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Saturday, January 17, 2009

Social Security Trust Fund

There is so much misinformation about this issue. It is causing a lot of anger and confusion, as in this DU thread. However, the confusion over the issue has been fed by loopy idiots like Paul Krugman, as in this interview, and politicians like Pelosi, who apparently believes that the trust fund has assets in the same way she believes that natural gas is not a fossil fuel and that the Supreme Court is just like God.

There isn't a Social Security trust fund in the form of any assets other than year by year taxation of US persons. There is a "trust fund" that serves as a bookkeeping device for how much money we "owe" to future retirees, but there are no independent assets in there. So as soon as Social Security current receipts stop exceeding benefits paid out, the general fund (i.e. corporate and personal income taxes, excise taxes and the like) will have to be used to pay benefits.

The way Social Security works is that current workers pay in taxes every year, and those funds are used to send checks to current retirees. That's all. It's a pass-through program. The surplus is moved over to the general fund and is used for other purposes.

The last time the surplus ran out (in the early 1980s), the current system was put in place. Since then there have been minor revisions, but basically Social Security taxes have been used to defray other taxes.

The 2008 Social Security Trustees report (which covers operations in 2007) shows what is happening. In 2007, the 12.40% of wages (up to the max) amounted to 560.9 billion. The total cost of the benefits program was 494.5 billion, leaving a 66.4 billion dollar surplus. That money was given to the general fund (the rest of the government).

The total cost of the benefits program is composed of benefits paid out (489.1 billion), administrative costs (3.1 billion) and the railroad benefits exchange (3.6 billion).

Because the surplus is given to the general fund, the bookkeeping entry for interest and taxation of benefits means nothing. The bottom line is that when the cost of the benefits program exceeds the revenues paid in, we are either going to have to borrow money to pay benefits (and pay the interest on that borrowed money virtually to infinity) or we must raise other taxes or the SS payroll tax to pay for benefits.

What really matters for SS are only two things - the ratio of wages taxed to benefits, and the ratio of workers to beneficiaries. If Congress passed a law wiping out the "trust fund", absolutely nothing would change about the funding of Social Security. Nothing.

If you look at the table at the link, you can tell that the surplus was rising quickly through 2007. (In 2003, for example, it was about 50 billion.) That helped to offset other budget problems.

In 2008, the surplus appears to have stopped rising, and from here on in, the surplus will start decreasing. How do I know that? Well,
Nor is my contention at all controversial. For example, BLS has calculated that while average weekly wages for production and non-supervisory personnel rose from $598 to $611 from Dec 07 to Dec 08, the Dec 08 average weekly wage has not increased since August.

Again, referring to the table in the '08 SS Trustees report, the year in which benefit cost was projected to be about equal to taxes paid in was 2015, and in 2016 a deficit of about 18 billion dollars was projected.

Because of the fact that the surplus has been used to finance general operations of the US government, the effects of a declining surplus are going to start to hurt before 2015. And due to our current unemployment situation and demographics, we are going to see people retiring earlier than expected. Early retirees receive less monthly, but will receive it for longer. An early retiree may be working, but will be working at a part-time job paying much less in employment taxes.

The demographics (taken from 2007 ACS):
US age distribution of population in 2007:
55-59: 6.0%
60-64: 4.8%
65-69: 3.6%
70-74: 2.9%
75-79: 2.5%
80-84: 1.9%
85 > : 1.7%
So although even in an Obama administration people will not be immortal, the percent of the population exiting retirement feet first from the last three brackets will be much less than the percentage of the population entiring retirement for years to come. The peak distribution bracket in 2007 was 45-49, which composed 7.6% of the population.

The majority of the 60-64 bracket in 2007 will be eligible for retirement of some sort by the end of 2009, and the rest will be eligible in 2010. Because of the economy, we will see them retiring more quickly than expected, and we will see the wage base declining more quickly than expected. So the break-even point is probably more along the lines of 2013.

But, as I noted before, the effects for the federal budget will be felt long before 2013. For example, let's assume that the surplus is halved by the end of 2010, which appears pretty likely. Thus, instead of Social Security taxes supporting the general fund to the tune of 66 billion dollars as it did in 2007, let's assume that the general fund only gets 33 billion dollars in 2010.

The effect this has on the ability to borrow is quite massive. At 5%, borrowing a trillion dollars costs the treasury about 50 billion a year, so 33 billion dollars less means 600 billion less borrowed. And then, of course, receipts from personal income taxes and corporate taxes are also falling right now, so we aren't going to be bailed out by other taxes.

