Social Security, Budget Surpluses
& Their Relationship to the Economy:
How to Resolve Confusions and Refocus Policy

This analysis is based on the innovative IEA conceptual and policy framework.
This is still a working-paper discussion draft, but is posted now because of its current political relevance.
It is not to be published elsewhere without the author's permission (info@iea-macro-economics.org).
(c) 2000 by John S. Atlee, all rights reserved

Summary Conclusions
  1. Social Security has no "crisis." The myth was caused by the SS Trustees' 1996 assumption of 6% unemployment -- their 5% and 4 1/2% projections have no financial problems.
  2. Insulate Social Security from inappropriate economic assumptions, economic mismanagement and misuse of its surpluses.
  3. Use all SS surpluses borrowed from the Trust Fund for public debt reduction -- to prevent a Reagan-like buildup after 2015 when the Trust Fund needs the money for Baby Boomer benefits.
  4. Base SS financial projections on a "standardized" Humphrey/Hawkins 4% unemployment rate, with deviations from these values transferred to the main Federal budget's Stabilization Account, where this recession-mitigating "automatic stabilizer effect" can best be evaluated and managed. This makes possible a FICA rate reduction.
  5. End the "unified budget" fiscal monstrosity by completely removing the SS and other retirement trust funds from it-- as required of business pension funds.
  6. In the main Federal budget, separate the congress-controlled Policy Budget (based on the "standardized" 4% unemployment rate) from the economy-controlled Stabilization Account, for more fiscal and economic responsibility.
  7. Offer Supplementary Social Security Accounts, based on private stocks and bonds, as a small business alternative to a private pension plan.
Annotated Contents

I. Key Definitions -- and Budget Confusions.

II. Social Security Benefits From the Worker's Perspective.

III. Social Security Financing and Its Relations To the Main Federal Budget

  1. The basics -- the financial projections and the Baby Boom Bulge.
  2. How the SS Trust Fund and Treasury work together as a public financial intermediary, comparable to private pension funds.
  3. The nuts & bolts of financing the Baby Boom retirement bulge
IV. The Key Relationship Between the Federal Fiscal Balance
          and the Overall Economy's National Credit Balance V. Why the SS Account -- and Other Retirement-Related Trust Funds --
        Should be Completely out of the Main Federal Budget.
  1. Main reason: To end the confusion and fiscal irresponsibility of the "unified budget"
  2. It would help clarify and counter misconceptions
  3. It would facilitate more fiscally responsible discussion and management of the main federal budget
VI. Social Security Should Not be Held Hostage to Government Economic Mismanagement
          and Unreliable and Ever-Changing Economic Projections. VII. Social Security and Rethinking Retirement VIII. The Most Urgent Legislative Goals
  1. Social security reforms
  2. Federal budget reforms
References

Now is a historic window of opportunity for making these basic reforms!



 
I. Key Definitions -- and Unified Budget Confusions

The fight to "Save Social Security" and its beguiling Trust Fund surplus is largely a battle of ideas -- concepts, relationships, perceptions. Those who define the terms of debate tend to win. The many confusions and intentional misinformations put forth by the privatizers seemed to give them an initial advantage. To restore public confidence in Social Security, the public needs to understand more clearly how the system works, how it is financed, and how it is related to the rest of the budget and the whole economy. Moreover, friends of SS urgently need to put forward a bold new approach that will solve the alleged "crisis" in the most effective way, and put opponents on the defensive. (Otherwise, the expected stock market crash may not come soon enough to save SS from the privatizers.)

"Social Security" (SS) -- In this article = OASDI (Old Age, Survivors & Disability Insurance), excludes Medicare)

Unified budget  (or "whole budget") =  The combination of trust funds and federal funds.  Trust fund surpluses reduce Federal funds deficits.

Trust funds  have earmarked taxes or other independent sources of revenue. These include, with projected FY 2000 budget surpluses (in billions): Federal funds -- everything in the unified budget except the Trust Funds.

"On budget" == everything in the unified budget except SS and the Postal Service. This includes three other retirement-related trust funds that have the same Baby Boom problem as SS, and whose surpluses also conceal part of the federal funds deficit, as well as all the minor trust funds. The only differences now between federal funds and on budget are the Postal Service (in federal funds but off budget) and the non-SS trust funds (on budget but not in trust funds).

"Off budget" -- SS was designated "off budget" in the 1985 Gramm-Rudman-Hollings "Balanced Budget" Act -- presumably as a technical sop to those who have long wanted to protect the SS Trust Fund by taking SS entirely out of the Budget. This designation causes budget confusion and further complicates some unified budget tables by giving SS a separate line, but does nothing to prevent the SS surplus from continuing to conceal part of the the Federal funds deficit. The Postal Service is also designated "off budget," for more obvious reasons.

Deficit/surplus concepts

Confusions, confusions . . .

Here are some interesting illustrations of the confusions caused by the unified budget concept from the The Congressional Budget Office (CBO) The Budget and Economic Outlook:Fiscal Years 2001-2010:

All this budget confusion -- and related policy hocus-pocus -- could be eliminated very simply by taking out of the present unified budget all four of the retirement-related trust funds, with their beguiling surpluses. This would leave just two simple budget categories:

  1. the main budget (now called "federal funds" budget), which would then generally be referred to simply as "the budget" (unless otherwise specified);
  2. all the off budget "business-like" (semi-independent and self-financed) government activities such as the retirement trust funds, Postal Service, TVA and federal financial institutions.

In this article, I use the term "main budget" in this sense -- i.e., the unified budget without the four retirement-related trust funds, or the federal funds budget including the remaining 150 or so trust funds which are financially insignificant because they do not have the large Baby Boom financial accumulations and current surpluses.

The CBO's three alternative baseline budget projections

The freeze and capped versions of the unified budget (which include SS and the other retirement trust funds) have projected cumulative surpluses that are almost identical by 2010 -- about $4200 billion. Even the "on budget" versions (excluding SS) are almost $2000 billion. It is these unrealistically optimistic versions that present such a juicy target for tax-cutters.

With such a variety of budget definitions and economic and policy assumptions, politicians can chose a combination to support almost any policy position. For budget sanity, all the retirement trust funds must be taken out of the main budget, and the main budget fiscal balance (deficit/surplus) must be separated into its Policy Budget (the Congress-controlled component based on "standardized" 4% unemployment values) and the Stabilization Account (the economy-controlled residual). (see Section VI)

 

II. Social Security Benefits From the worker's perspective

Financial safety net.  The three main elements of the Social Security System (OASDI) -- retirement annuity (comparable to private pension plans), death benefit for survivors (compable to private life insurance), and disability insurance -- constitute the basic financial safety net of almost every American family, as well as providing an expression of social solidarity among the whole American people.

Financial asset.  What is not as generally recognized is that the SS retirement annuity is, for the vast majority of workers, their most important form of saving and most valuable financial asset. Together with the other SS benefits, this package may now be worth as much as $1 million of private pension and insurance policies.

Retirement benefits.  These are guaranteed for life. The amount is determined largely by the amount and duration of past earnings -- much like private defined-benefit pension plans, but with these significant differences:

  1. The before-retirement values of FICA contributions and related benefits are adjusted for the growth of average U.S. real wages (to maintain relative standard of living), and retirement benefits are adjusted for inflation -- two invaluable features that few private pension programs do, or can offer.
  2. The relationship of contributions to benefits is "progressive" -- in relation to their FICA contributions, lower-income workers may get as much as double what higher-income workers get. This is one reason why some upper-income people would like to opt out of SS and/or "privatize" the system.
  3. The SS benefits for dependents, disability and survivors are also not available in most private pension/benefit plans or tax-subsidized IRAs and 401(k)s.

