Executive Summary
Once again, the Social Security and Medicare Boards of Trustees have released their annual report on the fiscal health of the Social Security and Medicare programs, and once again the Trustees report shows that the fiscal health of the two programs has further deteriorated, a combination of primarily slower-than-projected growth, upwards adjustments to long-term costs (Medicare), and increases in estimated longevity (Social Security). With the latest projections, the Social Security trust fund is projected to be exhausted in 2036 (last year it was anticipated to last until 2037), and the Medicare trust fund will be depleted in 2024 (compared to last year's estimate of 2029). But while it's true that the systems are both headed for serious trouble as the trust funds potentially go "bankrupt" - the reality is that the actual depletion of the trust funds may still have a far less severe financial planning impact than many assume, for one simple reason: the overwhelming majority of Social Security and Medicare benefits will actually still be funded, via our ongoing Social Security and Medicare tax system!
The inspiration for today's blog post comes from the recent release itself of the Social Security and Medicare 2011 Trustees Report, and a follow-up article about it from Marketwatch last week, along with a discussion that emerged last week on the same topic in my retirement income panel session at the FPA Maryland spring symposium.
The rising discussion and furor over the dire long-term situation on Social Security and Medicare is starting to permeate the consciousness of the average American, and especially the average financial planner, who is increasingly cognizant of the fact that the trust funds for one or both systems may run out of money in our clients' lifetimes. Yet with all the discussion about the potential depletion of the assets we have set aside over the decades for Social Security and Medicare, we seem to continue to forget the most important part: that each year, MOST of the benefits we pay out for Social Security and Medicare are actually funded from current tax revenues collected from current workers. The only purpose of the trust fund is to pay the difference, when committed benefits exceed collected revenue.
Accordingly, the Trustees Report points out that in fact, Social Security just reached the crossing point this year - total revenues collected from employee FICA taxes exceeded the benefits being paid out to Social Security recipients. Notably, though, while benefits paid exceeded taxes collected, the trust fund actually still isn't depleting yet - because the money is invested and generates a (modest) return. In point of fact, it won't be until 2022 that the benefits paid are anticipated to exceed the tax revenues collected plus interest income generated by the trust fund assets themselves. Once that crossover point is reached, only then does the trust fund begin to deplete, ultimately running out in 2036. Medicare is in a similar situation, although it has already reached the crossover point where benefits paid exceed both tax revenues and interest income, so the trust fund balance is declining currently - and again, is projected to run out in 2024.
The truly important question, though, is what happens to the benefits paid by the programs if/when the trust funds are actually depleted? The answer is that in theory, they can continue paying as much of the benefits as they can manage, simply using the ongoing tax revenues that are still being collected. And how much is that? Most of it!
In fact, as the Trustees Report notes, the Social Security system could continue to pay 3/4ths of its benefits in 2037, even after the trust fund is exhausted, simply by directing then-current tax revenue against the benefits promised at the time. Medicare would actually have enough income from tax revenues to pay 90 percent of its benefit costs when the trust fund is initially exhausted, although that percentage too declines to revenue that pays about 3/4ths of benefits by 2045 due to shifting demographics.
Of course, shortfalls to pay benefits of this magnitude are still significant. But nonetheless, it's important to observe that "Social Security and Medicare going 'bankrupt'" does not mean all payments stop and benefits go to $0! It actually means that 75% to 90% of benefits are still fully funded. This is a big contrast to the assumption of many clients - that "bankrupt" actually means ALL benefits will cease and the drop-off would not be 10%-25% of the benefits, but 100% of the benefits.
Similarly, it's notable that the Trustees report states that the actuarial shortfall to make the system solvent has risen to a "mere" 2.22% of taxable payroll for Social Security, and 0.79% of taxable payroll for Medicare. In other words - slightly oversimplified - we could solve virtually all the solvency problems of Social Security and Medicare with a 2.22% + 0.79% = ~3 percentage point increase in overall payroll taxes (applied annually on an ongoing basis). Granted, a 3 percentage point increase in all payroll taxes is not a trivial thing - there are significant potential economic ramifications, and relative to the 15.3% current tax rate for Social Security and Medicare, that's a big jump - but we're still only talking about needing to raise revenues by a few percentage points. Which implies that the solutions some clients worry about - like means-testing Social Security benefits to reduce or eliminate them completely for wealthier high income individuals - may actually be an unnecessary and far more extreme step for system solvency than realized.
