaged socioeconomic groups and/or those with less education than the average. Yet these are precisely the people who depend most on Social Security.

According to Krugman, the really terrible idea was to raise the age for the full Social Security benefits to kick in. He does raise some important issues with regards to what is just and fair, but to claim that something is "unprecedented" does not indicate that it is not the most logical thing to do. There are many unprecedented facts that make these unprecedented actions necessary. Longevity is now unprecedented as more people born today can expect to live longer including to retirement age and then beyond. Thus the pool of beneficiaries is unprecedented now and will only get more dramatic as the baby boomers retire. In fact, the demographic chart of the US is quite unique in that a group of cohorts are larger than the groups of older as well as younger cohorts. The chart below shows that bulge from the web site AGE DISTRIBUTION. It is easy to see the two largest bands are in the range 35 to 44.


Here Are "Just The Facts", Obama (Paul Krugman)
Let us now look at some the graphs that are provided by Social Security Administration at Fast Facts: Figures About Social Security, 2010.

New Benefit Awards, 2009
Benefits were awarded to about 5.7 million persons; of those, 48% were retired workers and 17% were disabled workers. The remaining 35% were survivors or the spouses and children of retired or disabled workers. These awards represent not only new entrants to the benefit rolls but also persons already on the rolls who become entitled to a different benefit, particularly conversions of disabled-worker benefits to retired-worker benefits at full retirement age.

The table that accompanies the above passage and pie chart gives the total percent of new recipients as 57% for retired workers and dependents. Thus 43% fall under the other two categories of disabled workers and survivors of deceased workers. Also new awards for disabled recipients are growing at a faster rate than simply retiring recipients at a rate of 2.6% vs. 1.9% respectively as the growth trends are shown below.

Looking at the facts in the Supplemental Security Income (SSI) program is even more lopsided with respect to retired vs. the other categories. On top of this, benefits for non-retiring recipients is actually higher that retiring recipients.



Are Social Security taxes regressive?
The Economist magazine brings up some important points about the progressivity of payroll taxes. The first being the obvious fact that payroll taxes are taxed on the first $106,800 per year and afterwards are not taxed, thus the percentage of payroll taxes to income decreases. The second point being based on marginal utility from the last dollar earned. This takes some value judgments of what the value of various cohort groups are. But once this theory is used then how would any tax policy be anything other than regressive? How high of tax rate would it have to be on the top 400 American earners to the bottom one percent so that both marginal utilities would equalize? But more importantly, for our discussion here, is whether the tax and benefit structures are fair and equitable. In this regards the Economist provides some important points.

But the folks who claim the payroll tax is regressive do not take into account that it is not so much a tax, but a contribution to a forced saving/social-insurance scheme. Over 12% of payroll taxes fund Social Security (this includes old age and disability). The amount of payroll taxes paid during your working years determines your benefit. The benefit formula for Social Security is highly progressive. The lower your average earnings the higher a benefit you get relative to your contribution.

The Economist goes on to summarize two studies from the National Bureau of Economic Research. The first showing that the actual return on investments from payroll taxes for "low earners earn a 5.19% internal rate of return on their contributions to Social Security, while high earners get just 0.54%." The second points out that the rates look more progressive when factoring in disability benefits and survivorship benefits, and they also question the assumptions that the poor get less benefits because they die earlier and start work earlier. Reasons for shorter life expectancy should also be evaluated for factors attributed to less disposable income along with occupations that they participate in and those that are "lifestyle choices". For example, the trend that higher income social groups have reduced consumption of cigarettes while lower income groups have been slower at reducing consumption where even higher taxes and costs have not diminished this trend as significantly.

Policies that Redistribute Income
It is quite difficult to give a summary of all the aspects of redistribution but some aspects are shown through the calculations of expected benefits by Social Security Online at Your Retirement Benefit: How It Is Figured. The first and second steps are to record the yearly taxed income over the taxable income history of a group of cohorts by age and adjust the earnings based on the Indexing Factors which are derived from the Average Wage Indexing Series. The link to indexing factors produces a vector of indexes for each year of workers born including future dates based on expected growth of averages wages. Simply add 62 to the year born to determine which is the year of "eligibility". This indexing factor gives more weight to earnings early in the working career than later. Although maybe small in the grand picture, it does provide more return on dollars invested for entering the work force earlier.

