Tuesday, December 14, 2004

It's a Social Program, Not a 401(k)!!

Number three in a continuing series.

Myth #4: Social Security is a pension or an insurance plan. (Reality: Social Security is a social program, the only social program that is so well funded and secure that it will not need a dime of additional Federal taxes for decades.)

We often hear of Social Security as a pension plan or an insurance plan. Comparing Social Security to private employer pension plans gives rise to a number of misleading and alarming observations about Social Security’s desirability. First and foremost is the charge that the individual worker gets a bad investment deal out of the system. My favorite barking mad Libertarian P.J. O’Rourke offers the typical argument:

"And if we're age twenty-four to sixty-two, we can expect a return of between -0.34 percent and -1.7 percent, and might be better off leaving the money in our old jeans and going through the closet when we retire."

Then there’s the "Ponzi Scheme" charge, named after the famous swindler who offered big dividends to investors, paid for by the investment of newer investors. Here’s O’Rourke again in the same article:

"Charles Ponzi made a profit on this, and so does the U.S. government. Social Security payroll-tax receipts have always been greater than Social Security benefit payments and will continue to be until about 2013, when the baby-boom sucker pool retires. The federal government has taken this surplus revenue, spent it and given the Social Security trust-fund IOUs in return."

(SIDE NOTE: I urge people to read O’Rourke’s article. See how many logical fallacies and statements of objective falsehood you can find. I’ve found 37 so far.)

These arguments would be more persuasive if Social Security was in fact a pension or insurance plan or a 401(k). But it's not any of those. It’s not a personal investment. It’s a government social program that happens to be funded largely through a special levy of payroll tax. Don’t believe me? I don’t blame%2

Saturday, December 04, 2004

More Social Security Myth Busting

Today we debunk a couple more myths surrounding Social Security. We can tackle Myth #2 and Myth #3 at the same time, as they are two different facets of the same misconception. (Myth #1 and the introduction to this topic is here.) First though here’s a tip of the hat to a wonderful resource on the myths of the Social Security debate at the Center for Economic and Policy Research. These guys have it nailed.

Now for today’s myth busting. Here they are:

Myth #2: The Social Security Trust Funds don't really exist except as an accounting fiction. (Reality: The Trust Funds are definitely real, with real assets far above the credit quality and safety of any bank or insurance company in the world.)

Myth #3: Politicians often "raid" the Trust Funds to pay for other Federal budget needs. (Reality: The Trust Funds pay for no other programs except what they are charged to do. Not a penny has been spent from their operating budgets for any other program ...ever.)

To understand what’s really happening, you have to look at the basic structure of the Trust Funds. There are four of them, two related to Social Security and two related to Medicare. Here are the definitions of each from the 2004 SSA Trustees Report:

Trust Fund:
Separate accounts in the United States Treasury in which are deposited the taxes received under the Federal Insurance Contributions Act, the Self-Employment Contributions Act, contributions resulting from coverage of State and local government employees; any sums received under the financial interchange with the railroad retirement account; voluntary hospital and medical insurance premiums; and transfers of Federal general revenues. Funds not withdrawn for current monthly or service benefits, the financial interchange, and administrative expenses are invested in interest-bearing Federal securities, as required by law; the interest earned is also deposited in the trust funds.

  • Old-Age and Survivors Insurance (OASI). The trust fund used for paying monthly benefits to retired-worker (old-age) beneficiaries and their spouses and children and to survivors of deceased insured workers.
  • Disability Insurance (DI). The trust fund used for paying monthly benefits to disabled-worker beneficiaries and their spouses and children and for providing rehabilitation services to the disabled.
  • Hospital Insurance (HI). The trust fund used for paying part of the costs of inpatient hospital services and related care for aged and disabled individuals who meet the eligibility requirements. Also known as Medicare Part A.
  • Supplementary Medical Insurance (SMI). The Medicare trust fund composed of the Part B Account, the Part D Account, and the Transitional Assistance Account. The Part B Account pays for a portion of the costs of physicians' services, outpatient hospital services, and other related medical and health services for voluntarily enrolled aged and disabled individuals. The Part D Account pays private plans to provide prescription drug coverage, beginning in 2006. The Transitional Assistance Account pays for transitional assistance under the prescription drug card program in 2004 and 2005.

So the OASI and DI Trust Funds are what we know as Social Security. Now look at the definition above, which says:

"Funds not withdrawn for current monthly or service benefits, the financial interchange, and administrative expenses are invested in interest-bearing Federal securities, as required by law; the interest earned is also deposited in the trust funds."

