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.

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CBO explains why future GDP growth will be slower than in the past

It's a very common argument on the left that the Social Security Trustees underestimate future rates of economic growth, and that if only the economy would grow in the future as fast as it did in the past then Social Security's solvency would be assured. (I mean you, Economic Policy Institute; and you, American Prospect; and you, David Langer.)

I've tried to explain elsewhere why the Social Security Trustees project lower economic growth in the future. This difference comes down to the fact that the Trustees don't think about "GDP growth" as a single thing, but break it down into its components and project how those components will change over time. In fact, despite Langer's claim that "The Gross Domestic Product (GDP) is the key economic assumption in estimating costs," it actually plays no direct part in estimating Social Security's finances: Social Security doesn't collect taxes based on GDP, nor does it pay benefits based on GDP. Projections of GDP growth are really a byproduct of the other estimates the Trustees and actuaries do; they could easily project Social Security's finances without ever calculating future GDP.

In any case, since my explanations are apparently tainted, here's how CBO director/blogger Doug Elmendorf explained their projections for future GDP growth:

Projected growth from 2015 to 2019 is also below historical average growth rates, a difference that is more than accounted for by slower growth in the labor force because of the retirement of the baby boom generation. Over the postwar period, the labor force grew at an average annual rate of 1.6 percent; by contrast, we project it to grow only 0.4 percent per year in the period from 2015 through 2019. As a result, potential GDP grew 3.4 percent per year on average in the postwar period, but CBO expects that it will grow by only 2.4 percent annually (allowing for a tad more productivity growth) in the 2015-2019 period.

In other words, the economy will grow more slowly in the future because the labor force will grow more slowly in the future. No conspiracy needed. Click here to read Elmendorf's full blog post.

Update: For those interested in playing around with the economic/demographic assumptions to see how they'll affect Social Security's long-term financing, a while back I put together a simple Excel-based model that lets you choose your own inputs. You can read about it and download the file here.

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