Social Security Privatization

How does the point that privatization is a wash for the Social Security trust fund relate to the argument that the transition cost is zero?

Both points rely on a dynamic analysis — over time (he says redundantly).

Arnold… you know what would be really useful? “Arnold Kling’s Social Security Spreadsheet”. Have it compare current assumptions, band-aid fixes, radical privatization for solvency of Social Security system as a whole and individual retirees over the next 50 years. Have the formulae and input values explicit and some kind of blogo-community process for adjusting them. Post in table form on a dedicated page on this site. If I knew the first thing about this stuff, I’d do it myself. But I do know that it would start to make a visible case for change.

I think Miron and Murphy have it bass-ackwards. For starters, they dismiss the notion of returns on private Social Security accounts because the current system doesn’t really pay returns. That’s true, but so what? The point is that workers who are allowed to drop out of the system would be able to invest their money where it yields more retirement income than they would have received from Social Security.

Yes, those same workers would receive lower Social Security benefits (or the equivalent in a lump-sum payoff for taxes already paid). But, given the declining worker-to-retiree ratio, they have to be better off if they’re allowed to put their money into almost any private investment vehicle. It doesn’t have to be the stock market; high-grade corporate bonds would do the trick.

The net transition cost is zero because money “borrowed” to cover near-term benefits is “repaid” by lower benefits paid to future retirees. But that has nothing to do with Miron and Murphy’s abracadabra with the mythical trust fund.

cb, I’m not talking about the constitutionality of Social Security. I agree that it’s unconstitutional. In fact, I recently ran a long post on just that subject. It’s here.

I’m talking about the mechanics of privatizing Social Security. It has to go something like this: Younger workers are allowed to drop out of the Social Security system, but at some point the system has to borrow to pay the benefits of persons who are already retired or weren’t young enough to drop out of the system. The younger workers who don’t have to pay Social Security taxes have money to invest in private accounts, which yield greater returns than the “returns” they would have realized from traditional Social Security. Some of those additional returns are captured by the government, in the form of taxes, to repay the money borrowed earlier. The younger workers keep the rest, and they’re still better off than they would have been had they been forced to stay in the system.

As older workers die off, the cost of their benefits is reduced, eventually to zero, which eventually reduces the need for borrowing and taxation to zero. It’s the older workers’ benefits that go down, in the aggregate, because they’re dying off. And as their benefits go down, borrowing to defray those benefits goes down, which means that younger workers have to pay a smaller and smaller fraction of their returns from private accounts. The net effect on a particular cohort of younger workers depends on how the government arranges the borrowing and taxation over time.

There’s no free lunch — but those who are allowed to privatize will definitely enjoy a bigger meal than those who aren’t. It’s too bad for younger workers that they can’t simply walk away from the system and keep all the returns from their private accounts — but someone has to cover the benefits of older workers who supported those who went before them and now, quite reasonably, expect something in return.

At the end of a transition like the one I’ve described, no one would be worse off than they expected to be, and a lot of (younger) people woudl be better off than if they had been forced to stay in the system. I don’t see a better way out of the Social Security mess.

Privatization is a remedy for the fundamental problem facing SS — not insolvency, but the fact that it is about to start paying negative returns to millions of today’s young workers, and no more than trivial positive returns to anybody, as the SS actuaries show.

SS funding gap remedies that are simple and sensible in principle — such as delaying retirement age as the population gains longer and healthier life expectancy — fail the political test because they are benefit cutbacks that drive these already negative-to-miniscule rates of return further down.

A fundamental promise of FDR and SS’s founders was that SS would always pay a “fair” positive return to everybody. Of course its great popularity has resulted from paying *much more* than a fair return to the first generations of participants.

That closing the funding gap per se is not the difficult or serious problem facing SS can be seen from the fact that big funding gaps in SS have been closed *repeatedly* since the 1940s with no serious problem by raising taxes and (later) cutting benefits.

Today’s problem is that they’ve run out of room to do so while maintaining the promised positive returns for participants — and starkly negative returns stand to make SS as unpopular in the future as big positive ones made it popular in the past.

Real returns figure to be 25% lower than even the formula ones the SSA actuaries give above because of the funding shortfall, as either a tax hike or benefit cut to close the shortfall reduces return on contributions accordingly — and *that’s* the problem of closing the funding gap.

That said, privatization certainly can play some role in reducing the funding gap.

E.g: In the SSA figures referred to above, note that a low-income single male gets a little less than zero return on SS contributions — let’s round up so he gets $1 forty years from now for $1 contributed today, both current value. (Ease of computation!)

Now say that instead of paying $1 of SS tax today he invests in real savings. The gov’t now must borrow $1 to cover the lost tax revenue to pay somebody else’s benefit. The average real rate on long-term gov’t bonds since going off the gold standard has been 2% — say it pays that on the borrowing. Meanwhile the individual invests the $1 in SS savings to earn 4% (no reason to go nuts with growth stocks, investment grade corporate bonds and the like will do).

Forty years in the future the individual will have $4.80 in savings instead of a $1 benefit. The gov’t will have to pay off $2.20 in bonds, assuming it compounded its interest charges, but owe $0 in benefits to the individual. That creates a net gain of $1.60 betwen them that can be divided between them by some formula with both coming out ahead.

Being that that amount is 160% more than the entire benefit owed to the individual on his contributions under the current benefit formula, it is nothing to dismiss lightly.

An additional fiscal benefit is that the government’s borrowing is shifted forward to today when it can be afforded, and is reduced 40 years from now when it will be borrowing up to its neck trying to finance Medicare.

So while privatization won’t close the SS financing gap by itself, its potential contribution towards doing so shouldn’t be sneezed at.

