The most pressing budgetary challenge for governments in advanced economies is paying for rising benefit obligations tied to aging populations. Indeed, credible estimates of the mismatch between future spending and revenue for these programs, starting with pay-as-you-go state pensions, are so jarring in several major countries, such as Spain, that exposing the scale of the problem would seem to be in everyone’s interest as a way of spurring action.
But that is not necessarily the top-line message from official reporting on these programs. The longstanding practice has been to treat publicly-mandated pay-as-you-go benefit programs (to the degree that they are aimed at the broad workforce and not just public sector workers) as not incurring ironclad benefit obligations that must be honored in the future. Rather, outlay projections for these programs are seen as estimates of future benefits based on today’s formulas which are subject to change at any time through new legislation.
Further, the accounting rules stipulate that the assessed value of future benefits should be measured against the expected tax collections from future workers and not just the assets on hand at the time of the valuation (hence the pay-as-you-go designation).
When taken together, these conventions mean that large unfunded liabilities for pay-as-you-go systems, even after accounting for future receipts, are not reflected in the primary public balance sheet estimates cited most often by the relevant authorities.
Of course, this technically accurate reading of what is required and allowable under the law does not necessarily match up with political or economic reality.
Politicians in many countries approach what is being earned under these programs as solemn commitments that must be kept. Many voters seem to view the matter similarly, as reflected in their reactions to potential reform plans. A recent column by Toby Nangle in the Financial Times highlighted the disconnect between the way the European Union officially account for these obligations and how they are seen in a political context.
Current scorekeeping practices in the US also reflect a conflicting view of what these commitments imply for the federal budget.
In the federal government’s official balance sheet report, produced annually by the Treasury Department, the unfunded liabilities of Social Security and Medicare are shown as separate tabulations from the official projections of the government’s assets and liabilities. So, for instance, in this year’s report, the federal government had assets totaling $5.4 trillion at the end of fiscal year 2023 and liabilities of $42.9 trillion, for a net position of -$37.5 trillion. Not included in these totals is the estimate of the excess of the present value Social Security benefits over future tax receipts ($25.2 trillion), or the parallel estimate for Medicare ($53.1 trillion when Parts B and D are included in the calculation).
Complicating the picture still further is the argument, made recently by the chief actuary of the Social Security Administration, that Social Security cannot contribute to future debt accumulation because benefits can be paid from the program’s trust funds only to the degree they are covered by incoming revenue or from reserves. After 2033, with the trust funds projected to run short of funding compared to benefit commitments, the expectation is that spending would have to be cut to prevent annual deficits. Put another way, if it is correct to view the trust funds as limiting Social Security and Medicare outlays, then these programs can never build up unfunded liabilities.
Congressional Budget Office (CBO) projections provide a different perspective. The agency adheres to the long-standing practice of including spending on entitlements based on benefit rules reflected in current law even when the trust funds are expected to run short of funds. Consequently, for both Social Security and Medicare Hospital Insurance (HI), CBO assumes spending on benefits will continue indefinitely even after the trust funds run short in the 2030s, which is one important reason federal debt is expected to rise rapidly. In effect, CBO assumes Congress will authorize borrowing as needed to prevent benefit cuts.
Which argument is most compelling depends on one’s perspective. In the US context, it seems unlikely that Congress would allow automatic cuts in Social Security and Medicare, which would affect the very old and new retirees equally. On the other hand, Congress has never relied on borrowing to such a degree to pay for Social Security and Medicare, so it is also not unreasonable to think their unfunded liabilities will have to be addressed, one way or another.
What should not be in dispute is the difficulty of the task that lies ahead. No matter the labeling, the promises made under these pay-as-you-go programs are going to be hard for politicians to keep.
Originally published by the American Enterprise Institute. Republished with permission.
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