Saturday, March 15, 2008

What does it mean to “save the surplus”?

In the comments, Bruce Webb reacts to a line in the Wall Street Journal op-ed:

The whole notion that somehow Congress has been 'raiding', 'looting' or otherwise doing something nefarious with the Trust Fund derives entirely from the implication that the Special Treasuries are not in fact hard investments, which is to say one or more versions of the 'phony IOU' argument.
Well I am not buying. I believe in the Full Faith and Credit of the United States, further I have a pretty good idea of the political firestorm that would erupt at any suggestion that the General Fund as the representative of taxpayers at large would refuse to replay legal obligations to that subset of taxpayers that paid for all those surpluses to start with.

This raises the general question of what it means to "save the surplus" or "raid the trust fund." There are different definitions, and often disagreements over these issues arise from definitional, not empirical, differences.

Orszag and Stiglitz make a useful distinction between "narrow" and "broad" prefunding of pension benefits:

"Prefunding" can be used in a narrow or broad sense. In its narrow sense, prefunding means that the pension system is accumulating assets against future projected payments. In a broader sense, however, prefunding means increasing national saving.

Put in the Social Security context, it's possible to break the narrow versus broad prefunding question down even further. "Saving the surplus" can mean that a dollar of surplus Social Security taxes implies:

  • A dollar increase in the Social Security trust fund: This is the narrowest definition of pre-funding, and in this sense the surplus is indisputably "saved." Any surplus taxes are by law used to purchase special issue Treasury bonds. These bonds carry a market rate of interest and are backed by the full faith and credit of the U.S. government. There is no possibility that the government will not honor these bonds, and there are no reform plans that propose that they not be honored.
  • A dollar increase in the overall budget balance: This is an intermediate level of pre-funding, and most advocates would be satisfied if this level were achieved. If Social Security's cash balance improves by one dollar and nothing else changes in the rest of the budget, then the overall budget balance will improve by one dollar. Borrowing from the public will be reduced by one dollars (or, if the budget were in surplus, one dollar of existing debt could be repaid). At the least, this level of prefunding makes it easier for the government to repay the Social Security trust fund in the future, since the smaller government debt implies lower annual interest costs.
  • A dollar increase in national saving: If an additional dollar of Social Security surplus adds to government saving, by the above process, and if individuals do not alter their saving behavior, then total saving in the economy will increase by one dollar. This saving adds to the stock of investment capital, such as factories, computers, etc., and this additional capital makes future workers more productive and increases economic output. This increased economic output makes it easier to repay the trust fund in the future: wages will be higher and thus tax receipts will be higher even with a constant tax rate. Thus, we could repay the trust fund without making future workers' after-tax wages lower than they otherwise would have been.

When we talk about "saving the surplus" it makes sense to be clear which definition of saving we're relying on. In the WSJ op-ed, I was implicitly referencing the second definition of prefunding: that an increase in the Social Security annual surplus, as would be produced by Senator Obama's proposal, would translate to an equal improvement in the overall budget balance, and therefore a reduction in government borrowing.

But is this likely to take place? A trio of econometric studies by well-respected economists have concluded that Social Security surpluses since the 1980s have not translated to improved budget balances. The basic analytical technique is to ask how changes in the Social Security balance correlated with changes to the overall budget balance, after adjusting for other factors. Kent Smetters of the Wharton Schol, who wrote the first such study, concludes:

"…there is no empirical evidence supporting the claim that trust fund assets have reduced the level of debt held by the public. In fact, the evidence suggests just the opposite: trust fund assets have probably increased the level of debt held by the public."

Barry Bosworth and Gary Burtless of the Brookings Institution, using a sample of OECD countries to supplement results focusing on the U.S., conclude:

"A large portion of the accumulation within national social insurance systems is offset for the government sector as a whole by larger deficits in other budgetary accounts. On average, OECD countries have been able to save only a small portion of any funds accumulated within their social insurance systems in anticipation of large expected liabilities when a growing fraction of the national population is retired. Between 60 and 100 percent of the saving within pension funds is offset by reductions in government saving elsewhere in the public budget."

