"The crisis is now!” Well, there he goes again. President Bush has identified another grave and gathering threat requiring immediate and drastic action. This time it’s Social Security. The President insists on nothing less than restructuring the program from the ground up, converting it from a defined benefits program (where the government guarantees a specified benefit) into a defined contributions program (like a 401k, where you contribute a certain amount and your benefit is whatever the market and your decisions produce).

These dire warnings sound like what we heard in the buildup to the war in Iraq. A major difference is that this time the information the President uses to build his case is a matter of public record. This time we can know the facts. This time we need to know the facts!

    A good place to start is the Summary of the 2004 Annual Reports published by the Social Security and Medicare Boards of Trustees. It is a brief, well written summary of the operations of Social Security and Medicare for calendar year 2003 and the Trustees’ projections for the future.

    Here are a few of the high points:

• In 2003 Social Security ran a $152 billion surplus.
• Social Security finished 2003 with trust fund assets of
  $1.53 trillion.
• In 2018 Social Security will need to start using a portion of the trust fund’s interest to pay benefits.
• Interest payments will keep the trust fund balance increasing until 2029 when all of this interest and some of the principal will be required to pay benefits.
• By 2042 the trust fund will be exhausted leaving the system with only enough income to pay 73 percent of full benefits.

    According to the Trustees, Social Security could be brought into actuarial balance for the next 75 years by an immediate 13 percent cut in benefits, an immediate 15 percent increase in taxes, or by some combination of the two.

    Today, Social Security is the sole source of income for almost 20 percent of America’s seniors and the principal source of income for two thirds. The concern for the unintended consequences of government actions is a standard element of conservative thinking. The President has tossed this concern aside when he is uses relatively minor problems with Social Security to justify radical modifications to this complex, successful and critical program. He claims to be motivated by a concern for the long term future of Social Security and its beneficiaries, but this is hard to believe, if we assume that he or any of his staff were actually concerned enough to read as far as the fifth paragraph of the Trustees’ Summary, which begins:

As we reported last year, Medicare's financial difficulties come sooner--and are much more severe--than those confronting Social Security.

    The Trustees go on to point out that in 2004, Medicare’s Hospital Insurance (HI) Trust Fund will begin running deficits. More ominously, the projected depletion date of this fund has advanced from 2026 to 2019 since the last projection. Just for reference, although this Summary doesn’t mention it, the Trustees' projected date for the depletion of the Social Security trust fund is moving in the opposite direction. In 2000, the projected depletion date was 2037. The current projection is for 2042. In other words, in the past four years the projected depletion date has moved out five years.

    The scale of the Medicare problem also overshadows the problems with Social Security. By 2024, the government will spend more on Medicare benefits than on Social Security. The effect of rising medical costs will not be limited to the government. Social Security beneficiaries will be swamped by a rising tide of Medicare premiums (up 17 percent in 2004) and coinsurance costs. The Trustees estimate that these costs will increase from 15 percent of the average Social Security benefit in 2003 to 35 percent by 2010, 50 percent by 2030 and 80 percent by 2078. After 2006 these costs include the new drug benefit, but we are still talking about the typical Social Security beneficiary spending half of his or her benefits on medical care by 2030. If this is not unpleasant enough, the Trustees add the caveat that their near term Medicare projections are probably overly optimistic because they are based on current law, mandating reductions in future physician payments which the Trustees consider “politically unrealistic.”

So here we are. President Bush is exaggerating the problems with Social Security; ignoring the problems with Medicare, and telling us we need to do just what he says and we need to do it now. Four years ago this might have been surprising. Today, the only surprise is how blatant he is about choosing the facts and projections that support the course of action that he has already decided to take.

The Trustees projected problems with Social Security are a “slam dunk," but the same Trustees prediction of more serious problems with Medicare are ignored. This is not just an eerie parallel with the run up to the war in Iraq where he overstated the case for alleged WMDs in Iraq while minimizing the threat of real nuclear weapons in North Korea. This is the exact same script. He has just done a cut and paste, substituting Social Security for Iraq and Medicare for North Korea. This is insulting! Does he really think we’re that stupid? Are we??

    In his haste the President has conveniently forgotten that we are already twenty years into a plan to ensure the long term future of Social Security. This is probably not a coincidence. He has some very good reasons for not wanting to dwell on this plan which began in 1982 when Ronald Reagan appointed the National Commission on Social Security Reform headed by Alan Greenspan.

