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683 r December 19,1988 T HE CASE FOR KEEPING SOCIAL SECURITY IN THE BUDGET INTRODUCTION Social Security is the federal budgets second largest program, exceeded only by national defense. Roughly 20 percent of all federal spending is allocated for Social Security benefit payments, while about one-quarter of all federal revenues are raised through the Social.
Security payroll tax Because the systems revenues are projected to outpace payments substantially for about the next fifteen years, there has been growing concern that Congress will spend these retirement surpluses on other federal programs, as it has been doing in recent years, rather than prudently placing workers contributions to the system in safe, interest-bearing investments. Pressure understandably thus is growing in Wash ington to insulate the entire Social Security program from the rest of the federal budget. This would be accomplished by establishing an off-budget Social Security reserve to be drawn down when the baby-boom generation reaches retirement age.
In theory, th e idea may have some appeal. In the hard reality of Washington, however, it would fail. The reason: moving Social Security permanently off-budget would not deter Congress from continuing to raid the trust fund Conflicting with a Unified Budget. In additio n , the proposal would create a wide range of new problems. It would conflict, for instance, with the longstanding principle of maintaining a unified federal budget for measuring the impact of federal fiscal policy on the United States economy. Since Social Security taxes are part of total federal revenues and Social Security expenditures are part of total federal outlays, the program should be included in the budget and thus in calculating the deficit. Failure to do so would render the deficit meaningless a s a measure of the gap between taxes and spending.
Lawmakers during the last eight years wisely have been shifting all off-budget federal spending back on-budget. This process should not now be reversed Massive New Pressures. If Social Security is removed from the budget, moreover, the pressures to spend the temporary fund surplus on higher retirement benefits or on government-sponsored investment programs such as education, infrastructure, and health care would be irresistible politically. Assigning to Co n gress the task of managing a reserve fund thatis increasing at the rate of $4O-billion-t0-$50 billioneaeh year would be inviting a massive increase in such spending. At the same time, it would unleash massive new pressures to raise general taxes. The reeo n : moving Social Security off-budget would increase the official deficit by the amount of the current Social Security surplus, or $40 billion to $50 billion per year. This artificially higher deficit would be used by liberals to argue that the budget canno t be balanced without a major new tax increase If Social Security were removed permanently from the budget, therefore, federal spending and taxes likely would rise substantially. Just as important, by instilling within the public a false sense of security t hat with a mere accounting change the pension program would be permanently safe from political tampering, the proposal to create an off-budget Social Security reserve fund would impede those Social Security reforms necessary to ensure that todays workers a ctually receive their promised pension benefits HOW SOCIAL SECURITY IS INCLUDED IN THE BUDGET Though Social Security today is technically off-budget, it is so only-in the sense that it is listed separately in the unified federal budget. In accordance with the 1985 Gramm-Rudman-Hollings .Balanced Budget Act, all final budget totals must include Social Security and all other trust fund programs, like the highway trust fund. This means that the annual budget deficit figure reported by the press includes the S ocial Security surplus.
The surplus in the Social Security program currently reduces the total federal deficit by a substantial sum each year (though not by the overwhelming margin sometimes erroneously suggested In the current fiscal year, taxes in the en tire Social Security system, including the Hospital Insurance Trust Fund, will exceed the systems expenditures by about $40 billion. This amounts to 0.8 percent of the Gross National Product (GNP) and thus reduces the total federal deficit by this amount. Under the most widely cited intermediate projections of the Social Security Administration (SSA), the program will continue to reduce the total federal deficit by about 0.8 percent of GNP each year for about the next fifteen years? After that, the amount o f Social Security taxes in excess of expenditures will start declining, turning into a deficit by 2013 As a result of current Social Security surpluses, together with modest recent spending restraints in the remainder of the budget and the normal growth o f revenues through strong economic growth, the federal budget deficit has declined from 6.2 percent of GNP in 1983 1 662, July 11,1988 2 Ibid Peter J. Ferrara, The Great Social Security Surplus Hoax, Heritage Foundation Buckgrounder Number 2 to about 3 per cent of GNP, or about $150 billion, for fiscal 19
88. Moreover, the fiscal outlook is projected to continue improving. By 1993 the deficit will fall to about 2.0 percent of GNP, according to the Congressional Budget Office THE ARGU MENT FOR MOVING SOCIAL SECURITY OFF-BUDGET Critics of the-current system of budget accounting for Social-Security argue correctly that the Social Security surpluses are not being saved, but rather are funding other federal programs. The 1983 amendments to the Social Security Act, intended to place the system on a sound financial footing, assumed that Congress would build up large reserves in the Social Security Trust Fund over the next two decades, while the proportion of Americans in the labor force was l a rge, so that retirement funds would be available for the baby-boom generation when it entered retirement age. Building these reserves was said to be necessary, because while today there are 3.3 workers supporting every retired person, by the year 2030 the re will be only 2.0 workers for every Social Security recipient.
