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467 November 4, 1985 FOR SOCIAL SECURITY, THE CRISIS CONTINUES INTRODUCTION The Social Security system's financing crisis has not been ended the 1983 legislation, designed to "rescue" the Social Security system most lawmakers have convinced themselves tha t the retirement program now has a rosy long-term future. One commentator has even talked mockingly of a "crisis of riches anticipating enormous surpluses that will need to be spent. Nothing could be further from the .truth. The system is still chronically ill It simply has been camouflaged and postponed. Yet thanks to The latest official reports reveal that Social Security still faces major financing problems, particularly over the long term To be sure, on the basis of the Social Security Administration's (SSA widely cited intermediate assumptions (known as Alternative IIB the program will start to run significant surpluses by 1990 and continue to do so until about 20 05. But in approximately 2015, the program will start running substantial annual deficits , and these will continue indefinitely. By 2026, before today's young workers retire, the program's combined trust'funds will be completely exhausted, leaving the program unable to pay promised benefits. Over the 75-year period projected in the SSA assump t ions, the entire program will run a cumulative deficit 50 percent greater than the total amount the 1983 legislation raised in new revenues and saved by benefit cuts. Under these projections, paying all the benefits promised to today's young workers would require raising the total Social Security payroll tax rate to 23 percent, from 14.1 percent today. Those looking for relief from federal deficits can take little comfort from the prospect of Social Security surpluses in the near term. The SSA projects tha t the program's annual surpluses will make only a small dent in future federal deficits. Since the program's financial projections do not indicate any surplus in the overall, unified, federal budget, Social Security surpluses.do not offer any prospect of a reduction in the national debt, as some have suggested. And by the time today's young workers retire, Social Security alone will be running annual deficits half as large, as a percent of GNP, as today's entire federal deficit. Moreover under the SSA's supposedly pessimistic projections Alternative 111), significant annual surpluses never even develop. Rather, Social Security's trust funds become completely exhausted by 1998, revealing the program's continuing short-term vulnerability to adverse economic conditions young workers under these projections would require a total Social Security payroll tax of about 37 percent. By the time today's young workers retire, Social Security alone would be running an annual deficit larger, as a percentage of GNP, tha n today's entire federal budget deficit increases now scheduled for 1988 and 1990 could be rescinded in the 1990s without immediately jeopardizing benefit payments more fundamental reform, the program then would be unable to pay promised benefits to the ba b y boom generation without dpubling payrdll taxes. Permanent tax cuts in the 1990s could be made possible only by adopting fundamental reforms today Paying all promised benefits to today's Under the intermediate assumptions, Social Security tax rate But wi thout It is clear that Social Security was not rescued in 19 83. The system is still sailing on a crash course toward a financial iceberg. Congress must recognize this and change its course. SOCIAL SECURITY.FINANCING HOW IT WORM A Pav-As-Ydu-Go System So cial Security is financed primarily by payroll taxes paid by employers and employees. Payroll tax revenues are deposited in the Social Security trust funds used to pay the program's current beneficiaries. Any surplus of revenues over expenditures is loane d to the federal government in return for specially issued interest-bearing bonds. The federal government spends the borrowed funds on other programs. The Social Security trust funds hold the bonds until the program's revenues fall short of expenditures, t hen the bonds are traded back to the government for the cash needed to finance benefits. If the program's revenues and accumulated trust fund bonds ever became insufficient to finance expenditures, then the program would be unable legally to pay promised b enefits. It would, in effect, be bankrupt. The federal government then would have to bail out the system 2RelationshiD with the Federal Budaet In the comprehensive, unified federal budget, all Social Security payroll taxes paid by employers and workers ar e counted as federal income. Funds paid into Social Security by the federal government such as interest on the trust fund bonds and payroll taxes paid by the federal government as an employer, are intragovernmental transfers counted neither as income nor e xpenditures for the federal government as a whole. Funds paid out of the Social Security trust funds to retired Americans and for other program benefits or administrative expenses are counted as federal expenditures. The net impact of Social Security on th e unified federal budget in any year is consequently measured by the surplus or deficit in the Social Security accounts for that year (not counting the amounts paid by the federal government itself into Social Security, since these are intragovernmental t ransfers). The Trust Funds and the National Debt Total Social Security trust fund assets are not a store of funds for future use. The reason is that no money exists in the funds: the cash has already been loaned to the federal government and spent. The tru st fund llassetsll are no more than claims against the federal government, which will have to be financed out of federal revenues or borrowing when they are needed to finance Social Security benefits sense represent an offset to the national debt merely a n internal federal account indicating that one part of the federal government owes money to another part of the federal government if they ever have to be cashed in to pay promised benefits national debt is only reduced when a surplus is run in the entire u nified federal budget fund balance is that it indicates the size of the tab that may face future taxpayers in repaying the money borrowed from Social Security to finance other federal programs As for Social Security itself, the trust fund balance indicate s the cash the program can demand from the federal Treasury to pay promised benefits under current law The total Social Security trust fund balance thus does not in any The trust funds are Indeed, trust fund assets will add to the national debt The The onl y real economic significance of the Social Security trust THE FINANCIAL OUTLOOK Table 1 summarizes the latest financial projections for the program under the SSAIs widely cited, intermediate, IIAlternative IIB 3TABLE 1 Alternative IIB Assumptions Social Se c uritv Financinq Social Security Expenditures As a Percent of Taxable Payroll Social Security Unified Budget Annual Surplus or Deficit As a Percent of GNP Social Security Trust Funds As a Percent of GNP 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030 203 5 2040 2045 2050 2055 13.96% 14 04 14 30 13.96 14.21 15.16 16 88 19 04 21.17% 22 64 23 24 23.26% 23 20 23.20% 23 14 0.12% 0.68% 0.58 0.72 0.61 0.22 0.48 1.33 2 15 2 69 2 88 2 84 2.77 2.74 2 68 1.44 4.49% 8 18 11.56% 14.69 16.54% 15 58 10 63 1.37 10.22%U -2 0.37 28.17 33.77 37.74 40.42 lJ 2 Calculated on the basis of trust fund totals at the end of the year. Trust funds exhausted in 2026 Source: Calculated from Harry C. Ballantyne, Chief Actuary, Social Security Administration Long-Range Estimates of Social Security Trust Fund Operations in Dollars,Il Actuarial Note 125, Social Security Administration, U.S. D e partment of Health and Human Services (April 1985): 1985 Annual Report of the Board of Trustees of the Federal Old-Acre and Survivors Insurance and Disability Insurance Trust Funds March 28, 1985; 1985 Annual Report of the Board of Trustees of the Federal Hospital Insurance Trust Fund, March 28, 1985 4assumptions. OASDHI), comprising programs for retirement income (OASI), disability insurance DI and Medicare hospital insurance (HI The projections assume that any of the program's trust funds can borrow from any of the others as needed-assuming otherwise would simply mean that the program would be unable to pay full benefits even sooner than indicated The projections are for all of Social Security (known as According to these projections, Social Security wil l begin to run substantial surpluses around the year 1990, continuing until about 20 05. Around 2015, however, the program will begin running substantial annual deficits, which will continue for the remaining 40 years of projections. By 2026, the trust fun ds for the entire program will be exhausted, and Social Security will pe unable to pay any of the benefits promised under current law. Short-Term