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Social Security truths I: The myth of the trust fund

People of good will can genuinely disagree about the wisdom of private accounts or other Social Security reform measures, but before we get too far into that dialog, we should at least make sure we all agree on some basic truths regarding the existing system.

I am continually dismayed by the amount of disinformation out there on this topic. I assure you, that is no accident. The government is not anxious to draw attention to how the system really works.

What I'm going to tackle now is this notion of a Social Security "trust fund." Many people believe that an account exists somewhere, flush with funds from FICA payroll tax surpluses, strengthening the Social Security system for decades into the future.

Well, it's not true. I know many of you already know this, so you should feel free to skip this post, but I'm going to address the myth of "transition costs" later, and this is a prerequisite.

Each year, Social Security takes in more money in payroll taxes than it needs to meet the current obligations of the system. The leftover surplus is then "invested" in the so-called "trust fund." This mode of investment, however, is a dubious one. The surplus is used to purchase a certain type of government bond. Like all bonds, these are debt instruments. Essentially, it means the monies are transferred into general revenues, where they are immediately spent by Congress on wars, farm subsidies, debt service, whatever. The Social Security trust fund contains no actual money, merely IOUs from the government, promising that someday they'll pay back the money they've already spent.

I would like to think the problem with this should be obvious. The fund we're led to believe safeguards our payroll taxes and will pay our benefits when we retire is nothing more than a pile of debt.

Some of the president's opponents, Josh Marshall being a notable example, have had some grand fun mischaracterizing our position as "government bonds are worthless pieces of paper." As is often the case, Marshall completely misses the point. Government bonds can be a sound investment vehicle for you, me, Josh Marshall or the government of China. For the government to purchase treasury bonds as an "investment," however, makes no sense.

If you write me an IOU, that piece of paper has value to me. If you write one to yourself, however, you've accomplished nothing. When the time comes for Social Security to redeem these bonds, how will they be paid for? There are three options:

  • cut government services
  • raise taxes
  • borrow more money

or some combination of the three. In other words, the vaunted "trust fund" is nothing more than a promise that the government will someday pay Social Security back with money that it doesn't have.

This is more than merely dumb; it's dishonest. Referring to an enormous unfunded mandate as a "trust fund" is disingenuous in the extreme. It encourages us to believe it's an asset when it's really an obligation. It also masks the true size of the federal budget deficit, by moving the Social Security surplus into general revenues, where it doesn't belong.

Think of it as a corporation that raided its pension fund until there was nothing left in it, and then said, "Don't worry. We'll pay that money back out of our revenue stream when the time comes." The difference is that in the corporate world, people would go to jail for that type of shenanigans.

This is exactly why Al Gore wanted a Social Security "lockbox." The lockbox is merely an annoying metaphor for actually saving the Social Security surpluses instead of spending them. He knew that the surpluses were being spent as fast as they came in, and he recognized that this practice was unwise for the future of the program.

It's hard to argue with that in principle, but in practice, the lockbox raises some interesting questions. Where would we invest the funds? If we were to choose government securities, we'd be right back in the same mess we're in now. If we were to choose private securities, we'd face some uncomfortable questions about how the government would choose which corporations to own stock in, and whether widespread government ownership of private corporations is a good idea. Moreover, the critics of private accounts would have to explain why it's okay for the government to invest our contributions in the stock market, but it's somehow sinister for us to do so individually.

Despite these details, I think the lockbox idea is sound, but it probably never stood a chance of becoming reality, even if the 2000 elections had worked out differently. It's not very likely that Congress would vote to deprive itself of a revenue stream of borrowed money, particularly when most Congressmen will be long retired when the bills start coming due.

It must be pointed out, however, that the private accounts the president proposes will accomplish much the same thing, albeit on a smaller scale. The money that workers choose to divert to private accounts will be out of reach for the Washington spenders. It will be in a highly distributed "lockbox." Unlike the bogus "trust fund," this is real money that will be safeguarded against the day that it's needed, and it can never be converted into debt.

The president's plan provides for no more than 4% of one's income to be diverted to private accounts, but that 4% would represent a partial return to fiscal sanity, as our payroll taxes will begin to build genuine wealth as opposed to accumulating government debt.

I support private accounts, but they are not a cure-all for everything that ails Social Security. Nonetheless, they can help move us down the road of honest accounting. One way or another, the money we pay into the system should be set aside for our old age, not immediately consumed by a spendthrift government. Private accounts can help.

The transition costs of such a program? That's a subject for the next post. (God, I'm starting to sound like Paul Krugman!)


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I see some of my thoughts trickled in there...

