Thoughts on the 'Next Progressive Agenda':
Federal Budget & Social Security Reform
John Atlee, 3/13/2001

  1. Basic Strategy
  2. Federal Budget Reform
    1. Problem 1: Inclusion of Social Security in the operating budget causes confusion
    2. Problem 2: Budget based on guesstimates of future economic conditions
    3. Problem 3: The dual meaning of "fiscal responsibility" for the Federal Government
    4. Problem 4: The surplus: balancing debt reduction with social investment
    5. Problem 5: Tax Reform
  3. Social Security Reform
    1. Problem 1: SS Trust Fund not protected by "lockbox" promises
    2. Problem 2: SS financial health is hostage to economic conditions

A. Basic Strategy

In order to get progressive benefits, it is important to focus on the political and economic strategies and tools that can actually achieve those benefits. And these strategies and tools include not only the legal and institutional changes but the concepts, terminology, and public perceptions that can most effectively influence the public debate.

B. Federal Budget Reform

Most progressive benefits cost money, and government budgets control the money. A democratic (small D) federal budget should be both fiscally and economically responsible, and its operation should be fully understandable ("transparent," in financial terms) to both Congress and the public. The present budget framework fails all of these criteria. A primary aim of President Bush's tax-cut proposal is the same as President Reagan's, 20 years ago: to "reduce the size of government" by structurally reducing its financial resources, so as to preempt increased spending on social investments. With the present budget framework it is as difficult as 20 years ago to evaluate this proposal with the kind of certainty that would end public confusion and stop the Bush steamroller.

Therefore, next to campaign and election reform, federal budget reform should be at the top of any progressive agenda -- particularly since the purported Social Security "crisis" is closely related to the needed budget reforms.

Problem 1

When Social Security is accumulating massive financial reserves to finance future Baby Boomer retirement benefits, the inclusion of the SS account, with its huge current budget surpluses, in the main operating budget causes serious public (and congressional) confusion about the meaning and significance of "THE budget surplus." This makes responsible discussion of federal budget and tax policy difficult, and invites misappropriation of SS and other retirement fund surpluses -- Medicare A, civil service and military -- for other purposes.

The Congressional Budget Office (CBO) says this "unified" budget is necessary because it "provides the most relevant picture of the government's current impact on the economy." ("Budget and Economic Outlook: Fiscal Years 2002-2011," ch. 1, p.21 in the HTML version) Even if this were true -- which is highly debatable -- the main purpose of the federal budget should be to help the government manage its own finances in the most efficient and understandable way possible, and now it doesn't do that. Even the net economic impact could be more understandably explained in a special appendix or footnotes.

Solution 1:  Abolish the anomalous, confusing" and obsolete "unified" budget.

Take the whole SS account -- and also the civil service and military retirement accounts, and retirement-related Medicare trust fund -- completely out of the current operating budget, as corporate pension funds are required to be, and as SS was before the "unified" budget was adopted in 1968 to conceal Vietnam War deficits. This will make much clearer to both Congress and voters how much REAL (non-retirement-fund) "budget surplus" is available for tax cuts, increased spending and debt reduction.

Special significance for the current budget, surplus and tax-cut debates -- Together, the CBO-projected civilian and military retirement and Medicare surpluses that are still included in the current operating budget total nearly $400 billion during 2002-2011. Taking this out of the operating budget reduces by $400 to the total non-retirement-fund surplus honestly available for tax cuts, spending or debt reduction.

More importantly, during the more predictable first five years (2002--2006), this amount is only a puny $81 billion. This means that during the more credible part of the budget projection most of the "non-SS surplus" actually belongs to these other retirement reserves, It is only in the highly speculative outer years that the non-retirement fund surplus becomes really significant. (It seems reasonable to assume that, in Bush strategy, one reason the tax cut is back-loaded to later years is so that as the now-projected surplus increases it will be unobtrusively eliminated by distributing it to wealthy taxpayers before it can be spent on social investment.) A basic "permanent" tax rate cut at this time would be extremely unsound policy.

Problem 2

The budget the President submits to Congress, and the other budgets that Congress works with, are now based on ever-changing and unreliable "guestimates" of future economic performance that assume future recessions (of unknown severity) and an average unemployment rate above 5%. This makes budget -- and budget surplus -- debates confusing and irresponsible, and subject to intentional partisan distortion.

