Category Archives: Social Security

Happy Birthday Social Security! A Refresher Course in Macroeconomics For Laurence Kotlikoff

By Yeva Nersisyan
No day goes by without some deficit hawk trying to spread fear among ordinary Americans about the looming fiscal crisis. One gets the impression that the hawks are competing with one another to see who can come up with the scariest scenario. And it seems to be working. A recent USA Today/Gallup poll found that 64% of those surveyed in the poll disapprove of president Obama’s handling of the federal budget deficit. But Obama’s discretionary stimulus has been very small relative to the magnitude of the crisis we are in, and as discussed here most of the deficit was due to automatic stabilizers. Hence Obama’s policies have little to do with the rising deficit, and public disapproval of his policy demonstrates how misinformed the public is on the issues of federal deficit and debt.
A recent piece from one Boston University Economics professor, Laurence Kotlikoff, published in Bloomberg, was too outrageous to leave uncommented. Most of the deficit hawks seem to be united around the same agenda: getting rid of the very modest safety net that the U.S. government provides to its population. After making a bold claim that the U.S. is bankrupt here is what he has to say:

What it [the U.S.] can and must do is radically simplify its tax, health-care, retirement and financial systems, each of which is a complete mess. But this is the good news. It means they can each be redesigned to achieve their legitimate purposes at much lower cost and, in the process, revitalize the economy. 