    The Greenspan Commission addressed the retirement of the unusually large Baby Boom generation by proposing that Social Security move from the traditional pay-as-you-go funding to a partially pre-funded approach designed to lessen the burden on the post Baby Boom generations. Congress immediately implemented these proposals. Payroll taxes were increased well beyond the level required to pay current benefits. As a result, Social Security became a cash cow, generating surplus funds to be deposited in the Social Security Trust Fund, immediately borrowed by the general fund and then used to pay the day-to-day expenses of the government. Ostensibly, borrowing from the Trust Fund was intended to reduce or eliminate borrowing from the public. Ideally, this would make additional public funds available as capital to grow the economy. At a minimum, this plan should have left the government with little or no publicly held debt when the Boomers retired. Then, if necessary, the government could go to the credit markets to fund the Boomer’s retirement without overly burdening the post Baby Boom generations with debt or higher taxes.

    To ensure that hard pressed politicians didn’t just spend this extra tax revenue like they did every other dollar they could get their hands on, the Greenspan Commission… Well, they didn’t actually do anything– which brings us to the much avoided question of whether the Greenspan plan has been more effective in easing the Baby Boomers through retirement or in shifting the tax burden onto working people. The fact that we are already discussing a new rescue seems to argue for the latter.

    To see how effective the Greenspan plan has been in shifting the burden of taxation onto working people consider the case of a middle class family of four with an income of $80,000 and assume they take the standard deduction and the $2,000 Child Tax Credit. If they live off a smallish trust fund generating dividends and long term capital gains, their 2004 federal tax bill comes to a total of $895. For a working family with the same income, the feds will collect $12,240 in payroll taxes (half being paid by their employers) and an additional $5,970 in income tax. If it makes you feel any better, at $80,000 the investor family is only $1,500 from maxing out of the investor-only 5 percent tax bracket on their first $59,400 of taxable income. Any additional income above $81,500 will be taxed at the maximum rate of 15 percent, a rate just a little less than what the government will collect in payroll taxes when your children go out and get their first part-time jobs.

This is an amazing discrepancy in tax burden, but the real surprise is that nobody notices. Payroll taxes have become a stealth tax. Despite the fact that for most Americans the government collects more in payroll taxes than it does in income taxes, our national discussion about tax cuts or tax policy is always focused on the income tax.

    The competitiveness of American labor has been an issue in the forefront for years. To show how serious they were about jobs, Congress actually put the word “Jobs” in the name of the 2003 tax cut bill “The Jobs and Growth Tax Relief and Reconciliation Act of 2003.” This bill cut the maximum tax on long term capital gains and dividends by 25 percent and 61 percent respectively, but the payroll tax, a direct 15.3 percent surcharge on American labor, was untouched and unmentioned.

    Since 1983 the maximum Social Security component of the payroll tax has increased from $1,927.80 to $5,580. Ronald Reagan’s tax cutting credentials remain intact even though he signed the legislation that increased this tax on some workers by up to 290 percent.

    Okay, so the Greenspan plan has been very effective in generating payroll tax revenue from the American workers. That was always part of the plan. The real question is how effective has it been in securing the retirement of the Baby Boomers and minimizing the financial burden on the post Baby Boom generations. On paper, it looks pretty encouraging. The Trustees tell us that a combination of some fairly minor cuts and additional taxes will keep the system in balance for 75 years. With no changes, the system will be solvent until 2042. Not too bad for legislation put in place in the early 80’s and running on dead reckoning ever since.

    Although the Trustees' projections show that American workers have paid full price for a Social Security system secure well into the future, that security is far less than certain because the Greenspan plan relied on a generation of fiscally responsible political leaders who would voluntarily refrain from using the money borrowed from Social Security to fund their “cause d’jour.” The common belief that the Social Security Trust Fund by itself will provide this security is just flat wrong. The Trust Fund was never designed as a repository for real assets. It is only a record of the money that has been raised for Social Security and spent on something else. It provides security to future beneficiaries only if that money is spent in a fashion that makes it easier for the future government to bear the expense of their retirement (for example, to retire the government’s publicly held debt).

When the Social Security Trustees project solvency until 2042 they assume that the Trust Fund contains assets which can be readily converted into the cash needed to pay benefits. This is simply not the case.

The fund contains no third party assets--only the government’s own IOUs (a practice that is illegal in the private sector, for obvious reasons). In order for Social Security to cash in these IOUs, the government will need to raise taxes, cut spending, and/or increase borrowing. The first two options are just not in the repertoire of today’s politicians. That leaves borrowing, which is becoming less and less feasible because for too long it has been the solution of choice to all our fiscal problems.