In other words, a dollar of Social Security surpluses tends to be offset by 60 cents to one dollar in increased spending or reduced taxes in the non-Social Security portion of the budget.

John Shoven of Stanford and Sita Nataraj of Occidental College examined trust fund saving throughout the federal budget. Their conclusions are summarized as:

"The authors find a strong negative relationship between the surpluses: an additional dollar of surplus in the trust funds is associated with a $1.50 decrease in the federal funds surplus. This finding is not significantly different from a $1.00 decrease, which would suggest a dollar-for-dollar offset of trust fund surplus with spending increases or tax cuts; the authors are able to reject the hypothesis that the full dollar of trust fund surplus is saved by the government."

To sum up, the best evidence suggests that Social Security surpluses, rather than building savings to help pay future Social Security benefits, instead tend to subsidize present consumption. Put another way, Social Security surpluses allows current spending to be higher, or current taxes lower, than they otherwise would be. Several preliminary policy conclusions follow from these findings:

First, that it makes little attempt to increase Social Security surpluses in the near-term, unless a more reliable mechanism to save these surpluses is found. Investment in assets other than Treasury bonds might provide better prospects for broad saving; personal accounts also might do so. But these are questions for a different post.

Second, changes to Social Security taxes and benefits prior to the trust fund exhaustion date (currently 2040) can be justified. If surpluses since the 1980s had been "saved" in a broad budgetary sense, one could say that taxpayers during those years had fully "paid for" their future benefits, even if trust fund repayment exerted a burden on the non-Social Security budget in the years from 2017-2040. However, if Social Security surpluses were "spent" this implies that taxpayers since the 1980s enjoyed a higher level of government services or lower level of government taxes than would otherwise have been the case. Given this, their moral claim that benefits cannot be changed prior to the trust fund's exhaustion appears weaker.


Bruce Webb said...

"However, if Social Security surpluses were "spent" this implies that taxpayers since the 1980s enjoyed a higher level of government services or lower level of government taxes than would otherwise have been the case. Given this, their moral claim that benefits cannot be changed prior to the trust fund's exhaustion appears weaker."

Well there are two problems with this argument, one based in equity, the other in equity coupled with policy preferences.

If Social Security surpluses since the 1980s had been financed by the entire spectrum of people who benefited by those higher services or lower taxes then it would be one thing. But they were not. Instead a subset of workers, specifically wage workers, were told that if they paid more in now that the money plus accrued interest would be used to backfill as much of the future gap between Social Security income and cost as possible for as long as possible. That the money was used in the interim to provide services to the entire country including those who were not in fact paying this particular surtax doesn't erase the moral claim, ignoring it would make every non-wage worker or earner over the cap something of a free rider on the backs of the working class. Nothing historically new but hardly fitting into anyone's definition of 'equity'. Instead it is more akin to Taxation without Representation.

Second there is built in the assumption that the benefits of those extra services and lower taxes themselves were distributed equitably, that even if the tax was falling on wage workers in an inequitable way that at least they were getting an equitable benefit. Well that does not seem to be the case, most of the tax cuts since the 1980s went to the upper quintiles, while some of the extra services like 'Star Wars' really were not much of a benefit to any worker not directly employed in defense industries. (Because if I am a stockholder in a defense contractor there really is no such thing as a wasted program, even a failed weapons system means money in the pocket if you are operating under a Cost-Plus basis, as most of these contracts are.) So we are looking at a worker financed tax most of whose direct benefits flowed in the form of profits to holders of capital. Once again not a new historical phenomenon, but not one that workers will greet with glee. If it looks like a rip off, and sounds like a rip off, I am willing to call it a rip-off.

On a final note. Though people on my side of the aisle (left) like to claim that Reagan raided Social Security to finance Star Wars and while people on the other side like to claim that Johnson raided it to pay for the Great Society neither is true. Congress and the President are tasked with maintain a prudent reserve in the Trust Fund to guard against temporary fluctuations in tax income through changes in employment. This reserve is defined as a Trust Fund ratio of at least 100. Johnson inherited a $21 billion TF and a 122 ratio, he kept the ratio pretty steady with a low of 95 and a high of 110 but did hand off the TF with a 101 ratio and a $34 bn balance. Thus he didn't really borrow anything and the dollars even then were not particularly significant in context.

