April 17, 2014

Social Security Series-Social Security's Trust Funds Mask the Problem

Issue #2

Some commentators have suggested that the financial problems confronting Social Security are overblown because the large balance building up in the Social Security trust funds will carry the program for decades. Projections made by the Social Security trustees show that the balance of the trust funds will grow from $1.7 trillion today to $3.9 trillion in 2022[1] and when joined with the flow of ongoing tax receipts, there would be ample resources to pay all promised benefits until 2042. Those who take this position are also quick to point out that the trust funds hold the safest securities on earth: U.S. Treasury bonds.

Armed with these statistics, the argument is made that even the youngest post World War II baby boomers--who are now just over 40 years old--are likely to get most if not all of their benefits. Do we really need to worry then about Social Security's condition? Don't we have another 30 or 40 years before there is a problem?

The answers are: yes, we do have to worry about Social Security's condition; and: no, we can't wait for decades before taking action.

No nest egg in the trust funds

The argument that Social Security is on sound footing for decades to come rests on the proposition that its trust funds constitute a nest egg of savings from which future benefits can be paid. They don't. They are simply a matter of intergovernmental bookkeeping. As explained by the Congressional Budget Office (CBO):

Trust funds have no particular economic significance. They do not hold separate cash balances; instead they function primarily as accounting mechanisms to track receipts and spending for programs that have specific taxes or other revenues earmarked for their use.[2]

Social Security's earmarked revenues -- payroll taxes and the taxation of benefits -- flow into the Treasury and any surplus not needed to pay current Social Security benefits or administrative costs goes to pay for other government operations. This surplus is credited to the trust funds in the form of special issue Treasury bonds, which amounts to a promise from one arm of government (Treasury) to repay IOUs to another arm of government (Social Security). The trust funds are also credited with interest on their balances, but as CBO points out, “because that interest represents the government paying itself, it provides no net revenues to the government and has no effect on the total budget.”[3]

The key point is that the same trust fund “assets” are a future liability for the Treasury. So while it may be comforting to think of the trust funds accumulating trillions in federal government bonds over the next twenty years, in reality that just means the government will owe itself a lot of money.

When the government posts one of its own securities to one of its own accounts--whether it's labeled a trust fund or something else--it hasn't purchased anything or established a claim against some other person or entity. It has simply created an IOU from one of its own accounts to another. Thus, when the Trustees say that Social Security is “solvent” until 2042 they are only saying that the program will have sufficient claims on the Treasury (i.e., taxpayers) to pay full benefits until that date. The more important issue is how much paying off the IOUs is going to cost and whether it is affordable. When the time comes for the trust fund balances to be converted into benefit payments, the relevant question will be: where does the money come from?

Absent tax increases or spending cuts, the government will have to sell the trust fund balances to the public… that is, sell the bonds to you, to me, to foreign governments, to anyone willing to buy them. Selling the bonds held by the Social Security trust funds is simply borrowing from the public, and asking people to buy them some day in the future is no different than asking people to buy government bonds today to cover budget deficits.

A widening gap between tax receipts and expenditures

Borrowing can be a useful device for governments to deal with temporary revenue shortfalls. But the Social Security problem is not temporary. Today, Social Security taxes are running ahead of benefits by about $80 billion. But by 2009, the annual excess will start to fall and by 2018 there won't be any excesses at all. From then on, widening deficits are projected for as far as the eye can see. Even if one wanted to borrow to ease the problem, you couldn't do so forever, and at some point one would have to pay back what was borrowed.

At first, the gap between promised benefits and dedicated revenues will be relatively small -- $16 billion in 2018 -- but it will grow very quickly as those who were born in the peak of the baby boom begin to retire in large numbers during the 2020s. In the Trustees' most recent projections, the annual shortfall grows to $250 billion by 2030 and in 2041, the last full year of trust fund “solvency,” Social Security faces a cash deficit of $370 billion. All told, between 2018 and 2041 paying off the trust fund bonds will require a cash infusion of $5.4 trillion. The key issue in assessing Social Security's finances is not, therefore, the size of the trust fund balance but the difference between expenditures and dedicated revenues.

When told that the system is safe until 2042, it is easy for people to dismiss the problem. Given the uncertainty in making projections, why should we take seriously something that may happen 37 years from now? Thirty-seven years is nearly half a normal lifetime and many things could change. However, if we recognize that the trust funds don't constitute a source of genuine savings that can be drawn down to meet benefit payments, it then becomes clear that a declining surplus of cash on hand is the beginning of the problem. Under current projections, that happens in 2009, only four years away. The problem gets worse when receipts are no longer enough to cover expenditures. The trustees say that will happen in 2018… only 13 years away.

The timing is uncertain but the trend is not

It is true that these are estimates and all of the specific numbers will change, but they could change for the worse as well as the better.

What is not uncertain is that we are living longer and having fewer babies… and to discount the significance of this as an enduring trend is to ignore the inevitable. Fewer people will be paying for each recipient's benefits as the ratio of workers to recipients drops from more than 3 to 1 today to just over 2 to 1 in 2025. The population age 65 and older will grow from 37 million to 62 million--an increase of 26 million people. The workforce, however, will grow by only 21 million. In effect, if these projections hold, less than one worker would be added to the labor force for each additional person joining the ranks of the aged population.

Trust fund solvency says nothing about how society will meet the growing fiscal burden reflected in these projections. Because the trust funds are primarily an accounting device for keeping track of the programs' claims on general revenues, their existence does not ease the burden of paying future benefits.

In summary, the concept of trust funds misleads people because it implies that there really are resources being held in reserve… real assets that can be used. That's the theory. The reality is that assets are not created by giving yourself an IOU and promising to sell that IOU when money is needed later. There may be a legal obligation to pay future benefits because the IOU exists on the books, but the real issue is how the government and society will afford them.

If the debate over Social Security reform is to result in a sustainable system, policy makers will have to focus more on economic and budgetary consequences than on governmental bookkeeping.

Social Security Reform Issue #2

[1] This number and all others herein are expressed as 2004 constant (i.e., inflation adjusted) dollars. They are based on the so-called “Intermediate” or central forecast of the 2004 Social Security Trustees Report.

[2] CBO, The Budget and Economic Outlook: Fiscal Years 2006 to 2015, January 2005 p.22.


[3] CBO, The Outlook for Social Security, June 2004 p.2.