The authority that he uses to support his claim that the U.S. is bankrupt is nothing other than the I.M.F (and you thought that the I.M.F is rethinking its position on economic policy!). But what exactly does he mean by “simplifying” the tax, health-care and retirement systems? The only thing that comes to mind is downsizing – cut, cut and cut. How else would you achieve the 14% permanent fiscal adjustment that he thinks is needed? According to Kotlikoff, not only will this help put the fiscal house in order but it will also “revitalize the economy”. Moreover, these programs could still be able to achieve their “legitimate purposes at much lower cost”. What could be better?
This is the most extreme deficit hawk position that one encounters. There is a legitimate concern about a double-dip recession in the U.S. Household balance sheets are no better than they were before the crisis. Household debt stands at 122% of personal disposable income. The unemployment rate is high and is expected to stay high for the foreseeable future. In this situation the U.S. consumer can by no means be expected to pull the economy out of the hole. U.S. corporations, facing uncertainty about the strength of consumer demand, aren’t hiring despite sitting on huge piles of cash. Just what exactly will fill the aggregate spending gap when the government withdraws its spending and how cutting entitlements will “revitalize the economy” is a mystery to me. And probably to Kotlikoff too, since he makes no attempt to offer explanation in this article.
According to the IMF closing the fiscal gap will require a “permanent annual fiscal adjustment equal to about 14 percent of U.S. GDP.” (“The fiscal gap is the value today (the present value) of the difference between projected spending (including servicing official debt) and projected revenue in all future years.”) This is the preferred definition of the fiscal gap promulgated by infinite horizon deficit warriors like Kotlikoff. In their world, an adjustment in the government’s fiscal balance from a 9% deficit to a 5% surplus (i.e. 14% adjustment) will take place without any negative effects on the rest of the economy. In the real world, however, we cannot have an adjustment in government’s financial balance without simultaneously having an adjustment in the non-government sector’s financial balance. A 14% of GDP fiscal adjustment means that the non-government sector’s financial balance will also adjust by the same amount, only in the other direction. For example, households could adjust their budgets to run huge deficits to allow the government to tighten its fiscal stance.
So what are our options according to Kotlikoff? To achieve this fiscal adjustment we will need nothing less than doubling of all of our taxes. “Such a tax hike would leave the U.S. running a surplus equal to 5 percent of GDP this year, rather than a 9 percent deficit”. (Of course doubling taxes is not something that he seems to be in favor of. This is just used to demonstrate how enormous the “hole” is). But one year will not do it. The U.S government will need to run a 5% surplus for many years to come to pay for scheduled expenses down the road.
Since the official deficit and debt numbers don’t look scary enough Kotlikoff offers us his own calculations. You see, the federal debt held by the public stands only at 53% of GDP and is expected to climb up to only about 68% in 2011. Compared to other developed nations this is a relatively low number. One could look at Japan and say: “Well, they have managed not to go bankrupt with a 200% Debt-to-GDP ratio so why would the U.S. be in trouble with a much lower level of debt?” Kotlikoff will then tell you that the fiscal gap is “more than 15 times the official debt”, a whopping $202 trillion. When baby boomers fully retire and collect all of their oversized benefits we will have an annual bill of $4 Trillion in today’s dollars. And if after all of this you still have any doubts then Kotlikoff will point you to the direction of Greece (I won’t go into that in this blog but you can read here on why the U.S. is not like Greece). Who wouldn’t be scared?
The alarming situation we are in, according to the deficit hysteria crowd, is the result of the government running a Ponzi scheme for 6 decades as it has been taking resources from the young and giving them to the old. If their point is that we are taking real resources from the young and giving them to the old, then yes, that’s what we are doing. And that’s what every society is doing, has always done, and will always be doing unless you want to let the elderly population die of hunger. Ditto for infants—the lazy do-nothings expect us, the working age population, to take care of them! Why can’t those lazy infants and elderly people pull their own weight?
But if it is all about real resources, the debate shifts to a completely different dimension. Will we have enough resources so that baby boomers can get a decent standard of living when they retire? Will the economy be able to produce enough to sustain its non-working members—young and old? This is the real issue and it cannot be solved by cutting government spending nor by raising taxes today. Nor can it even be resolved by ramping up financial saving today—that would only lead to more dollars chasing scarce resources tomorrow.
What matters is our capacity to produce goods and services in the future. If we want to be able to produce more in the future we need to invest more in education, technologies and infrastructure today. But if Kotlikoff thinks that we are redistributing “financial resources” from the young to the old (and I suspect that’s what he believes) then this is a false concern as explained below.
First of all, as discussed in many posts on this blog, the government is the monopoly issuer of the country’s currency and hence it cannot go bankrupt. It doesn’t need tax or bond revenues to spend; it simply spends by crediting bank accounts which ultimately amounts to creating new currency (cash or deposits in commercial banks). It then sells government securities to drain any excess reserves that the banking system might receive as a result of government spending. This is done to help the Fed hit its interest rate target. And even if the government wanted to, it couldn’t spend your tax money. Why? Because just as government spending creates new money, taxing destroys money. Government cannot spend that which doesn’t exist.
Both government bonds and currency are liabilities of the Federal government (Treasury and Fed), its IOUs. There is only one difference between the two – bonds pay higher interest than reserves. The government pays interest on bonds to offer an interest earning alternative to reserves. To get us to accept the currency, it imposes taxes on us. If currency is government’s IOU why would government need to borrow its own IOUs in order to spend? Furthermore, there is no balance sheet operation that allows one to borrow one’s own IOUs. When the government sells bonds, it simply exchanges one type of IOU for the other – this is not borrowing. When you deliver government’s IOUs to it to pay your taxes, it simply extinguishes your tax liability, just like you deliver bank deposits (bank IOUs) to a bank to discharge your obligations (bank loans) to it. If you could issue IOUs that were as acceptable as government IOUs, i.e. if everything was for sale in your IOUs, what kind of crazy idea would it be for you to borrow them back in order to spend?
The second problem with Kotlikoff’s argument is his presumption that government can somehow run fiscal surpluses for years on end. As explained in many posts on this blog government’s fiscal surplus means that the non-government sector is running a deficit. In other words, the government is injecting less income into the private sector (through its spending) then it is draining out of it (through taxation). Assuming a 4% of GDP trade deficit (although it could shrink if the government cuts spending), the negative adjustment in private sector (firms and households) balances desired by Kotlikoff will be in the amount of 9% of GDP (5% government surplus + 4% current account deficit/foreign sector surplus). The private sector will be dissaving at a rate of 9% of GDP per year. Can this go on forever or for many years as the IMF says it should?
In Kotlikoff’s world, where this somehow will have only positive effects, it can. But in the real world this is operationally impossible. For one thing, the private sector cannot indefinitely run a deficit without facing solvency problems – it is a user of the currency not the issuer. More importantly, a persistent federal budget surplus is impossible for a sovereign currency issuer like the US because the funds used to pay taxes ultimately come from government spending. If it continuously withdraws more funds from the economy then it’s injecting into the economy then at some point the private sector’s previously accumulated hoards of government IOUs will be depleted. People will simply be unable to pay their taxes.
Deficit hawks such as Dr. Kotlikoff simply shift the public debate from pressing issues such as high unemployment to false concerns about fiscal solvency and debt sustainability. They devise numbers which are meaningless for a nation operating with a sovereign currency, and use these to misinform and scare ordinary people. They are the reason why the very people who benefit from successful government programs (such as Social Security) undermine their own economic well-being by electing deficit hawks to Congress.
The academic experts calling for deficit reduction are irresponsible to say the least. They feel they can say anything without being held accountable for the impact of their ideas on the lives of people. We should devise some standard of accountability for professional economists, maybe similar to what we have for doctors. This would definitely throw some water on the deficit hysteria fire.

