Fix Social Security, Reduce the Trade Deficit

If America had a solvent Social Security program that wasn’t promising rich couples $100,000 per year, the trade deficit would be dramatically smaller.

Social Security’s Trustees just released their 2025 report, showing that the retirement program’s trust fund will be exhausted in 2033 and the program’s long-term funding gap now tops $25 trillion.

Congress’s reaction? None that I’ve seen. Your elected officials basically don’t care, and won’t care until the Social Security funding crisis is breathing down their necks.

But is there anything that could make them care?

What if fixing Social Security could also reduce the [cue drum roll] trade deficit?

Politicians may not care about Social Security, but they do care about the trade deficit. Some seem to care about it a lot. Economists not so much, but who cares what they think these days?

Regardless, what’s less well-understood is how a program like Social Security can impact the trade deficit. If people understood that, then perhaps a desire to reduce the trade deficit would inspire Americans to finally reform Social Security – the right way.

Some national income accounting

The trade deficit is the difference between the value of the goods and services we import and the value of the goods and services we export. The trade deficit in 2024 was around $918 billion.

But there’s a flip side to the trade deficit, which is the capital account surplus. That reflects the flow of money rather than the flow of goods. The deficit of goods is matched by a surplus of capital.

When we give foreigners our money in exchange for their goods, they need to do something with those dollars. They can spend them on U.S. goods. Or, they can invest them in the U.S., funding startups, buying existing companies, or purchasing Treasury bonds.

To understand this, it may help to look at how GDP is calculated using the so-called expenditure approach:

Y (GDP, or economic output) = C (consumer spending) + I (investment, such as building new factories) + G (government expenditures) + X (exports) – M (imports)

Exports and imports are often treated as a single term, net exports, which is (X – M). That’s what people think of as the trade surplus or deficit. The reason you net out exports and imports from the rest of the GDP equation is because exports are things we produce but don’t consume, while imports are things that we consume but don’t produce.

Hopefully clear so far. So here’s what it looks like without the labels:

Y = C + I + G + (X – M)

Now let’s switch the equation around a bit to isolate the trade deficit (X – M):

Y – C – G – I = (X – M)

This simply means that output minus consumption, government spending and investment is equal to the trade deficit.

Now, national saving is equal to GDP minus consumption minus government spending. In other words, saving is the amount of production left over after we subtract what households and the government spend. For simplicity, let’s say that national saving, Y – C – G, is equal to S.

So, we can rewrite our equation again as:

S – I = (X – M)

That means that the amount the economy saves minus the amount that’s invested in the economy is equal to the trade deficit.

As I discussed elsewhere, if we were big savers, like the Japanese, we’d save enough to not only cover all the investment that our own economy needs, but to invest additional amounts abroad. And so we’d have a trade surplus.

But since we’re actually big spenders – or rather, our government is a big spender, at least relative to what it collects – we end up with a trade deficit.

Okay, so here’s where Social Security enters the picture.

And it does so in two ways, both of which reduce national saving and in the process increase the trade deficit.

First, we’re currently borrowing to pay Social Security benefits. Because Social Security is no longer collecting enough in payroll taxes to cover the benefits it owes, the Social Security trust fund redeems the roughly $2.7 trillion in special-issue Treasury bonds that it holds.

This coming year, Social Security will redeem about $217 billion in trust fund bonds to keep benefit checks arriving in mailboxes. The Treasury doesn’t have that kind of cash lying around, so it borrows the money to repay Social Security. Since borrowing is the opposite of saving, that reduces national saving by roughly $217 billion.

So, if the government weren’t forced to borrow to fund Social Security – say, if we increased taxes or reduced benefits – the trade deficit would have been around $217 billion lower.

By 2033, the year the retirement trust fund will be exhausted, Social Security’s cash flow deficit will be $350 billion in today’s dollars. If we continued to borrow to keep paying full promised benefits, as I fear we will, Social Security will drive up the trade deficit even more.

Reforms that balance Social Security’s finances should reduce the trade deficit.

But there’s a second way that Social Security affects the trade deficit, which is more subtle but more interesting and more important.

One of the main sources of investment capital for U.S. businesses is Americans’ retirement savings. Each month we put aside money into pensions and 401(k)s, and that money gets invested so firms can build factories, do research, and so on.

