Wednesday, April 1, 2009

Recession could cut life of Social Security trust fund by five years

I was asked yesterday how the current recession, which has significantly reduced the Social Security surplus, might affect the life of the trust fund. I put together some back-of-the-envelope numbers that at least guestimate the effects. These are necessarily approximations and mix CBO and SSA projections together (CBO, because they have they latest data available; SSA, because the Trustees projections for solvency remain the most prominent and well-understood). Take them with a grain of salt, but qualitatively I believe they should get in the ballpark.

Here's how CBO summarizes the differences in Social Security cash flow – meaning tax income (payroll tax revenues plus income taxes levied on retirement benefits) minus benefits and administrative costs – between their March 2008 budget projections, which also formed the basis for their August 2008 long-term Social Security projections, and their current March 2009 projections:

Even as of 2018, cash flow is almost $50 billion per year lower than was previously projected. I'm assuming this difference declines to zero within 10 years following 2018, although it's possible that the effect is permanent.

Next I calculate the present value of these new-found losses to tax income. Discounted at a nominal interest rate of 5.4 percent, which is a rough average of the 10-year Treasury bond rate from CBO's latest economic projections, this produces a present value as of 2009 of $621 billion. In other words, these future declines in payroll tax revenues are roughly equivalent to the trust fund balance simply being $621 billion lower as of today.

Next, I compound this present value forward to the year 2040 at a 5.2% interest rate, which is closer to the longer-term rates used in CBO's August 2008 Social Security update. This produces a value as of 2040 of $2.99 trillion. This shows the rough lost value to the trust at the point in which the fund is near exhaustion. In CBO's projections, the program is running annual nominal deficits of around $550 billion at that point (that's around $300 billion in today's dollars, for anyone interested).

Now, I simply divide $2.99 trillion by $550 billion, which gives me a value of 5.45. This indicates that the lost income to the trust fund today is worth around five and one half years of solvency in the 2040s. The Social Security Trustees currently project the program will become insolvent in the year 2041, so the current recession could push that insolvency date forward to around 2036.

Bear in mind that these numbers are approximate – you wouldn't want to do brain surgery this way. We will know more when the next Trustees Report is released. Moreover, lower wages today due to the recession can lead to lower promised benefits in the future, although I suspect the offset won't be on anything close to a one-to-one basis. (Losing a year of earnings due to unemployment would reduce benefits only if that year were among the worker's highest 35 and if he doesn't make it up by extending his work life later. In addition, if unemployment is concentrated among low earners, their benefits may become more progressive and partially make up for any losses.)

In any event, though, this gives a rough feeling for the scale of the effects of the recession on long-term Social Security financing.


Jim Glass said...

"Recession could cut life of Social Security trust fund by five years"

Hmmm... just what difference will this make?

In 2030 SS cost is expected to exceed payroll tax revenue by ~ $400 billion. So...

* Without the Trust Fund, the govt would have to collect $400 billion of general revenue (income tax) to pay all promised benefits. But...

* With the Trust Fund, the govt will have to collect $400 billion of general revenue (income tax) to pay all promised benefits (paying the revenue to itself to redeem the TF bonds).

Now the difference between $400b and $400b seems to be $0 ... so it seems that whether the trust fund exists or not makes no difference to the financing of Social Security, $0.

If the Trust Fund makes no difference, contributes $0 to funding Social Security, then as to its life being shortened, who cares?

Andrew G. Biggs said...

In addition to the emotional resonance the trust fund appears to have for some folks, it has a strong legal meaning: without it, SSA can pay only the amount affordable using current tax revenues. So while there isn't a ton of economic meaning, it does signal a policy change at which time taxes begin to trump benefits.

Jim Glass said...

the trust fund ... has a strong legal meaning: without it, SSA can pay only the amount affordable using current tax revenues .

It has a legal meaning, but I'm not sure how strong it is when it can be changed by the stroke of a pen at a signing ceremony after a one-vote majority of Congress changes the law. The law isn't binding on Congress in any meaningful sense when it can change the law at will.

For instance, does anyone expect Medicare benefits to be slashed in 2019 after the Medicare Trust Fund is exhausted -- as the law commands!

ISTM that the "emotional resonance" and resulting politics of the trust fund are pretty much the entire import of the thing -- not that those are to be slighted!

BTW, why does everyone go on and on so emotionally about the Social Security trust fund, while near totally ignoring the Medicare trust fund? When the latter is in much worse shape, and health benefits are frankly a lot more life-and-death important to many seniors than SS?

WilliamLarsen said...

High deficits in the future make it difficult to pay social security benefits

Social Security by law cannot borrow money. It has statutory authority to spend only those funds received from the dedicated social security tax on wages, tax on benefits and funds in the trust fund. Federal Law prohibits transferring general revenues to any trust fund.[4]

By law the trust fund cannot be drawn down to zero. The trustees must submit a report promptly to congress detailing benefit cuts or tax increases when in any given year the trust fund is projected to fall below 20% of that given years expenses. Social Security's ability to pay future promised benefits is dependent solely on the ability to raise social security taxes.[5]

For over twenty years the Social Security Trustees have projected and reported the trust fund to be exhausted anywhere between 2019 and 2042 which is decades before its original projection of 2060. Where is their report detailing benefit cuts and/or tax increases to rectify the inadequacy?

[4] United States Code Title 42, Chapter7, Subchapter VII, Sec. 911 (a),
[5] United States Code Title 42, Chapter7, Subchapter VII, Sec. 910 (a),

General revenues by law, cannot be used to pay social security benefits. It is limited to the dedicated tax revenue of 10.6%
(OASI) and 1.8% (DI).