Social Security Trust Funds: Why Solvency = Discounted Interest Only Loan
by Bruce Webb
Are the Special Treasuries that make up the Social Security Trust Funds real? Absolutely, quite apart from legal and historical arguments the DI Trust Fund will be cashing in some $23 billion of them in 2010 along with taking some $9 billion [edit] in interest, their reality is affirmed every time a SS Disability check gets credited to a beneficiaries account each month. QED.
But does that mean that all of those Special Treasuries in the combined Trust Funds will get paid back? Or need to be paid back? Well no, if we fix Social Security in precisely the right way, those Trust Funds get converted into a discounted interest only loan, and the principal simply rolls over forever. To understand why this should be we can start with the following from Steve Goss, the Chief Actuary of Social Security in his recent article for the Social Security Bulletin The Future Financial Status of the Social Security Program
However, the occurrence of a negative cash flow, when tax revenue alone is insufficient to pay full scheduled benefits, does not necessarily mean that the trust funds are moving toward exhaustion. In fact, in a perfectly pay-as-you-go (PAYGO) financing approach, with the assets in the trust fund maintained consistently at the level of a “contingency reserve” targeted at one year’s cost for the program, the program might well be in a position of having negative cash flow on a permanent basis. This would occur when the interest rate on the trust fund assets is greater than the rate of growth in program cost. In this case, interest on the trust fund assets would be more than enough to grow the assets as fast as program cost, leaving some of the interest available to augment current tax revenue to meet current cost. Under the trustees’ current intermediate assumptions, the long-term average real interest rate is assumed at 2.9 percent, and real growth of OASDI program cost (growth in excess of price inflation) is projected to average about 1.6 percent from 2030 to 2080. Thus, if program modifications are made to maintain a consistent level of trust fund assets in the future, interest on those assets would generally augment current tax income in the payment of scheduled benefits.
Emphasis mine. I’ll unpack this a little under the fold.
The first thing needed to understand this is how the Trustees define Trust Fund solvency. For them ‘solvency’ means ‘one year of cost equivalent in the Trust Fund at the end of each year’. So if we take the OAS (Old Age/Survivors) Trust Fund in isolation from the DI Trust Fund we get the following projection Table IV.A1.—Operations of the OASI Trust Fund, Calendar Years 2005-19 we can see that OAS TF Balances not only vastly exceed OAS Cost for 2011, they also project to continue to do so for the next ten years. Which is why the Trustees are able to report that OAS in isolation meets the test for ‘Short Term Actuarial Balance’. And if you scrolled down the page from that link to Table IV.A3 you would see the same thing is true for combined OASDI. On the other hand if you paused at Table IV.A2 you would see that is decidedly not the case for the DI Trust Fund, it projects to go to a 91% of cost reserve at year end 2014 and to total exhaustion in 2018. Not only does DI fail the ten year test for solvency, it has for some years. So it needs to be fixed and as it turns out we know what the cost of that fix would be over 25 years and over 75 years thus handily achieving short term (10 year) and long term (75) actuarial balance, it would require an increase in FICA devoted to DI of 0.30%.
But that is not the focus of the post. Instead I want to explore how “a perfectly pay-as-you-go (PAYGO) financing approach” is consistent with “negative cash flow on a permanent basis”. Well Steve explains it but in somewhat condensed fashion. If the U.S. enters a period that experiences an extended period of real growth then Social Security costs increase every year. That is on a nominal dollar basis increases in population, real wage, and inflation, however moderate, add to total program costs. This may or may not also mean an increase in GDP devoted to Social Security which could remain flat, but the year end balances needed to maintain solvency need to be bigger year over year. The following table shows us income excluding interest and cost for the 75 year projection period Table VI.F9.—OASDI and HI Annual Income Excluding Interest, Cost, and Balance in Current Dollars, Calendar Years 2010-85 and tells us that projected cost under Intermediate Cost projections will increase from $710 billion in 2010 to $27 TRILLION in 2085. Meaning that for the combined Trust Funds to be judged solvent there would need to be an equivalent $27 trillion in Special Treasuries to offset that.
