Illustration by Jan Buchczik
Illustration by Jan Buchczik

Now that health care is off the front burner, it’s time to fix Social Security. Social Security’s trustees say the system needs only “modest changes.” In fact, the system is desperately broke.

The proof is buried deep in the trustees’ own 2012 report in a complex table, numbered IV.B6. The system’s actuaries prepare the report’s tables. But what the trustees make of them is up to the trustees. Clearly this year, as in others, the trustees ignored table IV.B6. How else could they have come up with their blase statement that Congress should address Social Security’s finances “in a timely way”?

Table IV.B6 is a long-run balance sheet for Social Security. It shows that the system’s $88.9 trillion in liabilities exceed its $68.4 trillion in assets by $20.5 trillion.

The liabilities are the present value of the system’s projected benefit payments, whereas the assets are the system’s $2.7 trillion trust fund plus $65.7 trillion in projected taxes, also valued in the present.

The $20.5 trillion fiscal gap separating Social Security’s liabilities and assets -- its unfunded liability -- is enormous; it is 1.4 times U.S. gross domestic product and 34 times annual Social Security taxes.

Because $20.5 trillion is equal to 31 percent of the projected taxes, the system is 31 percent underfunded. To pay all promised benefits would require immediately and permanently raising Social Security’s 12.4 percent payroll tax (split evenly between employer and employee) by 31 percent, or 3.9 percentage points.

Election Year

American workers would be ill-disposed, particularly in an election year, to say goodbye to the current temporary two-percentage-point payroll-tax cut, let alone surrender 3.9 cents more per dollar earned in exchange for no extra benefits.

What about cutting benefits? The $20.5 trillion is 23 percent of the present value of projected benefits. Hence, “saving” Social Security this way requires reducing all benefits immediately and permanently by almost one quarter -- a non-starter for most of the system’s 55 million beneficiaries.

How about increasing the retirement age from 67 to 70 for those now 50 and younger? This means waiting 20 years to start cutting benefits for new retirees by only 20 percent. That’s far too little too late. If we wait 20 years to act, we will need to cut benefits by almost 50 percent to eliminate the system’s funding gap.

So why did the trustees ignore the magnitude of the problem? One answer is that this is an election year and the trustees are political appointees. Another is that the trustees assessed the system’s finances based on a different table, IB.IV5, which reports a much smaller unfunded liability -- only $8.6 trillion.

The $20.5 trillion measure is called the infinite-horizon unfunded liability because it considers all future Social Security benefit commitments and tax receipts. The $8.6 trillion measure is called the 75-year unfunded liability because it considers only the next 75 years.

The trustees may reckon that looking out 75 years is far enough given the enormous uncertainties the future holds. That’s a terrible mistake for three reasons.

First, today’s children will be retired in 75 years. How can the trustees focus on what our kids will pay to today’s adults and ignore the benefits our kids will be promised, but won’t receive?

Second, looking out just 75 years is an invitation to procrastinate. The 1983 Greenspan Commission was charged with fixing Social Security for good. But it looked only 75 years ahead, thus ignoring 29 huge cash-flow deficit years that are now in the current 75-year projection window. This decision helps explain why the system is now in worse financial shape than it has ever been.

Economic Relativity

Third, and most important, economic theory tells us that the time path of a government’s cash flows, but not their infinite-horizon present value, is a matter of how the government chooses to label its receipts and payments. Thus, table IV.B5 measures our choice of words, whereas table IV.B6 measures the system’s true economic condition. Since there is nothing sacrosanct about the government’s choice of words, table IV.B5 needs to be taken for what it is -- meaningless.

We need to fix Social Security without sacrificing its key objectives. If we are going to ask younger generations to take most of the hit for this broken Ponzi scheme, let’s give them a modern Social Security system that’s simple, transparent, fair, efficient and financially sound.

I propose a plan that freezes the existing system, pays off all accrued benefits as they come due, and has all workers contribute 8 percent of their pay to a personal security account.

Account contributions are split between spouses and legal partners, and the government makes matching contributions on behalf of the poor, disabled and unemployed. All account balances are collectively invested by a government computer in a single, market-weighted, global index fund of stocks, bonds and real estate. Wall Street plays no role and earns no fees.

Between ages 60 and 70, the same computer gradually converts each person’s account balance into inflation-protected annuities. In so doing, the government tops up each participant’s account balance to ensure it at least equals the beneficiaries’ contributions adjusted for inflation.

In paying off the system’s accrued, rather than its projected, benefits, the system’s $20.5 trillion unfunded liability is more than eliminated. Yes, this payoff to young workers from the old system will be substantially less than they have been falsely promised. But they will get a first-rate, modern retirement system that will never go broke.

(Laurence Kotlikoff is an economist at Boston University and the co-author, with Scott Burns, of “The Clash of Generations.” The opinions expressed are his own.)

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Today’s highlights: the editors on why China should think small to spur growth and why outsourcing is (mostly) good; Caroline Baum on the presidential outsourcing debate; Edward Glaeser on why Australia’s mineral wealth does little to create jobs; Michael Kinsley on the glories of outsourcing; Ezra Klein on Obama’s tax gamble; Laurence Kotlikoff on Social Security’s solvency.

To contact the writer of this article: Laurence Kotlikoff at kotlikoff@gmail.com

To contact the editor responsible for this article: James Greiff at jgreiff@bloomberg.net