The Social Security Trust Fund
To begin we must understand why we have a trust fund in the first place. Everyone agrees that some time in the next 15 to 25 years demographics will push spending on Social Security obligations above the revenue raised by the payroll tax that funds them – that expenditures will exceed receipts and that we will need to begin making up the difference somehow. In a world without the trust fund we would have three options: decrease spending (that is, cut benefits or other programs), borrow money (that is, run up debt), or increase taxes (that is, extract more revenue from the taxpayers and the economy). There is actually a fourth option – devalue the dollar by printing money – but even politicians who have historically flirted with that economically disastrous ploy are probably not foolish enough to use it in this case, if for no other reason than that the COLA provisions ensure that the resulting inflation would drive up the obligations at least as fast as the money supply.
The demographics are sobering: in the foreseeable future the number of workers paying to support each Social Security beneficiary will reach two; that is, every working American will be responsible for, in addition to his own needs and those of his family, half of the retirement benefit for someone else. To cover that obligation would require either massive budget cuts elsewhere or massive borrowing or massive increases in the payroll tax collected to fund Social Security.
More than 20 years ago the Greenspan commission concluded that all these options were untenable – that neither cutting nor borrowing nor taxing at such levels could be sustained. The Social Security trust fund was specifically envisioned as a means to avoid such untenable schemes.
What does the trust fund do? In principle it is an investment account that we can use to fund future obligations. The revenue generated by the current payroll tax is more than we need to fund current Social Security obligations, and the excess is deposited into the trust fund, which invests the money in U.S. Government Bonds; the bonds pay interest, which increases the value of the trust fund over time. When we need the money in the future, we will liquidate the bonds and use the proceeds to cover the shortfall in the Social Security budget.
It sounds quite secure and straightforward: the money is in the account, and the investments are backed by the “full faith and credit of the United States government”, which is not going to default on them. But is the reality as secure and straightforward as it seems?
When we ask whether the money in the trust fund will be sufficient to cover future obligations we do not merely count the money we’ve deposited; we also count the interest we will earn on that money. We, in fact, depend on that investment income to make the numbers work. But where does that income come from? The answer is: it comes from the federal treasury; interest paid on federal government bonds is an expense in the federal government budget. And when the bonds are liquidated the federal government will have three options for raising the extra money required to pay that expense: cut the budget elsewhere, borrow money, or increase taxes. Notice that those are the same three options that were available for paying the Social Security shortfall directly in the first place.