March 30, 2000

What the Trustees' Report Indicates about the
Financial Status of Social Security

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The Social Security Board of Trustees today released the 60th annual report on the program's financial and actuarial status. The report shows improvement in the program's long-term fiscal status due primarily to the continued strong performance of the U.S. economy and improved prospects for the economy's future performance.

The Social Security trustees' report reaffirms that Social Security does not face a near-term crisis. Payroll tax revenues currently exceed benefit payments and are resulting in the accumulation of a steadily growing surplus that will allow benefits to be paid in full for the next 37 years. In the long term, however, the system will face an imbalance. The 1999 trustees' report includes three important dates related to the imbalance.

The Social Security actuaries project that in 2015, benefit payments will begin to exceed the combination of payroll tax revenues and funds that Social Security receives from the taxation of a portion of the Social Security benefits that higher-income beneficiaries receive. Nevertheless, 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 tax revenue — will continue to exceed benefit payments for a number of years after 2015. Social Security will continue to pay full benefits during this period.

The second key date is the year in which the combination of annual tax revenues and interest earnings 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 needed to pay full benefits. The trustees' report projects this will occur in 2025. During the years between 2025 and the third key date, Social Security will continue to pay full benefits, because the combination of tax revenues, interest earnings, and income from redeeming Treasury bonds will be sufficient to do so.

The third key date is the year in which the Social Security surpluses now building up will be exhausted. After that, 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 2037.

The trustees' report shows that the belief that Social Security will eventually collapse and be unable to pay any benefits is not correct.

There has been confusion and misunderstanding about the third key date. It sometimes is portrayed as the date on which Social Security runs out of money. Many Americans mistakenly think this means there will be no benefits for them after 2037.


1997 Report

1998 Report

1999 Report 2000 Report
Long Term Deficit 2.23% 2.19% 2.07% 1.89%
Year Costs Exceed Tax Revenue 2012 2013 2014 2015
Year Costs Exceed Tax Revenue and Interest 2019 2021 2022 2025
Year In Which Social Security Surplus is Exhausted 2029 2032 2034 2037

This is not the case. As the trustees have said, Social Security will not be out of money when the trust fund surplus is exhausted in 2037. The trust funds will continue after that to receive large sums from annual payroll tax collections. The problem is that, according to the trustees' calculations, the incoming revenues after that date will be sufficient to cover about 70 percent of benefit payments, rather than 100 percent. That is what is meant when the term "insolvency" is used to describe the condition of the trust funds after the third key date.

That the revenues will be sufficient to defray about 70 percent rather than 100 percent of benefit costs signals the need for action to restore long-term actuarial balance to the Social Security system. The widespread belief that revenues will cover zero percent of benefits after 2037, however, is incorrect.

The trustees' report also contains one other important 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 1.89 percent of taxable payroll over the 75-year-period.

The key dates and the long-term deficit show a significant improvement over the trustees' 1997, 1998, and 1999 reports, which the trustees attribute primarily to better actual and expected economic performance. As indicated in the table above, the long-term deficit in Social Security has declined from 2.23 percent of taxable payroll in the trustees' 1997 report, 2.19 percent in the 1998 report, and 2.07 percent in the 1999 report, to 1.89 percent in the new report. The date by which the trust funds are projected to be exhausted has moved back from 2029, as forecast in 1997, to 2032 as projected in 1998, 2034 as projected last year, and 2037 in the new report.

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 dates based on the intermediate assumptions).


Social Security Surplus Has Not Evaporated
Due to Deficit 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 2037 and will be able to pay few or no benefits after that date. The polling data indicate that 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.

The surplus revenues that the Social Security trust funds receive each year (i.e., the amounts by which the trust funds' income in a year exceeds the amount needed to pay Social Security benefits and administrative costs in that year) are provided to the U.S. Treasury. In return, the Treasury provides the trust funds with Treasury bonds backed by the full faith and credit of the U.S. government. These bonds are assets that private investment-fund managers regard as the safest and most secure investments they can make. When financial markets become volatile, many private investors shift assets into Treasury securities to avert losses.

Under current law, once these surplus revenues are provided to the Treasury, they may be used to help fund other government operations. This is a practice that was followed for many years but is not used today because the rest of the budget is in surplus. This practice did not reduce the assets of the Social Security trust funds. Once the trust funds use their surplus revenues to purchase Treasury bonds, what the Treasury does with these revenues does not directly affect the trust funds' assets. The trust funds receive the same amount of Treasury bonds whether the Treasury uses these revenues to fund a program, finance a tax cut, or pay down the debt.

To be sure, if the Treasury uses these revenues to pay down debt rather than to expand programs or institute tax cuts, that should add to national saving. If such a policy is maintained over many years, it should result in a modestly larger economy that will generate modestly increased payroll tax revenue for the trust funds in future decades. But the notion that the trust funds have been raided and this is why Social Security faces long-term financial difficulties is incorrect. Social Security faces a long-term problem for demographic reasons, not because the trust funds have somehow been looted.


