Soc Sec XXXIX: Pay/Go & Unfunded Liabilities

In the course of the two posts on Backwards Transfers (XXXVI & XXXVII) it became clear that even experts had a somewhat confused concept of the relation of past and future as it comes to Social Security finance. So this post will attempt to add some clarity.

Social Security is by design a Pay/Go system in which current premiums/taxes are used to pay out current benefits. Despite some hysterical hand-waving this is not a ‘pyramid scheme’ or a ‘ponzi scheme’, it is an insurance plan functioning much like any other insurance plan. The major difference between the Social Security Administration and New York Life is that the United States government functions as its own re-insurer with Full Faith and Credit backed up by the inherent power to tax.

Like any insurance plan Social Security takes on future obligations, obligations that will have to be met using resources available in the year of benefit collection. These obligations create legal liabilities, the law requires that Social Security to the best of its ability payout future benefits per the current benefit schedule. Now under Pay/Go the assumption is that these future obligations will be met by a continuation of the taxation mechanism currently in place (FICA payroll plus tax on benefits) backed up by a reserve fund (the Trust Funds) which itself generates a moderate amount of income in the way of interest on the Special Treasuries.

Which leads me to pause for a moment and shout: SOCIAL SECURITY IS NOT THE TRUST FUND. The Trust Funds exist to smooth out short to medium term discrepancies between income from tax collected and cost from benefits paid out, they were not designed and do not serve as an investment fund a la CalPers.

Okay we have an insurance plan whose benefit payouts fundamentally depend on future tax collections. Are those payouts ‘liabilities’? Well yes. Are they ‘unfunded liabilities’? Well it depends on your definition of ‘unfunded’. When the Federal government enters into any contract whether for aircraft carriers or retirement security it rarely if ever actually has dollars tucked away to pay for the entire contract over its entire span, instead it relies on future income streams. In the case of Social Security that income stream primarily is a dedicated FICA tax. My argument or maybe just by bare assertion that those future benefits are funded liabilities for as long as we can project that total income and Trust Fund claims on the Treasury will meet cost. So what are “unfunded liabilities’ in the context of a Pay/Go system? One answer (if not necessarilly THE answer) can be found under the fold.

My answer is that the term ‘unfunded liability’ is limited to the gap between the scheduled benefit and projected income going forward. It has nothing to do with benefits paid to past beneficiaries, those obligations have been fully satisfied with ongoing Pay/Go collections. In this case the past is really the past and done is done. The notion that unfunded liability going forward is a result of extra payouts in the past is simply wrong, for one thing the current unfunded liability totals more than the totals of all benefits paid out to date (Infinite Future unfunded $13.6 trillion, past total benefits $12 trillion), for another those payments were funded. But lets go to the numbers:

These may not be legible on your screen but the relevant links are: IV.B6-Unfunded Obligations Through the Infinite Horizon & IV.B7-Present Values of OASDI
The tables are laid out in different ways but what they deliver in toto is six values: total gap between future income and future cost for the 75 year, 100 year, and Infinite Future Horizon, and then those numbers discounted by the Trust Fund balance at year end 2007 ($2.2 trillion). So the following will lay out the gross and the net for all three periods:
75 year: $6.6 / $4.4 trillion
100 year: $17.1 / $15.2 trillion
Infinite: $15.8 / $13.6 trillion
What is the significance of these numbers? Well I think I will follow up in comments.