Social Security Crisis Closer than You Think

Monday, August 11, 2014
Jason J. Fichtner

The latest Social Security Trustees’ report shows the projected dates of insolvency for the program’s trust funds remain largely unchanged. Regrettably, some misinterpret this as an indication that Social Security doesn’t require immediate reform. Make no mistake: There is a Social Security crisis.

Misunderstanding the critical state of the program’s financial health will lead to grave consequences for all of the program’s beneficiaries — both current and future.

The 2014 report projects depletion of the combined Old Age, Survivors, and Disability Insurance trust funds in 2033. Social Security has no borrowing authority, and after the trust funds are exhausted there is only enough payroll tax revenue to cover a projected 77 percent of benefits; meaning future benefit payments must be reduced by about 23 percent. But the resulting cut in benefits will actually be much worse for retirees, workers and the economy if we don’t act now to reform Social Security.

In 2013, total benefit costs offset by taxes on those benefits, plus administrative expenses, came to $832 billion. Most, but not all, of this cost was covered by payroll taxes ($726 billion), with the balance substantially covered by interest ($103 billion) on money Congress “borrowed” from the trust funds — which means Social Security is currently adding to the deficit.

When the trust funds are depleted, the upcoming year’s benefits will be suddenly and immediately reduced by nearly $200 billion (in 2013 dollars), and not just for that year alone. The 23 percent haircut will persist indefinitely without legislative action. Gross Domestic Product includes government outlays, including spending on entitlement programs. Hence, less social security spending by definition results in a smaller GDP. Additionally, a sudden and large reduction of social security benefits would also result in less private consumption, since beneficiaries will have less money to spend, and this too would presumably result in an additional corresponding negative effect on GDP.

If the economy shrinks, relative to where it was otherwise heading, the one-quarter reduction in Social Security benefits will have a reverse dynamic effect on the economy; as GDP falls, employment falls, income and taxable wages fall, and even less payroll tax revenue will come into the Social Security program, resulting in even further reductions to benefits beyond the 23 percent haircut that will occur when the trust funds are depleted in 2033.

And don’t mistakenly believe we can just raise payroll taxes to cover any shortfall without also causing drastically harmful effects on the economy. If we raised the payroll tax rate today, it would have to rise from 12.4 percent to about 15.2 percent — that’s a nominal 23 percent increase in the payroll tax rate. If we wait until 2033, the rate would have to increase to approximately 16.5 percent; over 4 percentage points higher than the payroll tax rate is today and a nominal 33 percent increase.

But wait, it’s actually much worse than that. Because Social Security benefits decline at a much slower rate than GDP and payroll taxes, the benefit formulas result in benefit level changes that considerably lag behind other changes in the economy, especially during periods of decline. Further, disability applications jump dramatically during economic downturns (increasing about 25 percent during the Great Recession), and disability payment increases then quickly follow. This puts even more financial pressure on Social Security. Finally, fertility and immigration rates tend to decline during times of economic stress — which, over the longer term, reduces revenue coming into the program and adversely affects Social Security financing.

What this all means is that the Social Security crisis that appears to be coming in 2033 is actually here now.

The Social Security Trustees recommend that “lawmakers address the projected trust fund shortfalls in a timely way in order to phase in necessary changes gradually and give workers and beneficiaries time to adjust to them.” While this phrasing reflects the traditionally reserved tone of the Trustees, we simply cannot get around the facts the trustees report lays out: the response to the Social Security crisis cannot wait until 2033. The crisis is here now, and is a tsunami that will drown us all and harm both retirees and workers. If we put off immediate, meaningful reform and passively wait for the trust funds to dry up, the ensuing reduction in Social Security benefits may well bring with it a vicious cycle from which neither Social Security nor the general economy will be able to escape.

Social Security Trust Funds' Health In Bad Shape

Wednesday, June 5, 2013
Jason J. Fichtner

Pre-colonial English explorers assumed that black swans didn't exist, simply because they had seen only white swans. In the book "Black Swan," Nassim Nicholas Taleb describes how people are too wedded to biases of history and become blinded to the impact of a rare event.

In other words, just because something has a small probability of happening doesn't mean it can't — or won't.

Social scientists (especially economists and actuaries) use history as a guide to projecting the probability of an event occurring in the future. If an event has a low probability of happening, we usually discount it or ignore it altogether.

But the recently released Social Security Trustees report has us wondering if we're blinded to the Black Swan headed our way.

The 2013 report released last Friday estimates the Social Security trust funds will become exhausted in 2033, just 20 short years from now.

It also estimates that the 75-year shortfall is $9.6 trillion in present value terms. If we indefinitely extend past the 75-year period, the "infinite horizon," the shortfall is a whopping $23.1 trillion.

As bad as those numbers are, Harvard and Dartmouth social scientists Gary King and Samir Soneji assert that the finances are far worse because the Social Security actuaries are underestimating how long we will live — a claim the SSA actuaries refute.

Without going into the weeds of methodological conflicts, we suggest that the worst-case future for Social Security might be worse than the program's trustees think, and that the Black Swan may be swimming right up behind us.

A Game Of 'What If'

While the commonly reported figures for trust fund insolvency are based on intermediate assumptions — not too high, not too low — the trustees also calculate high- and low-cost assumptions. Social insurance experts are well aware that the high-cost projections of Social Security's future do not represent a worst-case scenario — the combined trust fund insolvency date under the high-cost assumptions is 2027, just 14 years from now.