But let me ask you this, you are obsessed with the fact that the trust fund contains no actual monies, just an IOU. What do you think your bank account is? Sure the bank has enough money to pay you back if you want your cash, but only because it is such a large institution. If there was a run on the bank not everyone could get all their money immediately, the bank would have to liquidate it's investments.
When you put your money in a bank, the bank uses that money to fund it's own investments and make money.
When you buy a stock or a bond it's the same thing.
In fact when you cash your paycheck the dollars in your hand are only worth what the market bears. There is no intrinsice value. Money is a unit of labor. The amount of labor it equates to fluctuates with the economy.
But I'm sure you know that. The point is that SS investing in Treasury Bonds is inherently no different than you or I doing it.
If the government ever defulted on those Bonds it would send a message to investors that Treasury Bonds were no longer the safest investment in the world. That would likely spur many investors to dump their Treasuries, this could be devatating to the economy, so of course they will never let it happen. They'll just borrow more and increase the deficit, that's how it works.

Your entire argument hinges around the distinction between the government investing in itself as being a bad thing. I would rather see a bit more fiscal discipline, if they didn't raid the "lockbox" so to speak deficits would be higher. Raiding the trust fund keeps them artificially lower. But if they are going to spend more than they take in (not counting SS) is it better for the one area of the government that has a deficit to borrow from another that has a surplus at a reduced interest rate? Or is it better for the government to borrow from outside sources at a higher rate of interest?

I now your answer will be they should reign in spending..but since we both know that won't happen I believe it's better to borrow internally where you can control the interest rate. Corporations do it all the time. Why not government? It's the same thing really.

I think you're just hung up on the belief that when the time comes government won't honr it's obligations. I see no reason to believe it won't. As I mentioned it will cause a loss of faith in government instruments which will be disastorous. I'd also remind you that if we take a portion of the SS revenue now and invest it in private accounts the government will have to redeem some portion of the trust fund in order to make payments - why do you believe that the govt will honor it's obligations now, but for some reason won't honor them in the future?
An additional impact of raiding the trust fund now is that govt will have to borrow elsewhere to make up the shortfall. This additional outside borrowing will further increse our national debt and make it that much harder to eliminate the deficit.

Better yet, let me choose to not pay SS tax (and thereby not get retirement money) and invest as I see fit to plan for my own retirement. My money, my choice.

Z, I'm sorry, but there *is* a big difference in you or I investing in government bonds and the government doing so itself, as I pointed out in my post. Your bank analogy is accurate, as far as it goes, but misses the point. Yes, my checking account is an IOU after a fashion, but there's a fundamental difference in the bank's assigning an IOU to me and assigning one to itself.

And to correct one other point, I do not worry that the government will default on its Social Security obligations. I think it will have no choice but to pay (although likely with reduced benefits). My problem is not whether, but how we are going to make good on these obligations -- through taxation and borrowing, obviously, but that sucks, because we're talking trillions of dollars worth of liabilities here, and rather than setting the surpluses aside in anticipation of that day, we are simply spending them as fast as they come in, and that's a problem.

Investment only creates value if the person or org. you give money to goes and creates something of value and sells it. The government can't create value, so it borrowing from itself (which is identical to it investing in itself) will not accomplish anything. Only the private sector creates value. If the government gives you an interest rate on an investment, this merely recognizes inflation - i.e. they can just print more money to pay you back if the want. The only way the government could even sustain the value of your SS contributions without taxing somebody somewhere and giving that money to you is to immediately use your money to purchase something with a stable or increasing value, for instance to purchase silver or gold and set it aside for you.

But silver is not going to increase in mass. The best it can do, barring changes in demand or supply, is maintain its current value.

Social Security has always relied on an increasing population to simulate the creation of value. Well our population isn't increasing all that much any more, and people are living longer after retirement. No amount of tax hikes can save it in the long run. The sooner we shoot this sick horse the better.

Wow. That was quite an essay. It was a valiant attempt on your part to explain SS. Most of your arguments were great, but I would be remiss if I didn't address some of your comments.

First, you claim that using the phrase "trust fund" is disingenuious. The SS Administration merely uses that phrase the way it's used everywhere else in the private sector. If a trust fund is set up for some kid somewhere, a trustee is assigned, and it is his responsibility to manage it. Most trustees invest the funds to earn a return. There may be some who just sit on the cash (or put it in cash-equivalants, such as CD's, savings accounts, etc.), but they would be poor trustees, because
they could be earning solid returns elsewhere. If a trustee invested in Treasury securities, he would be thought of as a respectable, albeit very conservative, trustee. This is done a lot, by many, many trustees. Treasury securities are thought to be the safest investment around, because it is backed by the full faith and credit of the U.S. Government. So usage of the phrase "trust fund" is not misleading. Most people understand (or should understand) that trust funds are invested.

Also, you say that they represent they have "assets" when what they have are "obligations". Well, actually they do have assets, because whether Treasury securities are owned by the SSA, a private company, a pension fund, or you or me, they are assets to the holder. They go on the balance sheet as assets, the same as investments in equities, or land, or idle cash sitting in a checking account. The "obligation" belongs to the Treasury department. Yes, I know the SSA and the Treasury department are all "Government", but that fact doesn't mean the Treasury would not honor it obligation to the SSA. There is an entire realm of accounting called Government and Not-for-Profit Accounting that covers this kind of thing. It covers "funding" and "expenditures" and is quite boring.

