April 24, 2014

After Sixty Years, It's Time to Rethink the "Trust Fund"

Facing Facts Alert 6

The Truth about Entitlements and the Budget A Fax Alert from The Concord Coalition FAX ALERT ( Number 6, August 17, 1995) AFTER SIXTY YEARS, IT'S TIME TO RETHINK THE "TRUST FUND" Social Security's sixtieth anniversary is giving Congress and the White House a welcome opportunity to expound on a favorite theme: "protecting and preserving" the Social Security "trust funds." This emphasis on trust funds serves a political purposeuto minimize the scale of reforms needed to save the system. Trust-fund accounting makes it possible to balance illusory near-term "surpluses" against yawning longer-term deficits. This in turn allows politicians to claim that only a minor tax increase is needed to balance the system over the next seventy-five years. But good politics doesn't always make sound policy. What really matters in assessing Social Security's long-term financial health is a much simpler concept: the OASDI system's annual operating balance (that is, its yearly tax revenues minus its yearly outlays). By 2025 -- a year when the Social Security Administration (SSA) says that the system's trust funds will still be "solvent"-- Social Security will nonetheless be running an annual operating deficit of $482 billion, or more than one-fifth of that year's projected expenditures. This is the annual amount Congress will have to raise in 2025 through new taxes (or else save through spending cuts) to keep the overall federal deficit from growing. It's time that we purged the debate over Social Security of the misleading rhetoric about trust funds and recognized the truth. The program faces a far more serious financial crisis than the official wisdom admits. No Earned Right The place to start is by getting straight what the Social Security trust funds areuand what they aren't. "Trust fund" normally means an account in which duly recorded deposits are held "in trust" for the depositors. This is not the case with Social Security. First of all, there is no direct record of individual contributions. All types of federal revenues flow into the same IRS bank accounts and are spent immediately. Although Treasury makes monthly estimates of total tax receipts earmarked for Social Security (estimates which may not be finalized until years later), the only way SSA can determine an individual's lifetime FICA contributions is to infer the amount indirectly from his or her wage history. As for property rights, there are none. In its PR material, SSA often implies that payroll "contributions" create a contractual claim to future benefits much as contributions to a private pension fund. But the Supreme Court has repeatedly ruled that Social Security rests solely on the sovereign (and distinct) powers of government to tax and to dispense benefits, that no participant accrues any property rights, and that Congress can change taxes or benefits anytime that it wishes. No matter, say those who insist on the trust-fund mythology: Even if payroll taxes confer no property rights, they do confer a "moral" or "statutory" right to a benefit payback which is loosely related to lifetime contributionsuand that amounts to the same thing. Not really. To start with, the notion that individual contributions are even loosely related to benefits is hard to square with the enormous variation in actual paybacks. If you're a low-income worker retiring at age 65 today, the value of your lifetime benefits is 80 percent greater than the value of your lifetime contributions; if you're a high-income worker, it is 10 percent greater. If you're an average-earning male with a nonworking spouse, the value is 120 percent greater; if you're a single male, it is 20 percent greater. Such differences are magnified by even vaster differences between generations. If you're a typical single male who retired in 1980, you're getting a windfall of $74,000 above and beyond your and your employer's FICA contributions plus interest. If you're a typical single male who will be retiring in 2010, you'll suffer a net loss of $15,000. And that brings us to a second problem with the statutory right argument: The "right" keeps changing, mostly because Congress has repeatedly revised the tax and benefit rules at the expense of younger generations of workers and taxpayers. Originally, Social Security was supposed to be financed forever at a payroll tax rate of 6.0 percent. Today that tax rate is 12.4 percent. By 2030, it will have to rise to at least 17.3 percent. One might argue that even if the payback ratios are skewed and the rules of the game have been repeatedly altered, Congress still ought to regard the existing rules as finaluand use the trust funds to reassure future beneficiaries that they will receive what they are now promised. But if we really wanted to do that, proper trust-fund accounting would require us to formally acknowledge all of these future benefit liabilities (i.e., what is owed to those whose contributions are being held "in trust"). That would in turn require recognizing a debt obligationuas real as the official national debt -- amounting to $8.3 trillion. To offset this liability, even on paper, the OASDI trust