Demoaraphics Such a financial picture is primarily a consequence of demographic trends. The "baby boom" gener ation, born during the high fertility years after World War 11 is now working and paying taxes into Social Security. Starting in the 19908, moreover, the relatively small generation born during the low fertility years of the Great Depression and World War I1 will be retiring, easing the program's benefit obligations increases during the late 1970s and scheduled through 1990, this favorable ratio of retirees to workers explains the near-term surpluses in the program Combined with substantial Social Security tax The Lonaer Term Trend Around 2015, this pattern changes dramatically as the baby boom generation starts to retire, placing huge financial burdens on the system. At the same time, the work force will be dominated by the relatively small generation of w orkers born during the low fertility years since the mid-19608, resulting in weaker revenue flows into the system. With this double whammy, the system's basic financial structure soon will collapse. These projections suggest that under current law Social S ecurity will not be able to pay all the benefits promised to young workers entering the work force today. By 2035, when these workers will be retiring, not only will the program's trust funds be exhausted, but 1. The Alternative IIB projections for OASDI alone indicate that the trust funds for this portion of the program would be exhausted by 20 49. But when HI is added in and the entire program is analyzed, as in Table 1, the data show the program taken as a.whole unable to pay full benefits by 2026 5- So cial Security expenditpres will be running almost 50 percent greater than revenues each year. With no trust fund reserves, column 1 in Table 1 shows approximately how high payroll taxes would have to be raised to generate enough revenues to pay benefit ob ligations in those years. The data indicate that paying all the benefits promised to today's young workers would require a total Social Security payroll tax rate.of more than 23 percent compared with 14.1 percent today. Over the entire 75-year period proje cted by the SSA, the Alternative IIB assumptions show Social Security running a cumulative deficit 50 percent greater than the total amount raised by new revenues or by cuts in benefits understhe 1983 legislation passed to save Social Security from bankru p tcy. These projections indicate in other words, that Social Security still faces a long-term financing crisis that will impede the system's ability to honor its obligations to today's young workers CHECKING THE ASSUMPTIONS The problems are even worse than these projections indicate because thelAlternative IIB assumptions are probably too optimistic. Economic Assumptions The IIB assumptions view the economy as performing much better in the future than it has in most of the past 20 years. Example inflation i s assumed to stabilize at 4 percent by 1990, and unemployment at 6 percent, where they are expected to remain for the following 70 years. Further, the most important economic factor for Social Security, the rate of growth in real wages, is assumed to stab i lize at 1.6 percent every year for about 20 years, and then 1.5 2. Table 1 shows that expenditures in that year are 23.24 percent of taxable payroll. But revenues in that year are projected at 16.06 percent of taxable payroll. See 1985 Annual Reuort of th e Board of Trustees of the Federal Old-Aee and Survivors Insurance and Disabilitv Insurance Trust Funds March 28, 1985 (hereinafter "1985 OASDI Trustee's Reoort Appendix E, Table E3 3. The 75-year deficit under Alternative IIB assumptions is' 3.16 percent of taxable payroll. See 1985 OASDI Trustee's Reuort, Appendix E, Table E 3. The 1983 legislation was projected to close the program's long-term revenue gap by 2.09 percent of taxable payroll. See 1983 Annual Reoort of the Board of Trustees of the Federal O ld-Ane and Survivors Insurance and Disabilitv Insurance Trust Funds hereinafter "1983 OASDI Trustee's Reoort 4. These assumptions are listed in 1985 OASDI Trustee 's Reoort 6 percent every year for the following 50 years. Yet over the past 15 years, real growth in wages has actually been negative, and over the past 30 years, rea1,wages have grown at an average rate of only about 1.0 percent a year. These economic assumptions, moreover, leave little room for the periodic, steep recessions that have characte rized the past couple of decades. Such recessions can devastate Social Security financing since slowdowns in employment and wages result in substantially less revenue than expected from the payroll tax accompanies such recessions as it did in the 19708, i n dexed benefits cause expenditures to rise despite the weakened revenue base, further damaging the program's financial health. It was just such economic performance that created the financial crisis requiring the Social Security bailout legislation in 1977 , which enacted the schedule of steadily increasing payroll taxes through 19 90. Similar economic developments led to the more recent crisis and the 1983 bailout If strong inflation Demoaraphic Assumptions Probably most important for the long term are the demographic projections expectancy rate of growth over the last 40 years will slow future retirees live longer than the SSA now projects, they will draw more benefits from the program, adding to its financial burdens Alternative IIB projections assume tha t the life But if The SSA longevity assumption is highly questionable. It reckons on no dramatic U.S. medical breakthroughs. This seems very implausible. Over the next 75 years, given the current pace of major medical and biotech discoveries, life expectan c y could be extended well beyond that predicted by the cautious SSA. Even if the baby boom generation were to live an average of only five years more than now expected, the financial impact on Social Security would be overwhelming 75 years may become, in f act, the new chief source of intractable financial problems for Social Security. Alternative IIB projections al.so assume that the fertility rate will increase substantially and permanently from current levels. Yet the downward trend in fertiligy has a 200-year history, falling from 7.04 in 1800 to 1.76 in 19 83. Powerful social, economic, and technological trends account for this decline and, if anything Longer-than-anticipated life expectancies over the next 5. Social Security Administration, Office of t he Actuary 6. See Peter J. Ferrara, Social'Securitv: The Inherent Contradiction (Washington, D.C Cat0 Institute, 1980), Table 33. The fertility rate in each year is the average liftime births per woman that could be expected, given births experienced by women at each age in that year 7portend a further drop--not an increase already have significantly lower fertility rates than t he U.S such as West Germany, where the rate is 1. 4. Moreover, it took the back-to-back cataclysms of the Great Depression and World War I1 to produce the relatively brief fertility increase of the postwar baby boom Many West European countries Lower futur e fertility rates, of course, mean fewer workers to pay taxes to finance the accrued benefit obligations under Social Security's pay-as-you-go system. This, in turn, means an even bleaker financial outlook for the program. Realism and Prudence In contrast with the Alternative IIB assumptions, the SSA's so-called pessimistic Alternative I11 aspmptions (see Table 2 are actually quite reasonable and prudent. Alternative I11 scenario, for example, is assumed to stabilize permanently at 5 percent, unemployment at 7 percent, and real wage growth at 1 percent. An economic slowdown is assumed in 1986, and a recession in 19 89. Moreover, fertility and life expectancy are assumed to follow longstanding trends more closely. The Alternative I11 assumptions, in other words, do not expect past trends to alter significantly in the future Inflation in the Criticism that the assumptions for Social Security's financial projections are too optimistic has led the SSA to modify the Alternative IIB and Alternative I11 assumpti o ns, making them less optimistic. Yet the Alternative I11 assumptions are still at least quitesplausible, and many independent analysts agree with this view. Indeed, the U.S. government itself is officially admitting that the Alternative I11 projections ar e at least reasonably possible by publishing them in the SSA reports 7. These assumptions are listed in 1985 OASDI Trustee's ReDort 8. See, e.g., Rita Ricardo-Campbell Social Security Reform: A Mature System in an Aging Society" in John H. Moore, ed To Pro mote Prosoeritv: U.S. Domestic Policv in the Mid-1980s. (Stanford, California: Hoover Institution, 1984); Peter J. Peterson The Coming Crash of Social Security The New York Review of Books, December 2, 1982; A. Haeworth Robertson The National Commission's Failure to Achieve Real Reform" and Paul Craig Roberts Social