So the bottom line is that while the long-term viability of Social Security and Medicare are definitely a concern - outflows can only exceed inflows for a limited period of time before the money runs out - the bankruptcy of the trust funds for Social Security and Medicare is not the same bankruptcy of the entire programs. Even when the trust fund is depleted, the systems can still pay 75% - 90% of benefits, simply funded from then-current tax revenues. Which means in all likelihood, even clients who are deeply concerned about their benefits from these systems should probably be talking about potential haircuts to their future benefits, and not assuming that their benefits will be eliminated to $0! In turn, this may affect decisions, as well - for instance, if the shortfall in Social Security still allows 100% of benefits to be paid out for the next 25 years, and 75% of benefits to be paid out thereafter, does it still make sense for clients to take benefits early because they're afraid about solvency of the system?
So what do you think? Are you and/or your clients worried about the solvency of Social Security and Medicare? Do you ever talk about what might happen if the trust funds really do run out of money? Would the observation that tax revenues can still pay 75% to 90% of promised benefits be a relief to any of your clients? Would it change any planning decisions you might make or have already made?
Michael, love your other posts, this one misses two critical and basic points:
1) The trust funds are not assets, they are liabilities. What is a bond but a liability??? They are money that has already been spent on general expenses. Drawing on the trust fund means that government bonds need to be redeemed. How? By raising revenue to redeem the bond – we have to be taxed to access the so-called trust funds!
2) The above means that money that was once used for general expenses (SS and Medicare taxes) won’t be there for general expenses, as it will go to SS & Medicare. What takes the place of SS & Medicare taxes previously spent on general revenue?
The trust funds are assets. They simply happen to be assets that are “separately” also a liability of another part of the government.
The trust fund simply owns Treasuries. It owns the same Treasuries many financial planners own in their client portfolios.
According to your logic, it’s silly for clients to invest in government bonds at all, and all clients who own government bonds own a liability because the only way they get their bond interest and principal is by being taxed to generate the cash in the first place.
Yes, at the meta level for the sustainability of the system, this can become problematic when the government debt reaches unsustainable levels. But it doesn’t mean the trust fund isn’t holding assets. It is. It’s holding bond assets – which by definition, are an asset to the bond owner and a liability to the bond issuer. The complication in this case is that different sections of the same government are the owner and the issuer, but frankly it’s not THAT different from the fact that our clients own many government bonds and also happen to be the people who are taxed to generate the revenue to pay the bonds.
Mr. Kitces, Thanks for clearing up this misconception many have. Additional you could also note that, had the Social Security Trust Fund not invested in these treasury bonds, then the SSTF would have had to sell a further amount of treasury bond to others and simply would be paying the same amount of bond interest to others. That might help to make this more clear.
No, that’s not the same as clients owning bonds. Clients will own something that is an asset to them, a liability to the government.
Contrary, the government owns something that it owes itself. Meanwhile it has spent the money. If you are familiar with the movie Dumb & Dumber, the government had a brief case (trust fund) full of money. They spent the money and gave themselves IOUs (bonds). The IOU paper that they ran around with was not an asset to them, they couldn’t spend it. Now, if someone was dumb enough to buy the IOU (or to buy Treasuries), they could consider it an asset. The Government considering Treasuries an asset is as dumb as me writing an IOU and saying it’s an asset.
Where is the money to pay the benefits? It’s IOUs. It needs to actually come from somewhere, and since it is physically impossible to spend the same money twice, which is what your scenario implies is what will happen. Money’s gone, you just have an IOU. It’s a part of general spending, it’s long history.
This is the point that the media does not understand about the solvency issue, and why it is more of an issue that is being reported. It’s our job to understand and pass that information on.
According to this logic, why would your clients EVER own a government bond?
A government bond is an IOU. An IOU that is only paid by taxing YOUR CLIENT, the owner of the bond.
The only reason any client owning a government bond is an asset is because that client pays taxes to give the government the revenue to pay back that very IOU.
