Why We Can't Wait to Act on the Debt
Last week, Paul Krugman took issue with Tom Friedman's comparison between climate change and the debt situation, but unfortunately missed the mark quite badly. While Friedman argued that both are long-term problems which must be addressed beginning today to avoid dire consequences in the future, Krugman disagreed, arguing that those of us who support gradual deficit reduction and entitlement reform "never, as far as I can tell, really ask why it’s important to do this now." Krugman uses Social Security an example, but suggests the same argument applies to other programs. He writes (emphasis added):
...think about it... the threat, if you like, is that future benefits will fall short of what people now expect. To avert this threat, the usual suspects insist that we must gradually reduce the program’s generosity. That is, in order to guard against cuts in future benefits we must … cut future benefits. Huh?
OK, there are some arguments you could make; maybe the adjustment would be smoother, with less of a "cliff" when the trust fund runs out, if we set benefits on a downward glide path. But that’s a second-order issue, literally: we aren’t talking about preserving the overall level of benefits, we’re just talking about reducing its variance around a smooth trend.
Unfortunately, Dr. Krugman's argument is very flawed. To begin with, he suggests that "deficit scolds" are concerned exclusively with spending scheduled to take place well into the future, when in fact we've called for trillions of dollars of deficit reduction this decade in addition to long-term reforms. He also suggests that Social Security may indeed be solvent (he uses the word "affordable") if projections turn out to be too pessimistic, but the Social Security Administration believes with 97.5 percent certainty that the trust fund will be exhausted by 2042, and as early as the late 2020s.
More fundamentally, though, he appears to misunderstand the consequences of waiting to address the debt. As with climate change, the consequences of heavy debt accumulation are in fact quite difficult to reverse. Large continued deficits lead to a large stock of debt, which would result in slower economic growth and higher interest payments that in combination with the debt level itself make it difficult to return to reasonable debt levels. As Tom Friedman explained, "at some point, the debt will get so large that big tax increases and spending cuts will simply go to pay interest."
Krugman's argument is especially flawed when it comes to Social Security, which must legally abide by trust fund accounting (whether or not it is economically important, which we explain here). Acting now to reform Social Security is not akin to avoiding benefit cuts with benefits cuts. Changes made today and implemented gradually could be better targeted, economically fairer to beneficiaries, and indeed smaller than would otherwise be the case.
How could changes be smaller?
First, the sooner we make changes the more people can share the burden of those changes. That means less drastic benefit or contribution changes per person. Second, trust fund accounting (which Dr. Krugman appears to believe in) allows money to be saved and accumulate interest. In practice, this may or may not result in any actual savings in an economic sense, but it does under the law allow for Social Security changes to occur more gradually and defer the date by which spending and contributions will need to be brought into line. As an example, current law calls for a 25 percent across-the-board benefit reduction in 2033; by contrast, the Simpson-Bowles plan would avoid insolvency with the combined value of tax and benefit changes being the equivalent of only an 11 percent benefit reduction (about four-sevenths of that total from revenue). Avoiding trust fund insolvency with both gradual benefit reductions and revenue increases gets to a much better outcome than an automatic reduction when the trust fund runs out.
So, how much smaller could changes be? According to our calculations, based on projections by the Social Security Trustees, acting today would require changes equal to 2.7 percent of taxable payroll to keep Social Security solvent through 2087. Waiting until 2023 would require a 3.3 percent change, and waiting until 2033 a 4.2 percent increase. These differences are not insignificant. (Also note that a similar principle is true for the fiscal gap as a whole; the longer we wait, the larger the necessary adjustment).
Source: CRFB calculations based on Social Security Trustees
Why would changes be better targeted?
Acting now leaves time and room for intelligent changes to the program. Current retirees can be largely protected. Benefit formulas can be changed in a progressive way which exempts lower earners. Revenue can be raised through gradual increases in the taxable maximum or broadening of the tax base. Eligibility criteria could be altered only in line with changing demographics and in a way that encourages work. Additionally, enough savings can be generated to offer new protections for the most vulnerable.
On the other hand, current law projections call for a 25 percent across-the-board benefit reduction in 2033. All beneficiaries would be affected, from the wealthy, newly retired 62 year-old to the poor 102 year-old to the disabled worker to the elderly widow. It is true that policymakers could act just in advance of this automatic cut to better allocate the changes. However, by that point their choices would be quite limited. As Social Security Trustee Charles Blahous explained, "by 2033, even eliminating all benefits for new retirees would be insufficient to close the program’s deficit, as would the largest payroll tax increase heretofore enacted."
Why would changes be economically fairer?
Despite Dr. Krugman's assertion to the contrary, making changes gradually and in advance rather than abruptly and by surprise is far from "a second-order issue". Dr. Krugman would be one of the first to explain that abrupt spending cuts or tax increases in the current economic environment would be damaging. But the reasons for making gradual changes go far beyond that. Social Security is in large part a retirement program, and individuals make savings, work, and retirement decisions based on it. Making rapid changes to the program will not only result in extraordinarily unfair notches, it would also rob Americans of the chance to plan and prepare for changes in benefits.
It is for these reasons and others that Charles Blahous and Bob Greenstein (president of the Center on Budget and Policy Priorities) wrote the 2010 paper Social Security Shortfall Warrants Action Soon. As they explained:
Social Security faces a significant shortfall, which policy makers would be better off addressing sooner rather than later. Prompt action would reduce the risks of sudden future changes in the benefit structure, better inform current workers’ retirement planning and increase public confidence in Social Security. All projections regarding the program’s finances contain an element of uncertainty, but this is not a reason to adopt a “wait-and-see” attitude. Under the overwhelming majority of possible scenarios, and allowing for variance in a wide range of critical variables, Social Security’s future shortfall will be substantial. It is also much more likely that the shortfall will be significantly larger than now projected than that it will vanish altogether. All of these factors argue for acting soon. Reasonable and well-intentioned people will have differences over the best way to resolve the Social Security shortfall. We share a common interest, however, in taking action to do so at the earliest practicable time.
It is clear there are benefits to being proactive when we know we have to act in the future. Putting off smarter reforms today invites potentially large and sudden policy changes down the road. Even if the changes turn out to be greater than necessary, it is much easier for Congress to slow or reverse those changes rather than scrambling to implement sudden benefit reductions or tax increases. Delaying action is entirely unnecessary when we can put in place gradual changes to the budget sooner rather than later.