The CBO’s Misplaced Fear of a Looming Fiscal Crisis

By Eric Tymoigne

The Congressional Budget Office (CBO) has just released an 8-page brief titled “Federal Debt and the Risk of a Fiscal Crisis.” In it you will find all the traditional arguments regarding government deficits and debt: “unsustainability,” “crowding out”, bond rates rising to “unaffordable” levels because of fears that the Treasury would default or “monetize the debt,” the need to raise taxes to pay for interest servicing and government spending, the need “to restore investor’s confidence” by cutting government spending and raising taxes. This gives us an opportunity to go over those issues one more time.

  1. “growing budget deficits will cause debt to rise to unsupportable levels”

A government with a sovereign currency (i.e. one that creates its own currency by fiat, only issues securities denominated in its own currency and does not promise to convert its currency into a foreign currency under any condition) does not face any liquidity or solvency constraints. All spending and debt servicing is done by crediting the accounts of the bond holders (be they foreign or domestic) and a monetarily-sovereign government can do that at will by simply pushing a computer button to mark up the size of the bond holder’s account (see Bernanke attesting to this here).

In the US, financial market participants (forget about the hopelessly misguided international “credit ratings”) recognize this implicitly by not rating Treasuries and related government-entities bonds like Fannie and Freddie. They know that the US government will always pay because it faces no operational constraint when it comes to making payments denominated in a sovereign currency. It can, quite literally, afford to buy anything for sale in its own unit of account.

This, of course, as many of us have already stated, does not mean that the government should spend without restraint. It only means that it is incorrect to state that government will “run of out money” or “burden our grandchildren” with debt (which, after all, allows us to earn interest on a very safe security), arguments that are commonly used by those who wish to reduce government services. These arguments are not wholly without merit. That is, there may well be things that the government is currently doing that the private economy could or should be doing. But that is not the case being made by the CBO, the pundits or the politicians. They are focused on questions of “affordability” and “sustainability,” which have no place in the debate over the proper size and role for government (a debate we would prefer to have). So let us get to that debate by recognizing that there is no operational constraint – ever – for a monetarily sovereign government. Any financial commitments, be they for Social Security, Medicare, the war effort, etc., that come due today and into the infinite future can be made on time and in full. Of course, this means that there is no need for a lock box, a trust fund or any of other accounting gimmick, to help the government make payments in the future. We can simply recognize that every government payment is made through the general budget. Once this is understood, issues like Social Security, Medicare and other important problems can be analyzed properly: it is not a financial problem; it is a productivity/growth problem. Such an understanding would lead to very different policies than the one currently proposed by the CBO (see Randy’s post here).

