Making Sense of the 2012 Social Security Trustees’ Report

Filed Under (Retirement Policy, U.S. Fiscal Policy) by Jeffrey Brown on Apr 24, 2012

Yesterday, the Trustees of the Social Security and Medicare Trust Funds issued their annual report on the financial status of these entitlement programs.  These annual reports have been published for decades, and are generally recognized as the most credible, unbiased, and objective assessment of the long-run financial situation facing these programs.  I am going to focus on the Social Security program in this post.

Interest groups and policy analysts from across the political spectrum immediately issued press releases trying to spin the findings of the report.  Here are the first two that crossed my virtual desk yesterday:

The National Academy of Social Insurance (of which I was a member for many years before finally resigning over frustration at their defense of the status quo) issued a release spinning the report in the most positive light possible:  The 2012 Trustees Report shows that Social Security is 100 percent solvent until 2033, but faces a moderate long-term shortfall. In 2011, Social Security had a surplus – revenue plus interest income in excess of outgo – of $69 billion. Reserves are projected to grow to $3.1 trillion by the end of 2020 … While the trustees’ projections indicate that major changes are not needed, modest changes should be made in a timely manner and can bring Social Security into long-term balance.

In sharp contrast, the Committee for a Responsible Federal Budget issued a release stating:  “Today, the Social Security and Medicare Trustees released their 2012 report on the financial status of Social Security and Medicare, showing that reforms will be needed soon to make these programs sustainable … Social Security as a whole is on an unsustainable path … Social Security’s financial status has deteriorated significantly since last year’s report … Currently, Social Security is adding significantly to unified budget deficits. Not counting the payroll tax holiday this year and last year, the program is projected to run a $53 billion deficit in 2012 and $937 billion from 2013 through 2022.”

Both NASI and CRFB are highly respected organizations, yet the pictures they paint could not be more different.  So, who is right?  Is it possible to reconcile these two views?

Like last week’s post, in which I tried to cut through the rhetoric over the cost of the Affordable Care Act, this post tries to cut through the rhetoric over Social Security’s finances by using a fictitious debate.  And just like last week, the answer to “who is right?” is “It depends …”

Let’s focus on what appears to be a factual disagreement.  NASI says “In 2011, Social Security had a surplus.”  CRFB says “Social security is adding significantly to unified budget deficits.”

How can the program be running both a surplus and adding to the deficit?

The answer is that it depends on whether you think about interest on the Social Security trust funds as being income or not.  One’s views about the Trust Funds also help shed light on whether we should view Social Security as being in financial distress now (the CRFB view), or whether we still have two decades before we have any real problems (the NASI view).

How does the Trust Fund work?  (For this post, I am going to ignore the distinction between the retirement and disability trust funds – implicitly, I am assuming that Congress will simply re-allocate the payroll tax revenue across the two programs, as they have done in the past when needed).

Let’s go back a few years to the pre-financial crisis, say, 2007.  Suppose you earned $50,000 that year.  You and your employer each paid 6.2% of payroll into the system, for a total of 12.4%.  This was approximately $6,200 that the U.S. Treasury collected, and this money was designated for the Social Security Trust Fund.

Social Security took most of that $6,200 (just to keep that math easy, let’s say they took $5,200 of it), and paid it out to current retirees and other beneficiaries (such as disabled workers, widows, etc).  The remaining $1,000 was not needed in that year, so it was handed back to the U.S. Treasury.  In return, the U.S. Treasury issued a $1,000 special-issue U.S. Treasury bond to the Social Security trust funds.  Like other U.S. Treasuries, this one was backed by the full faith and credit of the U.S. government.

Now, back in 2007, like in most years in recent history, the U.S. government was running budget deficits.  Thus, the Treasury department basically took your $1,000 and used it to finance the government spending that we were doing in excess of the income tax revenue we were bringing in.  They did not actually invest the money in financial securities – rather, they spent it.  Of course, they still owe the $1,000 to the Social Security trust fund.

