Time for Clarity: Income vs Cost & the Six Approaches to ‘fixing’ Social Security
by Bruce Webb
Over the next couple of days I’ll be rolling out what I am tentatively calling the Northwest Plan for Fixing Social Security, ‘Northwest’ because the three current contributers happen to live in the Pacific Northwest. But before doing so I want to lay out some of the conceptual differences underlying various discussions of Social Security Crisis.
Everyone I think would agree that Crisis is marked by a gap between Income and Cost at various future points and intervals. But that is where agreement stops and conflict starts.
Social Security starts from the position that it is obligated by law to pay out benefits under the current schedule and it breaks down Income and Cost as seen in this table: Table IV.A3.—Operations of the Combined OASI and DI Trust Funds, Calendar Years 2003-17 [Amounts in billions] In their formulation it breaks down as follows:
Income = Net contributions (FICA payroll tax) + Tax on Benefits + Net Interest
Cost= Benefits + Administration + RRB Interchange
Income – Cost = Net increase during year which added to year beginning Trust Fund Balance = Total TF Assets which as of Jan 1, 2008 was $2.2 trillion.
In this model Income-Cost = Surplus/Deficit and indeed it is this figure that is used in Unified Budget Surplus/Deficit. But that is just the Trustees position.
Others including the people at AEI look at this from a totally different direction and insist that we should properly see this in terms of Cash Flow to and from the General Fund, Under their formulation it breaks down like this:
Cash Income=Net contributions +Tax on Benefits
Cash Outlays=Benefits + Administration + RRB Interchange
Liabilities=Existing Trust Fund Balance plus Net Interest.
What was for Social Security at the end of 2007 a $2.2 trillion asset is for AEI a $2.2 trillion liability which needs to be addressed sooner rather than later. In fact from their perspective it is even worse than that. Because if you take this ‘funded liability’ and add it to ‘”unfunded obligation for past and current participant” of $15.2 trillion you end up with a “Present value of future cost less future taxes for current participants” of $17.4 trillion. Table IV.B7.—Present Values of OASDI Cost Less Tax Revenue and Unfunded Obligations for Program Participants[Present values as of January 1, 2008; dollar amounts in trillions]
Neither model is illegitimate in itself, it is just that the first takes the view point of the beneficiary while the second takes the viewpoint of the future taxpayer. What is the future retirees’ asset, the year end Trust Fund balance, is the current taxpayers’ liability. Which is where the problems start. Because the two populations only partially overlap in space and time. Some current taxpayers will receive only a small fraction of their income in retirement under Social Security. On the other hand they pay most of the income tax needed to redeem the Trust Fund. While certain future beneficiaries will rely on Social Security for most of their income in retirement and may not pay any income tax at all. And of course there is a whole range of people who fall in between.
Now under either model there are six possible approaches to closing the gap between income however defined and cost.
1. Raise the retirement age
2. Change the formulae for initial benefits and/or adjustment of future benefits
3. Raise the current payroll cap or change the formula which annually adjusts it
4. Exploit the long term premium of stocks over bonds by diversifying away from Special Treasuries
5. Raise payroll tax across the board
6. Target policy in ways that increase Real Wage going forward.
(Actually it is not as simple as this suggests, this implicitly holds the demographic assumptions steady. We could also target policy at the fertility, mortality and immigration numbers, but that only over-complicates an already complex question).
If as AEI does you consider the Trust Fund to be a liability whose future funding should be minimized or avoided in the interest of ‘sustainable solvency’ then the obvious starting points are 1 & 2. If you are a future retiree who will be mostly reliant on Social Security and doesn’t anticipate paying income tax in retirement 1 & 2 would be your last resort. In fact since from this standpoint ‘crisis’ is defined as a benefit cut in 2041 1 & 2 might add up to a cure that is worse than the disease, and particularly if like me you don’t have any solid plans to be around after 2041.
So when evaluating any Social Security ‘Reform’ plan it is important to see what they are fixing, are they looking out for the interest of the future beneficiary? Or just the future taxpayer? And which taxpayer? The worker making under the median or the taxpayer who earns their income from gains on capital?
Cui bono? Cui poena? Those are the questions we should be starting with.