This mounting surplus, however, is not kept separate, nor is it likely that the cash will be available when it is needed. Legislators have been spending todays Social Security surplus on curr ent federal programs. Spending on these programs can increase precisely because any surpluses in the Social Security trust fund, by law, must be invested in Treasury bonds.
The federal Treasury simply records an IOU to the Social Security system when it s pends the surpluses. This interfund accounting procedure enables Congress to use the Social Security trust fund surpluses to reduce federal borrowing requirements and thus the deficit.
Ultimately, this allows new spending to take place without an increase in the deficit 1 Trillion Dollar IOUs. The problem is that, if this practice continues, the Treasury or more accurately tomorrows taxpayers will owe the Social Security system an estimated 7 trillion by the year 2015 and $12 trillion by the year 20
30. H ence a sizable tax hike will be necessary to pay the retirement benefits owed to todays workers, despite recent payroll tax hikes. The only alternative would be for Congress to slash promised retirement benefits, or to take other such steps as raising the retirement age, when these trillion dollar IOUs come due!
A number of Washington scholars and policy makers believe that Congress would be prohibited from spending the Social Security surpluses if a separate off-budget Social.
Security reserve fund were created. Brookings Institution Economist Henry Aaron, for instance, advocates separating Social ecurity from the budget and using the surpluses to increase the stock of national savings. Removing Social Security from the budget, the argument goes, would p l ace the system back on financially sound footing because after 20 or 30 years, when todays young workers retire, the Social Security Administration would have huge asset reserves in contrast to paper IOUs from the already debt-ridden Treasury 3 Congressio n al Budget Office, The Economic and Budget Outlook: An Update, August 1988 4 Another method of avoiding the crash in Social Security is for the U.S. to allow entry to substantially more immigrants, who are net contributors to the Social Security system 5 H e nry Aaron, Social Security and the Trust Fund Surplus, testimony before the National Economic Commission, September 7,1988 3 One result of this, of course, would be to increase immediately the official federal deficit by 40 billion to $50 billion, rising t o about $100 billion in 1993 (in current dollars because the reported deficit would no longer include any surplus or deficit in Social Security Accounting Trick. If the entire Social Security system, including the Hospital Insurance trust fund, were remov e d from the federal budget, the total reported federal deficit would increase each year for the next fifteen years or so by about0;8 percent of.GNP, or the equivalent of roughly 40 billion this year. Many of those who advocate separating Social Security fr o m the budget only propose to remove the Old Age and Survivors Insurance and Disability Insurance trust funds, which are projected to be heavily in surplus, while leaving the Hospital Insurance trust fund, projected to run big deficits, on-budget. This wou ld increase the total reported federal deficit by about 0.9 percent of GNP by 1995,l.O percent of GNP by 2000, and 1.07 percent of GNP by 2005, or the equivalent of about $50 billion in 1988 dollars.