  1. “A growing portion of people’s savings would go to purchase government debt rather than toward investments in productive capital goods such as factories and computers.”

First, this sentence seems to imply that government activities are unproductive (given that, following their logic, Treasury issuances “finance” government spending), which is simply wrong, just look around you in the street and your eyes will cross dozens of essential government services.

Second, the internal logic gets confusing for two reasons. One, if people are so afraid of a growing fiscal crisis, why would they buy more treasuries with their precious savings? Why not use their savings to buy bonds to fund “productive capital goods”? Using the CBO’s own logic, higher rates on government bonds would not help given that a “fiscal crisis” is expected and given that participants are supposed to allocate funds efficiently toward the most productive economic activity (and so not the government according to them). Second, we are told that “it is also possible that investors would lose confidence abruptly and interest rates on government debt would rise sharply.” I will get back to what the government can do in that case, but you cannot get it both ways; either financial market participants buy more government securities or they don’t.

Third, this argument drives home the crowding-out effect. I am not going to go back to the old debates between Keynes and others on this, but the bottom line is that promoting thriftiness (increasing the propensity to save out of monetary income) depresses economic activity (because monetary profits and incomes go down) and so decreases willingness to invest (i.e. to increase production capacities). In addition, by spending, the government releases funds in the private sector that can be used to fund private economic activity; there is a crowding-in, not a crowding-out. This is not theory, this is what happens in practice, higher government spending injects reserves and cash in the system, which immediately places downward pressure on short-term rates unless the Fed compensates for it by selling securities and draining reserves (which is what the Fed does on a daily basis).

  1. “if the payment of interest on the extra debt was financed by imposing higher marginal tax rates, those rates would discourage work and saving and further reduce output.”

No, as noted many times here, all spending and servicing is done by crediting creditor’s account not by taxing (or issuing bonds). Taxes are not a funding source for monetarily-sovereign governments, they serve to reduce the purchasing power of the private sector so that more real resources can be allocated to the government without leading to inflation (again all this does not mean that the government should raise taxes and takeover the entire economy; it is just a plain statement of the effects of taxation). All interest payments on domestically-denominated government securities (we are talking about a monetarily-sovereign government) can be paid, and have been met, at all times, whatever the amount, whatever their size in the government budget.

  1. “a growing level of federal debt would also increase the probability of a sudden fiscal crisis, during which investors would lose confidence in the government’s ability to manage its budget, and the government would thereby lose its ability to borrow at affordable rates.”

If the US Treasury cannot issue bonds at the rate it likes there is a very simple solution: do not issue them. This does not alter in any way its spending capacity given that the US federal government is a monetarily-sovereign government so bond issuances are not a source of funds for the government. Think of the Federal Reserve: does it need to borrow its own Federal Reserve notes to be able to spend? No, all spending is done by issuing more notes (or, more accurately, crediting more accounts) and if the Fed ever decided borrow its own notes by issuing Fed bonds to holders of Federal Reserve notes (a pretty weird idea), a failure of the auction would not alter its spending power. The Treasury uses the Fed as an accountant (or fiscal agent) for its own economic operations; the “independence” of the Fed in making monetary policy does not alter this fact.

  1. “It is possible that interest rates would rise gradually as investors’ confidence declined, giving legislators advance warning of the worsening situation and sufficient time to make policy choices that could avert a crisis.”

It is always possible that anything can happen, but what is the record? The record is that there is no relationship between the fiscal position of the US government and T-bond rates. Massive deficits in WWII went pari passu with record low interest rates on the whole Treasury yield curve. With the help of the central bank, the government made a point of keeping long-term rates on treasuries at about 2% for the entire war and beyond, despite massive deficits. There is a repetition of this story playing out right now, and Japan has been doing the same for more than a decade. Despite its mounting government debt, the yield on 10-year government bonds is not more than 2% as of July 2010. In the end, market rates tend to follow whatever the central bank does in terms of short-term rates, not what the fiscal position of the government is.