As someone said in an earlier comment, the solvency or insolvency of the trust fund is irrelvant. The real issue is how to provide a given level of benefits at the lowest cost to participants. There’s only one way to do that: privatization. Social Security doesn’t yield a real return; it’s merely a transfer-payment Ponzi scheme that’s going to begin claiming victims in about 14 years. Private accounts, on the other hand, do yield real returns. Therefore, privatization must provide a given level of benefits at the lowest cost to participants. The only question, then, is how to get from the present transfer-payment scheme to a system of private accunts.

SS funding gap remedies that are simple and sensible in principle — such as delaying retirement age as the population gains longer and healthier life expectancy — fail the political test because they are benefit cutbacks that drive these already negative-to-miniscule rates of return further down.

A fundamental promise of FDR and SS’s founders was that SS would always pay a “fair” positive return to everybody. Of course its great popularity has resulted from paying *much more* than a fair return to the first generations of participants.

1. SSI is an Insurance system, not a savings system. ‘Returns’ were never promised, only benefits if someone became a certain age (and later benefits if someone became disabled).

Now say that instead of paying $1 of SS tax today he invests in real savings. The gov’t now must borrow $1 to cover the lost tax revenue to pay somebody else’s benefit. The average real rate on long-term gov’t bonds since going off the gold standard has been 2% — say it pays that on the borrowing. Meanwhile the individual invests the $1 in SS savings to earn 4% (no reason to go nuts with growth stocks, investment grade corporate bonds and the like will do).

Forty years in the future the individual will have $4.80 in savings instead of a $1 benefit. The gov’t will have to pay off $2.20 in bonds, assuming it compounded its interest charges, but owe $0 in benefits to the individual. That creates a net gain of $1.60 betwen them that can be divided between them by some formula with both coming out ahead.

A static analysis if I ever saw one.

1. Increasing US borrowing today will likely increase interest rates. Increasing interest rates will boost the cost of the bond that your hypothetical investor will have to pay off (or his children will pay off in the form of taxes…rather ironic they will pay taxes for debt incurred today just like we pay taxes for our ‘debt’ incurred to our parents thru their SSI payments).

2. Increasing interest rates, of course, hurts stock returns attacking the benefit side of your equation.

The SSI trust fund surplus today is artifically raising stock returns and dampening gov’t bond returns. You can’t assume that will all stay the same if you just flip a switch and reverse the structure of the trust fund.

A fundamental promise of FDR and SS’s founders was that SS would always pay a “fair” positive return to everybody. Of course its great popularity has resulted from paying *much more* than a fair return to the first generations of participants.

