The Administration’s Point Man on Social Security

Brad DeLong’s Semi-Daily Blog, 3/28/05

….But [Charles] Blahous doesn’t understand the Bush Social Security Plan. He can’t hash out specifics inside the West Wing.

Here are some selections from a briefing he gave the morning of the State of the Union address. He says a great many things that are simply wrong. For example:

(1) BLAHOUS: The problem that we now face is not one that we can tax our way out of, for a very simple reason: The costs and the current program are growing faster than the underlying tax base. So if we were to raise taxes today to deal with it, and the costs of the program continued to grow faster than the tax base, then in the future, future generations would simply have to come back and raise taxes again.

Here Blahous is simply wrong: The 2005 Trustees Report says that a 1.8 percentage point increase in Social Security taxes would be expected to balance the system out to 2075, and that a 3.5 percentage point increase would be expected to balance the system out to infinity. I think these numbers are high: I think it’s more like 1.2 and 2.0, respectively.

Let’s move on:

(2) BLAHOUS: It’s also not a problem that, under the current system, we can grow our way out of. The current system is designed so that benefits grow as fast as wages and the economy grow. And what this means is that if the economy does grow faster than projected, then wages will grow faster than projected; we will collect higher revenues, to be sure, and we might be able to push off that 2018 date, or 2042 date by a few years, but we would also owe more benefits as a consequence of the higher growth.

Here also Blahous is simply wrong: faster productivity growth improves Social Security’s finances by an amount equal to roughly half of life expectancy at retirement times the change in the productivity growth rate. 1% per year faster productivity growth reduces the deficit by about 1 percentage point. The point is that faster productivity growth raises the current Social Security tax base relative to its current obligations: pay-as-you-go systems like Social Security make sense only if productivity growth is relatively high, and the faster is productivity growth the more sense they make.

(3) BLAHOUS: With respect to the fiscal effects of the personal accounts, in a long-term sense — and I know those of you who have talked to me have heard me say this before — but in the long-term sense, obviously, the personal accounts, as we would structure them, would not create a net new cost for the system. To the extent that people put money in these accounts and invest in these accounts, there would be a corresponding reduction in the government’s liabilities from the Social Security system that is equal in present value to the money placed in the personal accounts up front. So in a long-term sense, the personal accounts would have a net neutral effect on the fiscal situation of the Social Security and on the federal government.

Here, once again, Blahous is simply wrong: given divorces, remarriages, the progressivity of the benefit formula, and so forth, in a large number of cases the government does not have a large enough Social Security liability to be able to reduce it enough to balance the cost of the money diverted to the private account. A ballpark estimate is that the Bush private accounts proposal has a net fiscal cost to the U.S. government of some $1.1 trillion in present value–half a percentage point or so of taxable payroll.

Most of this net fiscal cost comes because the private accounts proposal is biased toward the rich. The working and middle classes essentially borrow from their traditional Social Security benefit at 3% per year plus inflation to fund their private accounts (this is what makes private accounts a relatively lousy deal for them). Because of the limited reach of the clawback, the upper middle class and the rich get to borrow to fund their private accounts at less than 2% per year.

(4) Q: In saying that there is no net added cost to the program, are you implying — is it implicit that there is a benefit offset of one-third current guaranteed benefit because you’re diverting one-third of revenues away from this program? If that’s not correct, what would the benefit offset be to traditional benefits, and how would it be calculated?

BLAHOUS: The way that the election is put before the individual in a personal account structure of this type is that in return for the opportunity to get the benefits from the personal account, the person foregoes a certain amount of benefits from the traditional system. Now, the way that election is structured, the person comes out ahead if their personal account exceeds a 3 percent real rate of return, which is the rate of return that the trust fund bonds receive. So, basically, the net effect on an individual’s benefits would be zero if his personal account earned a 3 percent real rate of return. To the extent that his personal account gets a higher rate of return, his net benefit would increase as a consequence of making that decision.

Q: So he would only get a benefit to the extent that his portfolio performed in excess of 3 percent?

