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The Myth of the Social Security "Trust Fund"

Tags Big GovernmentTaxes and SpendingU.S. EconomyInterventionism

07/05/2010Robert P. Murphy

At times I am amazed that the general public hasn't rounded up all of us economists and thrown us over Niagara Falls. Forget complicated and technical issues like the business cycle — we economists can't even agree on whether Social Security is broke.

Recently Dean Baker and our old friend Paul Krugman claimed with exasperation that only a liar or a fool could possibly think that Social Security was insolvent. After all, it's sitting on an enormous trust fund! In this article, I'll explain why the layperson is perfectly right to dismiss the "trust fund" as an accounting gimmick and to have yet another reason to worry about our economic future.

Dean Baker: Nothing to See Here

Economist Dean Baker — who runs the clever blog "Beat the Press" — went ballistic after hearing an NPR report on the state of Social Security:

I often think it's too bad that Social Security isn't a private company. If it were, it could sue Marketplace Radio for libel for this sort of reporting. Does Marketplace's host have any idea what she is talking about when she says: "Social Security is in such a sorry state"? According to the Congressional Budget Office the program can pay all benefits for the next 34 years with no changes whatsoever and even after that can pay more than 75 percent of benefits indefinitely. The program is in much better shape in this respect that it was in the 40s, 50s, 60s, or 70s. So what on earth is this person talking about? Can Marketplace Radio pay all its expenses for the next 34 years?

I agree wholeheartedly with Baker's first point: It would indeed be great if Social Security were a private company. In that case, I could call them up and cancel my membership. Because I'm self-employed, I currently pay 15.3 percent (up to a threshold) in Social Security and Medicare "contributions" to the government out of my paychecks. I would be thrilled if Social Security were a private company and actually needed my consent before confiscating so much of my income.

But let's address the substance of Baker's argument: He says the Social Security program is currently "in much better shape" than it has been in the past. Yes, but that's because it was broke in the past, as well. Here is what the Social Security Administration's (SSA) official website has to say about the so-called Greenspan Commission's 1983 report:

The National Commission on Social Security Reform (informally known as the Greenspan Commission after its Chairman) was appointed by the Congress and the President in 1981 to study and make recommendations regarding the short-term financing crisis that Social Security faced at that time. Estimates were that the Old-Age and Survivors Insurance Trust Fund would run out of money possibly as early as August 1983. This bipartisan Commission was to make recommendations to Congress on how to solve the problems facing Social Security. Their report, issued in January 1983, became the basis for the 1983 Social Security Amendments which resolved the short-term financing problem and made many other significant changes in Social Security law.

So how did the Commission turn around the bleak prognosis for Social Security? Did Alan Greenspan offer to chip in his consulting income, or did they sell off some old baseball cards stored in the SSA's attic?

Of course not; they raised taxes and reduced benefits. In fact, in 2004 Paul Krugman actually praised Ronald Reagan's maturity in raising taxes to "fix" Social Security:

Mr. Reagan's second tax increase was also motivated by a sense of responsibility … I'm referring to the Social Security Reform Act of 1983, which followed the recommendations of a commission led by Alan Greenspan. Its key provision was an increase in the payroll tax that pays for Social Security and Medicare hospital insurance.

For many middle- and low-income families, this tax increase more than undid any gains from Mr. Reagan's income tax cuts. In 1980, according to Congressional Budget Office estimates, middle-income families with children paid 8.2 percent of their income in income taxes, and 9.5 percent in payroll taxes. By 1988 the income tax share was down to 6.6 percent — but the payroll tax share was up to 11.8 percent, and the combined burden was up, not down.

Nonetheless, there was broad bipartisan support for the payroll tax increase because it was part of a deal. The public was told that the extra revenue would be used to build up a trust fund dedicated to the preservation of Social Security benefits, securing the system's future.

So I don't really see how this history is supposed to reassure us. The people who are saying that Social Security is broke are warning the public that we will need to either suffer a payroll tax hike, or deal with a reduction in promised benefits, or both. Dean Baker then comes along and says that's nonsense, because we've been in this situation before, and we solved it — by raising taxes and cutting benefits.

Before leaving the Baker quotation, let me make one last observation: He is simply wrong when he says that NPR's Marketplace isn't as solidly funded as Social Security. When the CBO report says that Social Security can continue making its scheduled benefits payments for the next 34 years "with no changes whatsoever," that figure still assumes that the payroll taxes continue piling in.

When Dean Baker rhetorically asked his question, "Can Marketplace Radio pay all its expenses for the next 34 years?" he led the reader to believe that the trust fund has 34 years' worth of benefit payments stockpiled. But of course it doesn't have that much. To repeat, the CBO projections show that the annual shortfalls between outgoing benefit payments and incoming Social Security tax revenues will eventually whittle away the trust fund to nothing by the year 2043.Download PDF

So the analog for Marketplace Radio is not, "Do you guys have 34 years' worth of expenses saved up in the bank?" No, the proper analog would be, "Do you have enough assets right now to cover any projected operating deficits over the next 34 years?" Since I assume Marketplace Radio is not filing for bankruptcy anytime soon, their answer would be, "Yes, Mr. Baker, of course we do. That's why we're solvent and we're allowed to stay in business."

In contrast, the Social Security System as currently configured is insolvent. The present value of their expected revenue stream is less than the present value of their expected expenses. That's what it means to be bankrupt.

Yes, they can "fix" this situation by forcing people to cough up more money, or by paying people less than they had previously promised them. No kidding, who ever denied that? That's the whole point of the warnings, to get the public ready for the tax hikes and benefit cuts.

