Social Security: Disaster Is Closer Than It Appears

Every car sold since I was born carries a warning on the passenger side view mirror: "Objects in the mirror are closer than they appear."  Car manufacturers provide this warning because the same mirror produces different views of the same traffic: one accurate and one dangerous.

The Social Security debate has its own set of mirrors, with an illusion actually designed to make the problem look smaller than it is.  The difference here, of course, is that car manufacturers see the danger of misreading traffic, whereas those in our government want the public to misread the size of the underfunding of Social Security.

The problem in Social Security is that the system has made more promises than it has money.  This problem is expressed as the "shortfall."  The figure represents the amount of promises left over after the trust fund has been exhausted.  It is total amount of promises in excess of what Social Security can pay.

The Trustees provide information on the "shortfall" in two different forms.  One is the 75-year shortfall, and the other is the infinite shortfall.  In 2012, the Trustees determined that Social Security has a shortfall of 20.5 trillion dollars over the infinite horizon, whereas the 75-year shortfall is roughly $8.6 trillion.  So to believe that the 75-year "shortfall" is meaningful, you have to believe that the vast majority of Social Security's problems lie 76 years or more away.  

No one does, of course.  Washington uses this view because it makes the problem appear smaller -- about 12 trillion dollars smaller.  So it is important for readers to understand how the illusion works.

The illusion works by stating that costs aren't costs.  Social Security is financed by making promises to current workers of future benefits.  The payroll tax is recognized as revenue today.  The cost of the promise isn't booked until the check is paid.  The 75-year figure captures all of the revenue but only a fraction of the actual cost because it ignores the financing cost -- future benefits. 

The calculation for the 75-year solvency number captures all of the projected revenue that falls within the 75-year window.  The calculation captures only a fraction of the cost because the majority of the cost for collecting the revenue falls outside of the 75-year window.  The "infinite" figure captures all revenue and the full cost to accept the revenue.  

  • For someone who is 50 years old, it captures the next 17 years of revenue and all of the projected costs for that person, because the formulas assume that that retiree will die within the 75-year window.
  • For someone who doesn't die within the 75-year window, the formula includes only the cost of benefits which should fall in the 75-year window. For the person born today, the formula will capture roughly 49 years of taxes and 8 years of projected benefits. While that retiree might collect longer than 8 years, the remaining cost is outside of the 75-year window.
  • The problem is more visible for the person who is born in 8 years. The formula will capture all 49 years of revenue for that worker but will not accrue any cost for the promises made in taking the money.

While I am not 75, the government has declared Social Security solvent for 75 years three different times in my life.  So it is important to understand the difference between fixed and solvent.  "Fixed" means that you have no problem.  The cost to fix the system is 20.5 trillion dollars.  Solvent means that you have made your problem a problem for someone else.

Every car sold since I was born carries a warning on the passenger side view mirror: "Objects in the mirror are closer than they appear."  Car manufacturers provide this warning because the same mirror produces different views of the same traffic: one accurate and one dangerous.

The Social Security debate has its own set of mirrors, with an illusion actually designed to make the problem look smaller than it is.  The difference here, of course, is that car manufacturers see the danger of misreading traffic, whereas those in our government want the public to misread the size of the underfunding of Social Security.

The problem in Social Security is that the system has made more promises than it has money.  This problem is expressed as the "shortfall."  The figure represents the amount of promises left over after the trust fund has been exhausted.  It is total amount of promises in excess of what Social Security can pay.

The Trustees provide information on the "shortfall" in two different forms.  One is the 75-year shortfall, and the other is the infinite shortfall.  In 2012, the Trustees determined that Social Security has a shortfall of 20.5 trillion dollars over the infinite horizon, whereas the 75-year shortfall is roughly $8.6 trillion.  So to believe that the 75-year "shortfall" is meaningful, you have to believe that the vast majority of Social Security's problems lie 76 years or more away.  

No one does, of course.  Washington uses this view because it makes the problem appear smaller -- about 12 trillion dollars smaller.  So it is important for readers to understand how the illusion works.

The illusion works by stating that costs aren't costs.  Social Security is financed by making promises to current workers of future benefits.  The payroll tax is recognized as revenue today.  The cost of the promise isn't booked until the check is paid.  The 75-year figure captures all of the revenue but only a fraction of the actual cost because it ignores the financing cost -- future benefits. 

The calculation for the 75-year solvency number captures all of the projected revenue that falls within the 75-year window.  The calculation captures only a fraction of the cost because the majority of the cost for collecting the revenue falls outside of the 75-year window.  The "infinite" figure captures all revenue and the full cost to accept the revenue.  

  • For someone who is 50 years old, it captures the next 17 years of revenue and all of the projected costs for that person, because the formulas assume that that retiree will die within the 75-year window.
  • For someone who doesn't die within the 75-year window, the formula includes only the cost of benefits which should fall in the 75-year window. For the person born today, the formula will capture roughly 49 years of taxes and 8 years of projected benefits. While that retiree might collect longer than 8 years, the remaining cost is outside of the 75-year window.
  • The problem is more visible for the person who is born in 8 years. The formula will capture all 49 years of revenue for that worker but will not accrue any cost for the promises made in taking the money.

While I am not 75, the government has declared Social Security solvent for 75 years three different times in my life.  So it is important to understand the difference between fixed and solvent.  "Fixed" means that you have no problem.  The cost to fix the system is 20.5 trillion dollars.  Solvent means that you have made your problem a problem for someone else.