Individual accounts.  Each worker and his/her employer make FICA contributions into the individual worker's SS account -- much as in supplementary company pension plans, 401(k)s and IRAs. However, unlike many company pension programs, SS has always been fully "portable" when moving from one job to another because each worker's account is safely managed by the national SS system, with an administratiive cost far below that of private policies -- and is also free of confusing and risky private investment decisions.

Thus, from the individual worker's perspective, SS is essentially a government-sponsored but semi-independent mandatory self-financed retirement and insurance program with benefits based on the prior FICA contributions of the individual recipient and his/her employers. It has many similarities to private pensions, IRAs and 401(k)s that need to be more clearly recognized by taking the whole SS account out of the main federal budget, like the Postal Service is, so that workers can look at the SS System as a unified whole and understand how their rapidly growing assets are invested.

"Misinformation" misconceptions.  In a complex matter like SS, a half-truth can be worse than a bald-faced lie because the latter is more easily recognized and countered. The supposed SS "crisis," and other highly misleading ideas being assiduously cultivated by leading Republicans and right-wing think tanks -- and by the Wall Street financial firms who expect a huge increase in mutual fund profits from its privatization -- give rise to the cynical belief of many young people that there won't be any benefits for their generation when they retire.

One of the most subversive and socially divisive of these misconceptions is the idea that SS is an "intergenerational transfer" system. In terms of total current financial flows, SS does indeed operate mostly on a pay-as-you-go basis in which benefit outflows are financed mainly by current contribution inflows from employers and workers -- as is also true of most private business pension programs. Looking at it this way allows the privatizers to characterize SS as a system in which struggling young workers are financing aging retirees' high standard of living. However, looking at it from the perspective of the individual worker, they are financing their own SS retirement benefits by their own financial saving through their own (and their employers') FICA contributions. Moreover, ironically, one of the main functions of the SS System is to avoid the need for the pre-industrial, pre-SS "intergenerational transfer" system in which adult children had financial responsibility for their aging parents. Fortunately, many young people and most middle-aged people realize this.

 

III. Social Security Financing and Its Relationship
To the Main Federal Budget

A. The Basics

As long as the SS account is still in the unified budget (though misleadingly labelled "off budget"), FICA contributions flow through the Treasury's general fund, and benefit payments are part of general fund outlays. But the SS System is essentially self-financed -- a government-sponsored but semi-independent mandatory retirement and social insurance program. For fiscal responsibility and "transparency" of its operations, the whole SS account should be completely separated from the main oprating budget, as corporate pensions funds are required to be.

The 75-year projections.  Just as private pension funds have to do in managing life-long defined-benefit pensions, SS must set benefit rates and contribution rates so that total projected contributions, together with the interest earned on Trust Fund investments, will be adequate to finance total projected benefit payments for 75 years ahead -- based on projected work-life, life-spans and other actuarial relationships. But because SS covers practically the whole labor force, it must also take account of projected future economic conditions and unemployment rates. Thus, the assumptions used by the Social Security Trustees in making their projections are crucial to understanding the nature of the purported SS financial "crisis," and proposed ways to solve it. (Section VI explains how this problem is due primarily to inappropriate economic assumptions. See also "The Phony Social Security 'Crisis'")

The "Baby Boom"(1946-63) population bulge and the SS Trust Fund.  While the Boomers are earning their maximum incomes, their total FICA contributions are much more than enough to finance the current retirement benefits for their parents' smaller Depression-and-WWII generation. But when the Boomers retire, beginning about 2010, this imbalance will be reversed. Private business defined-benefit pension plans will have to face a similar problem.

To avoid having to raise contribution rates or reduce benefits when that happens, the Boomers' work-life surplus contributions are going into the SS Trust Fund and being invested in earning assets, much as in private pension funds. But since the U.S. government doesn't risk private-business failure or outsource closings, SS doesn't need to "fully-fund" its total future pension obligations, as private companies are required to do. Only the Baby Boom bulge requires full-funding. Thus, privatizers who say that the SS system is "a Ponzi scheme with huge unfunded pension liabilities" are either ignorant of the facts or intentionally falsifying them -- or merely assuming that Congress will continue using the SS surpluses to mask main-budget fiscal irresponsibilitiy.

This error is well illustrated by Lawrence Lindsey, presidential candidate George W. Bush's chief economic adviser, when he says: "The reason Social Security is a problem is that we have a pay-as-you-go-system. As soon as the money goes in, it flows out in the form of benefits. What we need is a system where there is a buildup in dividends and interest, the way private pension accounts work." -- March 17 interview, reported in April 3rd BUSINESS WEEK. (He says Bush favors "voluntary personal accounts" and, implicitly, supports reduction in younger workers later SS benefits.)

B. How the SS Trust Fund and Treasury work together,
     in the unified budget framework, as a financial intermediary.

The 2000 OASDI Trustees Report notes that: "The accumulation and subsequent redemption of substantial trust fund assets has important economic and public policy implications that go well beyond the operation of the OASDI program itself. [But] Discussion of these broader issues is not within the scope of this report."

This article attempts to bring some of those implications into clearer focus.

SS financial intermediation.  Insurance companies that operate private pension funds are called financial intermediaries because they accept retirement savings from workers and employers and lend these funds out to borrowers to earn interest that increases the size of the future pensions. The SS Trust Fund performs a similar function, in cooperation with the U.S. Treasury, within the very inappropriate framework of the present unified budget.

Business, and state and local government, pension funds invest in marketable stocks and bonds -- often US Treasury bonds (popularly called T-bonds) -- but the SS Trust Fund is not permitted to do this. Therefore, the Treasury has to serve as the trust funds' own financial intermediary, borrowing back all the Baby Boomer surplus, in exchange for special non-marketable Treasury securities that, for convenience, we'll call SS T-bonds. The Treasury pays interest on the SS T-bonds just as it does on the publicly owned T-bonds.

The "lockbox" confusion.  Both President Clinton and the Republicans talk of putting the SS surpluses into a "lockbox" to prevent their being misused to finance budget-busting tax cuts or spending increases. This is a bad metaphor both logically and politically because it implies a basic misunderstanding of the role of trust funds. The SS Trust Fund is not a "Fort Knox" full of billion dollar bills. As with private pension funds, a key purpose of the SS Trust Fund is to invest the money to enhance the value of the pension benefits, and that means lending the money to borrowers who pay interest on it. In this case, the borrower is the federal government itself. Once the SS Trust Fund is out of the budget, the lockbox metaphor will be unneeded because direct comparisons with private pension funds will be more obvious.

The "embezzlement" issue.  Until recently, the Treasury used the borrowed SS surplus to finance part of the main-budget deficits. Some critics (including the present author) have referred to that process as "embezzlement." But under the unified budget rules, the Treasury simply had no viable alternative. The political dishonesty lies in continuing to use the unified budget system which hides part of the main budget deficit by netting the trust fund surpluses against it, rather than putting them in "transparent" independent accounts.

The "non-Social Security surplus" confusion -- continued budget hocus-pocus.  In the present budget/surplus debate, the term "non-SS surplus" is generally used as if it referred to the surplus in the main (federal funds) budget. But it refers to the unified budget with only the SS surplus removed. In the 1999 unified budget, the "non-SS surplus" was $88 billion -- which precisely concealed the continuing $88 billion deficit in the federal funds budget. Of that "non-SS surplus", $64 billion -- fully half as much as the $125 billion SS surplus -- was due to the other three large retirement-related trust funds -- civil service retirement, military retirement and Medicare, which probably have much the same Baby Boom problems as SS, and should also be effectively "off budget." The first significant federal funds surplus isn't projected until 2006 -- beyond the Clinton budget horizon.

