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A Primer on the Social Security and Medicare Trustees’ Reports: Part I -- Concepts

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A Primer on the Social Security and Medicare Trustees’ Reports: Part I -- Concepts

May 23, 2011

Earlier this month, the annual reports of the Social Security and Medicare Trustees (I am one) were released. This piece is one of two that I will author for e21 on the annual reports. In this first one I will focus on process, concepts and essential findings of the reports. In the second piece I will summarize quantitative determinations with respect to program finances. Essentially, this will be the concepts piece, while the next will deliver the numbers.

Who the Trustees are: There are six Trustees, always including the current Secretary of the Treasury (the Managing Trustee), the Secretary of HHS, the Secretary of Labor, and the Social Security Commissioner. There are also two Public Trustees, including one Democrat (Dr. Robert Reischauer) and one Republican (me). The two Public Trustees are nominated by the President, confirmed by the Senate, and serve four-year terms. The Public Trustee positions were established by the 1983 Social Security amendments so that two external pairs of eyes would review and vouch for the financial projections, to substantiate public confidence in them.

Why the annual reports exist: The annual reports are required by law under Section 201 of the Social Security Act. The primary purpose is to report to Congress on the financial status of the Social Security and Medicare Trust Funds, though over the years the reports have grown more expansive and now contain a great deal of further information about program finances. The reports are thus, by statute, the “official” pronouncements on the financial status of Social Security and Medicare. Various congressional points of order, for example, rest upon the projected state of program finances as assessed by the Trustees’ methodology.

What Trust Funds are covered: The Social Security report evaluates the finances of the Old-Age and Survivors Insurance (OASI) Trust Fund, the Disability Insurance (DI) Trust Fund, and the combined (OASDI) Trust Funds. The Medicare report covers the Hospital Insurance (HI) Trust Fund and the Supplementary Insurance (SMI) Trust Fund.

What documents are published: In addition to the full Social Security and Medicare reports, an annual Summary is also published. The Summary contains a condensation of the most important financial information in the main report, a descriptive “all Trustees” message, as well as a separate “Public Trustees” message. The last of these covers any subjects that the two Public Trustees choose to emphasize in a particular year.

How the projections are made: The basic economic and demographic assumptions employed by the Trustees are first developed by the Social Security Administration Office of the Actuary, subject to review (and possible tweaks) by the Trustees. In developing their recommendations, the Actuary’s office also consults the recommendations and viewpoints of a variety of outside sources, including periodic Technical Panels. The same economic/demographic assumptions are used for the Medicare report as for the Social Security report. In addition, the CMS Office of the Actuary makes recommendations for projections of future health care cost inflation, which assumptions are also subject to review and tweaking by the Trustees. Like the SSA Actuary, the CMS Actuary has the benefit of periodic Technical Panels convened to review the assumptions and methodology.

The significance of the Trust Funds: The Trust Funds are very important insofar as they determine the spending authority of the Social Security and Medicare programs. Without a positive balance in their respective Trust Funds, the programs lack the authority to deliver benefits. In both Social Security and in Medicare HI, the primary financing sources are the payroll taxes paid from workers, and income taxes levied on Social Security benefits (Medicare HI also has additional income from premiums and from payments by states). Whenever these dedicated incoming revenues fall short of payment obligations, the programs can draw on any Trust Fund balances to keep payments flowing.

For the most part – but not entirely – the balances in these Trust Funds reflect past program surpluses of income over expenditures. Whenever such a past surplus was run, it was used to finance the general operations of the federal government, in exchange for which the General Fund issued special-issue Treasury bonds to the Trust Funds, which in turn accrue interest. Not all of the money in the Trust Funds, however, reflects such past surpluses. Congress always has the option of simply legislating General Fund transfers to the Trust Funds, and indeed did so for Social Security as part of last December’s tax law. Such deposits are simply issuances of additional debt with no dedicated revenue source behind them.

These distinctions are particularly important in the Medicare SMI Trust Fund, which operates somewhat differently from the others. In Medicare SMI, some program income comes from premiums paid by beneficiaries, but the vast majority comes straight from general revenues. “Trust Fund solvency” thus has little economic meaning in practice for SMI, because the program is always deemed to be “solvent” virtually by statutory construction. It is simply given General Fund revenues in whatever amount is required.

