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July 12, 2010

There is no lock box

Lifting the income cap on social security taxes would reduce our dependence on foreign debt and help balance the budget, if we allow the Bush tax cuts to expire.

You see, a lot of people in America think there's a trust, in this sense - that we take your money through payroll taxes and then we hold it for you, and then when you retire, we give it back to you. But that's not the way it works.

There is no "trust fund," just IOUs that I saw firsthand, that future generations will pay - will pay for either in higher taxes, or reduced benefits, or cuts to other critical government programs.

The office here in Parkersburg stores those IOUs. They're stacked in a filing cabinet. Imagine - the retirement security for future generations is sitting in a filing cabinet.

-President George W. Bush, Parkersburg, West Virginia, April 5, 2005

Well, the filling cabinets at the Bureau of Public Debt sure aren't empty, in fact by the end of 2009 they contained about $2,540,348,000,000 in treasuries. However, the point George W. Bush was famously attempting to make is that the social security trust fund is an example of the government essentially loaning money to itself. By contrast, as of January 2010 the US owed about $3,706,000,000,000 to foreign countries. While the amount of debt owed to foreign creditors has more than doubled since 2004, it is projected to go even higher in the coming years, which could have serious economic and political consequences. One big reason for our growing reliance on foreign debt is that the amount of debt financed by the social security trust fund via payroll taxes is leveling off and starting to decline:

Operations in quarter
ending Mar. 31, 2010
[In billions]
Income $172.9
Outgo 174.1
Difference -1.2

Operations in 2009
[In billions]
Income $807.5
Outgo 685.8
Difference 121.7

Lifting the income limit on social security taxes would reverse that trend. One way to think of the social security trust fund is that it's an investment in government. This is an idea that might horrify some, but consider the alternative. Would you rather have trillions of dollars in treasuries owned by the social security trust fund, or trillions of dollars in treasuries owned by foreign entities who might not always agree with our national interests? By failing to adequately fund social security, we're ensuring that there is not enough money available to invest in its trust fund either, which means the government must look elsewhere to service its growing debt.

There are other reasons to fix projected social security shortfalls. Both in terms of payroll taxes paid and benefits received, social security accounts for about a fifth of the federal budget each year or around four percent of Gross Domestic Product. It's a massive program, and it will only grow in the future, whether we fix it or not.

As the Associated Press reported on March 17, 2010, "For more than two decades, Social Security collected more money in payroll taxes than it paid out in benefits - billions more each year. Not anymore. This year, for the first time since the 1980s, when Congress last overhauled Social Security, the retirement program is projected to pay out more in benefits than it collects in taxes - nearly $29 billion more." However the Brookings Institution adds some equally important details:

Social Security derives revenues from three sources: payroll taxes levied on covered earnings, earmarked income taxes levied on benefits, and interest earnings on reserves. According to the Social Security Trustees' annual report, released in May 2009, revenues from these sources in calendar year 2010 were projected to be, respectively: $701 billion, $26 billion, and $120 billion, for a total of $848 billion. Expenditures were anticipated to be $709 billion....

And reserves will grow for years to come. CBO anticipates cumulative surpluses of well over $1 trillion in the next decade. Surpluses boost reserves; Social Security’s ‘accumulated revenue’ is going to grow, not shrink. Eventually, of course, the retirement of the baby-boom generation and their attendant benefit claims will cause outlays to exceed total revenues and the trust funds will indeed begin to shrink. According to last year’s trustees report, reserves would be exhausted in 2037.

In other words, although we've stopped contributing to the trust fund, it's still accumulating value through interest paid by the federal government. That interest is paid for by foreign debt, not taxes, which makes the overall debt even worse.

To avoid exhausting the social security trust fund or going deeper in debt, one idea that has received support from George W. Bush, Lindsey Graham, Barack Obama, Peter Orszag, and others is raising the payroll tax cap. Currently, only the first $106,800 anyone earns is subject to the %6.2 payroll tax for Social Security. While their solutions vary, they all agree lifting the limit will make a difference. According to the Wall Street Journal, "As executive pay has increased, the percentage of wages subject to payroll taxes has shrunk, to 83% from 90% in 1982. Compensation that isn't subject to the portion of payroll tax that funds old-age benefits now represents foregone revenue of $115 billion a year. Social Security Administration actuaries estimate removing the earnings ceiling could eliminate the trust fund's deficit altogether for the next 75 years, or nearly eliminate it if credit toward benefits was provided for the additional taxable earnings."