As we already stated on this blog before, a simple observation of how government finance operates shows that government spending injects reserves into the banking system (pressing down short-term interest rate), while the payment of taxes reduces/destroys reserves (pushing short-term rates up). The Fed has institutions that allow it to coordinate on a daily basis with the Treasury (they call each other every day) to make sure that all these government operations do not push the interest rate outside the Fed’s target range.

  1. “If the United States encountered a fiscal crisis, the abrupt rise in interest rates would reflect investors’ fears that the government would renege on the terms of its existing debt or that it would increase the supply of money to finance its activities or pay creditors and thereby boost inflation.”

That’s a repeat of the first question but with a bit of elaboration. The US government cannot default on its securities for financial reasons, it is perfectly solvent and liquid. (Sovereign governments can, as we have conceded on this blog, refuse to pay – e.g. Japan after the war – but that is because it was unwilling to repay, not because it was unable to pay.) Thus, despite Reinhart and Rogoff’s warnings, the credit history of the US government (and any monetarily-sovereign government) remains perfect. No government with a non-convertible, sovereign currency has ever bounced a check trying to make payment in its own unit of account.

The US government always pays by crediting the account of someone (i.e. “monetary creation”). If the creditor is a bank, this leads to higher reserves, if it is a non-bank institution it leads also to an increase in the money supply. It has been like this from day one of Treasury activities. It is not a choice the government can make (between increasing the money supply, taxing or issuing bonds); any spending must lead to a monetary creation; there is no alternative. Again taxes and bonds are not funding sources for the US federal government; however they have important functions. Taxes help to keep inflation in check (in addition to maintaining demand for the government’s monetary instruments). Bond sales allow the government to deficit spend without creating excessive volatility in the federal funds market. If financial market participants want more bonds, the Treasury issues more to keep bond rates high enough for its tastes; if financial market participants do not want more treasury bonds, the government does not issue to avoid raising rates. The US Treasury (and any monetarily sovereign government as long as they understand it) has total control over the rate it pays on its debts; whether the government understands this or not is another question. A monetarily sovereign government does not have to pay “market rates” in order to convince markets to hold its bonds. Indeed, it does not even have to issue securities if it does not want to. In the US, it is usually the financial institutions that beg the Treasury to issue more securities.

The recent episode of the “Supplementary Financing Program” is a very good illustration of that point. Financial market participants were crying for more Treasuries and the Fed could not keep pace. As a consequence the Treasury agreed to issue more Treasuries than expected to meet the demand and help the Fed drain reserves and thereby hit their interest rate target. According to the Federal Reserve Bank of New York (DOMESTIC OPEN MARKET OPERATIONS DURING 2008, page 28): “To help manage the balance sheet impact of the Federal Reserve’s liquidity initiatives, the Treasury announced the establishment of a temporary Supplementary Financing Program (SFP) on September 17. The program consists of a series of Treasury bills issued by Treasury, the proceeds of which are deposited in an account at the Federal Reserve, draining reserve balances from the banking sector.”

Now look how this was deformed by the Treasury (quite a few journalists and bloggers followed): “The Treasury Department announced today the initiation of a temporary Supplementary Financing Program at the request of the Federal Reserve. The program will consist of a series of Treasury bills, apart from Treasury’s current borrowing program, which will provide cash for use in the Federal Reserve initiatives.” No, Mr. Treasury, this was not done for funding purpose; it was done to drain reserves from the banking system. The Fed does not need any cash from the Treasury. The Fed is the monopoly supplier of cash.