The third step is to pick the top 35 adjusted income years and add them up. This results in individuals that work more than 35 years pay into the system with no additional benefits in SS. It is difficult to know ahead of time which years will be more beneficial for the calculations. So starting early, maybe not be such a great advantage since more years working with no more benefits. This does seem to open up the possibility of the program being changed to make eligibility not strictly on age but by number of years paid into the system above a minimum threshold in income. Most pension systems work this way, so why not the biggest pension plan out there? So somewhere between 40 to 45 years working seems reasonable. Take for example the minimum for this program is 45, then the person that starts working at 17 retires in 62, while the person that finishes schooling at age 28 retires at 73.

The fourth step is to divide the total adjusted income by 420 which is number of months in 35 years, which results in the average monthly wage adjusted income. Step five is the key to how the whole system provides more returns for dollar invested than high income earners. The first $761 is multiplied by 90% and then has further kinks in the benefits per dollar taxed at 32% for between $761 and $4,586, and another kink above $4,586 with a multiplier of 15%. Thus for example to get the most return on the payroll tax a worker would need to earn $9,132 but since indexing the worker needed to earn just over $618 in 1951. Step 6 is just to add up the individual calculations on benefits and step 7 to reduce this amount by 25% which is the expected SS benefits.

What does this all mean?
Those that have the greatest needs from Social Security look to be getting more benefits over time from the disability and survivorship benefits allotments. This then calls into question whether raising the age of full retirement benefits for Social Security will help that much, or whether it just limits the growth in the secondary aspects. Those factors could be such things as dependents not getting stipends as early in both Social Security and SSI, increased number of years of work over the 35 years for maximum benefits under SS, and delayment in receiving health benefits.

If the system was suppose to be designed as to be a non-discriminatory benefits package then providing two ways to become eligible seems reasonable. One based on age that may need to be adjusted based on life expectancy like it currently is designed, and the second way is through longevity in the work force like pensions.


Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: No specific positions mentioned.This was meant as continuation of the post {not published/instablog} at SA: seekingalpha.com/instablog/772484-ronald...

Paul Kruman is at it again with a post entitled Early Social Security Projections. This got me to exploring some of the issues about Social Security also, and for that I am grateful. This is his attempt at setting up his straw man argument.

You see, in discussions of Social Security it’s often argued that in the program’s early years, nobody could have imagined the increases in life expectancy that have actually occurred, so nobody could have imagined that we’d have as many beneficiaries relative to the number of people of working age. And I thought I knew that this was wrong — that people in the 30s and 40s did know about rising life expectancy, and expected it to continue.

When declaring that "nobody could have imagined", then it seems pretty easy to refute such comments as someone, somewhere must of at least thought about it. And sure enough he uses the 1945 Social Security Trustees’ report. But a bigger question is whether the people (Congress and President) that were suppose to make decisions about how to maintain the fund and thus benefits for future generations were even aware of such information (or even read it) and whether they made any corrective action early enough. Several passages of the report paints a different reaction than what Krugman could be imagining.

Two estimates, based on lower and higher assumptions, of the level premium cost of the benefits now provided by the system are 4 percent and 7 percent of covered pay rolls. This means that if pay-roll taxes of this magnitude (employer tax and employee tax combined) had been levied from the beginning of the program and were continued indefinitely, the system as a whole would be self-supporting if the assumptions eventuate. But Congress has now maintained old-age and survivors insurance tax rates at 1 percent each on employees and employers for 9 years instead of permitting the scheduled increases of the act to become effective, although in the war years economic conditions have imposed little obstacle to such increases. {Page 28}

The report's conclusion goes on to ask for clarification on "its short-run and long-run financial policies for the program" considering the 1 percent rate then currently used and whether the fund should be decreased until it is "three times annual benefits". That last portion seems like not much financial backup in the trust fund if allowed to drop to that low. Even if the rates were to increase to 6% total of taxable pay rolls that still only provides positive cash flows during the 1950s and 1960s.
Rising Life Expectancies? 

