Jagadeesh Gokhale is back with a new book laying out a fresh doomsday scenario for Social Security. But before dipping into the Cato Institute scholar’s (and Bush appointee to the Social Security Advisory Board) latest research-and-destroy mission, it’s useful to have a look at his past record as a budget analyst and champion of a dubious “present value” accounting measure.
In August 2003, Joe Lieberman, then in the early stages of launching a presidential bid, wrote a letter to Treasury Secretary John Snow in which he accused the administration of “stripping out” from its 2004 budget the findings of an internal Treasury paper that Snow’s predecessor Paul O’Neill had ordered up. Attempting to stake out a position as the toughest of the deficit hawks, Lieberman suggested that “this administration is trying to hide the true nature of our financial obligations from the American people in order to advance its agenda of cutting taxes indiscriminately.”
The paper was written by Gokhale, then at the Cleveland Fed, and Kent Smetters, then deputy assistant Treasury secretary for economic policy. Contrary of Lieberman’s claim, Smetters claimed it had been “for internal discussion only,” to try to help O’Neill “think about [the deficit] from an economic perspective.” There was no conspiracy to suppress it, he said; the administration considered including it in the budget but then decided against it. Gokhale and Smetters revised their paper and presented it four times in Washington in May 2003, including to the American Enterprise Institute. They then published it as an AEI monograph.
What made the report such a hot item was the outsized estimates it produced for the long-term federal deficit and the method it used to arrive at the portion that derived from Social Security and Medicare. The CBO’s most recent estimate had the entire federal debt growing to $3.8 trillion by 2008. Gokhale and Smetters brushed this aside, calculating that the federal budget’s 2004 “fiscal imbalance” came to $44.2 trillion in 2003 dollars, and that this would rise to $54 trillion by 2008 if steps weren’t taken immediately to correct it. Of that, Medicare would account for $36.6 trillion and Social Security for $7 trillion. The rest of the federal budget would account for “only” $500 billion.
The $7 trillion they projected for Social Security was twice the $3.5 trillion deficit the trustees had calculated the program would generate over the next 75 years. But Gokhale and Smetters dismissed Social Security’s traditional 75-year projection, saying it was “arbitrary” and significantly understated the fiscal hole the program was digging.
They proposed replacing it with a “present value” measure in which “all future spending and revenue are not only reduced for inflation but additionally discounted by the government’s (inflation-adjusted) long-term borrowing rate. “This calculation enables us to determine how much money the government must come up with immediately to put fiscal policy on a sustainable course”: or, what it must generate in spending cuts or tax increases to do so. The advantage of their method, according to Smetters and Gokhale, was that it stretched out into “perpetuity,” covering all the – many, many – future years that the 75-year projections missed. The result would be “forward-looking,” not “backward looking,” they argued, and thus would make it harder for Congress to enact new programs that hit future generations with most of the long-term costs.
Hard-line critics were delighted by this new and more dire way of viewing Social Security and Medicare. Gokhale and Smetters had performed a “great service,” declared Olivia Mitchell of the Wharton School’s Pension Research Center, by making it possible for lawmakers to look beyond the 75-year cutoff and, perhaps, helping to educate the public about the the reality behind the federal government’s promises. Robert Inman, an economist at the Wharton School, called the paper “absolutely essential information for effective budgeting.”
Lieberman was anxious to put across the Smetters-Gokhale analysis as big news because he could use it to denounce the Bush tax cuts and push for a return to the Clinton-era policy of deficit reduction and debt paydown. The following year, while attempting to kick-start his brief presidential run, Lieberman introduced, unsuccessfully, a bill that would have forced the federal government to follow “present value” accounting rules, nailing Gokhale and Smetters’ “more accurate” numbers into its official budget. “It is the necessary first step on the road back to fiscal balance,” he said.
Others made the obvious point, however, that an open-ended cost projection into infinity wasn’t very useful to lawmakers trying to create a series of annual budgets in the real world. “We really have no idea what Medicare and Medicaid costs are going to look like in 30 to 40 years, let alone 75 or further out,” said Richard Kogan, senior fellow at the Center on Budget and Policy Priorities. “Things could be much better or they could be much worse.” A projection into an infinite future was also infinitely susceptible to change in any of its components. The CBPP’s Jason Furman and Robert Greenstein pointed out that more than two-thirds of the “infinite” deficit was situated past the 75-year point.
The White House and its allies were actually of two minds. While they were happy to spin extravagant projections of the destructiveness of Social Security and Medicare, they didn’t want their tax-cutting agenda undermined. On one hand, an infinite projection of Social Security’s revenues and outlays made private accounts look more attractive, because, conservative columnist Bruce Bartlett explained, “much of the saving will fall more than 75 years in the future.”
On the other hand, the total picture was deceptively alarming. Using the same assumptions as Smetters and Gokhale, Bartlett calculated that the figure for the size of the future economy that would correspond to their $44.2 trillion “present value” deficit figure was $682 trillion. In other words, the “fiscal imbalance” would be only 6.5% of GDP: “something to be concerned about, but hardly a crisis in the making.”