Well under Intermediate Cost assumptions that is not going to happen, even after we add interest back in. If we roll back to Table VI.F8.—Operations of the Combined OASI and DI Trust Funds, in Current Dollars, Calendar Years 2010-85 we see interest backfilling the gap and increasing TF balances up to 2027 or so, and then a more or less rapid collapse in balances due to Trust Fund redemption until the TF is exhausted in 2037, exposing SS to a 22-25% cost gap over the rest of the 75 year projection. Note that in this scenario the entirety of the combined Trust Fund principal has to be redeemed over a ten year period from 2027 to 2037 at an average rate of $400 billion a year plus the shrinking yet substantial interest charges. This is what the Wall Street boys really see as the crisis.
But if we look at Low Cost assumptions we see something totally different. Under LC Costs project to be $18 trillion in 2085 but all of that would be offset by $19 trillion of income EXCLUDING interest. This doesn’t mean the income tax payers get off totally scot free here, there is a period from 2026 to 2050 where a portion of interest accrued still has to be taken in cash, but not all of it, instead that retained portion of the interest simply transforms into Trust Fund principal and starts itself earning interest with the result that the Trust Fund balance goes to $119 trillion (Table F8) which equates to a TF Ratio of 1049, or ten times what is needed for solvency. Not only would this be unnecessary, it is actually problematic, and shows the perils of overfixing Social Security.
So where is the happy median? Well it is in what Steve Goss calls ‘sustainable solvency’ which is a Trust Fund with a flat to rising TF ratio at the end of the 75 year period. But what this means in practice is that instead of seeing the TF peak in dollar terms and then go to exhaustion or to have the balance go to ten times what is necessary it would instead need to grow steadily to match the $20 trillion or so in costs for 2085 suggested by that balanced outcome. Which logically means that Trust Fund principal is NEVER cashed in, just rolled over. Moreover and less intuitively it means that income excluding interest has to be maintained enough below cost to drain off enough accrued interest to keep the rest of that interest from exploding the year end balance. Which is how “a perfectly pay-as-you-go (PAYGO) financing approach” = “negative cash flow on a permanent basis”
So while the answer to the question are the Special Treasuries in the Trust Fund real obligations of the US Treasury, the answer is ‘absolutely’, shown not just with the current state of DI which is cashing them in as I type, but also because a steady-state Pay-Go requires at least some of the interest accruing to be paid in cash. But not all, a portion of that interest has to be retained and converted to principal to maintain a steady TF Ratio and so sustainable solvency.
Is the principal on what is in effect an interest only loan really a debt to Treasury or the Public it represents? Well that is more a question of language than anything, but the simple fact remains that small changes in revenue today while creating a permanent obligation in the form of cash interest transfers almost totally removes any need to redeem the principal in the Trust Fund over the next 75 years. For example if you examine the spreadsheet underpinning the NW Plan for a Real Social Security Fix: 2009 OASDI Trigger you will see the Trust Fund balance hitting its first peak of $4964 billion in 2026 but only redeeming $158 billion in principal until its new low of $4826 in 2035 after which it resumes its steady rise. Discount that ten year $158 billion for inflation and you see this would truly be a non-event
Okay in what way does this also make it ‘discounted’. Well simple enough, the interest retained to maintain sustainable solvency is not financed out of the then current economy, instead it comes in the form of newly created Special Treasuries. And since it is then part of the sustainable solvency principal that never has be be cashed in if normal growth continues the real cost to the economy is the difference between the Real Interest Rate of 2.9% and the Real Cost increase of 1.6%, or less than half of the rate on the face of the note.
Under the NW Plan we deliver 100% of benefits, achieve sustainable solvency, and relieve capital of the need to ever pay back the principal they borrowed, all at zero up front cost to the wealthy. All they have to do is to agree to pay heavily discounted to face of the note interest on the money they borrowed and continue to borrow though 2023. Who exactly is sucking the tits of the milk cow in this scenario?
Romans!!!
Everyone with a few bucks in the bank is a pillager, I love those guys, look like my ancestors.
nanute
hahahaha. We know who the cow molesters are. Firstly, I had to watch a Jamie Dimon credit card commercial before Forbes let me read the article. Then in addtion to all the bits of wisdom peppered thru the article, I get a core concept like this…”…it’s just accounting..”…referring to the trust fund. Spoken like a true CEO. No discussion of off balance sheet accounting or if we can break out or losses separately, we can show a profit and pay nice bonuses. I guess those are accounting techniques reserved for biz, and the author wanted to keep things simple for his Forbes readership.
We are constantly bombarded with these arguments, which is why we are here to shout out the counter arguments. If only we had “Flat Tax” Forbes circulation.
