To Fix Social Security, First Ask Why It Is Deep in the Red   (January 18, 2011)

Social Security is at risk; to truly repair it, we must understand why the system is imploding.

The American public have not been told the truth about their retirement system, Social Security: it is already deep in the red. The Social Security Adminstration Trustees continue to issue reassurances of decades of solvency that are based on projections which no longer bear any connection to reality.

As noted in The Fraud at the Heart of Social Security (January 17, 2011), shortfalls which were supposed to occur in 2018 already happened in 2010.

For instance, the SSA projects the "first year that outgo exceeds income excluding interest in OASI" (the primary SSA fund, Old Age and Survivors) is 2018. Yet here are the actual numbers from fiscal year 2010:

2010 outlays $580 billion
2010 receipts $540 billion

For the SSA as a whole, the difference between outlays and receipts in 2010 was a $76 billion shortfall ($707 billion - $ 631 billion).

The SSA Trustees' projections do not reflect economic realities. They'd estimated $41 billion deficit for fiscal year 2010 (excluding interest income) in August 2010 and the actual number was $76 billion--almost double their guesstimate. Their estimate of total revenues was too rich by $50 billion as well.

SSA's estimate for 2011 income is $855 billion--fully $114 billion more than the system's 2010 income. The reality is that revenues are declining, not rising. According to the SSA, the system's income for 2009 was $807 billion ($698.2 billion in the OASI and $109.3 billion in the DI). Total income in 2010 was $741 billion: a massive decline of $66 billion from 2009 to 2010.

That is right in line with 2011 outlays of $742 billion. The slightest dip in revenues in 2011 or the slightest increase in outlays would mean that outlays would exceed total income in 2011, not 2025 as estimated by the SSA Trustees.

To fully understand Social Security, we need to strip it out of the Federal Budget. Once upon a time, Social Security's accounts were separated from the rest of the Federal Budget. Since it is a "pay as you go" retirement system with a surplus designed to fund future shortfalls, that made sense.

Here is the breakdown of Federal receipts and expenses, with SSA separate:

Federal Outlays, 2010

total: $3.456 trillion

Social Security: $707 billion (20% of total)

All other Federal programs: $2.749 trillion

Federal Receipts, 2010

total: $2.162 trillion

Social Security: $631 billion (29% of total)

All other Federal programs: $1.531 trillion

So the 2010 deficit including Social Security is $1.29 trillion, or 37.4%.

If we strip out Social Security, then we see that the Federal government is actually borrowing a horrendous 44.3% of its outlays.

Federal budget with Social Security stripped out:

Total outlays: $2.749 trillion
total receipts: $1.531 trillion
2010 deficit: $1.218 trillion

Many analysts have noted that incorporating Social Security in a unified budget allowed the Federal government to spend the SSA surpluses over the past 27 years, after SSA was "saved" in 1983 via higher FICA payroll taxes.

In exchange for this $2.6 trillion in cash, SSA was given non-marketable securities, IOUs which as I explain yesterday in The Fraud at the Heart of Social Security are merely markers for actual Treasury bonds which must be sold, and interest must be paid on.

The Treasury paid Social Security $110 billion in interest in 2010 on its IOUs--one reason why it's so confusing to understand the national debt, which includes the IOUs pledged to SSA, and the "external debt" "owned by the public," which accrued $200 billion in interest costs to the Treasury in 2010.

To really understand the system, we must ask: where did the Treasury get the $110 billion to pay this interest to Social Security? Short answer: it borrowed it on the global bond market. You see where this dynamic leads: the SSA Trustees never address where the Treasury obtains the $110 billion in annual interest, or where the Treasury will get the money to redeem the IOUs in the SSA "Trust Fund."

The Trustees' report assumes that the Treasury can obtain these gargantuan sums without any impact on Social Security, as if SSA is some island that is unconnected to the rest of the Federal government.

But if the Treasury runs into a spot of bother selling trillions of dollars in freshly issued bonds, then that will most certainly impact Social Security, which is as dependent on the sale of those new bonds as any other government program.

In other words, there is no "trust Fund" or "lockbox": Social Security is entirely dependent on the Treasury's sale of new bonds for its own solvency. If interest rates spike and/or global buyers become wary of Treasuries, costs for borrowing will skyrocket, crowding out all other Federal spending.

Being tied into the unified budget, Social Security will be as impacted as any other program.

The first step to restoring the solvency of Social Security is to jettison the illusory "Trust Fund" and remove the SSA from the unified Federal budget. The surpluses accumulated over the past 27 years have already been spent, and the Treasury will have to fund any shortfalls between Social Security outlays and income with 1) tax increases or 2) additional borrowing.

If there is to be a Grand Triage in the Federal Budget--and there will be--I would place SSA above everything. Defense will take its lumps, but no one is threatening to do more than cut it back to its pre-2001 budget.

To protect the basic income of retirees, survivors and the disabled, we have to put SSA ahead of everything else, including Medicare. And we have to do so in a way which doesn't end up creating a debt monster which eats up a third of all tax revenues to pay interest on the ballooning debt.

More on that tomorrow.

There are several structural/demographic trends which are behind the rising gap between Social Security receipts and outlays.

1. We have to face up to The End of (Paying) Work (January 21, 2009): the decline in conventional jobs is not cyclical, it is structural, and the decline is far from playing out. SSA tax receipts will not recover to 2009 levels, they will continue to decline.

2. Demographics are against a retirement system designed in the 1930s. People live longer and retire earlier now. No system that leans on two workers to pay for one retiree is sustainable. These trends have been described in depth in numerous books, for example:

Fewer: How the New Demography of Depopulation Will Shape Our Future

The Coming Generational Storm: What You Need to Know about America's Economic Future

3. Baby Boomers are retiring at 62 rather than wait until 66 years of age to retire. Many have lost jobs and assets, and waiting to 66 is not an option.

4. The trend to contract/free-lance labor as a substitute for conventional fulltime employment means more income will fall outside the Social Security payroll tax system. The FICA (SSA and Medicare) taxes for self-employed workers is a heavy 15.3%, and so there is a big incentive to write off as many expenses as possible for the 17 million contract/free-lance workers.

Indeed, legitimate business deductions can reduce the gross income of a free-lancer to near-zero in net income, and the self-employed only pay the 15.3% on net income.

Add these four trends up and you get a system with lower revenues and skyrocketing outlays. Aligning income to expenses will require monumental adjustments.

It's not "good" or "bad," it's simply adaptation to changing realities.

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