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Friday, June 19, 2009

Don't Worry, Be Happy: Characterization of Social Security Trust Funds

A. Haeworth Robertson
Former Chief Actuary, Social Security Administration, 1975-78

The nature and significance of Social Security trust funds is sometimes misrepresented to the public. This appears to be the case in Social Security Brief #30 issued on May 12, 2009 by the National Academy of Social Insurance. The section of this brief entitled “Where does the Social Security surplus go?” states essentially the following:

“Some people worry when they hear that Social Security annual cash surpluses are loaned to the U.S. Treasury and the government spends the cash on other activities.” Don’t worry, be happy, because when a Social Security surplus is loaned to the government it reduces the debt owed to the public by the amount of the surplus and thereby makes it “easier to afford Social Security and other activities of the government in the future.” (Emphasis added)

I believe that this conclusion is incorrect and that it is an inappropriate way to characterize the nature and value of the trust funds.

Those who believe the brief’s conclusion is correct appear to rely on the assumption that “intragovernmental debt” is different from “public debt.” Perhaps it is, but no matter how the debt is labeled:

  • the U.S. government’s responsibility to pay interest and eventually repay the loans is no different.
  • the amount of future taxes required to pay interest and eventually repay the loans is no different.

Collecting surplus Social Security taxes and loaning the funds to the government and calling it “intragovernmental debt” does not “make it easier to afford Social Security and other activities of the government in the future” than if the government borrowed that same amount from someone else and called it “public debt.”

There are, however, other consequences to collecting surplus Social Security taxes and loaning them to the government:

  • The government uses Social Security taxpayer money to finance other government programs during the years that surplus Social Security taxes are added to the “trust fund,” and thereafter uses general revenue to finance Social Security benefits. This results in a subtle cost-shifting between one generation of the Social Security taxpaying population and a later generation of the general taxpaying population.
  • By the time the trust fund is nearly exhausted, say in 2037, Social Security benefits and administrative expenses will be financed 76% by payroll taxes and 24% by general revenue (to redeem Treasury securities). Therefore, this financing procedure is, in effect, an ingenious method of gradual transition from payroll tax financing to significant general revenue financing.
  • After 2037 when the trust fund has no more Treasury securities to be redeemed, the government could--with a change in the law--finance the deficit between payroll taxes and benefits by simply continuing to use general revenue or by borrowing, just as it will have been doing since 2016 to pay interest on or redeem Treasury securities. The result would be a seamless shift to still more general revenue financing after 2037.
  • Labeling some of the government’s debt as intragovernmental debt (the part borrowed from the trust funds), and thus reducing the acknowledged public debt, may lead some people to believe the government’s fiscal condition is stronger than it really is. Accordingly, the government may be able to offer lower interest rates than otherwise required to induce the general public to buy Treasury securities. However, this will work only so long as the voluntary purchasers of Treasury securities fail to recognize the true government debt. (It may be relevant to note that at the beginning of 2009, 24 percent of the total national debt was owed to the Social Security trust funds; and another 19 percent was owed to other federal trust funds or accounts.)
  • By requiring Social Security taxpayers to pay excess taxes that are then used to buy Treasury securities (using the ruse of building up a “trust fund” to finance Social Security benefits), the government may be able to pay a lower interest rate on such securities than if it had to sell them on the open market. (An effective subsidization of government operations—and general taxpayers-- by Social Security taxpayers?)
  • By requiring Social Security taxpayers to pay excess taxes that are then used to buy Treasury securities, the government takes funds from the hands of such taxpayers that are thus not available for alternative uses. Such taxpayers might well have made more productive use of these funds if they’d had a choice.
  • For the unsophisticated, all the rhetoric frequently used to describe the “trust funds” tends to bestow on the trust funds an undeserved significance; to obscure the fact that funds purportedly collected to pay Social Security benefits are diverted to other government programs; and to suggest that Social Security is more financially viable, during the period the “trust funds” exist, than it really is.

Acknowledgment of the true nature and significance of the Social Security trust funds will be important as the nation considers alternative ways to make the program viable. It will be of particular significance when considering proposals to increase payroll taxes at a time they are not needed to pay current benefits. Such tax increases might put the system’s income and outgo into “arithmetic balance,” but they would result in a trust fund buildup of questionable value.

