Mendo Island Journal — Timely. Useful. Sometimes Cranky.

Trusting The Fund: A Citizen’s Guide To Social Security’s Trust Fund…

In Class War, Social Security on March 12, 2013 at 8:23 am



Just as a smothering fog obscures the landscape, discussions of Social Security are inevitably enshrouded in impenetrable mythology, misunderstanding, and misinformation. Does anybody really know how the system works? Of course. And truth be told, it isn’t all that hard to grasp. It’s just that nobody ever bothered to properly explain it to the rest of us. The tropes you hear from time to time serve only to confuse, never to enlighten. Remember Al Gore’s “lock box?” What the heck was that?

Even worse, the topic is burdened with ideological baggage. How you prefer to think about it, and what you choose to believe, is likely influenced by your position on the left-right continuum, and by your place in the partisan political divide. (Wouldn’t it be nice if we relied instead on the facts?) Indeed, our politicians are as susceptible as anybody, maybe more so. Senator Tom Coburn from Oklahoma has no doubt about the severity of Social Security’s problem: “The fact is, is $2.8 trillion was stolen from Social Security. The money was spent. It’s broke. And we’re going to have to fund 2.8 trillion over the next 20 years just to make the payments that we’ve got. I think most people would think we ought to fix that.” And according to Rand Paul, Senator from Kentucky, “most young people acknowledge that it’s broken—it’s broken so badly that the only way we fix it, and the only way it can continue, is we have to look at the eligibility.”

Whatever they may “acknowledge,” I assure you that most young people know nothing factual about Social Security’s finances, or its future prospects. They’re not alone. The public at large is more or less clueless—even persons whom you might suppose to be quite intelligent and well informed. Why is that? How is it we’ve failed to understand this most important of government programs? The question is especially crucial in the present political climate, with all the furor over whether or not we’re in the midst of a fiscal crisis, and what should or shouldn’t be done about it. Social Security has always had its critics, but now they’ve been empowered in a particularly significant way. A lot depends on the citizenry understanding who is telling the truth. It wouldn’t hurt if the man on the street understood a bit about how the system works.

To that end, a few basics. Social Security was originally constituted as a “pay-as-you-go” program, where current workers, through dedicated payroll taxes, pay for the benefits of current retirees. In some sense you’re paying for your parents’ retirement, and your kids will pay for yours. This works well enough if the ratio of workers to retirees is sufficiently large—that is, if there are many workers paying into the system for every retiree collecting benefits—but demographic changes have been long underway which, if not addressed, make this arrangement increasingly untenable. Fortunately, those changes have been addressed, as we will see.

Like the income tax, Social Security’s dedicated funding stream, the payroll tax, is automatically withheld from most peoples’ paychecks. But is it large enough? Way back in the 1980s, it was apparent that it was not. Actuaries back then realized that, some decades in the future, the pay-as-you-go system as then constituted would collapse with the retirement of the baby boomers. Once the baby boom wave swept into the system, there would be too many retirees and not enough workers paying taxes to support them. What to do?

President Reagan convened a commission, chaired by none other than Alan Greenspan, to study the problem and recommend a solution. This so-called Greenspan Commission proposed increasing the payroll tax, in order to build up a large nest-egg that could be drawn upon decades later to help pay for benefits for baby boom retirees. The proposal was adopted. From that point on, the Social Security system ran large surpluses year after year, above and beyond what was necessary to pay for current retirees, and those excess funds were set aside in what is known as the Social Security Trust Fund. The Trust Fund buildup was an example of eminent good sense and laudable foresight, but it soon enough became the subject of unwarranted controversy and gross misunderstanding. It’s a fascinating story.

The controversy mostly derives from the fact that the Trust Fund invests its funds by loaning them to the government. This isn’t as odd as you might think. In fact, it’s quite a reasonable thing to do. After all, the Trust Fund has to do something with its money. And the government, running perennial budget deficits, needs to borrow from someone; why not borrow from the Trust Fund? Don’t worry for the moment that the Trust Fund is itself part of the government; you’ll see how this all ends up making sense.