Proponents of this accounting change maintain that this would be a more appropriate measure of the deficit, because the excess of Social Security taxes over outlays is not actually a program surplus but a reserve to pay future retirement obligations. The objective of shifting Social Security off-budget, theref o re, is to achieve a balanced budget for all programs exclusive of Social Security and to create large and mounting reserves in the off-budget Social Security system REASONS FOR KEEPING SOCIAL, SECURITY IN THE UNIFIED BUDGET The arguments in favor of a new budgetary treatment of Social Security are based upon the admirable goal of restoring the integrity of the Social Security system. On first examination, those arguments are appealing. Closer examination reveals four flaws 1) 1t.would distort the impact of federal fiscal policy on the economy The only economically meaningful calculation of the federal budget deficit is total federal revenues minus total federal expenditures. This indicates the amount the federal government must borrow from the private secto r during the fiscal year, which is what most Americans assume the deficit measures! Social Security taxes are part of federal revenues and Social Security expenditures are part of total federal spending. If Social Security taxes 6 The most accurate account of the impact of government fiscal policy on the capital markets would be a Public Sector Borrowing Requirement (PSBR), as is used in Britain. This would measure the net borrowing requirements of all levels of government in the U.S local, state, and feder a l and any government-owned corporation or organization. In the absence of such a policy variable, the federal deficit figure is a second-best measure of just the federal governments impact on the economy 4 exceed program expenditures, then the federal gov e rnment as a whole has to borrow less from the private sector? Thus excluding the Social Security surplus from the budget would give an inflated picture of the governments borrowing needs. The Congressional Budget Office (CBO) analysis of the budget treatm e nt of Social Security agrees with this assessment. In its 1988 report entitled The Economic and Budget Outlook, CBO states Excluding Social Security or any other government program from the budget] totals would distort the governments impact on the econom y and misrepresent its borrowing needs.a I 2) It would hinder efforts to establish budget priorities Removing Social Security from the budget would be inconsistent with a second important function of the federal budget: to provide a framework for setting n a tional spending priorities. It is no secret among lawmakers that the main motive for moving programs off-budget is to shield them from the budget process and thus from the forces of spending restraint. Postal workers, for instance, recently demonstrated, demanding that the U.S.
Postal Service be moved off-budget so that Congress could not cut its budget. Experience teaches that moving programs outside the restraint of the normal budget process typically produces runaway spending in these programs? This alm ost certainly would be the case with Social Security if the program were moved off-budget, because Congress could easily respond to pressures to add new benefits by increasing expenditures without pushing the program into visible deficit Avoiding Hard Dec i sions. Some lawmakers say that, since Social Security benefits are a vital source of income to many elderly, they should be protected from the budget.process But this would imply that Social Security is somehow more essential to the nations well-being tha n national defense, education, the federal criminal justice system, or entitlement programs for the poor all of which must each year contend with other federal programs for federal. funding. The fact is that a key function of Congress is to make the hard d ecisions about such difficult spending practices.
Nor is it accurate to grant special budget status to Social Security because the program is a self-contained trust fund with its own revenue source. There is at best a weak relationship between the Social S ecurity pa~oll taxes that young workers pay today and the Social Security benefits they receive in 30 or so years. In fact, the Social Security program in effect is an income transfer from workers to retirees. And unlike private pensionsprograms workers h a ve no legal claim to certain levels of future benefits based upon what they have paid into the system. The Supreme Court has expressly given Congress the right to alter amend, or repeal any provisions of the Social Security Act 7 Even if the Social Securi t y Administration (SSA) were to invest its trust fund surpluses in private securities rather than federal government bonds, this would not alter the analysis. If the SSA invested $40 billion in private securities the federal government would have to borrow an additional $40 billion to $50 billion from private sources. But the federal governments SSA would be lending $40 billion to $50 billion to the private sector, so the net effect on the capital markets would be zero 8 Congressional Budget Office, op. ck, p. 62 9 Thomas J. DiLorenzo, Putting Off-Budget Federal Spending Back on the Books, Heritage Foundation Buckgounder No. 406, January 30,1985 10 Fleming v. Nestor, 363 U.S. 603 (1960 5 3) It would encourage Congress to raise taxes enormously Despite the im p ression given by the media and many in Congress, the federal tax burden today is near an all-time high. Total federal taxes in 1987 consumed 19.4 percent of gross national product, well above the post-World War Il average of just over 18 percent. The dang e r of moving Social Security off-budget is that the burden of Social Security taxes then be used to argue that the tax burden has declined and that Americans can afford a tax hike. These claims would seem credible on the surface because the governments off i cial federal revenue estimates no longer would include the Social Security tax, which consumes about 15 percent of the average workers pay check (including the tax paid for him by the employer), and 7 percent of GNP. But the Social Security payroll tax is as much or more of a burden on the average American family as other forms of taxation, such as personal income taxes and excise taxes. would be ignored by Washington- politicians; Budget figuresexcluding Social Security would 4) Even with Social Security removed from the budget, Congress would continue to spend the programs surpluses There is widespread aMety about the current practice of borrowing Social Security surpluses for current spending. A mere accounting change is unlikely to alter this practice.
