Beyond Solvency

When we think about Social Security reform, we tend to look at options in terms of their impact solvency -- measured over a 75 years period. In their latest report, the Trustees estimate this shortfall to be 1.92 percent of taxable payroll. While solvency is a necessary condition for Social Security reform -- it is not a sufficient one. At minimum, policy makers must ensure we achieve something called sustainable solvency, which insures the program can be sustained over the long-run.

There are a number of problems with looking only at solvency, but one of the key issue is that this measure essentially works on closing the average 75-year gap (after accounting for trust fund assets and interest), even though the program's costs are growing over time. While the program's 75-year shortfall is 1.92 percent of taxable payroll, that shortfall is more than twice as big -- about 4 percent of payroll -- by 2080. That means that an immediate 2 percent payroll tax increase (or equivalent spending cut) would more than make Social Security solvent -- but would only close half of the program's gap in the final years of the budget window. Such a cliff effect will cause the program to fall out of 75-year solvency in the not-to-distant future.

This is one of the reasons that CRFB encourages a focus on cash flow. Though it may be too late to make the changes sufficient to balance Social Security's revenues and expenses every year, any reform plan must eventually bring the two in line -- and the sooner the better. When evaluating based on this measure, policy makers may choose different options.

The following options would each achieve or nearly achieve solvency based on CBO's current law estimate of the short-fall -- but would have drastically different cash-flow effects. 

Percent of Shortfall Closed
Option 75-Year Solvency 2040 2080
Increase Payroll Tax by 2% by 2030 100% 50% 60%
Eliminate Taxable Maximum 100% 50% 30%
Implement Progressive Price Indexing, Protecting the Bottom 30% 90% 30% 110%
Index AIME and Bend Points in PIA Formula to Prices 110% 40% 130%

Numbers based on percent of GDP and rounded to the nearest 10%

Notice that although these options would also achieve solvency, or at least come close, they would have very different cash flow implications. The second two options put the system on a sustainable path -- since they offer a growing amount of savings over time -- enough to close the cash-flow gap in 2080. The first two options have their own advantage though -- they tend to do more in the earlier years. When designing an entire reform package, policy makers should look to both minimize cash-flow deficits over the next few decades and ensure savings grow over time in order to lead to eventual cash-flow balance.

Achieving sustainable solvency is important for anyone serious about reform.

Check out our analysis of the Social Security Trustees report.