Solution 2:  Separate the Policy Budget from the Stabilization Account

The projections of future tax receipts and spending that Congress uses to make the budget should be based on constant -- what the CBO calls "standardized" -- economic assumptions. (Economists call such deficit/surplus estimates "structural.")

The Policy Budget.
The most appropriate basis for standardization is the unemployment rate, because that affects, and is affected by, most other aspects of the economy -- and also most other aspects of the budget. The most appropriate unemployment rate is the 4% that was the standard policy target during the relatively prosperous and non-inflationary first 27 years after WW2, and that was legally mandated by the historic but largely ignored Humphrey/Hawkins "Full Employment and Balanced Growth Act of 1978." Now this target has finally been regained after the ensuing 27 years of OPEC- and Reagan-induced high-unemployment depression.

This renewed demonstration that low unemployment is not incompatible with low inflation has finally discredited the infamous Phillips Curve/NAIRU (Non-Accelerating-Inflation Rate of Unemployment) idea that so long prevented focus on full-employment as the key policy target.

Basing the Policy Budget on this stable economic assumption will make budget debates much more realistic and understandable ("transparent" in financial lingo) to both Congress and voters. This will make it more difficult for Congress to pass fiscally and economically irresponsible Reagan-type tax-cuts.

Special significance for the current budget, surplus and tax-cut debate -- A recent Institute for Economic Analysis study found that a 1% change in the unemployment rate tends to affect the "unified" budget deficit or surplus by about .7% of GDP ( Thus, basing the GDP projection on 4% unemployment instead of the CBO's 5% tends to increase the projected 10-year Policy Budget surplus by about $1.2 trillion.

Does this "rosy scenario" projection tend to reduce the degree of fiscal responsibility, by increasing the temptation for more generous tax cuts or spending increases? Not if there is serious political commitment to fiscal responsibility. This budget framework actually provides a more clear-cut inducement to BALANCING the Policy Budget and responsibly managing the Stabilization Account, year after year. Preferably, under present conditions, it would also be possible to include in this balance perhaps 2% of each budget to further reduce the Public debt. The larger prospective surplus merely provides a larger total within which to construct the ten-year series of balanced budgets and continued debt reduction.

The "trigger" mechanism for preventing tax cuts from causing renewed deficits or slowdown in debt reduction -- If this device is based on the present "unified" budget, it could be triggered in a recession, at a time when a temporary tax cut is actually needed. But Basing it on the 4% unemployment Policy Budget would avoid that possibility because that budget version reflects only Congress's own policy actions -- including its target for regular debt reduction. The effect on the budget of economic conditions -- and of any pro-active fiscal policy actions -- would be reflected entirely in the Stabilization Account.

The Stabilization Account.
Economists have long viewed the effect of the economy on federal tax receipts and depression-relief spending as an "automatic stabilizer" that reduces the effect of economic fluctuations on households and businesses, and thus reduces the accelerating-spiral aspect of recessions and booms. If the Policy Budget is based on a standardized 4% unemployment rate, the residual surplus or deficit represents the "automatic stabilizer" effect of economic conditions (and Fed policy) on the budget; it becomes, in effect, an empirically identifiable Stabilization Account.

Problem 3

The dual meaning of "fiscal responsibility" for the Federal Government -- For households and businesses -- and even state and local governments -- this means maintaining an on-going balance between spending and income, with judicious use of credit ("deficits") only for "capital" outlays that will produce valuable future services. But because the Federal government controls the money supply and has almost unlimited borrowing capacity (as in WW II!), it also has a primary responsibility for how its budget decisions affect the whole economy.

Now, as in the past, when recession looms, Congress debates whether, when, and how much "fiscal stimulation" is needed -- always on the basis of unreliable and ever-changing economic information. As Fed Chairman Greenspan has pointed out, the resulting actions have usually been ill-conceived, ill-timed or both. This responsibility will be much easier to understand and fulfill when the Policy Budget, which best expresses household and business type "fiscal" responsibility, is separated from the Stabilization Account, which best expresses the government's economic responsibility. How can the federal government best exercise this basic responsibility?

Solution 3:  Use the Stabilization Account pro-actively.