Security: Myths and Realities in Peter J. Ferrara, ed Social Securitv: ProsDects for Real Reform (Washington, D.C.: Cat0 Institute, 1985); James R. Capra, Peter D. Skepardas, and Roger B. Kubar ych Social Security: An Analysis of its Problems Federal Reserve Bank of New York Ouarterlv Review, Autumn 1982 8THE GRIM FUTURE The Alternative I11 projections, summarized in Table 2, show the continuing short-term vulnerability of the program to adverse economic performance. Under these projections, annual surpluses never develop and the trust funds for the entire program will be completely exhausted in 19 98. This means that the program would be unable to pay its promised benefits. By 2035, when young workers entering the work force today will be retiring, Social Security expenditure obligations ukder these projections would be 2.3 times as large as revenue promised benefits in that year would require a total Social Security payroll tax rate of about 3 7 percent tax burden, split between employer and employee, of $7,500 for a worker making 20,0 00. The worker would still have to pay federal state, and local taxes out of his,remaining income Paying all This means a Social Security The cumulative deficit f or Social Security over the 75-year projection period, under these assumptions, would be more than 4.5 times as large as the financial gap closed by the 1983 legislation. Clearly, with such a disastrous long-term outlook under plausible assumptions, simpl e prudence would dictate that fundamental reform be adopted now to avoid the possibility of intractable future difficulties. SOCIAL SECURITY, THE FEDERAL DEFICIT, AND THE NATIONAL DEBT Since Social Security is almost one-third of the federal budget its fin ancial prospects raise important questions for federal finances as a whole. The projections based on the SSAs assumptions show that Social Security, as currently_=tmctured,.offers only a relatively small reduction in -federal def kits during projected sur p lus years with the prospect of a much larger increase in federal deficits in future years 9. Table 2 shows expenditures in that year at 37.44 percent of taxable payroll. But revenues in that year are projected at 16.35 percent of taxable payroll. 1985 OAS DI Trustees Reoort Appendix E, Table E3 10. The 75-year deficit under Alternative I11 assumptions is 12.49 percent of taxable payroll, 1985 OASDI Trustees ReoorL Appendix E, Table E 3. The 1983 legislation under Alternative I11 assumptions was projected to close the programs long-term revenue gap by 2.7 percent of taxable payroll. See Lt 9Alternative IIB Assumptions and the Deficit Column 2 of Table 1 shows the annual Social Security surplus or deficit contributed to the unified federal budget under the Al t ernative IIB assumptions surplus developing from 1990 to 2005 of about 0.60 percent to 0.70 percent of GNP. The annual surplus declines thereafter, and by 2015 the program runs annual deficits, which continue for the remaining 40 years projected. These So c ial Security deficits climb to more than 2 percent of GNP by 2025 and almost 3 percent of GNP by 2035 The projections show an annual The federal budget deficit in the fiscal year just ended was about 5.5 percent of GNP. The projected Social Security surpl uses from 1990 to 2005 would offset from 10 to 13 percent of a federal budget deficit of the same size relative to GNP during those years would be a significant reduction in federal deficits. Security surplus during the just-ended fiscal year would have reduced the nearly $200 billion federal deficit by $20 to $30 billion. However, it is also clear that Social Security by itself will not come anywhere close to eliminating federal budget deficits of the same magni tude, relative to GNP, as today's federal red ink. Moreover, the extent to which Social Security could reduce federal deficits in future years is already reflected in the usual Office of Management and Budget and Congressional Budget Office projections of the def kit That Such a Social Over the long run, the projections in Table 1 show Social Security adding substantially to federal deficits each year. By the time today's young workers retired, and indefinitely thereafter Social Security deficits would be increasing the total federal deficit by 2 to 3 percent of GNP-about half as much, relative to GNP, as today's entire federal deficit. Alternative IIB Assumptions and the National Debt Column 3 in Table 1 shows the projected annual balances, as a percent of GNP, of the combined trust funds for all of Social Security 11. The data actually overstate the annual Social Security surpluses for the unified budget, and understate the deficits, because ,only interest income paid by the federal government has been ex c luded from Social Security income in the calculation of surpluses and deficits in the table. Technically, taxes paid by the federal government as an employer and certain specified annual payments to the program from federal general revenues should also be excluded. But the Social Security Administration does not publish long-range projections of such items. Based on data published through 1994, the overstatement of surpluses and understatement of deficits probably amounts to about 0.10 percent of GNP each year 10 under Alternative IIB assumptions of GNP in 2010, falling into a substantial deficit by 20 30. By 2055, the program will have run a cumulative deficit of about 40 percent of GNP in that year The balance peaks at 16i254 percent A trust fund balance of today of the same magnitude, relative to GNP, at the peak balance in 2020 would be about $600 billion. While this appears to be a significant sum, it would be no more than a modest cushion when compared with the enormous liabilities of Social Security, for it would constitute only a little more than 10 percent of thelsmoney intended to operate the program on a fully funded basis. Moreover, such a positive balance would equal only about 40 percent of the total assets of private pensions, including Indivi dual Retirement Accounts and 401(k) pension plans. And even this trust fund balance would last for only one year, dwindling eventuallyto zero. In addition, this peak balance would not represent 600 billion in cash, but rather 600 billion in claims against the federal government So these trust fund assets would not be, in any sense, an offset to the total national debt. They would be, instead, a mountain of federal IOUs, which could themselves become an addition to the national debt if they ever had to be c ashed in to pay promised benefits-as seems likely only by running a surplus in the overall, unified federal budget. Since there is no indication in the projections of annual Social Security,surpluses and deficits in Table 1 that Social Security will lead t o surpluses in the overall, unified federal budget, neither those projections nor the projected annual Social Security trust fund balances imply any reduction .in the national debt The total national debt can be reduced The Picture Under Alternative I11 A s sumptions Column 2 of Table 2 shows the impact Social Security would have on federal dfificits under the less optimistic Alternative I11 assumptions. Here, significant Social Security surpluses reducing federal deficits never develop, and by 1995 the prog r am is running heavy deficits, which continue to expand for the next 60 years, adding considerably to overall federal deficits. Even before today's young workers retire, Social Security alone under these projections would be 12. As noted in Table 1, the tr ust funds are actually exhausted in 2026 13. Calculated from Statement of Liabilities and Other Financial Commitments of the United States Government as of SeDtember 30. 1984, in Office of the Secretary, U.S. Department of Treasury, Treasurv Bulletin, 1st Quarter, Fiscal 85, Winter Issue 14. The projections again actually overstate the annual Social Security surpluses for the unified budget, and understate the deficits, for the reasons explained in footnote 11 11 1985 1990 1995 2000 2005 2010 2015 2020 202 5 2030 2035 2040 2045 2050 2055 TABLE 2 Social Securitv Financinq Alternative I11 AssumDtions Social Security Social Security Unified Budget Social Security Expenditures Annual Surplus Trust Funds 1 As a Percent of or Deficit As a As a Percent Taxable Payr o ll Percent of GNP of GNP 14.26 15.61% 16.30% 16 78 17.96% 20 07 23 34 27 40 31.74% 35 28 37.44 38 69 39.76 40.81% 41.52 0.0% 0.0 0.28 0.49 0.97 1.83 3 11 4 66 6.27 7 51 8 19 8.51 8 73 8.95 9 04 1.35 1.45 0.08 1.12% 2 4.43 10.13 19.5.9 33.38 51.09 70.66 88 .51 95.18 119.06 130.79 140.10 Calculated on the basis of trust fund totals at the end of the year. Trust funds exhausted in 19. 