Common Sense on Social Security

A Centrist Perspective on the Social Security Reform Dilemma

Social Security Reform: Breaking the Stalemate

Section 5. The True Meaning of Long-Term Solvency

Given that solvency is THE issue, one might reasonably assume that the concept of solvency had long ago been crisply defined and widely accepted. That would be a mistake. The standard definition of solvency for Social Security has been put together rather awkwardly.

Social Security's traditional definition seems simple enough. Compare money now on hand plus money coming in during the next 75 years against benefit payments owed over the next 76 years. If the funding is exactly sufficient to pay the obligations, the program is said to be "in actuarial balance." To the ordinary citizen, the term "actuarial balance" seems like a technical synonym for solvency.

The math is moderately sophisticated but straightforward. The present values of Social Security's future income and cost streams are each divided by the present value of taxable payroll over the same time period. According to current estimates, expressed in present value terms, cash on hand plus future income is worth 13.49% of future taxable payroll, while future benefits are worth 15.56% of future taxable payroll. The difference between costs of 15.56% and revenues of 13.49% is 2.07%. As a result, the program is said to be 2.07% out of actuarial balance.

If the payroll tax were to be raised by 2.07 percentage points, voil, Social Security's actuaries would declare the program to be "in actuarial balance."

Certainly sounds like solvency, doesn't it? Now take a closer look. Suppose this were actually done. Imagine the payroll tax rising by 2.07%. On the black line-red line graph, the black line of revenue rises by two percentage points. The point at which the cost line intersects the revenue line gets pushed out half a dozen years. With larger annual surpluses in the early years, the Trust Fund fattens up nicely. By 2025, its value peaks at 40% of GDP. After that, rising payments to Boomer retirees begin nibbling away at principle. The Trust Fund shrinks to 28% of GDP by 2050. By 2070, the Trust Fund withers to 8% of GDP. By 2076, the Fund is insolvent. Some solution! Actuarial balance turns out not to be a workable measure of Social Security's lasting solvency after all. It's based on an asset depletion approach to forecasting future solvency. Treating "actuarial balance" as a synonym for lasting solvency is a serious blunder.

Error or not, the pronouncement of the amount by which the Social Security program is "out of actuarial balance" is an established ritual, the official quantification of Social Security's insolvency risk. In 1998, Social Security Trustees declared the program to be out of balance by 2.19% of taxable payroll. In the spring of 1999, they solemnly updated their estimate to 2.07%. In the spring, of 2000, the same misleading ritual will no doubt be repeated.

The Trustees' annual rite is not without consequences. Congressman Robert Matsui, the ranking Democrat on the Social Security subcommittee of the House Ways and Means Committee, has echoed the Trustees by characterizing the Social Security financing gap as "a two percent problem." With the financing gap ultimately reaching 6.6% of taxable payroll, Matsui's remark badly understates the gravity of the situation. Worse yet, the 1983 Greenspan Commission went astray on precisely this point. The recommendations of the Greenspan Commission were tailored to produce actuarial balance, not genuine solvency, with the regrettable result that the nation finds itself wrestling once again with Social Security's long-term financing crisis.

The goal of solvency requires a more rigorous definition, one related to the stability of Social Security's capital resources over time, one based on an asset stability approach to solvency. If Social Security's pool of assets is equal to 60% of GDP in 2050, by 2075 its pool of assets should still be worth at least 60% of GDP. If Social Security's Trust Fund ratio, i.e., the size of its Trust Fund versus the size of its annual payment to beneficiaries, is equal to 8.83 in 2070, it should still be equal to 8.83 in 2075. Lasting solvency, in other words, is best understood as an asset stability or capital stability concept.

Under what conditions might Congress decide to declare victory on Social Security? Will Congress content itself with the goal of "restoring actuarial balance"? If this should happen, it would be a real danger signal. What is needed, instead, is a capital stability solution that finally puts Social Security on the path to lasting solvency.

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Revision Date April 13, 2006