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.

Top Ten Myths of Social Security: Myth #2 – Economic Growth will Save Social Security

Filed Under (Retirement Policy, U.S. Fiscal Policy) by Jeffrey Brown on Dec 6, 2010

A few weeks ago, I posted the first in a series of myths about Social Security (click here for the first one). Today, I want to tackle a second major myth concerning Social Security, namely, that we need not concern ourselves about Social Security’s shortfalls, because the problem will go away thanks to economic growth.

Some Social Security analysts and commentators argue that the economic growth assumptions in the Social Security Trustees’ Report are too pessimistic, and that with higher economic growth, Social Security’s finances will remain strong for the foreseeable future. One of the highest profile supporters of this view is Paul Krugman, who wrote in a 2005 editorial that “faster growth will yield a bonanza of payroll tax revenue that will keep the current system sound for generations to come.”

If only it were so easy! Unfortunately, this myth sounds plausible to many, especially when the statement is being made by a Nobel Laureate (although I should hasten to add that Krugman won his Nobel prize for research completely unrelated to Social Security, a topic on which he has no particular academic expertise).

The basis for this myth is that the Social Security Trustees’ Report assumes a rate of economic growth over the next 75 years that is lower than the historical growth rate over the past several decades. If one were to simply increase the assumed rate of economic growth to this historical level, Social Security’s financial woes would appear much less severe.

Importantly, the assumed low rate of economic growth does not arise from a pessimistic view about future productivity growth. Indeed, the long-run rate of productivity growth assumed in the 2010 Trustees Report for the next seventy-five years is 1.7%, which is in-line with total productivity growth over the past five economic cycles (covering the period 1966-2007) (see p. 93 of 2010 Trustees Report) Rather, the low rate of economic growth stems from the assumed reduction in total employment growth On pages 100-101, the Trustees discuss their assumptions in detail, noting that this growth slow-down is attributable to the slowing of growth of the working age population, a “natural consequence of the baby-boom generation approaching retirement and succeeding lower-birth-rate cohorts reaching working age.” While one might argue that their specific assumptions are pessimistic, it seems hard to argue with the basic logic that some reduction in the growth rate of total employment is justified, given that the entire baby boom generation will move from being part of the labor force to being entirely out of the labor force over the next seventy-five years.

More generally, while it is correct that higher rates of economic growth lead to higher tax revenues in the future, it is important to understand that in a wage-indexed system such as ours, future benefit obligations also grow when wages rise. Specifically, the current Social Security benefit formula is designed to hold benefits constant relative to a retiree’s average (wage indexed) lifetime income. As average earnings rise, therefore, so do promised benefits. Thus, while economic growth does improve the long-run sustainability of the system (a point made by Brad DeLong, among others), under most reasonable assumptions the need for policy changes is not eliminated. Indeed, if the economic growth rate were increased to historic levels, this would only postpone the onset of cash flow deficits by a few years.

More generally, analysts are no doubt correct to assert that the actuarial and economic assumptions used to evaluate the future cash flow problems of Social Security are, in fact, just assumptions. It is certainly true that any set of projections will, ex post, likely turn out to be wrong. But uncertainty about the future cuts both ways, suggesting that while Social Security’s future cash flow may turn out to be better than expected, they could also be worse than expected. Prudent planning for the future should actually place more weight on the downside risk than on the upside potential.

The bottom line is that, yes, future projections are subject to considerable uncertainty. But to avoid making politically difficult policy corrections based on the fact that the future might turn out better than expected strikes me as unwise. Rather than using the existence of uncertainty as an excuse to avoid responsible policy actions, policymakers should look for ways to reform the Social Security system so that it is more resilient to unexpected demographic and economic shocks.