Posted on June 19, 2009  |  Add your comment
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Thank you for your thoughtful comment, Haeworth. We will look into your concerns. Joni Lavery
Haeworth:I commend you for your knowledge and your courage.Rarely do we see such forthrightness in the media today.I will provide excerpts from three good third parties and the links to verify some of your thoughts. "In 2008, $5.8trillion was held by the public and $4.2 trillion was intragovernmental debt which arises when one party of the government borrows from another. It is debt represented by government funds, involving Social Security and Medicare trust funds. When the Government borrows these excess receipts, it still has an obligation to repay them to the trust funds with interest.The Federal Government's Financial Health: A Citizen's Guide to the Financial Report of the U.S. Government http://www.gao.gov/financial/fy2008/citizensguide2008.pdf. "Each of the social insurance programs has an associated trust fund to account for its activity. The collection of earmarked taxes and other earmarked revenue is credited to the corresponding trust fund that will use these funds to meet a particular government purpose. If the collection from taxes and other sources exceed the payments to the beneficiaries, the excess revenue is invested in Treasury securities or 'loaned' to the Treasury's general fund. Therefore, the trust fund balances do not represent cash.The Government does not set aside assets to pay future benefits or other expenses associated with earmarked funds. The cash receipts collected from the public for an earmarked fund are deposited in the U.S. Treasury, which uses the cash for general government purposes.'Fiscal Year 2008 Financial Report of the U.S. Governmenthttp://www.gao.gov/financial/fy2008financialreport.html. "The present Social Security system has its surpluses accumulate in the trust fund. These surpluses increase the government's capacity to pay future benefits, only if they result in smaller amounts of public debt issuance that would occur if there were no surpluses. This is because reducing near-term debt increases the government's capacity to issue future debt to pay benefits when the trust fund bonds are redeemed. Running a Social Security surplus today would instead lead to more debt outside the trust fund that must be paid by future generations, leaving them with no net gain.In order for Social Security surpluses to be saved, taxes and spending in the non Social Security portion of the budget must be set recognizing that special-issue government bonds held by the trust fund are liabilities that are every bit as real and important as debt held by the public. Only when the trust fund bonds are equal to publicly held debt, then the non Social Security budget will plan in advance for redeeming them by using Social Security surpluses to reduce public debt issuance. When used to lower publicly held debt today, the surplus increases the government's capacity to issue publicly held debt to pay for future Social Security benefits.Issue Brief No. 4 Social Security Reform: Mechanisms for Achieving True Pre-Fundinghttp://www.treas.gov/press/releases/reports/ss_issuebrief_no.4.pdf.Don Levit,CLU,ChFCDonaldLevit@aol.com
Mr. Robertson is absolutely correct. However, America's pension problem is even bigger than social security and Medicare, which the Social Security Trustees report is in worse financial shape than Social Security. All across the land state and local pension systems are under-funded; the total under-funding is reputedly $2 trillion; State and local pensions that are under-funded share the cause of their under-funding with Social Security and Medicare: Government has over-promised and is not capable of fulfilling its promises.State and local pension systems are compromised by (1) the political power of public employee unions to extract from legislatures pension and health care promises far beyond what employees can expect in the private sector; (2) the propensity of legislatures to make such promises for the future while failing to fund those promises in advance of the need to honor them; and (3) over-optimistic actuarial assumptions about the rate of return on investments. What we see is equivalent to a vast, nationwide Ponzi process going on at all levels of federal, state, and local governments, a Ponzi process that dwarfs the totality of all the private Ponzi schemes that ever existed. Haeworth Robertson, who was Chief Actuary of Social Security for three years (1975-1978) spent a vast amount of his time, energy and personal resources to warn America about the funding problems of Social Security and Medicare. He wrote and published three books on the subject between 1981 and 1997. David Walker, Comptroller General of the U.S. from 1998 to 2008 also has been warning about the funding problems of federal entitlements for at least the past five years. In 2004 the International Monetary Fund warned the U.S. Government that to fund Social Security and Medicare adequately "world require an immediate and permanent 60 percent hike in the federal income tax yield, or a 50% cut in Social Security and Medicare benefits . . . with the burden on future generations increasing if further corrective measures are delayed." The Peter G. Peterson Foundation published a monograph on the subject in 2008 entitled The State of the Union's Finances citing the federal government's own financial statement as of September 30, 2007 that if unfunded entitlement obligations were taken into account, the nation's debts were then $53 trillion [more than the total net worth of American households], rather than the published "public debt" figure of $10 trillion. The Congress of the United States, which created this problem, tries to pretend the problem does not exist, behaving like the proverbial ostrich with its head in the sand. General Motors and Chrysler were bankrupted in large part by improvident promises pension and health care promises these companies made to the United Auto Workers Union under the pressure of the union's power to shut down these capital intensive companies, inflicting great losses during strikes. The U.S. Government system of entitlements is bankrupt as well, but the actual repudiation of liabilities can be postponed for a long time due to the power of the federal government to issue debt payable in money of its own issue. The eventual repudiation of its obligations will be in the form of high inflation that devalues the promises, and in part by a more direct form of repudiation--cutting benefits and raising taxes. There is a solution to these problems: cutting government spending to the level necessary to match government tax revenues. Cutting spending will require telling the beneficiaries of government spending that their benefits will be reduced. The alternative is much higher taxes, and apparently no level of government is ready, willing, and able politically to raise taxes enough to balance their budgets, or they would not be running persistent deficits. Frederic G. MarksCheviot Value Management, Inc.Santa Monica, CA 90401