“SSI is an Insurance system, not a savings system. ‘Returns’ were never promised…”
~~~~

That is false, they were.

The founders of SS — FDR personally — explicitly promised “fair returns” on contributions to SS that were positive and comparable to market rates. They in fact stated they expected the average yield to participants to be a real 3%, that on government bonds, varying somewhat with the individual’s situation, somewhat more for low contribution levels and less for higher ones, but positive for *everybody*.

As to the “insurance system” claim that keeps being made by defenders of the status quo, this is rather ironic:

FDR personally insisted on the “insurance system” terminology to make sure that SS *was* funded with savings, on an actuarially sound basis, with returns on benefits computed *as a commercial insurer* would compute them.

That is why he called it an “insurance system” — while others who wanted to create an unfunded paygo system as you describe *opposed* using the “insurance” terminology.

When FDR was presented with plans that weren’t funded on an actuarially sound basis as an *insurance program* would be, he literally threw the first one in the trash in the office to make his point, and later vetoed an alternative.

As a result, FDR’s SS Act of 1935 was a funded plan in which benefits were explicitly tied to contributions earning a positive rate of return — a principle publicly promised by FDR and SS’s other founders.

(All the changes that turned SS into the paygo system it is now came *later*, starting in 1939 when after first being over-ridden on his veto of the first ones, FDR gave up fighting them because he had to fight WWII. Then SS was *really* turned into what it is today in the 1950s and 1960s, when it was amended to increase benefits and cut funding almost every two years. And of course it was bankrupt by 1980.)

So it’s really rather bizarre to hear defenders of the SS status quo say SS doesn’t have to be funded with real investments *because* it’s an insurance program! FDR must be popping wheelies about this, wherever he is.

His “insurance” terminology was talking about the *funding*. What real-world insurance program isn’t funded and actuarially sound?

“… only benefits if someone became a certain age…”

It’s also a torturing of the English language to call that “insurance” — that’s what’s known as a “pension”.

E.g. if you go to the SSA web site you will find its actuaries describing the SS retirement benefit as a “defined benefit pension plan”, and if you go into the historical section you will find discussions of how the pension benefit’s funding moved from insurance basis — as commercial insurers fund pensions — in the early days, to paygo.

I mean, c’mon: Real “insurance” only pays off upon the occurrence of an insurable risk that is uncertain to happen. Health insurance doesn’t pay off if you don’t need medical treatment, auto insurance doesn’t pay off if you don’t have a car accident, and life insurance doesn’t pay off if you don’t die during the policy period.

If SS is “insurance against poverty in old age” then what’s the insurable risk that occurred that Warren Buffett is collecting on? (And Bill Gates will too?)

Nothing. None. Warren’s collecting on his credits in a defined benefit pension plan, pure and simple — although the plan happens today to be unfunded and massively actuarially unsound on a paygo basis.

To call that pension an “insurance benefit” is a bit of word play worthy of the Ministry of Truth.

And Warren’s receiving a far higher-than-market rate of return on his credited contributions – which will be paid for by today’s young when they receive a negative-to-zilch return on theirs, in flat contradiction to SS’s explicit founding promises.

Now, one doesn’t have to be a political genius to realize that they won’t like that, and that as the future majority of voters they may take it upon themselves to change the program in ways today’s defenders of SS wouldn’t at all approve, if their objections aren’t anticipated.

Of course SS yields a real return. By reducing borrowing today costs are cut in the future.

I really like this idea that not funding a major liability produces a positive real rate of return. Not saving is saving! I’ve got to use this in my life.

If $100B less of 30 yr bonds are issued in 2000 then coupon payments that would have been made from 2001-2031 are eliminated.

Yup. There’s savings every year for 29 years, all the way until that really big coupon comes due in the end.

Reducing borrowing today requires raising taxes today, which means that today’s workers are simply paying now for what they might or might not get later. They could put the same money to work in private accounts and be better off.

Reducing Fed. gov’t borrowing today reduces taxes tomorrow (to repay the principle of the bond that would have been issued today) as well as eliminates the interest payments that would have been made over those 30 years.

Assume for the sake of argument that the SSI trust fund surplus does not cause increased Federal spending. In that case a real return is generated simply by the fact that the Federal Gov’t is paying down debt today (or not increasing it as fast as it would otherwise).

I really like this idea that not funding a major liability produces a positive real rate of return. Not saving is saving! I’ve got to use this in my life.

If $100B less of 30 yr bonds are issued in 2000 then coupon payments that would have been made from 2001-2031 are eliminated.

Yup. There’s savings every year for 29 years, all the way until that really big coupon comes due in the end.

Actually you missed it.

1. It’s the year 2000, SSI ‘surplus’ is $100B. Gov’t borrowing was going to be $500B (6% interest rate for 30 years). Now it is only $400B. In 30 years it is estimated that SSI will have to pay $100B for retirees from the year 2000.

2. Gov’t makes coupon payments of $24B per year for 30 years (6% * $400B to make things simple) or $720B. To make it simplier, let’s assume gov’t waits until 2031 to make both the coupon payments and principle payment in one big lump sum without compound interest accruing. At the end of 30 years it must also pay off the bonds of $400B which brings you up to $1,120B. Finally, SSI was amazingly accurate in its prediction of expenses this year but let’s have a little fun and say its $99B (say there was a little variance in SSI’s estimates of lifespans back in 2000). So by 2031 gov’t must tax or borrow $1,219B.

3. Imagine in 2000 SSI was really a ‘pay as you go’ system and taxes were cut by $100B so as to generate no surplus in the trust fund. Gov’t borrowing this year is $500B. Over 30 years the coupon payments will be $900B ($500B*6%*30yrs). At the end of 30 years gov’t will have to also pay back $500B bringing you up to $1400B and finally the $99B in SSI payments leaves you at $1,499B

In this simple model you see a savings of $280B. That return, though, is shared by all of society. Taxpayers (or the loanable funds market) will find their burden in 2031 to be $280B less than what it otherwise would have been.

Of course, a more dyanamic model would account for the fact that by not borrowing $100B extra in 2000 the economy would be able to invest that much more in private capital. So by 2031 the economy should be a bit larger because of the investment made in 2000.

Tom,

Didn’t mean to imply I was directing my mini-tirade at you, your posts make the most sense me. I’m just irritated because, and I think you said it, the entire SS system is a Ponzi scheme – new ‘investors’ monies are being used to pay off the first ‘investors’ return, that is a classic Ponzi scheme. I agree with you whole heartedly that the issue is how to change it.

