The New Debate Over Social Security Reform: Part II

Volume II (Number 7 July 8, 1996

According to the 1996 Trustees' report, Social Security outlays are due to exceed tax revenues beginning in 2012, a year sooner than projected in 1995. By 2020, the shortfall is expected to rise to 2.0 percent of the taxable payroll of covered workers; by 2030, to 4.0 percent; and by 2070, to 5.5 percent. Meanwhile, three out of four Americans doubt that Social Security will be able to fulfill its promises to new retirees within twenty years and a growing number of voices, liberal and conservative alike, are advocating radical reform.

Nonetheless, there are those who claim that Social Security's troubles are overblown. According to the apologists, the system's funding shortfall is both far offuSocial Security will be able to pay "every cent" of current-law benefits until 2029uand relatively small: A "quite manageable" 2.2 percent of payroll tax hike would ensure Social Security's solvency "indefinitely." Summing up this view, Robert Ball, former Social Security Commissioner and outspoken member of the President's Social Security Advisory Council, declares that there is "no financial crisis in Social Security."

In Part I of this series, we explained why many are concluding that Social Security is unsustainable in its current form. This alert looks at the apologists' counter-claim and why it misrepresents the fiscal bottom line.

The 2.2 Percent Solution

It is true that Social Security will be "solvent" until 2029 meaning that, until that date, the Old-Age, Survivors, and Disability Insurance (OASDI) trust funds are projected to possess sufficient "assets," and hence budget authority, to cover current-law benefit promises. But since these assets represent nothing more than Treasury IOUs, this solvency is a mere technicality. Fiscally, what matters is Social Security's operating balance that is, the annual difference between its outlays and its tax revenues. As soon as this balance turns negative (beginning in 2012), full benefits can only be paid if Congress raises taxes, cuts other federal spending, or borrows from the public. By 2029, the last year Social Security is projected to be solvent, the OASDI trust funds will be running an annual operating deficit of roughly $650 billion, or 23 percent of outlays. This figure represents the annual savings that Congress must find in Social Security to keep this supposedly self-financing program from adding to the overall federal deficit.

As for the 2.2 percent of payroll tax hike, it refers to the annual improvement in Social Security's operating balance that would be needed to close the system's "actuarial deficit", that is, to ensure that total outlays do not exceed total trust-fund income (plus trust-fund assets) over the next seventy-five years, the period for which projections are made. (Technically, this measure allows for a small contingency reserve at the end of the projection period; this reserve, however, would not postpone bankruptcy by more than an extra three or four years.) Although Social Security's actuarial deficit could be closed through benefit cuts as well as tax hikes, the apologists tend to lean heavily on the latteruand indeed, by phrasing the entire problem in terms of the "percent of payroll" required to balance the OASDI trust funds, the actuarial deficit measure naturally tends to push policy in this direction.

Again, the apologists are technically correct: A 2.2 percent of payroll tax hike would restore Social Security to "exact actuarial balance," a key official measure of solvency. However, they fail to mention a couple of caveats. First, the solution requires that we raise taxes (or cut benefits) by 2.2 percent of payroll in 1996 and every year thereafter. Few if any of those who cite this measure advocate an immediate tax hike of this size (much less a benefit cut). Yet to the extent that savings is pushed off into future years, in other words, to the extent that reforms are "incremental," something almost all the apologists insist on, the total savings needed to close Social Security's actuarial deficit will rise.

Moreover, the 2.2 percent solution presupposes that the entire improvement in Social Security's balance will be translated into genuine economic savings that can later be used to cover the system's operating deficits. That can only occur if the federal government runs a general budget surplus equal to the new Social Security surpluses every year. But Congress has thus far failed to follow this strategy with the existing Social Security surplus, which is why the OASDI trust funds now contain nothing but a half-trillion-dollar stack of Treasury IOUs. Indeed, even counting the existing surplus, the general budget is still deep in the red. At present, there exists no institutional framework to ensure that Congress will exercise more fiscal discipline in the future than it has in the past. One might take the 2.2 percent solution more seriously if its advocates were also to suggest new and highly stringent measures designed to force fiscal policy not just toward budget balance, but toward large surpluses. To our knowledge, however, none have suggested a single such safeguard.

If the new surpluses are not saved, then, once Social Security outlays exceed tax revenues, Congress will still have to raise taxes, cut other spending, or borrow from the public to pay current-law benefits. True, Social Security would not register its first operating deficit until 2021, nine years later than is now projected. But thereafter, deficits would steadily widen, to 3.3 percent of payroll by 2070, the year to which "reform" will have supposedly guaranteed the system's solvency.

This brings us to a final caveat. Even assuming the surpluses are saved, the 2.2 percent solution does not constitute the permanent fix apologists imply. Either the time frame over which they propose to keep Social Security in balance will remain a full seventy-five years, in which case we would have to enact an additional incremental tax hike (or benefit cut), on top of the already legislated 2.2 percent tax hike, in each and every future year. Or else that time frame will remain fixed at the seventy-five years between 1996 and 2070, in which case, when the trust funds become insolvent in 2071, we would have to slash benefits or jack up taxes all at once by an extra 3.3 percent of payroll. To say that 2071 is "too far away to matter" is tantamount to saying that Congress could painlessly finance any amount of deficit spending today simply by issuing seventy-five-year zero coupon bonds (where payment of both principal and interest is deferred to the bond's due date).

The Real Issue

All of this ignores the real issue framing today's debate, which is not how to meet some official test of Social Security's solvency, but how to ensure the program's economic sustainability and generational equity.

The official projections themselves may be overly optimistic. According to the Trustees' "high-cost" scenario, whose key economic and demographic assumptions more closely reflect historical experience, we would need an immediate tax hike of 5.7 percent of payroll (not 2.2 percent) to close Social Security's actuarial deficit. And even this fix, under this scenario, would still leave huge operating deficits starting in 2025.

Then there is the issue of fairness to younger generations. Today, for the first time, large categories of newly retiring workers are due to get back less than the market value of their prior contributions. Everyone agrees that in the future these "market losers" will comprise a growing share of all beneficiaries. Any reform that merely raises taxes or cuts future benefits will worsen this cascading pattern of generational inequity.

Annual OASDI Operating Balance,* as a Percent of Taxable Payroll

Current-LawProjection Projection with2.2% Solution (a)

*According to the Trustees' official 1996 "intermediate" projection. (a) - Assumes a permanent 2.19 percent of payroll FICA tax hike in 1996.

The only escape from this perilously unstable chain letter is to somehow transition from today's pay-as-you-go Social Security system to a self-funded system in which workers' contributions are truly saved, thereby boosting national income and allowing higher returns to contributors. These considerations are now leading many to look at a radical solution: putting some or all FICA contributions into personally owned accounts, and thus moving them entirely outside the federal budget.

One is left with the impression that the 2.2 percent apologists don't care much about these broader questions, and that the only purpose of their proposals is to forestall any significant change for current and soon-to-retire beneficiaries by making Social Security appear solvent on paper. In the end, this approach only further undermines the program they profess to champion, for it betrays the very historical foundations on which Social Security has always rested: economic sustainability and the enthusiastic support of every generation.


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