Protecting Social Security and Maintaining Fiscal Responsibility
In Time of Crisis:
A New Approach

The four basic changes proposed:  
The Present Fiscal Crisis

In the 2000 election campaign both parties promised to put Social Security (SS) and Medicare Baby-Boom surpluses in a "lock box" and not raid them for non-SS purposes. But that promise was broken even before the 9/11 terrorist attack, by Bush's budget-busting tax cut and the recession. Now those promises seem entirely out the window. Congress seems set to "spend what it takes" to repair the attack damage and win the "war" against terrorism -- without much concern about how that spending will be paid for. Since Bush seems to have little interest in addressing, or even acknowledging, the aspects of US foreign policy that have fueled Arab/Muslim anger, that war and its costs are likely to escalate sharply.

In the interest of "bipartisan national unity," the Democrats have refrained from demanding cancellation of Bush's future tax cuts or opposing his star wars research, and have even offered to cut back on their own long-sought education and other social investment plans. But the Administration is hinting that it wants to take advantage of the crisis to get more tax cuts for business and the wealthy under the banner of "fiscal stimulus." Thus, it now seems likely that the whole SS surplus will soon go to financing non-SS deficits, as before 1998. It would be a real tragedy if this crisis leads to a repetition of the Reagan/Bush fiscal irresponsibility of the 1980s that spent the entire SS surplus and quadrupled the federal debt and its interest burden on taxpayers. That would be very expensive "collateral damage" from the terrorist attack.

This article suggests that the best way of preventing this outcome would be to use the crisis to make some long-needed basic reforms in how we deal with the budget and Social Security finances -- fiscally and economically sound changes that will make both of them easier to understand, easier to manage, and less vulnerable to political shenanigans.

The Budget
  1. Take Social Security "off budget" -- completely and honestly. Finally end the 33-year-old "unified" budget. Mixing pension fund with operating budget makes a confusing and embezzlement-prone arrangement that is rightly prohibited for business pension funds. This would help prevent the raiding of SS surpluses for non-SS purposes better than the "lockbox" promises. And in terms of accounting "transparency" and public understanding, the removal of SS benefits from the federal spending "pie chart," and the explicit inclusion of the interest cost of both the public and SS components of the national debt, would provide a clearer perspective on the relative size of the main components of federal spending -- interest, military, safety-net/anti-poverty, etc.
  2. Adopt a "Standardized" Policy Budget.  The Congressional Budget Office (CBO) now calculates a supplementary "standardized" federal budget based on a constant unemployment rate. This device separates the result of congressional tax and spending policy decisions -- which are all that Congress really controls -- from the residual effect of economic fluctuations, which the CBO calls the "cyclical" surplus or deficit, and which is largely influenced, indirectly, by Federal Reserve monetary policy. Using this budget concept as "the" budget -- as the main version for budget planning and debate -- would end the confusing and time wasting debates over which of the ever-changing-and-unreliable economic forecasts is the most appropriate assumption on which to base budget projections. And it would facilitate retrospective analysis of year-to-year changes in budget elements.
  3. Use 4% unemployment as the basis for Policy Budget standardization.  The economy has now again demonstrated its ability to reach, without inflation, the 4% unemployment rate mandated by the historic (but long-ignored) Humphrey/Hawkins "Full Employment and Balanced Growth Act of 1978" as a preliminary "full employment" policy target. Thus, it would be fiscally sound and politically appropriate for Congress to use this legislatively prescribed 4% unemployment rate target (rather than the CBO's present 5.2%) as the basis for standardization.
  4. Recognize the current political advantages of this SS-free Policy Budget.  It would be easier to allocate Federal spending on its own merits (instead of clumsily trying to stimulate the economy), and would encourage paying for it responsibly by projected tax receipts. It would provide a sounder and less controversial basis for judging fiscal responsibility.
  5. Before the 9/11 attack such a Policy Budget would have projected a 2002 (non-SS) surplus perhaps $80-100 billion more than the comparable unified budget -- enough to have gotten Congress out of its pre-attack "fiscal straightjacket" with less partisan wrangling. Now this budget would tell more clearly -- and more non-partisanly -- than the unified budget how much fiscally responsible "wartime" tax-cut reduction and/or tax increase is needed to pay for post-attack spending increases. The CBO should make a preliminary projection on this basis as soon as possible.