Thus, the hot political debate on "how to use the non-SS surplus" is a dangerous charade; it's really about how to prevent the tenuously projected federal funds surplus from actually occurring -- by anticipatory tax cuts and spending increases that use up the other retirement trust fund surpluses. This confusion can probably be ended only by eliminating the unified budget or by taking all the retirement programs out of it -- and by the other SS and budget reforms suggested by this article. (These reforms could gain additional support if civil service employees and veterans were to politically mobilize to protect their retirement funds the way the Social Security constituency has.)

Moreover, although even many Republicans recognize that additional social-investment spending is badly needed, there is still no courageous discussion (even by the Democrats) of what taxes are needed to actually cover this spending in a balanced Federal funds budget.

"The government owes the SS Trust Fund debt to itself" confusion.  Yes, the SS T-bonds are an intragovernment debt owed by the Treasury to the SS Trust Fund. But to say that the government owes this SS T-bond debt "to itself" is the kind of confused thinking that got corporate pension funds in trouble before they were forced to separate their pension funds from their operating accounts. The Trust Fund, acting as a financial intermediary, holds its Baby Boom assets in trust for the future SS beneficiaries, who are part of the public. Therefore, the SS T-bond debt, although not directly held by the public, is a fast-growing part of the $5.6 trillion (gross) Federal debt owed to the public. The only way to reduce the gross federal debt and its $354 billion a year interest burden on taxpayers is by running a continuous surplus in the federal funds (non-retirement-fund) budget.

President Clinton's plan to use 100% of the SS surpluses to "pay down the public debt" was an astute political ploy to save the SS surplus from fiscally irresponsible tax-cutters. But his challenge, "Let's make America debt-free for the first time since 1835!" is not an accurate statement of what he proposes. There was no SS Trust Fund in 1835, and the Treasury's debt to the Trust Fund is not just an accounting device. As the SS Trustee Report says, the SS T-bonds, like any other Treasury securities, are legally "backed by the full faith and credit of the US government." Clinton's proposal does not eliminate all of the Federal (or national) debt; it only prevents its further escalation by continued use of SS surpluses to finance and disguise federal funds deficits.

The present unified budget and its pie chart visual presentations omit the trust funds' interest cost by subtracting it from the interest on the publicly held debt. This, in effect, canceals more than half of the government's total $354 billion a year interest cost -- the same way the unified budget has in the past concealed a large part of the actual (federal funds) budget deficit -- and causes this huge interest cost to get too little attention in the current debate over the debt pay-down.

If all of the Trust Funds were removed from the unified budget and allowed to invest their surpluses independently in non-federal marketable bonds, the Treasury could not borrow this money back from them, and would have to finance federal-funds deficits entirely by public borrowing. But this would not significantly affect the Treasury's total borrowing or the gross debt and interest cost. Removing the trust funds from the unified budget would make these fiscal realities much more "transparent" (to use the term Wall Street analysts favor) and understandable to the public.

C. The nuts and bolts of financing the Baby Boom retirement bulge
      in the unified budget framework

The Trust Fund buildup period (to about 2015-2020), and the debt swap.  Clinton's 2000 budget calls for the Treasury to use all of the SS current surplus that it borrows back from the SS Trust Fund (except for a small part diverted to the Medicare trust fund in 2001-2002) to pay down the present public debt. This reduces the more visible publicly held portion, while the debt to the SS Trust Fund increases by an equal amount. In effect, the Treasury facilitates the buildup of the SS Trust Fund's Baby Boom reserves by a dual "debt swap" of pubic T-bonds for SS T-bonds. In fact, the CBO-projected gross federal debt actually increases from $5.6. trillion in 1999 to $6.0 trillion in 2005, and the interest payments on it increase from $354 billion in 1999 to $362 billion in 2005 -- for reasons that are not immediately clear to me. Since the SS current surplus includes the Treasury's interest payment on the outstanding SS T-bonds, when the public debt is reduced, the interest saving on that part of the Federal debt is offset by the increased interest on the SS T-bonds.

(Clinton's October 1999 "Lockbox Plan" proposed to "transfer to the SS Trust Fund" the 2011 to 2044 "interest savings" from the public debt pay-down. But his actuaries apparently forgot about the corresponding SS Trust Fund T-bond interest buildup, and the necessary post-buildup regrowth of the public debt and interest on it.)

Looking ahead, it is easy to see why this two-phase debt swap is necessary in the unified budget framework. As the Boomer retirement benefit bulge hits the SS Trust Fund, the Treasury will have to begin paying off its SS T-bond debt. Where will it get the money for this? Since a main purpose of the Trust Fund buildup was to avoid the need for a tax increase at this point, and a federal funds surplus is politically unlikely, the Treasury will again need to borrow from the public. But it would be a return to Reaganesque fiscal irresponsibility to pile this new borrowing on top of the 2001 level of existing public debt. So the Treasury uses the SS surpluses from the Trust Fund buildup to pay down the present public debt. Clinton estimates that it can all be redeemed by 2013, before the subsequent new buildup of public debt begins.

Public and Greenspan support for the public debt pay-down.  Fortunately, Clinton's leadership on this process seems to have inspired widespread public support for it, even among Republicans. Fed Chairman Alan Greenspan, in his February 17th semiannual Humphrey-Hawkins report to Congress, weighed in with his own support, by welcoming

"...the wise choice of the Administration and the Congress to allow the bulk of the unified budget surpluses projected for the next several years [mainly SS] to build[,] and [to] retire debt to the public. The idea that we should stop borrowing from the Social Security Trust Fund to finance other outlays has gained surprising -- and welcome -- traction, and it establishes, in effect, a new budgetary framework that is centered on the on-budget [non-SS] surplus and how it should be used. This new framework is useful because it offers a clear objective that should strengthen budgetary discipline."

As Greenspan implies, this should make it difficult for political candidates to talk about using any part of the SS surplus for financing irresponsible tax cuts or spending increases. In fact, this should also make it more difficult for politicians to advocate any tax cuts or spending increases without higher taxes to finance them. (Again, all of this could be achieved more easily and reliably if SS and the other retirement funds were completely out of the budget.)

But support hasn't been unanimous.  Aside from the Reaganite "smaller government" ideologues who simply want to use the large debt and current deficits as a political lever to further reduce public social investment spending, it is likely that many opponents simply haven't looked far enough ahead at the financial implications of the SS Baby Boom reserve buildup and its liquidation.

Some Wall Streeters have opposed the pay-down because it would redeem most of the large "risk-free" and highly liquid marketable Treasury debt that provides Wall Street with both a standard of reference for other debt securities and interest rates, and a secure place for investment retreat during "bear" days on Wall Street.

This problem could easily be resolved if the SS Trust Fund were permitted to use its current surpluses to purchase suitable marketable securities in the open market, like private pension funds do, with the Treasury serving as friendly broker for their purchase. If the maturities of these securities are properly "laddered." they would automatically mature when the Trust Fund later needs the money to pay the bulge of Boomer benefits. This procedure would render the Treasury's presently projected "debt swapping" operation unnecessary, make the Trust Fund's operations more transparent and publically understandable, and help to protect SS from inappropriate use of its surpluses by forcing the Treasury to finance any federal funds deficits by openly borrowing from the public.

The liberal/Keynesian opposition to debt-reduction.  The most surprising opposition is from some liberal political leaders, columnists and think-tankers, who bitterly criticized Clinton for setting debt reduction as a primary policy goal, and for planning to use all of the SS surplus for reducing the public debt rather than spending part of it for the badly needed public investments that Clinton mentioned in his State of the Union speech but short-changed in his budget.

