UPDATED: Social Security Surpluses Are Not 'Only on Paper'

Sometimes straight news reporting takes as fact things that are not true. This appears to happen when so many "experts" repeat something that the reporters assume it must be true. The recent Fiscal Times article by Michelle Hirsch and Edmund L. Andrews about labor groups protesting potential Social Security cuts provides two scary examples.

First, it repeats the canard that the Social Security surpluses are only "on paper." This is a fundamental misunderstanding. The surpluses on any given date, such as today, represent the government borrowing that did not occur due to previous excesses of collections over spending. If the beneficiaries and future beneficiaries had not paid those extra taxes, then the federal government would currently be on the hook for the interest and, eventually, paying off the principal for the amount of bonds involved. This would, of course, have included government borrowing to pay the interest on its previous borrowing, etc. All of this borrowing was prevented by the higher taxes that the baby boomers (especially) have paid in over the period in which Social Security has been running the surplus that so many people claim isn't real.

When the federal government pays benefits funded by interest and principal of the "paper" surpluses, it is spending on benefits money that would otherwise have been spent on borrowing for the general fund. So the beneficiaries have the same kind of claim on the Treasury that other creditors would otherwise have. (Current hysterical commentators on the deficit would say one example is the Chinese government.) People who say the surpluses are "only paper" are saying, in essence, that payments by taxpayers in the past, so that they could receive benefits later, are not the same kind of moral and legal claim on the federal government that the purchase of bonds by the Chinese would be.

They say that even though, if taxpayers hadn't paid these extra amounts, the Chinese (or somebody) would have bought the bonds and received the payment. To put this another way, commentators who say the securities in the Social Security trust funds shouldn't count are calling for a default on federal obligations that would have the same moral and ethical meaning as if the federal government chose not to pay off foreign bondholders. In both an economic and moral sense, the Social Security trust fund balances should not be viewed as "fake" or "paper" at all. This is money that was paid in, and beneficiaries have a very strong claim that this money should be used for their benefits.

There is at least some excuse for misunderstanding what the Social Security trust funds represent and what previous surpluses have accomplished. That is a complicated matter. There is no reason to report patently false statements without saying they are patently false. Yet that is the reporters' second mistake, quoting former Sen. Alan Simpson's statement that Social Security "was set up when the life expectancy was 57 years, and that's why they set 65 as the retirement date. Now the life expectancy is 78... we have to adjust that and make it work for the future."

I'm not sure what is more scary: that the co-chairman of the supposedly nonpartisan and expert deficit reduction commission is either misinformed or distorting, or that this misinformation is blandly repeated even in settings like TFT that hope to be authoritative. In fact, when Social Security was created, the actuaries knew full well what would happen to life expectancy. The forecasts at the time anticipated that life expectancies would increase; anticipated there would be extra costs; scheduled a series of increases in the payroll tax to cover those extra costs. The costs in 1980 were amazingly close to what was projected in 1935. Moreover, they projected that 12.7 percent of Americans would be over age 65 in 2000; the actual number was 12.4 percent. The whole idea that Social Security was designed for life expectancies as of 1935 is simply false.

The TFT article reports claims from both sides. But when claims on one side are simply false, that may be "balanced" -- but it sure as heck is not accurate.

Joseph White is Director of the Center for Policy Studies at Case Western Reserve University. 

Edmund Andrews replies:
Joseph White is fighting one of the many surreal battles involving the future of Social Security. He is angry that the recent Fiscal Times story, which I helped write, describes surpluses of the Social Security Trust Fund as “essentially on paper.”

He says that’s false, because the surpluses were the result of real payroll contributions exceeding payouts for many years. And he correctly points out that they are in the form of Treasury bonds that have the same legal obligations as the Treasuries held by investors around the world.

White’s right about the legal obligations. But he’s ducking the economic reality: the surplus isn’t like some huge piggy bank that the government can crack open when payroll taxes start to run short.

