Budget Rules Could Mask Social Security Funding Costs

Millions of Americans could face automatic Social Security benefit reductions if the program's trust funds run out of money, while federal budget rules could obscure the cost of using general revenue to maintain payments. Kent Smetters, faculty director of the Penn Wharton Budget Model, warned that this accounting approach could make a costly funding gap appear resolved without addressing its underlying cause.

According to Smetters, the Penn Wharton Budget Model estimates that Social Security could reach insolvency in 2033, triggering a benefit reduction of about 15% under current law. The cuts would affect both existing beneficiaries and new enrollees if incoming payroll taxes could not cover scheduled payments.

The Congressional Budget Office's most recent 10-year budget outlook, by comparison, projects that Social Security's main trust fund will be depleted in 2032. The CBO estimates that benefits would subsequently fall by an average of 28% annually, reducing payments by approximately $2.7 trillion over the 2032 to 2036 period.

Smetters said the law governing payments after trust fund depletion requires benefits to align with the payroll taxes collected each month.

"What the law actually says is that when the trust fund depletes, benefits have to be reduced to a level that's consistent with just the monthly payroll taxes that come in. We estimate that to be about a 15% reduction of benefits, which is sizable," Smetters said.

A separate budget rule affects how the nonpartisan Congressional Budget Office calculates the fiscal consequences of trust fund depletion and transfers from general revenue. Smetters argued that the approach could make borrowing to sustain benefit payments appear to carry no additional cost in official budget calculations.

He said the accounting treatment would not resolve the underlying financing shortfall, despite the substantial borrowing required to support payments.

"We all know that's just like the left hand paying the right hand or vice versa. It doesn't do anything to solve the actual funding problem. But nonetheless, that's going to score as though it's costless, zero dollars, even though that borrowing from general revenue will be substantial – almost 200% of GDP within 75 years, or over 400% of taxable payroll over 75 years," Smetters said.

Smetters warned that the budget treatment could influence lawmakers by making general revenue transfers appear to be a straightforward solution to the program's financing problems.

He cautioned that the rule could "almost cast a die of what's going to actually happen, because I think policymakers are going to see that it's kind of like the easy button for looking like they've solved Social Security."

Beyond the accounting implications, Smetters said using general revenue to cover Social Security's shortfall could concern bond investors and intensify broader federal fiscal pressures through higher interest rates.

He said financial markets currently expect the president and Congress to agree on a solution, warning that investors could react harshly if policymakers fail to address the funding challenge.

"bond markets are currently making a bet that Congress and the president will eventually get their act together, because if they don't, future bond markets are just going to pound them," Smetters said, describing general revenue transfers as the "ultimate sign that we've given up."

Despite the differing insolvency projections, Smetters said policymakers still have several options to address the funding gap. The Penn Wharton Budget Model has outlined seven illustrative approaches, ranging from substantial tax revenue increases to significant benefit reductions, with intermediate alternatives between those extremes.

He said the available options would produce different long-term economic outcomes but maintained that there was still time for policymakers to consider them.

"Even though seven years is not that far away, the good news is there are a range of options," Smetters said.

He argued that preventing insolvency and reducing federal debt would require cooperation across party lines rather than reliance on accounting changes.

"Unless we go with the gimmick approach in terms of this general revenue transfer, the fact of the matter is it requires really having adults in the room on both sides of the aisle," he said.

Smetters pointed to Social Security reforms enacted during the 1980s under President Ronald Reagan and Democratic House Speaker Tip O'Neill as an example of bipartisan action. He said the two leaders put aside personal political ambitions to address the program's financial challenges.

"They decided we're jumping off this bridge together because the country is worth it, and they were going to put their personal politics, personal ambitions aside to solve this problem," Smetters said. "We just don't have that rhetoric right now."

He warned that delaying action could increase the likelihood of lawmakers relying on general revenue transfers while federal deficits continue to grow.

"The longer that we wait, the more likely it's just going to be this pure optics, easy button and make it look like we've solved Social Security despite not actually doing anything, and we're going to absorb these really large budget deficits going forward," he added.