Revised: April 28, 1998
Understanding the Financial Status of the
Social Security System in Light of the
1998 Trustees' Report
by Kilolo Kijakazi, Wendell Primus, and Robert Greenstein
The Board of Trustees of the Federal Old Age and Survivors Insurance and Disability Insurance Trust Funds released the 58th annual report on the financial and actuarial status of Social Security today. This report provides updated projections on the long-term imbalance between program revenue and expenditures over the next 75 years. The report shows an improvement in the long-term fiscal status "due in large part to better actual and expected economic performance."
The Social Security trustees reaffirmed that Social Security faces no near-term crisis. Payroll tax revenues currently exceed benefit payments and have resulted in the accumulation of a surplus that will allow benefits to be paid in full for the next 34 years. In the long term, however, the system will face an imbalance. The 1998 trustees' report highlights three important dates related to the imbalance.
- The Social Security actuaries projected that in 2013, benefit payments will begin to exceed payroll tax revenues and funds that Social Security receives from the taxation of a portion of Social Security benefits received by high-income beneficiaries. However, annual trust fund income which includes the interest earnings the trust funds receive on the Treasury bonds they hold, as well as the income from taxes will continue to exceed benefit payments for some years after 2013. Social Security will continue to pay full benefits during that subsequent period.
- The second key date is the year in which the combination of annual tax revenues and the annual interest earnings the trust funds receive will no longer be sufficient to cover all benefit costs, and the trustees will have to begin redeeming Treasury bonds they hold to raise the additional funds they need to pay full benefits. The trustees' report projects this will occur in 2021. During the years after 2021 (up to the third key date), Social Security will continue to pay full benefits because the combination of tax revenues, interest earnings, and income from redeeming the Treasury bonds will be sufficient to do so.
- The third key date is the date after which the Social Security surpluses now building up will be exhausted. After that date, the only income to the trust funds will be from payroll tax revenue and funds from the partial taxation of benefits, and annual revenues will not be sufficient to pay full benefits. The trustees project this year to be 2032.
It is the third key date about which there has been much confusion and misunderstanding. This date is sometimes pictured as the date on which Social Security goes bankrupt and runs out of money. Many Americans may mistakenly think the trustees' report means there will be no benefits for them after 2032.
That is not the case. As the trustees have indicated, Social Security will not be bankrupt when the trust fund surplus is exhausted after 2032. The trust funds will continue after that year to receive large sums from payroll tax collections. The problem is that after 2032, according to the trustees' calculations, the incoming taxes will be sufficient to cover about 70 percent to 75 percent of the benefit payments rather than 100 percent of these costs. That is what is meant by the use of the term "insolvency" to describe the condition of the trust funds after the third key date.
That the revenues will be sufficient to defray 70 percent to 75 percent rather than 100 percent of benefit costs signals the need for action to restore long-term balance to the Social Security system. At the same time, the widespread belief that revenues will cover zero percent of benefits after 2032 is incorrect. The graph on the next page, drawn from data in the trustees' report, shows that the percentage of benefits Social Security revenues will be sufficient to cover is projected to remain fairly level after 2032, declining only seven percentage points over the subsequent 40 years.
The trustees' report also contains another key number related to Social Security's long-term imbalance the size of the projected shortfall in Social Security over the next 75 years. The new report places the amount of the shortfall that is, the amount by which trust fund income and revenues over the next 75 years will fall short of what is needed to pay full benefits over that period at 2.19 percent of taxable payroll over the 75-year-period.
Figure 1: Percentage of Social Security Benefits
That Can be Paid With Revenues and Interest
* To pay 100 percent of benefits in this year requires that 23 percent of the benefits be financed by drawing down the trust fund surplus.
Source: 1997 Annual report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds
The three key dates and the long-term deficit show an improvement over the trustees' 1997 report. The trustees attribute this development to better actual and expected economic performance. As indicated in Table 1 below, the long-term deficit in Social Security has declined from 2.23 percent of taxable payroll in 1997 to 2.19 percent in 1998. The date by which the trust funds are projected to be exhausted has moved back from 2029 as forecasted in 1997 to 2032.
Long Term Deficit
Year Costs Exceed Tax Revenue
Year Costs Exceed Tax Revenue & Interest
Year After Which Social Security Surplus is Exhausted
The Trustees Projections Are Conservative
The trustees' reports regularly provide three sets of projections due to the uncertainty of making estimates over a period as long as 75 years. One set of projections incorporates fairly optimistic economic and demographic assumptions. A second set is based on pessimistic assumptions. The third set consists of intermediate estimates, regarded by the trustees as the "best estimates." The dates referred to above are the best estimates (i.e., the intermediate assumptions).
