Social Security and the federal deficit (part 2)

This is the second part of a two-part blog prompted by an alarmist Washington Post article on Social Security, as well as the Post ombudsman’s muddleheaded response. Last Wednesday, we looked at links between the Social Security surplus (and future deficit) and the overall federal deficit and debt. Today, we’ll look at the impact of the Great Recession on Social Security and whether the fact that Social Security is now running a primary deficit will add to the nation’s budget problems, as Post reporter Lori Montgomery claims.

How have the Great Recession and weak recovery affected Social Security to date?

Compared to intermediate projections in the last prerecession (2007) trustees report, the number of workers covered by Social Security last year was down seven percent and the number of beneficiaries was up one percent in 2010, according to the latest report. The cumulative impact was that the Social Security trust fund held $2.6 trillion at the end of 2010 rather than the $2.9 trillion projected in the 2007 report.

How will the recession and weak recovery affect the future of the trust fund?

The Social Security actuaries project slower economic growth over the next decade, though long-run assumptions remain unchanged. As a result of lower projected employment growth, wage growth and other factors, the trust fund is expected to peak at around $3.7 trillion rather than the $6.0 trillion projected in 2007 and to be exhausted five years sooner—in 2036 rather than 2041.

How will the recession affect Social Security’s long-run outlook?

Because benefits are mostly paid out of current tax revenues as opposed to savings, Social Security’s long-run outlook isn’t as affected as one might think if focusing only on the trust fund.  The 2011 report projected a 75-year shortfall equal to 2.22 percent of taxable payroll, an increase from 1.95 percent in the 2007 report (some of this is due to the changing 75-year projection period and other factors besides the weak economy). This means that a relatively modest increase in the Social Security tax on employers and employees from 6.2 percent to around 7.3 percent of earnings would put the program in long-term balance, though more progressive revenue options, like lifting the cap on taxable earnings, would be preferable.

Why do some people say Social Security is already running a deficit?

Social Security had $781 billion in revenues in 2010. Of this, $637 billion was revenue from payroll taxes and $118 billion was interest on trust fund assets. Meanwhile, Social Security had $713 billion in expenditures, the bulk of which ($702 billion) was paid out in Social Security benefits. Since current tax revenues no longer cover current expenditures, Social Security is running what’s known as a primary deficit (sometimes referred to as a “cash-flow” deficit) even though it is still building up savings in the trust fund.

What’s the significance of this cash-flow deficit, if any?

By definition, Social Security will run a deficit when it taps into its savings to help pay for the Baby Boomer retirement. Running a primary deficit is a normal stage in the process of moving from saving to dissaving. The fact that this is happening sooner than expected is actually beneficial in the short run—since Social Security serves as an automatic stabilizer for the economy. Older workers tapping retirement benefits when they lose their jobs helps them and the sputtering economy—and does so at no cost to Social Security since benefits are adjusted for early retirement. Lower-than-anticipated payroll tax revenues do, however, add modestly to the system’s long-run challenges.

Does this “add to the nation’s budget problems?”

As explained last week, Social Security cannot contribute to the federal debt over time because it is prohibited from borrowing. This is analogous to a family with indebted parents and a thrifty child who is saving money from a newspaper route. When the child dips into her piggy bank to buy a bike, she’s contributing to her family’s “deficit” simply by tapping into her savings. She’s also adding to her family’s net indebtedness because there are now fewer savings in her piggy bank to offset her parents’ credit card debt. However, it would be absurd to hold the child responsible for her parents’ mounting debt.