Vice President Gore and House Speaker Gephardt received the harshest criticism for saying that they would continue to pay down the debt even if the economy were in recession. Presumably (hopefully!) Gore and Gephardt they were referring only to inviolability of the SS surplus -- which should not even be in the main budget -- and the fact that "saving SS" needs the near-term public debt reduction to prepare for the later public debt expansion. But the fact that there was this much confusion about it is additional evidence of the need for eliminating the unified budget entirely or taking SS and its surpluses completely out of it -- and out of the related political debates.

The liberal frustration is understandable. But this reaction would seem to be both short-sighted and politically timid -- like the earlier liberal opposition to taking SS out of the unified budget because it would increase the apparent size of the deficit and thus make it more difficult to get needed spending increases (or prevent further Republican cuts). There are several specific problems with their argument:

First, the basic problem isn't the President's proposed public debt pay-down; it's how to get the funds to finance the needed public investment spending. Unless we get rid of the unified budget or get all the retirement funds out of it, or put SS projections on a 4% unemployment basis, that near-term debt pay-down is the only way to really save SS and prevent a Reaganite public debt explosion after 2020 when the SS Trust Fund will need more cash to finance Boomer retirement benefits.

Second, when they say that the debt isn't a serious problem as long as it doesn't increase faster than the GDP, they seem to ignore the way this Reagan legacy's $354 billion annual interest burden preempts spending for the social investments they want to increase.

The tax-increase alternative.  To advocate deficit financing of federal spending when the economy is operating at near full employment implicitly seems to accept Republican philosophy regarding budget and tax limitations. As Clinton's budget charts make clear, the US is the least-taxed industrial nation. Some kinds of higher taxes would probably be politically acceptable -- and even welcome -- if they are specifically designed to finance public investments the voters really care about.

For instance, the renewed large OPEC "oil tax" (all monopoly-rigged prices should be considered "private taxes") is re-alerting the public to the need for energy conservation to reduce the oil imports that are such a large part of our dangerously increasing and financially costly foreign trade deficit -- and to reduce the threat of global warming. And it should be obvious from the 1970s experience that higher after-tax energy prices are one of the most effective means of doing that. If the small fuel tax increase that Clinton proposed in 1993 were enacted today and phased in gradually as the present many-times-that-high OPEC oil price-tax inevitably declines again, the public would probably gladly accept it -- and hardly notice its impact.

If liberals can now mobilize the political clout in Congress to get needed additional social-investment spending, they will probably also have the clout to finance it by a tax increase rather than borrowing from the crucial SS surplus. The best answer to this problem would be to develop a more challenging and courageous vision of the needed policy initiatives, so as to inspire a larger voter turnout to win more liberal clout in Congress.

Now, while the economy is booming and Greenspan is even raising interest rates to slow it down, is a unique historical window of opportunity to invoke the stabilization function of fiscal policy and actually raise taxes to run a meaningful federal funds deficit to more quickly reduce the huge Reagan debt burden and its historically high real interest rates.

After the 2015-2020 peak of the Baby Boom reserve buildup -- implications of the "low cost" (4%-5% unemployment) SS projections.  The SS Trustees' 2000 Report notes:

"Under the low cost alternative I assumptions [the 4 1/2% unemployment version], the combined trust fund ratio [assets as percent of of expenditure]...begins declining during the retirement years of the "Baby-Boom" generation. However, this decline ceases after 2045, and the ratio rises slightly after 2060 even though annual [income/expenditure] balances remain negative at a level around 1% of payroll. This occurs because the projected trust fund interest earnings are high enough to offset the annual deficits and still keep the trust funds growing nearly as fast as annual outgo." In effect, the Trust Fund builds up a SS "endowment fund."

In the Trustees 2000 chart of the Trust Fund Ratio, Figure 1, below, their new 4 1/2% unemployment line looks much like the 5% unemployment line in their 1999 version, but it now rises to almost six times annual expenditures and then declines only slightly.

The 4% "stabilized employment" projection recommended in this article -- based on the 4% unemployment policy target mandated by the Humphrey/Hawkins "Full Employment and Balanced Growth Act of 1978> -- would probably rise to seven and a half times expenditures, with enough surplus to finance the possible initiatives discussed later.

What the Trustees' 4 1/2% "low cost" projections show conclusively is that their much discussed SS "crisis" was caused by their own inappropriate economic assumptions, not by inadequacies of the present SS System.

However, if it is decided to adopt the "save SS" strategy proposed here, the "endowment fund" accumulation of Trust Fund reserves presents several questions and possibilities:

An alternative to the SS/Treasury debt swap during the SS Trust Fund's build-up and liquidation of assets.  Once SS is out of the unified budget, and FICA receipts and benefit payments go directly into and out of the Trust Fund account (rather than through the Treasury's general fund), it would be possible for the Trust Fund to operate in a more transparent manner, like an independent pension fund -- with more effective protection from potential future misuse of its surpluses.

In the Trust Fund's reserve build-up phase, the Treasury would not have to "borrow back" SS current surpluses in exchange for the non-marketable SS T-bonds, and use this money to retire publicly held debt. It could buy, for the Trust Fund account, outstanding marketable Treasury securities with maturities specifically tailored for the Trust Fund's fairly predictable later need for more cash when Baby Boom retirements begin -- much the way private pension funds and other financial intermediaries must coordinate the timing of their assets and obligations.

This would obviate the need for the second stage of the Treasury debt swap as now contemplated. The "automatic" inflow of money to the Trust Fund as its securities mature would mean that the Treasury would not have to go back to the capital market to borrow the funds needed then by the Trust Fund for Boomer retirements -- with all the potential political and economic uncertainties that could arise at that time.

To the extent it is deemed more appropriate not to reduce the publicly held federal debt that much, the Trust Fund could be permitted to buy suitable corporate bond index funds.

National political candidates' proposals for managing the SS Trust Fund buildup and liquidation should be considered a key aspect of the "save SS first" campaign, and getting firm commitments to it from all candidates should have high priority.

A 2/8/00 New York Times article on the Clinton budget was headed "Reaganomics vs. Clintonomics is a Central Issue in 2000." The huge Reagan debt build-up during the 1980s is comparable to earlier debt buildups during wars and major depressions. But that is probably the only time in history that such a huge debt buildup was caused primarily by ideological fiscal irresponsibility. Usually the financial burden of those major debt buildups and their interest payments was reduced only gradually as the growth of the economy diminished their relative size (ratio to GDP). But they were sometimes also reduced by main-budget surpluses during subsequent period of high prosperity. Now is another window of opportunity for that. The most economically appropriate way to do it is discussed in Part IV.

 

IV. The Key Relationship Between the Federal Budget's Fiscal Balance
and the Overall Economy's National Credit Balance

The unified budget is based on the NIPA and Keynesian theory.  It is interesting to note two "non-political" reasons why the unified budget was originally adopted and why it has been retained so long -- the National Income and Product Accounts (NIPA), which produce the GDP measure of economic output and growth, and Keynesian economic theory.

Because the NIPA are conceptually unable to deal with money and credit, they measure each sector's "real" saving by subtracting its total spending from its total income. This, in effect, "nets out" credit flows by subtracting borrowing from financial saving. This is essentially what the unified budget does with the Federal government account. Keynesian theory was developed about the same time as the NIPA, and its basic analysis uses the NIPA conceptual framework. Thus, Keynesian economists tend to think in these terms. This has two basic implications for the Federal budget and its relationship to the rest of the economy: conceptual and functional.