I basically agree with Haeworth and would just a slightly different perspective. When the NASI brief says that on-budget borrowing from Social Security reduces borrowing from the public, it's assuming that all else is equal, that is to say, that the amount of borrowing by the on-budget is independent of the size of the Social Security surplus. But there's good reason to assume that's not the case: imagine if policymakers target a unified budget deficit of $x billion. If the off-budget (Social Security) surplus increases, then policymakers may spend more or tax less on the on-budget side to maintain the targeted unified budget balances. Since policymakers do reference the unified budget balance and seem to want to deficit spend, at least as much as public opinion allows, I think this is at least a plausible argument.There's some econometric evidence that this is what happens. A trio of studies by well-respected economists have concluded that Social Security surpluses since the 1980s have not translated to improved budget balances. The basic analytical technique is to ask how changes in the Social Security balance correlated with changes to the overall budget balance, after adjusting for other factors. Kent Smetters of the Wharton Schol, who wrote the first such study, concludes:"…there is no empirical evidence supporting the claim that trust fund assets have reduced the level of debt held by the public. In fact, the evidence suggests just the opposite: trust fund assets have probably increased the level of debt held by the public."Barry Bosworth and Gary Burtless of the Brookings Institution, using a sample of OECD countries to supplement results focusing on the U.S., conclude:"A large portion of the accumulation within national social insurance systems is offset for the government sector as a whole by larger deficits in other budgetary accounts. On average, OECD countries have been able to save only a small portion of any funds accumulated within their social insurance systems in anticipation of large expected liabilities when a growing fraction of the national population is retired. Between 60 and 100 percent of the saving within pension funds is offset by reductions in government saving elsewhere in the public budget."In other words, a dollar of Social Security surpluses tends to be offset by 60 cents to one dollar in increased spending or reduced taxes in the non-Social Security portion of the budget.John Shoven of Stanford and Sita Nataraj of Occidental College examined trust fund saving throughout the federal budget. Their conclusions are summarized as:"The authors find a strong negative relationship between the surpluses: an additional dollar of surplus in the trust funds is associated with a $1.50 decrease in the federal funds surplus. This finding is not significantly different from a $1.00 decrease, which would suggest a dollar-for-dollar offset of trust fund surplus with spending increases or tax cuts; the authors are able to reject the hypothesis that the full dollar of trust fund surplus is saved by the government."To sum up, the best evidence suggests that Social Security surpluses, rather than building savings to help pay future Social Security benefits, instead tend to subsidize present consumption.
If Andrew is right one possible solution is just to eliminate what CBO calls SS primary surplus. This could be done by reallocating FICA to add 0.02% to DI, deducting that amount from OAS. This would put DI back in short term actuarial balance while eliminating much of OASs remaining (and shrinking) primary surplus. If necessary there could be an additional small diversion from OAS to HI.If that is that the net effect of primary surpluses is as Andrew suggests actually is more than matched by General Fund borrowing. Just remove the paper temptation.I have to say that this message today kind of flies against the argument this spring that we should be spooked because under some calculations the combined primary surplus vanished in Feb. So what Over the long run this could be addressed by an active attempt to target what I call Baby Bear, SS running not too hot and not cold with a more or less steady state TF ratio around 130. Colleague and I have advanced such a plan based on a direct increase to DI with no reallocation from OAS to either DI or HI but it could easily adapted to keep FICA level over the medium term.But considering how fast primary surpluses are vanishing it seems a little odd to consider any negative effects they had when they were running North of $100 bn a year.Bruce Webb
Frederic:I agree with your assessment of the fiscal sustainability of state and local pensions.This underfunding only adds to our debt load.Bear in mind, though, that the states and cities do have actual pension trusts, which hold real assets.And, while almost all of the retiree health care benefits are pay-as-you-go with few reserves, at least they are pay-as-you-go financing.As I stated in my first posting, the payroll taxes are not automatically deposited in the trust funds.First they go to the Treasury's general fund where they are used to pay for general governmental expenses, just like all other revenue collections. So much for earmarking of the contributions to pay for benefits. Way back in 1938, the Advisory Council was concerned about this lack of "direct deposit." As it recommended "The receipts of the taxes levied in Title 8 of the law should through permanent appropriation be credited automatically to an old-age insurance fund and not to the general fund for later appropriation. It is believed that such an arrangement will be constitutional. The old-age insurance fund should specifically be made a trust fund, with designated trustees acting on the behalf of the beneficiaries. The trust fund should be dedicated exclusively to the payment of the benefits provided under the program. Since the taxes levied are essentially contributions intended to finance the benefit program, it is not only logical but expedient to provide for automatic crediting of tax proceeds to the old age insurance fund.In recommending these technical changes in the method of handling the contributions under the program, the Council believes the technical improvements here recommended will simplify and strengthen the financial provisions of the program." http://www.ssa.gov/history/reports/38advise.html. So, it can be strongly suggested that Social Security and Medicare are not even pay-as-you-go systems, much less having trust funds holding reserves that can pay benefits.Don Levit

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