Social Security's funding gap

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Throughout the 2004 political campaign, President Bush warned that Social Security's long-term financial health was deteriorating, while Democratic presidential nominee John Kerry and his party downplayed the evolving financial crisis and demagogued the issue. At the time, Social Security's unfunded obligation over the next 75 years totaled $3.7 trillion in net present value (measured in 2003 dollars). That projection was based on the intermediate assumptions in the 2004 trustees' report. Over the infinite horizon, the net present value of Social Security's unfunded obligation totaled $10.4 trillion (measured in 2003 dollars).

Last week, the trustees issued their 2005 report, which detailed how Social Security's finances changed during the preceding election year. Even though inflation increased by only 2.7 percent in 2004, the program's 75-year unfunded obligation increased by more than 8 percent, rising to a net present value of $4 trillion (measured in 2004 dollars). Over the infinite horizon, in 2004 Social Security's unfunded obligation increased by $700 billion, or nearly 7 percent, rising to $11.1 trillion (measured in 2004 dollars).

In other words, Social Security's long-term finances deteriorated during the election year, contrary to the Democrats' pre-election and post-election assertions. Moreover, while Democrats downplay the consequences of the size of the 75-year shortage, they completely ignore what happens beyond that period. The fact that the $11.1 trillion unfunded obligation over the infinite horizon substantially exceeds the $4 trillion unfunded-obligation estimate over the next 75 years (2005-2079) "reflects a significant financing gap in [Social Security] after 2079," the trustees asserted in their report.

The obviously abysmal condition of Social Security's finances is clearly conveyed by the net present value of the program's unfunded obligations of $4 trillion over 75 years and $11.1 trillion in perpetuity. Technically, these net-present-value estimates represent how much additional funds the Social Security Trust Fund would need in its account today, earning interest, in order to meet the promised benefits over the next 75 years or into perpetuity. At the end of 2004, the trust-fund asset balance was nearly $1.7 trillion. These assets consisted solely of special-issue Treasury securities. To be sure, these IOUs are backed by the full faith and credit of the U.S. government. Nevertheless, in order to obtain the funds to redeem these IOUs, the federal government will have only a few options: raising taxes; increasing borrowing domestically and/or internationally; reducing spending on other government programs; or pursuing a combination of these options. Thus, because there are no real marketable assets in the trust fund, such as stocks or corporate bonds, which could be sold on the open market for the cash needed to fund promised Social Security benefits, today's trust-fund assets (i.e., $1.7 trillion) effectively represent unfunded obligations in their own right. That means that the actual net present value of Social Security's unfunded obligation currently totals $5.7 trillion ($4 trillion plus $1.7 trillion) over 75 years and $12.8 trillion ($11.1 trillion plus $1.7 trillion) in perpetuity.

It gets worse. The 2004 trustees' report projected that Social Security would move from a cash-flow surplus (i.e., payroll-tax revenue exceeds benefit payments) to a cash-flow deficit (benefits exceed payroll-tax revenue) in 2018. Last week's trustees' report said this crisis situation would erupt in 2017, a year earlier. It is a crisis because in order to pay the promised Social Security benefits, the federal government will confront the same options outlined above: Either taxes will have to be raised; or the budget deficit will be increased as more money will have to be borrowed on the open markets; or government spending -- on Social Security benefits or on other programs -- will have to be cut.

Its cash-flow crisis quickly worsens after erupting in 2017. Expressed in constant 2004 dollars, Social Security's annual cash-flow shortages will exceed $100 billion by 2022, $200 billion by 2027 and $300 billion by 2034. Over a three-year period (2038-2040), the trustees project that Social Security's cash-flow deficit will exceed $1 trillion (measured in today's purchasing power).

It still gets worse. In 2041, the Social Security Trust Fund goes bust. After that, annual payroll-tax revenue will be sufficient to pay less than 75 percent of promised benefits. Over time, that situation gets worse as the percentage of promised benefits payable by payroll taxes declines, falling to 68 percent in 2079.

If Democrats would remove their heads from the sand, Republicans in Congress and the White House would welcome them at Social Security's problem-solving table.