(Click on tables for clearer images.)

This is Table 9 that Krugman references in his post. It is interesting to note that while the populations of those 65 and older is increasing every time period including for both men and women, adults in the 20 to 64 age group decreased for both low assumptions and high assumptions over the period 1980 to 2000. The low assumptions table even has a decrease in this age group in 2000 that is below even the 1955 estimate with men sliding back to the same spot and women decreasing more in numbers. The two estimated sequences are derived from two reports and not from the SSA/Trust Fund. The two reports are: 1. the 1935 report by the Committee on Economic Security, and 2. the 1938 report by the National Resource Committee.

The low assumptions ratio result as Krugman pointed out was amazingly close considering all the other factors that turned out wrong like total population and immigration patterns. His ratio of adults and the elderly of the low assumptions estimate was 20.8% and the 2000 census data showed 21.1%. But he should have read the report to see that the high assumptions were not given equal consideration to the low assumptions results. The following is from the report on page 20.

(b) Mortality --- Mortality rates by sex and age have been steadily improving since the turn of the century for both sexes and virtually all ages up to 60, with very little change at ages above 60. ... In the low-cost assumptions discussed in this section, very little improvement in mortality rates is assumed. In the high-cost assumptions some improvement is assumed but their assumption of improvement beyond age 65 is believed by many to be too optimistic.

Thus, the report is saying that it is better to go with the low-cost assumptions and only to use the high-cost for the extreme possibility. It was not, like what Krugman is assuming, that the low and high are of equal value and came from the same set of data points and assumptions. The ironic aspect is that Krugman already knows that longevity is not increasing that much for the older population than it is for the younger living longer.

Live Long And Prosper While life expectancy is rising, life expectancy at age 65 — which is what is relevant here — isn’t rising nearly as fast.

"Damn it, it is not electron shells, we are talking about electron configuration!"
That small quote was from my college professor in Chemistry, but for Krugman it should not be the demographics of age groups that matter as much as participation rates. Table 10 below shows the expected number of recipients of "old-age insurance" up to the year 2000. The difference to note from Table 9 is that even adding up all the columns does not equal the total for the population over 65. The participation rate from these two tables is just over 58% for the low assumptions scenario and 71% for the high assumptions scenario. According to the Social Security Administration, "Nine out of ten individuals age 65 and older receive Social Security benefits." That means as much as a fifth to one-third of the elderly were not suppose to receive the benefits according to these scenarios. Even with this data, it does not tell us how many of the "wives of primary beneficiaries" are 65 or older. Since husbands still tend to be older than their wives, then at least some of that pool of recipients was under 65 making the non-participation rate lower than what I calculated. 


It looks like a variety of social attitudes changed since the 1945 report and possibly work/leisure incentives. Although the following quote is related more to the "reconversion" of a war time economy to a consumer economy, it does point out the writers' attitude in the report, "It is assumed, nevertheless, that a rather large number of persons eligible for retirement benefits remain in employment." Another indirect demographic trend that they completely missed is women participation in the work force. On page 23 of the report they discuss greater woman participation because of the depression and subsequent war, "Moreover, the labor market was increased by many married women seeking employment to reinforce what they hoped might be only a temporary inadequacy in their husband's income."

Confirmation Bias
From the analysis above, it shows that Paul Krugman found some shred of evidence that confirmed his political bias and then failed to fully understand the information he was sharing. He, of course, has a great burden defending big government entitlement programs and Keynesianism at all economic and political cost. I close with another quote from the report that shows they understood that the program as designed could have some major flaws that will have to be addressed at some time in the future.

In fact, for demographic reasons alone, as discussed earlier in this section, the system cannot be expected even eventually to level out to a fixed relationship between contributions and benefits.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: No positions mentioned.

One of our readers recently asked the following questions:

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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: No positions mentioned.