98. Source: Calculated from Harry C. Ballantyne, Chief Actuary, Social Security Administration, IILong-Range Estimates of Soci al Security Trust Fund Operations in Dollars Actuarial Note 125, Social Security Administration, U.S. Department of Health and Human Services, April 1985; 1985 Annual Report of the Board of Trustees of the Federal Old-Aae and Survivors Insurance and Disab i litv Insurance Trust Funds March 28, 1985; 1985 Annual Report of the Board of Trustees of the Federal Hospital Insurance Trust Fund, March 28, 1985 12 running a deficit, as a percent of GNP, as large as today's deficit relative to GNP, for the entire fede ral budget. Column 3 in Table 2 shows the total Social Security trust fund balances as a percent of GNP under th% Alternative I11 assumptions. No substantial trust fund balance ever develops, and the trust funds are completely exhausted by 19 98. By the end of the projection period if these assumptions prove more accurate, the program will: have run a cumulative deficit almost one and a half times the GNP in that year A REASSESSMENT BY CONGRESS The gloomy prospects for the nation's retirement system have been scrupulously ignored by Congress. Lawmakers predictably seek to avoid the political minefield of Social Security. Unfortunately, this determination to ignore the continuing problems of the system has been encouraged by a study that purports to show t h at the future of Social Security is remarkably rosy A recent, widely distributed article by former Senate aide Stuart Sweet indicates that the OASDI portion of Social Security (which is all of the program except hospital insurance, or about 80 percent of the entire program) under the Alternative IIB assumptions would run such a huge annual surplus that the federal budget would15be balanced by 2001 and the entire national debt liquidated by 20 16. This is a distressingly erroneous representation of publishe d, publicly available, government data. Due to a misunderstanding of the nature of Social Security financing, Sweet incorrectly calculates the Social Security surplus as reflected in the unified federal budget also conducts his analysis in nominal dollars , and therefore does not He 15. Stuart Sweet America's Great Opportunity: The Incredible Social Security Surplus," A.B. Laffer Associates, Lomita, California, July 15, 1985 16. Sweet incorrectly includes interest income on the Social Security trust fund bo nds as reducing the federal deficit. But as noted, this interest is paid by the federal government itself, and consequently is an intragovernmental transfer, which cannot reduce the federal deficit 13 adequatelyl,account for the impact of inflation and ec onomic growth over time. In addition, Sweet's calculations fail to include the deficits in the hospital insurance (HI) portion of the program. In fact, by 2001, under Alternative IIB assumptions, OASDI woBld run a surplus in the unified federal budget of 1.1 percent of GNP. As noted, the deficit in the fiscal year that ended September 30 amounted to 5.5 percent of GNP. Clearly, the projected OAS DI surplus is not even remotely sufficient to eliminate federal deficits of today's magnitude as a percent of GNP. There is no justification moreover, for focusing'only on OASDI and excluding, as Sweet does, the projected deficits in the HI portion of the program from the analysis. The federal budget may well be balanced by 2001, but that will be primarily because of factors such as economic growth, inflation spending restraint, or tax increases-not because of Social Security. POLICY IMPLICATIONS I Under current law, the total Social Security tax rate will increase in 1988 to 15.02 percent, and in 1990 to 15.3 percent. Under the Alternative IIB assumptions, these tax increases could be rescinded in the 1990s without immediately jeopardizing benefit the tr u st fund accumulation now projected to begin in the 1990s Without significant trust fund reserves, the program will be unable to pay full benefits as soon as the later projected annual Social Security deficits begin for the program itself, such deficits wi l l begin by 2017 payments. But this would eliminate most of the annual surpluses and I Counting all of the income and gxpenditures 17. Sweet assumes that the federal deficit, apart from Social Security, would remain at 200 billion in nominal dollars each y e ar indefinitely. But this is unlikely, because inflation and economic growth would make 200 billion in nominal dollars a relatively trivial amount over time. With such an assumption, Sweet's analysis suggests that the federal deficit, apart from Social Se c urity, would fall to about 1 percent of GNP in 2001 and be in balance soon thereafter. It is this assumption that, supposedly, balances the federal budget by 2001, and pays off the national debt by 2016, and not the impact of Social Security finances 18. C alculated from Harry C. Ballantyne, Chief Actuary, Social Security Administration Long-Range Estimates of Social Security Trust Fund Operations in Dollars Actuarial Note 125, Social Security Administration, U.S. Department of Health and Human Services, Ap r il 1985 19. Calculated from the sources cited in Tables 1 and 2 I 14 - Without more fundamental reform, therefore, payroll tax cuts in the 1990s would leave the program unable to pay full benefits to the baby boom generation. Under the Alternative'IIB ass u mptions, paying benefits without trust fund support would require total payroll tax rates of 21.2 percent in 2g25 and 22.6 percent in 2030--or almost a assumptions, there is no room for payroll tax cuts in the 199Os, since the program would face financial collapse by 1998. doubling of today's rates. Of course, under the Alternative I11 The groundwork for permanent tax cuts in the 199Os, however This reform would allow workers to contribute could be laid by more fundamental reform today, such as allowing wo rkers to substitute expanded "Super IRAs" for part of their Social Security coverage extra funds to their IRAs above amounts allowed under current law to purchase disability and life insurance and health care for their retirement years. Under this plan, workers would receive 100 percent income tax credits for these contributions, rather than the usual IRA deduction. But to the extent that workers exercised this option, their Social Security retirement benefits would be reduced in proportion to the amount o f tax credits received over the years. The accumulated funds in these Super IRAs would more than make up for these foregone Soc;lpl Security benefits, leaving Americans with higher benefits overall. With this reform Social Security would be substantially strengthened financially, since payroll taxes financing Social Security would be maintained in full, while the tax credit for Super IRA contributions would be taken against income taxes, not payroll taxes. Moreover, over the long run Social Security expen d itures would be reduced, as workers relied increasingly on their Super IRAs rather than Social Security. If this change were adopted now, and expanded over time, Social Security taxes could be cut in the 1990s. By the time the baby boom generation retired , Social Security expenditures could be reduced sufficiently to enable the benefit obligations made to the baby boomers to be financed in full. Moreover, as the option was continually expanded, Social Security expenditures would be reduced commensurately, a nd payroll taxes could be cut steadily 20. 1985 OASDI Trustee's ReDort, Appendix E 21. See Peter J. Ferrara, ed Social Securitv: ProsDects for Real Returns (Washington D.C.: Cat0 Institute, 1985); Ferrara The Social. Security System" in Stuart Butler Mich a el Sanera and W. Bruce Weinrod, eds., Mandate for LeadershiD 11: Continuinn the Conservative Revolution (Washington, D.C.: The Heritage Foundation, 1984); Ferrara Rebuilding Social Security, Part 2 Heritage Foundation Backprounder No. 346, April 1984 15 C O NCLUSION The limited solvency of Social Security has been achieved through years of relentless increases in Social Security taxes (with many still scheduled to come) and substantial cuts in future benefits. I This combination makes Social Security a poor d eal for tgdayls young workers, even if all promised benefits are somehow paid. Further benefit reductions or accelerated tax increases'might improve the fiscal outlook for the program, but only at the price of making it an even worse deal retirement on th e promise of Social Security benefits. Today's young workers would be foolish to base their Fundamental reforms are necessary so that this generation can look forward to a secure and prosperous retirement. The longer Congress ignores the true condition of the system, and grasps at straws suggesting that Social Security is sound, the more today's young workers will lose. Prepared for The Heritage Foundation by Peter J. Ferrara member of the White House Office of Policy Development a Washington attorney, for merly a i I 22. For further discussion of the bad deal Social Security now offers to today's young workers, see Peter J. Ferrara and John R. Lott, Jr Rates of Return Promised by Social Security to Today's Young Workers in Peter J. Ferrara, ed Social Secur itv: ProsDects for Real Reform (Washington D.C Cat0 Institute, 1985 16