Smetters, too, in testimony before the House Judiciary Committee in March 2003, argued that the Bush tax cuts had relatively little impact on the long-term fiscal equation, although he declined to quantify this. But his numbers on Social Security and Medicare were scary enough that they might be of great help in selling a drastic restructuring of Social Security, if and when the administration was ready to take up that project again.
In fact, Smetters and Gokhale noted in a Wall Street Journal op-ed in July that the Social Security trustees – largely Bush political appointees – had decided to include an “infinite” solvency projection alongside the three standard 75-year projections for OASI and DI in their latest annual report, issued in March. The new analysis arrived at the same numbers Gokhale and Smetters had: $3.5 trillion in unfunded obligations over the next 75 years, and $7 trillion more after that.
That didn’t go over well with the accredited experts. The American Academy of Actuaries, the principal professional group representing pension actuaries, objected publicly to the administration’s attempt to institutionalize the infinite projection. In a letter to the trustees dated December 19, 2003, the Academy came close to accusing the Bush administration of trying to deceive the public. “The new measures,” it said, “provide little if any useful information about the program’s long-range finances and indeed are likely to mislead anyone lacking technical expertise in the demographic, economic and actuarial aspects of the program’s finances into believing the program is in far worse financial condition than is actually indicated.”
The actuaries’ letter didn’t dissuade the Social Security trustees from continuing to include an “infinite” projection in their annual report. In fact, Gokhale’s analysis in his new book relies on the trustees’ 2008 report, which calculates Social Security’s fiscal deficit over 75 years at $4.3 trillion and over infinity at $13.6 trillion. And nowhere in sight is a number for, say, Gokhale’s estimate of GDP for the U.S. economy out to “infinity.” Without such a number, his calculations look awfully scary – but awfully hollow, too.
by coberly
30 May 2010 at 10:53
I wish you could get more publicity with this. Unfortunately neither the press nor the public, not to say the Congress, would have any idea what you are talking about. The infinite future numbers are useful to the bad guys because they look scary. But they don’t mean anything … not that we don’t know what the future will look like, but that the numbers don’t add anything to our knowledge about Social Security financing.
You take the same assumptions that are used to generate the 75 year projection, and then project them “to infinity.” All you have done is said that a 4% (of payroll) gap between the present tax rate and the expected (“promised”) benefits, adds up to more money over “forever” than it does over 75 years. The reason that you get a finite answer to a forever calculation is that by assuming an interest rate on a sufficient amount of money, eventually the interest is paying the “deficit,” entirely and can (theoretically) continue to do so forever. Before that point (where interest pays the full cost of the deficit) there are complications because the interest at first pays more than the full cost, so it accumulates by compounding, and a cutoff date allows the principle to be applied to the “total” (up to that point) deficit. This leads to a 2% of payroll “shortfall” at the 75 year projection date.
It’s nice to know that the shortfall never grows beyond that 4%. It’s even nicer to know that a payroll tax increase of 2% on the worker and 2% on the employer “solves” the SS shortfall forever.
It’s even nicer to know that we don’t need the 2% increase right away, but can approach it at a rate of 0.02% per year.. or about 20 cents per week per year.
Bottom line: it’s one thing to argue impressionistically against these guys, but it would be better to understand what the numbers really say. And to have a way to grab congressmen by the throat and explain it to them.
by accountants directory
06 Oct 2010 at 08:50
I wish you could get more publicity with this. Unfortunately neither the press nor the public, not to say the Congress, would have any idea what you are talking about. The infinite future numbers are useful to the bad guys because they look scary. But they don’t mean anything … not that we don’t know what the future will look like, but that the numbers don’t add anything to our knowledge about Social Security financing.
You take the same assumptions that are used to generate the 75 year projection, and then project them “to infinity.” All you have done is said that a 4% (of payroll) gap between the present tax rate and the expected (“promised”) benefits, adds up to more money over “forever” than it does over 75 years. The reason that you get a finite answer to a forever calculation is that by assuming an interest rate on a sufficient amount of money, eventually the interest is paying the “deficit,” entirely and can (theoretically) continue to do so forever. Before that point (where interest pays the full cost of the deficit) there are complications because the interest at first pays more than the full cost, so it accumulates by compounding, and a cutoff date allows the principle to be applied to the “total” (up to that point) deficit. This leads to a 2% of payroll “shortfall” at the 75 year projection date.
It’s nice to know that the shortfall never grows beyond that 4%. It’s even nicer to know that a payroll tax increase of 2% on the worker and 2% on the employer “solves” the SS shortfall forever.
It’s even nicer to know that we don’t need the 2% increase right away, but can approach it at a rate of 0.02% per year.. or about 20 cents per week per year.
Bottom line: it’s one thing to argue impressionistically against these guys, but it would be better to understand what the numbers really say. And to have a way to grab congressmen by the throat and explain it to them.