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A Guide to the 2014 Social Security Trustees Report

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A Guide to the 2014 Social Security Trustees Report

August 4, 2014

On Monday, July 28, the Social Security trustees released our annual analysis of the program’s financial condition (the full report can be found here, a summary here, and a video of our press conference here). The following day I testified on the report before the House Ways and Means Committee’s Subcommittee on Social Security (my testimony can be found here and video here). The Social Security report is one of two such annual reports, the other covering Medicare, which I will summarize in my next piece for e21. Below I attempt to highlight the most significant news in the Social Security report. 

Social Security’s Disability Insurance Fund Faces Depletion in 2016

Social Security has two trust funds. Payments for retired workers as well as spouses, children and survivors are made from the Old-Age and Survivors (OASI) trust fund. Payments for disabled workers and their dependents are made from the Disability Insurance (DI) trust fund. It has become commonplace to refer to the two trust funds’ combined operations as though they were one fund. This nomenclature is convenient but not truly accurate. By law each of the two trust funds must separately have a positive balance to allow them to make benefit payments. 

The trustees have been warning for several years (long before I became one) that Social Security is on an unsustainable financial trajectory. We have now moved from a long-term problem to an immediate one. The DI trust fund is currently projected to be depleted in two years, in the fourth quarter of 2016. At that point, unless the law is changed disability payments will drop suddenly by 19 percent. 

Projected DI Income, Cost and Expenditures

(As a Percentage of Taxable Payroll)

Some have suggested that the impending DI trust fund depletion can appropriately be handled simply by reallocating payroll taxes between Social Security’s trust funds (currently 10.6 points of the 12.4 percent Social Security payroll tax go to OASI, the other 1.8 points to DI). This suggests a misdiagnosis. OASI/DI taxes have indeed been reallocated in the past (most recently in 1994) to address situations in which the division of taxes between the two funds was disproportional to their respective benefit obligations. This precedent does not apply to the current situation. To the contrary, OASI now faces a bigger shortfall in both absolute and relative terms than DI. Transferring taxes from OASI to DI would actually weaken the trust fund in the relatively weaker long-term condition.

The main reason DI is hitting the wall first is that the baby boomers are moving through their years of peak DI incidence before converting to the retirement rolls. Thus this is the first depletion triggered by financial strains affecting both sides of Social Security alike. While lawmakers may wish to include some interfund borrowing or a temporary tax reallocation as part of a comprehensive Social Security solution it would be counterproductive to enact either as a standalone policy, if it served to facilitate continued delay of needed reforms. 

The bottom line is that the Social Security financing crunch, long warned about, is now arriving. Its root cause is costs rising faster than its tax base can sustain, due to population aging, pay-as-you-go financing, and rising per capita benefits. Rearranging the deck chairs, rather than slowing cost growth, would be an inadequate response with potentially ruinous implications for the program.

Projected Social Security Income, Cost and Expenditures

(Theoretical Combined Trust Funds, as a Percentage of Taxable Payroll)

Social Security’s Financing Shortfall May Soon Be Insolubly Large 

A table in our report shows how the current shortfall has grown far beyond its size during Social Security’s 1982-1983 crisis. Social Security was then saved from insolvency by a last-moment bipartisan rescue. The emergency measures required were intensely controversial. They included a six-month cost of living adjustment delay, first-time income taxation of seniors’ benefits, a retirement age increase, accelerating a previously-enacted payroll tax increase, and bringing newly hired federal employees (and their payroll taxes) into the system. Together, those and other measures closed a long-term shortfall estimated at 1.82 percent of the program’s tax base.

We currently show a long-term shortfall equal to 2.88 percent of the tax base—much larger than in 1982. The increase is actually greater than that, because the trustees’ actuarial methodology has since changed. The 1983 methods would show today’s shortfall as relatively twice as large as then. Thus we are already at a point where a bipartisan agreement would require the left to accept benefit restraints roughly twice as large as in 1983, and the right to accept tax increases twice as large—unless either side gives even more ground. There is no assurance of such an agreement, which as the problem worsens becomes even less likely.

If the problem grows politically insoluble, Social Security’s financing structure must eventually be abandoned. This would most likely require permanent financing from the government’s general fund, which is funded largely by income taxes that not all Americans pay. Gone forever would be the program’s contribution-benefit link, and the conception of Social Security as an “earned benefit.” Benefits would be as unpredictably changeable as they have historically been in other general revenue-financed programs.

The Problem Reflects an Excess of Obligations to Those Already in the System 

Social Security’s shortfall is already on the books in one important sense. As this table shows, it consists entirely of an excess of scheduled benefits over contributions for people already in the system. Though the effects will be spread years into the future, the gap does not arise from any inadequacy of contributions by future workers. To the contrary, those now entering the workforce stand to pay far more than they will receive—fully 4.4 percent of future taxable wages—irrespective of whether the system is balanced by assessing them with higher taxes or lower scheduled benefits. The only way to prevent these net income losses for younger generations is to slow benefit growth for those already in the system.

We Didn’t Much Change our Long-term Outlook, but the Short-term Problem is More Urgent

We made only minor changes to our long-term assumptions. We slightly lowered our long-term price inflation assumption from 2.8 percent to 2.7 percent, to be more in line with current trends and policies. We also found a lower ratio of taxable earnings to total average wages; this slightly worsens the shortfall because revenues flow from taxable earnings, whereas benefit growth is indexed to the Average Wage Index (AWI). Together these effects were slight, adding 0.1 percentage point to the 75-year imbalance. Add the 0.06 percentage point deterioration resulting from another year having passed, and one has a reasonable sense of why the total imbalance worsened from 2.72 percent to 2.88 percent of taxable payroll. There were other small changes, but they largely canceled out.

Some Presentational Improvements Were Included

The trustees changed our scheduled benefit illustrations to eliminate confusion caused by earlier reports. From 2002-2013 a column labeled “percent of earnings” in the benefit illustrations had been widely misinterpreted as comparing a worker’s benefits to his own prior earnings level when it actually compared the benefit to the earnings of younger workers still in the workforce who were at a comparable percentile of the wage distribution relative to their own peers. This presentation was at the root of many having long misinterpreted the trustees’ reports as indicating that “Social Security benefits replace about 40 percent of preretirement earnings for the average person”, when in actuality the amount of preretirement income replaced is substantially higher. Syl Schieber recently testified on some of the confusion caused by the previous presentation. 

Because there is no universally agreed-upon method of calculating pre-retirement income replacement rates, the trustees opted to remove the misunderstood measure, and to simply present scheduled benefits alongside projected growth in the AWI. This enables readers both to compare a worker’s benefit to average prevailing worker wages at the time the benefit is paid, as well as to average wages paid when that retiree had still been working.

Overall, this year’s report shows us a critical year closer to a Social Security financing crisis, with the certainty of its resolution increasingly in doubt.

 

Charles Blahous is a senior research fellow for the Mercatus Center, a research fellow for the Hoover Institution, a public trustee for Social Security and Medicare, and a contributor to e21.

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