Simcivic Update #4:

Is CBPP's Greenstein on the Right Track?

March 29, 2002

Highlights

Robert Greenstein and Richard Kogan of the prestigious Center on Budget and Policy Priorities recently issued an analysis that compares the size of Social Security's long-term shortfall to the long-term revenue losses from President Bush's tax cut.

A Manageable Shortfall   Greenstein and Kogan are relatively optimistic about the eventual size of the Social Security shortfall. The two authors contend that Social Security's 75-year shortfall equals -0.72% of GDP, which, they say, is less than half the revenue shortfall to be expected from President Bush's tax cuts.

As evidence for their case, Greenstein and Kogan cite a carefully-selected statistic from the Social Security Trustees' Report for 2002.

Simulator Also Shows Size of Shortfall.   As our Simulator shows, Social Security faces a cumulative shortfall of $127 Trillion from 2003 through 2075. With cumulative GDP of $7500 Trillion over the same time period, the true shortfall works out to be 1.69% of GDP, not 0.72%.

Social Security's solvency crisis would be easier to solve if Greenstein and Kogan's estimate of the future shortfall were on the money. But they're not, and it won't be.

Introduction

On March 26, 2002, Robert Greenstein and Richard Kogan of the Center on Budget and Policy Priorities issued an analysis that compares Social Security's long-run shortfall with the long-run budgetary losses to be expected from President Bush's tax cuts.

As one can see from their title, these two authors believe the revenue loss from the tax cut will be far greater than the revenue shortfall facing Social Security.

It is not our intention to comment on long-run impact of the tax cut. Nor do we intend to determine which is larger - the Social Security shortfall, or the tax cut revenue loss.

We do believe, however, that the Greenstein-Kogan assertion on Social Security's long-run shortfall deserves close scrutiny. Mr. Greenstein's Center on Budget and Policy Priorities has a strong reputation, which gives his argument extra weight. This is the Greenstein-Kogan assertion that we intend to examine:

"The Trustees' report projects that the Social Security shortfall over the next 75 years will equal 1.87 percent of covered payroll, or 0.72 percent of the Gross Domestic Product over this period…. The cost of the tax cut over 75 years equals at least 1.6 percent of GDP. In other words, it is more than twice as large as the entire Social Security shortfall."

These are important assertions. Is accurate to say that Social Security's shortfall over the next seventy-five years is likely to equal 0.72 percent of GDP?

Does the Trustees' Report Support This Argument?

The new Trustees' Report lends some support to this view. The following data – its image excerpted from the Report – is Greenstein and Kogan's key source.

All figures are calculated as a Percent of GDP. The first column represents Income as a Percent of GDP, the next represents Outgo, and the final column represents the difference. As is clear, the "75-year" line does show a shortfall of -.72, i.e, a shortfall equal to 0.72 Percent of GDP.

Greenstein and Kogan have gotten the citation right. But they haven't gotten the story right.

In calculating Income, the Social Security actuaries, who author most of the Trustees' Report, begin by including several factors: Payroll tax receipts, receipts from taxing retiree benefits, Trust Fund cash in hand as of January 1, 2002, and interest earnings expected from the Trust Fund in years to come.

In calculating Outgo, the actuaries include payments to all beneficiaries - retirees, survivors, and the disabled.

As the next step in this analysis, one might expect the actuaries to take an arithmetic average of Social Security's year-by-year shortfalls, and report that as Social Security's cumulative 75-year shortfall. That might be the expectation, but that's not what's going on here.

The analysis, instead, is based on a series of present value calculations. Year-by-year Income and Outgo totals, as well as the final Difference calculation, have been restated in present value terms, using discounted cash flow analysis.

As we'll see, other analytic approaches tell quite a different story.

A Different View

The table immediately preceding Greenstein and Kogan's "Summarized Rates" selection gives a more realistic picture. The key section is excerpted here. Again, all figures represent Percent of GDP, but in this case, the year-by-year calculations are given in current year terms, not converted into present value terms.

A Definitional Note: OASDI, as you no doubt know, stands for "Old Age, Survivors, and Disability Insurance." OASDI summarizes the overall combined status for Social Security's retirement insurance program, its survivors program, and its disability insurance program.

"Intermediate" - as you may know - refers to the actuaries' intermediate forecast - the forecast that almost everyone uses as the starting point in discussing Social Security reform.

By 2020, according to this table, Social Security is already in deficit. Not that benefits aren't being paid. They are, thanks to the asset in the Social Security Trust Fund.

Note the size of the deficit in 2025. Income equals 5.09% of GDP, Outgo equals 6.23% of GDP, and the shortfall in 2025 already equals 1.14% of GDP.

Note the last line in the table, showing the size of the deficit in 2080. Income equals 4.70% of GDP. Outgo equals 7.04% of GDP. Result? A shortfall in 2080 that equals 2.35% of GDP.

From this angle, one sees a Social Security shortfall that exceeds one percent of GDP even before 2025, a shortfall that reaches 2.35% of GDP by 2080. Where's the seventy-five year average of -0.72%, of which Greenstein and Kogan have written? Nowhere in sight.

