In 1982, I wrote a paper for the Transactions of the Society of Actuaries entitled, “A Better Financing Approach for Social Security1”. At the time, the National Commission on Social Security Reform was studying ways to solve the system’s impending short-term funding crisis and long-term funding imbalance, which eventually led to adoption of the 1983 Amendments to the system.
My proposed approach was relatively simple and anticipated:
- Making reasonable deterministic assumptions about the future
- Annual valuations to systematically compare the present values of system assets and liabilities
- A level tax rate if all assumptions about the future were realized (and no future changes in assumptions or benefits),
- Significant trust fund accumulation,
- Automatic adjustments of future tax rates to amortize:
- Gains and losses from experience more or less favorable than assumed
- Changes in actuarial assumptions
- Changes in system benefits
I also discussed in the paper that if Congress did not want to implement the automatic tax rate changes (or didn’t like the expected trust fund accumulation), it could always decide to adjust benefits accordingly.
Readers of this blog will note that my recommended approach for ongoing Social Security financing involved most of the same basic actuarial principles we currently advocate for ongoing personal planning in retirement as discussed most recently in our post of April 1, 2023.
Needless to say, my recommended approach for Social Security financing was roundly rejected by those who commented on the paper, and many of them argued for continuation of current-cost financing of the system.
What financing approach did Congress adopt in the 1983 Amendments?
With the 1983 Amendments, Congress adopted a financing approach that involved most of the items suggested in my proposed approach, including:
- Making reasonable deterministic assumptions about the future (with one exception discussed below),
- Annual valuations to systematically compare the present value of system assets and liabilities,
- A level tax rate (after a brief phase-in), and
- Significant trust fund accumulation
Congress did not, however, adopt the recommended automatic adjustment process.
Because the Social Security Actuaries and Trustees used a 75-year projection period, they effectively assumed that for each year after the end of the 75-year projection period, annual system benefit payments would equal annual system income. Under my approach, I effectively assumed that the shortfall in the 75th year would remain essentially constant for all subsequent years. As discussed in our post of April 1, 2023, SSA Actuarial Note 2023.8 shows that about two-thirds of the total experience losses (deviations of actual experience from assumed experience) since 1983 have resulted from this Trustees’ overly optimistic and (in my opinion) unreasonable implied assumption.
And, the Trustees and Social Security actuaries continue to make this unreasonable implied assumption without discussing the implications of doing so in their annual Trustees’ report. Yet an aware 6th grader could look at Actuarial Note 2023.8 and see that continuation of these losses are expected to occur in the future under current law even if all other assumptions are realized.
As shown in Actuarial Note 2023.8, the remaining sources of gains and losses (including demographic data and assumptions) have contributed very little to the decrease in the system’s funded status since 1983. This latter fact is important because it seems to contradict the frequently heard assertion that Social Security’s funded status has deteriorated largely due to demographic experience since 1983.
What if?
So, what if Congress had adopted the automatic adjustment process recommended in the Better Financing Approach for Social Security (or a similar process adopted for the Canada Pension Plan)? The short answer is that automatic gradual tax increases would have kicked in fairly quickly in response to the actuarial losses resulting from the unreasonable implicit assumption respecting benefits payable after the 75-year projection period. In lieu of those gradual tax increases, Congress could have, of course, scaled back benefits (or adopted some combination of tax increases and benefit reductions) to maintain the system’s funded status at approximately 100%.
Alternatively, the Trustees could have determined that the implicit assumption with respect to years after the end of the 75-year projection period was unreasonable and adopted a more reasonable assumption. The associated increase in tax rates could have been amortized over a number of years to smooth the impact.
But, since Congress did not adopt automatic adjustments to keep the system in (or near) actuarial balance and because system trust funds continued to grow, no action was taken, and we now face the accumulated cost of Congressional inaction over the past 35 or so years. This cost is now significantly higher than the additional cost that I estimated for the level cost in 1983, and the political actions in the relatively near future to address system financing issues will likely significantly erode confidence in the system.
Summary
In my paper, I cited the following four advantages of adopting a Better Financing Approach for Social Security:
- The cost of system benefits will be more equitably shared by current and future generations of taxpayers,
- Confidence in the ability of the system to provide the benefits promised will be greatly enhanced,
- Adjustments to the tax rate will be automatic and better insulated from the political process, and
- Benefits and costs will be better correlated.
Unfortunately, adoption of the basic actuarial principle of automatically adjusting system financing to maintain a reasonable relationship between system assets and liabilities over time was not adopted for Social Security in 1983 and will likely not be a part of upcoming system reform. It will be interesting to see how Congress resolves the upcoming Social Security mess that arguably could have been relatively easily avoided through use of a more gradual automatic adjustment process.
1 The
Society of Actuaries does not make a copy of this paper available on its
website. Here is a link to the table of contents for the 1983
Transactions Volume 35 in which it was published. TSA83V35 (soa.org)
