November 27, 2014

Social Security Moving Back To The Policy Agenda

With pressure mounting to show progress in reining in the nation’s unsustainable structural budget deficit, Social Security reform may soon return to the policy agenda.

Presidents Bill Clinton and George W. Bush each made attempts at reforming Social Security in their second terms when they no longer faced the prospect of having to run for re-election. Nevertheless, both efforts ran aground in the treacherous political waters that surround this issue.

At first glance, circumstances may now seem even less favorable for reform. President Obama is in his first term and re-election considerations are very much in play. Moreover, the economy is still fragile, the public is in a very distrustful mood, huge near-term deficits make an infusion of general revenues improbable, and partisan divisions are deeper than ever following a bruising battle over health care reform.

And yet, a closer look reveals reasons to think that these circumstances enhance rather than impede the prospects of another attempt at Social Security reform.

For one thing, it is increasingly clear that Social Security’s finances are in trouble. No longer can it be argued that excess cash flows from the Social Security payroll tax is making a positive contribution to the federal budget. This year, for the first time since 1983, it is expected that the program will pay out more than it takes in.

The Congressional Budget Office (CBO) projects that annual Social Security cash deficits will persist through 2013. Small surpluses will then reappear for a couple of years before turning into permanent and growing deficits by 2016. Over the coming 10-year budget window, Social Security will run a cumulative cash deficit of $223 billion, according to the CBO projections.

The emergence of cash flow deficits means that Social Security will need to begin redeeming the special U.S Treasury bonds that make up its trust fund account.

That, in turn, will put pressure on the rest of the budget because the only choices available will be to cut other spending, raise taxes, or borrow the money (i.e., increase the deficit). What was once considered to be a “long-term” problem has moved to the present. And the longer one looks into the future, the larger the financing challenge becomes. According to the most recent Social Security trustees report (2009) the annual cash deficit will reach 1.4 percent of GDP by 2035 before leveling off.

Fiscal considerations aside, there is also the issue of public trust in government. The public is increasingly frustrated with the inability or unwillingness of elected leaders to work together on solutions to known problems. Financial markets are also keeping a sharp eye on Washington’s ability to manage its deteriorating fiscal condition.

Reaching bipartisan consensus on a plan to shore up Social Security would send a positive signal to both the public and the financial markets. It would say to the public that politicians can work together to solve important problems and it would say to financial markets that Washington is not paralyzed in the face of mounting debt.

It is true that rising health care costs present an even bigger challenge over the long term and that serious reforms of the tax system will also be needed. But if the political challenge of tackling Social Security’s financing gap is daunting, Medicare and tax reform may prove even more difficult. With Social Security reform, the options are at least well known and have been debated for years. Thus, when looking for ways to address the structural deficit, Social Security has gone from being the “third rail of American politics” to the “low hanging fruit.”

In recognition of the debate to come, the Senate Special Committee on Aging released a new report last week titled, Social Security Modernization: Options To Address Solvency and Benefit Adequacy.

The report is very thorough in describing how Social Security works, how it has been successful, and how benefits might be improved for the most vulnerable. In a reminder of the program’s importance, the report states “it is estimated that 44 percent of older Americans would be considered poor by federal standards if they did not receive Social Security benefits. And for the majority of retired Americans, Social Security serves as their primary source of income.”

Thirty options for improving Social Security’s 75-year actuarial balance (solvency) are examined in the report. They include various ways of either raising revenue or reducing promised benefits.

While the report is quite informative in some respects, it falls short of being a comprehensive guide to Social Security reform.

Benefit adequacy is, of course, a key consideration in assessing the program’s future. But so, too, is individual and generational equity. In a glossary of terms, the report describes equity as follows:

Equity, Including Intergenerational – the goal to ensure that the costs and benefits of Social Security bear some relationship to contributions and that a much greater burden is not placed on certain specific groups, including certain generations of workers.

