November 26, 2014

How To Measure Social Security's Financial Status

Volume IV, Number 6
June 15, 1998


In April, Congress held hearings on the Social Security Administration's FY 1997 Accountability Report. Among the items discussed: SSA's proud announcement that its "net financial position" is a positive $606 billion. A few weeks later, the Trustees' 1998 Annual Report highlighted another measure of Social Security's financial status called "actuarial balance." That balance came in at a negative $3.5 trillion. Meanwhile, new rules proposed by the Federal Accounting Standards Advisory Board (FASAB) would require SSA to report a "closed group" obligation of $8.9 trillion.

The public may find all of this confusing. According to SSA's Accountability Report, which says the agency's number one goal is to "rebuild public confidence," Social Security is flush with cash. But according to FASAB, it has unfunded obligations several times greater than the inflation-adjusted cost of World War II.

Here's what the various numbers mean. And here's why, despite what defenders of the status quo claim, the $8.9 trillion number may be the most important of all.

Binding the Unborn

Let's start with SSA's "net financial position" of $606 billion at the end of FY 1997. This measure focuses exclusively on Social Security's current year trust-fund balance-and ignores all future benefits beyond the trivial amount that has accrued during the last month of the last fiscal year. By this measure, Social Security's financial status looks great and is getting better. After all, the trust funds are now racking up surpluses of roughly $100 billion a year.

But as everyone knows, demography will soon turn all of this around. By 2032, the Social Security trust funds are projected to run out of money. Thereafter, they will be able to pay only a declining fraction--just three-quarters and falling--of currently legislated benefits. Any long-term measure of Social Security's financial status can hardly talk about a surplus. It must instead declare the trust funds to be in deficit.

How much in deficit? To answer this question, the Trustees have invented a measure called "actuarial balance." At the end of FY 1997, that balance was a deficit of $3.5 trillion. This (present value) sum--equivalent to a permanent tax hike of 2.2 percent of payroll--represents the amount of savings Congress would have to find in Social Security in order to keep the trust funds solvent over the next seventy-five years.

While more meaningful than Social Security's net financial position, the actuarial balance measure suffers from a number of shortcomings. (See our alert of January 10, 1997.) For one thing, it assumes that the time horizon for trust-fund solvency will remain forever fixed at seventy-five years from today--when in fact Social Security's actuarial deficit will keep growing as the horizon moves forward in each future year. For another, it may rest on overly optimistic demographic and economic assumptions. If we accept the Trustees' high-cost scenario, Social Security's 2.2 percent of payroll actuarial deficit becomes a 5.4 percent of payroll deficit.

But there are more fundamental problems. The actuarial balance measure assumes that trust-fund surpluses accumulated in prior years constitute genuine savings that can be drawn down to finance trust-fund deficits incurred in later years. But they don't. Social Security's assets are just a stack of Treasury IOUs. For the trust funds to redeem them, Congress will have to cut other spending, raise taxes, or borrow from the public. What matters fiscally is Social Security's operating balance--that is, the annual difference between the program's outlays and tax revenues. This operating balance is now projected to turn negative in 2013 and widen to an annual deficit of $734 billion by 2031, the last full year the trust funds are technically solvent.

Finally, actuarial balance counts future tax contributions as government assets-while it does not count the trillions of dollars of future benefits "earned" by those contributions, but payable beyond the next seventy-five years, as government liabilities. This odd practice may be acceptable for contributors who are already in the system. Perhaps one can assume that they have assented politically to Social Security's pay-as-you-go principle. But it seems problematic when applied to contributors who have yet to enter the system. It suggests that government can exact enormous obligations from future generations without their consent--what Thomas Jefferson called "binding the unborn."

The Closed Group Liability

Is there a way to measure the long-term financial status of Social Security without counting the contributions of future generations? It turns out there is. This measure, called a "closed group" liability, assumes that Social Security will be closed to all new entrants. It then looks at what today's workers and retirees are due to receive in future benefits over and above current trust-fund assets plus what those same workers and retirees are due to pay in future contributions. At the end of FY 1996, Social Security's closed group liability was a staggering (present value) figure of $8.9 trillion.

Unlike actuarial balance, there is nothing odd about this measure. Private pension plans calculate a similar measure (called an unfunded benefit liability) every year. Indeed, federal law requires them to do so.

Social Security's closed group liability has great practical significance. First, it gives us some idea of the effect of the system on private-sector savings--and hence on living standards. Social Security reduces capital formation because it promises households future benefit income, but creates no real economic resources to generate that income. As a result, households put less into other (fully funded) forms of savings. Imagine that U.S. private pensions were all run on a pay-as-you-go basis-that is, that they were just as guaranteed as they are today, but without saving anything. Now imagine how the U.S. economy would function without the $4 trillion in productive assets those plans now hold.

Second, the closed group liability measures the subsidy today's adults expect from future generations--which is another way of saying it measures the extent to which future generations will fail to get their money's worth from Social Security. This subsidy explains why the payback in a funded system is higher than in a mature pay-as-you-go system. In Social Security, workers must always divert a part of their contributions to paying off the unfunded claims of the previous generation. The subsidy is the price that participants in a mature pay-as-you-go system must pay for giving huge windfalls to the system's earliest participants (who received full benefits in return for very modest payroll taxes).

Finally, the closed group liability is a measure of the transition cost to a funded Social Security system. To the extent that government moves toward a funded system without repudiating the benefits promised under the current system, this liability will come due. It is the debt future generations will have to liquidate before they can invest their own contributions free and clear.

Perverse Logic

SSA computes Social Security's closed group liability each year for internal purposes, but has never officially published the numbers. Back in the 1980s, several other government agencies tried to make them better known. But in recent years, they have dropped the numbers from their official reports. Until FY 1994, Social Security's closed group liability was included in the consolidated financial statements published by the Treasury. Now it is not. Until FY 1993, it was included in the President's budget. Now it is not.

Defenders of the status quo insist that the closed group liability measure is meaningless in a pay-as-you-go system like Social Security--and so oppose the new FASAB reporting requirement. Why? Because, they say, government is sovereign and so can always raise more revenue from future taxpayers. Perhaps it can. But that doesn't make the liability any less real. By the same perverse logic, we could ignore any worrisome liability of the federal government--including the national debt. And no one suggests going down that road.

Let's Make a Deal

The status quoists' last line of defense is to say that Social Security has no liabilities because government has no contractual obligation to pay benefits. Here they finally arrive at the truth. Social Security is simply a legislated entitlement that Congress has often changed in the past without prior notice and will certainly change again in the future. It is essential that Americans know this, both to make adequate preparation for their own retirement and to make informed choices as voters.

But this argument exposes a basic contradiction in the status quoists' position. If they really believe that Social Security entails no contractual obligation, why do they endorse terminology--such as "trust funds" and "insured status" and "earned benefits"--that imply it is a property right? To the insiders who know the system is unsustainable, the status quoists insist that benefit promises can be abrogated at any time. But to the public, they insist that Social Security is a sacred contract.

Let's make a deal. The Concord Coalition will gladly drop all talk of Social Security's unfunded benefit liabilities if the status quoists drop all talk of contracts and rights. As for SSA's efforts to "rebuild public confidence" in the system, there's no better place to begin than to come clean about the huge fiscal challenge it faces--and to help devise ways to cope with it.

FACING FACTS AUTHORS: Neil Howe and Richard Jackson CONCORD COALITION EXECUTIVE DIRECTOR: Martha Phillips

. Last updated: 15 Jun 1998