Veronique de Rugy: The Facts About Social Security

Editor's Note: Reason columnist and Mercatus Center economist Veronique de Rugy appears weekly on Bloomberg TV to separate economic fact from economic myth.

Myth 1: There is no crisis. Social Security will never be insolvent.

Fact 1: Under the best-case scenario, the trustees report finds that the probability of Social Security never becoming insolvent is less than 2.5 percent.

The only scenario under which the Social Security trust fund will never go insolvent is based on projections which the Treasury Department itself considers to be extremely unlikely.

The above chart plots the trustees' projections of the future balance of the Social Security trust fund under three scenarios (expressed as a percentage of the annual cost of Social Security).

The purple line plots the trust fund balance under high-cost assumptions, the red line plots the trust fund balance under intermediate assumptions, and the blue line plots the trust fund balance under low-cost assumptions. Which of these projections is most likely to occur?

To determine the likely balance of the trust fund in the future, the Social Security trustees performed stochastic modeling, estimating the likelihood of various exhaustion dates under different assumptions. This modeling concluded that there is less than a 2.5 percent chance that the trust fund will continue to exist beyond 2048. Instead, the middle of the road estimate is that the trust fund is exhausted by 2036.

Myth 2: Social Security won't contribute to the federal deficit for decades.

Fact 2: Starting this year the program will run a cash flow deficit which will add to the federal deficit.

In theory, Social Security benefits are self-financing with a 12.4 percent payroll tax, but that doesn't mean the money collected will pay for benefits. This is because when Congress changed the law in 1983 so that in any given year, current taxpayers pay more in taxes than the program needs to pay out benefits, Congress also required that the program invest the difference, or surplus, into a trust fund, which can only invest money in special-issue Treasury bonds.

So what has the Treasury done with the money? Well, the federal government has spent it on its daily consumption: education, loan guarantees, wars, etc. In other words, the government has already spent the money it received in exchange for the IOUs. The most recent projections say that, beginning in 2014, the program will begin permanently paying out more in benefits than it collects in taxes. At that point, the program will start redeeming the IOUs in the trust fund and use them to pay benefits to current seniors until they run out. But remember, the money is not there anymore. So then what? In order to repay the program so it can continue to pay out benefits at the promised levels, the federal government will have to borrow more money, increase taxes to get more revenue, or print more dollars.

The only way Social Security payments to seniors won't increase future deficits is if the federal government prints more money or taxes the American people a second time to pay back the money it owes to the trust fund. My guess is that the government will borrow more money.

Myth 3: The Patient Protection and Affordable Care Act fixed the funding problems related to Medicare.

Fact 3: Under the best economic assumptions, less than half of all future Medicare spending will come from dedicated sources.

Medicare is funded by two trust funds, HI (Hospital Insurance) and SMI (Supplementary Medical Insurance).

As we can see on this chart, even under the best assumptions about the success of the Patient Protection and Affordable Care Act, over 50 percent of all Medicare spending will come from dedicated sources (premiums, tax on benefits, and payroll). By law, SMI spending comes from the general fund. Considering the growth in revenue needed for it, this means that other parts of the budget will have to be reduced or we would have to find other sources of revenue

Also, the HI program is already spending more than it collects while drawing on the assets in its trust fund. Contrary to last year's projections, the trustees report finds that by 2024 (not 2029) the HI trust fund will be exhausted (see the purple above). At this time dedicated HI funds will be sufficient to cover 90 percent of HI costs, meaning that either taxpayers will be forced to make up the difference or the program will be underfunded by 10 percent.

The trustees-including Secretary of Health and Human Services Kathleen Sebelius and the secretaries of the Treasury and Labor Departments-say "nearly all" of the improvement in the outlook of the HI trust fund is due to health-care overhaul legislation, which cut some costs, and will raise new revenue via an increased payroll tax and a new tax on investment income.

While Medicare costs over the next 75 years are projected to be 25 percent lower due to the health care law, these cost savings rest primarily on drastic reductions in the reimbursement rates for Medicare services-reductions in reimbursements that are extremely unlikely to happen in a world where politicians are subject to powerful pressures from their constituencies.

Therefore, as the trustees note, "actual future costs for Medicare are likely to exceed those shown by the current-law projections in this report."

Contributing Editor Veronique de Rugy is a senior research fellow at the Mercatus Center at George Mason University.