This has been going on for about three decades.  As a result, the Social Security trust fund now owns several trillion dollars’ worth of government bonds.  And the U.S. Treasury pays the trust funds interest on these bonds.

Today, to a first approximation, the entire $6,200 that a $50,000 per year worker and her employer pay into the system is all going to pay benefits.  So there are no more new deposits to the trust fund.  But the balance of the account is quite large, and is spinning off interest.

So here is the key question.  Should the interest that Treasury is paying to the Social Security trust funds be counted as income?  Here is how a discussion might go between NASI and CRFB representatives.  (Any misrepresentations of views are mine alone).

NASI: “Of course the interest should count as income.  The interest grows the trust funds, and the trust funds represent a legal claim by the trust funds that will be backed by the full faith and credit of the U.S. government.”

CRFB: “Yes, but while these bonds – and their interest – represent an asset to Social Security, they are a liability to the U.S. Treasury.  And because the Treasury spent that money rather than saving it, it is crazy to think that we should count this as income.  The interest payments are just an accounting fiction, not a real flow of money into the government as a whole.”

NASI:  “Ah, but the trust funds do represent real savings.  If the Treasury had not issued this debt to Social Security, they would have had to increase public borrowing.  So the Trust Fund balance represents money that the U.S. did not have to borrow – and that is a form of saving.”

CRFB: “But for decades, Congress used the Social Security surpluses to hide the deficits in the rest of the government.  As a result, Congress spent more money over the past few decades than they would have if they had not been able to hide the true cost of their profligacy behind a unified budget framework.”

NASI: “There is no way to know for sure that the Social Security surpluses led to increased spending by Congress.”

CRFB: “Ah, but there is – at least two academic studies (here and here) have shown that this is exactly what happened.”

NASI: “Academic studies aside, there is no question that we should count this interest.  And if we do count it, it is clear that Social Security is running a surplus.  It is also clear that the program can pay 100% of promised benefits at least until 2033.”

CRFB:  “But that is a narrow perspective.  We care about the government budget as a whole – not just the narrow question of the Trust Funds.  From that perspective, what we know is that the amount of money we are collecting in payroll taxes today is no longer enough to cover the payments to beneficiaries.  The days of cash flow surpluses are gone.  And because interest on the trust fund is just one arm of government (Treasury) making a paper transfer to another arm of government (the Trust Funds), this does not represent real income to the government as a whole.  As such, the program is in dire straits, and needs to be fixed now.”

That fictitious debate roughly captures the economic disagreement underlying these two very different assessments of the latest Trustees’ Report.

I happen to support the CRFB view that the problem is serious, that we need to address it sooner rather than later, and that there is no pain-free solution.  But at the end of the day, it is impossible to fully refute the NASI view because we cannot go back in time and re-run an alternate history to know how spending would have responded in the absence of past Social Security surpluses.

Regardless of which view one holds, it is becoming increasingly difficult to deny the existence of a financing problem.  Even if you take the NASI view that we do not have a problem until the trust funds run dry in 2033, it is worth noting that this date is quite a bit earlier than what has been previously estimated.  Furthermore, 21 years is not a very long time when we are talking about a retirement program.  After all, nearly half of today’s 65-year olds will still be alive in 2033 and relying on Social Security benefits.  Today’s 46-year olds will reach their normal retirement age in 2033.  And today’s college students will be nearly half-way to their own retirement age.  We need to make changes now – so that we have time to phase-in the changes gradually and to allow individuals to adjust.

So, regardless of one’s views about the trust funds, it seems obvious to me that the real story behind the release of the Trustees’ Report is that the problem is real, it may be larger than we previously thought, and that it is not going to go away on its own.

What Happens When the Disability Insurance Trust Fund Runs Out of Money?