I’m no economist, but I know that if we stopped SS today, the gov’t would have a boatload of ‘liabilities’, and no assets to pay for them. One could make the argument that my future stream of taxes are an asset, but aren’t those assets also increased by the liabilities of payouts to me when I retire. The bottom line is that the monies ‘owed’ to today’s retirees suppossed to be returns on their invested tax dollars. Somebody want to show me where that is. Somebody mentioned earlier something about the SS Fund holding treasuries. Huh? Explain please.

Aside from the fact that this whole thing is a socialist Ponzi scheme, most of the posts advocating privatization seem to be basing their arguments on the belief that monies lent to the private sector have better returns than monies lent to the government. Yep. It’s called a belief that individuals know better what to do with their money, acting in self-interest, than some arrogant do-gooder in Washington (hope I’m not giving away my political persuasions). However, I would like to see any change to SS to have some safeguards, I wouldn’t want to see a bunch of old people w/ no income because they invested their retirement taxes in Enron-like investments (I guess mutual funds will be the only choices).

Aside, I find it interesting that this belief in the power of government to do good has seemed to correspond w/ the rise of economic illiteracy. I don’t know for sure, I’m relatively young, but economic conversations in my world, on the internet, and on TV generally leave me depressed.

Bernard,

It goes without saying that establishing private accounts reduces the stream of promised benefits. That doesn’t reduce outflows because people working aren’t retiress, it’s yesterday’s workers that are now retired and receiving benefits, unless you mean to cut them off.

Boonton,

You’re entire argument seems to be that by keeping the system the way it is now, we have lower debt, and therefore lower taxes, therefore young people like myself are better off than if we raise the debt. Uh, no. This is a Ponzi scheme, cut and dried, and therefore the returns generated to late investors are determined by the players making the rules, which in this case is the baby-boomers. Nothing personal, but can I have my taxes back? I prefer the capital markets. You did, though, include a paragraph at the end about money being invested in the economy would theoretically cause the economy to be larger. Yes, sir, it’s called supply-side economics. You also, somewhere, made an assumption that surplus’ were not spent. My entire beef with our government is that the surplus generated from baby-boomers SS taxes were indeed spent. All those fund that are suppossed to pay for their benefits are not there, gone, up in smoke in the Great Society and pork. Guess what, I’m paying for it and I’m pissed.

Whew. I feel better. Interesting nuggets to chew on –

Currently, half of all SS taxes are paid by employers (which, coincidentally is also the employee, if you’re self-employed). It will be interesting to see how the proposals handle that. Are those funds going to be continued to be remitted to the gov’t, I mean, it’s not the employees money (arguably it’s the consumers, or owners of the companies money)? Maybe those funds can be used to pay the existing benefit liabilities? I doubt it is enough, but maybe. Somebody before mentioned taxing the returns of privatized accounts. Maybe the combination could make a significant contribution.

I don’t see anyway that anything of significance can be accomplished without raising the retirement age – (I agreed with you, Boonton!!)

Will significant adaptation of Health Savings Accounts lower projected health costs? I believe so, people use ‘free’ products more than they do when they’re not.

I will not attempt a robust dynamic analysis of privatising SS, but some thoughts that I think people are not considering. When you remove, say $100B, from the Treasury coffers and put them in the hands of investment managers (who are those people going to be anyway – will they be subject to Social Investing laws, how will the participate in corporate governance issues, etc. ), it is true that treasury rates will go up statically because the demand for funds by the treasury will go up. Arguably, rates of return in corporate securities will go up because they are tied to treasuries. Modern financial theory says returns are based off the risk free rate, which is treasuries. Corporate bonds all trade to a spread over the comparable treasury. However, maybe other variables in the financial theory will change – perhaps the expected return. Then again, a $100 increase in demand for corporate securities will lower the corporate spreads. I’m tired of typing (and thinking), but my point is that there are many variables that have as yet to be covered in this thread. Somebody said something about a static analysis, all of the analysis’ have been relatively static.

The bottom line is that socialist Ponzi schemes are un-American. Returns generated by the private sector are necessarily higher than gov’t ‘returns’. SS was a fine idea during the depression, but it’s time to change. You can either tinker with the numbers and pretend it’ll be OK, or you can fundamentally change the system.

I still miss the ‘there’s no net economic change’ point, I just know that my money is being transferred to someone else, with the promise of getting a ‘return’, all the while the demographics of our country say otherwise, according to the experts.

SS is just a government program approaching a time of political trouble because it has made promises it can’t keep. Nothing more.

So sayeth Jim Glass.

Cheers!!!

Can we verify that the fund is buying treasuries w/ surplus funds? Anybody know for sure? My understanding is that the fund is basically an accounting paper fund, money going to the gov’t goes into the big pool.

Where can I find information on this subject? I would like to verify that the amount of taxes paid by workers for the last 50 years is still there. Thanks.

Also, are these bonds in the SS fund counted in the federal debt. If not, then this is just a fake accounting transaction.

Well, yeah. If General Motors issued General Motors bonds to General Motors, held them in an account payable to General Motors, that it legally could use for any purpose it desired, called that account a “trust fund”, and said that trust fund secured its employees’ pensions, everyone involved would go to jail.

Of course the Saturn Division of General Motors could borrow money from its parent company. GM would have ‘loan to Saturn’ as an asset & Saturn would have ‘loan from GM’ as a liability. When you look at GM as a whole, though, the accounting nets to zero. But this isn’t a meaningless fiction, by treating Saturn as a distinct ‘company within a company’ GM is better able to manage the unit for profitablity and is able to track how many GM resources Saturn is using.

Accounting wise the Trust Fund is forcing the gov’t to tax more than it is spending on SSI today. That is real savings which generates a net return as I demonstrated.

Where can I find information on this subject? I would like to verify that the amount of taxes paid by workers for the last 50 years is still there. Thanks

I imagine you may want to start looking at the SSI web site as well as the Treasury Dept’s web site. You will probably find it very dry and technical. More importantly, it will probably be more accounting centered than economics centered.

BTW, spending has been going up. After watergate, there was a specific change in the legislature that made it easier for Congress to spend, I can’t remember exactly what it was. Line item veto, maybe.