In other words, I receive interest in my bond because the government pays it back to me with some of the tax dollars I just paid to them in the first place. All your clients who own government bonds own something that is only an asset with value because they pay the tax revenue to the government that will fund the payments to the bond (at least, in the system aggregate).
The trust fund DOES own Treasuries. They could choose to liquidate all the Treasuries to your clients, take the cash, and simply sit on that. Unfortunately, that would exacerbate the viability of the trust fund, as you would be liquidating for a yield with a lower return.
But as long as government bonds are an asset that’s bought and sold in the real world, there IS an asset there. A bond is an IOU. That’s what the trust fund owns.
But yes, of course if the government reaches the point where it must default on its own bonds, there’s a serious problem. That has nothing to do directly with Social Security. That’s true of any government where the outflows exceeds the inflows at an untenable pace.
In point of fact, as my post highlights indirectly, Social Security has now actually become a net seller of Treasuries, not a net buyer as it was for the past several decades.
And again, as the post highlights, when you say “Where is the money to pay the benefits? It’s IOUs.” is not entirely correct. That’s how we pay less than 25% of the benefits. In fact, up until this year, that was how we paid 0% of the benefits. The other 100%-declining-to-75% of benefits is still paid with an immediate redirection of tax revenues on employee wages to benefits payments.
Michael, there is a huge distinction between owning debt someone else issues, and creating debt you owe yourself. An entity creating its own for purposes of simply stating that an ‘asset’ exists is not an investment. I’m not arguing that point, I’m arguing your point that an entity creating IOUs drawn on itself holds assets; at best they hold nothing, which means they have nothing to pay for Medicare benefits without re-taxing (a second time) to pay those benefits.
Why would anyone own a government bond? Because they believe the government will pay them back, and that their principal will be secure. More and more don’t believe that, as you’ll note the increase in hard asset prices. This is entirely different than why the government own a government bond, which I’m getting the feeling you don’t agree with. There is no reason for the government to own a bond it creates other than so it can spend the money today, and not bear the consequences until later (later meaning closer to now).
The trust fund could liquidate the Treasuries to our clients? Not sure I’m following. Are you saying the Treasury could pay our clients in Treasury securities to pay their Medicare costs? Or they’ll pay doctors in Treasuries? It really doesn’t matter what they pay them in, the facts are they have to raise money / or inflate however they pay. The way paying someone a security would play out is there would be a significant discount to accept these IOUs which would only grow as more was needed to pay benefits.
To your last paragraph, I made a 2nd point above. The taxes have gone into general revenue. You now are taking money from general revenue to pay current SS benefits. What replaces the money that went to general revenue? You can’t look at our fiscal picture and say, “well, the trust fund tax is covered” and ignore the fact that revenue now needs to be generated to replace what was spent on general revenue. You can, but it’s like focusing on the 5 star garden sitting outside a house of cards. Who is going to focus on how well the garden is doing when your home is in shambles?
I don’t currently have time to add my two cents, but this post reminded me of a podcast/blog I heard last fall from NPR’s Planet Money so I thought I should share. Planet Money (in my opinion) does interesting and unusual stories on all things money. The link to the trust fund issue is below:
http://www.npr.org/blogs/money/2010/11/18/131420919/are-the-social-security-trust-funds-a-mirage
Thanks for the link Mark. I’m glad to hear something mainstream explaining this topic.
A few more truths that can help frame the issue:
1) You can’t spend money twice. The money came in, and was spent. And future spending will be from needing to raise money again.
2) Think like the IRS would if they audited this transaction or looked at these ‘trusts’ like actual trusts.
What would happen if we tried to do this? They would collapse the transaction, and remove the fake ‘bond’ issuance.
Look, it’s easy to collapse this when we ignore the bonds. Money came in (SS taxes), money went out (to pay benefits and then general revenue). Since there’s no money, when we need more money for SS & Medicare benefits, it will have to be raised. How will is raise it? By selling bonds (aka printing money). But let’s realize printing money is extremely distructive to wealth.