The conceptual framework: NIPA vs. Flow of Funds.  Should the SS Trust Fund's current financial surplus be netted against current main-budget deficits -- as in the NIPA measure of the federal government's impact on the economy? Or should the Trust Fund surplus be treated as an independent component of the economy's total supply of financial saving -- as both government and private pension fund reserves are now treated in the Federal Reserve's Flow of Funds Accounts?

Some Keynesian economists have opposed taking SS out of the unified budget because traditional Keynesian theory and economic stabilization policies are based largely on the non-credit conceptual perspective of the NIP accounts. They justify this position by saying that when the Treasury finances current deficits by borrowing from the SS Trust Fund the government is just "borrowing from itself."

It gives useful perspective on this question to look at individual household finances. If a family borrows mortgage money to buy a house at the same time that it is saving money for the kids' education through a money market mutual fund, should we say that this is "borrowing from itself," and subtract its money market saving from its mortgage borrowing? Probably yes, if we are interested primarily in the family's net worth. But if we are more interested in the motivational and functional dynamics of its finances, it is more useful to keep the saving and borrowing separate when they are unrelated in purpose and timing.

Similarly, if the SS and other trust funds are completely out of the main Federal budget, it would be easier to understand not only the political dynamics of the budget itself, but also the economic relationships between the Federal budget and the economy

A few years ago some liberal political and organization leaders opposed taking SS out of the budget because they feared the resulting increase in the apparent size of the deficit would make it more politically difficult to get needed increases (and/or prevent further cutbacks) in Federal spending. In 20/20 hindsight, that was shortsighted strategy. The present prospect of soon having surpluses even in the federal funds (non-trust fund) budget, makes this argument more clearly counterproductive. From their perspective, there is now far more reason to work for separation of the SS account. But if the SS system had been left completely out of the budget, as it was before 1969, it is more likely that Congress would not have allowed such huge deficits in the first place.

The functional aspect: how the Federal budget affects, and is affected by, the economy.  Every recession "automatically" increases Federal deficits by reducing tax receipts and increasing "depression-relief" spending. For SS, a recession reduces the SS Trust Fund surplus by stopping FICA contributions from the unemployed and by increasing retirement benefits for those forced into involuntary retirement. Economists call this an "automatic stabilizer effect" because it tends to mitigate a recession by partially compensating for the corresponding recession-induced reduction in credit-financed investment spending by businesses and consumers which tends to cause a recession to "feed on itself."

The economic stabilization role of the Federal fiscal balance in relation to the National Credit Balance (between financial saving and borrowing) is to compensate for destabilizing changes in private consumer and business borrowing.  Thus, in relation to stabilization policy, the most economically appropriate size of the Federal deficit or surplus depends primarily on the current amount of private consumer and business borrowing.

For optimum stabilization effect, if business and consumer borrowing are becoming excessive, as they seem to be during 1999 and early 2000 (forcing up interest rates), Federal borrowing to finance budget deficits should decline -- as, fortunately, it has already been doing. In the other direction, if the Federal Reserve misplays its monetary policy and causes another recession, the "automatic stabilizer effect" will again come into action and increase Federal deficits. But that is really a very inefficient stabilization tool.

FASTA -- the pro-active automatic stabilizer.  Forty years ago, the prestigious Commission on Money and Credit suggested that the efficiency of the automtic stabilizer could be greatly increased if there were a Formula Administered Stabilization Tax Adjustment (FASTA) to change the Federal Fiscal Balance (FFB) (surplus or deficit) by precisely the amount needed to prevemt a recession (or excessive growth inflation) from happening. Instead of allowing the economy to control the FFB, it should be pro-actively managed to stabilize the economy.
 
The dual Federal Fiscal Balance.  To provide the most appropriate FFB measure for FASTA to work with, the FFB needs to be separated into its two functional components:

The crucial implication for "Saving Social Security."  If the "automatic stabilizer effect" is good for the economy, the two functional components of the basic SS surplus should also be separated, with the SS financial projections based on the "standardized" 4% unemployment rate, and any economy-caused shortfall reflected only in the main budget's Stabilization Account where it can be most effectively analyzed -- and controlled by FASTA. Without having to guess at future economic conditions, the SS Trustees need make only one projection, and it will probably be much easier to make, as well as less confusing.

As mentioned elsewhere, basing the SS projections on the 4% unemployment assumption could very well make it possible to reduce the FICA contribution rate, which is so widely considered a burdensome "tax." But this is not an indirect main-budget subsidy for SS. It is merely a means of insulating SS from ever-changing and unreliable economic forecasts and from government mismanagement of the economy -- and for consolidating the effect of the economy on the budget in the most appropriate place for dealing with it.

 

V. Why the Social Security Account
And Other Retirement-Related Trust Funds
Should be Completely Out of the Main Federal Budget

A. Main Reason: To end the confusion and fiscal irresponsibility of the "unified budget"

Social Security is the largest Federal program, and dominates the budget pie charts on both the receipt and expenditure sides. It is the only major program still in the budget that is essentially self-financing. It would be much easier to understand and manage the SS program -- and the rest of the budget -- if SS were "spun off" like the Postal Service, credit agencies and TVA.

In 1969 (partly to hide Vietnam War deficits), the SS account was merged with the main federal budget in "unified" budget. In recognition of the inappropriateness of this procedure, the budget tables now make a pretense of keeping the SS account separate by misleadingly labelling it "off-budget." However, in most of the the budget totals, including the key fiscal balance (deficit or surplus), the SS account is in fact fully integrated with the rest of the budget -- as are the other retirement-related trust funds for civil service and military retirement and Medicare.

Thus, for the next three decades the surpluses of the trust funds were used to offset (and politically hide) the large Reaganite deficits in the rest of the budget, and thus, implicitly, to finance other government spending -- a practice that is no longer permitted for business pension funds. This and related budget confusions make it difficult to be sure what the various political candidates are really promising regarding budget surpluses and SS.

President Clinton's ringing challenge to "Save Social Security First" was a fiscally responsible and politically savvy first step towards ending the long-continued misuse of SS Trust Fund money. His proposal to use 100% of the SS surplus now for paying down the public debt was a key step towards "saving SS". But the key next step in preventing future Reaganite fiscal irresponsibility is to adopt for the federal budget the solution now required for formerly troubled private business pension funds: keep the pension fund separate from the operating budget.

For real and "transparent" fiscal responsibility, the whole Social Security Account -- FICA contributions, interest receipts, benefit payments, operating expenses and Trust Fund surpluses -- should be completely separated from the main Federal budget and treated as a federally-sponsored but financially independent agency, with the SS Account presented as a separate budget appendix -- as the Postal Service and most federally-sponsored financial agencies are now. The Civil Service and Military retirement programs should be treated the same way. (For simplicity the 150 or so minor trust funds, which have no large financial reserves, could be considered part of the present federal funds budget.)

The President and Congress should both be required to present their proposed budgets in this way -- particularly the pie charts, tables and other graphic presentations that provide the main basis for public and congressional understanding of the budget. These graphic presentations should be "transparent" enough that people can view them understandably as independent operations.

The "unified" budget also hides big interest costs.  Integration of the trust funds, including SS, with the rest of the budget has hidden, and still hides, a large portion of one of the largest regular federal expenditures, the interest cost of the huge federal debt. In the CBO's listing of federal "outlays" for 1999, "net interest" is $230 billion. But the actual taxpayer cost of interest on the gross Federal debt was $354 billion. The $52 billion to SS and $67 billion to the other trust funds was netted out as an intra-government transfer, because the trust funds are also part of the government. The fact that the Treasury borrows this interest payment back, along with the SS current surplus, doesn't make it "just an accounting fiction." When SS needs that money to pay Boomer benefits, the Treasury will have to finance this debt redemption from tax receipts or borrowing from the public. The SS T-bond interest cost is, of course, reflected in the the main budget deficit. But by hiding it in the "net interest" main budget expense item, it distorts the picture of the government's spending allocations and thus makes real fiscal responsibility more difficult for members of Congress as well as the general public.