467 November 4, 1985 FOR SOCIAL SECURITY, THE CRISIS CONTINUES INTRODUCTION The Social Security system's financing crisis has not been ended the 1983 legislation, designed to "rescue" the Social Security system most lawmakers have convinced themselves tha t the retirement program now has a rosy long-term future. One commentator has even talked mockingly of a "crisis of riches anticipating enormous surpluses that will need to be spent. Nothing could be further from the .truth. The system is still chronically ill It simply has been camouflaged and postponed. Yet thanks to The latest official reports reveal that Social Security still faces major financing problems, particularly over the long term To be sure, on the basis of the Social Security Administration's (SSA widely cited intermediate assumptions (known as Alternative IIB the program will start to run significant surpluses by 1990 and continue to do so until about 20 05. But in approximately 2015, the program will start running substantial annual deficits , and these will continue indefinitely. By 2026, before today's young workers retire, the program's combined trust'funds will be completely exhausted, leaving the program unable to pay promised benefits. Over the 75-year period projected in the SSA assump t ions, the entire program will run a cumulative deficit 50 percent greater than the total amount the 1983 legislation raised in new revenues and saved by benefit cuts. Under these projections, paying all the benefits promised to today's young workers would require raising the total Social Security payroll tax rate to 23 percent, from 14.1 percent today. Those looking for relief from federal deficits can take little comfort from the prospect of Social Security surpluses in the near term. The SSA projects tha t the program's annual surpluses will make only a small dent in future federal deficits. Since the program's financial projections do not indicate any surplus in the overall, unified, federal budget, Social Security surpluses.do not offer any prospect of a reduction in the national debt, as some have suggested. And by the time today's young workers retire, Social Security alone will be running annual deficits half as large, as a percent of GNP, as today's entire federal deficit. Moreover under the SSA's supposedly pessimistic projections Alternative 111), significant annual surpluses never even develop. Rather, Social Security's trust funds become completely exhausted by 1998, revealing the program's continuing short-term vulnerability to adverse economic conditions young workers under these projections would require a total Social Security payroll tax of about 37 percent. By the time today's young workers retire, Social Security alone would be running an annual deficit larger, as a percentage of GNP, tha n today's entire federal budget deficit increases now scheduled for 1988 and 1990 could be rescinded in the 1990s without immediately jeopardizing benefit payments more fundamental reform, the program then would be unable to pay promised benefits to the ba b y boom generation without dpubling payrdll taxes. Permanent tax cuts in the 1990s could be made possible only by adopting fundamental reforms today Paying all promised benefits to today's Under the intermediate assumptions, Social Security tax rate But wi thout It is clear that Social Security was not rescued in 19 83. The system is still sailing on a crash course toward a financial iceberg. Congress must recognize this and change its course. SOCIAL SECURITY.FINANCING HOW IT WORM A Pav-As-Ydu-Go System So cial Security is financed primarily by payroll taxes paid by employers and employees. Payroll tax revenues are deposited in the Social Security trust funds used to pay the program's current beneficiaries. Any surplus of revenues over expenditures is loane d to the federal government in return for specially issued interest-bearing bonds. The federal government spends the borrowed funds on other programs. The Social Security trust funds hold the bonds until the program's revenues fall short of expenditures, t hen the bonds are traded back to the government for the cash needed to finance benefits. If the program's revenues and accumulated trust fund bonds ever became insufficient to finance expenditures, then the program would be unable legally to pay promised b enefits. It would, in effect, be bankrupt. The federal government then would have to bail out the system 2RelationshiD with the Federal Budaet In the comprehensive, unified federal budget, all Social Security payroll taxes paid by employers and workers ar e counted as federal income. Funds paid into Social Security by the federal government such as interest on the trust fund bonds and payroll taxes paid by the federal government as an employer, are intragovernmental transfers counted neither as income nor e xpenditures for the federal government as a whole. Funds paid out of the Social Security trust funds to retired Americans and for other program benefits or administrative expenses are counted as federal expenditures. The net impact of Social Security on th e unified federal budget in any year is consequently measured by the surplus or deficit in the Social Security accounts for that year (not counting the amounts paid by the federal government itself into Social Security, since these are intragovernmental t ransfers). The Trust Funds and the National Debt Total Social Security trust fund assets are not a store of funds for future use. The reason is that no money exists in the funds: the cash has already been loaned to the federal government and spent. The tru st fund llassetsll are no more than claims against the federal government, which will have to be financed out of federal revenues or borrowing when they are needed to finance Social Security benefits sense represent an offset to the national debt merely a n internal federal account indicating that one part of the federal government owes money to another part of the federal government if they ever have to be cashed in to pay promised benefits national debt is only reduced when a surplus is run in the entire u nified federal budget fund balance is that it indicates the size of the tab that may face future taxpayers in repaying the money borrowed from Social Security to finance other federal programs As for Social Security itself, the trust fund balance indicate s the cash the program can demand from the federal Treasury to pay promised benefits under current law The total Social Security trust fund balance thus does not in any The trust funds are Indeed, trust fund assets will add to the national debt The The onl y real economic significance of the Social Security trust THE FINANCIAL OUTLOOK Table 1 summarizes the latest financial projections for the program under the SSAIs widely cited, intermediate, IIAlternative IIB 3TABLE 1 Alternative IIB Assumptions Social Se c uritv Financinq Social Security Expenditures As a Percent of Taxable Payroll Social Security Unified Budget Annual Surplus or Deficit As a Percent of GNP Social Security Trust Funds As a Percent of GNP 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030 203 5 2040 2045 2050 2055 13.96% 14 04 14 30 13.96 14.21 15.16 16 88 19 04 21.17% 22 64 23 24 23.26% 23 20 23.20% 23 14 0.12% 0.68% 0.58 0.72 0.61 0.22 0.48 1.33 2 15 2 69 2 88 2 84 2.77 2.74 2 68 1.44 4.49% 8 18 11.56% 14.69 16.54% 15 58 10 63 1.37 10.22%U -2 0.37 28.17 33.77 37.74 40.42 lJ 2 Calculated on the basis of trust fund totals at the end of the year. Trust funds exhausted in 2026 Source: Calculated from Harry C. Ballantyne, Chief Actuary, Social Security Administration Long-Range Estimates of Social Security Trust Fund Operations in Dollars,Il Actuarial Note 125, Social Security Administration, U.S. D e partment of Health and Human Services (April 1985): 1985 Annual Report of the Board of Trustees of the Federal Old-Acre and Survivors Insurance and Disability Insurance Trust Funds March 28, 1985; 1985 Annual Report of the Board of Trustees of the Federal Hospital Insurance Trust Fund, March 28, 1985 4assumptions. OASDHI), comprising programs for retirement income (OASI), disability insurance DI and Medicare hospital insurance (HI The projections assume that any of the program's trust funds can borrow from any of the others as needed-assuming otherwise would simply mean that the program would be unable to pay full benefits even sooner than indicated The projections are for all of Social Security (known as According to these projections, Social Security wil l begin to run substantial surpluses around the year 1990, continuing until about 20 05. Around 2015, however, the program will begin running substantial annual deficits, which will continue for the remaining 40 years of projections. By 2026, the trust fun ds for the entire program will be exhausted, and Social Security will pe unable to pay any of the benefits promised under current law. Short-Term Demoaraphics Such