By its inherent nature, Congress has the political incentive to spend the Social Security surplus on current programs that yield immediate political benefits, rather than prudently saving for workers retirement 20 to 30 years in the future.
Even if Social Security were transformed into a separate reserve fund, Congress would continue to manage the fund and thus could devise schemes to spend the tens of billions of dollars of annual surpluses. Examples: legislators could raise benefit levels or spend the s u rpluses on new programs for the elderly, such as long-term nursing home care. More likely, Congress could divert the surpluses into spending categories, which it deceptively could label national investments including such expenditures as education, housin g , or infrastructure repair. This new spending would arouse little political resistance because technically it would not increase the deficit; it would simply spend down an off-budget surplus. Proposals to spend the Social Security surplus as soon as it is moved off-budget are in fact already circulating on Capitol Hill. Senator Terry Sanford, the North Carolina Democrat, for example, is proposing spending the surpluses on a public infrastructure revitalization program Swedish Scenario. It has been said tha t Congress could be prohibited by law from spending the surpluses by re uirin that the surplus funds be invested in the stock market or other private investments. But investing Social Security funds in the stock market would mean that the government eventu a lly would own a huge proportion of the nations industry and commerce, threatening the foundation of the U.S. economic system. And such investments could be used to reward politically influential special interest groups (such as declining industries in pol i tically sensitive states) or to increase the regulation of the private 91 11 Stuart J. Sweet, The Incredible Social Security Surplus Growing Year By Year, A.B. Laffer Associates 1988 6 sector by imposing conditions of investment (such as adoption of compa rable worth pay scales or parental leave policies).
This scenario already has happened in Sweden. Writes Irving Kristol of New York University Graduate School The Swedish surplus is invested in four streams: government bonds, housing bonds;.long termcapita l projects,- and new ,issues of common,stock. In effect, the socialist governments of Sweden have socialized the investment process while refraining from outright nationalization of the means of production. It is, of course, not socialism in any meaningfu l sense of the term but simply collectivism, statism. It is not a scenario likely to be attractive to the American people.12 ROLLING BACK THE SOCIAL SECURITY PAYROLL TAX According to a recent study by the Institute for Research on the Economics of Taxation IRET), the Social Security payroll tax hikes of 1988 and 1990 will increase the tax burden of working Americans by one-half trillion dollars over the next fifteen years. These tax hikes will cost the economy an estimated one-half million jobs and will red u ce GNP and capital stock by $100 bi1li0n.l~ Repealing these hefty anti-growth payroll taxes should be a major goal of the Bush Administration, as a prelude to structural reform of the Social Security system.14 It could be argued that moving Social Securit y out of the budget will make cutting the programs payroll taxes politically more feasible. According to the Social Security Administrations intermediate projections, the substantial Social Security payroll tax increases could be repealed, and the program s till would be able to pay all promised benefits for the next 30 years. And with Social Security off-budget, these payroll tax cuts could .be enacted without increasing the reported deficit. But the other side of the political coin is that moving the progr a m off-budget also would mean that surpluses could be spent without adding to the deficit. A successful effort to reduce payroll taxes needs time to develop grass-roots support, while Congress is already looking at ways to spend off-budget Social Security s urpluses HOW TO PREVENT CONGRESS FROM SPENDING THE SOCIAL SECURITY SURPLUS A simple accounting change will not prevent Congress from spending Social Security taxes on other programs. Moving Social Security out of the budget does not address the inherent p r oblem with Social Security which is mainly one of demographics. The 1983 12 Irving Kristol, That Bizarre Social Security Surplus, 77ie Wall Street Joimtal, June 17,1988, p. 26 13 Aldona Robbins and Gary Robbms, Effects of the 1988 and 1990 Social Security Tax Increases, Institute for Research on the Economics of Taxation, Econoniic RepoH No. 39,1988 14 Peter J. Ferrara, Upcoming Social Security Tax Hikes Can Threaten Retirement Benefits, Heritage Foundation Backgrounder, Number 597, August 5,1988.
