Social Security

Via Brad de Long, news comes that Ed Lazear, chairman of President Bush's Council of Economic Advisors, believes we don't have to worry about Social Security's solvency anymore.

Alas, a blog » Blog Archive » Bush’s Chief Economist Predicts Social Security “Crisis” Will Never Happen: Capital Commerce1 quotes Edward Lazear, the Chair of Bush’s Council of Economic Advisers, answering a question about productivity growth:

I wouldn’t necessarily say 3 percent. But I would expect that we could expect to see high rates, perhaps not quite at the 3 percent level, but somewhere higher than 2 percent. I would expect somewhere closer to 3 percent … If I’m thinking about long-term productivity growth and asking, “Do the fundamentals exist for persistent high productivity growth in the upper 2 percent range?” I think we can still be there, again as long as we continue to maintain policies that are consistent with an open economy.

If Bush’s chief economist is right, then there’s no Social Security shortfall [over the next 75 years].... Predicting the future isn’t simple; the Trustees have to make certain assumptions. One of their assumptions is that productivity increases for the next 75 years will be, on average, 1.7% a year. If they’re right, then the next 75 years will feature the lowest productivity gains in American history....

But what if the next 75 years aren’t actually the worst 75 years in US economic history?... That brings us back to Edward Lazear’s prediction of near-3% growth in productivity. If he’s right, then maybe there won’t be any Social Security shortfall. Higher productivity means, at least in theory, that workers earn more; workers earning more means that, without raising taxes, payroll tax revenues go up...

Here are the relevant figures from the 2006 Social Security Administration Trustees report. Figure II.D7 shows us the balance in the Social Security trust fund under three scenarios: low cost (labeled I), high cost (labeled III), and intermediate cost (labeled II).

The intermediate cost projections are the headline projections that everyone talks about: the line plummets to zero in 2040, hence the claim that on that date Social Security will be "bankrupt". But the low cost (optimistic scenario) has the trust fund bottoming out at 400% of annual cost and rising after about 2060. What are the key differences in assumptions that underlie the different scenarios? That's in Table II.C1:

The faster we breed, the quicker we die, the more immigration we allow, etc., the more healthy is the trust fund. The relevant figure here is productivity growth: the intermediate scenario assumes productivity growth will be 1.7% for the next 75 years, which is historically very low, whereas the low cost scenario predicts a more normal rate of productivity growth of 2%. Ed Lazear is much more optimistic, predicting productivity growth "closer to 3%". In an earlier posting, DeLong gives us a rule of thumb for assessing the impact of productivity growth: each 0.1 percentage point increase in projected productivity growth reduces the long-horizon Social Security deficit by 0.1% of taxable payroll. The Trustees estimate the long-term actuarial deficit at 2.02% of payroll, assuming 1.7% productivity growth. At 2.0% productivity growth, it's down to 1.7% of payroll. At 3.0% productivity growth, it's down to 0.7% of payroll. High productivity growth brings the problem down to manageable size, where we can start talking about doing some minor tinkering somewhere down the road rather than gigantic reforms immediately.

By the way, for the last decade the unemployment rate (even accounting for the 2001 recession) has averaged under 5%, considerably below the intermediate projection. So that's another factor that could very well push the deficit projection down.

The real crisis is in Medicare (and the health system in general), not Social Security.