Unfortunately, this year's projections are already somewhat out-of-date, because they do not incorporate the change in the Consumer Price Index that the Bureau of Labor Statistics announced on April 16, 1998. The announcement came too late to be reflected in this year's trustees' report. It will be reflected in next year's report.
The BLS action will reduce the CPI by 0.2 percentage points annually. Since Social Security benefits are adjusted each year by the CPI, the long-term Social Security projections are highly sensitive to projections concerning the CPI. Had the trustees been able to reflect the new CPI reduction in their projections, their projections would show a somewhat smaller long-term imbalance and show the system remaining solvent for a somewhat longer period. We are not able to estimate the exact effects of the CPI change on Social Security solvency projections. The change could reduce the long-term imbalance by as much as one-eighth, although the effect may be somewhat smaller than that.
The trustees' estimates are conservative for a second reason as well. The Trustees' report projects growth in the national economy, as measured by change in the real gross domestic product, as averaging 1.4 percent per year over the next 75 years. This rate is less than half the average rate of growth over the past 75 years. Given the projected decline in the rate of growth of the labor force in the future, the trustees' estimate of future economic growth is appropriately conservative. Should this cautious projection prove too conservative, however, as could be the case, the long-term financial status of Social Security would be better than the trustees project.
Social Security Surplus Has Not Evaporated Due to
Excess Spending in the Rest of the Budget
Polling data indicate that much of the general public mistakenly believes Social Security will not be able to pay full benefits until 2032 and will be able to pay little or no benefits after that date. The polling data indicate one reason many Americans hold such views is the widespread belief that the government has squandered the Social Security surplus by spending it on other items, and that the surplus consequently will not be available for benefits when needed. This perception is not correct.
Social Security reserves are invested in Treasury bonds that are backed by the full faith and credit of the U.S. government. These are assets that private investment fund managers regard as the safest and most secure investment they can make. Indeed, when financial markets become volatile, many private investors shift assets into Treasury securities to avert losses.
- When workers make payroll tax contributions, these funds are sent to the Treasury where they are credited to the Old Age and Survivors Insurance trust fund and to the Disability Insurance trust fund through the issuance of interest-bearing Treasury bonds. The trust funds essentially hold these bonds.
- The trust funds are not like bank safes where cash reserves are kept. They are like private pension plans that contain financial assets. In this case, the financial assets are the Treasury bonds.
- The Treasury treats the proceeds it receives from selling bonds to the Social Security trust funds in exactly the same way as it treats the proceeds from the sale of bonds to private investors. The Treasury uses these funds to meet ongoing expenses of the federal government. When funds are needed for Social Security payments, the Social Security trustees can redeem these bonds just as private investors can redeem Treasury bonds they hold and the trustees can thereby provide the Social Security trust funds with resources to pay Social Security benefits.
- Even proponents of fully or partially replacing Social Security with private individual accounts acknowledge the safety of Treasury securities. When proposals for individual accounts are criticized for exposing workers and retirees to market risk and the possible loss of savings, proponents argue that losses can be avoided if workers invest their savings in Treasury bills and bonds.
Another belief that some of the public holds is that Social Security benefits will not be there for them despite the trustees' forecasts because the trust fund surpluses are being soaked up by excessive administrative costs. Social Security's administrative costs total less than one percent of benefits, however, making management of Social Security efficient and inexpensive. This cost is lower than that of private pensions plans and much lower than that of insurance companies.
Importance of the Social Security Surplus and the Implications
of a Return to Pure Pay-As-You-Go Financing
As explained above, it is the Social Security reserves and the interest earned on them that prevent the system from becoming insolvent in 2013, when annual benefit expenditures begin to exceed annual payroll tax revenue. The interest income will keep the system solvent until 2021, and the combination of the interest income and the income from drawing down the surplus (i.e., from redeeming the Treasury bonds) then keeps the system solvent until 2032.
This means that any reduction in the Social Security surplus will accelerate the point of program insolvency. If the surplus is used to create individual accounts or payroll taxes are reduced to restore Social Security to a pure pay-as-you-go system, the surplus will be smaller (or cease to exist). As a result, the key dates described above including the insolvency date will be pushed forward by a reduction in the Social Security surplus unless Social Security benefits are reduced by greater amounts than would otherwise be necessary.
The national debate on Social Security reform is underway. The trustees report provides vital information for this debate and for the development of proposals to restore long-term solvency to the system.