Whether that spending is using SS funds, I don’t know.

Line item veto has next to nothing to do with spending. In the early 70’s Nixon, in a bid to win the senior vote, raised SSI benefits dramatically. I would accept that as one instance where the fund surplus lead to higher gov’t spending. Cases like that aside, I don’t think there is an argument that the trust fund has caused gov’t spending to increase as much or more than the funds surplus.

This is why increasing and saving current payroll taxes cannot help meet future shortfalls, but are just equivalent to a current contraction of the money supply and a future printing of new dollars.

I disagree. Imagine that the gov’t expects to have to spend $500B in 2011. Each year the gov’t, to prepare for this, runs a surplus of $100B. (to keep it simple, assume the national debt is $1000B and interest rates are 0%). Each year $100B of dollar bills are collected. The gov’t then buys back $100B of bonds with those dollar bills. The money in the economy doesn’t contract, it flows from the taxpayer to the gov’t to the owner of the bonds.

The national debt falls from $1,000B to $500B. In 2011 the gov’t borrows $500B and spends it on whatever it has to. Like someone paying off his credit cards because he knows he’ll have to soon put a new roof on his house, the gov’t in this simplistic example successfully saved for a future expense.

Good point, Bernard. The point is whether or not those debt securities held by the fund are listed as debt by the feds. If not , then it’s a paper transaction. If not, then our debt is substantially larger than being reported. Conceptually, it is easy to understand that the gov’t owing money to itself is a wash, the question is whether the fund is considered a separate entity. If there are assets, separate assets (treasuries or not) that exist to fund the baby boomers benefits, then it’s a completely different story than if it’s netted out and those funds have actually been spent.

I am also curious about the projections. I saw a program on TV the other day talking about the generation behind me, that apparently is much larger than mine. I have no idea if that’s true, but if it is, wouldn’t those workers taxes be ample enough to pay benefits to tomorrow’s retirees. I know enough about numbers to know that slight changes in assumptions can significantly change projections, especially 50 years out.

boonton,

I’ve been to both sites, as well as the Cato Institutes SS site, none of which I could find anything of signifance, probably didn’t look real hard. I would like to see detailed #’s and assumptions, and again, whether those securities held in the fund are counted in the debt is important.

I was wrong, it wasn’t the line item veto, it was the committee and subcommittee bill of rights, effectively transferring enourmous power (along w/ other bills) away from committee chairman. I don’t remember the #’s I saw, it was years ago, but there was a significant increase in spending that started in the 70’s. There’s a good article in the Autumn ’04 Wilson Quarterly about the increased partisonship in Congress that mentions it (not in reference to increased spending, but it was a consequence nonetheless). This is not to make an argument that Congress has spent the surplus, but merely that spending has increased. I still say that if those SS bonds are in the debt #’s, then they represent assets of the fund, and therefore have not been spent, but I am not convinced of that, as of yet. Bernard is right, whether or not they’re gov’t bonds, corp bonds, or equity, the point is whether or not the gov’t is netting those bonds when they report gov’t debt. The fed, for instance, does not net their holdings of treasuries, although they do remit the interest and principal payments to the treasury, net of costs to run the fed.

A question for Jim Glass and others who ridicule the idea of a trust fund:

Suppose the excess of payroll taxes over benefits paid – the trust fund – were invested in private securities instead of treasuries. Let’s say, to be conservative, the money was invested in high-grade corporate bonds.

Would you then think there was a trust fund?

You may not remember, but Alan Greenspan once got in hot water by suggesting that one way to make sure the Trust Fund contained real economic assets would be to buy German bonds (and not bullets and bureaucrats, for example). At maturity, the proceeds would be converted to dollars and could be paid out in SS payments.

But this simply gives the SS recipients more purchasing power to bid and compete for a given supply of goods and services in the future, the same as if they were simply given newly printed dollars.

Private securities are only different to the extent that their purchase may result in a larger supply of goods and services in the future if effective use is made of the current security sale proceeds by the private sector.

Regards, Don

Jim,

I notice you dodged my question, despite being “glad to answer it.” Ever consider a career in politics?

Still, I’ll answer yours.

What tangible value do you believe the SS trust fund has?

The trust fund holds treasury securities. Those have a tangible value, damn it. Just like corporate bonds do. Anyone who thinks they don’t is not worth talking to about this issue.

Do the bonds in the trust fund have a net positive value on the Treasury’s consolidated balance sheet of the US?

Depends on whether you consider the trust fund a separate entity or not.

Do the bonds in the trust fund reduce at all the amount of general revenue the government will have to use to meet the gap between SS payroll tax collections and SS benefits promised in out years, compared to if there was no trust fund?

Complicated question. That’s why I asked mine. The simple answer is no, but that conceals more than it reveals. The government has to pay back the bonds sold to SS, true, and use general revenue to do so. But this has nothing to do with Social Security.

The government borrows money from the trust fund to pay for other activities. If the trust fund were privately invested the government would still have to borrow that money, only it would do so in the capital markets. Instead of owing that money to the trust fund it would owe it to other bond holders. The debt owed to SS is not a SS problem. It is a problem of fiscal irresponsibility in the whole government. Notice that this problem would exist even if there were no such thing as Social Security.

Does the trust fund legally assure that SS benefits promised today will be paid, with trust fund bonds being payable to SS beneficiaries the way US Treasury bonds are to the public — so that, say, if a future Congress decides it doesn’t want to raise the general revenue to pay the bonds it can’t reduce benefits by a corresponding amount?

Actually, yes. Because a future Congress may also decide it doesn’t want to pay off bonds held by other investors.

And let me comment on this:

Well, yeah. If General Motors issued General Motors bonds to General Motors, held them in an account payable to General Motors, that it legally could use for any purpose it desired, called that account a “trust fund”, and said that trust fund secured its employees’ pensions, everyone involved would go to jail.

Complete nonsense. Companies routinely owe huge sums to their pension plans. This is exactly equivalent to what you describe. Unfunded pension liabilities in this country are about $350 billion. Until recently GM had a $10 billion unfunded pension liability. It erased this by selling bonds and using the proceeds to cover it, but there was nothing illegal about the underfunding.