Equity receives scant treatment in the body of the report, and yet Social Security’s commitment to this goal will be tested by many of the reform options likely to be considered. For example, simultaneously raising the cap on taxable wages, now $106,800, and scaling back future benefits for upper income beneficiaries would risk a negative value of contributions for those affected. Whether this would reduce overall public support for the program is an issue to be considered.

Another shortcoming of the report is its focus on 75-year trust fund solvency, which  minimizes the magnitude of the fiscal challenge, says nothing about the program’s impact on national savings or equity and leads to the conclusion that only “minor changes to the system are needed.”

By this measure, Social Security is said to be “solvent” until 2037 and that full benefits can be paid until that time. That may sound reassuring, but all it really means is that the government owes itself a great deal of money.

Trust-fund accounting obscures the magnitude and timing of Social Security’s financing gap by assuming that trust-fund surpluses accumulated in prior years can be drawn down to defray deficits incurred in future years.  However, the trust funds are bookkeeping devices, not a mechanism for savings. The special issue U.S. Treasury bonds they contain represent a promise from one arm of government (Treasury) to satisfy claims held by another arm of government (Social Security). They do not indicate how these claims will be satisfied or whether real resources are being set aside to match future obligations. Thus, their existence does not, alone, ease the burden of paying future benefits.

The real test of fiscal sustainability is how effectively, and in what time frame, reforms close Social Security’s long-term gap between outlays and dedicated tax revenues. In other words, the question to ask is not what the program looks like over a 75-year average but how it looks at the end of the 75th year. Are we on a sustainable path or headed over a cliff?

Reforms that focus just on actuarial balance may achieve temporary “solvency” but quickly leave the program “insolvent” as new years of large deficits are added to the 75-year average and trust fund surpluses are subtracted. That, in fact, is what happened in the case of the 1983 reforms. By 1985, the trustees estimated that the program was solvent for just 64 years, not 75, and 10 years later solvency was projected for just 35 years. That projection is now down to 28 years (from 2009). 

As an example, consider the effect of raising the payroll tax by 2.2 percentage points, from 12.4 percent of taxable payroll to 14.6 percent. In the context of actuarial balance this reform, as reported by the Senate Aging Committee, would fix the problem. And yet, according to estimates by Social Security’s chief actuary, this reform would only add 7 years of cash surpluses and close just 50 percent of the gap in the 75th year.

Meanwhile, nothing would prevent the government from simply spending the new revenues. For the 2.2 percent “solution” to work in something other than an accounting sense, the new money would have to be saved. That means politicians would have to allow the program’s extra interest-earning assets to accumulate unspent for decades – a proposition that seems highly unlikely and in any event cannot be guaranteed.

When the time comes for the President and Congress to consider actual reform plans, more consideration will have to be given to how the program looks in its 75th year, not just the average over that time, and how the equity standard is achieved.

The Concord Coalition believes that Social Security reform plans should meet three fundamental objectives¾ensuring Social Security’s long-term fiscal sustainability, raising national savings, and improving the system's generational equity:

  • Long-term fiscal sustainability.  The first goal of reform should be to close Social Security’s financing gap over the lifetimes of our children and beyond.  The only way to do so without burdening tomorrow’s workers and taxpayers is to reduce Social Security’s long-term cost.
  • Increased national savings.  As America ages, the economy will inevitably have to transfer a rising share of real resources from workers to retirees.  This burden can be made more bearable by increasing the size of tomorrow’s economy.  The surest way to do this is by raising national savings rates and hence, ultimately, productivity growth.  Without new savings, reform is a zero-sum game.
  • Generational equity.  As currently structured, Social Security benefits offer each new generation of workers declining value on their contributions. Reform must not exacerbate—and ideally should improve—the generational inequity underlying the current system.

 

For further information, please see the Social Security Administration's scoring of various reform options as well a report by the Senate Special Committee on Aging titled "Social Security Modernization: Options to Address Solvency and Benefit Adequacy."