[Vision2020] Social Security Time Lime

[David M. Budge]

Donald Luskin

Natinal Review Online
January 11, 2005, 8:42 a.m.
The C-Word: Say It
The Social Security crisis begins in just 5 years.

The leftist opponents of Social Security reform want you to believe 
there's no "crisis," and that whatever problems the system may have 
won't materialize for more than 35 years. Funny how such equanimity and 
patience seem to elude them when the subject is global warming.

It's even funnier when you realize the objective fact is this: The 
Social Security crisis actually starts a lot sooner than advocates of 
reform are saying. The Social Security crisis begins to materialize in 
just 5 years.

Here are the facts. You decide whether they amount to a "crisis."

Right now the Social Security program collects more in taxes -- both 
FICA taxes from current workers and income taxes on benefits from 
current retirees -- than it pays out in benefits to retirees. That 
surplus goes into Social Security trust funds, where it is used to buy 
Treasury bonds that are held as an investment toward the payment of 
future benefits. The purchase by the trust funds of those Treasury bonds 
is no different than if you or I bought them. The Treasury issues the 
bonds in exchange for cash, which is used to finance the current 
expenditures of the federal government.

According to the latest annual report 
<http://www.ssa.gov/OACT/TR/TR04/IV_SRest.html#wp207413> of the Trustees 
of the Social Security Trust Funds, the surplus in 2004 was $64.4 
billion dollars. It will be higher this year -- at $87.7 billion. The 
surplus will keep getting bigger and bigger through 2008, when it will 
reach $108 billion. Each year, that's more and more money that the 
federal government won't have to raise from the world capital markets. 
It's a captive audience of bond buyers -- and a growing one.

But in 2009, just 5 years from now, the surplus will start to shrink. In 
2009 it will fall to $103.7 billion, and in that year the federal 
government will have to go to the capital markets to raise $4.3 billion 
that it didn't have to raise the year before. That's not a lot of money 
in the grand governmental scheme of things. But it's an important 
turning point for Social Security -- it's the year the crisis begins.

Every year after that the crisis will deepen. Each year the government 
will get several billion dollars less from the Social Security surplus 
than it did the year before, and it will have to make up that difference 
by tapping the capital markets, or by raising taxes or trimming spending.

Most observers point to 2018 as the earliest year for the Social 
Security crisis to begin. But that's only the year the crisis will pass 
an especially attention-grabbing milestone. That's the year, according 
to the trustees 
<http://www.ssa.gov/OACT/TR/TR04/II_project.html#wp105724>, that the 
Social Security surplus will disappear entirely and become a deficit. In 
other words, for the first time tax revenues will be less than the 
benefits paid out that year. From the standpoint of public finance, 
though, it will just be another painful year in which the federal 
government had to raise more money from capital markets -- or raise 
taxes more or trim more spending -- than it did the year before. By 
2018, the Treasury will have already received $359 billion less cash 
each year, cumulatively, than it received in the peak year of 2008.

Starting in 2018, as soon as Social Security tax revenues are 
insufficient to cover benefit payments, the gap will be made up as the 
trust funds redeem the Treasury bills they have been hoarding. Not only 
will the Social Security system no longer give cash to the federal 
government in exchange for Treasury bonds. Starting in 2018 the 
situation will be just the opposite: The Social Security system will 
give back the Treasury bonds held in the trust funds -- and the interest 
on those bonds, which is held in the form of more bonds -- and demand 
cash for them.

According to the Social Security actuary 
<http://www.ssa.gov/OACT/TR/TR04/lr6F9-2.html>, in 2018 the trust funds 
will demand $23.4 billion in cash from the federal government. The trust 
funds will redeem the last of their bonds in 2041 -- demanding from the 
government $1.003 trillion that year. From 2018 through 2041, the trust 
funds will redeem bonds worth, cumulatively, $11.9 trillion. Once again, 
just to be perfectly clear, let me emphasize that the federal government 
will have to come up with this $11.9 trillion somehow -- either by 
tapping the capital markets, raising taxes, or trimming spending.

This should illuminate the debate on whether the trust funds are "real" 
or not. They are perfectly "real" in the sense that the Treasury bonds 
they hold are valid legal claims on the government. But they are not 
"real" in the sense that they, as a June, 2004, Congressional Budget 
Office report <http://www.cbo.gov/showdoc.cfm?index=5530&sequence=1> put 
it, "contain no financial resources" in and of themselves. For their 
value to be realized, the Treasury bills they hold must be redeemed for 
cash by the government -- and that cash has to come from somewhere.

 From the standpoint of public finance, the crisis ends in 2042 when the 
trust funds' hoard of bonds is completely exhausted. Under current law, 
Social Security benefits will then be trimmed such that they will be 
payable out of current tax revenues. According to the trustees 
<http://www.ssa.gov/OACT/TR/TR04/II_project.html#wp105057>, benefits 
will have to be cut 27 percent from their present scheduled levels, with 
the situation only getting worse as time goes by. So, yes, the drain on 
the Treasury will end in 2042 -- but at that point the crisis will 
simply be inherited by retirees in the form of lower benefits.

Those are all simple facts. Yes, they are estimates. They might be off a 
little bit one way or the other. But the general pattern is clear. 
Social Security will start to become a drag on the budget of the federal 
government in 2009. The state of affairs will get progressively worse 
through 2042, by which time Social Security will have consumed $11.9 
trillion from the federal budget. And after that, Social Security 
benefits will be automatically cut. If that isn't a "crisis," I don't 
know what is.

The opponents of reform claim that the Social Security crisis is, in 
fact, a crisis of general public finance -- not one of the Social 
Security system itself. They see Social Security as an entity separate 
from the federal government, and maintain that its own dedicated stream 
of tax revenues and trust-fund assets will keep it going for more than a 
third of a century.

That's a fair point of view, as far as it goes. At the same time, it is 
dangerously myopic to treat Social Security in isolation from the 
overall finances of government. That would be like finding nothing 
troubling about a factory that dumps pollutants into a river. That may 
be no problem for the factory itself, but it can be a major problem for 
everyone downriver. And when it comes to Social Security, we're all 
downriver.

But the case of Social Security is even worse than that. By 2042 the 
pollution will back up into the factory itself. Unless the opponents of 
reform don't think it's a problem to automatically cut benefits by 27 
percent all at once in 2042, then Social Security itself has a "crisis" 
-- maybe not right now, but surely by then.

Don't be too hard on the advocates of reform when they throw the C-word 
around. It's fully justified. In fact, I'd even dare to use that most 
dangerous of all political words to describe the crisis. Yes, the 
I-word: imminent.

-- Donald Luskin is chief investment officer of Trend Macrolytics LLC 
<http://www.trendmacro.com/default2.asp>, an independent economics and 
investment-research firm. He welcomes your comments at 
don at trendmacro.com <mailto:%20don at trendmacro.com>.

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