What Is the Social Security Trust Fund, Anyway?

Periodically, an economist working on Social Security reform has to try to succinctly explain to non-economists what the Trust Fund is. I think I'm getting better at it, so let me try the newest version on you.

Think of the Trust Fund as a line of credit that the Social Security system extends to the rest of the government. The balance in the Trust Fund is simply the current value--principal plus interest credited at the Treasury bond rate--of all the withdrawals that the rest of the government has made historically on that line of credit to pay for things other than Social Security. Its projected balance at the end of the year is $1.85 trillion. Under current law, that balance is projected to peak at $3.61 trillion in 2022 before declining to zero in 2041. During those 20 years, the Social Security system will be calling in the loans that it has made to the rest of the government.

Keeping track of the total amount outstanding on these loans is the accounting purpose of the Trust Fund balance. It also has a legal purpose. Specifically, as long as the the Trust Fund balance is positive, then the system can pay the benefits implied by current law. It would require the Congress and the President to execute a new law to interrupt this process. When the Trust Fund hits zero, then it would take a new law to get full benefits paid on time--they would be paid only as tax revenues flow into the system.

This summary suggests three things to keep in mind about the current debate:

1) Contrary to what I suggested in a post three months ago, current beneficiaries and those nearing retirement age do have a stake in these debates, even if their benefits as implied by current law would not change. Any deviation in the path of the Trust Fund from its currently projected path makes the timely payment of their benefits less certain than it appears today. Policy makers will likely have to view this as a constraint on possible reforms if they are to assure those in or near retirement that their benefits are not becoming less secure as a result of reforms. Bye bye carveout PRAs.

2) It appears to be an official White House talking point that the Trust Fund is merely "a file cabinet full of IOUs." Here's an excerpt from a speech last week:

Now, secondly, Social Security is not a savings account. In my travels around the country I hear people say, why don't you just give us the money back we put in. But that's not the way Social Security works. It's a pay-as-you-go system. You pay; we go ahead and spend. (Laughter.) You pay through payroll taxes; we spend on paying for the beneficiaries, the retirees for that year. But if we've got any money left over, we didn't save it for you, we spent it on government. That's the way it works. It's a pay-as-you-go. And then there's -- all that's left over is a file cabinet full of IOUs. I have seen the file cabinet in West Virginia firsthand, and I saw all the IOUs. But the system is not the kind of system where we're holding the money for you. That's not the way it works. We're spending your money and left behind some paper that can only be good if the government decides to redeem the paper. That's a pay-as-you-go system.

Similar phrasing also appears on the Treasury's Social Security website:

There Are More People Collecting Benefits. As the Baby Boom generation begins retiring in 2008, there will be a dramatic rise in retirees who will be living longer. Social Security is a pay as you go system that leaves workers with IOUs, not personal accounts.

Ignore the non sequitur for a moment and just consider how silly the last sentence is. Every financial security--from dollar bills to Treasury bonds to corporate stock--is an IOU, and there would be no more physical evidence of a personal retirement account than there is of the Trust Fund. This is a talking point that needs to be dropped.

(As an aside, we often hear this phrase attributed to the President as having called the Trust Fund "a bunch of worthless IOUs," but I cannot find a link to an official document. Can anyone send me such a link?)

3) The sentiment being expressed in this reference to the filing cabinet is that the Trust Fund is an unreliable way to pre-fund future Social Security obligations, in the sense of paying more taxes now so that future generations of workers will have to pay fewer taxes later. We spend every dime of the Social Security surplus that is building up the Trust Fund. OMB Director Josh Bolten admits as much in this interview on C-SPAN's Q&A program:

LAMB: As you know, Mr. Walker has a 15-year appointment, so he doesn’t have to worry about the job he’s in. Is he saying -- I mean, this whole business of using the Social Security surplus as a way to keep the deficit down, first of all, what do you say about that?

BOLTEN: Well, he’s right, that what this administration has been doing, what this Congress has been doing, and in fact, going back in time, is that as Social Security money has been coming in, there has been a paper IOU sent over a file cabinet in West Virginia, somewhere to the Social Security system, and then government has been spending the money. That’s one reason why I think the president’s Social Security reforms are so important, because I think we put ourselves much more into a system where people get to keep more of their own money rather than relying on a government promise. ...

Republicans have, for quite a while, been saying that the Trust Fund is unreliable, and when they do, they attribute it to "the government spending the money." This may have been okay rhetorically when Democrats were in power, but it is a sham when they control both houses of Congress and the Presidency.

There is nothing inherent in Trust Fund accounting that requires the government to spend the Social Security surplus. The President could announce a policy of balancing the on-budget deficit (i.e., not the unified deficit, that includes the Social Security surplus) over the business cycle, and Congress could pass annual budgets consistent with that policy. Voila! The surplus is saved, and the IOUs in the Trust Fund actually do represent the extent to which the government has repurchased its own debt on behalf of future generations. This policy would have allowed the government to run a deficit during a recession, but it would have also required the government to run on-budget surpluses afterwards (in other words, now) after the recession. It is this last part that we seem to be unable to do.

So, perhaps sadly, the Administration's conclusion is correct: if Social Security is to pre-fund any future liabilities, then this pre-funding needs to be done in a new system such as personal accounts that deprives the government of the cash surpluses to spend. But the Administration's reasoning is all wrong--it is not because Trust Fund securities (like all other financial securities) are IOUs, but because the federal government--including this Administration--chooses not to implement a sensible budget policy.

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