Thanks largely to the upcoming retirement of the baby boom generation, Social Security benefit payments soon will exceed payroll tax revenues. Beginning in about a dozen years, thesae annual cash-flow deficits will begin to climb rapidly, soaring to $100 billion in 2015 and $500 billion in 2025. Defenders of the current system claim that these huge shortfalls are not a cause for concern because money in the Social Security Trust Fund can be used to finance all promised benefits until 2032.
President Bill Clinton, moreover, has proposed that a significant share of projected budget surpluses be diverted to the Trust Fund. Supporters argue that this move would allow benefits to be fully financed through 2049. The implication, of course, is that Social Security can continue for another 50 years without a tax increase. Therefore, argue supporters of the status quo, there is no need for fundamental reform, such as privatization.
Yet these assertions are based on a gross misrepresentation. The Social Security Trust Fund is a deception. It contains no genuine assets, only government bonds--IOUs that have no value beyond a promise to impose higher taxes on future workers. Even the Clinton Administration admits that the Trust Fund is fraudulent, stating in its proposed budget for fiscal year 2000 that:
These [Trust Fund] balances are available to finance future benefit payments and other trust fund expenditures--but only in a bookkeeping sense. These funds are not set up to be pension funds, like the funds of private pension plans. They do not consist of real economic assets that can be drawn down in the future to fund benefits. Instead, they are claims on the Treasury, that, when redeemed, will have to be financed by raising taxes, borrowing from the public, or reducing benefits or other expenditures. The existence of large trust fund balances, therefore, does not, by itself, make it easier for the government to pay benefits.
THE KEY QUESTION: DOES THE MONEY RUN OUT IN 2013 OR 2032?
Social Security receives the bulk of its revenue from the 12.4 percent payroll tax imposed on workers (see appendix). Income taxes imposed on the Social Security income of retirees also are counted as revenue for the program. Most of that money is paid out in benefits immediately. Since the mid-1980s, however, revenues have exceeded outlays, and these annual cash surpluses are expected to continue until 2013. After 2013, annual deficits will grow rapidly, reflecting the retirement of the baby boom generation.
Surplus Social Security revenues are collected by the Treasury and spent on other government programs. In exchange, the Treasury issues an IOU to the Social Security Trust Fund. In theory, this IOU will earn interest until it is cashed in to help pay retirement benefits for the baby boom generation. These IOUs, combined with the taxes that are paid into the system every year, supposedly mean that the Trust Fund will be able to fully finance benefits through 2032.
But the IOUs are not real assets. Social Security will run short of money in 2013, if not before, and proposals to add more IOUs to the Trust Fund are nothing but hollow budget gimmicks.
Why the Trust Fund's IOUs Are Not Real Assets
The bonds held by the Social Security Trust Fund are meaningless. The Congressional Research Service (CRS) notes that "Simply put, the trust funds do not reflect an independent store of money for the program or the government...." What, then, is the purpose of the Trust Fund? According to the Congressional Budget Office, "Trust Funds have no particular economic significance; they function primarily as accounting mechanisms to track receipts and spending for programs that have specific taxes or other revenues earmarked for their use."
The bonds have no independent value because, as the CRS notes, "When the government issues a bond to one of its own accounts, it hasn't purchased anything or established a claim against another entity or person. It is simply creating a form of IOU from one of its accounts to another." And just as an individual or a business cannot write an IOU to itself and count that as an asset (because the IOU is simultaneously a liability), neither can the government.
The Comptroller General of the United States recently testified to this effect: "[An] increase in assets to the SSTF [Social Security Trust Fund] is an equal increase in claims on the Treasury. One government fund is lending to another. These net out on the government's books." An actuary from the Social Security Administration admitted that the Trust Fund is a fiction, writing in 1990 that "in the more relevant area of actually obtaining cash to pay promised benefits in the future, the trust funds accomplish nothing...."
In reality, the Trust Fund's holdings simply measure that one part of the government--the Treasury--owes money to another part of the government--the Social Security Trust Fund. Indeed, the best possible interpretation of the Trust Fund is that the IOUs are a measure of how much taxes will have to be raised in the future. A group of government actuaries acknowledged this fact, writing that "we are not accumulating a true trust fund and are instead merely accumulating a right to future government revenues."
The preposterous nature of this arrangement is exposed when the time comes for the Trust Fund to redeem these IOUs. As the U.S. General Accounting Office (GAO) explains, "While the Trust Funds' Treasury Securities [bonds] are assets of the Social Security program, they are also liabilities for the rest of the federal government that, when redeemed, will have to be financed by raising taxes, borrowing from the public, or reducing other federal expenditures."