When private companies go bankrupt the pensioners often lose out. Not illegal. The claim that private pension plans are wonderfully run in accordance with the highest standards of prudence and responsibility is just wrong. It doesn’t help your cause.

If the answers to these questions are No, No, No, then what exactly is the substance of the trust fund that deserves respect?

As a mechanism that permits the gov’t to build up savings to pay for higher expected expenses in the future.

I notice you dodged my question, despite being “glad to answer it.” Ever consider a career in politics?

I didn’t dodge it — just trying to define terms, to try and understand what you think a “trust fund” is and what its effects are.

What tangible value do you believe the SS trust fund has?

The trust fund holds treasury securities. Those have a tangible value, damn it. Just like corporate bonds do. Anyone who thinks they don’t is not worth talking to about this issue.

Ahem. You’re disagreeing with the US Treasury here. Do you think really think its opinion is so worthless?

Do the bonds in the trust fund have a net positive value on the Treasury’s consolidated balance sheet of the US?

Depends on whether you consider the trust fund a separate entity or not. …

Bah. The consolidated balance sheet of the US is a real thing, published by the Treasury.

The bonds are an asset on it or they are not. What “you consider” has nothing to do with it. It is a matter of fact.

Should I politely suggest that anyone who can’t answer this question of simple fact is not worth talking to about this issue?

No, I’ll be more polite and note (again) that the bonds are not on the balance sheet, because the Treasury deems they have no tangible value to it — unlike other assets, such as cash and foreign bonds it may hold — and explain why they don’t.

Imagine that you owe $10,000 to, say, you’re mother, due on 1/1/2010. To assure you will be able to pay it you write an IOU to yourself, “I owe me $10,000 due 1/1/2010”. You then put in an envelope and label it “trust fund”.

Have you created an asset of tangible value to you that will secure your debt to your mother?

Of course not. Why, exactly? Because it leaves your position totally unchanged. Before, you had to pay the $10,000 to your mother from your income (or other assets) and after writing the IOU to yourself you still have to pay the $10,000 to your mother from your income (or other assets). So, $0 difference to you, $0 value to you.

Now, if you have a very good credit rating you might be able to sell your $10,000 IOU to a bank or a German or somebody (assuming you change it from “I owe me” to “I owe bearer”) for the full $10,000. It will then be an asset worth $10,000 to them.

But you still wind up net $0. Because if you use the $10,000 you get from the German to pay your mother, then you then have to pay $10,000 to the German at the same time from your income (or other assets), just as before. So the IOU you write to yourself is never worth anything to you. It’s a big $0.

It is exactly the same situation with the SS trust fund bonds. They are IOUs the Treasury issues to itself. So they have $0 value to it. So it does not report them on its balance sheet. When it redeems them to fund future SS benefits it will have to raise general revenue exactly as if they did not exist. Zero change to it, zero value.

It could sell the bonds on the market — but this produces zero ($0) net value to it because then when the bonds are redeemed it will have to pay the bond buyers the exact same amount it would have used to pay SS benefits. Again, $0 change to it, zero value.

OK? That’s why the SS bonds are not on the Treasury’s balance sheet — and there’s nothing subjective about it.

As Don noted, and I did before, this is described every year by the government itself in the Perspectives, so it’s not a secret.

Does the trust fund legally assure that SS benefits promised today will be paid, with trust fund bonds being payable to SS beneficiaries the way US Treasury bonds are to the public — so that, say, if a future Congress decides it doesn’t want to raise the general revenue to pay the bonds it can’t reduce benefits by a corresponding amount?

Actually, yes. Because a future Congress may also decide it doesn’t want to pay off bonds held by other investors.

Wrong again. The Constitution requires full payment on all bonds payable to the public. Congress can’t decide not to pay. But the Treasury can cancel the SS bonds owed to itself at will, or use them for any non-SS purpose it wishes, as the Perspectives notes. And the Supreme Court has said Congress can cut or eliminate any and all SS benefits at will — even those funded by the “trust fund”!– just like any other government program.

When you make mistakes like these, you know, maybe you should be less eager to declare others “not worth talking to about this issue”, eh?

And let me comment on this:

Well, yeah. If General Motors issued General Motors bonds to General Motors, held them in an account payable to General Motors, that it legally could use for any purpose it desired, called that account a “trust fund”, and said that trust fund secured its employees’ pensions, everyone involved would go to jail.

Complete nonsense. Companies routinely owe huge sums to their pension plans. This is exactly equivalent to what you describe.

“Equivalent” — nonsense. That’s what SS actually does claiming it is funding benefits through the trust fund.

No business can claim it funds a retirement plan like that without go-to-jail time — because, as you point out, it is the same as leaving it unfunded. Glad you agree.

To claim you have funded a plan while leaving it effectively unfunded is dishonest!

No business ever funds a defined benefit pension plan by contributing its own bonds to the plan. It is absolutely illegal because it is a transaction without economic substance, giving an IOU to itself with $0 asset value to it, to the plan.

Hey, wouldn’t it be just great if we could all pay our debts like that, by writing out 30-year IOUs to ourselves and distributing them to our creditors!

Unfunded pension liabilities in this country are about $350 billion.

Um, we are talking about funding plans, not unfunded ones.

No company ever funds a plan with its own bonds.

Until recently GM had a $10 billion unfunded pension liability. It erased this by selling bonds and using the proceeds to cover it…

Yes, it sold its bonds to third parties and contributed the cash it received in return — an asset in anyone’s book — to its pension plan.

It did not contribute its own bonds to its pension plan. Nobody does that.

Except the government with Social Security, of course.

… but there was nothing illegal about the underfunding.

As a matter of fact, GM had to ask the government for permission to underfund, by requesting a Section 412 waiver of the funding requirement, justified by business hardship and a promise to make good soon, with evidence that it would be able to do so. As do all other employers that underfund pension plans must do.

It is most definitely illegal to underfund without getting a 412 waiver that grants government permission to do so.

Many say the government is too generous in issuing such waivers, but that is another story.

Of course, the government is very generous with itself on that score.

Bah. The consolidated balance sheet of the US is a real thing, published by the Treasury.

The bonds are an asset on it or they are not. What “you consider” has nothing to do with it. It is a matter of fact.

