Each year the six-member Board of Trustees who oversee the financial operations of Social Security report to Congress on the actuarial status of the Old-Age, Survivors, and Disability Insurance Trust Funds. The 2008 report concludes that, “Social Security’s trust funds are projected to allow full payment of scheduled benefits until they become exhausted in 2041.” This date, which is the same as reported in 2007, is widely taken as a sign of Social Security’s financial outlook.

Unfortunately, fixating on the trust fund’s exhaustion date is seriously misleading. The accumulation of surpluses in the trust fund gives an exaggerated notion of Social Security’s ability to pay its way. These surpluses have been loaned to the U.S. Treasury in order to finance current government spending. In exchange, the trust fund receives from the Treasury nonmarketable securities that are useless as a means of forward funding. These "special issue" securities have no market price (they are not traded) and are backed by nothing of tangible value.

When Social Security begins running cash flow deficits, it is supposed to use the trust fund to pay benefits. However, the presence or absence of a trust fund makes no economic difference. To pay benefits, Social Security must present its special issue securities to the Treasury, which in turn will have to extract the funds from the private economy through higher taxes or further public borrowing. What matters is Social Security’s cash flow surplus, i.e., the surplus of tax revenues over costs.

As the table below shows, Social Security’s cash flow is projected to weaken until the end of 2016, when the payroll tax will just cover costs. Beginning in 2017—over two decades before its projected exhaustion date—Social Security will start running cash deficits. These deficits are expected to increase steadily, exceeding $800 billion in 2040.

These cash deficits must be covered. However, the political risks involved in raising taxes or cutting benefits will give politicians a strong incentive to defer action as long as possible by relying on debt financing to cover Social Security’s growing cash deficits—a sure recipe for inflating.