    This is not to say that the Baby Boomers benefits will not be paid. Perhaps later generations will see the retirement of this most gullible generation as some sort of sacred trust. If they do, they will bear the full cost of these benefits. The charade of collecting money for Social Security and spending it on something else will be absolutely irrelevant. The Social Security Trust Fund will not in any way lighten their load. In the words of Daniel Patrick Moynihan and Richard Parsons, co-chairs of President Bush’s 2001 commission on Social Security, the Social Security trust fund “is a financial obligation, not a financial asset."

    The pronouncements of Alan Greenspan, the father of the Social Security surplus, are usually more subtle and nuanced. His meaning is frequently obscure to all but the most serious financial analysts. His latest pronouncements on Social Security: “Cut benefits.” Hmmm… What could that mean? No proud father here and rightfully so.

President Bush is anxious to get on with the next rescue of Social Security without spending a moment to review or reflect on the last one. He has good reason for his haste. There is enough blame to go around for the failure of the Greenspan plan, but no one deserves a bigger share than George Bush and the free-lunch conservatives.

    The administrations of Ronald Regan and Bush the Elder borrowed approximately $300 billion in surplus payroll taxes, but that was just a drop in the bucket compared to their total borrowing of over three trillion dollars. They increased the national debt from $930 billion to over four trillion dollars in 12 years. The Social Security surpluses were swept away in a torrent of borrowing and fiscal irresponsibility.

    By the late 80’s the handwriting was on the wall. Senator Moynihan, originally an enthusiastic member of the Greenspan Commission, began calling the process of borrowing the payroll surpluses to pay the day to day expenses of the government “thievery.” Republican Senator John Heinz, given his corporate background, had a different slant on the issue. He called it “embezzlement”. Senator Moynihan proposed a roll back of the surplus payroll taxes and was roundly criticized by Bush the Elder’s administration as “irresponsible.”

    The Clinton administration was the high water mark for the Greenspan plan. Although they added $1.6 trillion to the national debt, a portion of the Social Security surplus was actually used to pay down the publicly held debt. Clinton helped put the country on the road to fiscal responsibility. Unfortunately, he spent far too much time celebrating this accomplishment and not enough time explaining just how far we still had to travel down that road. Before Clinton left office, we all knew how he defined “sex,” but virtually no one knew or cared how he (and everyone else in Washington) defined “surplus.”

In common parlance, surplus is synonymous with prosperity and wealth. It is antithetical to indebtedness. Not in Washington! In Washington, you can be crowing about a surplus while you are going deeper into debt.

This is the result of a little sleight of hand introduced into government accounting by the Johnson administration in an attempt to minimize the apparent financial cost of the Vietnam War. LBJ concocted a plan to “unify the federal budget.” As a result, the deficit/surplus metric, which we all pay so much attention to, is applied across all government accounts. Assets of the trust funds are “unified” with the debts of the general fund. This produces a much better looking deficit/surplus, but it has essentially turned it into a measure of cash flow. Now, when the government borrows from one of its trust funds, the borrowed cash reduces the deficit or increases the surplus. The obligation to repay this money is added to the national debt, but it does not result in any immediate cash flow so it does not enter into the deficit/surplus calculation. If you look at the Treasury’s website Debt to the Penny, you will see that in year 2000 while we were all celebrating a surplus of $236 billion the national debt increased by $18 billion. The entire surplus and then some was borrowed from the trust funds.

    If your bank decided to unify its accounts, every time you made a big deposit they could claim a surplus, throw a party, increase dividends, and give everybody a raise. That’s exactly what happened when the current Bush administration came to town.

    If it had suited his purposes in 2000, candidate Bush would have been justified in calling this type of accounting “fuzzy math,” but a surplus by any definition was just what he needed. Bush campaigned for tax cuts saying that this surplus belonged to the people and not the government. He wanted to return it to the people through a series of cuts to the income tax. Perhaps this is just a nuance, but $220 billion of the $226 billion surplus in 2000 was borrowed from Trust Funds for Social Security, Medicare, Civil Service Retirement and Unemployment. This surplus belonged to the working people. Cutting income taxes and especially taxes on investments was not going to return the surplus to the people who created it. These cuts were designed to transfer the surplus to a substantially different group of people.

George Bush used the surplus funds contributed by American workers as an excuse to reduce taxes for the “Haves and the Have Mores” --a phrase Bush himself has used to describe the people he calls “my base.”

In doing so he betrayed the American workers who were willing to pay for their retirement system. Whatever it was before, at this point, the Greenspan plan became a complete fraud. The surplus funds from Social Security were explicitly being used to reduce taxes on the most privileged among us - not to reduce the government’s debt.

    Just to add insult to injury, the President now complains about the anemic returns on the Trust Fund. What difference does it make how much interest the Trust Fund generates if he steals it all?

