April 3, 2015

Social Security Disability Fund Will Run Empty Next Year

Jason J. Fichtner

Former Senior Research Fellow
Summary

Policy makers should not squander this opportunity to begin critical reforms to the disability insurance program. Absent near-term, fundamental reform, Social Security's broader financing problem could grow too large to solve at all. Reforms should focus on improving the program's long-term solvency, incentives for those who can work to do so, and ensuring a reliable safety net for temporarily or partially disabled individuals.

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There is widespread confusion about the coming insolvency of the Social Security Disability Insurance Trust Fund.

Regrettably, some use this confusion to avoid taking the necessary steps to reform this critically vital program and instead are only looking to place a financial Band-Aid on a program that is hemorrhaging dollars.

As we await the coming spring release of the 2015 Social Security Trustees report, it's important to recall that the 2014 report showed a continuation of the current trend toward insolvency of both the retirement and disability trust funds. The trustees last estimated that Social Security's combined Old-Age and Survivors Insurance (OASI) and Disability Insurance (DI) trust funds will become exhausted in 2033, less than 20 years from now. While the larger retirement fund is estimated to be depleted in 2034, the disability trust fund will run empty in 2016, right in time for the presidential election. It's unlikely that the 2015 report will show much, if any, improvement.

Although commonly reported as combined, the OASI and DI trust funds are legally separate because they are designed to serve different purposes and different populations. If no legislative action is taken to shore up the finances of the disability insurance program, benefits will have to be cut by almost 20 % once the DI trust fund becomes insolvent, since by law the program can only pay out in benefits what it receives in revenues.

According to the Social Security Administration, the DI program was $30 billion short in 2014 and drew down from the trust fund assets to pay full benefits, leaving only $60 billion left in the trust fund. That's enough to cover only the financial shortfall for two years: 2015 and 2016. By 2017, revenues alone will no longer be sufficient to pay full disability benefits to 9 million people.

A common suggestion is to shore up the disability insurance trust fund by simply shifting payroll tax funds from Social Security's much larger retirement trust fund, which is projected to remain solvent through 2034. In other words, one year of retirement fund solvency buys you 17 years of disability trust fund solvency. By itself, however, such a reallocation would put off only necessary, substantive repairs, delay the financial reckoning for the disability program and hasten the insolvency of the retirement fund.

Another option, which I addressed in a previous MarketWatch column, is to allow the disability trust fund to borrow from the retirement trust fund for a temporary period. This interfund borrowing would provide the short-term financial patch necessary to ensure that those receiving disability benefits would continue to receive full benefits. It wouldn't, however, mask the financial shortfall of the disability insurance program or lessen the pressure for policy makers to enact real, necessary, meaningful reforms. This interfund borrowing has been done before. In fact, in 1982 the retirement trust fund had to borrow from the disability trust fund to pay full benefits.

While historically the financial assets of one trust fund have intermittently been used to shore up the other, sharing resources between trust funds isn't part of current law and requires an act of Congress. Such acts call into question the continued utility of maintaining legally separate trust funds

Merging the OASI and DI trust funds and their obligations would create the least amount of unnecessary fiscal accounting and associated stress. Furthermore, merging the two trust funds would acknowledge that some interaction effects exist between the two programs. For example, a reform to the retirement system to further increase the full retirement age — without changes to the earliest eligible age for retirement benefits — would make disability benefits more financially advantageous to those younger than full retirement age and would put additional financial stress on the disability program.

Merging the two trust funds would have its drawbacks, however. The programs were designed for separate insurance purposes: One insures against old age and for surviving a spouse, whereas the other insures in case of disability. Broadly speaking, if the two trust funds were combined, any financial or operational problems associated with the individual programs might be harder to discern and receive less attention; policy makers could miss timely opportunities regarding any future needed reforms.

However, none of the options discussed would alleviate the fiscal stress placed on the U.S. budget by short- and long-term unfunded obligations of the Social Security programs. Any one of the three options (a payroll tax reallocation, interfund borrowing or merging the trust funds) — without meaningful structural reforms — only delays the day of financial reckoning.

Further, any stopgap resolution of the pending 2016 DI shortfall does nothing to solve the underlying disincentives inherent in both the disability program and the retirement program that discourage work, saving and investment, as outlined in a recent Mercatus Center research paper I co-wrote with Dr. Jason Seligman. In other settings, when reforms have been successful at restoring actuarial solvency and fiscal balance, reforms have been integrated.

Dr. Seligman and I are both part of the McCrery-Pomeroy SSDI Solutions Initiative sponsored by The Committee for a Responsible Federal Budget to identify practical reforms to the disability insurance program. A list of selected papers and reform ideas can be found here. (I'll write more about the various reform ideas once the papers are released later this year.)

Congress must do better than simply apply a payroll tax reallocation to a program that is in dire need of serious reform. Charles Blahous, one of the two public trustees for Social Security, recent wrote: "Those who suggest that DI's impending reserve depletion warrants no action beyond taking revenues away from the Social Security retirement fund appear to be unfamiliar with the basis for the current allocation as enacted in 1994."

Policy makers should not squander this opportunity to begin critical reforms to the disability insurance program. Absent near-term, fundamental reform, Social Security's broader financing problem could grow too large to solve at all. Reforms should focus on improving the program's long-term solvency, incentives for those who can work to do so, and ensuring a reliable safety net for temporarily or partially disabled individuals.