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February 24, 2005
Actuarial assumptions and my beef with H.R. 530
Today's best Social Security analysis is by Arnold Kling. By the way, if you don't read his blog, you should.
The memorandum to which he refers is can be found at the SSA website.
He gets it right. At issue is the rate at which a worker trades off benefits when he or she contributes to a private account. If I'm reading it as he does, it appears that this proposal shaves the benefits by 3%, which means the private accounts have to return at least that much for the worker to break even. His problem with that is that 3% is too high. Alas, it looks like this is, as he says, "dictated by the Social Security actuaries."
I have to agree with Kling that 3% makes the system look more solvent, but might bias people against private accounts (or lead to inflated claims about the returns on those accounts--something which also appears to be happening).
Kling says,
"Actuarial scoring" of Social Security and the reform proposals is a menace. The assumptions used in scoring are rigid and misleading. If you want to be in a position to evaluate Social Security reform objectively and accurately, the first thing you have to do is throw out the actuarial analysis. Pay no attention to the "trust fund," the "solvency" of the system, or other noise generated by the actuaries.
They certainly are rigid. And it's true that the solvency or lack thereof depends on those rigid assumptions. I'd be more comfortable with a lower number, but that means that private accounts would have to be introduced much more gradually (to satisfy anyone's definition of actuarially sound). Of course, that wouldn't bother me one bit.
Oh, and one more thing. The proposal in the memo, which apparently is now going by the name of H.R. 530, lets anyone under age 55 start a private account. Read it!
I give you David Altig and Jagadeesh Gokhale's idea from back in 1996, nine years ago. (Yes, the David Altig of macroblog.)
Calculations using the current distributions of Social Security benefits by age and sex (assuming a 1.8 percent internal rate of return on the contributions of those included in the present system, and an 8 percent return on investments in private capital markets) suggest that 42 is the appropriate cutoff age. With this as the dividing line, 18 percent of the contributions of those age 42 and younger would be sufficient to provide those age 43 and older with benefits at least equal to those received under the current system. For younger workers, future benefits may be greater than those offered by the current system, because their contributions will reap the higher private rate of return for an even longer period.
Having dithered for nine years, I'd say the appropriate cutoff is at a younger age now. And this paragraph from the same 1996 article is delicious in its irony.
For an individual starting from scratch, the rate of return from a funded system will clearly exceed that of the unfunded scheme. However, if the cutoff age below which individuals are shifted to the privatized system is too high (say, 55), some workers would not have enough remaining years to exploit the increased private returns, leaving them worse off than before.
I don't know whether to laugh or cry.
Posted by William Polley at February 24, 2005 4:26 PM
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