The government actuaries mentioned above came to the same conclusion. They asked: "Where would the cash required to pay the principal and interest on the bonds come from?" Their answer: "The Treasury would have to (1) increase its borrowing from the private sector and from other countries to raise the cash necessary to fund the deficiency in the OASDI program, or (2) raise taxes."
Mythical Interest Income
It should also be obvious that the interest "paid" to the Trust Fund is equally meaningless. It is true that the bonds in the Trust Fund receive interest, but that interest income takes the form of additional IOUs. In other words, the original IOUs result in more IOUs. The CRS refers to the supposed interest payments as "paper income."
The GAO concurs: "The interest credited to the trust fund...is an internal transaction of the government. One part of the government (the Treasury) credits the interest to another part (the trust fund), so the two transactions offset one another and have no budgetary effect."
Finally, recall the question that prompted this discussion: Do Social Security's deficits begin in 2013 or 2032? The Comptroller General answered that question recently, testifying that "Without the President's proposal, payroll tax receipts will fall short of benefit payments in 2013; with the President's proposal, payroll tax receipts also fall short of benefit payments in 2013."
CLINTON'S FRAUDULENT GIMMICK
Since the Trust Fund is demonstrably meaningless, it should come as no surprise that a range of analysts have condemned the President's plan. Writing in The New Republic, syndicated columnist Matthew Miller stated that the Administration's plan is nothing more than "a phantom bookkeeping transfer each year from the rest of the budget to the trust fund."
A particularly odd feature of the White House proposal is that the President is creating $2 of IOUs for every $1 of Social Security surplus that is spent on other government programs. The first IOU is created when extra Social Security revenues are "lent" to the Treasury. Then, when this extra money is used by the Treasury to reduce the national debt, the Trust Fund would get another set of bonds. As stated in The Washington Post, "the net effect would be that the program would get a second set of IOUs...."
Other analysts have been equally critical. Reviewing the White House claim that its plan will delay the program's bankruptcy, the Associated Press reported, "The blunt answer is that it does so only on paper. The trust fund will now hold more Treasury bonds--the second set of IOUs. But they will be worth the same as the first set--nothing." The Comptroller General agreed, testifying that "although the trust funds will appear to have more resources as a result of the proposal, in reality nothing about the program has changed."
Ironically, this use of accounting gimmicks overshadows the fact that the Administration actually is advocating a policy--paying down the national debt--that has some merit. The President even acknowledged that this was the real policy, remarking that "we will, in effect, be buying back the national debt." But as Matthew Miller has pointed out, "Clinton could have called for using the surpluses to pay down debt without the phony hike in the trust funds."
CONCLUSION
According to the GAO, the proposal put forth by the Administration "does not represent a Social Security reform plan." Privatization is the only way to solve Social Security's financial woes while also increasing retirement income for today's workers.
The concept of individual accounts has bipartisan support in Congress. Moreover, about two dozen nations around the world have shown that private retirement systems are feasible. As evidence mounts that White House plan is phony, baby boomers can only hope that the Administration will abandon gimmicks and embrace real reform.
Daniel J. Mitchell, Ph.D. is a McKenna Senior Fellow in Political Economy in The Thomas A. Roe Institute for Economic Policy Studies at The Heritage Foundation.
APPENDIX:
SOCIAL SECURITY'S RISING TAX BURDEN
Payroll taxes have been one of the fastest-growing burdens on families over the past three decades. As the following charts illustrate, the rate has climbed steadily.
The payroll tax, however, is only part of the burden. As recently as 1971, Social Security taxes were applied only to the first $7,800 of income; today, they are applied to the first $72,600 in wages. By taxing more of a worker's income and at a higher rate, the payroll tax has become a bigger burden than the income tax for about 75 percent of U.S. workers.
Because of this crippling burden, the consequences of trying to finance Social Security's deficit with higher taxes would be catastrophic. Just bringing the system into balance would require an increase of about 6 percentage points in payroll tax rates.
Moreover, this estimate is based on a set of economic assumptions that may not be warranted. Based on the Social Security Administration's less optimistic assumptions, payroll tax rates would have to rise to 28 percent for promised benefits to be paid. Although such tax increases might be sufficient to pay promised future benefits, the economy would suffer severe consequences. Total job losses could reach as high as 3.5 million even under the more favorable assumptions, and fewer jobs would mean lower Social Security payroll tax collections, causing the actual tax burden to climb even higher.