Measuring Social Securitys Financial Outlook Within An Aging Society

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Measuring Social Securitys Financial Outlook
Within An Aging Society

• Jagadeesh Gokhale and Kent Smetters
• Fiscal Challenges
• An Interdisciplinary Approach to Budget Policy
• University of Southern California
• Gould School of Law
• February 11, 2006

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Social Securitys Financial Status

• Traditional measures of financial solvency
• Crossover date
• benefit outlays begin to exceed program revenues
  (2017)
• Trust-fund exhaustion date
• 2042
• Or
• Trust fund ratio (trust fund value/one years
  outlays)
• Deemed inadequate when it reaches 12-14 percent
• Actuarial balance
• 75-year summarized income rate minus summarized
  cost rate (1.92)

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Problems w/ Older Measures

• Create a misleading impression of Social
  Securitys finances
• Introduce a bias in policymaking when considering
  Social Security reform

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Recently Adopted Newer Measures

• Deal with both problems but
• are buried in the Trustees annual reports
• receive little attention by policymakers/media
• Allowing them greater prominence could revive
  momentum for reforming Social Security

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Social SecurityProgram Summary -- I

• Payroll taxes of 12.4 percent up to 94,200 of
  earnings
• 95 of work-force covered
• Retirement benefits replace 40 of pre-ret.
  earnings, on average
• Replacement rate is 90 for poorest participants

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Social SecurityProgram Summary -- II

• Rights to benefits are non-contractual
• Benefits based on laws in effect at time of
  eligibility
• Eligibility rules and benefit formula subject to
  change
• A DB (as opposed to a DC) system
• Benefits linked to wage and contribution history
• Program operating on pay-as-you-go basis
• Past generations received generous returns on
  contributions
• Future generations must, therefore, receive lower
  returns

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Social SecurityPrevious Reform -- I

• 1981 OASDI projections insolvency was imminent

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Social SecurityPrevious Reform -- II

• Long-range Declining worker/beneficiary ratio
• Solution Enacted Increase systems resources
• Payroll tax hikes
• Benefits subject to income taxes
• Gradual increase in normal retirement age to 67
  after 2003

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Current Financial Status -- I

• Trust fund contains securities worth 1.7
  trillion
• But system is still mostly pay-as-you-go
• For full funding, TF should be 12.8 trillion
  today
• Post 1983 reform projections
• Solvency through 2057
• Todays projections
• Cross-over date is 2017 TF exhausted 2042
• Present value of 75-year cash flow shortfall 4
  trillion

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The Moving Window Problem

• Shortfall reappeared after 1983 reforms
• Moving window phenomenon
• 1983 75 2058
• 2005 75 2080
• 75-year window beginning today includes 22 years
  of shortfall that the 1983 reform did not
  consider
• Inject 4 trillion in TF immediately ? 75-year
  solvency
• must represent net increase in national saving
• Similar 75-year shortfall will reappear in 22
  years 2027
• SS Trustees Another 7.1 trillion shortfall
  arises after 2080

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Social Securitys Total Imbalance

• 4 7.1 11.1 trillion under current policies
  and projections
• 3.5 percent of all future taxable payrolls
• No reform in 2005?imbalance has grown larger
• interest accrual on the 11.1 trillion imbalance
  
• 666 billion in just 1 year
• Giving up 0.4 percent of payrolls for every 5
  years without reform

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Solvency vs. Sustainability

• Solvencydefined per period of time
• Ability to pay this years benefits
• Ability to pay benefits over 75 years w/o
  borrowing
• Sustainability
• Ability to fund benefits indefinitely
• Targeting solvency over a limited horizon ?
  insolvency grows larger as budget window moves
  forward

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Sustainable Solvency

• Modified concept Sustainable Solvency
• Cash flow solvency over 75 years
• Stable or rising Trust Fund Ratio near horizons
  end
• Shows whether solvency will continue as budget
  window moves ahead
• But, TFR may begin declining soon after 75th year
• ? sustaniability is not guaranteed

