This week on Facing the Future, host Bob Bixby spoke with Dr. Kent Smetters, faculty director of the Penn Wharton Budget Model (PWBM). They discussed three illustrative Social Security reform packages designed by PWBM to keep the program’s trust funds solvent for 75 years while improving the budget outlook and growing the economy. One package relies exclusively on tax increases, another relies exclusively on spending cuts and the third features a mix of tax and spending changes.
Social Security is currently paying out more in benefits than it is collecting in revenue. Without change, the program’s trustees estimate that Social Security’s Old Age and Survivors Insurance trust fund will be depleted in about six years, forcing an automatic benefit cut of 22 percent.
Smetters observed, “Congress is unlikely to allow that to happen,” which is why the PWBM illustrative packages were scored against a baseline scenario that assumes benefits will be maintained at promised levels, even if that means relying exclusively on borrowing. In Smetters’ estimate, that approach would potentially increase the debt by “a couple hundred percent of GDP over the 75-year window.”
Smetters explained that the economic impact varies significantly depending on the approach taken. The revenue-only package would grow the economy by less than half a percent in 2060 relative to all debt financing, while the benefit-cutting approach could boost GDP by about 12% over the same period. The balanced approach falls in between, projecting approximately 3.7% GDP growth relative to the baseline.
“They all solve the same budget problem,” Smetters said, “but they have very different economic outcomes. Not terribly surprising that tax increases are going to grow the economy quite a bit less relative to things that eventually curtail spending growth over time. If you’re willing to go the benefit route, then by 2060, we predict that wages will be about 10.5% higher than they otherwise would have been under the baseline debt finance approach, and if you’re willing to do the tax approach, it’s quite a bit smaller. It’s about a 1.2% increase in wages relative to the debt finance approach. And so these are very different outcomes, but they also have different sacrifices.”
A central theme of the discussion was the concept of implicit debt—the unfunded obligations of Social Security not reflected in official Treasury debt. Smetters estimates that this implicit debt amounts to about $62 trillion, a figure even higher than the Social Security trustees’ estimate ($54.9 trillion).
He emphasized the importance of understanding this implicit debt. “What the $62 trillion number represents is how much people alive in the past and alive today, are going to take out of the Social Security system above what they’ve paid into the system, all in present value today.
The different reform packages have varying impacts on reducing this implicit debt. The tax increase-only approach would lower it to about $45 trillion, while the benefit-cutting approach could reduce it to approximately $33 trillion.
Smetters gave an example to illustrate the difference between explicit Treasury debt and the implicit debt of Social Security: “Suppose that you’re a young whippersnapper, and I’m trying to take money from you using the political system – you know, out of your wallet and into my wallet. And so I’m old, you’re young, and there’s really two ways I could do it. One is that I could have the government sell Treasury debt, and just give me a dollar from that Treasury debt. Who’s going to finance it? It’s going to be you, the young generation. And that’s going to show up explicitly as Treasury debt. But there’s another way we can do it. We’ll just create a pay-as-you-go system that directly has a payroll tax on you, that has you paying into the system. It comes to me in the form of a benefit of being an older person. The economics are exactly the same. The incentives, the work, the saving, everything’s identical. But in the second case, it will never show up as Treasury debt. Economists call this the labeling problem.”
Throughout the conversation, Smetters stressed the need for a rational, measured approach to reform. He cautioned against alarmism, saying, “We need to get away from ‘the sky is falling’ message. We do have time to have a rational trade-off discussion.” He acknowledged that while the problem was serious, it was not imminent enough to justify panic or drastic immediate cuts to benefits for vulnerable populations.
Putting Social Security in the broader fiscal context, Smetters expressed hope that credible reforms of the program could reassure financial markets that the government is up to handling its unsustainable debt and potentially pave the way for broader budgetary reforms.
His warning about the debt-financing approach is clear: “How far could we go, assuming that bond markets keep believing that Congress will eventually get its act together up until the point where that belief is not mathematically possible? ….We did this calculation, and we said it’s roughly around 20 years. Now, there’s a variance and so we said there’s actually some chance it could be as low as 14, 15 years as this outer bound calculation. And so, members of Congress would say, okay, if this is an outer bound calculation, what’s the soonest that we could have this crisis? And my answer is, well, it could happen tomorrow because it really comes down to when do capital markets believe that Congress no longer get its act together.”
Hear more on Facing the Future. Concord Coalition Senior Advisor Bob Bixby hosts the program each week on WKXL in Concord N.H., and it is also available via podcast. Join us as The Concord Coalition team discusses issues relating to national fiscal policy with budget experts, industry leaders, and elected officials. Past broadcasts are available here. You can subscribe to the podcast on Spotify, Pandora, iTunes, Google Podcasts, Stitcher, or with an RSS feed. Follow Facing the Future on Facebook, and watch videos from past episodes on The Concord Coalition YouTube channel.