But if there isn’t enough domestic savings to fill businesses’ investments needs – that is, if S is less than I – then firms get capital from abroad. As discussed above, that flow of investment capital into the U.S. translates into an increase in the trade deficit.

So what does Social Security have to do with this?

Well, each year, Americans accrue – or earn the right to – about $2 trillion in future Social Security benefits. Sometimes researchers refer to these accrued benefits as “Social Security Wealth.” Currently, accrued Social Security benefits are worth more than $50 trillion.

But Social Security is a pay-as-you-go program. There isn’t any actual saving going on. What Americans are earning each year is a right to future benefits paid for by future taxpayers.

Now – and here’s the slightly controversial part – if Americans were accruing lower future Social Security benefits, they would save more for retirement on their own.

Say, imagine a high-income couple, retiring in 2025 at the full retirement age of 67. Together, they’ll collect $94,836 in annual Social Security benefits. (I kid you not.) Assuming they each live an additional 15 years and ignoring interest, that’s $1.4 million in benefits they’ll get from Social Security.

Now, imagine that couple’s Social Security benefits were reduced. Is it plausible that they wouldn’t save more to make up the difference?

It’s not, and research from various countries concludes there is a substantial trade-off between government pension benefits and personal savings. In the table below I summarize some of their findings.

Note that this trade-off isn’t dollar-for-dollar. Low-income individuals don’t seem to respond very much to changes to government pension benefits. If you reduce future benefits for low-income working Americans, they don’t increase their savings very much – probably because they have so little income to save, and because they may be less financially informed regarding the benefits they would receive in the future.

That’s why we have a Social Security program in the first place: to ensure a decent retirement income for people who otherwise wouldn’t save much on their own.

But middle- and high-income households treat government pensions more as part of their overall retirement savings portfolio. They have a rough idea of the income they need in retirement as well as the income they’ll receive from Social Security. If Social Security benefits are increased, they’ll save a bit less on their own; if benefits are cut, they’ll save a bit more. (Retirement ages may also be affected, but I’m trying to keep things simple.)

This is particularly an issue for the U.S. Social Security program, where benefits extend much further up the income ladder than in other Anglo countries. The figures below are the maximum retirement benefit paid to a single individual in 2021, translated into U.S. dollars using the exchange rates at the time.

In countries like the United Kingdom, Australia, Canada and New Zealand, substitution of tax-and-transfer government pension benefits for real household savings is smaller, simply because high-income retirees receive only about one-third of the benefits that Social Security pays to high-income retirees.

For instance, compare Social Security to the Canada Pension Plan (CPP). Under Social Security, individuals accrue future benefits based upon earnings up to $176,100. They don’t accrue benefits on earnings above that amount, so at that point personal retirement savings should increase. In Canada, individuals stop accruing CPP pension benefits once their earnings hit about $59,000 US. At a much lower income point, Canadians need to start saving more on their own. That will affect national saving and, by extension, the trade deficit.

Imagine a Social Security reform that eliminated new benefit accruals for Americans earning over $59,000 per year. It wouldn’t affect the benefits they’d already earned, but going forward only salaries up to $59,000 would be entered into Social Security’s benefit formula.*

That step alone would reduce the value of future Social Security benefits accrued each year by about one-third, saving the program about $675 billion in future costs without touching benefits for the poor. (Yes, for the moment we’d still need to levy the 12.4% Social Security payroll tax on earnings up to $176,100. But over time that could be reduced.)

Now let’s imagine that these higher-income Americans increased their own retirement savings to make up 75 percent of the difference. That’s not a crazy assumption given what the research literature finds.

If so, household retirement savings would increase by about $500 billion per year.

And those extra savings have to go somewhere. Most would probably be invested domestically, which would reduce the need for foreign capital and, in the process, the trade deficit. Alternately, to the degree Americans invested those extra savings overseas, that outward flow of capital also would reduce the trade deficit.

I’m not saying this is an exact science. But either way, these extra savings would significantly reduce the trade deficit.

The short story is this: If you had a solvent Social Security program that wasn’t promising $100,000 per year to rich couples, the trade deficit would be dramatically lower.

Get on it, MAGA.

* This is a point I’ll write on in the future, but this approach to Social Security reform — pay benefits that have already been accrued, but reduce the rate of future benefit accruals — while fair, is also the less economically efficient way to go about reform. An economically-superior approach would cut accrued benefits while maintaining the right to accrue future benefits. The problem is that, to most people, this way of doing things seems obviously unfair.