    The impending demise of the Greenspan plan goes a long way towards explaining the President’s motivations. His urgency is not the result of any funding shortfall. It is driven by the need to pre-empt serious discussion of the Greenspan plan. How the President’s proposals would solve the basic problems of Social Security is not clear, but they are perfectly tailored as an end game to the Greenspan plan. First, they begin to relieve the government of its obligation to guarantee the benefits people thought that they had earned. Second, a completely restructured Social Security system makes it much easier to explain the need for trillions of dollars in transition costs. Otherwise, how would he and his successors explain the trillions of dollars required when Social Security begins cashing the IOUs racked up under the Greenspan plan?

The Bush plan relies on the same “swinging for the fences” approach made infamous in the 80’s by the owners of bankrupt savings and loans. They decided to bet other people’s money on high risk ventures in an attempt to return their banks to solvency before they were shut down. The bankers had nothing to loose.

Bush may have no way to loose. If the stock market takes off, most everybody will be a winner. If not, Bush apologists will trot out their Darwinian “Devil take the hind most” philosophy and wash their hands of the whole thing.

    This is a time when Social Security really needs its friends. Unfortunately, many who consider themselves to be supporters of workers and Social Security have decided to mount a “see no evil” defense. They claim full faith in the Social Security Trust Fund. They acknowledge long term imbalances, but they are apt to try to solve them by increasing the payroll tax. Perfect! Collect more money from today’s workers; spend it on something completely different and somehow that will ensure the future of Social Security.

    In the 2000 campaign Al Gore tried to address the diversion of payroll taxes with his much lampooned calls for a lock box. Perhaps one reason his proposal prompted more ridicule than careful thought was that he was trying to solve a problem he was not willing to clearly identify (i.e., for twenty years over a trillion dollars collected from America’s workers to fund their retirement has been misappropriated).

    This is where all talk of changing Social Security goes wrong. Until we understand where we are and how we got here, how can we reasonably expect to “fix” the system or even decide if it needs to be fixed? The most critical element that needs to be examined is the Social Security Trust Fund. For many years the federal government has found the concept of these accounts useful for a number of purposes. In most cases these accounts are really used more like a checking account. That was the case with the Social Security Trust Fund through most of its history. In 1980 it had a balance of just $26 billion. The Social Security Trust Fund is actually two separate accounts: one for retirement and survivors benefits and another for disability benefits. Each of these accounts was created and named by the government. The words “Trust Fund” appear in both names. In this usage “Trust Fund” is a proper noun – it is part of the name. It should not be confused with a description of the account. These accounts share virtually nothing in common with trust funds from the private sector. Using this type of account to receive trillions of dollars of retirement money over decades was not just a bad idea; it was an insanely bad idea.

    If you’re not convinced of that, try building your own Trust Fund. All you need to do is earmark a portion of your income for retirement. Each month take that money and use it to pay your bills. Get some official looking promissory notes made out to you and sign them at the bottom. Better yet, sign your children’s name at the bottom – that’s the way the government does it. Put these notes in a shoe box which you name “My Retirement Trust Fund” (Remember, It’s your shoe box. You can name it anything you want.). That’s it; you’re done. Enjoy your golden years.

Through some quirk in human nature, millions of people who would never, personally, fall for such nonsense seem to think that just such a charade can work on a national scale.

They have full faith in the Trust Fund. After all, it would be unprecedented for the United States to renege on the bonds held there. True enough, but it is unprecedented for the United Sates government to be holding trillions of dollars in what are essentially I-O-MEs. No one should be surprised when unprecedented foolishness results in unprecedented disaster.

    Before we can talk about changing Social Security we need an honest accounting system. Without it there is no rational basis to propose or evaluate changes. Without it discussion of the system is difficult. President Bush recently said the Social Security will “be in the red” by 2018 –when Social Security starts cashing some of the IOUs it owns. That would be an outrageous statement coming from your banker if you had saved a nice little nest egg of a couple of trillion over the last forty years and finally came by to make your first withdrawal. Perhaps it is not so unreasonable in a discussion about the Social Security Trust Fund.

    Rationalizing Social Security’s accounting system requires debunking the myth of the Trust Fund. Once we all agree that this emperor has no clothes, we need to stop paying the tailor. The surpluses going into the Trust Fund need to be invested in real assets - mortgage backed securities come immediately to mind. This is not a complete solution, but it will provide real assets for the retirement of the Baby Boomers and give the country a more accurate measure of our national deficit. Then, maybe, George Bush’s base may have to start paying their taxes again.

= THE POTOMAC HOME =