Saturday, April 12, 2008

Trust Fund Depletion: Crisis? or Tax Cut?

Social Security 'Crisis' comes in two forms: shortfall and depletion. 'Shortfall' is that time when receipts from payroll tax and tax on benefits fall short of cost and so Trust Fund assets first need to be tapped. Shortfall currently is projected for 2017 under Intermediate Cost projections. But in this post I propose to examine 'Depletion', the date when all Trust Fund assets are depleted, currently projected for 2041.

Whether Depletion constitutes crisis depends on where you are sitting. Under current law at Depletion benefits are automatically reduced to whatever level then current Social Security income sustains, a level that currently projects at 78% of the scheduled benefit. On the other hand the current benefit schedule would have a 2040 benefit 160% in real terms of what a similarly situated retiree gets today and by application of Rosser's Equation we have 78% of 160% = 125%. So 'crisis' is here defined as '25% better check than my Mom gets today'. While it is a nice feature of Social Security that each generation gets a better outcome you have to ask whether the difference between 25% better and 60% better rises to the level of national priority when we have 47 million people uninsured. As an example a person scheduled to retire in 2041 would be 33 today and likely to have young children and moreover have plenty of time to plan for retirement. Telling that young parent that his retirement check 33 years out is more important than funding his childrens' education or health care is on examination kind of absurd. And yet that is where 'crisis' takes us.

Now lets move up the age scale and see what a 2041 crisis means to someone currently 66, or 55, or 44. If I am 66 and preparing for full retirement next year the prospect of a benefit cut 31 years out isn't exactly scary and even less so if the proposed cures include phased in cuts in between (as most 'reform' plans do). I'll be very lucky to still be kicking at 97. Similar considerations hit for the 55 year old, mortality tables suggest that half of his cohort will be dead and most of the rest on the way out, any 'reform' plan that carries some combination of tax increases and benefit cuts is just going to hit you twice. Now a 44 year old is on the cusp, she is likely to still be drawing benefits in 2041, but on the other hand she is looking at a potential of 23 years of higher taxes until retirement in 2031 coupled with ten years of whatever phased in benefits cuts might be required to 'save' Social Security. On balance none of these people have a reason to move on Social Security, 'crisis' in numeric context is no crisis at all.

But now let's move down the age scale and see what a 2041 depletion crisis means to someone 22, 11, and 1 years old. Time to bring in some numbers.

Under Intermediate Cost assumptions, Social Security starts drawing on the General Fund in 2017 as income from taxation lags total cost. Initially this just takes a portion of the interest due but mounts until in the mid 2020s all accrued interest is needed at which time it becomes necessary to start redeeming the principal. Eventually by 2040 this transfer from the General Fund reaches $806 billion. (Which is a lot of money but when adjusted for inflation works out to $335 billion in inflation adjusted constant dollars or less than they typical Bush deficit.) But then the obligation effectively ceases, after an additional transfer of  $267 billion in 2041 the legal obligation on the General Fund simply stops. Result? $806 billion tax dollars suddenly freed up.

Which gives the taxpayers of 2041 some choices. They can examine Rosser's Equation and figure that 78% of 160% = 125% is just not that bad a deal for Grandpa and so use that $806 billion somewhere else, say to shore up Grandpa's Medicare, or maybe they will just take it back in the form of a tax cut, or some combination of spending and tax cuts.

So where does that 22 year old fit in this picture? Well he is not retirement eligible until 2053 and so has a full 12 years of an effective tax cut in exchange for potentially having to take a somewhat lower retirement. At worst it is a near wash. And the 11 year old of today? In 2041 he will only be 44 and maybe more inclined to take his chances funding his IRA than continuing to pay General Fund taxes to bolster Social Security. 

When you sum it all up there is only a narrow band of people on either side of 30 for whom a crisis defined as a minor cut in real benefits 32 years out even makes sense, and that would have to be weighed against other uses for that current payroll dollar. As for Boomer's and Millennials both there is exactly zero reason to move on this front.


Andrew G. Biggs said...

This raises two interesting point: First, what is meant by 'crisis', and second, how big a problem would it be.

As I see it, 2017 indicates a 'crisis' (or problem, or whatever) for the non-Social Security budget, since that's when Social Security stops subsidizing the rest of the budget and starts needing to be subsidized. 2041 is a 'crisis' for Social Security, since that's when the legal obligation of the on-budget to subsidize Social Security stops and when, under law, benefits would be cut by 25% or so.

Tom Saving (former public Trustee) often argued that these hard distinctions didn't make sense. If we managed to come up with the general revenues to fund Social Security through 2041, he said, it's hard to believe we wouldn't continue to do so after trust fund exhaustion. Alternately, and more likely, I think, is that if we can't afford to fund full benefits post-2041 it's unlikely we'll do so pre-2041 either. In other words, politically economy-wise, benefit reductions are likely well in advance of when the trust fund runs out.

But Bruce also raises the important issue of what a 'benefit cut' is. Even if the trust fund runs out and benefits are cut, the real, inflation-adjusted purchasing power of benefits will be higher post-2041 than they are today. I did a paper a few years ago (which for whatever reason I was attacked for) which showed that, while the number of seniors in poverty would double, the actual poverty rate would be lower than it is today. (See ). Reform options like price indexing would also allow for higher average benefits in the future; they would simply smooth the reductions so they occurred earlier.

