Grasping Reality on TypePad, by Brad DeLong

I swear, I must have been very bad indeed in a previous life, and must be working off a huge karmic burden. Yes, it is Donald "George Soros Will Crash the Market to Elect Democrats!" and "Bond Yields Are Not Interest Rates!" Luskin--and once again he is far out of his depth:

The Conspiracy to Keep You Poor and Stupid: Brad DeLong sez....

[I]ndexation of benefits after retirement to the price level, not the wage level, adds a wedge between Social Security's costs and its resources roughly equal to half of life expectancy at retirement times the trend productivity growth rate. Each 0.1 percentage point increase in the growth rate of productivity reduces the long-horizon Social Security deficit by approximately 0.1% of taxable payroll.... Real wage and productivity growth of 3.0% per year (as opposed to the 1.1% per year assumed by SSA) would wipe out the 75-year deficit.

The system's unfunded obligation is $13 trillion.... Faster growth would increase both the future revenues and the future benefits in approximately equal measure. The revenues would arrive before the higher benefits must be paid, so there's an illusory improvement if you use a flawed metric like 75-year actuarial balance which counts the inflow but overlooks the outflow, but the actual total deficit, which is on the books already, isn't really affected.

The idea that faster economic growth will eliminate unfunded liability is simply incorrect, as Jagadeesh Gokhale demonstrates in a definitive paper...

Now that's not what the thoughtful and intelligent Jagadeesh Gokhale says. In an impressive and well-argued paper, Jagadeesh Gokhale (2006), "Wage Growth and the Measurement of Social Security’s Financial Condition," at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=920156#PaperDownload, Jagadeesh says two things:

• In a year-by-year pay-as-you-go-balance system, faster real wage growth makes the state of Social Security look better: because it raises each year's wages relative to that year's benefits, it means we need a lower tax rate in each future year less above their current levels in order to balance that year's Social Security tax collections with that year's Social Security benefits.
• In a substantially prefunded full-intertemporal-balance system with a sufficiently rapidly declining ratio of workers-to-beneficiaries, faster real wage growth makes the state of Social Security look worse: the declining worker-to-beneficiary ratio means that a larger share of workers than beneficiaries are in the near future (when faster wage growth makes relative wages lower) and a larger share of beneficiaries than workers are in the far future (when faster wage growth makes relative benefits higher), thus faster real wage growth raises average benefits more than average wages.

I have always thought that the right way to think about Social Security is as a system in which in the long run retirement age is a constant fraction of life expectancy, in which case faster real wage growth definitely helps the system. Jagadeesh taught me that things can work differently--if we assume that the retirement age will never rise, and that life expectancy will continue to grow, thus pushing the worker-to-beneficiary ratio downward.

But only somebody as far out of his depth as a Donald Luskin would ever say that the idea that faster real wage growth can help the Social Security system is "simply incorrect." If it is incorrect (which I don't think it is, not for the most relevant baseline), it is incorrect for a complicated, subtle, and debateable reason. Just listen to Jagadeesh Gokhale try to explain what is going on:

[A]nnual balance ratios... would be larger in all future years [with faster wage growth].... The infinite-horizon actuarial balance is usually interpreted as immediate and permanent payroll tax hike required to balance the system’s intertemporal budget constraint. A reduction in the actuarial balance under faster wage growth means that such a tax increase must be larger. However, an increase in each future year’s annual balance ratios under faster wage growth implies that the “pay-as-you-go” tax rate increase that must be levied in each future year would be smaller....

The conundrum mentioned earlier is resolved in the following sense. Although faster growth leads to smaller pay-as-you-go tax rate hikes in each future year, the share of future wages that is subject to larger tax pay-as-you-go tax rates (compared to the average rate under slower wage growth) increases. The latter (weighting effect) may be sufficiently large under faster wage growth to generate a larger actuarial balance.... The choice between pay-as-you-go and prefunding methods for resolving future financial shortfalls is no longer unambiguous...