It just seems you are making too much light of the "promise" to pay when Treasury securities are redeemed. This "promise" is about the best promise you can obtain from anyone. It's a more solid promise than you would get from the bonds of Microsoft, or G.E., or Exxon, or Ford. That's the reason returns are generally better for corporate bonds than they are for Treasury bonds - they're a litte riskier.

Also, you drew a comparison to corporate pension funds, and mentioned that they do not "raid" their pension funds. But 91% of all pension funds are underfunded, and most companies use expectations of future returns to determine their current contributions (I'm refering to defined contribution plans). So in a sense they do "raid" their funds, in the sense that they use expected future returns to determine how much to put it today, i.e. they don't just accumulate as much money needed to be fully funded at all times.

Which brings me to my next point. Under the current SS system, it is not necessarily a bad thing for the SSA to invest the trust fund (excess of inflows (SS revenue + interest) over outflow (SS benefits paid + admin expenses). Treasury securities, as I mentioned before, are about the safest investment in the world. I suppose there exists a SLIGHT risk, but do you think the Treasury is going to default on its obligations? This is NEVER going to happen. What are the alternatives to investing in Treasury securities?

a) Not invest at all. Put it in the "lockbox" and leave it. This is certainly not good custodianship of our monies. We would lose purchasing power due to inflation, which is always present and positive.
b) Put the money in banks (CD's, money market accounts, etc.). This is not going to happen.
As it is, the FDIC only insures up to $100,000, and if there is no FDIC insurance, this money is only as secure as the individual banks. The present banking system would have to be overhauled.
c) Invest in U.S. stocks and bonds. This is a bad idea for many reasons, chief among them being that this is basically socialism. It would play havok with our free market economy.
d) Invest in foreign countries, or the companies contained therein. This is probably a bad idea, too, but for different reasons. I think most countries would not allow the U.S. government to own part of its companies. You know, sovereignty issues.

Not many good choices, right? I agree. Which is why I'm on the same page as you in supporting private investment accounts. As you mentioned previously, even FDR supported this idea. Why not give us at least partial control of our SS monies, and let us take a crack at doing better than ultra-safe Treasury securities.

Very good points, Tracy. I'm afraid, however, that I'm not being clear on one point. I'm not afraid that the Treasury will default on its obligation to SS. I understand that the promise is sound, and that's not my issue. My issue is that when they *do* redeem the bonds in the trust fund, it's going to cost a hell of a lot of money, because the funds that should have been set aside were spent on general outlays.

And thanks for detailing some of the problematic aspects of the "lockbox" idea. I had similar concerns on how the funds would be "invested" exactly, but you have articulated them much better than I could have.

So are Sam and Doug playing "bad cop" to Barry's "good cop"?

"I'm tellin' you, Mr. Security, I'm offering you the best deal you're going to get, because I'm tellin' you if Sammy gets a hold of you there's no predictin' what he might do."

Barry, maybe you could dispel another myth for me. I'm 33 years old, and I have about that many years to go when I retire. Is it true that I shouldn't bother paying attention to this stuff because Social Security won't exist when I retire? ;p

Roger, I don't know, but I'd stop sending payments in just to be on the safe side.

No, Barry! Don't tell him that! I want Roger to keep contributing for at least 8 or 9 years so I can collect some of his money....uh, Roger, would it be more convenient for you to just start sending me small checks now?


How about I send it to you in sacks with large dollar signs printed on them?

It's strange, though, maybe it's a generational thing, but from the time I started working at 14 and learned about this Social Security thing I'd be paying into, every adult I ever had contact with would half-jokingly tell me that it didn't matter, the money wouldn't be there when I finally retired. I guess that cynicism has really stuck with me over the years.

I do notice that most of the people I see talking about it on blogs and on the radio seem to be at least ten years older than me (not that there's anything WRONG with that, of course). I wonder how many people my age and younger are as passionate about this issue.

Barry, you mention that "when they *do* redeem the bonds in the trust fund, it's going to cost a hell of a lot of money", but actually they (SSA) are redeeming bonds all the time. They redeemed bonds last year, this year, and will continue to do so. Perhaps you are using another way of emphasizing that by the year 2042 (or 2052, depending on who you believe), the SS trust fund will finally be exhausted, and since at that point the SSA will only be receiving 70 cents per dollar that it needs to pay out, the Treasury would have to come to the rescue. Well, that is why the sooner we can fix this problem the better.

You mention in the same sentence that "the funds that should have been set aside were spent on general outlays." Now we are back to my questions of "set aside where? and how?". Do you really want the SS monies in a lockbox where they sit idle earning 0% (and losing purchasing power due to inflation)? As it is, in 2004, it looks like the trust fund earned around 5.5% in interest income. $87 billion in interest. If the lockbox idea had been used for the last 20 years, the trust fund would have a LOT less than the $1.68 trillion it currently has.

> Now we are back to my questions of "set aside where? and how?"

Well, you *know* my answer to that one. ;-)

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