B. It would help clarify and counter misconceptions

  1. Reduce young people's cynicism regarding the future availability of their SS benefits -- probably more effectively than any other currently discussed reform.

  2. Facilitate comparisons with private pension and insurance plans.  Viewing the SS System as an independent agency would help highlight its similarities to, and differences from, private pension and insurance plans, as outlined in Section I. This would help to clarify many key sources of confusion and misunderstanding.

  3. Counter privatizers' false charges:
  4. Clarify the "just accounting fictions" idea.  The federal trust funds -- like similar devices in business and household accounts -- are a highly useful means of separating accounts with long-run implications from current operations.

  5. Clarify the "entitlement" confusion.  Unfortuntely, in the present federal budget, SS is misleadingly classified as an "entitlement" program along with means-tested "welfare" and other programs financed from general tax revenues. This linkage has been a main source of confusion in the SS debate, and lends important support to those who want to link SS with "welfare" in order to discredit it. For instance, a 3/12/98 Washington Post pie chart labeled "government transfers to the poor" was mainly Social Security.

    SS is an "entitlement" only in the participation sense that every citizen is entitled to vote. No one is "entitled" to SS benefits who has not paid in the required amount of FICA contributions -- as in any private pension or insurance program. It is likely that most SS beneficiaries, who spent their working lives making FICA contributions, would resent the Washington Post and unified budget linkage. The fact that lower income workers get a proportunately larger benefit, in relation to their FICA contributions, should not be a reason to link SS with means-tested "entitlements." The only way to end this confusion is to take this self-financed social insurance completely out of the Federal operating budget.

  6. Clarify the "Contributions" vs. "taxes" confusion.  "Taxes" are levied on the general public, usually without any direct link to a particular type of spending or beneficiary. FICA (Federal Insurance Contibutions Act) payroll deductions are explicitly called "contributions," rather than "taxes," to emphasize that these deductions are insurance premiums for the specific benefit of the individual worker, as in business pension programs. When the SS accounts are independent of the main budget, current FICA contributions should be omitted from the main tax and spending presentations -- the way Post Office receipts are.

  7. Counter the basically false perception that FICA contributions are "regressive taxes."  Keeping benefits and contributions together in a separate SS account will make it easier for ordinary people to understand that FICA contributions are "regressive" only in that better-paid workers don't have to make FICA contributions on income above $61,000 -- a limit that should probably be removed. More importantly, it will make it easier for people to understand that the SS System is clearly progressive, in a redistributive sense, because low income workers "get back" proportionately more in benefits, in relation to their FICA contributions, than do higher income workers.

  8. Clarify the "embezzlement" confusion.  Using the Trust Fund surplus to finance the main Federal deficit was not the "crime" -- the Treasury actually had no choice. Unless the SS Trust Fund is permitted to buy corporate stock or non-Federal bonds (as some are now proposing) the Treasury must continue to borrow back (i.e. provide an investment outlet for) all of the SS surplus funds that flow into the Trust Fund. The "crime" was allowing this process to camouflage the huge size of main budget deficit, thereby reducing the political and moral pressure to reduce the deficit by fiscally responsible means. Reagan-like fiscal irresponsibility could best be avoided in the future by taking the whole SS account out of the main Federal budget.

C. It would facilitate more responsible discussion and managment of the main Federal budget.
  1. Make it easier for fiscally responsible political candidates to explain their position.

  2. Reduce the manifest "size of government" -- as a target for those who want to reduce its size for ideological reasons.

  3. Reduce the size of the "total budget surplus" (most of which is SS surplus), as a target for ideological tax cutters.

  4. Eliminate confusing distinctions:
  5. Provide better perspective on federal spending allocations.  With self-financed SS out of the main budget (as the Postal Service is), the relative sizes of main-budget government spending on the military, debt interest, education, welfare, United Nations, foreign aid, etc. would become clearer -- particularly if "tax expenditures" are included.

  6. Encourage more fiscal responsibility by helping to focus analytical and policy attention on the budget's real current operating deficit or surplus.  There is hot political discussion now about "how to spend the huge budget surplus." But this apparent surplus is still a misleading illusion caused by the present inappropriate way of treating the trust funds. Like SS, the non-SS trust funds for Medicare, civilian and military retirement, etc., represent financial saving to meet future obligations, and thus should also be separated from the current operating budget. If their roughly $80 billion a year surplus is taken "off budget," as it should be, and as SS already is, the Congressional Budget Office's 2001-2010 cumulative surplus projection of $838 billion would be almost wiped out. In fact, it is only after 2005 that there would be any surplus. Moreover, as former CBO Director Robert Reischauer points out, even the lowest CBO surplus projection (even as presently calculated) may in practice be hundreds of billions too high. In any case, estimates that far ahead are highly speculative, and not a fiscally responsible basis for a permanent tax cut now.

    Clearly, the first and most important step to reduce the present deficit/surplus confusion would be to take SS -- and the civilian and military retirement and Medicare trust funds -- completely out of the main Federal budget, so that Congress and the public can get a clearer picture of the real fiscal balance.

  7. Help clarify the implications of "paying down the national debt."

  8. Help pave the way for separating the fiscal balance (surplus or deficit) in the "Policy Budget" from the surplus or deficit in the "Stabilization Account."  It would be much easier to understand and manage the deficit in a fiscally responsible manner if the effects of congressional legislative decisions -- the "Policy Budget" -- were separated from the effects of the economy on the budget -- the "Stabilization Account," as explained in Part IV. (See also, "A Twin-Deficit Perspective on the Federal Budget.") Separating SS and its Trust Fund surplus from the main federal budget would provide key impetus for this basic improvement in budget management.

  9. Help clarify the relations between the Federal budget and the rest of the economy.
 
VI. Social Security should not be held hostage --
to unreliable and ever-changing economic projections
and to government economic mismanagement

There are three main reasons why the present Social Security System has been projected to go bankrupt by 2029, 2034, 2037, and now 2050 (Clinton's extended target):

To understand the present SS "crisis," and to protect it from political tampering by the privatizers and tax-cutters, these factors need to be be clearly distinguished. This section focuses mainly on the economic projections.

The financial health of SS -- like that of the federal budget -- is highly sensitive to economic conditions, particularly the unemployment rate.  Low unemployment reduces the number of older and partially disabled people who can't find jobs, and the number forced into involuntary retirement. Also, when the "pool of job-seekers" is low, employers have more incentive to tailor their working conditions to attract and hold onto older workers and those partially disabled. More importantly, the lower the unemployment rate the more the effective labor force is increased by people who were previously not looking for work, and thus not counted as unemployed --"discouraged workers," people bored and restless in retirement, women who can then afford child care, welfare mothers, inner city youths, etc. When more people are working, SS gets more FICA contributions and has to make fewer benefit payments, increasing the SS surplus. These basic facts have been well demonstrated by the Clinton Economic Boom.

The SS Commission's crisis-inducing economic asumptions.  The SS Commission's 75 year projections are admittedly based on a lot of guesswork -- "guestimates." That's why they offer three different projections, based on different sets of assumptions, the key one being the unemployment rate. They merely consider their intermediate projection as the "most likely" version.

