Every year, the trustees of the Social Security Trust Fund give their report assessing the health of Social Security. Every year, the report draws a line in the sand beyond which retirees and other Social Security recipients will no longer receive full benefits, raising a big debate about what steps the government should take in order to shore up the program on which millions of retirees rely for the bulk of their income in their old age.
Yet behind all the assumptions and actuarial projections contained within the report, one glaring omission makes its conclusions essentially meaningless: the failure to consider political reality. Given the inability of decision-makers in the government to reach compromise until the last possible minute, the only thing the Social Security Trustees report really tells us is that 2033 will be the year in which Congress and whoever the president happens to be will have to begin negotiations to avoid what might eventually be dubbed the "Social Security cliff."
What the report says
This year's report makes its usual set of ominous projections. According to its analysis, the deficit between Social Security payroll tax revenue and benefits paid will keep rising, and by 2020, the interest on the Treasury bonds held in the Trust Fund will no longer be sufficient to cover that deficit. That in turn will force the Trust Fund to start redeeming bonds, and by 2033, the Trustees project that the Social Security Trust Fund will be empty.
At that point, the program would have tough choices. With no increase in taxes, the program's revenue would be enough to pay about 75% of benefits. Alternatively, to sustain benefit levels, withholding taxes would have to rise from their current level of 12.4% -- split equally between employer and employee -- to about 16.5%. The other option would be for the government to agree to changes in benefits that would reduce the program's overall cost, such as increasing the retirement age, making changes to inflation adjustments on benefits, or adding restrictions like means-testing to the benefit calculation.
A dose of reality
When you consider the track record of dealing with major changes in the laws that have the most financial impact on Americans, the government doesn't fare all that well. Back in 2010, when tax cuts enacted in the early 2000s were set to expire, Congress and the president agreed to extend the provisions for another two years without really addressing the substantive issues of keeping the cuts versus letting them expire.
Then, the debt-ceiling debate arose in 2011. Lawmakers took the nation to the brink of default before finally coming to a compromise, and that inspired ratings agency Standard & Poor's to downgrade the former AAA credit rating of U.S. Treasury obligations. S&P specifically referred to the government's inability to put together enough of a deficit-reduction package to satisfy the ratings agency.
Worst of all, at the end of last year, the fiscal-cliff debate lingered until the end of December and beyond, leaving taxpayers completely unable to plan properly for their 2012 tax returns in light of the government's failure to clarify the provisions of the alternative minimum tax. With AMT patches having been enacted every year, it was reasonable for taxpayers to assume new measures would be put in place, but Congress ended up providing AMT relief retroactively going back more than a year in its New Year's compromise.
Letting automatic cuts happen
Until sequestration hit, though, the government usually managed to get things handled in the long run without major incident. But the government's allowing automatic spending cuts to occur raises the possibility that political gridlock could indeed lead to retirees going over the Social Security cliff in 2033.
Moreover, when it comes to retirement issues, the government has given private employers huge latitude in maintaining pension-plan deficits. Boeing (NYSE:BA), General Electric (NYSE:GE), and Ford (NYSE:F) have had some of the worst pension shortfalls among U.S. companies, but the extent of the problem is as broad as it is deep, with a huge number of employers dealing with pension liability issues. Yet rules governing pension plans have allowed companies plenty of time to address any problems.
With that track record, lawmakers are likely to give themselves the same latitude in 2033 or whenever the Social Security cliff hits. All the government would have to do is to approve deficit spending to cover the benefits shortfall.
As an intellectual exercise, the Social Security Trustees Report serves the valuable purpose of focusing public attention on the financial challenges that government programs face. But without realizing the reality of Social Security's status as a third-rail political issue, you shouldn't plan on its conclusions reflecting the reality of the situation when it finally comes decades down the road.
Fool contributor Dan Caplinger has no position in any stocks mentioned. You can follow him on Twitter: @DanCaplinger. The Motley Fool recommends Ford and owns shares of Ford and General Electric. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.