  6. Recognize the analytical and policy-making value of a "standardized" measure of the "automatic stabilizer" effect.  Economists have long viewed the effect of recessions on the budget as an economically useful "automatic stabilizer" that partially mitigates a recession by taking less tax money out of the economy and putting back more in "safety-net" spending. Thus, this budget component should be more meaningfully called a "Stabilization Account"-- rather than the CBO's "cyclical surplus or deficit." As most people now realize, Fed monetary policy largely controls the economy's growth rate and unemployment rate, and a "standardized" Stabilization Account would provide a valuable measure of the budget cost of recessions that the Fed causes or permits.
  7. Use the Stabilization Account pro-actively, via temporary tax cuts, to fight recession.  Since the one-time $38 billion tax rebate was explicitly intended as "fiscal stimulus," it would have been included in the Stabilization Account deficit rather than being allowed to reduce the Policy Budget surplus. Now that the 9/11 attack has sharply accelerated the pre-attack recession (from the economy's 3 to 3 1/2% long-run trend growth rate) there is growing consensus that even larger federal deficit stimulus may be needed. But this could be done more simply and effectively by a precise temporary "off budget" reduction of income and/or FICA withholding taxes that would affect only the Stabilization Account. Most of the resulting increase in weekly after-tax income would undoubtedly be spent immediately. This would be far more efficient than an arbitrary, clumsy and expensive mailed-check "rebate" -- or a proposed long-run-expensive capital gains tax cut. A disruptive "austere" across-the-board federal spending cut would clearly be counterproductive, both economically and budget-wise.
Coordination of Monetary and Fiscal Policy

To be most efficient, a pro-active increase in the Stabilization Account deficit should be viewed in a credit-flow perspective, as a complement to Fed monetary policy. The economically most appropriate amount would increase the economy's total demand for credit (federal, business, consumer and state/local borrowing) just enough to counter recession-induced "pushing on a string" credit conditions -- as perhaps best indicated by the "real" Federal Funds rate. The Fed can then increase the money supply (M1) at an adequate recovery rate without pushing the real Fed Funds rate below zero (as in Japan!) and causing a precipitous reduction in the dollar exchange rate. (Cf. "Monetary and Fiscal Policy Sunshine Act")

Social Security
  1. Standardize SS financial projections on the same 4% unemployment basis as the main federal budget.  The SS Commission's 4 1/2% unemployment "low cost" projection is financially sound for the foreseeable future (see chart) This shows clearly that the supposed "crisis" is not due to the basic actuarial relationships but to the inappropriate economic assumptions in the Commission's much publicized 5 1/2% unemployment projection. (A 4% unemployment projection would probably even permit a reduction in FICA tax rates.)
  2. Any recession-induced shortfall of SS Baby-Boom surpluses from the standardized amount should affect only the main budget's Stabilization Balance -- not the Baby-Boom reserve.  Moreover, if it is decided to apply a temporary anti-recession withholding tax cut to FICA contributions, the resulting deviations of Baby-Boom surpluses from the standardized values should also be reflected only in the Stabilization Account.
  3. (Note: In this article, the term "Baby-Boom" is used with SS surpluses and reserves as an explicit political reminder of this vital purpose of the large and rapidly-growing SS trust fund.)

  4. Invest SS Baby-Boom reserves in maturity-laddered investment-quality private bonds and mortgages (including GNMA and FNMA) -- but not in stock.  Then, after 2020, when SS needs to liquidate assets to finance Baby-Boom benefits, the money would come from the maturing private securities rather than from renewed Treasury borrowing from the public.

