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Tricky Finance

Mises Daily: Monday, January 04, 1999 by

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Watching the national debate about what to do or not do about Social Security (SS), it is tempting to think the worst about our fellow citizens and the people who represent them in Washington. The debate suggests that most people have no idea what SS is, how the program figures in Washington's finances, or how SS comes to shuffle around hundreds of billions of dollars every year. Politicians, meanwhile, add to the level of confusion by telling outright lies to and playing on the fears of an aging electorate. The result is a confused muddle where opinion and hearsay play a bigger part than do the hard legal and financial realities.

The biggest fallacy of the debate over SS is that there is a cash surplus flowing into or assets held by SS that must be "saved" or can be privatized by Congress and the White House for future retirees. In fact, every cash dollar raised in SS payroll taxes not immediately spent paying benefits to current SS recipients is spent on other federal programs. The reason for this is that the SS Administration is not a separate entity, contrary to what most Americans believe, but is a fiscal captive of the U.S. Treasury.

By law, the SS Administration and other federal trust funds must "invest" any surplus funds in non-marketable Treasury debt, thus providing politicians of both parties with extra money to spend on public works projects, welfare payments or an extra aircraft carrier. Federal trust funds hold roughly $1.3 trillion in special Treasury bonds, about $725 billion for SS trust funds, $160 billion for Medicare funds and the bulk of the rest in civil service retirement accounts.

But all of these IOUs are merely an accounting entry and do not represent a store of value – the classical, legal definition of an asset – that would provide the federal government with the resources to make these legally promised payments in the future. President Clinton in his recent State of the Union Message warned that the SS trust funds "will be exhausted by 2032," but in fact the trust funds are already and completely insolvent. The proverbial piggy bank is empty save a bunch of dubious IOUs from Uncle Sam, IOUs that the Treasury must one day redeem via new taxes or borrowing.

Government estimates for the fiscal 1999 budget surplus, for instance, have been raised to almost $80 billion, in part because of rising SS payroll tax contributions. As the surplus grows, the Republican Congress and the Clinton Administration play a now familiar game regarding the surplus generated by SS and other trust funds, a game that past Congresses have played with past administrations for decades. Yet this political charade is performed at the expense of working American families, people who bear the cost of Washington's fiscal chicanery by paying taxes for programs that never actually spend the money raised.

For example, the Republican Congress wants to cut taxes because inflows from SS contributions are swelling the Treasury's cash flow, thereby reducing the "public'" budget deficit. Yet despite the increasingly rosy fiscal outlook, the Clinton White House and congressional Democrats decry proposals to cut SS taxes. They argue that the growing surplus must be protected to "save Social Security." Yet neither the Republicans nor the Democrats are really telling Americans even part of the fiscal truth about SS.

The key point to understand is that paying SS taxes is not an "investment" in the economic sense of the term, nor do participants "save" any money when they make contributions. Current contributions pay current benefits, with any "surplus" cash remaining in the Treasury's general fund. The SS Administration receives an IOU from the Treasury, but these debt instruments held by the SS Trust Funds are not "assets" but rather are unfunded liabilities. The amounts shown as being held by the SS trust funds, the Medicare or highway trust funds, simply represent the amount of money that has been diverted to general spending.

The SS Trust Funds, and all federal trust funds, are merely an accounting entry on the Treasury's balance sheet representing money that has been collected in taxes but not yet spent for the purpose prescribed by law. But the dark secret that nobody in Washington will admit is that all federal trust funds, whether for SS or Medicare or Interstate Highways, are a financial fraud, an act of fiscal criminality perpetrated on the American taxpayer by both political parties.

By law, no private company can invest pension funds in its own debt, but it's okay for Uncle Sam to steal surplus SS payroll contributions, gasoline taxes or any dedicated tax where funds raised in a given year are not immediately spent. Thanks to the duplicity of FDR, when Americans make SS contributions, many believe that they are saving money for their future retirement. But the reality is that, because today's surpluses are "invested" in the Treasury's own debt, the Treasury's ability to make SS payments in the future is entirely dependent on its ability to borrow in the markets and/or tax future generations.

Thus when Republicans call for tax cuts in the face of rising SS surpluses, they are attempting to do the right thing and give Americans back money that is not required to pay current SS benefits. Meanwhile, most Democrats prey upon the fears of the elderly by bemoaning attempts to give working families back more of their own money. Ironically, two Democrats, Senators Ernest Hollings (D-S.C.) and Patrick Moynihan (D-NY) attempted to press this point earlier in the decade, but neither party was interested in cutting taxes at that time. Indeed, the SS Commission chaired by Fed Chairman Alan Greenspan did nothing to fix SS's solvency and in reality raised taxes to help feed Washington's spending machine.

One of the more amusing spectacles in the debate over SS is to see and hear "policy experts" arguing about whether it would be better to place surplus funds in private stocks or to continue the practice of "investing" SS funds not needed to pay current benefits in non-marketable Treasury debt. By law, the Treasury pays "interest" on the debt held by the SS Administration, but no cash payment is ever made and, most important, there is no increase in the Treasury's ability to pay future benefits.

If it wanted to, Congress could set the interest paid to the SS Administration at 150% annually and it would not improve the system's finances at all. Likewise, moving SS on or off budget will not change the situation one iota. When the Treasury recently made an adjustment in the interest paid on Treasury debt held by the SS Administration, it made absolutely no impact on the government's ability to pay future benefits. The financial press dutifully reported the event, but not one news story questioned whether the Treasury's adjustment had any real, financial significance.

They key issue to remember is that the SS trust funds and interest payments made by the Treasury are simply a bookkeeping entry. In fact, were present SS payers were allowed to keep their own money and invest it in private stocks and bonds, they would arguably come out way ahead compared to the current system. Not only would their money be growing in real investments, but the return would be real as opposed to the fictional arrangement that currently exists between the SS Administration and the Treasury.

But the "privatization" proposals being batted about Washington do nothing of the sort. The worst of them require that we forestall tax cuts and garner even more "contributions" in order to build another mandatory system atop the present one. Some have proposed plans that would make the U.S. Treasury the decisive player in who wins or loses in the stock market. Such proposals are based on fantasy and obscure the real point; namely the inefficient and immoral taking by Congress of money from working families under the false pretense of funding an insurance program that is really just a tax-and-spend redistribution scheme.

The chief question regarding SS should be not how to save this bankrupt socialist contraption but rather how to get rid of it. Cutting payroll contributions is a good start, but the Congress is going to need to gird itself for the real battle: namely, cutting and/or means-testing minimum retirement benefits and allowing younger Americans the opportunity to opt out of the SS system entirely.

Moreover, as part of a broader program of fiscal renovation, Congress should forbid the Treasury from "investing" surplus funds in its own debt and mandate that taxes for all federal programs involving "trust funds" be immediately reduced to a level approximating to outlays in any fiscal year. Any residual surpluses should be rebated back to the taxpayers.

It is time to reject FDR's great collectivist experiment, return to Americans full control over their financial affairs and impose upon the Treasury the same fiscal rules that any private company or bank must follow. The way for Congress to reform SS is to tell the American people the hard financial truth about SS and other federal trust funds, and begin the difficult but manageable process of dismantling the system once and for all.

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Christopher Whalen is an investment banker who lives and works in New York.

See also Whalen's letter to the Wall Street Journal.