[Update: Bernard Yomtov convinced me that the CBPP did not make the error I suggested below. Instead, the way that they accomplished the swindle is explained in this post.]

As a share of GDP, increases in future Medicare and Social Security benefits are much larger than the tax cuts enacted by the Bush Administration. The figures are roughly 10 percent of GDP and roughly 2 percent of GDP, respectively.

However, the Center on Budget and Policy Priorities compares the present value of future entitlement shortfalls to the tax cuts. This method, cited in the New York Times by Paul Krugman, uses an interest rate to discount future dollars to present dollars. Since the entitlement shortfalls are farther in the future, they are discounted more heavily, which reduces their magnitude. According to Krugman and to the CBPP, this shows that the present value of the shortfalls in Social Security in Medicare comes to less than $10 trillion, which makes it smaller than the revenue foregone by the Bush tax cuts.

(For a basic introduction to interest rates and present value, go here. For a discussion of present value calculations in the context of the Federal Budget, see the discussion of generational accounting here.)

With discounting, the choice of the interest rate is crucial. A low interest rate would artificially diminish the magnitude of the Bush tax cuts. A high interest rate would artificially diminish the value of the future entitlements.

What is a good interest rate to use? As this article shows, this is a difficult issue. However, almost all economists would agree that a real (inflation-adjusted) interest rate is more appropriate than a nominal interest rate. Most economists would agree that the best estimate of the long-term real interest rate is the rate on inflation-indexed Treasury securities, or TIPS, which currently is about 2 percent.

What interest rate did the CBPP use? The answer is buried, quite literally, in a footnote that says only

Assumes level of GDP and interest rates projected by the Social Security actuaries

I did a search to try to find the interest rate projected by actuaries. I found this document from the year 2000, which gives an interest rate of 6.9 percent. I found this answer using a query on the Social Security web site, which gives an interest rate of 6.4 percent.

These are nominal interest rates, not real discount rates. They are three times the rate that one should use, so that they completely distort the relationship between present and future budget actions. Using an interest rate over 6 percent artificially reduces the impact of future entitlements relative to near-term tax cuts. I am certain that if one re-did the calculation with a more reasonable interest rate–less than 2 percent–then this would show that it is the entitlement shortfalls that exceed the tax cuts in their impact.

To put this another way, if an interest rate over 6 percent can be assumed, then switching Social Security and Medicare to private accounts earning that rate will have the appearance of tripling the rate of return that individuals earn. If the Bush Administration were to use such an interest rate to justify a privatization proposal, I am sure that Krugman and the economists at the CBPP would be the first to cry “foul.”

For Discussion. What hidden assumptions might distort a calculation that is expressed in terms of the share of GDP rather than in terms of present value?