That said, most people on the left don't buy this argument. They say that Social Security's purpose isn't simply poverty protection but income replacement (i.e., it's social insurance against loss of income due to age). In this context, the trust fund exhaustion WOULD be a big deal, since the replacement rate (benefits/pre-retirement earnings) would fall by a lot. If people hadn't prepared for this ahead of time, their retirement income adequacy would be significantly short of what they'd want it to be. So it depends on what you think the purpose of the Social Security program is, or what it should be, in the future.


Bruce Webb said...

Thanks Andy. We disagree on our approach but you have always been civil, more civil than maybe some of my attacks would invite.

Saving is of course correct. If we can afford a $806 billion (current dollar) transfer in 2040 we could equally afford it in 2042. Nothing really changes in that respect, instead of a General Fund repaying principal borrowed a couple of decades before, it would be simply subsidizing Social Security directly, there would be no accompaning change for the financial markets.

Which is an argument for putting some of these numbers in context. How much borrowing would we need to do in 2017? in 2023? in 2035? If we can afford to respond to a recession that may or may not have started with an emergency $165 billion package possibly to be followed up with another one (if Democrats get there way) does it make sense to argue that a predicted borrowing need of $30 billion or so in 2017 represents some risk? Or if we adjust dollars for inflation and show a need to transfer $319 billion in 2040 why would that be some sort of crisis? In the context of a projected deficit of $300 billion in the first six months of FY 2008?

Arguments that we can't NOT afford the cost of a war, and that we can't NOT afford the cost of a one time stimulus package, but that we CAN'T afford to meet our legal obligation to repay Social Security taxes borrowed even when the dollar amounts are in context smaller is rather baffling. Table VI.F7.—Operations of the Combined OASI and DI Trust Funds, in Constant 2008 Dollars, Calendar Years 2008-85 [In billions]

The problem for privatizers as I see it is one of time shift. In 1988 we had a outlook that included General Fund deficits 'as far as the eye can see' and a Trust Fund that was expected to go to depletion right as the crest of the Baby Boomers retired after 2023. Double whammy. But by 1998 we had an understanding that growth could come in faster than Intermediate Cost assumptions, that General Fund deficits were not in fact structural, that under the right combination of tax and spending policy could be brought to balance, and that Trust Fund Depletion could in fact be moved back simply by the natural actions of the economy. And ultimately to a point when the demographic impact of the Boomers on the system was more or less over. (I'll be 84 in 2041, assuming I exercise more and eat right {as if} the mortality tables suggest most of us will have pushed on to Buffalo and points beyond.)

In the face of the numbers as referenced in this very illuminating table from EPI Changes in Trustees Projections Over Time the questions in 1998 should have been 'Why did the outlook for Trust Fund depletion improve three years in the course of a single year?' and 'Can this process continue?' At least those were the questions I asked myself in real time. When you take the 1997 Report and compare it to the 1998 Report what changed? Was it dramatic changes in fertility, mortality or immigration projections? Well no, not that I could tell. Instead the answer seemed to be that short term growth numbers were coming in at much higher levels than projected and so setting the base for future GDP at higher levels. Given that God was not at that point creating more Boomers this meant that the future ratio of GDP to Boomer got bigger making Social Security more future affordable.

Even though the advance seen in the 1998 Report continued without cease right through the 2004 Report nobody seemed to pause to pose the two questions I was asking. Except of course Dean Baker and Mark Weisbrot who summed it up in two words: Phony Crisis
The roof analogy is illuminating, but we can make it more accurate. Imagine that it’s not going to rain for more than 30 years. And the rain, when it does arrive (and it might not), will be pretty light. And imagine that the average household will have a lot more income for roof repair by the time the rain approaches.
Now add this: most of the people who say they want to fix the roof actually want to knock holes in it.
This is the situation facing Social Security, and it is well known to those who have looked at the numbers."

Well I didn't see a lot of reason to disagree with that assessment when I first ran across it and still don't.

Bruce Webb said...

And a point I forgot to make.

In the 2007 Report Trust Fund shortfall was set for 2017 and depletion at 2041.

In the 2008 Report Trust Fund shortfall was set for 2017 and depletion at 2041.

Hence the alarmist tone of the Press Release. But clearly visible to the plain eye (if you knew where to look) was this change:

2007 Report. Required benefit cut in 2041-25%
2008 Report. Required benefit cut in 2041-22%

Or we could look at changes in 'Unfunded Liability' (in scare quotes because there really is no such thing) and come up with the same conclusion: despite some really disappointing economic numbers in Q4 2007 somewhere between a sixth and an eighth of the long term gap simply disappeared over the course of the last reporting year. You can dive deep into the numbers and explain this away as a one-year outcome based on a methodological change in immigration assumptions and so not likely to be repeated. To which I would reply 'It's always something'.

My mental model does not need giant improvements in solvency outlook in each and every year, every little bit of grind down on the crisis narrative helps.

muthu said...
This comment has been removed by a blog administrator.