Brad Setser

Brad Setser: Follow the Money

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The budget deficit before all the bad stuff

by Brad Setser
November 23, 2004

Isn’t that what leaving any increase in deficit associated with partial privatization of social security off the books implies?

Bush’s formula on the dollar in Santiago emphasized the need to control both short-term and long-term deficits. I suspected he was laying the groundwork for arguing that his valiant efforts to reduce the relatively small (1.5% of GDP) deficit in the social security account after 2042 should offset the say 1.5% increase in the current budget deficit associated with many partial privatization schemes. But even I did not think they would float the idea of excluding any increase in the deficit associated with the transition off the books.

W has long spoke against the “soft bigotry of low expectations” — the idea that you are doing a student who does not meet educational standards a favor by promoting the student to the next grade, irregardless. But isn’t that kind of like what the Bush economic team is proposing here? If you cannot meet the 2% of GDP fiscal deficit target in 2008, conventionally defined, shift the goal post/ make the test easier/ change the way the deficit is measured so a 4% of GDP deficit is now called a 2% of GDP deficit. Judging from the currency markets today, I suspect cooking the books won’t pass the global test.

That is why the market should discount the administration’s new talk of fiscal discipline — they show no signs of being willing to make hard choices. A serious proposal for partially privatizing social security would raise taxes to fund the transition costs — not change the way the deficit is measured so that the transition costs are kept off the official books.

Incidentally, Steve Friedman is leaving the White House. He clearly was no Robert Rubin. But I suspect he did exert some moderating influence on W’s economic policy — Friedman and Rubin worked extremely closely together at Goldman Sachs, so I suspect he shared at least some of Rubin’s economic policy instincts. The names floating around for the NEC job right now are not encouraging.Incidentally, I am not at all sure W is doing himself any favors by emphasizing the long-term deficit:

1) Medicare is in much worse shape than social security. It has a much larger long-term deficit than social security. W made its long-term deficit worse with the Karl Rove “I want to win Florida” prescription drug benefit.

2) It is easy to see how partial privatization could increase, not decrease Social security’s long-term deficit. Roubini wrote about this recently in his blog. To cut the long-term deficit in the social security system, you need to increase revenues/ decrease benefits. Partial privatization reduces the systems’ revenues, which means the needed cut in benefits is much deeper. If you partially privatize and don’t cut benefits enough to eliminate the existing (after 2042) deficit AND the additional deficit created by diverting funds into private accounts, you make the system’s long-term deficits worse.

3) The deficit in the general fund — i.e. the non-social security part of the government — starts looking pretty scary after 2010 or so if you assume W’s tax cuts are made permanent. That is a much more immediate problem than the post 2042 social security deficit.

13 Comments

  • Posted by Tom DC/VA

    Both the 2018 and 2042 “problems” are easily solved provided the federal government balances its books tomorrow. The real crisis was in 2001 when the Bush administration purposely created a structural deficit.

  • Posted by anne

    Dear Brad, there is a mis-type in line 3 of paragraph 2. Nice post.

    http://www.nytimes.com/2004/11/28/politics/28secure.html?

    Vast Borrowing Seen in Altering Social Security
    By RICHARD W. STEVENSON

    WASHINGTON – The White House and Republicans in Congress are all but certain to embrace large-scale government borrowing to help finance President Bush’s plan to create personal investment accounts in Social Security, according to administration officials, members of Congress and independent analysts.

    The White House says it has made no decisions about how to pay for establishing the accounts, and among Republicans on Capitol Hill there are divergent opinions about how much borrowing would be prudent at a time when the government is running large budget deficits. Many Democrats say that the costs associated with setting up personal accounts just make Social Security’s financial problems worse, and that the United States can scarcely afford to add to its rapidly growing national debt.

    But proponents of Mr. Bush’s effort to make investment accounts the centerpiece of an overhaul of the retirement system said there were no realistic alternatives to some increases in borrowing, a requirement the White House is beginning to acknowledge.

    “The administration hasn’t settled on any particular Social Security reform plan,” Joshua B. Bolten, the director of the White House’s Office of Management and Budget, said in an e-mail message in response to questions about overhauling the system.

    “The president does support personal accounts, which need not add over all to the cost of the program but could in the short run require additional borrowing to finance the transition,” Mr. Bolten said. “I believe there’s a strong case that this approach not only makes sense as a matter of savings policy, but is also fiscally prudent.”