In their 1996 report, their three unemployment rates were: 5% (alterntive I), 6% (alternative II), and 7% (alternative III), as shown in the charts below. (The dashed-lines were my rough estimates of a comparable 4% unemployment projection.) Their 1999 and 2000 projections reduced all three rates by a half percent, to 6 1/2%, 5 1/2% and 4 1/2% -- "largely due to the actual and assumed improvements in the economy."

1996*   Note on 1996 charts below -- The 1996 charts below came from the printed version of the 1996 Report, to which the low-unemployment line was added prior to scanning. Clicking on one of these charts will take you to the SS Administration's online version of the same chart, which uses a format similar to the 2000 version shown next to it.

The Effect of Unemployment Rate Assumptions
on SS Financial Projections

The Social Security Trustees' 1996 and 2000 Summary Charts


Figure 1: Trust Fund Ratios for OASI and DI Trust Funds, Combined
[Assets as a percentage of annual expenditures]

 
1996   1996 OASDI+DI Trust Fund Ratios
2000 OASDI+DI Trust Fund Ratios

The Trust Fund asset ratios illustrate most dramatically the effect of the different economic assumptions in each year's projections. The Trustees' highly publicized SS "bankruptcy" warnings have been based on their intermediate (II) 6% and 5 1/2% unemployment projections.

But note that their "low cost" 5% and 4 1/2% unemployment projections, which they hardly mention in their reports, have no financial problems for the whole 75 years. In fact, in these projections, the asset ratios decline very little from their peaks, because the interest receipts from their SS-T-bonds add enough to current FICA contributions to adequately finance the Baby Boomers' full retirement benefits.

A "standardized" projection on the basis of the 4% unemployment rate mandated by the Humphrey-Hawkins "Full Employmen and Balance Growth Act of 1978" would provide enough additional resources to finance some of the additional SS programs now being proposed, or even a reduction in the FICA contribution rates.


Figure 2: OASDI Income Rates and Cost Rates
[As a percentage of taxable payroll]

 
1996   1996 OASDI Income and Cost Rates
2000   2000 OASDI Income and Cost Rates

Figure 2 shows the same unemployment-rate effect in a different way. The income-rate line remains fairly constant because it changes only when the FICA contribution rate changes, and the revenue from the tax on SS benefits is very small -- the equivalent of about 1/4 of one percent of taxable payroll. (In this chart, the Trust Fund's interest income, which becomes quite important as the Trust Fund accumulates its Baby Boom reserve, is excluded from the income-rate). The cost-rate lines rise rapidly from about 2010 to 2030 as the Baby Boom generation begins retirement.

But note that the "low cost" (I) alternatives (5% unemployment in 1996, 4 1/2% in 2000) rise only slightly above the income-rate line, even without the interest income. A "standardized" 4% unemployment cost-rate line, including the interest income would undoubtedly lie well below the income line all the way.


Figure 3: Worker / Beneficiary Ratios
 
1996

(Beneficiaries
per
100 Workers)

  1996 Benifs/100 Wrkrs
2000

(Workers
per
Beneficiary)

  2000 Workers/Beneficiary

Figure 3 shows the supposed burden of retirees on active workers. The 4% unemployment line would lie closer to 3 workers, and in later years would probably be not far below the present 3.3 workers. Section VII suggests how even this rate could be considerably improved with more appropriate retirement policies.


So it is clear that the scary SS "crisis" is due largely to the Commission's assumption that the future American economy will return to a 5 1/2 or 6% average "under-employment" rate. This assumption didn't sound quite as unreasonable four years ago. But after several years of near-4% unemployment without inflation, it is reasonable to ask why the projected health of SS should still have to be based on such a pessimistic projection.

The SS Commission's basic economic assumptions.  Their intermediate "most likely" unemployment projections have been based on the following assumptions:

  1. All capitalist economies have an inescapable "business cycle" that fluctuates between boom and depression, with the most likely long-run "sustainable" growth path somewhere in between.
  2. The corresponding minimum "sustainable" unemployment rate is still defined as the now discredited theoretical NAIRU -- the CBO's Non-Accelerating-Inflation Rate of Unemployment -- which was still assumed to be about 6% in 1996, and is now about 5.2%.
  3. The SS Trustees, like the CBO, consider that the US economy is now operating above the economy's "sustainable" growth path, and therefore expect actual unemployment to increase until it corresponds to that GDP growth path."
  4. The U.S. Government is either unable or unwilling to adopt more systematic and effective stabilization and growth policies that could reduce the average unemployment rate to the pre-1973-normal 4% level mandated by the Humphrey-Hawkins "Full-Employment and Balanced Growth Act of 1978."
  5. To be considered credible and responsible, an economic forecast and SS financial plan must be based on these assumptions.

These assumptions provide important food for thought in this election-year discussion of "saving SS." Failing to address them forthrightly perpetuates a fraud on the American public akin to the unified budget fraud.

Most critics of the Commission's 1996 pessimistic economic assumptions questioned their projection of a long-run economic growth rate of 1.4%, which is less than half the U.S. historical average. In such long-run projections, demographic factors can be predicted with reasonable accuracy, but cannot be controlled. By contrast, economic conditions cannot be predicted with any great accuracy, but can be controlled by more responsible and systematic economic policy. Thus, it is more useful, for both analysis and policy, to focus main attention on the unemployment rate -- as the Commission implicitly recognizes when it defines its three alternative projections that way.

Recessions, depressions and high unemployment are not natural disasters and are not inevitable; they are caused by economic mismanagement, and can be prevented or greatly mitigated by better macroeconomic policy tools.

Today, the U.S. has one of the most prosperous economies in the world, with unemployment now down to 4%. But even that is not really "full" employment. For 14 straight years before the 1974 four-fold OPEC oil price increase was allowed to wreck the world economy, most other major industrial countries kept their unemployment below 2%. And during the 28 years from 1945 to 1973, even U.S. unemployment was below 4% in ten years, close to 3% in four, and above 6% in only two -- with little inflation. We can and should do that again.

The logic of a "standardized" 4% unemployment rate for SS projections.  The present 4% unemployment without inflation, provides an invaluable historical "benchmark" by which to adjust the basic GDP labor force and productivity growth paths to Humphrey-Hawkins 4% unemployment equivalents, and to calculate the economy's "operating rate" (actual output as percent of potential) and the corresponding unemployment rate -- as the basis for a more resposible GDP growth-path policy target.

With this, the SS Commission could adjust its projection of the number of people working and the number receiving benefits to the 4% unemployment rate and use this as the basis for its basic financial projection. It could then easily make alternative projections with specific other unemployment rates (e.g., 5%, 3 1/2%), thus focusing attention on the basic factors affecting the projections, and let the politicians decide which unemployment rate they want to base policy on.

The actual economic growth rate -- and unemployment rate -- are primarily controlled by the money supply growth rate, which is controlled by the Federal Reserve. It's a little more complicated than that, of course (cf. Key Macroeconomic Policy Tools), but that's the basic relationship.

Because inflation is particularly bad for banks and other bond-holders, central banks like the U.S. Fed have traditionally focused more on preventing inflation than preventing unemployment. But that is more a political bias than an economic necessity; there are better ways to counter inflation than by recessions and high unemployment. The present Fed Chairman, Alan Greenspan, has shown unusual wisdom and social responsibility in allowing the unemployment rate to steadily decline to its present 30-year low. But there is no guarantee that future Fed chairmen will be as wise and socially responsible.

Insulate Social Security from economic mismanagement.  High unemployment increases the deficit in the main Federal budget at the same time that it reduces the SS Trust Fund surplus. Economists call that an "automatic stabilizer effect" because it tends to partially mitigate the severity of a recession -- by taking less tax money out of the economy and injecting more "depression-relief" funds into it.

