Money TalksDaniel Gross takes readers' questions about the economy, housing market, and credit crisis.

Remarks from the Fray:

I'm no economist, but I'm under the impression that this is a piece of fiction. I thought the story was the whole fund is used to buy T-Bills - which are then kept off the books when tallying the "official" national deficit.

Assuming my impressions are correct, what happens if no substantial changes are made in the next 20 or so years? The system goes into the red and starts "drawing on its trust fund" (in quotes because I consider it fiction), and instead of a 12 figure number written in black in the total national budget, we have a 12 figure number written in red - it would bankrupt us.

The reason I would consider it a crisis now is that you can't just wake up in 2045 and say "Whoops folks, we can't afford this program anymore, everybody's payments are cut by 30%". To be fair, you need to maintain payments to current retirees, and probably grandfather in people over 60.

This isn't to say I disagree with you about Medicare, just that I'm pretty sure the "Lockbox" is a fictional pretense for inaction.

--atworkforu

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I won't pretend to know the numbers or assumptions involved in projecting the Social Security Trust fund balance in the future, but I do know some of the arguments of Princeton and Gross are flawed.

First, Princeton is dismissive of the demographic projections, but unlike the economic, there is a high degree of confidence in these. We know pretty precisely the number and ages of people here now, and we can make pretty good guesses about how long they will work, live and migration rates. It doesn't take a "doomsayer" to be concerned that we will have an unprecedented shift in the proportion of the population that is in it's later years, and to worry about the economic outcomes of that.

Princeton and Gross both refer to the present surplus and high balance in the Trust and conclude that "Today Social Security is in the best state it ever has been." No! We're looking at only half the equation here. If you have a defined benefit retirement plan at your company, be glad these guys do not run it!

If you want to examine health of a retirement or insurance fund (social security is both), you have to look at both the fund balance and liabilities.

This is where those demographic projections become important. There really is a large demographic bubble in the population born in the 1945-1963 period. That isn't made up, it's very real. Those people are in their prime earning years now, so Social Security damn should be running a large surplus and have a large balance. That's no reason itself to celebrate, because that large wave of people will soon retire. Social Security is building up funds, but also liabilities. It's obligated to pay those persons back someday. Actually, projections have the fund going into the red within 10 years (a timeframe for which economic projections are more robust than reading goat entrails). The question isn't how much the fund has relative to past fund balances (as if), or how much the intake is in any given year, the question is if there will be enough in the future to pay back all the people who are now paying into it.

Of course, Princeton did address this, saying that some projections have us maintaining an above zero balance, finishing a 75 year period with a surplus of "trillions". This raises the question of what balance we should be maintaining. Do we want every age group to get back roughly what they put in, or do we want economic growth and higher future relative earnings to continually subsidize the immediate preceding generations as they retire. If it's the former, we should be maintaining trillions in surpluses at all times, never going anywhere close to zero (how secure would you feel if you were told that your company's defined benefit plan had a near zero fund balance after you've worked there a number of years?). If it's the latter, then the fund could hover above the zero mark and still be considered a success.

The statements of Princeton and Gross seem to indicate they are in the latter camp. They make no mention at all of maintaining balances to pay future liabilities.

That's important when considering the worker/beneficiary ratio. Princeton notices we've seen a sharp decline in that number, and it hasn't hurt us yet, and concludes that it therefore won't hurt us in the future. What? To understand the flaw in this, one needs to understand why that number is significant.

If we are going to run SS in such a way that it hovers just above zero, rather than actually maintaining the funds on hand to pay future liabilities, then we are taking on a risk. What if our projections are wrong? Princeton is very derisive of economic forecasting, saying that things could very well be better than projected, but what if they turn out to be worse? What then?

Well, then either SS has to cut payments to beneficiaries to close the shortfall, or general fund tax revenues have to be diverted to shore up the system. That's where the ratio becomes important. Making up a forecasting error when there are 42 workers per beneficiary probably won't be a major burden on those workers. A forecasting error when the ratio is 2.2 to 1 could be devastating. We're talking potentially percentage points of GDP here.

This at a time when we also project huge shortfalls in Medicare, which will also have to be severely cut or paid out of the general fund, at a time when proportionately less of America is working age.

Princeton may ultimately be right that things will simply work out. What he is wrong about is that we should assume so simply because there is a fund balance and surplus now. He's also overly dismissive of economic forecasting. Yes, it's difficult and requires educated guessing, but it's also essential for smart planning, because we really should want to know if that fund balance we have today is sufficient to cover the liabilities that must be paid tomorrow. Anticipation and preparation for the future, even in the face of multiple unknowns, is smart policy.

--Sanjait

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(12/16)

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