Implications for Action to Restore Long-Term Solvency

On the one hand, the trustees' report shows that Social Security faces no immediate crisis. The report also shows that the system is not in danger of collapsing and of "not being there" for people who are young today.

The trustees' projections indicate that the shortfall can be closed with relatively moderate steps if taken soon. Radical restructuring is not necessary to close a gap of this size.

On the other hand, the trustees' report demonstrates that the system still faces a significant long-term financing shortfall. Action is needed to address it.

The trustees' projection that the shortfall equals 1.89 percent of covered payroll over a 75-year period indicates the shortfall can be closed with relatively moderate steps if taken soon. Radical restructuring of the system is not necessary to close a gap of this size. As the two Public Trustees of the Social Security system wrote in the report released today "...the strong economy of the last four years has weakened the argument that Social Security must be radically changed because it is absolutely unaffordable." Radical restructuring proposals may be advanced for other reasons but should not be portrayed as needed to close the financing gap.

Radical restructuring proposals also ought not be portrayed as necessary to raise rates of return. The notion that raising rates of return entails replacing part of Social Security with individual accounts is not valid and has been rejected by leading economists who have studied this issue, including those who favor individual accounts. Rates of return are raised not by individual accounts per se but by two other factors. First, rates of return are raised by financing retirement benefits on an advance-funding basis rather than a pay-as-you-go basis. This enables the funds accumulated in advance to earn interest that compounds over time. Second, rates of return also can be raised by investing a portion of the assets accumulated through advance funding in equities, since equity investments are likely to yield higher average rates of return over time than the Treasury bonds in which Social Security's assets currently are fully invested. Providing advance funding and investing a portion of such funding in equities can be accomplished either through the Social Security trust funds or through individual accounts. Privatization approaches are not necessary to raise rates of return.


Lockbox Would Not Restore Solvency

It should be noted that a Social Security "lockbox" designed to prevent Social Security surpluses from being used to cover deficits elsewhere in the budget is not one of the types of steps that, if taken, would help to restore long-term solvency. The trustees' report already assumes that all Social Security surpluses ultimately will be used to finance Social Security benefits. A lockbox would provide no additional resources to Social Security and would neither reduce the long-term actuarial imbalance in the program nor extend the point at which Social Security is projected to become insolvent.

A lockbox would provide no additional resources to Social Security and would neither reduce the long-term actuarial imbalance nor extend the point at which Social Security becomes insolvent.

To be sure, a lockbox could result in more debt being paid down and fewer resources expended for other programs or tax cuts, but it would not directly affect Social Security solvency. This issue is an important one — if a lockbox is enacted and the public mistakenly believes that Social Security's financing problems have been substantially lessened as a result, it may become more difficult to garner public support for the politically difficult choices that policymakers will have to make to restore long-term solvency.

Paying down the debt also does not directly address Social Security's long-term financing gap, although it would help to ease the burdens on future generations when the baby boomers retire and Social Security and Medicare expenditures mount. Currently, 13 percent of the federal budget — $224 billion per year — is consumed by interest payments on the debt. Eliminating a large share of these interest payments — by eliminating much of the debt — would create more room in the budget to help accommodate rising Social Security and Medicare costs in future decades. But doing so does not itself close the Social Security or Medicare financing shortfalls. Other steps must be taken to accomplish that.


A Warning Light

Finally, even with its somewhat brighter projections, the trustees' report should act as a warning light to policymakers of all political persuasions who favor actions that would consume most or all of the projected non-Social Security surplus in other ways before Congress and the White House make any significant progress in determining what steps to take to restore long-term Social Security and Medicare solvency. Unfortunately, the past year has witnessed a growing trend toward policymakers pledging not to reduce any Social Security benefits or raise any Social Security taxes. If no benefits can be reduced and no additional revenues raised, restoring Social Security solvency will require extremely large transfers from the non-Social Security budget. (This is true for both privatization and non-privatization approaches; there is no "free lunch" here.) Moreover, the Medicare trust fund almost certainly will require substantial additional resources. For example, even the highly controversial proposals of the Breaux-Thomas commission, which currently have little chance of enactment, would close only a modest fraction of the long-term Medicare financing gap. It is unlikely that a package restoring long-term Medicare solvency can be enacted that does not include the infusion of significant additional resources, as well as changes in the Medicare program.

If most or all of the projected non-Social Security surpluses are used now for tax cuts or for a combination of tax cuts and program increases, that would preclude substantial budget transfers to Social Security and Medicare. And that, in turn, could render it difficult, if not impossible, for the foreseeable future to fashion Social Security or Medicare solvency packages that can pass. The data in the trustees' report consequently should serve as a reminder that the prudent course is to defer enactment of large tax cuts or spending increases until overall decisions can be made, in the context of deliberations on national priorities, regarding how much of the non-Social Security surpluses to reserve for use as part of broader Social Security and Medicare solvency proposals that have a potential for enactment.