The Trust Fund Facade

April 2005

After nearly four months of virtually non-stop coverage of the Social Security debate, by now, everyone has an opinion about how the current system could be fixed. Yet, for all the commotion, relatively little in the way of creating legislation or even concrete proposals has taken place, and at the moment it appears that little will be done as lawmakers on both sides of the aisle express doubts about whether reform of the system is immediately necessary.

The debate and proposed reforms have brought to the fore the strange accounting approach to which Social Security is subjected. Social Security since its inception has been an “off-budget” expense, separate from the rest of the federal budget. The rationale behind this was that since the system would ideally provide a collective retirement fund for workers, this fund should be kept separate to prevent the government from using it to pay off other expenses, like the cost of building an F-16, for instance. Keeping the system separate was important since ideally, money received from workers would be immediately paid out to those receiving benefits. Surplus dollars would be credited to a trust fund, so that those who paid into the system would still receive benefits later on when they retired in case the system did not receive enough in payments from current workers to do so.

These peculiarities constitute some of the flashpoints in the debate. One of the specifics is the trust fund. For most of its 70-odd years of existence, the system has been running a surplus, and thus the trust fund has been growing. However, in order to prevent the fund from being eroded away by inflation, extra money was put into government bonds, which earn interest, hypothetically offsetting inflation and maintaining the fund’s value. But by putting the surplus into bonds, this money has effectively been spent. According to the Congressional Budget Office (CBO), “Although separate taxes are collected for Social Security, the money left over after benefits are paid is used to fund other government programs or to pay down the debt held by the public.” This statement from the CBO, generally regarded as a trusted source, is the root of the contention about whether the presence of the trust fund actually means anything. Leading Democrats such as Nancy Pelosi and Charles Rangel have responded that the trust fund holds are “rock-solid” investments that merit the “full faith and credit” of the US government. The problem, however, is not that the bonds will be defaulted on, but rather that the money is essentially not there in the first place. In other words, Uncle Sam spent the money on an F-16 (and sold it to Pakistan).

The second flashpoint, related to the first, is the date dispute. Is it 2018 or 2042? According to both the CBO and the Social Security Trustees, the system will no longer be running a surplus by about 2018, as the baby boom generation retires and starts to draw benefits. After this happens, the system will still be able to legally operate because it has built up a surplus in the trust fund; however, to do so, it will have to draw from the trust fund, demanding its money back from the other branches of the federal government that borrowed it before in exchange for bonds. Social Security will then start adding to the federal deficit instead of subtracting from it as it does now. (As a side note, even though it is an “off-budget” item, the Social Security surplus typically gets thrown in with the rest of the government’s deficit, reducing it from $567 billion in FY 2004 to “only” $412 billion.) In 2042, the trust fund is projected to run out and thus legislative changes will be necessary to keep the system legally operating, but 2018 is an important date too since it is the year when legislative changes must take place in order to keep the system operating in surplus.

The mere fact that the system runs a deficit is not in and of itself a major problem. The contradictory views the two parties espouse when it comes to a balanced budget are ironic. Republicans are running large deficits on the budget as a whole right now, and yet want to fix Social Security before it starts to do so. Democrats castigate Bush for running these deficits, and yet would let Social Security go so far into debt that it legally could not operate.

One step that would help untangle this whole mess would be to take a unified budget approach, including Social Security with the rest of federal receipts and outlays. Since the original intent to prevent the government from spending workers’ retirement money has been abandoned, this seems like a rational move and has indeed been advocated previously for this reason and many others.

If Social Security were to be included with the rest of the budget, economists would presumably make projections about it in the way that they make projections about the rest of the budget. The CBO, however, does not make federal budget projections for the year 2042 or even the year 2018. An immediate explanation for this is that such extrapolation would be of limited use because of the difficulty in predicting something as complicated as a national budget that far in the future. When the Social Security Trustees came up with the 2042 estimate, this was actually the “middle” one. There were two other estimates as well, on either side of the 2042 number. One had the trust fund running out in 2031 or so, and the other one had the trust fund not running out at all, but instead stabilizing around 2040. This discrepancy in outcomes makes the point that all projections going out more than a decade or so are very uncertain.

Given this uncertainty, those who claim that we should refrain from immediate action have a point. There are some certainties however. One is that the retirement of the baby boom generation will put a strain on the system, forcing it into deficit. A second is that even after the baby boom “shock” to the system has passed, the demographics of the US population will necessitate a change eventually. While birth rates have not dropped as precipitously as in other developed countries, it is highly unlikely that the demographics will ever return to the state they were in when the system was founded, with 13 workers for every retiree.

Further evincing the soundness of the “wait and see” camp’s rationale is the fact that this problem differs from that of CO2 concentrations in the atmosphere; there is comparatively little lag time between Americans realizing that there is a problem and Congress being able to do something about it. The only delay would be in the legislative process itself, which can be accelerated if circumstances are dire enough. Ideally, any changes would be phased in gradually, but to extend this over 35 years, again, is not feasible.

While starting to change the system now to increase revenues would create the benefit of helping to decrease the federal deficit, at least if a unified budget view is taken, there is still time before a gradual phase-in must necessarily take place, even if 2018 is the target year. This gradual phase-in of a solution could take many forms, such as a higher payroll tax or a higher cap on income subjected to the tax, to name two of the most common proposals. It would seem, however, that Bush and the Republicans see this as an opportunity to advocate and push through a “solution” that would be anathema to Democrats, that of personal accounts. If the trust fund facade is recognized, I suspect that more people would be more inclined to put some of the money that they currently pay in to the system into an account that is specifically earmarked for them. After all, the original idea was to earmark the funds paid into the system for retirement specifically for retirement. However, regardless of the solution proposed, (Bush’s “solution” is in quotes above because he himself has admitted that it is budget neutral), both the true nature of the “trust fund” and the timeline over which such a solution needs to be enacted must be realized.