Monday, April 23, 2012

A big hit for Social Security

The Social Security Trustees released their annual report today on the program’s financial health, predicting a significantly larger funding shortfall than was projected only a few years ago.

Most news reports focus on the year when Social Security’s trust fund will be exhausted – today’s Trustees report projects insolvency in 2033, four years earlier than last year’s report.

But the key measure is the system’s “actuarial deficit,” which measures funding shortfalls over a full 75-year period. This year, the Trustees project a 75-year shortfall equal to 2.67 percent of the total wage base. That’s around $9.1 trillion in present value dollar terms, meaning that if we set aside $9.1 trillion today, earning interest, we’d have enough to cover full benefits for the next 75 years. Going back only to 2010, the Trustees projected a much smaller actuarial deficit of only 1.92 percent of payroll, equal to $5.9 trillion. So things have gotten a lot worse in a short space of time.

There are a lot of reasons for this, but the main drivers include rising disability costs, longer life spans and the effects of recession on tax receipts.

The short story is first, that taxes are going to have rise or benefits be cut, and by more than we previously thought; and second, the longer we wait to fix the system the bigger those cuts will have to be. Both President Obama and Gov. Romney should start talking about how they would fix Social Security.


WilliamLarsen said...

"This year, the Trustees project a 75-year shortfall equal to 2.67 percent of the total wage base. That’s around $9.1 trillion in present value dollar terms, meaning that if we set aside $9.1 trillion today, earning interest; we’d have enough to cover full benefits for the next 75 years."

Keep in mind that the 75 year time horizon includes all revenues from all workers during this time frame, but does not include all liabilities. For example a person who turns 67 in year 2086 will draw one year of benefits and then sees a drastic 27% reduction in benefits. It is far worse for those who were born after2020 for they will pay full taxes and in the year they are eligible for full social security OASI benefits, <73% of scheduled benefits can be paid and these are without COLA.

For COLA to be paid, there are certain criteria that must be met;

1. The CPI must increase year over year; The CPI must be the maximum it has been since COLA was implemented.

2. COLA is reduced when the OASI Trust fund to OASI expenses is less than 30%.

3. COLA is eliminated when the OASI Trust Fund to OASI expenses is less than 20%. This is done so that the OASI trust fund is not exhausted and allows for cash flow.

The reason for the sharp increase in the 2.67% from the 1.92% is not due to increase life expectancy nor is it due to disability costs. SSA has projected population out far into the future and at zero population growth; these are just as valid projections as was known in 1935 when the Social Security Act was passed.

A baby born this year can expect to live 17 days longer than a baby born last year at age 67. 17 days out of a life expectancy at age 67 of more than 20 years. We are looking at less than 1/4 of 1%. When you look at the present value cost of paying for 17 days some 87 years into the future we are looking at $17 set aside now; not much in the scheme of things.

So what is the reason for the big increase from 1.92% to 2.67%? It is called the "Cliff Effect."

“...the 75-year time horizon is arbitrary since it ignores what happens to system finances in years outside the valuation period. For example, we could eliminate the actuarial deficit by immediately raising the payroll tax by 1.86 percent of payroll. However, as we move one year into the future, the valuation window is shifted by one year, and we will find ourselves in an actuarial deficit once more. This deficit would continue to worsen as we put our near term surplus years behind us and add large deficit years into the valuation window. This is sometimes called the "cliff effect" because the measure can hide the fact that in year 76, system finances immediately "fall off the cliff" into large and ongoing deficits."

None of this is new to anyone who actually knows how Social Security works. The present value unfunded liability over 75 years not including accrued liabilities of those who will not receive a penny prior to the end of 75 years is more on the order of $27 Trillion.

WilliamLarsen said...

The trustees state that low wage growth is the cause behind the problem. Again this is a red herring and they know it. Low wage growth means that future benefits will grow more slowly.

The initial Social Security benefit is based on average lifetime-indexed wages. Wage growth is used to adjust past wages of future retires; similar to inflation being used to adjust social security benefits for current retires. When rate of economic growth, and its resulting increase in wages, exceeds the rate of return on the social security trust fund, then social security is actually disadvantaged due to economic growth.
For example if wages were to rise 5% this year, the initial social security benefit for future retires would also be 5% greater. If the trust fund investment returns did not match or exceed the 5% rate of growth then the trust fund would be falling behind on its ability to meet the payout commitment.

In simple terms economic growth will not save Social Security and in technical terms, increased economic growth makes funding social security worse.

Social Security revenues are based on wages earned by the worker. Productivity can contribute to real wage growth (see above) and/or the displacement of workers. Both of these conditions reduce social security revenues. Productivity growth will not help at all.

Reference site:

WilliamLarsen said...

"Both President Obama and Gov. Romney should start talking about how they would fix Social Security."

After decades of fixes and patches i myself am very tired of politicians trying to fix something that cannot be fixed. What is the definition of fix? Is it enslavement to an idea that was poorly defined and implemented with no design as to how fund it?

There are 118 million potential voters under age 46. The children for the boomers out number the boomers by close to 20%. Clearly the vast majority of those under 46 would opt out of Social Security if give the chance.

If this were allowed, what would happen to the 2.67% of payroll over 75 years? My estimate is it would hit double digits easily. This means the OASI program would begin having problem much earlier than 2033. At my age, with my cohorts life expectancy at age 67 I would see reduced COLA, followed by No COLA followed by reduced benefits. Is it better for me to opt out with the younger cohorts instead of throwing good money after bad?

As each additional cohort opt outs, it puts exponential strain on the program. So the question is who are was trying to fix social security for? In 1983 I wrote that the big fix proposed by the Greenspan Commission was not to fix social security but to be able to pay scheduled benefits to those who were currently age 55 and over. They knew this problem was going to come back bigger and badder in the future. They simply did not care, but bought votes.

Now is it possible for a candidate to buy votes: elect me and I will propose repeal of the Social Security Act and allow you to keep both the employer and employee contributions? Who would go for that?