2005 Social Security Trustees Report Reaffirms the Need for Action on Social Security Reform

Ed Lorenzen

March 23, 2005

The Social Security Trustees released the annual report on the financial condition of the Social Security system this morning.  The report shows that not only are the problems facing Social Security getting closer, but once the problems begin they will snowball quickly and place a rapidly growing burden on the economy and future taxpayers.  

Critics who suggest that the Trustees report presents an overly pessimistic outlook for the Social Security trust fund because it assumes slower economic growth in the future ignore the fact that the slowdown in economic growth assumed by the Trustees is a function of a declining labor force resulting from lower fertility rates and other demographic factors.

The summary numbers showing a slight deterioration in the financial outlook have been widely reported in the media.  The familiar refrain regarding Social Security finances will be modified slightly – Social Security costs begin to exceed annual revenues in 2017, by 2041 the trust fund is exhausted and the system will only be able to provide 76% of promised benefit levels. 

Over the 75 year valuation period the system faces an actuarial deficit of 1.92% of payroll and a shortfall of $4 trillion in present value terms – the amount that would need to be put into the system today to pay benefits for the next seventy five years.

Those overall numbers gloss over the magnitude of the problems after 2017.  The shortfall in 2017 is projected to be just 0.06% of GDP, or less than $10 billion in today’s dollars.  However, the shortfall increases rapidly in subsequent years, jumping to more than $100 billion in constant 2005 dollars (0.6% of GDP) by 2022 and more than $200 billion (1.18% of GDP) by 2028.   

The shortfalls continue to grow somewhat more gradually thereafter, reaching 1.5% of GDP ($319  billion in 2005 dollars) by 2035, ultimately reaching nearly 2% of GDP by the end of the 75 year valuation period.
Between 2017 and 2041 the U.S. Treasury will have to come up with more than $5 trillion in today’s dollars to cover the shortfalls in the Social Security system.  The existence of trust fund balances will not change the fact that these shortfalls will place tremendous pressures on rest of the budget and future taxpayer as well as the economy as a whole. 

In the absence of advance funding, whether through individual accounts or another means, Congress would be required to keep raising taxes or reducing benefits in the future as the annual deficit continues to grow.  Even if taxes were raised by 1.92% of payroll to eliminate the actuarial deficit over seventy five years, the system would begin to run annual cash deficits again in 2017, albeit with larger trust fund balances to cover those shortfalls on paper. 

The benefit reduction that would be required under current law would increase from 26% in 2041 to 32% by 2080.  As CBO Director Doug Holtz-Eakin noted in a forum hosted by Centrists.Org and the Alliance for Worker Retirement Security, the rate of return for future workers will continue to decline as the dependency ratio continues to increase under the current pay as you go system.  That is one reason that many have suggested moving from a pure pay as you go system to a partially funded system with advance funding through individual accounts. 

Every year the release of the Trustees report is met by criticism that the Trustees assumptions about economic growth are too pessimistic and the problems would be much smaller or disappear entirely if more optimistic economic assumptions were used.  Those putting forward that argument cite the fact that the economic growth assumed by the Trustees (declining to 1.8% a year by 2045 under the 2005 Trustees Report) is considerably lower than the historical average of 3.3% a year. 

What this argument fails to recognize is that the slowdown in economic growth is a function of a smaller labor force.  Economic growth has three components: total employment, productivity, and hours worked.  As the growth in total employment flattens out as a result of declining labor force growth, economic growth will decline accordingly.  When the lower rate of growth in the labor supply is taken into consideration, the Trustees estimates for economic growth are consistent with historical patterns.  This argument also ignores the fact that Social Security costs increase with economic growth because benefit levels grow as fast as the economy.

Social Security Administration Chief Actuary Steve Goss addressed this criticism of the Trustees Report at the forum hosted by Centrists.Org and the Alliance for Worker Retirement Security.

 

“A lower birth rate, fewer children born to the population as a whole, will mean that our population will grow more slowly in the future.  This is basically the answer to something that I am a little puzzled about why people are puzzled about it.  You have heard people wonder, “Why is it that the Social Security Trustees are projecting the gross domestic product, the output of the economy, to be growing at only about two percent in the future, when it has grown at about three percent or so in the past?”    One of the things that allows GDP to grow in the future is to have more workers, and if the rate of growth in the population of people of working age is going to slow down, then the rate of growth in the number of workers will likely slow down and that means that the rate of growth in the GDP itself will slow down also.  So, the growth rate in the population and the GDP will slow own as a result of lower birth rates.”

Conclusion.  The release of the Social Security Trustees Report for 2005 is a stark reminder that Social Security faces serious financial challenges that are rapidly approaching and cannot be assumed away by more optimistic assumptions.  The clear message of the report is that Congress and the President cannot afford to wait until a crisis is imminent to take action.

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Links:
2005 Social Security Trustees Annual Report

Centrists.Org The Fourth Entitlement:  Interest (December 1, 2003)

Centrists.Org Raising the Cap on Payroll Taxes Doesn't Solve the Social Security Problem
(November 17, 2003)

Centrists.Org No-BS Long-Term Budget Baseline Homepage

Centrists.Org Suggestions for Income Testing in Social Insurance Programs (October 27, 2003)

Centrists.Org Issue Summary:  Wealth Building (Basics)

Centrists.Org Issue Summary:  Social Security