Social Security fix, predicated on the principle of building large government reserves for 20 to 40 years, was sensible in theory. It has been fatally flawed in practice, proving defenseless against pressures in Congress to spend There are, however, genui n e solutions to the problem of congressional squandering of todays workers retirement incomes. One is to place the Social Security program back on a pay-as-you-go basis (with contingency reserves for a recession so that annual payroll taxes are set only at the level necessary to pay current.benefits;.This woul allow reductions baby-boom generation retires, Social Security payroll taxes would have to rise to a high of about 16 percent. This would, of course, be a burdensome tax rate to place on the next gene r ation of workers, but it would be only about 2 percent higher than todays payroll taxes. More important, the current buildup of IOU in the Social Security trust fund will have to be paid off by means of a tax hike in any case. And if the retirement age we r e raised slightly at that time, to reflect longer life expectancies, the tax would not have to be raised that high. Finally, if todays taxes are cut, private savings will rise, the economy will grow faster, and todays workers will bequeath a stronger econ o mic base to their children of about 10 percent in payroll taxes today, lasting through the year 2005.l 4 When the Substituting IRAs. Another solution to the problem of Congress spending todays Social Security payments is to allow workers to place all, or a portion, of their earnings into individual retirement accounts (IRAs), as a substitute for paying into Social Security.16 The many variations of this plan all share the common virtue of allowing workers to build up personal retirement accounts, rather th a n assigning Congress the responsibility for managing huge collective retirement reserves An IRA-type plan can be devised so as to assure current retirees that they will continue to receive full program benefits. One way to ensure this would be to collect s ufficient payroll taxes to pay benefits, but rather than collecting taxes sufficient to build a surplus allow workers to invest their surplus contributions into individual accounts, which they could not draw upon until they reached retirement age. This pr o posal would solve the congressional spending problem with respect to Social Security, because if Congress never received surplus retirement contributions, it could not spend them on other programs.17 CONCLUSION Moving Social Security off-budget might be a p pealing in theory, but removing 20 percent of federal spending and nearly 25 percent of federal revenues from the federal budget would distort seriously public understanding of the true federal deficit and its impact on the nations economy. This, in turn, would mean that Americas economic policy making would be based on a faulty picture of the public sector 15 David Koetz, Social Security: Its Funding Outlook and Significance for Government Finance Congressional Research Service, No. 86-674 EPW, 1986 16 Fe r rara, op. cit Sweet, op. cit 17 One model of this sort, called the Federal Employees Thrift Savings Plan, already exists. It allows federal employees to place portions of their group federal retirement contributions into individual savings plans. It might be appropriate to extend this newest feature of the federal employees retirement system to all Americans covered by Social Security 8 Heading Toward Insolvency. Moving Social Security completely off-budget also is a sure prescription for a major increase i n general taxes on top of recent and scheduled hikes in the Social Security payroll tax. Meanwhile, Congress no doubt quickly would discover a method to spend the off-budget Social Security surpluses In the end, taxes would be higher, spending would be gr e ater, and the Social Security system still would be on a course heading for-21st centuryho1vency Stephen Moore Grover M. Hermann Fellow in Federal Budgetary Affairs Peter J. Ferrara Associate Professor at the Geor e Mason University School of Law an d Sen ior Fellow of the Cat0 Institute 9
