A deficit of trust
The annual Social Security and Medicare trustees’ reports will be released today, prompting the usual scaremongering enabled by a widespread misunderstanding of how these programs operate and what deficits mean. As is always the case, it is helpful to separate out analyses of Social Security from Medicare, as they are different institutions facing very different challenges.
Turning first to Medicare, there’s no denying that Medicare is a large and growing contributor to federal budget deficits, since the dedicated premiums paid into the program don’t come close to covering costs. Nevertheless, the problem isn’t the design of Medicare itself, but rather health cost inflation. Shrinking or dismantling the program would only exacerbate Americans’ health insecurity, because Medicare does a better job of restraining costs than private insurers. This highlights a key theme in many debates about the budget deficit: reducing the deficit through any means possible should not be the goal. Instead, the goal should be to figure out how to boost Americans’ living standards. And in regards to healthcare, having the government collect taxes and pay for Medicare clearly boosts living standards relative to a scenario that sees Medicare gutted and taxes reduced.
Social Security, meanwhile, is still running a surplus, though this will change in a few years as the bulk of the Baby Boomers enter retirement. However, despite annual cash flow deficits that have appeared recently and will persist for some time, Social Security will be able to pay full benefits for much longer as it taps trust fund savings. Tapping the trust fund is not the sign of a crisis, instead it’s what’s supposed to happen. Policymakers in the early 1980s decided to build up a trust fund precisely to help smooth financing of Social Security in the face of the Baby Boomer bulge in the beneficiary population. This is analogous to the federal government running a deficit during a recession—it is not only appropriate but absolutely necessary. There is a crucial difference, however: unlike the rest of the federal government, Social Security is prohibited by law from borrowing—it can only “dissave” what it saved up in the first place. Unfortunately, many people associate running a deficit with borrowing, not spending down savings, and don’t understand that while Social Security can run annual surpluses or deficits the program cannot add to the federal debt over time.
Adding to the confusion is the issue of how Social Security relates to the rest of the federal government. Because Social Security has a dedicated revenue stream, is required to operate in long-term balance, and does not rely on the congressional appropriations process for funding, it is considered an off-budget program (other entities excluded from the federal budget include the U.S. Post Office, the Federal Reserve System and government-sponsored enterprises like Fannie Mae). However, it is often useful to look at the federal government as a whole, including Social Security. From such a “unified budget” perspective, the interest earned on Treasury bonds held in the trust fund amounts to a transfer from one part of government to another and therefore neither counts as revenue nor outlays for the government as a whole. So the fact that Social Security is currently running a cash-flow deficit—its tax revenues have not covered benefit costs since 2008—means Social Security is now contributing to a unified budget deficit.
But while it is technically true that by one measure Social Security is contributing to government deficits, anyone who makes a big deal about this is either confused, hoping to be misunderstood, or a bit of both. This is especially true when combined with an assumption that—without historical precedent and contrary to current law—transfers from the general fund will be made to Social Security to pay promised benefits if the trust fund is depleted. When language to this effect was added to the 2014 Social Security Trustees Report, it prompted an unusual dissent from Chief Actuary Stephen Goss. While most of the nonsense about Social Security and deficits comes from conservatives and pseudo-centrist deficit hawks eager to shrink or dismantle the program, there is a populist left version that accuses Congress of having “raided” the Social Security surplus to pay for wars and other wasteful spending—an unconvincing argument when you consider the global market for U.S. Treasuries.
Conservatives, meanwhile, have heeded W.C. Field’s advice that “if you can’t dazzle them with brilliance, baffle them with bullsh*t,” insisting in recent years that the trustees’ reports include appendices on the “Medicare and Social Security Trust Funds and the Federal Budget” and “Infinite Horizon Projections.” Nothing in these appendices is informative or genuinely alarming, but they serve as fodder for critics who rely on people overreacting to the word “deficit” and numbers expressed in trillions.
Another misconception some people have is assuming Social Security is advance-funded—that workers’ contributions are saved in a trust fund and later paid out to them as benefits. In fact, Social Security has always operated on a largely pay-as-you go basis, which let the program provide benefits at inception to seniors who had not had a chance to contribute. Most of the cost of benefits consists of transfers from current workers to current retirees and other beneficiaries, so even in the unlikely event that Congress allows the trust fund to run dry the program will still be able to pay about three-quarters of promised benefits—and in inflation-adjusted terms these benefits will be higher on average than those received by beneficiaries today. Don’t get us wrong, a cut in promised benefits would be terrible and unjust. But the scale of Social Security’s actuarial imbalance is completely manageable in an economy as rich as ours, but is often wildly overstated by those wanting the American public to lose faith in Social Security.
The buildup and draw-down of trust fund savings to pay for the Baby Boomer retirement is part of a plan put in place in 1983. At the time, the system was facing an imminent shortfall, and Congress legislated a gradual increase in the retirement age and other benefit cuts to build up the trust fund. It was well understood that this would not be a permanent fix, as increases in life expectancy and other factors require periodic adjustments to keep the system in balance. This seemed routine at the time, as the Social Security contribution rate had increased every other year or so in the previous three decades. However, no significant adjustments have been legislated since 1983 as Democrats resisted standalone benefit cuts while Republicans blocked proposals that included any revenue increases (alone or in combination with cuts).
More recently, the policy window has shifted in response to growing retirement insecurity, with Democrats unified in calling for expanded benefits and the Republican standard bearer saying he will simply leave benefits alone (though some in his campaign have suggested otherwise). This is the conversation we should be having: not how much to cut benefits, but whether and how much to increase them. This does, however, require revenues, which appears unlikely with today’s polarized Congress, even though voters in both parties favor increasing revenues over cutting benefits to fill a projected long-term shortfall.