Many of these same experts nonetheless claim that the worst-case future for Social Security is that promised benefits would have to take a 25% haircut if the trust funds go insolvent in 2033. Though a 25% reduction in benefits is scary enough, a Black Swan event could be catastrophically worse.

Consider a chronically sluggish economy that causes the gross domestic product to continue to fall well short of current projections, with attendant increases in disability rates and declines in birth rates.

Throw in a cure for cancer, and you have a flock (technically, a wedge) of Black Swans that will result in Social Security beneficiaries seeing far more than a 25% cut in their benefits.

We think the trustees and others who say "sooth" for a living should pay more heed to those surprising events that occasionally darken our skies and our lives.

The call of the Black Swan can often be heard before the bird itself arrives — and we should take advantage of such fortuitous heralding when it comes to the future of Social Security.

To be clear, we are not recommending that the current and normal distribution analyses that underlie the trustee reports should be replaced or even augmented by reliance on abnormal distributions.

Black Swan Czar?

We would, however, like to see the SSA's Office of the Chief Actuary hire a Black Swan Curator, charged with searching the skies for large birds headed our way, charting their course and finding a way to deflect those that might do us great harm.

One such bird is the stork, who threatens us more with his absence than with his presence, causing fertility rates to decline and Social Security's financial problems to increase.

Another is the vulture, whose absence is anticipated by King and Soneji, with inadequate mortality causing distress to the trust funds.

Perhaps most needed is the owl, whose wisdom may help us understand the influence of taxation and regulations on unemployment rates and GDP, and the subsequent impact of such economic parameters on the demographic assumptions (fertility, immigration, disability) used by the actuaries.

We hope that our recommendation to hire a Black Swan Curator (actual name optional) will be enthusiastically received.

But we are concerned that cost — and turf — control may prevent such a position from being created. We thus have ready a low-cost backup recommendation, which is that every trustee report be emblazoned with the warning: Black Swans Bite!

An Actuarial Ombudsman for the Public

Wednesday, July 18, 2012
Jason J. Fichtner

Although the Supreme Court upheld the Affordable Care Act (ACA), it’s still unclear whether we can truly afford the provisions in the law. Congress passed, and the President signed, the ACA with the promise that it wouldn't add to the federal deficit. Even after the Supreme Court decision, however, the only true debate now is over how much it will add to the deficit.

 The buck doesn’t stop there, unfortunately. Given the ever-increasing costs of Social Security, Medicare and Medicaid, how do we know if we can afford to keep any of the other entitlement promises Congress has made?Depending on which set of assumptions you look at, there are three, in the Social Security Trustees Report the trust funds may go bankrupt in 2027, 2033, or never. That’s a wide range of predictions. If the public had its own actuarial ombudsman, a source of unbiased information, we could have better policy discussions about the true costs of our legislative promises and the necessity of entitlement reform. Perhaps then the public could find answers as to where the trust funds are headed, and what could be done to avoid insolvency.

A credentialed American actuary, an actuarial ombudsman should be an independent individual, or at most a troika, and certainly not an organization or a committee. They should have the freedom to select support staff, to choose the major legislation to be analyzed, and to draw upon the analysis of others organizations like the Congressional Budget Office, Office of Management and Budget, Social Security Administration, Centers for Medicare and Medicaid Services, policy groups, universities, and more. The point would be to prepare an annual report to the public, submitted to the Congress and the President, laying out in plain English the future fiscal challenges facing the nation based on the promises we’ve made and the funding required.  

$100 trillion: that staggering sum is a lowball estimate of the amount needed to be placed in a bank account today, right now, to cover promises already made by our federal government. These promises are the scheduled payments to be made in the future to bondholders, social insurance trust funds, Social Security recipients, Medicare providers, federal employees and retirees, and a host of others. The $100 trillion is over and above taxes already scheduled to be collected under current laws.

$1 million: another staggering amount that is the cash required from each U.S. federal income taxpayer immediately, in order to set up the $100 trillion account. It presumably could be financed with more federal debt and thereby pushed off to future generations -- but that’s how we got in this mess in the first place. We’re mortgaging our kids and grandkids futures. Who’s to say that they will be willing or even able to meet the payments that we have bequeathed to them? It surely isn’t fair!

$500,000: the $1 million due from each taxpayer could theoretically be cut in half if we first confiscated the entire net worth of the top 1% of Americans and applied that money to the $100 trillion bank account. But that’s a silly idea. Any proposed confiscation will surely have some adverse effect on capital formation and job creation, likely leading to lower revenue collection and increased federal expenditures. As large as $100 trillion sounds, it’s actually based on the underlying premise that federal deficit spending will cease immediately and permanently, and that is currently not in the cards. As we continue to fund our priorities with even more debt, the $100 trillion amount will be that much larger. Not to mention, we have made no provision for state and local government debt. The $100 trillion is based on promises made at the federal level only. Add in state and local pensions and other debts and the amount increases by $10 trillion.

How did we get in this mess? The inescapable answer is that our politicians have been successful at buying votes by means of promising benefits in excess of taxes. They found it easier to get elected by promising benefits today and putting off paying the bill -- hoping that tomorrow will not show up while they’re still in office.

The United States faces yet another $1 trillion deficit and the acknowledged conventional national debt is now well over $15 trillion. The true national debt, including unfunded but real liabilities, is $100 trillion and growing. At some point, entitlement reform will be necessary. Deficit financing can’t go on forever. Where will the public turn for unbiased information? We think the time has come for an actuarial ombudsman.