By the way, one of the arguments used by "economists" who claim that Social Security and Medicare won't required raising taxes until the "trust funds" are exhausted is that we won't be increasing public debt. Whenever you see or hear the argument that taxes won't have to be raised until the trust funds run out, it stems from one of three causes: either the source is too dumb to pour fluids out of a boot when the directions are written on the heel (ID 10 T error), the source is parroting something said by someone they trust (a trusting dolt), or the the source is engaging in sophistry (Krugman 96 vs Krugman 04).

In a sense it is true that until the trust funds are exhausted, we won't be creating "new debt" to pay for them, because these mythical trust funds are included currently as part of the government debt figures. But it is a truth that obscures reality, because the general fund gets back all monies "paid" to these trust funds. Thus, we are not paying interest on debt. As a bunch of Alt-A negative amortization lenders have discovered in the last year, there is a massive difference in performance when the terms of the loan abruptly change and demand that the borrower now pay interest on the loan. In their current form, the trust funds are negative amortization obligations.

You can use this Treasury Direct site to view information about government debt and the percentages held by the public versus the government. Over the last year, debt held by the public has increased about 1.2 trillion dollars. Impressive, isn't it? We can't continue it forever.

Medicare is a more complicated question. There are "trust funds" for part of Medicare, but other parts are paid from the general fund anyway. Taking the two together, there are going to be major cuts and major increases in payments attributable to these services:

There are already changes in Medicare funding along the means-testing lines. Beginning in 2007, Medicare part B premiums rose for higher income couples and singles. These are the 2009 premiums that are deducted from the Social Security benefit check for single income brackets (double the MAGI figures for married filing jointly)
MAGI <= $85,000 individual: $96.40
MAGI <= $107,000 individual: $134.90
MAGI <= $160,000 individual: $192.70
MAGI <= $213,000 individual: $250.50
MAGI > $213,000 individual: $308.30

You can retire early on Social Security, but you aren't eligible for Medicare until 65. So the big bulge for Medicare is shifted back a few years. When it hits, you will see these brackets shift sharply downward. MAGI includes tax exempt interest income, so in effect those no AMT bonds won't be tax free any more for some retirees!

Part of the reason why it seems that Treasuries held by the Social Security Trust Fund have value is that normally when Treasuries are held they have value to whoever holds them even if the Treasury has spent the proceeds from issuing them. However, when the Treasury holds Treasuries it is holding its own debt. In order to spend the value of the Treasuries to pay Social Security recipients, it must sell its own debt which is borrowing. Because of this, the only way in which it could have avoided needing to borrow in order to spend the value of the Treasuries in the trust fund would be to have not already spent the proceeds from the Treasuries.

If the Treasury were to withdraw Treasuries from the account, it would have to sell them for cash to give to Social Security recipients. When it is the Fed that sells Treasuries, it is not borrowing. Instead it is sterilization since the Treasury does not get additional funds to spend. However if the Treasury were to sell previously issued Treasuries, it would be the same as if they were issuing new Treasuries since they would be removing the ability to spend from the rest of the economy to transfer to Social Security recipients. No saved wealth would be made available. Selling Treasuries is the same as what would need to be done if there were no savings from previous years in the trust fund. It is different than if the Treasury issued the Treasuries and they were then bought and resold later since in such a case the reselling would be offset by the buying. If the Treasuries in the trust fund were resold, it would be using one Treasury to borrow twice since they would never have been bought.

In 2018 when the trust fund will need to borrow it will be in the same situation as if someone were spending more in a year than he was earning that year and needed to borrow because of this. However, he would only need to borrow if he didn’t have savings from previous years, which indicates that the trust fund really doesn’t have savings from previous years. The only way in which it can be said that the trust fund has savings from previous years is in the same way that someone could say that he had a savings account if it was a savings account where if he wanted to withdraw $100.00 the bank would say that he had to pay them $100.00. Without any savings, he would have to borrow the $100.00 to give to the bank to get his $100.00. He certainly wouldn’t be able to use such savings account as collateral for a loan!

If government borrowing is increased to replace the increased amount of government borrowing that goes to Social Security, it will harm the economy by increasing interest rates. To the extent that the additional borrowing causes the dollar to fall, interest rates will rise even more. In addition, as the employed percent of the population becomes smaller, GDP will decline in proportion to spending. This will cause the dollar to fall even more. As inflation increases because of these factors, Social Security obligations will increase to the extent that they are indexed to inflation.

The lack of funding of Social Security will become more apparent in 2011 when baby boomers start to retire. Since the government has depended on having more paid into the trust fund each year than is paid out and is using the net inflow of funds for financing spending, even though there will still be a surplus until 2018 the government will have to increase borrowing before then to maintain the same level of spending.
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