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Bias In Traditional/Modified Approach--I

• Reforms that could reduce the 11.1 trillion
  imbalance appear to be worse under traditional
  measures
• Carve out Reform Actuarially fair
• Deposit a part of payroll taxes in personal
  accounts
• Participants future benefits under traditional
  system are reduced dollar-for-dollar in present
  value
• Systems finances Actuarially unchanged in
  present value but
• Trust fund exhaustion data
• Crossover date become
  worse
• 75-year actuarial imbalance

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Bias In Traditional/Modified Approach--II

• Reforms that could reduce the 11.1 trillion
  imbalance appear to be worse under traditional
  measures
• Carve out Reform With a haircut
• Deposit a part of payroll taxes in personal
  accounts
• Participants future benefits under traditional
  system reduced by more than dollar-for-dollar in
  present value
• Systems finances Imbalance reduced in present
  value but
• Trust fund exhaustion data
• Crossover date become
  worse
• 75-year actuarial imbalance

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Social Security Outlook Under Haircut Reform
and Financial Markets

• Improved SS finances should
• Increase saving and investment
• Improve labor market outcomes from lower taxes
• Use of traditional measures affects reform plans
• Try to avoid large losses in the short term

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New Measures

• Open Group Unfunded Obligation (OG)
• Present value of financial shortfall calculated
  in perpetuity under present laws (nets out
  Trust Fund past, present, and future
  generations)
• 11.1 trillion as of year-end 2004
• Additional funds that must be set aside today
  (invested at interest) to maintain present law
  taxes and spending
• Closed Group Unfunded Obligation (CG)
• Contribution to OG by past and living generations
  only
• Excludes shortfall on account of future
  generations
• 12 trillion as of year-end 2004
• Future generations will pay 0.9 trillion on net
• Insufficient to pay for the overhang of 12
  trillion they inherit

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Properties of New Measures

• Correctly indicate impact of reforms
• Actuarially fair carve out
• Traditional measures show worsening of SS
  finances
• But both OG and CG are unchanged
• Carve out with hair-cut
• Traditional measures are worsened (as before)
• OG improves (declines) CG reflects gain for
  future generations

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Importance of CG Measure

• Not widely understood
• Belief meaningful only in fully-funded context
• Each generation pays for own benefits
• CG would be non-zero if that were not true
• CG is also important under pay-as-you-go system
  (SS)
• Indicates redistributive impact of reform across
  generations
• Hike taxes and benefits in strictly pay-as-you-go
  manner
• ?OG remains constant but CG increases shows
  that current generations better off and future
  generations are worse off
• CG indicates extent of private saving crowd out
  under pay-as-you-go financing ? impact on capital
  accumulation and interest rates

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Too much emphasis on long-run?

• OG and CG include shortfalls beyond 75th year
• Enact idiot reform affect cash flow only after
  year 75 to eliminate 11.1 trillion imbalance
• But the 11.1 trillion shortfall is in present
  value
• 1 after 150 years 1 cent today
• idiot reform would involve obviously
  unrealistic promises
• Rather than overemphasizing the long run,
• OG and CG remove the policy bias under current
  measures and reveal the urgent need for action

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Personal Account Reform and Debt

• Economic perspective
• 1 of debt ? 1 of Social Security obligations
• Legally
• Debt and Social Security obligations are
  different
• Capital markets discount SS obligations more
  heavily
• Personal Accounts? more debt ? financial panic?
• But unlike SS obligations, debt not protected
  against inflation
• Debt could be reduced more easily than SS
  obligations
• If markets discount SS obligations by more ?
  willingness to accept a larger haircut under a
  personal accounts reform
• ? less debt created

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Conclusion

• Lack of momentum for reform due to misperceptions
  arising from traditional measures
• How big the problem is
• Impact of the current system on
• Intergenerational redistribution
• Capital accumulation and interest rates
• Impact of reform on financial markets
• Place to beginplace greater emphasis on OG-CG
  measures

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