What happens is this. Payroll taxes, like all taxes, go directly into the government’s “checking account,” which is formally known as the general fund. The Treasury then issues to the Trust Fund special interest bearing government bonds in the amount of any payroll taxes in excess of what is required to pay current retiree benefits. In so doing the Trust Fund effectively purchases bonds from, and loans money to, the government.

Is this so strange? It is not. After all, foreign governments, businesses, and private investors all loan money to the U.S. government through the purchase of its bonds. And why not? U.S. government debt is the gold standard for safety and liquidity. It is considered to be the safest investment on the planet.

Furthermore, the system is completely transparent and above board. You may be surprised to learn that bonds held by the Trust Fund are officially reported as part of the national debt. That sixteen trillion dollar debt you keep hearing about? Roughly two and a half trillion of it is held by the Social Security Trust Fund.

Now it is certainly true that the government’s debt to the Trust Fund will have to be repaid. But then, all of the national debt will have to be repaid—mostly by further borrowing, issuing new debt as old debt is retired. That’s just a consequence of deficit spending; it has nothing to do with where you borrow. If the government didn’t borrow from the Trust Fund to finance its deficit spending, it would have borrowed that same amount from the financial markets. Either way, both the solvency of Social Security and the indebtedness of the country would be the same.

Some persons, unfortunately including a fair number of politicians, say that we’ve been hoodwinked. The Trust Fund, they say, doesn’t contain real assets; it has been “looted;” all its money has been spent on other things; and the bonds it holds are just “worthless IOUs” from the government to itself. The first question one might ask is whether the government of China thinks that its U.S. government bonds are also worthless, or whether you think the government bonds in your own private investment portfolio are worthless. After all, the Trust Fund’s bonds have no lesser or greater standing than U.S. government bonds that are traded on the world’s financial markets. Fine. But perhaps you still can’t shake the feeling that something fishy is going on. Hold that thought: later on we’ll show how those “worthless” Trust Fund assets can nevertheless be used to pay actual Social Security benefits. Which, after all, is what they’re for.

In the meantime, let’s explore a bit deeper why some misinformed persons might think that Social Security’s assets have been misappropriated. It turns out that’s a fairly useful thing to consider, because it relates to the mistaken notion that Social Security is involved in whatever fiscal problems the country may be deemed to have, and that fixing our alleged fiscal mess involves fixing Social Security at the same time.

One possible cause for misunderstanding is that payroll tax receipts go directly into the government’s general fund—what we’ve referred to here as the “checking account.” Incidentally, Social Security benefits are paid out of the general fund as well. Persons who don’t understand or haven’t thought carefully about the loan arrangement we’ve already described might suppose that having payroll taxes land in the general fund gives politicians free license to spend them willy-nilly, without the usual constraints on government spending, like a wad of cash burning a hole in one’s pocket. In this telling, once that happens, the Social Security taxes that were supposed to be set aside have instead been “looted,” and are no more. That’s probably what Tom Coburn meant when he said that “$2.8 trillion was stolen from Social Security.”

It doesn’t work that way. All revenues go to the general fund: tax receipts, the proceeds of bond sales to the financial markets, whatever. Congressional appropriators decide how much to spend, and on what, and without referring to any Social Security funds that one might imagine are sloshing around in the government’s checkbook. Nobody answers the question of “can we afford it?” by saying, well, we have all this Social Security money—or even that we have any money at all!

Congress must also decide how much deficit spending to allow, and must periodically raise the “debt ceiling” which defines how large the national debt may be. Since bonds owned by the Trust Fund are part of the national debt, they don’t provide any way of getting around the debt ceiling. Being able to borrow from Social Security is a convenient and sensible arrangement, but there’s no sense in which it enables additional deficit spending. The government is completely able to borrow from the financial markets, and does so all the time. It would happily borrow there exclusively, without a second thought, if the Trust Fund invested its money elsewhere.