It’s going to be even worse once Medicare taxes don’t cover benefits (and I swore SS taxes already don’t cover what is paid out due to the down turn). Not only do you have to raise revenue to replace lost general revenue, you have to raise revenue to fill the hole. By moving $1 from general renvue to Medicare you need to raise $1 for general revenue, and at some point will need to raise more to cover Medicare.
So you would consider Social Security trust funds to be “real” if the trust fund just sold all the Treasuries it holds and instead bought a portfolio of stocks and corporate bonds instead? Then it would be a “real” trust fund because it would only own equity and debt in other entities, not “itself”?
Perhaps. But in order to do that Michael you need dollars. In order to create a bond you do not. So, why go through the step of creating a bond, admit you what you are doing is actually inflating by dollar creation? Because then we would have to admit what we do in this country is default on our obligations by inflation.
You also would have to solve the problem of creating new bonds; and you would have to admit you are spending money for future obligations today.
This is a political issue Michael, politicians do this in all areas. There is a fund meant to provide protection against radioactive material buried in Denver. When politicians needed to spend the funds, guess what they found? They already did. On other items. The funds for high speed rail are coming from highway taxes. 90% of the population uses the highways which at some point will be a serious issue do to lack of care for the bridges, etc. But, let’s spend that money on pet projects.
A government bond is a creation of the government to double spend money, and it is an inflationary tax that hurts the middle class and poor more than anyone.
As a planner, what is your analysis of the financial picture of Lloyd Christmas, after buying a Lambourgini, and spending all of the money in the briefcase and replacing it with IOUs he created? He too could state he could sell those IOUs and cover all of his future obligations. But, he could only get away with it for some time. He could maybe find someone who believes him that his IOUs have value. If he were the government he could force acceptance of his bonds. But in doing so they would admit a huge weakness, and confidence in the dollar, and in the government markets would decline. It is not acceptable to drop all of these bonds on the market any longer. If you don’t see that after the government has said they have to raid federal government retirement funds, I really don’t know what is going to make you change your perspective less a complete default (and yes, we’ve done it plenty of times in our history, and multiple times in the last century, so it will happen. Let’s not be just cheerleaders for clients, but realists).
Issuing debt is not inflationary money creation. Printing money to retire the debt is inflationary money creation.
The mere fact that the government has issued bonds is not inflationary. Not is investing Social Security excess cash flows into government bonds.
The inflationary issue is how the government ultimately retires that debt. That’s not a Social Security issue. That’s a government solvency issue. It would be the same problem if the Social Security trust fund had never bought a government bond once in history and only bought corporate bonds or other assets.
The issue of government debt load is real. But that’s an issuer problem, nt a Social Security trust fund issue, until/unless the government actually defaults on those bonds (or they otherwise lose liquidity or value).
You are mixing general government debt issues – which are real for certain – with a trust fund’s decision to hold one of any number of fungible assets.
Issuing debt is the first step in inflationary monetary creation. The second step does not occur without it. It is in fact essential to the process.
So, because we know a Brinks truck full of assets will be showing up on a regular schedule in the near future, you can ignore what that will do in the future, but the market is already telling us. How in the world do we believe truckloads of any asset can be dumped on the public, knowing that it will happen, and think it won’t be inflationary? By definition it will; it will crush the marketability of the asset being dumped.
Capital isn’t created out of thin air, no matter what asset the government calls it.
In fact, I think it’s extremely telling the government is raiding retirement funds, as opposed to what you suggest they would have no problem doing… selling an ‘asset.’
Useful information to pass along to clients would include the following:
“This assumed increase in life expectancy is the largest factor in a projected deterioration in the program’s finances.”
http://www.cepr.net/index.php/data-bytes/social-security-bytes/jump-in-life-expectancy-assumptions-drives-latest-social-security-projections
Also quite relevant:
http://publicsquare.net/is-social-security-in-crisis/social-security-the-sky-is-not-falling
Another critical task is for planners to separate SS from Medicare. The former can pay 100% of benefits for decades with only minor tweaks; the latter, well health care spending more specifically, is the main factor driving the country’s deficit.
Our dysfunctional health care system is the core problem and needs to be distinguished from SS. The main reasons both might blow up are entirely political, not economic. With sane health care spending we would be running surpluses.
I think I can save more to cover the income piece. Do we purchase more gap insurance to cover Medicare?