Should I politely suggest that anyone who can’t answer this question of simple fact is not worth talking to about this issue?…No, I’ll be more polite and note (again) that the bonds are not on the balance sheet, because the Treasury deems they have no tangible value to it — unlike other assets, such as cash and foreign bonds it may hold — and explain why they don’t.

The balance sheet is not a ‘real thing’. Balance sheet’s are accounting conventions that describe an underlying business but they are just that conventions. Business existed before double entry bookkeeping evolved into our modern day financial statements and accounting principles.

Imagine that you owe $10,000 to, say, you’re mother, due on 1/1/2010. To assure you will be able to pay it you write an IOU to yourself, “I owe me $10,000 due 1/1/2010”. You then put in an envelope and label it “trust fund”.

Have you created an asset of tangible value to you that will secure your debt to your mother?

Of course not. Why, exactly? Because it leaves your position totally unchanged. Before, you had to pay the $10,000 to your mother from your income (or other assets) and after writing the IOU to yourself you still have to pay the $10,000 to your mother from your income (or other assets). So, $0 difference to you, $0 value to you.

Cute and I agree you have created value in your little trust account there. So what? You aren’t describing SSI because SSI actually runs a surplus taking in more in taxes than it pays out in a benefit. In your little example, that would be like saying “I owe mom $10,000, therefore I’ll put my overtime income of $250 a month into paying down my credit card balance”.

Whether or not you save $10,000 by this method, every $250 payment you make strengthens your financial position for the day of reckoning when you’ll have to pay your mom.

Congress’s spending is restrained by deficits, there is nothing restraining spending of taxes — increases in tax revenue result in quickly increased spending until the deficit restraint hits again. (see recent history!)

Really? Explain why spending was rather well restrained during the Clinton years yet has gone thru the roof one the surplus disappeared?

====
Um, spending (including tax cuts) went through the roof before the surplus disappeared — as soon as it arrived, during the Clinton years, with the big bipartisan spending hikes before the 1998 election.

They are what made the surplus disappear, right? If you don’t believe so, tell us what you think did make the surplus disappear.

And once again, Rudy Penner, the head of the CBO, did explain that.

The post-Reagan deficits resulted in the bipartisan spending caps being imposed. Look at the legislative record. Then the spending caps blew apart when the surplus hit and the restraint imposed by the deficits disappeared.

At that point — as *you just said* — in response the to the unexpected surplus that was projected to last a decade, Congress and White House (and both parties, starting in 1998) went hog wild with spending and tax cuts wiping out the surplus until the unexpectedly large deficit arose after the unexpected recession, and the spending brakes went on, stabilizing the deficit where it is now.

And now you actually are citing this experience of the politicians immediately wiping out an unexpected a surplus that could have lasted a decade in support of your claim that government spending (including tax cuts) is inelastic to revenue increase! And as an example of how government saves!! Gosh golly.

Look, you’re arguing with Penner, the former CBO head, not me, when you deny that the deficit restrained spending and the elimination of the deficit resulted in the spending caps being blown off. If you want to do that be my guest.

But unless you can cite some academic evidence or similar persuasive authority to support this strange and heroic claim that gov’t spending (including tax cuts) is inelastic to revenue changes — as I invited you to do before — then you are pretty lonely on this. And the experience of 1997-2003 isn’t exactly the best empirical support for that claim!

“Note that the bonds held by Social Security are in fact backed by the full faith and credit of the US government.”

Really? To whom?? For that to be so, somebody has to be able to *invoke* that backing. Who can? Can you? Nope. Can any citizen? Nope.

Only the party that owns the bonds can. That’s the government. Dang, invoking the full faith and credit of itself against itself to force itself to pay itself is going to have a big impact on its financial situation. So that “full faith and credit” business is very meaningful!

“(BTW, where can I find this government balance sheet you refer to?)”

2003 Financial Report of the United States Government

From the balance sheet…
Assets/other assets/securities: $37.7 billion.

That’s somewhat less than the $1.5 trillion of bonds in the SS trust fund.

Ah, there’s a note:

“intragovernmental debt holdings [the SS trust fund bonds, etc] are eliminated in the consolidation of these financial statements”

… for reasons previously explained. And also explained in the Perspectives.

“In any case, nothing you wrote refutes my basic point:

The crisis facing Social Security, if there is one, stems from a presumed inability of the government to pay back the money it has borrowed from Social Security.”

False, wrong. That’s only about $1.5 trillion. The gov’t could pay that over future decades easy.

The problem is the $10 trillion current value unfunded SS liabilities on top of that — which the gov’t might be able to fund over future decades, if there wasn’t another $40 trillion to $60 trillion current value of other unfunded retirement liabilities on top of that.

With all these liabilities pegged to grow with growth in the economy, so there is no way economic growth is going to make them go away.

There is no way to close a funding gap of $50 trillion to $70 trillion current value without some combination of major benefit cuts and major tax increases. And the only way to mitigate those to some extent is with an injection of private investment into the system to finance some of the long-term future costs with real savings instead of taxes and cuts.

The SS trust fund is a red herring — near irrelevant to all this, because even nominally its balance is trivial compared to >$50 trillion, while in economic reality its value at funding future expenditures is exactly $0.00.

The only relevance it has is political in that millions of people beleive it really secures their future SS benefits by financing them in advance with real assets that have been saved to pay them in spite of whatever fiscal problems might hit the government — as a real trust would — in spite of the fact that of course it does no such thing.

If there were no Social Security the government would have borrowed the money elsewhere, and be presumptively equally unable to repay it.

Hence the “Social Security crisis” is not a “Social Security crisis” at all, but a general fiscal crisis.

??? If there were no Social Security and Medicare, etc., there’d be no $50 trillion to $70 trillion current value of unfunded liabilities and there’d be no fiscal problem at all. Sure.

C’mon, you don’t think that the “coming insolvency of the US” that DeLong is always going on about is due to a piddling $1.5 trillion owed to the SS trust fund, do you?

Or that the 20% of GDP that will be going to interest on the debt alone as projected by GAO in 2045 if entitlements aren’t brought into line is due just to the interest on a mere $1.5T borroweed from SS?

But unless you can cite some academic evidence or similar persuasive authority to support this strange and heroic claim that gov’t spending (including tax cuts) is inelastic to revenue changes — as I invited you to do before — then you are pretty lonely on this. And the experience of 1997-2003 isn’t exactly the best empirical support for that claim!