Another cause for misunderstanding is how the government reports its annual budget deficit or surplus. By law, Social Security is supposed to be “off-budget,” meaning its cash flows aren’t to be considered when calculating the country’s annual budget deficit. That makes sense, because Social Security is a self-funded system, with its own dedicated revenue stream, and its own specific expenditures. But somehow that doesn’t stop the government from producing two sets of budget numbers: one with Social Security included, and one without. The budget deficit you hear about in public pronouncements has been the one with Social Security included. Why? Because until recently, Social Security has been running surpluses, and when those surpluses are added into the overall budget numbers, the effect is to make the budget deficit look smaller than it otherwise would. Perhaps officials think that puts the best gloss possible on how they’re managing the country’s affairs. It might also be one reason some mistakenly think Social Security revenues have been misappropriated. According to that line of reasoning, if Social Security’s funds are offsetting spending and reducing the deficit, then they’re being improperly used for programs that have no right to them. Of course, that’s faulty logic, an artifact of what may be a bit of budget chicanery with no real consequence.

One reason it has no consequence is that it unhelpfully confuses the deficit with the debt. The deficit is just a potentially misleading statement of the government’s cash flows for a particular fiscal year. The debt is a statement of the government’s total indebtedness; the amount it owes to all its creditors. And remarkably, the debt doesn’t grow year by year in increments that precisely equal the reported budget deficit. Because of how Social Security’s surplus has masked the size of the deficit, the debt has actually grown more rapidly than the reported deficit would imply.

Here, then, is an important principle that you should burn into your brain: when trying to make sense of competing claims about Social Security, always remember that what actually matters is not the annual deficit, however it is stated, but the debt. It’s the country’s total indebtedness that we care about, along with (and especially) the cost of servicing that debt. And as we’ve seen, the government’s borrowing from the Trust Fund is duly noted in the official accounting of the debt.

All that said, the deficit-debt mismatch is changing because the baby boomers are starting to retire, and payroll taxes are no longer sufficient to completely cover Social Security benefits. This moment has been long anticipated, and now it is upon us. Even though events are playing out as expected, and even though the Trust Fund exists precisely for this situation, it is still the case that when Social Security’s cash flows are added into the budget numbers, the budget deficit now appears to be larger than it otherwise would be. For so many years Social Security was masking the reported size of the deficit, but now it has the potential to exaggerate it. Both effects are mirages, but it’s easy to see how demagogues might claim that Social Security is having a deleterious effect on the budget. And regardless of the direction of deficit-debt mismatch, the critics will inevitably criticize, and happily have it both ways. If Social Security is masking the deficit, then its funds are being misappropriated. And if it’s exaggerating the deficit, well, even worse: Social Security is increasing our budget deficit! As always, the real test is not the deficit but the debt. Not only has Social Security not had any effect at all on the debt; it will not have any effect going forward, for at least as long as the Trust Fund carries a balance.

Yet another reason misguided critics might try to claim that Social Security is involved in alleged fiscal problems, one about which even experts can apparently be confused, is that drawing upon the Trust Fund actually involves the Treasury issuing new debt—even as the size of the national debt remains unchanged. It’s important to understand how that can be, and a simple parable illustrates.

Our story begins with the Treasury collecting payroll taxes and paying Social Security benefits, but now payroll taxes are insufficient to completely cover those payments. So the Treasury turns to the Trust Fund to withdraw additional money to make up the difference. What does that mean? Let’s picture an exchange between an imaginary bureaucrat at Treasury—let’s call him “Ted”—and an imaginary bureaucrat at the Trust Fund—we’ll call him “Fred.”

Ted gets Fred on the horn. “Fred, I need to make a withdrawal.”

Fred has been waiting these past few decades for just this moment. “Um, Ted, you know all I have is these lousy bonds you sold me. If you want me to satisfy your request, I’ll need to sell some of them back to you.”

“Oh, yeah,” says Ted. “Ok, let me see what I can do.”

Ted hangs up and has the Treasury issue some new bonds, selling them to the public in the financial markets. This raises the necessary funds to buy back some of the Trust Fund’s bonds. “Oops,” you might suddenly be thinking. But don’t worry; this all works out.

Ted calls Fred again. “Fred, I have your money.”

“Ok, Ted, here are your bonds.” The Trust Fund has just redeemed some of its “worthless IOUs” for cold hard cash.