a financial picture is primarily a consequence of demographic trends. The "baby boom" gener ation, born during the high fertility years after World War 11 is now working and paying taxes into Social Security. Starting in the 19908, moreover, the relatively small generation born during the low fertility years of the Great Depression and World War I1 will be retiring, easing the program's benefit obligations increases during the late 1970s and scheduled through 1990, this favorable ratio of retirees to workers explains the near-term surpluses in the program Combined with substantial Social Security tax The Lonaer Term Trend Around 2015, this pattern changes dramatically as the baby boom generation starts to retire, placing huge financial burdens on the system. At the same time, the work force will be dominated by the relatively small generation of w orkers born during the low fertility years since the mid-19608, resulting in weaker revenue flows into the system. With this double whammy, the system's basic financial structure soon will collapse. These projections suggest that under current law Social S ecurity will not be able to pay all the benefits promised to young workers entering the work force today. By 2035, when these workers will be retiring, not only will the program's trust funds be exhausted, but 1. The Alternative IIB projections for OASDI alone indicate that the trust funds for this portion of the program would be exhausted by 20 49. But when HI is added in and the entire program is analyzed, as in Table 1, the data show the program taken as a.whole unable to pay full benefits by 2026 5- So cial Security expenditpres will be running almost 50 percent greater than revenues each year. With no trust fund reserves, column 1 in Table 1 shows approximately how high payroll taxes would have to be raised to generate enough revenues to pay benefit ob ligations in those years. The data indicate that paying all the benefits promised to today's young workers would require a total Social Security payroll tax rate.of more than 23 percent compared with 14.1 percent today. Over the entire 75-year period proje cted by the SSA, the Alternative IIB assumptions show Social Security running a cumulative deficit 50 percent greater than the total amount raised by new revenues or by cuts in benefits understhe 1983 legislation passed to save Social Security from bankru p tcy. These projections indicate in other words, that Social Security still faces a long-term financing crisis that will impede the system's ability to honor its obligations to today's young workers CHECKING THE ASSUMPTIONS The problems are even worse than these projections indicate because thelAlternative IIB assumptions are probably too optimistic. Economic Assumptions The IIB assumptions view the economy as performing much better in the future than it has in most of the past 20 years. Example inflation i s assumed to stabilize at 4 percent by 1990, and unemployment at 6 percent, where they are expected to remain for the following 70 years. Further, the most important economic factor for Social Security, the rate of growth in real wages, is assumed to stab i lize at 1.6 percent every year for about 20 years, and then 1.5 2. Table 1 shows that expenditures in that year are 23.24 percent of taxable payroll. But revenues in that year are projected at 16.06 percent of taxable payroll. See 1985 Annual Reuort of th e Board of Trustees of the Federal Old-Aee and Survivors Insurance and Disabilitv Insurance Trust Funds March 28, 1985 (hereinafter "1985 OASDI Trustee's Reoort Appendix E, Table E3 3. The 75-year deficit under Alternative IIB assumptions is' 3.16 percent of taxable payroll. See 1985 OASDI Trustee's Reuort, Appendix E, Table E 3. The 1983 legislation was projected to close the program's long-term revenue gap by 2.09 percent of taxable payroll. See 1983 Annual Reoort of the Board of Trustees of the Federal O ld-Ane and Survivors Insurance and Disabilitv Insurance Trust Funds hereinafter "1983 OASDI Trustee's Reoort 4. These assumptions are listed in 1985 OASDI Trustee 's Reoort 6 percent every year for the following 50 years. Yet over the past 15 years, real growth in wages has actually been negative, and over the past 30 years, rea1,wages have grown at an average rate of only about 1.0 percent a year. These economic assumptions, moreover, leave little room for the periodic, steep recessions that have characte rized the past couple of decades. Such recessions can devastate Social Security financing since slowdowns in employment and wages result in substantially less revenue than expected from the payroll tax accompanies such recessions as it did in the 19708, i n dexed benefits cause expenditures to rise despite the weakened revenue base, further damaging the program's financial health. It was just such economic performance that created the financial crisis requiring the Social Security bailout legislation in 1977 , which enacted the schedule of steadily increasing payroll taxes through 19 90. Similar economic developments led to the more recent crisis and the 1983 bailout If strong inflation Demoaraphic Assumptions Probably most important for the long term are the demographic projections expectancy rate of growth over the last 40 years will slow future retirees live longer than the SSA now projects, they will draw more benefits from the program, adding to its financial burdens Alternative IIB projections assume tha t the life But if The SSA longevity assumption is highly questionable. It reckons on no dramatic U.S. medical breakthroughs. This seems very implausible. Over the next 75 years, given the current pace of major medical and biotech discoveries, life expectan c y could be extended well beyond that predicted by the cautious SSA. Even if the baby boom generation were to live an average of only five years more than now expected, the financial impact on Social Security would be overwhelming 75 years may become, in f act, the new chief source of intractable financial problems for Social Security. Alternative IIB projections al.so assume that the fertility rate will increase substantially and permanently from current levels. Yet the downward trend in fertiligy has a 200-year history, falling from 7.04 in 1800 to 1.76 in 19 83. Powerful social, economic, and technological trends account for this decline and, if anything Longer-than-anticipated life expectancies over the next 5. Social Security Administration, Office of t he Actuary 6. See Peter J. Ferrara, Social'Securitv: The Inherent Contradiction (Washington, D.C Cat0 Institute, 1980), Table 33. The fertility rate in each year is the average liftime births per woman that could be expected, given births experienced by women at each age in that year 7portend a further drop--not an increase already have significantly lower fertility rates than t he U.S such as West Germany, where the rate is 1. 4. Moreover, it took the back-to-back cataclysms of the Great Depression and World War I1 to produce the relatively brief fertility increase of the postwar baby boom Many West European countries Lower futur e fertility rates, of course, mean fewer workers to pay taxes to finance the accrued benefit obligations under Social Security's pay-as-you-go system. This, in turn, means an even bleaker financial outlook for the program. Realism and Prudence In contrast with the Alternative IIB assumptions, the SSA's so-called pessimistic Alternative I11 aspmptions (see Table 2 are actually quite reasonable and prudent. Alternative I11 scenario, for example, is assumed to stabilize permanently at 5 percent, unemployment at 7 percent, and real wage growth at 1 percent. An economic slowdown is assumed in 1986, and a recession in 19 89. Moreover, fertility and life expectancy are assumed to follow longstanding trends more closely. The Alternative I11 assumptions, in other words, do not expect past trends to alter significantly in the future Inflation in the Criticism that the assumptions for Social Security's financial projections are too optimistic has led the SSA to modify the Alternative IIB and Alternative I11 assumpti o ns, making them less optimistic. Yet the Alternative I11 assumptions are still at least quitesplausible, and many independent analysts agree with this view. Indeed, the U.S. government itself is officially admitting that the Alternative I11 projections ar e at least reasonably possible by publishing them in the SSA reports 7. These assumptions are listed in 1985 OASDI Trustee's ReDort 8. See, e.g., Rita Ricardo-Campbell Social Security Reform: A Mature System in an Aging Society" in John H. Moore, ed To Pro mote Prosoeritv: U.S. Domestic Policv in the Mid-1980s. (Stanford, California: Hoover Institution, 1984); Peter J. Peterson The Coming Crash of Social Security The New York Review of Books, December 2, 1982; A. Haeworth Robertson The National Commission's Failure to Achieve Real Reform" and Paul Craig Roberts Social Security: Myths and