The Stabilization Account balance reflects economy-induced changes in withholding tax receipts and "safety net" outlays. Thus, if it is properly adjusted for seasonal and other special factors, it could give a more precise, timely and un-ambivalent indication of the need for compensatory fiscal policy than other indicators. More importantly, if the Policy Budget is normally balanced, this account could easily be used pro-actively.

Special significance for the present debate on anti-recession fiscal policy -- Forty years ago the prestigious "Report of the Commission on Money and Credit" suggested that the potentially most effective economic stabilization device would be an automatic, formula-controlled withholding tax adjustment. Their proposal has languished mainly because they could not decide on the activating formula -- unemployment and inflation often give conflicting signals. There is now again talk of counter-cyclical adjustment of withholding taxes, even FICA contributions. But there must be a functionally appropriate basis for the adjustments.

Maintaining the National Credit Balance -- A key financial aspect of recession is the decline in business credit-financing of investment, and consumer credit-financing of houses and durable goods, and the complementary "automatic stabilizer" increase in federal deficit. So, instead of allowing the Stabilization Account deficit (and federal debt) to be passively increased by recession, an impending recession could be greatly minimized or even preempted by viewing the Stabilization Account as a means of balancing the economy's total supply and demand for credit -- and, incidentally, stabilizing interest rates. The withholding tax adjustment would be programmed to automaticaly increase federal borrowing by the amount needed to offset any recession-inducing decline in consumer and business borrowing. If Social Security is reformed as proposed below, SS will, in effect, have its own "Stabilization Account," and FICA rates could be temporarily reduced without reducing the SS surplus. Pending the long-needed revision of the Fed's Flow of Funds Accounts, the most suitable adjustment basis is interest rates -- adjust federal borrowing to maintain stable and historically-normal low interest rates.

Problem 4

How should the surplus be allocated between "debt reduction" and more adequate social investment in education, affordable housing, universal health care, etc. Unfortunately, this question has deeply divided liberal/progressive activists -- mainly because of misunderstandings about the complex relationship between SS and the rest of the budget.

Solution 4A

Obviously, the most basic step in solving this problem is to reach a common understanding of these relationships. Here are some of the key facts.

To earn interest income on its Baby Boom reserves, SS is now permitted to invest only in Treasury bonds. So the Treasury, in effect, has to "borrow back" -- and pay interest on -- all SS current surpluses. When the non-SS budget had a huge deficit, the SS surpluses helped finance it, thus reducing the apparent size of the "unified" budget deficit. But now that this budget has a surplus, the Treasury has no effective choice but to use the money borrowed back from SS to reduce the publicly-held debt until all the redemption-available portion is paid off. But since the SS debt and the public debt are both part of the total national debt -- and its even larger interest cost in the Policy Budget -- this technical swap of SS debt for public debt doesn't change the amount of the combined debt, or its interest cost.

The basic purpose of the "Save SS First" slogan was to prevent the non-SS surplus from being again wiped out by Republican tax cuts, and the SS surplus again being used for these non-SS purposes. This would have caused another Reagan-type buildup of the national debt -- and its interest cost -- that would make it more difficult for the Treasury to borrow again from the public, in about 20 years, when SS needs to begin liquidating its reserves to pay the Baby Boom benefit bulge for which the Trust Fund is now being accumulated.

In short, as long as SS can invest only in Treasury bonds, the total national debt and its interest cost can be reduced only by a surplus in the NON-SS operating budget, and that is where the policy debate should be more clearly focused. Failing to clearly make this distinction merely confuses and handicaps those who want to both "save SS" and increase social investment. If SS were completely out of the unified budget, and permitted to invest its reserves in private bonds and mortgages, as later proposed for SS reform, this distinction would be so obvious it would probably not even be a subject of public debate.

The Reagan-induced interest cost of the public debt is still one of the largest items in the "unified" budget, and thus tends to preempt social investment spending. One of the disadvantages of the "unified" budget is that it hugely under emphasizes this cost by citing only the "net interest" (in most presentations), after subtracting the interest payments "received" by the government on the SS debt against the government's cash interest payments on the public debt. Thus, interest cost is one of the main aspects of the "big government" (if that is measured by federal spending) that conservatives like to attack, and a key reason (along with excessive military spending) why some Bush supporters feel over-taxed (even though American taxpayers are actually some of the lowest-taxed in the industrialized world).