Filed Under (Retirement Policy, U.S. Fiscal Policy) by Jeffrey Brown on Aug 29, 2011

Last week, the non-partisan Congressional Budget Office (CBO) put out an update of the financial status of the Social Security system’s finances (using, by the way, new “infographics” to illustrate the issues).  To policy wonks like myself who follow Social Security’s more closely than we do the Major League Baseball standings, the report simply confirms what we already know – namely, that the Social Security system is on a financially unsustainable course and that it is doomed to insolvency unless Congress gets its act together and makes some difficult decisions.

What really hit the news cycles in the past week, however, was the fact that the expected date of insolvency of the Disability trust fund is now just five years and a few months away – the year 2017.  This is a couple of decades earlier than we usually talk about exhausting the Social Security trust funds, and thus, I suspect, this news has caused some confusion.  So this blog attempts to explain how the trust funds work, and what the exhaustion of the trust fund means for recipients of disability payments.

First, it is worth knowing that the Social Security program is really more than one program.  Formally, there is the OASI program (Old-Age and Surivivors’ Insurance – think of this as the program for retirees and their widowed spouses), and the DI program (Disability Insurance – this is the one that pays benefits to workers who have a disability that severely limits their ability to work).

Second, while we often talk about the “Social Security trust fund,” there are, in fact, two separate funds – one for OASI, and one for DI.  While these are legally separate funds, they are often talked about as a “combined trust fund,” and most of the debate about the long-term problems facing Social Security use data on the combined trust fund.  This masks, however, the fact that the current financing status of the OASI and DI programs are not exact duplicates.  Specifically, the DI trust fund is expected to be exhausted much sooner than the OASI trust fund – 2017 according to the CBO’s most recent estimate.

Third, while we economists can forever debate the economic meaning of the trust funds (I will spare you this debate for now), there is little question about the legal meaning of the trust funds.  Specifically, it is widely understood that so long as the DI trust fund has a positive balance, the Social Security Administration can continue to send out benefit checks to DI recipients, even if the tax revenue flowing into Social Security from the DI portion of the payroll tax (known as the FICA tax) is insufficient to cover benefit payments.  This is because the DI trust fund can redeem the U.S. government bonds that it is holding.  And as long as the U.S. Treasury does not default on its obligations, this means that the Social Security Administration has the legal authority to issue checks.

So, what happens if and when the DI Trust Fund runs dry in 2017?  Well, if Congress failed to act in any way (an outcome I consider implausible, and will say more about below), the Social Security would find itself in a position in which it did not have sufficient dedicated revenue to cover benefits.  The most likely scenario is that they would begin delaying the issuance of checks to beneficiaries.   Eventually, the backlog of checks would grow so long that it would amount to a benefit cut – beneficiaries may only get 11 checks per year instead of 12, for example.  This would be a terrible outcome, because no matter what your views on the role or size of government, it is hard to explain how reneging on payments to some of our most financially vulnerable citizens is the best way to close a budget shortfall.

You may wonder why the Social Security Administration could not just “borrow” some of the OASI money to pay the DI beneficiaries.  And the short answer is that the agency does not appear to have the authority to do this.  Rather, it would require an act of Congress to re-allocate the proportion of the payroll tax revenue that goes to each program.  As they did in the 1980s, for example, Congress could simply state that a larger fraction of the existing FICA tax go to DI instead of OASI.  This patches the short-term problem facing DI, and allows checks to go out.  Of course, it is also “robbing Peter to pay Paul” because it simply makes the OASI trust fund go dry that much sooner.

What we really need is thoughtful reform of both the OASI and DI programs.  Both are important programs to the well-being of individuals who are retired or disabled, but both programs are also not financially sustainable.  We need to adjust benefits, taxes or eligibility in order to bring the system back into long-term balance.

So the good news is that those who rely on the Social Security Disability Insurance program most likely have little to fear about the 2017 insolvency date, because Congress will most likely paper over that problem by reallocating the FICA tax.  But the bad news is that their ability to do so will most likely lead to further delays in making the serious reforms that these programs so badly need.