“Uh, Fred, can I make a withdrawal now?” asks Ted.

“Sure,” says Fred, “here you go, buddy.” Fred sends the money back to Ted. Ted goes away and uses the money to cut Social Security checks.

But, you object, Treasury ultimately had to borrow more money to pay benefits. So much for the Trust Fund having real assets. But not so fast.

Remember: what matters is the debt, and it’s easy to see that the debt remains unchanged. How so? Well, those bonds that Fred sold back to Ted were part of the national debt, an obligation from the Treasury to the Trust Fund. Those bonds have now been retired, which reduces the national debt. But the bonds that Ted sold to the financial markets represent new debt, so they increase the national debt. And, wonder of wonders, the two offset exactly: the indebtedness of the country remains unchanged! Isn’t accounting great? One obligation is extinguished when a new one is created, and it’s a wash. Meanwhile, the checks go out, and the balance in the Trust Fund is reduced accordingly. Exactly what we wanted to happen.

Clearly, the paying of Social Security benefits with Trust Fund proceeds can go on in this manner until the Trust Fund is depleted, all without changing the overall indebtedness of the country. Given that the accounting is straightforward and easy to understand, it is shocking how even some acknowledged experts don’t seem to get it. Penn State accounting professor J. Edward Ketz wrote back in 2005 that

the government has had the privilege of looting the Social Security funds by transferring the money into the general fund, from which Congress can spend on whatever pork projects they wish. This ingenious way of raising taxes without explicit legislation has allowed the president and the Congress the use of an extra $2 trillion over the years.

We have already seen that this is false. Professor Ketz’s logic is faulty throughout:

The Congressional Budget Office and Democrats make the mistake of believing that Social Security has $2 trillion of assets without examining and realizing that these assets predominately consist of receivables from the general fund. These receivables aren’t collectible unless additional taxes are imposed on the populace. (As an aside, what type of return would an investor enjoy if he or she had to ante up the cost of the investment not once but twice?)

In confusing the government’s deficit spending with Social Security’s finances, Professor Ketz makes a mistake we’ve already discussed. Of course, in some sense “additional taxes” will indeed eventually need to be raised to pay back not just the Trust Fund but also the government’s other creditors, most notably the bond-holding public. Is the professor distraught over that? Nothing could be more silly than the implication that this amounts to double taxation to pay for Social Security. The money borrowed from the Trust Fund, like the money borrowed from the public, was used to pay for roads, bridges, wars, the Centers for Disease Control, and all manner of other government spending; Social Security will be paid for just once.

Professor Ketz isn’t the only expert who seems confused. Recently, former Clinton administration OMB director Alice Rivlin made a similar booboo (that’s a technical term). Writing in The New York Times, Rivlin advanced the startling (to her admirers, and to any reader who has gotten this far) claim that

Social Security currently adds to debt, because it pays out more benefits than it receives in taxes. While it accumulated credits when the higher ratio of workers to retirees was bringing in excess funds, Treasury has to borrow to redeem these credits.

And indeed it does. But as we have seen, such borrowing has no effect at all on the debt. Ms. Rivlin inexplicably seems to have a problem with the Trust Fund working as designed. It was, in truth, a rookie mistake, so elementary that one can’t help but wonder whether it was accidental or intentional. If accidental, could she have meant “deficit” instead of “debt?” Of course, even if she did, we’ve seen that the government’s reporting of the deficit isn’t a good gauge of what’s going on. And if intentional? Let’s not go there.

The slip is red meat to Social Security’s critics. If they can claim that Social Security adds to the debt (it doesn’t), then it follows that Social Security must be “fixed.” Remarkable, isn’t it? Decades ago, Greenspan & Company made careful plans for the long term solvency of Social Security, but now that it’s time to execute the plan, we suddenly have a problem. Is this a monumental bait-and-switch?

I suppose we should not beat this horse too much past the point of its being dead, but it bears repeating that Social Security is but one of the government’s many creditors, and we seem to have no problems with the status of all that other debt, which serves as a solid and trusted anchor to the world’s financial system. Why the double standard when it comes to the part of the debt owned by the Trust Fund? There is no logical reason that it should be so.