Like it or not, the surplus revenues were spent on current government operations. When the benefits come due, the Treasury will have to pay them out of general revenues (by redeeming the Trust Fund’s Treasuries). That will squeeze everything else in the federal budget, or require even more government borrowing – lots of it.

That will be painful, and the pain would fall on the next generations of workers who will either get less government service (highways, defense or whatever) for their tax payments or have to pay more taxes just to get the same amount of government in return.

It’s true that Social Security surpluses are binding legal obligations. But it strikes me as simplistic and disingenuous to say that Social Security doesn’t have a problem because it has a big surplus.

Joe White replies:
I appreciate Ed Andrews' response, but readers should note three things.

First, I do not know why he calls me angry, except perhaps to imply that someone who disagrees with him is irrational (thus his description of the issue, also, as "surreal"). I said I was scared. I am beyond anger at the misstatements I see in the mainstream press -- which is why I participate in this blog, rather than just boycotting the whole enterprise. But Mr. Andrews' response, in its failure to engage the points I made, is also scary. I would expect that from advocacy, but not from journalism.

Second, he does not respond at all to my point about former Sen. Simpson's misrepresentation of Social Security's history. I do wish that, when reporters quoted claims that are evidently false, they would say the claims are false.

Third, he appears to have entirely missed the point I was making about the effects of Social Security surpluses on the ability of the federal government, meaning future taxpayers, to pay future benefits.

Let's say the Treasury, when Social Security ran surpluses, invested them in private instruments -- such as stocks and bonds. The trust funds would then consist of "real" assets. But note: the Treasury would also have had to sell bonds to somebody else instead of to Social Security. The buyers of those bonds would eventually collect all the same money that would otherwise be paid out to Social Security beneficiaries. Either way you look at it, that's "real money."

Now: if Social Security surpluses had been invested in the private economy, earnings from those investments would be available to pay for Social Security benefits. On the other hand, Social Security beneficiaries would not be receiving any of the money that would be paid to all those other bondholders. So the financial question is whether use of the Social Security trust funds to avoid selling debt to private parties is better than selling debt to other parties but getting a flow of income from private investments.

The answer depends on the size of the return on the private investments. Under normal circumstances, the return on private investments is higher than the rate of return on federal debt, because of the risk premium (federal debt is very low risk). For individuals, relying on private investments alone is extremely risky. They may retire at the wrong time (say, 2008) and see their assets slashed at a time when they can no longer be replenished. If the federal government invested Social Security surpluses in private markets, however, it could normally ride out market swings. That will not always be true -- the markets did terribly for a long period up to 1982, and the Great Depression was another long negative period. But if a portion of Social Security financing were from a fund controlled by the federal government and invested in private equities and bonds, on the whole, that would have been a better deal than using the surplus only to avoid selling debt to private parties.

That is why I recommended modest trust-fund investment in private markets in my book, False Alarm: Why the Greatest Threat to Social Security and Medicare is the Campaign to "Save" Them. It is also why Robert Ball, longtime commissioner of Social Security, and many other analysts better-known than I have recommended investing some of the surpluses. The Canadian government has invested some of its pension funds. And, in fact, when Social Security was created, one of the original ideas was to invest surpluses in the private sector.

So why wasn't it done? Because conservatives have continually objected. The same coalition that keeps claiming Social Security is unsustainable and has to have its benefits cut has continually objected to investing surpluses in what they call "real" assets because that would be "socialism." The Social Security amendments of 1939 committed the program to reducing government debt instead because of these objections. The advisory council that recommended program changes at that time explained what reducing debt did, and why it improved federal government fiscal capacity, in exactly the same way I have. In recent years Alan Greenspan has been one of many prominent conservatives who objected to use of the surpluses to buy private assets.

