Shift Social Security’s start-up costs

February 5, 2014, 12:48 PM ET

Given that I have been thinking about unfunded “liabilities” in both Social Security and state and local pension plans, I was delighted that the Social Security actuaries recently released a new note on the program’s unfunded “obligations.”

There’s a $23.7 trillion gap to fill.

The measures used by the actuaries represent the difference between financial resources (scheduled taxes and the existing trust fund balances) and benefits scheduled under current law.  This difference is referred to as an “obligation” rather than as a “liability” because the program has no contractual or legal obligation to pay benefits in excess of scheduled taxes.  The difference between resources and scheduled benefits can be calculated on a “closed-group” or an “open-group” basis.

Because Social Security is financed essentially on a pay-as-you-go basis, the appropriate concept is the open group, which includes all current and future participants.  In contrast, state and local plans and private-sector defined-benefit plans, which are designed to be pre-funded, require the use of a closed-group approach – that is, including only current participants – to assess their financial status.  It is possible to calculate Social Security obligations based on a closed group, but that number should be viewed as a “transition cost.”  That is, the closed-group measure can be used if Social Security were converting to either: (1) an advance-funded system, or (2) another form, where the goal was to keep the financing of the old and new program separate.

The open-group obligations are the numbers laid out in the Trustees’ Report.  The difference between resources and scheduled benefits relative to payroll in 2013 equaled 2.6% over the next 75 years and 4% over an infinite horizon.  As a percent of gross domestic product (GDP), the unfunded obligations are 0.9% and 1.4%, respectively.

The closed-group estimates, however, are the numbers relevant to shifting the cost of legacy debt from Social Security to the Treasury.  The estimate is that, in 2013, the closed-group unfunded obligation amounted to $23.7 trillion.  Shifting $23.7 trillion from Treasury’s general fund to Social Security’s trust fund (something that would presumably happen over the course of many years) would provide the program with reserves comparable to that under a funded system.  With assets in the trust fund, future workers could then earn interest on their contributions, dramatically lowering the required contribution rate.  In practical terms, today’s payroll tax would not have to be raised much, if at all, above its current level for the program to be solvent.

Of course, transferring the legacy debt to the general fund of the Treasury does not eliminate the burden of financing Social Security.  The Treasury would then have to pay off this newly acquired debt.  The Treasury would need to increase revenue by raising the personal-income tax or the corporate tax, or both.  If the decision were to raise the personal-income tax to pay off the debt over 75 years, the ratio of personal income-taxes to taxable income would have to rise by roughly 4.6 percentage points.  In 2014, that would mean that personal income taxes would have to rise from about 19% of taxable income to about 23.6%. If that increase looks too big, Treasury could reduce the required rate hike by amortizing its new debt over a longer time period.

The mechanics would have to be worked out carefully, but freeing today’s and tomorrow’s workers from the legacy costs of Social Security would reduce labor costs and produce a more equitable tax structure.

Also by Alicia H. Munnell:

Shift retirement plans away from employers

Inherited pension debts hurt workers, firms

It’s too easy to take money from IRAs




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