Even Wiki seems confused about SS the last time I checked. Maybe Bruce and coberly could get some more mileage out of their work if they went and straightened Wiki out. Wiki lets anyone contribute if they seem to talk facts and sense.
@Cedric Regula
I feel your pain. I’m sorry you had to endure the hardship to get to the “hardship”
You can’t straighten out Wiki on this one. The truth is simply too bizarre in the face of what ‘everyone knows’. It is totally counter-intuitive that ‘Nothing’ is the second best plan for Social Security in the short run and that the first best plan comes with a 25 year cost of around a dime per week, oh and which means we never have to pay back the bonds in the Trust Funds and only come up with around 40% of the interest. Who the fuck is going to believe a couple of old fart ranters from the Pacific Northwest whose brains are probably rotted out by the constant rain when they are spouting crazy talk like that? And no they don’t care that we have numbers, nutters often do.
Dale seems to still hold out some hope of selling the truth via the masses, me I am just trying to work through some of the policy elites in DC while also spreading the word through the more informed parts of the left Blogosphere, pushing the Wiki boulder up the hill and keeping it there being more energy than I can expend right now.
Ah shit that should read “a dime per day”.
We know you guys grow pot up there too in your hippie communes.
Nope, all the best pot is grown north of me and south of Dale. You can find ‘Shrums around here if you know what you are doing but really the drug product of choice around these parts is Meth. One of the towns in my County got labeled Meth Capital of the country by I think Time. Which didn’t manage to make it onto the ‘Welcome To’ sign oddly enough.
Hmm. We just do peyote around here, and everything else is imported. Even the tequila.
Wiki is a good idea. The article in Wiki can be added to or corrected through the site’s software. I haven’t read it and it sounds like we all should. Requests for corrections or annotations of questionable data show up in the header of the article. NancyO
Ummm, Bruce? Umm, I’ll believe y’all. My mind isn’t rotted at all (I think) and I think y’all are right. Much better in every way than the information I got from SSA because the topic was not my area. I did data processing workflow analysis. And, I ran an office. You don’t have to know anything about the TF to do that. Actually, they didn’t think we had to know anything at all, but hey, they kept paying me. 😎 NancyO
Try the Mendocino green bud. Don’t ask me how I know, just try it. Nancy O.
bruce
dime per week isn’t that far off if you count only the employees share for the first 30 years.
OK, having the current $1.5T in FICA overpayments remain past the baby boom does make more sense when we’re looking at a nominal $27T cost in 2085 and the nice compound interest this savings is generating going forward.
I count 120M seniors alive in 2080, but going with 150M to be safer that’s a nominal average retirement income of $180,000.
We’re really going to inflate that much, a factor of 10 in 70 years? I guess if history is any guide we will, but count me skeptical. My skepticism is probably going to be proved wrong, but still.
Wow, 3.3% annual inflation does in fact get us there in 70 years.
Then again I think my skepticism is coming from the assumption that general inflation is going to create wage inflation this century. I lean more towards Perot being right in 1992 that the global wage is going to meet at $6/hr.
Dale my last run at this was for a family of four at 100% of FPL or $22k. I think that worked out to 65 cents a week assuming a 0.15% employee share. It seems both your and my definition of average worker and average household drift within the same accepted range but settle out in different places unless we rigidly define our terms.
And that and 10 yuan will get you half a liter of gasoline.
Wiki editors turned me down after a “review”.
Buff’s reassurances aside, this Republican Tea Party is about SS and Medcare from statements in the campaigns of TP winners in R primaries. Primaries have spoken.
Screw gold, gettin’ time to base our currency on convertability to kilojoules.
Course, given enough of it you can in fact convert any paper money into kJ.
Sure, cooking with cash!
bruce,
the difference is not material.
sure
when food gets scarce you are going to find out how well gold holds its value.
and you’d have to find a gas station that would honor your kj note.
Enron will make a market in them.
Oh man! After I exhumed Ken Lay and reburied him with a stake through his heart in a garlic field in Gilroy, Ca he is still making markets? Damn! Guess its time to take the advice of the original version of Day of the Dead and shoot them in the head or burn ’em. Just when you thought you did your due diligence.