A final point regarding inflation. Inflation is a potential issue, as we have always maintained. But, there is no automatic causation from the money supply to inflation (a point Paul Krugman appears to have forgotten). Inflationary pressures depend on the state of the economy (supply and demand-side factors). Most importantly, perhaps, it depends on people’s desire to hoard vs. spend cash. Even the massive deficits during WWII, when resources were fully employed, did not lead to a spiraling out of control of inflation. Finally, it is quite possible that causation actually runs the other way around – i.e. from inflation to the money supply – given the endogeneity of the money supply, but that’s a story for another day…

Why Dean Baker has Gone off the Rails on Social Security

By Stephanie Kelton

Some of the members of the president’s National Commission on Fiscal Responsibility and Reform are using the trumped-up crisis in Social Security to push their decades-in-the-making agenda of privatization. For example, Andy Stern, one of the commission’s key members, wants to see the system transformed from one that guarantees a minimum standard of living to the elderly, their dependents and the disabled into one that leaves them (in whole or in part) dependent on the vagaries of the market.

Asked to comment on Stern’s privatization proposal, Dean Baker recently said:

“I don’t think it’s necessarily a bad idea …. If he’s talking about getting money out of the trust fund for that purpose, I could live with it. You’d get a higher return now that stocks are falling.”

To defend his position, Baker pointed out that the Trust Fund, which consists almost entirely of non-marketable government securities, is only earning about three percent but that “it would be reasonable to assume a six or seven point return” on funds invested in the stock market. Hmm . . .

Seven is greater than three. You can’t argue with that. That is, unless you look more closely at what privatization would actually entail.

Since President Obama’s deficit commission hasn’t proposed anything concrete (yet) – i.e. we don’t know how much of the current system they want to privatize – let’s go ahead and use George W. Bush’s privatization proposal, simply for purposes of demonstration.

In 2005, President Bush pushed for partial privation of Social Security, which would have allowed workers under the age of 55 to divert up to 4 percent of their current payroll tax contribution into their own retirement accounts. Workers who decided to participate would then depend upon benefits from two sources: (1) the (now lower) guaranteed benefit they would continue to receive from Social Security and (2) the market benefit that would accrue in the form of gains in their personal account. Clearly, the more an individual diverts into private accounts, the less they would receive in the form of a guaranteed benefit, and, hence, the more they will rely upon gains in financial markets.

Here’s the way a Senior Administration Official sold the Bush plan in 2005:

“The way that the election is put before the individual in a personal account structure of this type is that in return for the opportunity to get the benefits from the personal account, the person foregoes a certain amount of benefits from the traditional system.

Now, the way that election is structured, the person comes out ahead if their personal account exceeds a 3 percent real rate of return, which is the rate of return that the trust fund bonds receive. So, basically, the net effect on an individual’s benefits would be zero if his personal account earned a 3 percent real rate of return. To the extent that his personal account gets a higher rate of return, his net benefit would increase as a consequence of making that decision . . . .

. . . the specific trade-off that you’re making in opting for a personal account is based on your decision that you
think you can beat the 3 percent real rate of return.”

So that’s the privatization pitch: privatization offers better prospects for growth and, ultimately, a more comfortable retirement. This is especially true in the case of younger workers, because they can get in early and experience the magic of compound interest. This, apparently, is where Dean Baker is coming from.

It’s a choice that seems to make sense for those who expect their personal account to earn a rate of return that exceeds the rate of return earned on Treasury bonds (held in the Trust Fund). But is it really such a no-brainer? Let’s look more closely at the implications of diverting withholdings into personal accounts.

Investing in a personal account means foregoing a portion of the guaranteed benefits that would have been received under the traditional system. Advocates of privatization see no harm in this, since earnings on personal savings accounts should more than offset the foregone benefits. Chart 1 on page 13 of this essay provides a diagrammatic description of the role of personal savings accounts in offsetting guaranteed benefit reductions.

It works like this. When a worker agrees to establish a personal account he is effectively asking the government to lend him part of his Social Security tax so that he can invest it in the stock market. The government would monitor these loans and investments by establishing parallel accounts, a ‘notional account’ (to keep track of the loan) and a ‘personal account’ (to keep track of the investment). This means that diverted payroll contributions would be double-counted, and each account would be credited, over time, with interest – the notional account would accumulate interest at the rate of return on Treasury bonds, and the personal account would accumulate interest at the nominal portfolio rate of return, less annual fees.

