More on how the future deficit is caused by over-generosity to past participants

This is a long post, so be sure to hit the 'read more' link to see the whole thing.

We’ve talked a bit here (and here, over at Angry Bear) about how Social Security’s large future shortfalls are a function not of over-generosity to future retirees, but to over-generosity to past ones. This sounds strange and it’s been a bit hard to explain given the data available. But I’ve spent a bit of time converting data in this paper by SSA economist Dean Leimer into a form that might help things make some more sense.

To start, this table shows the program’s deficit over the infinite horizon, measured in the 2008 Trustees Report as $13.6 trillion, or 3.2 percent of taxable payroll over that period. Folks who think the infinite horizon figure is crazy often focus on the, well, infinite part; how can we know, and why should we care, what will happen in the infinite future?

Those of us who think the infinite horizon measure has merit sometimes point out that the deficit isn’t a function of what we project will happen in the way off future, but of what happened in the past. Early participants received much, much more in benefits than they paid in taxes. As a result, the trust fund balance is much lower than it would have been had these early cohorts received only an actuarially fair return (defined as their benefits being equal in present value to their taxes; put another way, it means they would receive a return on their taxes equal to the interest rate paid on bonds on the trust fund).

To back this view, we sometimes point to this table, which breaks the infinite horizon shortfall down more finely. It shows that the $13.6 trillion deficit through the infinite horizon is fully accounted for by the fact that past and present participants received $15.2 trillion more in benefits than they paid in taxes. Future participants are projected to receive $1.5 trillion less in benefits than they’ll pay in taxes, even if Social Security were fully solvent. Add those two numbers together, subtract the current value of the trust fund ($2.2 trillion) and you have the $13.6 trillion deficit.

One question that’s been raised, however, is that the figures for past and present participants includes everyone currently over the age of 16. This means that the earliest participants are lumped together with people just entering the system now, so it’s not clear whether the $15.2 net transfer is really a function of over-generosity to past cohorts or to future ones.
I requested from the Social Security actuaries a cohort-by-cohort breakdown of the figures above, but they weren’t able to provide it. So alternately, I worked with data from Dean Leimer’s paper to convert it to a form more comparable to that show in Table IV.B7. Dean is probably the leading expert on how different cohorts have been treated under the Social Security program and he constructed his figures from SSA data, so I fully trust they’re technically correct. The issues was simply converting them for comparability, which I did.

I should note, however, that the numbers don’t exactly match up because Leimer’s projections of future taxes and benefits was based on the 2002 Trustees Report, which showed a significantly larger deficit than the 2008 Report. I discounted future dollar amounts based on the interest rates in the 2008 Report to keep things as comparable as possible, but the overall deficit is larger in Leimer’s figures due to his matching an older set of Trustees projections. Also note that all individuals born prior to 1900 are lumped together in Leimer’s data.

In any case, first here’s a chart showing real internal rates of return from Social Security for different birth cohorts. As you can see, early cohorts received very high returns while later cohorts received lower ones. Once a cohort is receiving a return below the trust fund interest rate (around 3 percent) the present value of that cohort’s taxes will exceed their benefits. These later cohorts will be net contributors to the system, meaning that they actually help keep the system solvent even if they’ll be the ones holding the bag when it’s going broke.


You may notice that for later cohorts returns tend to rise. Why is this? It’s because these figures are shown under scheduled taxes and benefits, which assumes (unrealistically) that full benefits can be paid at all times. As future cohorts will live longer and longer in retirement, they’ll receive more benefits and so returns will rise. But again, this is unrealistic; in real life, returns will inevitably stabilize.

Now here’s the second chart. It shows net transfers from Social Security by cohort, expressed in present value dollars to make them comparable to the numbers in Table IV.B7. If the dollar figure is positive that means that a given birth cohort received more in benefits than it paid in taxes (all in present value form); if the number is negative, it means they pay more in taxes than they’ll receive in benefits. Again, all this is under scheduled benefits, so solvency doesn’t come into play here.


What the table shows is that early cohorts – particularly those born prior to 1900 – received much more in benefits than they paid in taxes. For the pre-1900 cohorts, the bonus was around $14 trillion. The bonuses decline over time until they’re actually negative beginning with people retiring in the late 1990s. They stay negative for quite a while, and then some distant cohorts are actually slightly positive again (also due to the assumption that they live longer and collect more benefits).

If you add all the cohort figures up, they total around $22 trillion in present value. If you then subtract the current value of the trust fund, the total is around $20 trillion. This is larger than the current infinite horizon shortfall of $13.6 trillion, because the 2002 Trustees projections were more pessimistic.

But I think this basically shows the point we were discussing earlier. The so-called “infinite horizon” deficit has very little to do with what will happen hundreds of years from now and everything to do with what happened in the first 25 years or so that the Social Security program was running. Participants, rich and poor alike, were paid much more in benefits than they contributed in taxes. As a result, the trust fund balance – which should be somewhere around $16 trillion – is only around $2 trillion. This is what drives the long-term deficit.

I think in a way this makes reform easier to understand and resolve. We’ve inherited a ‘legacy debt’ due to over-generosity to prior generations. Whether this over-generosity was justified is an academic question. (Some say yes, to help reduce poverty; I agree there, but much of the legacy debt is due to over-generosity to high income participants, which is harder to justify.) In any case, though, it’s a done deal: the shortfall is what it is, and our only choices are how to deal with it. My argument, which I’ll expand on more fully in the future, is to treat this legacy debt more like a real debt: find the best, fairest and least economically damaging way to pay it off, which may be a way outside of the current Social Security financing structure. But that’s a question for another day.