Self Directed Investor
October 9, 2009
by Charles Blahous
Last month, the Congressional Budget Office provided Congressional staff with updated fiscal projections for the Social Security program. The most notable change in the projections was that Social Security will begin running deficits next year, in 2010. Only last year had CBO projected that Social Security’s surpluses would last until 2019.
Many are asking what CBO’s updated projections mean for Social Security, for the federal budget, for beneficiaries and for taxpayers. The critical points to understand are the following:
Cash shortfalls mean additional pressure on the federal budget and further burdens on taxpayers. A cash shortfall exists when incoming revenue from Social Security payroll taxes and benefit taxes are insufficient to fund promised benefits. So long as the Social Security Trust Fund carries a positive balance (as it will for many years), the costs of filling in the shortfall will be met not by reducing payments to beneficiaries but by the government’s allocating additional revenue to redeem bonds held by the Trust Fund. The obligation to produce this revenue worsens an already-dire budget outlook and increases the mounting cost burdens facing beleaguered taxpayers.
Interest payments exchanged between government accounts will cause the Social Security Trust Fund balance to continue to grow in the near term. Some misconceptions exist about this phenomenon. The fact that the Trust Fund balance will still grow does not mean that additional cash won’t be required. All that it means is that the government will continue to issue even more bonds (representing interest credits) than taxpayers are currently buying back.
To understand this, one can draw an analogy between Trust Fund debt and the debt embodied in a home mortgage. As long as incoming taxes exceed outgoing benefits, the government needn’t make cash payments on its “mortgage.” As soon as the incoming taxes fall short, it does. It just so happens that in the near term, the cash payments required aren’t as large as the annual interest on the mortgage. So the mortgage continues to get bigger, even though the borrower is now ponying up some cash.
CBO currently projects that the cash shortfall will be $10 billion in 2010 and $9 billion in 2011, before disappearing and re-emerging in 2016. The cash shortfalls will then grow more seriously, reaching $63 billion annually by 2019.
We don’t yet know if the Social Security Trustees agree with CBO’s projection. CBO’s projection is sensational because it would have Social Security’s deficits arriving earlier than almost any post-1983 government estimate. But we must remember that, despite CBO’s well-earned respect as a scorekeeping agency, their Social Security projections have been more volatile than those of the Social Security Trustees. In just the past year, CBO has gone from predicting cash surpluses until 2019, to hitting the wall next year in 2010. That’s a swing of nine years in just one year’s space of reports.
The Social Security Trustees, by contrast, have only shown nine years of variation in all of their annual reports since 1983 (their estimates have ranged from 2012 to 2021). Not for decades have the Trustees had an outlook as optimistic as CBO’s 2008 report. Nor have the Trustees yet released a report as pessimistic as CBO’s 2009 report.
While we don’t yet know whether the Social Security Trustees will also anticipate cash deficits arriving next year, there is ample reason to believe that things will be worse than foreseen in the 2009 Trustees’ report. That report predicted the arrival of cash deficits in 2016, though the median projection in the Trustees’ stochastic analysis was actually 2014. That report also assumed 2009 unemployment of 8.2%, peaking at 8.8% in 2010. Obviously, those projections look far too optimistic now.
The primary cause of the worsened near-term outlook is sagging payroll tax revenues caused by the ongoing recession. Other factors, such as the largest COLA in 27 years and rising disability claims, have played a role. Bu the chief culprit, by far, is the recession’s effect on payroll tax revenues. In March, CBO foresaw a thin $3 billion surplus for 2010; in September, they foresaw a $10 billion deficit. The chief reason was a lowering of the 2010 payroll tax revenue projection by $11 billion.
Most of the revenue deterioration was already evident by the time of CBO’s March projections, in which revenue projections had been lowered by $75 billion relative to the previous year’s report.
There was never a factual basis for the myth that the Social Security Trustees’ projections were too conservative. For years, those who have wanted to wish away the reality of the Social Security shortfall have selectively critiqued the Trustees’ assumptions for productivity growth, labor force participation by seniors, immigration, and other variables. Too often, these critiques failed to recognize that there were as many reasons for believing the Trustees’ projections too aggressive as too conservative.
It now seems extremely likely that Social Security finances are in significantly worse shape than foreseen in virtually any Trustees’ report since the last major reforms in 1983. But even before the Trustees incorporate the latest sobering economic data, the data show clearly that the Trustees’ previous projection record has not been too conservative.
The above chart ends with the Trustees’ 2009 projection of 2016 for the onset of permanent Social Security deficits, a date that is now nearly certain to move closer. But even before that data point is added, the trend is clear: most previous Trustees’ reports foresaw longer periods of surpluses (and of solvency) than what results from the incorporation of subsequent data.
The myth of overly-conservative Trustees’ reports was fueled by cherry-picking those few Trustees’ reports of the mid-1990s that did appear to be too conservative. Those reports, of course, appeared before a national surge in real wage growth caught all government forecasters – not just the Trustees – by surprise. That real wage growth surge pushed back the doomsday dates by a few years, after which they resumed their inexorable march closer in time.
If the latest CBO reports turn out to be right and cash deficits arrive next year, then even the Trustees’ most conservative reports of the mid-1990s will have overstated the program’s fiscal health.
CBO is almost certainly too optimistic with respect to the program’s long-term fiscal outlook. Despite their sobering near-term projections, CBO is almost certainly understating the program’s shortfall over the long term, for two reasons.
The first is that their primary projection assumes the literal and permanent extension of “current law,” meaning among other things that the entirety of the 2001/03 tax cuts will be allowed to expire and that effective tax rates will increase perpetually through “bracket creep.” This is an implausible assumption, conflicting with historical norms as well as the stated policies of the Obama Administration and the Congressional leadership of both parties. This assumption produces an overestimate of the likely amount of benefit tax revenue going forward.
The second is that CBO assumes that real wage growth will henceforth be 1.4% annually, in contrast with historical average over the last 40 years of 0.8%. Even if one believes that the last 40 years have showed unrepresentatively slow growth, it is unlikely that future wages will grow at a rate roughly 75% faster than the recent historical average.
If comprehensive health care reform is enacted, the outlook for Social Security will worsen further. Existing health care proposals before Congress would pass much of the costs of expanding health care coverage onto employers and workers. Nyce and Schieber found in a landmark recent paper that even in scenarios in which health care inflation remains constant or abates slightly, the cost of such expanded coverage will be felt in slower wage growth, with the most severe effects upon lower-wage workers. The result of slower wage growth would be depressed Social Security tax revenues, reduced growth in Social Security benefits, and accelerated program insolvency.
In sum, while we do not know the exact date at which program deficits will arrive, it is clear that they will arrive much sooner than most previous projections, refuting the myth of overly conservative Social Security projections. When that date arrives, difficult choices must be made between placing additional burdens on taxpayers and adding still more to skyrocketing deficits. Should comprehensive health care legislation be enacted, the outlook will worsen still further.
Though seniors can count on receiving their Social Security checks in the near term, the updated projections reveal that federal policy makers have permitted the Social Security problem to compound dramatically.
Charles Blahous is a Hudson Institute senior fellow.
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