Let’s start with:
http://www.cbo.gov/showdoc.cfm?index=4985&sequence=11 the table that shows revenues and outlays and public debt as a % of GDP.

Going from 1962 to 2003 revenue as a % of GDP has been between 16-20% with an average of 18.2% (note that 2003 is unusually low at 16.5%). I added a column to the ‘debt held by the public’ to indicate change from the previous year. So, for example, in 1962 debt was 43.6% and in 1962 it was 42.3% and the change was -1.3.

So I build a simple regression model:

Change in debt = B + B2 * Revenue

If your theory is correct, B2 will either be 0 or positive. Why? Because as revenue goes up total spending will increase to either match the revenue increase or will be even greater resulting in additional debt. The SSI trust fund is netted into these figures so it doesn’t matter if the spending increase is discretionary or caused by SSI paying out larger benefits.

The results:

Regression Statistics
Multiple R 0.556718244
R Square 0.309935203
Adjusted R Square 0.292241234
Standard Error 1.81363567
Observations 41

Coeff.____________T Stat
B = 22.7059_______4.146
B1 = -1.2551______-4.185

What this means is that gov’t borrowing from the public goes down as revenue goes up as a % of GDP. At least when we look at over 40 years of observations. Spending may indeed rise but paying off debt increases *more* which means that the SSI trust fund is a vehicle for gov’t saving.

My apologies Jim, I see where you linked to the T-Dept’s ‘Balance Sheet’. I still question whether this is a useful document or more of an accounting convention without economic substance.

Out of curiosity, I did another regression analysis with our table. I compared the change in revenue as a % of GDP to the change in outlays. In order to capture SSI I added the SSI surplus or deficit to outlays. The model is:

Change in net outlays = B + B1 * change in revenue

If Jim’s assertion is correct, B1 needs to be positive. If revenue goes up then outlays goes up as well. The results?

Regression Statistics
Multiple R 0.195100212
R Square 0.038064093
Adjusted R Square 0.01339907
Standard Error 0.840952055
Observations 41

____________df________SS________MS
Regression __1_____1.091381_____1.091381096
F_____________Significance F
1.543241715_____0.221554244

The Coefficients are:
Coefficients_____________________t stat
Intercept_______0.060844566______0.463
X Variable 1____-0.205372797_____-1.24

The regression tells us that the change in spending actually goes down when revenue goes up! This isn’t as shocking as it initially sounds. Many of the gov’t’s revenue sources are tied to the overall economy as is its spending. When times are good revenue goes up automatically and many spending elements like unemployment and welfare go down. Even SSI might experience spending cuts in a good economy, some people will choose to keep working if they are doing very well thereby cutting SSI payments and increasing both SSI revenue and general tax revenue.

Unfortunately, though, while Jim’s theory can be rejected the statistics are not significant enough to accept an alternate theory that revenue increases actually causes spending cuts (look at the t-scores, less than 80% confidence).

Jim,

Calm down. As Boonton points out, you’ve suddenluy switched gears from SS to “SS and Medicare.” And if you want to start taking PV’s out to 75 years and beyond be my guest. Just remember not to change your discount rates or growth assumptions by a fraction of a percent, or you’ll get pretty dramatically different results. Given the confidence intervals of these estimates they have pretty limited usefulness. What is the PV of the defense budget out to infinity? Pretty big, I’d guess.

The money held in the Social Security Trust Fund is held in treasury bonds backed by the full faith and credit of the government. By law these funds can only be used to pay Social Security benefits. In other words, the treasury is legally obligated to provide the money to pay the benefits. Can Congress change the law, change the benefits? Sure. But that doesn’t mean that the system as it operates today, under the laws governing it, is in serious trouble, or that the whole thing is a fiction. Is your 401K a fiction? What if Congress puts a tax on the assets in it? After all,if we have fiscal crisis who knows what will happen.

If you don’t like Social Security, fine. But stop the Chicken Little act.

The problem is the certificates are essentially an INCREASE in debt, because the gov’t is spending the cash in the fund and replacing it w/ a piece of paper. That debt issuance is not reflected in the debt figures, which is duplicitious. Even the Treasury says so, so I don’t get why you guys keep saying it isn’t. If the fund has ‘assets’, shouldn’t the other party in the transaction have ‘debt’? Yes, but they don’t count it that way.

What you are missing is the fact that what is essentially happening is that gov’t is taking debt out of the public’s hands today and putting it in the trust fund to get rid of cash that is not needed to pay benefits. Tomorrow it will take that debt out of the fund and put it back in the public’s hands in exchange for cash to pay benefits.

If you need an accounting analogy consider a cash rich corporation that buys its own stock back today but plans to sell its stock again on the market years later.

You didn’t answer the question — who can invoke the backing? The government against *itself*? 😉

Did you ever promise your creditors: “Don’t worrry, I’ll collect that guarantee against myself if I don’t want to pay later. So all my debts to you are secure!”

This is starting to sound like an argument with someone who demands to know what backs US dollars. What isn’t reflected on the balance sheet, Jim, and what doesn’t apply to the case of an individual who owes a creditor is that the US gov’t enjoys taxing authority. I do not hence Visa will just have to trust me that I will have a good job for the next 30 years and will be able to pay my credit cards.

The Treasury does report the debt owed to the Trust Fund, it simply isn’t listed under ‘debt held by the public’ because it isn’t held by the public. Likewise a company that buys back some of its own shares will ‘keep them’ in a special account that shows up on the stockholders equity portion of the balance sheet.

So let’s imagine a company that is cash rich right now but suspects it will have a major expense in 10 years. Let’s suppose this expense is so large that it knows there is no way it can pay for it without borrowing.

If the company doesn’t feel confident in its ability to invest the large lump of cash today in other companies and it doesn’t feel there are worthwhile internal investments to make at this time, then what would be wrong with the company buying back its own stock? Granted the future expense is still there but by reducing equity held by the public today the company has the option of reissuing the shares in the future.

This leads me to another issue I have with Jim’s ‘Treasury Balance Sheet’. A company’s balance sheet should list all the assets a company has. A company can only make use of those assets to pay its liabilities and have equity left over. Government can own assets (like military bases, roads, post offices etc.) but gov’t’s primary source of revenue is taxation not earnings on its assets (in fact, most of its assets will have no earnings at all).

Since taxation is the primary source of gov’t revenue the true underlying asset of a gov’t is the economy that it has jurisdiction to tax but to my knowledge no one has developed a method of depicting that in a meaningful way on a balance sheet.