Paul Krugman Gets Attacked by Zombies

Paul Krugman — my guilty pleasure when it comes to economics bloggers — recently joined in the whining about all the ignoramuses who keep lying about Social Security being in trouble:

On Social Security, [Alan] Simpson is repeating a zombie lie — that is, one of those misstatements that keeps being debunked, but keeps coming back.

Specifically, Simpson has resurrected the old nonsense about how Social Security will be bankrupt as soon as payroll tax revenues fall short of benefit payments, never mind the quarter century of surpluses that came first.

We went through all this at length back in 2005, but let me do this yet again.

Social Security is a government program funded by a dedicated tax. There are two ways to look at this. First, you can simply view the program as part of the general federal budget, with the … dedicated tax bit just a formality. And there's a lot to be said for that point of view; if you take it, benefits are a federal cost, payroll taxes a source of revenue, and they don't really have anything to do with each other.

Alternatively, you can look at Social Security on its own. And as a practical matter, this has considerable significance too; as long as Social Security still has funds in its trust fund, it doesn't need new legislation to keep paying promised benefits.

OK, so two views, both of some use. But here's what you can't do: you can't have it both ways. You can't say that for the last 25 years, when Social Security ran surpluses, well, that didn't mean anything, because it's just part of the federal government — but when payroll taxes fall short of benefits, even though there's lots of money in the trust fund, Social Security is broke.

I have read this particular excerpt several times now, and I think I finally get it: Krugman et al. really like the whole idea of the Social Security program, and so they are taking it personally when people say the system is broke. They think that to acknowledge the truth of that statement is to deny that it was a good idea for society to officially take care of widows and orphans.

So let's put that issue aside. It's true, I would argue with anyone who claims it's more compassionate to have the federal government perform these tasks, versus private individuals and charities, but that's not relevant to the fiscal debate.

"If the economy slumps again we may never see another Social Security surplus year until the taxes and benefit formulas are changed."

What we are talking about now is the fiscal situation of the federal government. The reason Social Security is relevant is that up until this year, it had been a net contributor to the rest of the government. The amount that the Treasury had to borrow from the private sector was smaller than it otherwise would have been, because Social Security was taking in more from its dedicated "contributions" than it was paying out annually in benefits.

That situation has already reversed itself, and if the economy slumps again (as I think it will) we may never see another surplus year until the taxes and benefit formulas are changed. In a sense, it's as if a major country who had always been a faithful purchaser of US Treasury debt, all of a sudden this year decided to not only stop accumulating new debt, but to actually start cashing it in.

So yes, Krugman does have a point: if people are trying to rank various government programs by their ability to "pay for themselves," then the people running Social Security should be given credit for the large surpluses they have acquired since the 1980s.

But that's not the purpose most people have in this debate. When they say, "Social Security is broke," they are trying to get Americans to see that this is yet another automatic drain on the Treasury that is now starting to kick in. Even if the politicians, against all odds, managed to get the rest of the government's finances in order, the mushrooming deficits of the Social Security Administration would lead to greater and greater general fund deficits. The so-called trust fund is completely irrelevant in this context.

Shredding Krugman's Logic

I think the easiest way to get this point across is to imagine that a young intern at the Social Security Administration gets mixed up and accidentally dumps all of the Treasury securities from the box labeled "trust fund" into the paper shredder. Oh no, now the catastrophe would befall Americans 34 years sooner!

Actually, nothing would happen from the point of view of American workers and taxpayers. Yes, the assets of the Social Security Administration would have fallen about $2.5 trillion. But in the very same act, the intern would have just wiped out $2.5 trillion of the federal debt! She would have singlehandedly eliminated the Obama deficits thus far.

Indeed, when they're not playing games, Paul Krugman and Dean Baker both know that it's silly to count the Social Security trust fund as an obligation of the federal government. When talking about the current federal debt, Krugman and Baker would both say that it is currently around 58 percent of GDP. That figure refers to the public debt outstanding held by the public — it excludes "intragovernmental debt," which is Treasury debt held by other arms of the federal government.

So if Krugman and Baker think Americans should relax, since there is still a solid $2.5 trillion in safe bonds sitting in the coffers of the Social Security Administration, that's fine. But then when they discuss the federal government's debt problem, they should say we currently have a debt-to-GDP ratio of 95 percent, which is the total outstanding public debt ($13.9 trillion) divided by official GDP ($14.6 trillion in the first quarter of 2010).


As Krugman notes, you can't have it both ways. If we are going to count the Treasury bonds in the trust fund as an asset of Social Security, then we have to also count those funds (and by consistency, other intragovernment debt) as liabilities of the Treasury.

It's true, such an accounting decision knocks the crisis in Social Security back by a few decades, but only by accelerating the crisis in the general federal debt. Accounting tricks can't alter the basic fact that the government has promised more than it can collect with the current tax code. Let's also remember that this is no partisan issue: on these pages I explained the absurdity behind George W. Bush's pain-free "privatization" plan for Social Security.

The time of reckoning is already upon us: Social Security is right now in deficit, sucking funds out of the general pool. Americans should brace for further tax hikes — in the name of "saving Social Security" — and anyone under 40 should have no illusions about retirement benefits.


Contact Robert P. Murphy

Robert P. Murphy is a Senior Fellow with the Mises Institute. He is the author of numerous books: Contra Krugman: Smashing the Errors of America's Most Famous Keynesian; Chaos Theory; Lessons for the Young Economist; Choice: Cooperation, Enterprise, and Human Action; The Politically Incorrect Guide to Capitalism; Understanding Bitcoin (with Silas Barta), among others. He is also host of The Bob Murphy Show.