The Simulator's View of the Shortfall

Our Social Security Solvency Simulator has its own way of illustrating the gap between anticipated Social Security revenues and anticipated obligations to retirees.

Built with figures from last year's Trustees Report, Chart 3A shows the gap between benefits and tax receipts rising swiftly after 2016, hitting 1% of GDP in the mid-2020's, and rising ultimately to more than 2% of GDP by 2075. The same story, told in graphic terms.

Social Security's interest earnings cover the gap temporarily. But, one must ask, when does the shortfall start to count? In 2038, when beneficiaries are at risk? Or as early as 2016, when the Federal Budget may be required to pay interest to Social Security?

To answer this question properly, it helps to view the situation not only from a Social Security perspective but also from a Federal Budget perspective. Turn to the Simulator's bar chart 3B (as shown in the following image). Bars above the 0% line represent cash that flows into the Federal Treasury, from Social Security. Bars below the 0% line represent cash that flows out of the Federal Treasury, and into Social Security.

Up through 2015, Social Security surpluses represent a source of cash for the Federal Treasury, which accumulates cash by selling Treasury Bonds to Social Security. Then the "Net Cash Flow" line crosses the 0% midpoint, and the story changes. The Federal Government starts paying interest to Social Security, interest on the Treasury Bonds that Social Security bought from the Treasury not long before.

By the mid 2020's, Federal interest payment to Social Security are already topping the 1% of GDP line. Slightly more than a deacde later, Federal payments to Social Security (interest and bond redemption combined) peak at almost 2% of GDP, just before Social Security completely runs out of assets.

No, the Social Security shortfall may not affect beneficiaries until the late 2030's. However, the Federal Budget and its supporting taxpayers get hit by the Social Security shortfall two decades earlier. While the Federal Budget angle on the issue is absent from the Greenstein-Kogan discussion, it is readily available on Simcivic's solvency simulator.


The Simulator's Cumulative Cash Calculations

Can the Simulator tell us directly how big the shortfall is? In part, yes. Open the Simulator, or hit "Reset," and then click the Results tab. You'll see the following display.

From 2003 through 2075, Social Security is capable of paying $361 Trillion in benefits, thanks to taxes collected and Trust Fund interest earned.

Total benefits due, however, during the same period equal $488 Trillion.

$488 Trillion due. $361 Trillion paid. A shortfall of $127 Trillion. That is Social Security's true shortfall. This is the view that gives the best understanding of Social Security's financial challenge.

Note the cumulative GDP figure of $7500 Trillion ($7.5 Quadrillion) over the same time period. (As Everett Dirksen would have said, "that's real money.") A shortfall of $127 Trillion represents 1.69% of cumulative GDP, 2003 through 2075. This isn't the only way to slice the data, but it is far more telling than the Greenstein-Kogan figure.

Why Such Discrepancies?

The discrepancies we've been examining are primarily caused by the distortions introduced whenever present value methods are used to size the magnitude of Social Security's long-run shortfall.

Present value calculations have a well-known weakness. They dramatically undervalue the distant future. If the distant future promises great value, they hide the value. If the distant future threatens serious loss, they minimize the long-run red ink.

Think of it this way. The Rocky Mountains are one of America's scenic wonders, and Denver enjoys a choice seat, right next to the Rockies' Front Range.

If one moves a little away from the mountains, into Denver's eastern suburb of Aurora, one can look west and see the Rockies stretching from Pikes Peak to Longs Peak, a spectacular hundred mile arc of rugged mountains and snow-capped peaks.

If one drives through Denver into Lakewood, its western suburb, nestled smack up against the foothills, this hundred-mile panorama almost completely disappears. All one sees are the close-in foothills, beautiful in their own right, but hardly the Rockies.

Relying on present value calculations to size Social Security's future shortfall is a bit like looking west from Lakewood, where only the close-in foothills are visible. Present value math magnifies the close-in foothills while hiding the distant peaks and valleys.

Conclusion

As a nation, we'll be badly misled if we accept Social Security shortfall estimates based on present value calculations.

We need better ways to size the challenge. Social Security's true shortfall hits 1% of GDP within the next two decades, reaches 2% of GDP by 2065, and climbs still higher in succeeding years.

Would that Greenstein and Kogan were right. Would that the long-run shortfall were only 0.72% of GDP. The Social Security solvency challenge would be much simpler.

Steve Johnson, President
Simcivic.org

Stay Tuned for Future Simcivic Updates

• MIT's Nobel Prize-winning economist Franco Modigliani wants Social Security's Trust Fund to invest in the stock market.

Is Professor Modigliani on the right track?

Is Robert Johnson's wealth-building strategy on the right track?

Is Dean Baker on the right track?

Is the Cato Institute on the right track?

Is Gary Burtless on the right track?

• The Social Security Administration uses a calculation called "actuarial balance" to measure its insolvency problem.

Is the SSA on the right track?

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