Solution 4B

The annually-balanced Policy Budget should include a specific regular allocation -- say, at least 2% of the total budget -- for debt reduction, for much the same reasons prudent households allocate specific budget amounts for home mortgage reduction, and tax rates should remain high enough to cover this amount. If Bush and the Republicans really wanted to be fiscally responsible, they would put more stress on protecting the non-SS surplus for reducing the total national debt as fast as economic and political conditions permit rather than forcing "permanent" tax rate reductions that could later prevent further debt reduction.

Solution 4C

Therefore, for liberals, the crucial budgetary choice here is between needed social investment spending and tax cuts, not between needed social investment and debt reduction. Polls suggest that most of the public seems to understand this. Now that Bush has demonstrated that he will not honor his bipartisan pretensions and will try to steamroller a conservataive agenda, liberals in Congress should take off their gloves and set forth a truly progressive agenda for the 2002 election, rather than being drawn into another tax-cutting competition.

Problem 5

A basic element in the budget aspect of any agenda should be real tax reform .

Solution 5:  If income tax rates are reduced, it should be only in a "package deal" with some of the following:

C. Social Security Reform

There is no Social Security "crisis" if Baby Boom Trust Fund reserves are protected from misappropriation and from recession-induced reductions.

Problem 1

In the "unified" budget framework the present "lock box" promises to keep hands off the SS surpluses are no more binding than other political promises. They will almost certainly be abandoned if federal budget deficits return, whether in the Policy Budget from deliberate Reagan-type fiscal strategy, or in the Stabilization Account from economic mismanagement. Moreover, if all the available public debt is actually paid off by 2010, long before the SS Trust Fund has finished its build up of Baby Boom reserves, there will be a strong political tendency to allow Policy Deficits to develop again as a place to "invest" the continued flow of SS current surpluses.

The basic budget reform of taking the SS account completely out of the operating budget will help to remedy the misappropriation problem by clarifying the relationship between SS and the rest of the federal budget. But it is not enough as long as SS is required to invest its Baby Boom surpluses only in U.S. Treasury securities.

Solution 1:  Beginning immediately, permit SS to invest its Baby Boom surpluses in private bonds and mortgages, as business pension funds do

-- but not in risky corporate stocks, which Fed Chairman Greenspan fears could risk federal intervention in private corporate decisions. SS could purchase, by regular "reverse auctions," market-offered "baskets" of investment grade bonds and mortgages that are timed to mature just as the funds are needed for Baby Boom benefits (thus making it unnecessary for SS to monitor market price shifts). Under present plans, this change would be necessary anyway after the PUBLIC debt is paid off. But why wait?

Permitting SS to invest its surpluses in private bonds and mortgages would:

Problem 2

The financial health of Social Security must not be hostage to recession unemployment. The supposed SS "crisis" is caused mainly by the SS Trustees' inappropriate economic assumption of recession-averaged high unemployment and slow growth. Even in their Year 2000 "low cost" (4 1/2% unemployment) projection, the present system accumulates enough reserves to adequately finance Baby Boomers' full benefits for the whole 75 years.

Solution 2:  Social Security financial projections should be made on the same constant ("standardized") 4% unemployment assumption as the main Policy Budget.

This projection could even make possible a fully responsible reduction in the FICA contribution ("tax") rate -- something that should make it politically interesting to President Bush as well as Democrats.

Together with the budget reforms previously outlined, these reforms will help protect the SS retirement reserves from misappropriation far better than the flimsy "lock box" promises that depend on easily reversible future political decisions.

But what if we continue to have recurrent recessions (as all the present SS, CBO and Presidential budget projections expect and allow for), and SS surpluses fall below their projection-assumed 4% unemployment rate? No problem. The 4%-unemployment-rate contributions to the SS Trust Fund would be legally guaranteed, with any shortfall reflected only in the budget's Stabilization Account -- along with all the other "automatic stabilizer" effects of the recession on the budget.

Many factors make this a historic window of opportunity to enact these long-needed basic budget and SS reforms. We must not let it slip by.

Posted: February 18, 2001
Last revised: March 13, 2001
To IEA home page