The Social Security Trust Fund
Imagine that the bonds in the trust fund are held for an average of 30 years and return an average annual interest rate of 6.4% (the average in 2004 for all the assets in the trust fund according to the Social Security Administration web-site). When we liquidate those bonds the accrued interest will amount to over 5 times the original principal. Thus less than 20% of the money paid out on the bond represents the original money put in, and more than 80% must come from the federal treasury and be financed by budget cuts or by borrowing or by taxes.
So what have we accomplished by carefully investing in the trust fund over all those years? We have succeeded in saving enough to cover about 20% of the Social Security shortfall, and have replaced the other 80% of the cutting/borrowing/taxing needed to cover that shortfall with – cutting/borrowing/taxing to pay interest on the trust fund bonds. It may be argued that taxing to cover bond interest is somehow different because it comes from the income tax rather than from the payroll tax; but ultimately it is the same money collected in a different form. Further, even that subtle difference is a matter of political will, not of principle: the form of taxation used to fund either is entirely at the discretion of the Congress and could be changed by them at any time. In the end, if the level of budget-cutting, borrowing, or taxation required to pay for the Social Security shortfall directly was untenable, then it is just as untenable when transformed into budget-cutting, borrowing, or taxation to pay interest on the trust fund bonds.
Of course the precise degree to which the value of the trust fund lies in interest income rather than principal depends on your assumptions about rates of return and how long the bonds are held, so 80% may not be the right number. And to the extent interest is accumulated in the account incrementally as accrued rather than as a lump sum at bond maturity – to the extent we pay the interest as we go along now rather than putting it off until later – the cost may at least be spread out over time. But in practice we can safely ignore those details, because the true situation is even worse. So far we’ve assumed that even if we’re not paying the interest as we go we are at least accumulating the principal – that the money received from bond sales is put away somewhere to be returned in the future. In fact it is not: we’ve been spending both that money and the interest accrued on it as fast as it’s come in. The description of the trust fund as an IOU is more than just emotional rhetoric: it reflects the underlying reality. When we liquidate the bonds in the trust fund, the entire amount paid out will come from contemporaneous federal revenues, backed by some combination of taxes and loans and cuts in other parts of the budget. So in reality the amount of money required from current federal revenues to cover the Social Security shortfall will be the entire amount of the shortfall – just as if the trust fund had never existed. True, it won’t come from the Social Security account (backed by the payroll tax); instead it will come from the general fund (backed by the income tax). Perhaps there is some advantage to one over the other, but it strikes me that the taxpayers and the economy of the future will not care overly about exactly which mechanism is used to extract that wealth from productive use.
Worse, in that regard the trust fund represents yet another kind of accounting fiction. By intent and by law the Social Security program is supposed to operate and fund itself independently of the rest of the government. But the trust fund, relying as it does on bond interest payments to meet its obligations, subverts that intention by building a dependence on general fund revenue into Social Security – by creating a backdoor mechanism for transferring money from the rest of the government into the Social Security program.