funds currently hold assets of just $423 billion, one-twentieth of total liabilities. (Both figures are for the end of FY 1994.) If a private pension were funded this way, the managers would be jailed for wholesale violations of federal ERISA regulations. In fact, if Social Security's unfunded benefit liability were to be amortized the way private firms must amortize their pension liabilities, it would add $670 billion each year to the federal deficit. Just a Memo Account Trust-fund mythologists hardly want to follow this chain of reasoning -- and so switch the argument entirely. Maybe individual contributions aren't held in trust. But at least this accounting is a convenient programmatic device ("trust fund" being just a nice name for it) whose purpose is to increase national savings and help defray the costs of the Baby Boom's retirement. Wrong again: The way the Social Security trust funds work mocks the whole purpose of prefunding. "Assets" are simply interest-bearing Treasury IOUs which are entirely internal to the federal government and whose sole function is to keep track of formal budget authority. None of the most-watched budgetary measures -- from total revenues or outlays to the unified budget deficit or Treasury debt held by the public -- are in the least bit altered by these paper transactions. So we arrive at what the Social Security trust funds really are: memo accounts. The federal budget includes over a hundred such trust funds -- none of which effect any genuine savings. It's a bit like the cash register receipt that reads: "You SAVED $35.67 for shopping at Acme Hardware today." Yes, it does represent a sort of hypothetical "savings." You may even find the information useful. But you'd never imagine this "savings" earns interestuor in any way changes your finances. When a federal trust fund is said to be "in balance," the designation is thus purely formal. It means only that the fund's cumulative revenueustretching from its establishment into the distant futureuis someday expected to match the fund's cumulative expenses. Such accounting says nothing about individual equity, income equity, or generational equityunor indeed about federal borrowing or national savings. "Balancing" a trust fund in this sense is meaningless. By the same reasoning, a promise by Treasury to redeem its bonds (someday) would allow us to ignore the annual federal deficit. If it wanted, Congress could "balance" the Social Security trust funds at any time simply by allotting to them some unrelated future revenue source (say, tariffs). In fact, Congress has already engaged in such shenanigans. In 1983, it allotted the income taxation of Social Security benefits to the Social Security trust funds. (Great: Does this mean that we should now shunt the income tax on federal pensions to the federal pension trust funds?) Then in 1993uin a surpassing act of illogicuCongress allotted a new tier of income tax on Social Security to the Hospital Insurance trust fund! Even more than its political utility, the beauty of the trust-fund concept is its infinite malleability. Let's cut to the bottom line. We face a choice. If we want Social Security to work like a private pension, we will have to fund it -- or, at the least, formally recognize its liabilities. If, on the other hand, we prefer to regard it as a pay-as-you-go safety net, let's bury the entire metaphysics of trust-fund accounting. Let's acknowledge that Social Security, like any other federal benefit program, is a simple transfer of income from current taxpayers to current beneficiaries. As such, it makes sense to subject it to an affluence test that relates benefits to need. And as such, all that is fiscally important is its yearly impact on the net difference between total federal revenues and total federal outlays. What Really Matters Looked at as a pay-as-you-go program, the outlook for Social Security is grave. Whereas the 1995 annual report of the Social Security Trustees says that the trust funds will be in balance until 2030, the system's yearly operating balance will sink into deficit starting in 2013. By 2020, this yearly cash deficit will hit $232 billion; by 2030, $766 billion. Under an alternative SSA projection that allows for greater population aging and slower economic growth, deficits would start in 1999 and hit $1.5 trillion by 2030. Again, these are the annual amounts taxes would have to be raised (or spending cut) to keep the overall federal deficit from growing. Any honest plan to balance Social Security must take this cash deficit measure as a benchmark. Unfortunately, most current reform plans buy into the trust-fund mythologyuthat is, they count trust-fund assets and interest in calculating long-term balance. Unless we are prepared to take the radical (and painful) step of "privatizing" the system, this kind of accounting is a hoax we play on the future. Come the 2020s, when our kids reach into the OASDI trust funds and find nothing but IOUs with their name at the bottom, they will wonder what we were possibly thinking when we declared Social Security "solvent" for generations to come.

FACING FACTS AUTHORS: Neil Howe and Richard Jackson CONCORD COALITION EXECUTIVE DIRECTOR: Martha Phillips