The Teamsters signed on to represent the Grower employees in Oaksterdam @ $18.00 per hour the first year, $26.00 the second year, providing the Prop 19 passes, which seems to be the course. Could some of the other recreationals be far behind? I know, what does this have to do with the disscussion, but, it was added in, so, being late to the show, just thought I’d add my two cents worth, for if this wins, I firmly belive that the “Greening of America” just might have a chance to turn the process around. Calll me batty, but, I do have an excuse,”I’m Old”.
bruce explained his arithmetic to me. he is actually right. it was not a difference in “average worker” so much as different expectation for how the “actuarial shortfall” in DI will be paid for. In any case what we are talking about here is the difference between a huge horrible increase in the cost of retirement and disability insurance of either ten cents per week or 65 cents per week. Certainly economy crippling numbers.
To be fair to me… the 65 cents pre week estimate would not increase again until about 2026. plenty of time to “get used to it” as the Trustees like to say.
what’s funny after Enron is people going around talking about
The Iron Law of Accounting.
and you’d have to find a gas station that would honor your kj note.
In theory they’d only be issued by the major oil producers so gas stations would in fact take them.
However, no doubt the next Enron would start issuing them too.
In case anyone looked up the citation to the Northwest plan and said “What th’?!”
i think i make it a lot clearer in a pdf I prepared for my Senator (who has, I think, ignored it). If Dan is willing, and there is any interest, maybe we could work out a way to make that available to anyone who asks for it.
Rodger
you are probably right about part of what you are saying, but i am afraid mostly wrong about the way things are done in the real world.
businesses, and even the government, keep track of their “resources” usually by “accounting” for them in terms of money. the benefits that folks eventually get from Social Security are real… groceries, the houses they live in, the video they rent… because there is not an infinite supply of resources… at least at any given time… societies have evolved ways to “ration” them. mostly by “money”… whether gold, federal notes, bank accounts, or the iou’s we call Bonds.
SS itself cannot go bankrupt, but not for the reasons you give. it can’t go bankrupt because there is an infinite (for the time being) supply of “taxpayers” who are willing to pay the tax because it buys them something they badly need: the right to those benefits when they get too old to work.
but there are two ways that SS can be said to “go bankrupt.” the more important way is that with a growing population of old people… mostly because they are living a rather long time after they get too old to work… the amount of money collected in taxes from those still working might become less than that number of old people needs to pay for basic needs. we have shown that a small incresae in the amount of the tax per worker… so small it would not be felt… can take care of the increased needs of a growing elderly population for as far as the eye can see. so, although SS could in a manner of speaking become “bankrupt” there is no reason it should. the second use of “bankrupt”in the SS “debate” is the Trust Fund running out of money. this is based on a completely ignorant idea of what the trust fund is about. people talk about it as though it were some kind of endowment that your rich great grandady left you so you’d never have to work… as long as you didn’t “touch the principle.” but the Social Security Trust Fund is more like a bank account you create to save up for christmas spending, or a business sets up to put its “excess” money in at any one time so it can draw on it when the bills come due. The current SS trust fund is large enough to cover the current recession and most of the extra costs of the baby boom retirement. about the time most of the boomers will be dead, the trust fund will, having done its job, run out of money… or at least out of the “extra” money over the normal “one year’s reserve.”
I am afraid that lif FICA were $0, it would affect the government’s ability to pay all benefits…. because money is the way we keep track of resources. the government could just “print” the money, or credit bank accounts… but without creating actual resources… that would just put more money in the world chasing the same limited resources… which would drive up prices and somewhere someone would not be able to afford to buy what he had reason to believe he had “earned” by his work.
now, it times of recession, or just times of ordinary predicted growth, the goverment, or a bank, can issue money it has not “collected” and rely on the growth of the economy to “pay for” it… because money is simply a means of exchanging resources.. it is not value itself. but the quantity of money cannot for long exceed the level of resources without the money price of those resources going up… leading to the problem of people earning “money” in one day that is not enough to pay for the things they need the next day.
So there is indeed a Trust Fund. it is indeed “just numbers in a book” (and a few pieces of paper that memorialize those numbers).. but that is the very real […]
What happens to the Treasury market when the SS Trust fund needs to start liquidating its securities to meet payout obligations?
What happens to the Treasury market when the SS Trust fund needs to start liquidating its securities to meet payout obligations?
What happens to the Treasury market when the SS Trust fund needs to start liquidating its securities to meet payout obligations?
The good news is we will be able to buy iPods at the 99 Yuan Store for only 99 yuan.
Over the period the SS Trust fund is supposed to pay out, the average amount is 115 billion a year. The past couple of years, the Treasury has sold that many bonds in a one week auction, at times.