Realities in Peter J. Ferrara, ed Social Securitv: ProsDects for Real Reform (Washington, D.C.: Cat0 Institute, 1985); James R. Capra, Peter D. Skepardas, and Roger B. Kubar ych Social Security: An Analysis of its Problems Federal Reserve Bank of New York Ouarterlv Review, Autumn 1982 8THE GRIM FUTURE The Alternative I11 projections, summarized in Table 2, show the continuing short-term vulnerability of the program to adverse economic performance. Under these projections, annual surpluses never develop and the trust funds for the entire program will be completely exhausted in 19 98. This means that the program would be unable to pay its promised benefits. By 2035, when young workers entering the work force today will be retiring, Social Security expenditure obligations ukder these projections would be 2.3 times as large as revenue promised benefits in that year would require a total Social Security payroll tax rate of about 3 7 percent tax burden, split between employer and employee, of $7,500 for a worker making 20,0 00. The worker would still have to pay federal state, and local taxes out of his,remaining income Paying all This means a Social Security The cumulative deficit f or Social Security over the 75-year projection period, under these assumptions, would be more than 4.5 times as large as the financial gap closed by the 1983 legislation. Clearly, with such a disastrous long-term outlook under plausible assumptions, simpl e prudence would dictate that fundamental reform be adopted now to avoid the possibility of intractable future difficulties. SOCIAL SECURITY, THE FEDERAL DEFICIT, AND THE NATIONAL DEBT Since Social Security is almost one-third of the federal budget its fin ancial prospects raise important questions for federal finances as a whole. The projections based on the SSAs assumptions show that Social Security, as currently_=tmctured,.offers only a relatively small reduction in -federal def kits during projected sur p lus years with the prospect of a much larger increase in federal deficits in future years 9. Table 2 shows expenditures in that year at 37.44 percent of taxable payroll. But revenues in that year are projected at 16.35 percent of taxable payroll. 1985 OAS DI Trustees Reoort Appendix E, Table E3 10. The 75-year deficit under Alternative I11 assumptions is 12.49 percent of taxable payroll, 1985 OASDI Trustees ReoorL Appendix E, Table E 3. The 1983 legislation under Alternative I11 assumptions was projected to close the programs long-term revenue gap by 2.7 percent of taxable payroll. See Lt 9Alternative IIB Assumptions and the Deficit Column 2 of Table 1 shows the annual Social Security surplus or deficit contributed to the unified federal budget under the Al t ernative IIB assumptions surplus developing from 1990 to 2005 of about 0.60 percent to 0.70 percent of GNP. The annual surplus declines thereafter, and by 2015 the program runs annual deficits, which continue for the remaining 40 years projected. These So c ial Security deficits climb to more than 2 percent of GNP by 2025 and almost 3 percent of GNP by 2035 The projections show an annual The federal budget deficit in the fiscal year just ended was about 5.5 percent of GNP. The projected Social Security surpl uses from 1990 to 2005 would offset from 10 to 13 percent of a federal budget deficit of the same size relative to GNP during those years would be a significant reduction in federal deficits. Security surplus during the just-ended fiscal year would have reduced the nearly $200 billion federal deficit by $20 to $30 billion. However, it is also clear that Social Security by itself will not come anywhere close to eliminating federal budget deficits of the same magni tude, relative to GNP, as today's federal red ink. Moreover, the extent to which Social Security could reduce federal deficits in future years is already reflected in the usual Office of Management and Budget and Congressional Budget Office projections of the def kit That Such a Social Over the long run, the projections in Table 1 show Social Security adding substantially to federal deficits each year. By the time today's young workers retired, and indefinitely thereafter Social Security deficits would be increasing the total federal deficit by 2 to 3 percent of GNP-about half as much, relative to GNP, as today's entire federal deficit. Alternative IIB Assumptions and the National Debt Column 3 in Table 1 shows the projected annual balances, as a percent of GNP, of the combined trust funds for all of Social Security 11. The data actually overstate the annual Social Security surpluses for the unified budget, and understate the deficits, because ,only interest income paid by the federal government has been ex c luded from Social Security income in the calculation of surpluses and deficits in the table. Technically, taxes paid by the federal government as an employer and certain specified annual payments to the program from federal general revenues should also be excluded. But the Social Security Administration does not publish long-range projections of such items. Based on data published through 1994, the overstatement of surpluses and understatement of deficits probably amounts to about 0.10 percent of GNP each year 10 under Alternative IIB assumptions of GNP in 2010, falling into a substantial deficit by 20 30. By 2055, the program will have run a cumulative deficit of about 40 percent of GNP in that year The balance peaks at 16i254 percent A trust fund balance of today of the same magnitude, relative to GNP, at the peak balance in 2020 would be about $600 billion. While this appears to be a significant sum, it would be no more than a modest cushion when compared with the enormous liabilities of Social Security, for it would constitute only a little more than 10 percent of thelsmoney intended to operate the program on a fully funded basis. Moreover, such a positive balance would equal only about 40 percent of the total assets of private pensions, including Indivi dual Retirement Accounts and 401(k) pension plans. And even this trust fund balance would last for only one year, dwindling eventuallyto zero. In addition, this peak balance would not represent 600 billion in cash, but rather 600 billion in claims against the federal government So these trust fund assets would not be, in any sense, an offset to the total national debt. They would be, instead, a mountain of federal IOUs, which could themselves become an addition to the national debt if they ever had to be c ashed in to pay promised benefits-as seems likely only by running a surplus in the overall, unified federal budget. Since there is no indication in the projections of annual Social Security,surpluses and deficits in Table 1 that Social Security will lead t o surpluses in the overall, unified federal budget, neither those projections nor the projected annual Social Security trust fund balances imply any reduction .in the national debt The total national debt can be reduced The Picture Under Alternative I11 A s sumptions Column 2 of Table 2 shows the impact Social Security would have on federal dfificits under the less optimistic Alternative I11 assumptions. Here, significant Social Security surpluses reducing federal deficits never develop, and by 1995 the prog r am is running heavy deficits, which continue to expand for the next 60 years, adding considerably to overall federal deficits. Even before today's young workers retire, Social Security alone under these projections would be 12. As noted in Table 1, the tr ust funds are actually exhausted in 2026 13. Calculated from Statement of Liabilities and Other Financial Commitments of the United States Government as of SeDtember 30. 1984, in Office of the Secretary, U.S. Department of Treasury, Treasurv Bulletin, 1st Quarter, Fiscal 85, Winter Issue 14. The projections again actually overstate the annual Social Security surpluses for the unified budget, and understate the deficits, for the reasons explained in footnote 11 11 1985 1990 1995 2000 2005 2010 2015 2020 202 5 2030 2035 2040 2045 2050 2055 TABLE 2 Social Securitv Financinq Alternative I11 AssumDtions Social Security Social Security Unified Budget Social Security Expenditures Annual Surplus Trust Funds 1 As a Percent of or Deficit As a As a Percent Taxable Payr o ll Percent of GNP of GNP 14.26 15.61% 16.30% 16 78 17.96% 20 07 23 34 27 40 31.74% 35 28 37.44 38 69 39.76 40.81% 41.52 0.0% 0.0 0.28 0.49 0.97 1.83 3 11 4 66 6.27 7 51 8 19 8.51 8 73 8.95 9 04 1.35 1.45 0.08 1.12% 2 4.43 10.13 19.5.9 33.38 51.09 70.66 88 .51 95.18 119.06 130.79 140.10 Calculated on the basis of trust fund totals at the end of the year. Trust funds exhausted in 19. 