The Social Security Trust Fund is basically an interest-bearing I.O.U. from the U.S. Treasury to the U.S. Social Security Administration. It allows one branch of government to keep track of what it ‘owes’ another branch of government, and thereby plays an accounting role. As long as the federal government is committed to using general revenue to cover all shortfalls in Social Security taxes, the trust fund plays no important economic role or in allocating resources. However, the recent published shortfall in the trust fund underscores the need for fiscal reform.
The government collects Social Security taxes and, in an accounting exercise, places ‘excess’ Social Security taxes into these trusts. The funds then invest in interest-bearing government debt, thereby lending these ‘excess’ Social Security taxes back to the government. When Social Security taxes are not sufficient to cover all payments to beneficiaries, part of the trust fund is redeemed to help pay Social Security benefits, creating an I.O.U. that the government owes to itself.
What would happen if we, figuratively speaking, raided the Social Security office and burned the I.O.U.s? Not a thing. The U.S. gross government debt would decline because gross debt includes debt owed between branches of the government. The debt that matters, the debt held by the public, would not change.
Think of this as a household where a child works to save for college and gives the money earned to her parents in exchange for an interest-bearing I.O.U. Freshman year, the child’s spending exceeds her income which she pays by redeeming part of the I.O.U. The child, then, is like the Social Security Administration and the parents serve as the Treasury. The I.O.U. exists, but in terms of total household debt, is neither an asset nor a debt of the household.
If the household is committed to using all household income to pay for the child’s spending when the I.O.U. is depleted, then the I.O.U. could be destroyed at any time with no effect on the household’s ability to spend. Unless the I.O.U. constrains the child’s spending, the existence of the I.O.U. does not matter. If the size of the I.O.U. does not limit the child’s spending, then it has no separate role in constraining overall household spending.
The existence of the trust fund and its size affects the economy only if it changes resource allocations, which are essentially tax collections or benefit payments. Today, Social Security benefits are paid using dedicated Social Security taxes supplemented using general revenues to cover the growing shortfall that began in 2009. The trust fund provides no real revenue; it serves only as the mechanism for the Social Security Administration to obtain general revenues. If general revenues will be provided even in the absence of the trust fund, then the claim plays no economic role.
When the trust fund runs dry, the law requires that revenue shortfalls must then be covered by benefit cuts. The latest estimates suggest that the trust fund will be depleted by 2034. When that happens, Social Security benefits would suddenly fall to about 80 percent of the promised level. During the last full year before the Fund is depleted, general revenue transfers would have covered about $400 billion of Social Security’s benefit cost, adjusted for 2017 dollars.
If Congress disallows the use of general revenues to pay benefits, it could use that money for other purposes. Moving $400 billion from Social Security benefits to other federal programs would certainly change resource allocations and have a significant economic—and political--effect. In our example, this would be like the parents telling their child that she must cut her spending when the I.O.U. runs out, leaving household income alone. Because Congress is expected to continue to make up the funding shortfall from general tax revenue, the effect of the dwindling trust fund is irrelevant to Social Security taxes or benefits. If Congress does have a change of heart, or at least of policy, then it is well advised to lower benefits gradually, rather than cut 20 percent all at once.
None of this means that Social Security is on a sustainable path. The sustainability of Social Security is firmly tied to the sustainability of the government’s overall fiscal situation, which is poor. Because Social Security, Medicare, and Medicaid make up the majority of federal government spending, any fiscal reform must include changes in these programs. The need for these changes, however, does not arise from the current or future status of the trust funds.
What, then, is the role of the trust fund? Politically, it allows the Social Security Administration and Social Security recipients to point to a quantity of funds dedicated to a single purpose. It is one part of the population’s claim to government resources. This makes it difficult to repurpose those funds. As the trust fund runs down, this political benefit is less useful.
The declining size of the fund should spur Congress to reform federal entitlement programs, including Social Security, with an eye toward long-run fiscal sustainability.
Dennis Jansen is the Director of the Private Enterprise Research Center and a Professor of Economics at Texas A&M University. Thomas Saving is the Director Emeritus of the Private Enterprise Research Center and a former public trustee of the Social Security and Medicare Trust Funds.
Interested in real economic insights? Want to stay ahead of the competition? Each weekday morning, e21 delivers a short email that includes e21 exclusive commentaries and the latest market news and updates from Washington. Sign up for the e21 Morning eBrief.