By Laurence Kotlikoff
Originally posted on Forbes 8/21/15
The Truth About Social Security’s Long Term Finances
In a recent NY Times column, political economist, Paul Krugman, writes, “Social Security does not face a financial crisis; its long-term funding shortfall could easily be closed with modest increases in revenue.”
Nothing could be further from the truth. Social Security’s 2015 Trustees Report came out just last month. It shows, in table VI. F1 (which is deeply buried in the Report’s appendix), that the system has a $25.8 trillion fiscal gap. This is the difference in the present value (the value in the present) between all future projected benefit outlays and the sum of two things — the present value of all project future Social Security taxes (including future federal income taxes levied on Social Security benefits) plus the system’s almost $3 trillion trust fund. There is a raging debate on whether to count Social Security’s trust fund as an asset. But it is an asset of the system. It’s also trivially small. Even treating it as an asset, as Social Security’s actuaries properly do, leaves the system almost $26 trillion in the red.
The $25.8 trillion fiscal gap is what we economists call an infinite horizon fiscal gap because it takes into account all future benefit outlays and all future taxes. This means it ignores neither benefits that will need to be paid in the future or taxes that will be collected in the future, no matter how far out in the future. But, and this is critical, the infinite horizon fiscal gap discounts (as in makes less of) benefit obligations and tax receipts the farther out in the future they are. So a dollar to be paid or collected in, say, 100 years, will be worth less than a dollar collected today. Indeed, given the Social Security actuaries 5.6 percent nominal annual interest rate assumption, a dollar to be paid or collected in 100 years is worth only 4 tenths of a penny! But Social Security’s benefits and taxes are indexed to inflation, so the question is not what a dollar will be worth in 100 years, but what will a dollar that is indexed to inflation be worth. The correct real (inflation adjusted) discount rate to use in this case, is the actuaries’ assume 2.9 percent real rate. This makes the value of an indexed dollar 100 years from now equal to 6 cents today.
The bottom line is that nothing in economics permits us to ignore the future, including the distant future. (Neither does basic morality, since it’s our kids and grandkids and … who will be around then.) But economics also tells us exactly how to deal properly with obligations and receipts far into the future, namely to make less of them — to discount them — but certainly not to ignore them.
Actuaries aren’t economists. But Social Security has brilliant actuaries working for it and they understand how to properly value and add together all of Social Security’s future obligations and taxes. This is why they have been presenting Social Security’s infinite horizon fiscal gap in a special table since 2002 in the Trustees Report. But, over time, as the fiscal gap gets larger, the table reporting it seems to get more deeply buried in the Report. And, whether the Trustees are appointed by a President who is a Republican or a Democrat, somehow the “Trustees” can’t find the time or space to discuss the infinite horizon fiscal gap. But economists can and do find the time. Over 1,200 economists, including top economists from every leading academic department, and 17 Nobel Laureates have publicly endorsed infinite horizon fiscal gap accounting. Paul Krugman has yet to do so.
What does Social Security’s $25.8 trillion fiscal gap, which is far larger than our economy’s $18 trillion annual GDP, mean, exactly? It means that the system is 32 percent underfinanced, i.e., it requires a 32 percent immediate and permanent hike in Social Security’s 12.4 percent employer plus employee FICA tax. If we don’t raise the system’s tax rate to 16.4 percent starting today and leave it at 16.4 percent forever, out kids will face even larger permanently tax hikes when they are ultimately enacted. This is the terribly zero-sum nature of fiscal policy.
Can the rest of the fiscal system bail out Social Security. Absolutely not. It’s in even worse shape. Uncle Sam’s overall (Social Security included) infinite horizon fiscal gap is now $210 trillion. I.e., for Uncle Sam to pay all his project (by the Congressional Budget Office) bills going forward he’d need to immediately and permanently raise all federal taxes by 58 percent.
Raising Social Security’s payroll tax rate by 32 percent is not a “modest increase in revenue.” Paul Krugman is entitled to his opinion, but, when it comes to the facts, Krugman could not be further off base in assessing Social Security’s fiscal crisis and the massive threat it and other take-as-you-go policies pose for our children.