This is the source of the confusion. What happens is that a portion of the collected FICA from our paychecks gets paid out in current benefits. Another portion (about 6/10ths of a penny per dollar) pays for administration of the program. Some is left over to be saved for the time when the baby boomers retire in large numbers, meaning more benefits will be paid out than taxes collected at that time. That leftover is invested in Treasury bonds, very similar to the bonds that your bank is required to hold to back up your savings and checking, or the same type that insurance companies hold to back up their assets.

Looking at Myth #2, that the Trust Funds are an accounting fiction, this is only true if you forget everything you ever learned about accounting and banking. The Trust Funds are administered as totally separate accounts, not commingled with any other Treasury funds, in an identical fashion that your checking account is held separate from all other checking accounts at your bank. Now in actual fact your checking account is not in a separate location physically separated from all other checking accounts, but it is a really existing, separate thing that you can, well, take to the bank. The Trust Funds are held separate in the exact same way.

You can see this reflected in President Bush’s latest budget message from the Office of Management & Budget. There are historical tables that show the performance of the budget going back decades. They clearly show the Trust funds as "off budget" items separate from the "on-budget", the operating budget of the government. Beyond the PDF version, there are also Excel spreadsheets of those historical tables. Take a look, for example, at Table 1.1 Summary of Receipts, Outlays, and Surpluses or Deficits (-): 1789-2009 to see what I mean.

The other important fact here is that since the Trust Funds' surplus is 100% exclusively invested in Treasury securities, that portfolio is by definition the safest and most secure portfolio in the world. No bank, insurance company, company pension fund, 401(k), mutual fund, separate account, foundation or endowment can even come close to the creditworthiness of a 100% riskless Treasury portfolio. Nor can it be duplicated anywhere else. For even if a financial institution decided to invest only in publicly available Treasuries, said institution would either have to accept low short term interest rates or a measure of long term market risk. Only the SSA Funds qualify for the best of both worlds. The class of Treasury securities they own enjoy long term interest rates, with the ability to redeem the bonds at any time for full face value.

This is like going to your bank and demanding that they give you the interest rate of their 10 year CD while giving you complete checking account access to any or all of the CD without penalty for early withdrawal. Riskless savings does not get better than that. No wonder the Republicans want to get out from under that deal!

Turning to Myth #3, that politicians regularly dip into the Trust Funds to fund other government operations, again this is a misunderstanding of how money and markets work. The Trust Funds are required to invest their surplus in riskless securities. The only riskless securities there are in the US are Treasury Bonds. So when the operating Federal budget runs red ink, the Treasury department creates Treasury bonds for investors to buy. The proceeds of those sales fund Federal deficit spending. The SSA Trust Funds are investors in those Treasuries, no different from any bank, brokerage house, mutual fund or insurance company that might be buying those riskless securities. So indirectly, the SSA surplus DOES fund our operating deficits to a limited extent, by virtue of their investing in Treasury bonds. But since they are independent legal entities, it is no more correct to say that politicians are "raiding" the SSA Trust funds than it would be to say that politicians are "raiding" the assets of a government bond mutual fund.

The language used by politicians of "raiding" the Trust Funds, or the opposite "placing Social Security in a lockbox" are colorful phrases that convey emotional messages rather than fact. The real issue behind the language is that many economists are worried what will happen to the economy when Social Security stops being a net buyer of Treasury bonds and starts redeeming them if the Federal government is still running a huge annual deficit and a huge national debt. The solution put into place by President Clinton was to return to significant surpluses in the Federal operating budget and pay down the national debt to the point where the Treasury bonds redeemed by the SSA program were the only debt service that the Federal government had to worry about. This program was succeeding to such a degree that by 2001, Fed Chair Alan Greenspan was actually discussing how the world of finance would operate if the Trust Funds were the only holders of U.S. Treasuries.

The failure of the Bush administration to continue on this path raises anew the specter of the Federal government triggering a huge inflationary crisis paying off a huge national debt service AND SSA obligation with inflated dollars off the printing press, OR with Treasury bonds that yield very high interest rates to attract the creditors necessary to absorb all the debt.

So in typical Republican fashion, instead of opting for fiscal austerity to clean up one’s own house, the administration in Washington is looking for ways to weasel out of the SSA obligation once and for all. This is like a family approaching the need to pay for their kid’s college tuition down the road with a plan to convince the kids to go to a state school or learn a blue collar trade instead of saving up for the bills. It’s disgusting. We shouldn’t let them get away with destroying Social Security.