98. Source: Calculated from Harry C. Ballantyne, Chief Actuary, Social Security Administration, IILong-Range Estimates of Soci al Security Trust Fund Operations in Dollars Actuarial Note 125, Social Security Administration, U.S. Department of Health and Human Services, April 1985; 1985 Annual Report of the Board of Trustees of the Federal Old-Aae and Survivors Insurance and Disab i litv Insurance Trust Funds March 28, 1985; 1985 Annual Report of the Board of Trustees of the Federal Hospital Insurance Trust Fund, March 28, 1985 12 running a deficit, as a percent of GNP, as large as today's deficit relative to GNP, for the entire fede ral budget. Column 3 in Table 2 shows the total Social Security trust fund balances as a percent of GNP under th% Alternative I11 assumptions. No substantial trust fund balance ever develops, and the trust funds are completely exhausted by 19 98. By the end of the projection period if these assumptions prove more accurate, the program will: have run a cumulative deficit almost one and a half times the GNP in that year A REASSESSMENT BY CONGRESS The gloomy prospects for the nation's retirement system have been scrupulously ignored by Congress. Lawmakers predictably seek to avoid the political minefield of Social Security. Unfortunately, this determination to ignore the continuing problems of the system has been encouraged by a study that purports to show t h at the future of Social Security is remarkably rosy A recent, widely distributed article by former Senate aide Stuart Sweet indicates that the OASDI portion of Social Security (which is all of the program except hospital insurance, or about 80 percent of the entire program) under the Alternative IIB assumptions would run such a huge annual surplus that the federal budget would15be balanced by 2001 and the entire national debt liquidated by 20 16. This is a distressingly erroneous representation of publishe d, publicly available, government data. Due to a misunderstanding of the nature of Social Security financing, Sweet incorrectly calculates the Social Security surplus as reflected in the unified federal budget also conducts his analysis in nominal dollars , and therefore does not He 15. Stuart Sweet America's Great Opportunity: The Incredible Social Security Surplus," A.B. Laffer Associates, Lomita, California, July 15, 1985 16. Sweet incorrectly includes interest income on the Social Security trust fund bo nds as reducing the federal deficit. But as noted, this interest is paid by the federal government itself, and consequently is an intragovernmental transfer, which cannot reduce the federal deficit 13 adequatelyl,account for the impact of inflation and ec onomic growth over time. In addition, Sweet's calculations fail to include the deficits in the hospital insurance (HI) portion of the program. In fact, by 2001, under Alternative IIB assumptions, OASDI woBld run a surplus in the unified federal budget of 1.1 percent of GNP. As noted, the deficit in the fiscal year that ended September 30 amounted to 5.5 percent of GNP. Clearly, the projected OAS DI surplus is not even remotely sufficient to eliminate federal deficits of today's magnitude as a percent of GNP. There is no justification moreover, for focusing'only on OASDI and excluding, as Sweet does, the projected deficits in the HI portion of the program from the analysis. The federal budget may well be balanced by 2001, but that will be primarily because of factors such as economic growth, inflation spending restraint, or tax increases-not because of Social Security. POLICY IMPLICATIONS I Under current law, the total Social Security tax rate will increase in 1988 to 15.02 percent, and in 1990 to 15.3 percent. Under the Alternative IIB assumptions, these tax increases could be rescinded in the 1990s without immediately jeopardizing benefit the tr u st fund accumulation now projected to begin in the 1990s Without significant trust fund reserves, the program will be unable to pay full benefits as soon as the later projected annual Social Security deficits begin for the program itself, such deficits wi l l begin by 2017 payments. But this would eliminate most of the annual surpluses and I Counting all of the income and gxpenditures 17. Sweet assumes that the federal deficit, apart from Social Security, would remain at 200 billion in nominal dollars each y e ar indefinitely. But this is unlikely, because inflation and economic growth would make 200 billion in nominal dollars a relatively trivial amount over time. With such an assumption, Sweet's analysis suggests that the federal deficit, apart from Social Se c urity, would fall to about 1 percent of GNP in 2001 and be in balance soon thereafter. It is this assumption that, supposedly, balances the federal budget by 2001, and pays off the national debt by 2016, and not the impact of Social Security finances 18. C alculated from Harry C. Ballantyne, Chief Actuary, Social Security Administration Long-Range Estimates of Social Security Trust Fund Operations in Dollars Actuarial Note 125, Social Security Administration, U.S. Department of Health and Human Services, Ap r il 1985 19. Calculated from the sources cited in Tables 1 and 2 I 14 - Without more fundamental reform, therefore, payroll tax cuts in the 1990s would leave the program unable to pay full benefits to the baby boom generation. Under the Alternative'IIB ass u mptions, paying benefits without trust fund support would require total payroll tax rates of 21.2 percent in 2g25 and 22.6 percent in 2030--or almost a assumptions, there is no room for payroll tax cuts in the 199Os, since the program would face financial collapse by 1998. doubling of today's rates. Of course, under the Alternative I11 The groundwork for permanent tax cuts in the 199Os, however This reform would allow workers to contribute could be laid by more fundamental reform today, such as allowing wo rkers to substitute expanded "Super IRAs" for part of their Social Security coverage extra funds to their IRAs above amounts allowed under current law to purchase disability and life insurance and health care for their retirement years. Under this plan, workers would receive 100 percent income tax credits for these contributions, rather than the usual IRA deduction. But to the extent that workers exercised this option, their Social Security retirement benefits would be reduced in proportion to the amount o f tax credits received over the years. The accumulated funds in these Super IRAs would more than make up for these foregone Soc;lpl Security benefits, leaving Americans with higher benefits overall. With this reform Social Security would be substantially strengthened financially, since payroll taxes financing Social Security would be maintained in full, while the tax credit for Super IRA contributions would be taken against income taxes, not payroll taxes. Moreover, over the long run Social Security expen d itures would be reduced, as workers relied increasingly on their Super IRAs rather than Social Security. If this change were adopted now, and expanded over time, Social Security taxes could be cut in the 1990s. By the time the baby boom generation retired , Social Security expenditures could be reduced sufficiently to enable the benefit obligations made to the baby boomers to be financed in full. Moreover, as the option was continually expanded, Social Security expenditures would be reduced commensurately, a nd payroll taxes could be cut steadily 20. 1985 OASDI Trustee's ReDort, Appendix E 21. See Peter J. Ferrara, ed Social Securitv: ProsDects for Real Returns (Washington D.C.: Cat0 Institute, 1985); Ferrara The Social. Security System" in Stuart Butler Mich a el Sanera and W. Bruce Weinrod, eds., Mandate for LeadershiD 11: Continuinn the Conservative Revolution (Washington, D.C.: The Heritage Foundation, 1984); Ferrara Rebuilding Social Security, Part 2 Heritage Foundation Backprounder No. 346, April 1984 15 C O NCLUSION The limited solvency of Social Security has been achieved through years of relentless increases in Social Security taxes (with many still scheduled to come) and substantial cuts in future benefits. I This combination makes Social Security a poor d eal for tgdayls young workers, even if all promised benefits are somehow paid. Further benefit reductions or accelerated tax increases'might improve the fiscal outlook for the program, but only at the price of making it an even worse deal retirement on th e promise of Social Security benefits. Today's young workers would be foolish to base their Fundamental reforms are necessary so that this generation can look forward to a secure and prosperous retirement. The longer Congress ignores the true condition of the system, and grasps at straws suggesting that Social Security is sound, the more today's young workers will lose. Prepared for The Heritage Foundation by Peter J. Ferrara member of the White House Office of Policy Development a Washington attorney, for merly a i I 22. For further discussion of the bad deal Social Security now offers to today's young workers, see Peter J. Ferrara and John R. Lott, Jr Rates of Return Promised by Social Security to Today's Young Workers in Peter J. Ferrara, ed Social Secur itv: ProsDects for Real Reform (Washington D.C Cat0 Institute, 1985 16
