Financing Social Security

According to a recent government projection, Social Security will run out of sufficient funds to cover full benefit payments in about 2042.  Such long-term projections are very sensitive to small changes in assumptions, and should be viewed with considerable skepticism.  In fact the projected date has been regularly extended over the last several years.  Nevertheless, let's take the Social Security projection at face value, and see what can be done to fix the problem? 

The Options 

There are basically three options.  Congress can (1) reduce the benefits to match the available FICA tax revenues, (2) increase the FICA tax rate, or (3) it can grant additional funds to cover the shortage. 

Reducing benefits deserves consideration only if there is no viable alternative.  It breaks a promise to workers who have already paid for the benefits. 

Increasing the FICA tax rate has the undesirable effect of reducing current disposable income, especially in the income group least likely to save.  That in turn lowers aggregate demand with a negative impact on the economy. 

The easiest option is for Congress to simply grant whatever additional credits are needed to cover the projected shortage.  It can do that just as easily as it can subsidize other government programs.  Then the public debate can focus on how the government should manage its fiscal affairs, rather than the silly claims about bankruptcy.

Future Borrowing Appears Unavoidable 

As of January 2004, the trust fund held about $1.5 trillion of Treasury bonds.  That amount will continue to grow until benefit payments start to exceed FICA tax revenues.  Current projections indicate that will occur about the year 2018.  Thereafter, the Treasury will have to use non-FICA revenues to redeem the trust fund bonds to cover benefit payments. 

At that time, the Treasury can avoid borrowing only if the on-budget surplus is at least equal to the shortfall in FICA tax revenues.  There is little chance of that being the case.  Therefore we should expect a bulge in government borrowing during the outer years when most of the baby boomers are drawing benefits.  The key question is whether the increasing public debt would drive long-term interest rates to a level that would seriously suppress business investment.  The historical record suggests not.  For example between 1990 and 2005, the yield on the 10-year T-bond fell from 8.4% to 4.2% even as the public debt increased by 78%.  

Conclusion 

Congress and the public should both recognize (1) there will be a temporary bulge in the national debt as the baby boomer retirement benefits reach their peak, and (2) the bulge is no reason for alarm.  In fact the historical record shows that higher values of the real deficit/GDP ratio have generally been associated with more rapid growth in the real output of the economy.