Just as for private pension funds, SS's large and rapidly growing interest earnings on its investments are vital for its long run financial health. But when SS is permitted to invest only in Treasury bonds, the Treasury's interest payments to SS are, in effect, a large taxpayer subsidy of SS that greatly reduces the real non-SS budget surplus. The present unified budget scam effectively hides this cost the same way it hid the pre-1998 non-SS deficits -- by subtracting SS interest receipts from the Treasury's total interest payments. This way, the cost becomes evident only after 2020 when the Treasury has to find the money to pay off the interest-financed SS bonds. Permitting SS to invest in private debt securities would "privatize" this interest cost and correspondingly increase the (non-SS) Policy Budget surplus. The 2002 increase of over $65 billion would finance a significant portion of the post-attack increase in spending.

This reform would obviously protect Baby Boom reserves from being raided for non-SS purposes much more effectively than the flimsy "lock box" promises -- and would make the SS trust fund seem more "real" to those who doubt SS's future. It would also make it unnecessary to pay off the entire public debt, some of which now plays a useful role in the management of monetary policy and private pension and insurance businesses. A further advantage of initiating this reform at this time is that, because of the recession, the interest rate "spread" between Treasury and private bonds and mortgages is much higher than usual. So the SS trust fund, which can afford to take a longer-run perspective than most private investors, can benefit from the higher rates at the same time that its security purchases tend to reduce the rates for private borrowers -- and help the housing industry.

Political Implications

Not mere smoke-and-mirror gimmicks.  These reforms are fundamental conceptual changes that increase the "transparency" (understandability) of the SS and budget systems, reduce the incentive for short-run political gamesmanship in budget making, and facilitate real fiscal and economic responsibility. For instance, they would help clarify the distinction between the public debt and the national debt (which includes Treasury debt to both SS and the public). This would help expose the basic misconception that Treasury borrowing from the SS trust fund to pay down the public debt also reduces the total national debt. These reforms would also help throw more light on a fact conveniently ignored by the privatizers -- that the overall social and economic "burden" of retiree benefits on future workers, and the effects on financial markets, will be much the same, whether the anticipatory prior financial saving is through Social Security or through private pensions and 401(k)s.

Basis for a political deal.  The larger non-SS Policy Budget surpluses resulting from these reforms would make possible needed spending increases without raiding SS Baby-Boom surpluses. Traditional fiscal conservatives would not need to fight for counter-productive across-the-board spending cuts. Liberal Democrats could fight for badly needed investment spending without divisively denouncing as Coolidge/Hoover "balanced budget theology" the fiscally responsible desire to reduce the high interest cost in the federal budget. Democratic supporters of Bush's tax cut could also work for more social spending. But in the present political environment in which Congress wants to maintain at least a façade of "wartime bipartisan national unity," the budget framework of these reforms would also tend to provide a strong check on Bush's tendency to Reagan-like fiscal irresponsibility.

In an 8/24 news conference Bush referred to the "fiscal straightjacket" his tax cut and the recession had imposed on Congress as "incredibly positive news" -- because it would halt growth of the federal government (except for his proposed military increases). If the Democrats allow the Republicans to use this crisis to wipe out the SS surplus and run big non-SS deficits, as during the 1980s, they can kiss goodbye to their hopes for more social spending and will have no platform on which to run a winning campaign in 2002 and 2004.

These budget and SS reforms create a budget framework that makes it easier to demand fiscal responsibility of the Republicans and also provides better bargaining power for the inevitable compromises. If the Democrats push these through now, history could well look back on them with the same approval it now looks back on Clinton's hard fought 1993 fiscal "revolution." If the Republicans block them, they will provide key planks to run on in 2002 and 2004.

A potential political bargaining chip to support efforts to rescind Bush's budget-busting tax cut and keep a lid on his military spending increases.  Since Bush measures the "size of government" by the non-military portion of the budget, it is worth noting that the Reagan/Bush regime -- which the current Bush seems to be imitating -- greatly increased the "size of government" by the huge slice of interest cost that its fiscally irresponsible fourfold increase in federal debt added to later budget pie charts. As a reminder of this lesson, it might be useful to initiate -- and hold hearings on -- a proposal to include in current Bush Policy Budgets a "sinking fund" amount equal to 20% of the interest cost of the part of the public debt added by the Reagan/Bush regime.

Written: September 12, 2001
Last revised: September 25, 2001
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