Reach for the Low-Hanging Fruit

It's time to reform Social Security

The country is on an unsustainable fiscal path. According to the Congressional Budget Office's alternative scenario (the one that makes realistic assumptions about future policies), by 2050 the national debt will reach 344 percent of the economy with entitlements consuming two-thirds of non-interest spending. While Medicare and Medicaid require some intricate work to reform, there are a few easy changes that could be done to Social Security. Think of it as the low-hanging fruit of entitlement reform.

Besides, we don't have a choice. This October, the Congressional Budget Office (CBO) released its Long-Term Projections for Social Security. Like the two long-term projections before it, this projection finds social security in even worse shape than expected. The main conclusion is that by 2014 the Social Security Trust fund will be running perpetual cash flow deficits—three years ahead of what was predicted last year.

Using the CBO's three most recent long-term projections for Social Security, the above chart graphs the decline. It shows the year-end balance of the Social Security accounts as percentages of taxable payroll (an estimate of the earnings subject to payroll taxation each year). Concretely, when the balance of these accounts becomes negative, Social Security is paying out more in benefits than it collects in payroll taxes in a given year. For context, in 2010 taxable payroll is projected to be $5.4 trillion in real terms.

As we see, the 2009 and 2010 projections each estimated an earlier onset of cash-flow deficits than the preceding year's projections. In 2008, the CBO projected that in 2019 outlays would exceed revenues for the first time since 1983; in 2009 the CBO projected that this threshold would be crossed in 2017; in 2010 it projected that a permanent deficit would start in 2014.

While part of the acceleration in the onset of Social Security deficits is due to the impact of the recession on tax revenues, all projections show that these unsustainable deficits will continue into the future. For one thing, about 54 million people are receiving Social Security benefits today, nearly a sixth of the American population. But under current law this proportion will increase rapidly as baby-boomers retire and life expectancy increases.  

What about the assets in the Social Security Trust Fund? According to the Social Security Trustees Report, the extra payroll taxes collected from taxpayers since 1983 amount to $2.5 trillion and should last us until 2037.

While this may be true, the existence of the trust fund has no budgetary impact. First, as the 2011 federal budget  explains in Chapter 27 of the Analytical Perspectives, government trust funds are meaningfully different from private sector ones. In a private trust, the beneficiaries legally own the income from it. That is not the case with a government trust fund.

Second, by law, the Social Security trust fund has to purchase Treasury securities with its tax income. In other words, the trust fund contains a bunch of IOUs but no actual resources with which to pay Social Security benefits. Read about it on page 421 of the budget: "The existence of large trust fund balances, therefore, does not, by itself, increase the government's ability to pay benefits." These trust fund balances are assets of the program but also liabilities of the Treasury, netting to zero for the government as a whole.

The problem is that Treasury no longer has the money. It was spent as part of the general fund on education, wars, and loans to people who can't get loans in the private sector. To pay back Social Security, the federal government will have to either raise taxes or borrow even more from domestic and foreign investors.

The bottom line is that by 2014 Social Security will be broke. For this reason, Social Security reform is needed now—the people who will depend on Social Security need time to adjust to a systematically reformed system; they should not have to scramble in response to a crisis caused by political procrastination.

Thankfully, some fair and easy solutions are available. Congress should cut benefits today for people who are 55 and younger. Those individuals still have plenty of time to adjust their expectations about future benefits and plan for retirement.

Second, we should gradually raise the age of eligibility to at least 70 and progressively increase it to track with life expectancy. Life expectancy today is 78.8, but even with recent changes, the retirement age is far below that, averaging 66 for those born after 1943 and 67 for those born in 1960 and later. Third, we should allow these programs to be means tested so that only those who really need the help get it. These changes are low-hanging fruit because they are easy to implement and allow lawmakers to pass reforms that won't kick in until years down the road.

According to a recent CBO cost estimate measuring the potential budgetary impact of various Social Security reforms, the changes to the eligibility age suggested above would gradually decrease Social Security spending by 6 percent. An estimate of the budgetary effect of means testing the program found that it would decrease Social Security spending by an additional 6 percent. Taken together, these reforms would delay the trust fund exhaustion by 4 years.  

Since the assets in the Trust Fund are synonymous with money that needs to be borrowed or taxes that need to be raised, a means tested program would reduce the amount of money the government would need to acquire. To put that another way, the reduction in spending will reduce our future taxes and/or debt.

Still not convinced? Here is a final argument: Not only is there no account with taxpayers' names on it that will pay benefits past 2014, Congress can—at any time—reduce or cancel benefits even for people who paid into the system their entire lives. The Supreme Court made this perfectly clear in its 1960 decision in Flemming v. Nestor, where it described Social Security as a "noncontractual…social welfare program." By law, when the Social Security Administration has used up all of its federal IOUs, benefits will be cut to the level of payroll taxes the government collects for Social Security. At that point, benefits will shrink to three-fourths of their current level, and there is nothing retirees can do about it.

So what do you prefer: Should Congress extend retirement age and means test the program now to guarantee future payments to the people who need it most, or should all benefits be cut in a time of crisis? We know what we would choose.

Veronique de Rugy is a senior research fellow at the Mercatus Center at George Mason University and a Reason columnist. Jakina Debnam is a research associate at the Mercatus Center.