Why is adding money to the social security trust fund important? For one thing it would restore public trust in the future of the program, but more importantly it would help restore the trust in US treasuries. As former CBO director Robert D. Reischauer explained, finding a solution for Social Security “would send a very important signal to the world,” that they can keep faith in the US and the US treasury. Just as important, it would be bringing in more money each year to help offset other debts already held and reduce the interest that we owe to foreign governments. Instead we'd be paying ourselves.

So what's an extra $115 billion or so a year? Well, over ten years, allowing for inflation and economic growth, that could mean as much as $2 trillion. Combine that with other savings and you start seeing positive signs:

The federal budget deficit for March showed a dramatic decline Monday because of a much lower estimate by the Obama administration of how much the financial bailout program will ultimately cost.

The Treasury Department said the March deficit totaled $65.4 billion. That compares with a $191.6 billion deficit a year ago. But $115 billion of the improvement was due to the administration's lower estimate of the cost of the Troubled Asset Relief Program.

$115 billion here, $115 billion there, pretty soon you're talking about a lot of money. The Center on Budget and Policy Priorities gives a pretty clear picture of the source for our current deficits, "Just two policies dating from the Bush Administration — tax cuts and the wars in Iraq and Afghanistan — accounted for over $500 billion of the deficit in 2009 and will account for almost $7 trillion in deficits in 2009 through 2019, including the associated debt-service costs."

Which also gives us a pretty easy solution. Reverse those policies by withdrawing from Iraq and Afghanistan then letting the Bush tax cuts expire. However, the scope and timing of our withdrawal from Afghanistan is still unclear, and President Obama is only planning to allow the tax cuts to expire for those earning over $250,000 a year. Politically, that might make a lot of sense, but financially it's a mistake and will make it hard to bring the deficit under control in the future, especially if Congress decides to make the cuts permanent.

If the tax cuts are allowed to expire after all, the Congressional Budget Office projects the following deficits over the next five years if things go as currently budgeted and the tax cuts expire as scheduled:

Year - Deficit
2010 - $1,349 Billion
2011 - $980 Billion
2012 - $650 Billion
2013 - $539 Billion
2014 - $475 Billion
2015 - $480 Billion

In terms of GDP, the CBO predicts:

Looking beyond 2011, CBO’s baseline projections show outlays remaining between 22.3 percent and 23.3 percent of GDP (compared with 24.1 percent in 2010) (see Summary Figure 2). Continued economic growth will allow payments for unemployment compensation and other benefit programs to subside, and discretionary spending is assumed to increase slowly. However, the retirement of more members of the baby-boom generation and rising health care spending per person will cause outlays for Medicare, Medicaid, and Social Security to continue to grow fairly rapidly.

The baseline projections show revenues rising to 20.2 percent of GDP by 2020 (compared with 14.9 percent in 2010), with most of the increase stemming from individual income tax receipts. Almost half of the increase in those receipts relative to the size of the economy can be attributed to the expiration of provisions originally enacted in the Economic Growth and Tax Relief Reconciliation Act of 2001, the Jobs and Growth Tax Relief Reconciliation Act of 2003, and the American Recovery and Reinvestment Act (ARRA), as well as other expiring tax provisions; the remainder is due to the economic recovery and structural features of the individual income tax system.

In other words, that is only a gap of about two or three percent of GDP. Lifting the cap on wages taxable for social security would reduce that gap even further, by $115 billion the first year, almost one percent of GDP annually. Combined with the resulting interest savings and measures such as Medicare savings from heathcare reform and reduced defense spending, it is conceivable that the deficit could actually be brought under control if economic growth returns and our leaders turn their focus to our future and the debt.

Posted by Mike at July 12, 2010 09:53 AM

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