When we turn to Reagan we see that he was handed a hand grenade. He inherited a TF ratio of 25 coming off six straight years of actual losses and cooperated in applying a fix that put the ratio back on path. By 1988 the ratio was back to 41, by 1992 it was back to 96. From this perspective neither Reagan or Bush I 'looted' anything. Instead they steadily built the Trust Fund to where it legally was supposed to be. The earliest date that you could possibly classify these borrowings as untoward would be 1994 and even then the big money didn't roll in until 1999 and after.
Table VI.A4.-Historical Operations of the Combined OASI and DI Trust Funds,Calendar Years 1957-2006 Basically both the 'looting' and 'pre-funding' narratives are inoperative for any year the TF ratio is under 100 which is to say every year from 1971 to 1992.

Andrew G. Biggs said...

Good points.

On your first, there is the issue that, even if Social Security surpluses weren't saved, the incidence of the consumption of those surpluses probably wasn't the same as the incidence of the payroll tax itself. In other words, it's possible that the payroll tax surpluses - funded by taxes on low earners -- made possible income tax reductions that primarily benefited high earners. Of course, the surpluses probably also allowed greater government spending, at least some of which may have gone to lower earners. But a valid point nonetheless.

That said, it's not clear how this plays out over time. For instance, since earnings tend to rise over the life cycle, you could have a person who was young during the Trust Fund build-up -- and therefore primarily paid payroll taxes, which subsidized others -- but who in the post-2017 period primarily paid income taxes, which would be used to repay the fund.

To get on top of this, you would need a separate analysis that examined not simply how Social Security surpluses affected the non-Social Security budget balance, but how it affected the incidence of non-Social Security taxing and spending. Not impossible, but difficult.

Anonymous said...

difficult, but unecessary.

in the first place you seem to ignore that the money borrowed from Social Security in principle paid for either part of the tax cuts, or part of the government spending.

either of these could translate into "investment" if in fact the economy had any demand for more investment

which the current state of the stock market suggests it does not.

but the reason none of it matters is that if Social Security stays just as it is, pay off the Trust Fund or not... it doens't really matter... goes back to pay as you go in 2017 if necessary or in 2040 when projected or some other time when convenient..

all that happens is that workers have a secure place to "defer" (save) their spending for a time until they need it (when they retire).

the rest of the economy can and will adapt to that. and all the theoretical strainings one way or the other will make no difference to any human being who does not make his living straining theoretical gnats.


Andrew G. Biggs said...

Coberly said: "you seem to ignore that the money borrowed from Social Security in principle paid for either part of the tax cuts, or part of the government spending. Either of these could translate into "investment" if in fact the economy had any demand for more investment."

An interesting point: even if the government "spends" the Social Security surplus on new projects or tax cuts, that could still translate into investment.

To get on top of this question, you'd need to know a couple things:
The public's marginal propensity to save: How much of a tax cut gets invested rather than consumed.
The government's marginal propensity to invest: How much of an extra dollar of revenue goes to capital projects.
And the average return on government investment.

This is a reasonable sized research project, but let me put it this way: So long as government and the public fail to invest 100% of the marginal dollar, and so long as government investment yields lower average returns than private investment (which, with the exception of education, it very likely does) then the stated balance of the trust fund will overstate the amount of true saving. My guess is that it would overstate it by a lot.

Anonymous said...


you are just obscuring the facts.

you have no more idea what the "marginal propensity to save" means to the real economy than i do.

how much "saving" is going on right now with the stock market and the housing markets?

the very simple fact that you are trying to bury with your expertise is that Social Security allows people to put aside a small part of their own income in order to spend it later, when they need it, guaranteed against inflation by "pay as you go" with wage indexing.

sure looks like "savings" to me.

it may not look like "investment" to you, but then i haven't seen much of a case that diverting money from social security will result in any real investment that will make a real difference to any reall people.