Since recession-induced deficits are good for the economy, it makes sense to concentrate that effect in the main budget's Stabilization Account, where it can be most effectively evaluated and managed, and to insulate the SS Trust Fund from it by putting the SS System on a "stabilized employment" (4% unemployment) basis, with any deviation of actual Trust Fund surpluses from this amount made up by a transfer of funds to or from the main budget -- as is done for fluctuating fiscal balances in the Post Office and other independent government enterprise accounts.

 

VII. Social Security and Rethinking Retirement

How the retirement age affects FICA rates and SS benefits.  So far this article has emphasized the need for insulating SS from budgetary mismanagement by taking it out of the main Federal budget, and insulating it from economic policy mismangement and inappropriate economic projections by putting the SS account on a "standardized" 4% unemployment basis. But there can be little doubt that the actuarial aspect of the SS "crisis" -- the fact that people are living longer -- also needs serious consideration. If most of us are now living well past 80, do we really want to spend more than a quarter of our adult lives in "affluent idleness," as the present frantic focus on "financial preparation for retirement" suggests? Whether we're thinking of Social Security or private pensions and 401(k)s, the same principle holds: the more of our lives we want to spend in retirement, the more money needs to be saved up for it during working years.

What should be the "normal" SS retirement age?  Extending it to age 70 is now being considered as a way to improve SS's financial prospects. Most people in normal good health are probably able and willing to continue working that long, and even longer, in agreeable working conditions. But it is unfair to apply the same retirement age to workers in life-long occupations that are particularly stressful and usually lead to shortened life-spans, particularly low-wage occupations. For fairness, there should be some adjustment of the normal SS retirement age to allow for these occupational differences, and this problem deserves more attention. And other people should be allowed to work as long as they want to, with their subsequent monthly SS benefit adjusted to their life-expectancy when they finally retire, if they prefer -- as with private annuities.

What does "retirement" mean?  Working full-blast until 65 and then stopping work abruptly for the rest of one's life is neither healthy nor economically sound. Many people who now retire this way at 65 (or earlier) without adequate preparation lose their zest for life and die prematurely. And many others find, a year or two after retirement, that full-time leisure, away from a work social environment and social contribution, is socially and psychologically unsatisfying, and "go back to work," either full time or part time, at the same job or another job, or on an entrepreneurial basis.

Facilitating "post-retirement" work.  What is needed is a holistic multi-dimensional approach to this problem which includes:

 
VIII. The Most Urgent Legislative Goals

President Clinton says that with the 2001 budget "The Nations's fiscal house is in order." It is indeed much closer to that goal than in 1992, but it will not really be in fiscally responsible order until all of the reforms proposed here are in place.

A. Social Security reforms

  1. Require the President and Congress, in their budget proposals, to completely separate the Social Security and other retirement-related programs (including benefit outlays, FICA contributions and interest receipts) from the main (federal funds) operating budget accounts, so that the Baby Boomers' crucial trust fund surpluses can no longer conceal main-budget deficits and Social Security interest receipts no longer conceal gross Federal debt interest costs, leaving a misleading main-budget surplus target for ideological tax-cutters.

    The fact that the "unified budget" now has a "non-SS" surplus, combined with President Clinton's demand that Congress "save SS first," and the latest, apparently bipartisan and publicly-supported, agreement that 100% of the SS surplus be devoted to "saving SS," offer a unique window of opportunity to take SS completely out of the budget. And the sooner the better -- before the delusion of huge future surpluses permits the ideological "government-size-reducers" to repeat the disastrous Reaganite tax reductions.

  2. Require the Social Security Commission to:

  3. Require that when economic conditions cause the relationship between FICA contributions and benefit payments in any year to be less favorable than the 4% unemployment projection, the shortfall in the resulting addition to the Trust Fund is made good by a transfer from the budget's general funds (with resulting negative effect on the federal funds fiscal balance), and that when economic conditions are more favorable than the 4% unemployment projection, the excess is transferred to the federal funds fiscal budget.

  4. Provide that:

    1. all additions to the SS and other retirement-related trust funds from current surpluses and accrued interest shall be used to reduce publicly-held Federal debt until all available public debt has been redeemed, or, at the Treasury's discretion, the Social Security Trust Fund may use its surpluses to purchase appropriate marketable securities, and
    2. when Trust Fund assets must be liquidated to finance Baby Boom retirement benefits this may be accomplished either by Treasury borrowing from the general public or, at the Treasury's discretion, by public sale of the Trust Fund's marketable securities.

These four measures will most effectively "save" SS, financially and politically. They should be put to a vote in Congress before the election, and should become key issues for progressive candidates in the 2000 election campaigns. They will also pave the way for later putting the SS account on a permanent 4% unemployment basis, and for separating the main Federal budget's fiscal balance into its policy and "stabilization" components.
  1. Prevent any combining of SS and Medicare trust funds. Both are both part of older Americans' safety net. But there are crucial differences between the SS (OASDI) income maintenance programs and the Medicare health care program. When the present chaotic Medicare and other health care systems are finally transformed into a universal single-payer system, there will be huge cost savings from administrative integration, computerizing of medical records and diagnosis, and more effective health maintenance programs. In the meantime, Medicare should not be linked to SS either administratively or budget-wise.

    Senator Bill Frist said, in his Republican response to President Clinton's final State of the Union speech: "To guarantee that seniors can rely on Medicare forever, we will add it to the Social Security lockbox, which will lock away the surplus for both Social Security and Medicare." Combining the shaky Medicare Trust Fund with the basically solid SS Trust Fund in the Republicans' dubious "lock box" would be a Trojan Horse that could seriously weaken SS.

    If support builds for taking SS out of the budget, it should be possible to extend that support to the Civil Service and veterans' retirement trust funds, which have the same effect as the SS Trust Fund in encouraging fiscal irresponsibility -- and the same risk of being undermined by that irresponsibility. Veterans and federal employes have significant voting clout when they realize their interests are threatened. When that discussion gets underway, the fact that the federal funds (non-trust fund) budget still has significant deficits will become obvious and further increase opposition to budget-busting tax cuts.

  2. Voluntary supplementary Social Security accounts?  Many other minor modifications of the SS system would undoubtedly be useful and appropriate. For instance, since "New Economy" workers may change jobs many times, it might make sense to offer them the voluntary possibility of transforming their private pension plans into fully "portable" individual supplementary SS accounts that could also contain broad-index stock mutual funds. These would be similar to 401(k) accounts except that workers wouldn't have to try to manage them personally and the administrative costs would be smaller. If there is wide support for these, many employers -- particularly small businesses -- may find they can dispense with the burden of separate company pension plans.

  3. FICA "tax cut"?  If the 4% standardized 4% unemployment rate is adopted for SS, and if it is desired to liquidate the SS "endowment fund" as soon as the Baby Boom retirement bulge is over, it would even be possible to reduce the FICA contribution rates -- rather than increase them, as in some of the present "reform" proposals.

B. Federal budget reforms

  1. The unified budget must go.  This fiscal monstrosity that integrates the retirement trust fund accounts with the main operating budget has been a primary cause of fiscal irresponsibility ever since it was begun three decades ago. (See Section V for a list of benefits from ending it.)

  2. Dual federal fiscal balance.  For fiscally responsible political debate and budget management, the fiscal balance should be separated into its two functional components:

 
References

2000 OASDI Trustees Report (PDF)

1996 OASDI Trustees Report

"Citizen's Guide" to President Clinton's 2001 Federal Budget

The Budget and Economic Outlook:Fiscal Years 2001-2010.


Written: April 4, 2001
Last revised: April 18, 2001
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