What, then, is Mr. Andrews' real point? Is he saying that there is simply no way to partially prefund a pension program? That would be news to lots of private pension managers, or even government pension managers in Canada. Is he saying that no prefunding occurs if you use the money to avoid other borrowing? He could be right that there would have been more prefunding if the coalition that now calls the financing "fake" and "paper" hadn't objected to other forms of financing. But that does not mean the use of surpluses to limit other federal obligations is simply "paper" financing.

Look at it this way. You know you will have to retire. So you pay off your mortgage before you retire. Yes, you still have to find money to live on. But you don't have to spend the same money on housing. Some of the money that you're not spending on housing is available for other living expenses. It's the same thing with Social Security. Money that is not being paid to other bondholders is available for benefits. Perhaps you would have been better off investing in the market and not paying off your mortgage. Perhaps the earnings from your stocks would be more than your mortgage payments. But nobody would say that paying off your mortgage has no economic benefits.

Yet Mr. Andrews is saying that future workers would have felt the same pain of paying benefits if they also had to pay interest to all those bondholders as if they did not. To follow up on this analogy, it's like saying that if you retire, and eventually have to ask your children for help, it wouldn't matter whether you had paid off your mortgage (so had lower expenses) or not. In fact, if you have lower expenses you will not have to ask for as much help, and may wait longer before asking.

No, the surplus is not a "piggy bank" that can be "broken open." But it represents ways that, to follow the simplistic common language, "baby boomers" paid extra while they were working so as to make it easier for "their children" to pay for the boomers' benefits. That's the economic reality, and it only makes the legal and moral obligations more compelling.

Ed Andrews replies:
Reading Joseph White’s follow-up  provides a vivid reminder of how much passion the topic of Social Security generates.

That’s fine.   This is a crucial pillar of American financial security, and those who have wanted to gut it have often been shameless in falsely crying “crisis’’ in order to justify “solutions.”

But here’s the thing: the clear implication of White’s post is that Social Security is just fine and that no one needs to do anything. Hey, it’s got a $2.5 trillion surplus, which is backed by the full faith of the U.S. Treasury.  What’s the problem?

But tapping the trust funds to pay benefits requires that existing workers at that time come up with the money.  I’m not saying they should default on the obligations.  But I am saying that they will have to give up more of their income to make good on obligations that my generation racked up. White says we “misunderstand what the trust funds represent and what previous surpluses have accomplished.”

Not true.  It’s clear that workers since the early 1980’s paid more in “real money” than they needed to finance Social Security outlays at the time.  But at the end of the day, the American public ran up huge deficits on everything from tax cuts to the war in Iraq.  Social Security surpluses were supposed to be pre-funding the baby-boom period, but that didn’t really happen.

The surpluses weren’t being saved, certainly not the way Norway has saved vast amounts of its oil revenues.  They were being consumed.   The “assets’’ left behind in the Trust Fund are obligations, which have to be either repaid or re-negotiated. You can argue that this wasn’t the fault of Social Security.  But these were decisions by America’s elected representatives and by extension the American public.  We were complicit in what happened.

There’s no fair way out of the mess.  Re-negotiating means trimming future benefits, raising taxes or delaying the official retirement age.  It’s like a soft default on promises to people about the benefits they would eventually receive. On the other hand, telling workers in 2025 or 2035 that they have to come up with more money isn’t fair either.  They didn’t do anything wrong.  

There’s a strange contradiction in the way people are talking about this. Many economists say that the only real measure of federal debt is debt held by the public.  That measure excludes debt owed to Social Security and other trust funds, because that is viewed as “intergovernmental debt” or debt the government owes itself.

At the same time, defenders of Social Security like White fervently argue that the obligations to Social Security are every bit as real as obligations to the Chinese. I don’t know if White holds both of these positions at the same time, but a lot of people do. The problem is, the  debt owed to Social Security isn’t just debt the government owes itself. It’s debt the government owes future Social Security recipients, and the time for real payback is looming just ahead.

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