NCPA - National Center for Policy Analysis


May 12, 2009

In 2005, the Social Security Trustees estimated that the program's unfunded liabilities were $8.5 trillion.  This means that even after accounting for payroll tax revenues the federal government would have to have this much money in the bank today, accruing interest, in order to pay promises to future retirees.  However, the trustees have made two valuation mistakes in calculating Social Security's unfunded liabilities, says Laurence J. Kotlikoff is a professor of economics at Boston University and a senior fellow with the National Center for Policy Analysis.

For example:

  • The first mistake involves failing to account for risk with respect to initial benefit awards as well as future tax payments.
  • The second mistake is the failure to account for the safety of the stream of Social Security benefits to a retiree once they commence.

In using too high a discount rate, Social Security understates the market value of these obligations; that is, Social Security is mispricing safe as well as risky streams of payments and receipts, says Kotlikoff:

  • In 2005 the average annual real yields on Treasury Inflation Protected Securities (TIPS) were 1.50 percent, 1.63 percent, 1.81 percent, and 1.97 percent for 5, 7, 10, and 20 year maturities, respectively.
  • Each of these yields is considerably lower than the 2.9 percent real (inflation-adjusted) yield used by the trustees in their 2005 unfunded liability calculations.
  • Using the TIPS term structure, the value of a $1 single-life real annuity for a 62-year-old male in 2005 is $15.40; this is 8.8 percent higher than SSA's $14.18 valuation.

An illustration of how these calculation errors affect the value of Social Security taxes and benefits is to compare the differences in net liabilities -- present value of lifetime taxes paid minus lifetime benefits paid -- between the trustees' estimates and the risk-pricing method for workers who retire at age 62.  For example:

  • For a 40-year- old college graduate male, the lifetime present value of unfunded liabilities is about $40,401 using the trustees' calculations, compared to $56,196 using the risk-pricing method.
  • For a 40-year- old college graduate female, the trustees' calculation is about $40,567, compared to the risk-adjusted price of $55,896.
  • For a 55-year-old college graduate male, the trustees' calculation is about $148,188, compared to a risk-adjusted $169,102.
  • For a 55-year-old college graduate female, it is about $117,479, compared to a risk-adjusted $134,341.

Source: Laurence J. Kotlikoff, "Measuring Social Security's True Liability," National Center for Policy Analysis, Brief Analysis No. 658, May 12, 2009.

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