Now that we’ve dispensed with sham fiscal concerns, we might want to briefly inquire about the health of Social Security itself. The very long term prospects for Social Security’s solvency depend on all kinds of factors about which the best we can do is make educated guesses. That guesswork, which involves anticipating how the country’s demographics might look in the distant future, and also how the economy will perform over time, is the job of actuaries working for Social Security’s trustees. From time to time they provide us with revised projections, the most recent being that the Trust Fund will be depleted sometime in the mid-2030s. All kinds of things can happen between now and then, and there are tweaks that can be made along the way to extend the Trust Fund’s life. The worst case is that if and when the Trust Fund is exhausted, Social Security benefits would have to be cut by perhaps as much as 25 percent. That would not be a pleasant outcome, but it would also not be the end of Social Security, much less the end of the world.

The truth is, it’s too soon to know how that will all play out. Social Security’s critics want us to make harmful changes to the program, because they claim it is complicit in what they suppose are the country’s fiscal problems. We have seen that it is not. And they also want us to make harmful changes to the program because they imagine that some day, in the distant future, it will not be able to fully deliver on the benefits promised. So they want us to cut those benefits now. And if at this point you want to throw up your hands in exasperation and ask what any of this has to do with our present fiscal debate, you are certainly not alone.

  1. In Ancient Greek language, Apocalypse is described as ‘lifting the veil of false truths and lies’.

    No bigger apocalypse can be described as the social security scam being perp’d on all by the banksters and politico’s. As you will read below they have told us all to that we must pay in for our own future security. Then we are told there is not enough money, which our government was supposed to be managing for our secure future. Now, just as the baby boomers are getting ready to collect, there is not enough money in the ‘system’ and we all must pay in more and delay our rightful benefits we paid into.

    What a crock of extreme bovine excrement!

    No, they stole it by clever design some 70 years ago and are still stealing our hard earned monies which many future retirees will never see. Until we truly expose and understand how deep this massive scam goes and why, we will not be able to abolish and change a system that was designed from the outset to take our personal wealth and freedoms and keep us in perpetual debt enslavement because we are the problem.

    Though the following is rather technical, it lifts the veil behind the scam. One thing for all us neo-legal eagles is to understand, by design, the laws were purposely written in opaque legalese language to confuse and obfuscate the real meanings behind the actual laws and jurisdictions.


    The Social Security Scam – Why all taxpayers must file income tax returns

    “You have been told that Social Security is an insurance program run by the federal government. You were led to believe that your income would be taxed at a certain rate for the cost of the program. Then in times of medical emergency or upon retirement you would be eligible for Social Security benefits. On the surface, this would seem to be an equitable arrangement.

    But the federal government failed to fully inform you as to all of the other ramifications of applying for a Social Security number. For instance, did you know that you became a federal employee? Well, you did – specifically you became a member of the Merchant Marine. You also became an employee of a corporation that is involved with importing to and from the U.S. possessions. Another consideration is that if FICA is based upon a percentage of your earnings, then the government has somehow been granted the right to know the amount of your income and the sources of your income – this is not a hallmark of freedom. These statements and more will be evidenced by the actual federal statutes and regulations further on this page.

    Like all great magicians, the federal government has you looking at the obvious while hiding the basis of the trick that the magician is performing right in front of your eyes.

    Lots of Americans have questioned the legitimacy of the personal income tax, but it seems that everyone just loves the Social Security program. Social Security is the sacred cow that no one is ever supposed to criticize. Oh, sure, some claimants of Social Security find fault with what claims are denied or only partially funded. And lots of people are now pointing out that Social Security is not going to be solvent in the near future. But up till now no one has questioned the legitimacy of the Social Security program. Well, that time has come.”

  2. If you are counting on S.S., you better think again. It is doomed to failure in the next few years. Less than 10 by my reckoning. The argument over the ‘trust fund’ is pointless. When the dollar is not the world’s reserve currency (soon) and the economy of the Us collapses, (soon) the social safety nets will all disappear. The name of the game is BAU (business as usual) until it isn’t possible anymore. That time is rapidly approaching. I’m planing for it, are you?

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