Taken as a whole, Social Security and Medicare are thus financed in part by revenues the programs themselves annually generate (such as payroll taxes, benefit taxes, and premium payments) and in part by General Fund revenues (provided either as interest payments, redemption of Trust Fund bonds, or legislated general revenue transfers). All of these various sources of revenues are mixed in the Trust Funds, committing federal resources and establishing spending authority. Unlike tax and premium contributions, however, interest payments, general revenue transfers and Trust Fund bond redemptions represent a draw on the general government fund for which there is no earmarked financing source. They thus represent obligations of the federal government, but do not answer the important question of how those obligations will be financed.

The Trustees’ report contains critical information with respect to all of these issues. The so-called insolvency (i.e., Trust Fund exhaustion) date tells how long the programs will have authority to make full benefit payments. Other information in the report tells Congress when program expenditures exceed incoming tax revenues, and by how much. This in turn illuminates how much in additional resources need to be found from within the General Fund to support these programs.

Clearly, while the Trust Fund balances are important for ensuring the continuing flow of benefits, there is much information that they do not provide. By themselves, they do not indicate whether current benefit schedules are equitable, or whether current tax schedules are equitable. They do not illuminate who will provide the financial resources to honor the substantial debt that they hold. And they also do not explain whether a bipartisan solution to projected financing shortfalls, one consistent with the core values of the various stakeholders, is still within reach.

Beyond the Summary and Trustees’ Messages, sections of the longer Trustees’ Reports worth reading: I’ll select three from each report:

The top 10 stories from this year’s Trustees’ Reports: Without getting into the specific numbers, the list below is an attempt to assess what are likely to be the biggest stories arising from the reports.

  1. Medicare HI insolvency five years earlier than projected last year (2029 to 2024). Though HI is but one part of Medicare, and the insolvency date is of limited meaning as explained above, the 5-year acceleration is a big story.
  2. Disability Insurance Trust Fund insolvent in 2018. Again, the insolvency date is not the only important factor. It will rightly draw attention, however, that the DI fund would be exhausted relatively soon.
  3. Expressed skepticism about the Medicare projections. Throughout the Trustees’ Medicare report, multiple reasons are given why actual costs are likely to be higher than shown.
  4. Permanent cash deficits in Social Security. This year’s report indicates that the cash shortfalls that began in Social Security in 2010 will be permanent.
  5. Significant worsening of Social Security’s long-term imbalance. The good news is that we are living longer than previously projected. The bad news is the largest single-year deterioration in Social Security’s long-term balance since the 1994 report.
  6. The shortfall is certain. From the Summary: “A supplementary analysis that allows plausible random variations from the intermediate assumptions employed in the report indicates that OASDI trust fund exhaustion is highly probable. . .” (more than 97.5% probable by mid-century).
  7. Action needed soon to protect the most vulnerable. From the All-Trustees’ message: “The long-run financial challenges facing Social Security and Medicare should be addressed soon. . . . Earlier action will also afford elected officials with a greater opportunity to minimize adverse impacts on vulnerable populations, including lower-income workers and those who are already substantially dependent on program benefits.”
  8. Cost growth is driven by population aging, and the critical time is from now through 2035. From the Public Trustees’ message: “Under current law, demographic trends will be the primary driver of cost growth for both Social Security and Medicare over the next couple of decades. . . . More than 90 percent of combined cost growth in Social Security and Medicare from 2007 through 2085 relative to GDP will have occurred by 2035 under current projections.”
  9. These are problems both for the programs themselves and for the larger budget. From the Public Trustees’ Message: “Whether viewed from the narrower trust fund perspective or from the wider unified budget perspective, the financial challenges confronting both programs must be addressed.”
  10. Costs of delay are probably understated. From the Public Trustees’ Message: “In the past, policy makers have been reluctant to significantly reduce the benefits of those who have already begun to collect them. In a practical sense, therefore, changes adversely affecting younger generations are likely to be much more severe than indicated in these simple illustrations. The costs that will be borne by younger generations will grow significantly each year that a new cohort of baby boomers joins the benefit rolls.”

In the next piece: Key facts and figures from the Trustees’ Reports…

Charles Blahous is a research fellow with the Hoover Institution and the author of Social Security: The Unfinished Work.

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