BLAHOUS: Right. You can think of it as saying — if you were making a decision on where to put your money going forward over the next 10 years, and you’re saying, should I put it in this account or that account, if you’re choosing to put your money over here instead of over here, then the net effect on you, as an individual, is to compare what would be the rate of return you get from this system, as opposed to putting it over here. And that would be the difference between the two.

Blahous is simply wrong yet again. It’s 3% only if you’re in the working or middle class–for the upper middle class, it is less. There is a net fiscal cost to the private accounts proposal, and it is a transfer from taxpayers in general to those whose earnings are near or above the Social Security maximum.

Last, let’s go to Blahous simply being evasive:

(5) BLAHOUS: In the near-term, however, of course, there will be transition financing required. Our estimate of the total amount of transition financing for the accounts, according to the schedule that I’ve outlined before, is about $664 billion through the end of the budget window of 2015. If you assume that — debt service effects on top of that, that would be another $90 billion.

Q: You talked about the $664 billion for the near-term costs. There’s been a lot of speculation in advance that it would be something like $2 trillion. Talk a little bit more about that. How do you square that?

BLAHOUS: I don’t want to say too much about it. Obviously, the $2 trillion number is not a number that was ever generated by us or by the Social Security actuaries, or any of the other nonpartisan scoring agencies. There were different assumptions that went into that number, and they reflected, I think, the thinking of other people beyond the scoring agencies.

Q: If I could follow up on a couple of questions that have already been asked — can you give us a second 10-year estimate on the revenue effect? Can you tell us how you would pay for that, in the first 10 years’ revenue loss? And am I right in assuming that in the way you describe this, because it’s a wash in terms of the net effect on Social Security from the accounts by themselves, that it would be fair to describe this as having — the personal accounts by themselves as having no effect whatsoever on the solvency issue?

BLAHOUS: On the second point, that’s a fair inference. On the first point, the long-term picture, of course, as you know, is very — it’s a very comprehensive picture. You’re looking forward 75 years over all time, depending on how you gauge things. And that can only be done accurately in the context of a comprehensive plan to fix the system. For example, if we were to do projections out beyond 2015, we would have to model what were the hypothetical changes made to fix the system’s finances, which are at this time yet undetermined.

Q: Putting those aside, what is the revenue implication of a fully phased-in 4 percent account of the type that you’ve laid out?

BLAHOUS: It would be very different depending overall on whether or not it was done alone or in the context of a comprehensive plan.

Q: Assuming it’s done alone, since that’s all you’re putting out here —

BLAHOUS: And the problem with assuming it’s done alone is that we aren’t advocating that it be done alone. We’re advocating that it be done in the context of a comprehensive plan.

Q: But you’re not saying what else is in there. You’re not saying what else is in the comprehensive plan, so —

BLAHOUS: Well, when we have — at the point where we can attach numbers to a comprehensive plan and model the effects of the accounts in that context, of course we’ll put those numbers forward. But until that — those specifications exist, we don’t have the ability to project that.

The answer to the question he’s being asked is: “Over the next twenty years, transition costs are about $2 trillion. To the extent that we do other reforms that cut–excuse me, slow the growth–of benefits, we recapture some of those.”

With (5), it’s clear that Blahous knows the answer to the question he’s being asked, but has been told not to give it out under any circumstances. (4), (3), 2), and (1) are somewhat harder to evaluate.

I’ve been told by people who worked with Bush Social Security Commission staff that (1) and (2) reflect Blahous’s general low level of knowledge about how the Social Security system actually works. Within the Social Security community, claims that prefunding tax increases cannot balance the system or that productivity growth does not improve the system’s financing are ludicrous. Yet Blahous makes them with a straight face.

I have heard from people who have talked to Social Security Administration staff that (3) and (4) result from the fact that Blahous simply did not do the staffwork to properly understand the impact of his own private-accounts proposal. That the proposal widened the fiscal deficit because in many cases the reach of the clawback was insufficient appears to have come as a great surprise to Blahous: he had only evaluated the impact of his plan on the median worker. That the proposal winds up transfering $1.1 trillion of wealth from the average taxpayer to the upper middle and upper classes also, I am told, came as a surprise to Blahous. I don’t know how reliable the sources of my sources are.