    Proponents say the necessary amount of borrowing could vary widely, from hundreds of billions to trillions of dollars over a decade, depending on how much money people are permitted to contribute to the accounts and whether the changes to Social Security include benefit cuts and tax increases.

    Borrowing by the government could be necessary to establish the personal accounts because of the way Social Security pays for benefits. Under the current system, the payroll tax levied on workers goes to benefits for people who are already retired. Personal accounts would be paid for out of the same pool of money; they would allow workers to divert a portion of their payroll taxes into accounts invested in mutual funds or other investments.

    The money going into the accounts would therefore no longer be available to pay benefits to current retirees. The shortfall would have to be made up somehow to preserve benefits for people who are already retired during the transition from one system to the other, and by nearly all estimates there is no way to make it up without relying at least in part on government borrowing.

    Mr. Bush and Republicans in Congress have paid little political price in the last four years for the swing from budget surpluses to deficits. But some polls show that Americans consider reducing the deficit to be a higher priority than many other goals, including cutting taxes, and embracing a new round of borrowing could pose political as well as economic risks.

    A reasonable amount of borrowing now, the proponents say, would avert a much bigger financial obligation decades later. They say personal accounts would yield higher returns for individuals than the current system and could be a catalyst to broader changes that would bring the benefits promised by Social Security into line with what the system, which is also about to come under intense financial strain from the aging of the baby boom generation and the increase in life expectancies, can afford to pay.

    Mr. Bush has vowed to push hard to remake Social Security. Republicans in Congress say the White House has signaled to them that Mr. Bush will put the issue at the top of his domestic agenda in the coming year.

  • Posted by brad

    anne — hope i fixed it. tis fair to say i would often have trouble passing a spelling test …

  • Posted by anne

    Brad,

    Your Blog is lovely, and I will look to it from now on. The puzzle I have is in the sentence below. How should I read “small deficit (1.5% of GDP) long-term deficit?” Thanks so much.

    I suspected he was laying the groundwork for arguing that his valiant efforts to reduce the relatively small deficit (1.5% of GDP) long-term deficit in the social security account after 2042 should offset the say 1.5% increase in the current budget deficit associated with many partial privatization schemes.

  • Posted by anne

    NYTimes

    Vast Borrowing Seen in Altering Social Security

    “To the extent that the transition is debt-financed, the ostensible macroeconomic benefits from individual accounts are undermined,” said Peter Orszag, an economist at the Brookings Institution who has been critical of personal account plans. “In particular, you do not get an increase in national savings. It’s engaging effectively in accounting gimmicks to make it look as if you’re doing something when you’re not.”

  • Posted by anne

    There may even be a wish to emphasize the borrowing costs in moving to privatize Social Security. As some of the borrowing costs are made clear, there may be a rationale accepted for cutting benefits in some manner for workers not yet retired.

  • Posted by anne

    Possibly you and Brad DeLong may wish to consider this most important article as well:

    http://www.nytimes.com/2004/11/28/international/africa/28swazi.html?oref=login&pagewanted=all&position=

    Hut by Hut, AIDS Steals Life in a Southern Africa Town
    By MICHAEL WINES and SHARON LaFRANIERE

    LAVUMISA, Swaziland – Victim by victim, AIDS is steadily boring through the heart of this small town.

  • Posted by William Stepp

    Steve Friedman was no Robert Rubin. No, he was an economic policy advisor, not Secretary of the Treasury. Apples vs. oranges.

  • Posted by brad

    William –

    Rubin started off at the head of Clinton’s National Economic Council before moving to Treasury. So both Rubin and Friedman had the same job for about two years.

    Anne — think i fixed that … meant to say something more like “relatively small deficit in social security after 2042″

  • Posted by anne

    Agreed; an important comment!

    Bush’s formula on the dollar in Santiago emphasized the need to control both short-term and long-term deficits. I suspected he was laying the groundwork for arguing that his valiant efforts to reduce the relatively small (1.5% of GDP) deficit in the social security account after 2042 should offset the say 1.5% increase in the current budget deficit associated with many partial privatization schemes. But even I did not think they would float the idea of excluding any increase in the deficit associated with the transition off the books.

  • Posted by ace

    irregardless chaps my hide.

  • Posted by baby blankets
  • Posted by Guest