To make the argument concrete, consider a highly simplified example. Suppose an individual’s notional account would equal $100,000 at retirement. If this person’s life expectancy at retirement is 20 years and the annuity draws zero interest and comes at zero administrative costs (simplifying assumptions), the annuity on this account would be $5,000. This sum – known as the “clawback” – would be deducted from the defined benefit amount, to arrive at the “benefit after clawback.” If the defined benefit (calculated using an inflation-index) would have otherwise been $12,000 per year, it will now be $7,000. Now, if the poverty-level of income is $16,000, this individual’s personal account will need to be sufficiently large (well above $100,000) to allow an additional (lifetime) benefit of $9,000 per year through annuitization.

As time goes on, the size of the clawback would grow, relative to the benefit, because the clawback would be proportional to wages, whereas the defined benefit would be fixed in real terms (i.e. indexed to prices). This would make workers increasingly dependent on the annuitized value of their personal accounts. Moreover, workers will have to pay a fee – to financial firms – to annuitize their individual accounts, a cost that could absorb as much as 10 to 20 percent of their savings, as Dean Baker showed when he was an outspoken critic of privatization in 2005.

With the size of the after-clawback benefit projected to decrease over time, it is likely that the whole private account will need to be annuitized. And, unless the stock market performs incredibly well, there is a good chance that the annuitized value of the private account will be insufficient to sustain many Americans in retirement.

The groups who are most vulnerable to this kind of shortfall are women and minorities, who make up a disproportionate share of America’s low-wage workers. This has been emphasized by Diana Zuckerman, president of the National Research Center for Women and Families, who argued that “[w]omen depend more on Social Security than men do, because women are less likely to have their own private pensions when they retire.” And, even when they do have pensions, Zuckerman said, “their pension checks are, on average, half as large as men’s are.” This means that our nation’s low-wage workers are particularly vulnerable because they are less likely to have other forms of saving, pensions, etc., to supplement Social Security in retirement.

So here we are again, this time with a Democratic president and a deficit commission stacked with conservatives posing the same question the Bush administration asked in 2005: Do you want your money in a Trust Fund that earns a 3 percent real return, or would you prefer to invest it in a personal account that might yield nearly 7 percent after inflation? Using this simple argument, people like Andy Stern will try to persuade Americans that the answer is fairly obvious.

For the sake of millions of Americans who are able to avoid the anguish of poverty only because of the benefits they receive under the current system, I hope Dean Baker will return to his roots and lead the progressive charge to preserve Social Security as we know it.

Social Security: Truth or Useful Fictions?

By L. Randall Wray [via CFEPS]


Social Security is an intergenerational assurance plan. Working generations agree to take care of retirees, dependents, survivors, and persons with disabilities. Currently, spouses, children, or parents of eligible workers make up more than a quarter of beneficiaries on OASDI. A large proportion will always be people without “normal” work histories who could not have made sufficient contributions to entitle them to a decent pension. Still, as a society, we have decided they should receive benefits.

Further, the program is not means tested. One need only meet statutory requirements to receive benefits. Indeed, as the Bush Commission’s Report emphasizes, the Supreme Court has twice ruled Social Security does not make intergenerational promises to the dead, but, rather, only to their survivors. The Bush Commission sees that as a weakness; I see it as a strength.


The Greenspan Commission tried to change Social Security from paygo to advance funding in 1983. But that is impossible; it just demonstrated a misunderstanding of accounting. The existence of a Trust Fund does not in any way, shape, or form enhance government’s ability to meet Social Security commitments. This point is difficult to get across.

The Social Security Trust Fund is one of Uncle Sam’s cookie jars. He also has a defense cookie jar, a corporate welfare cookie jar, etc. (See Figure 1.) We count taxes as Uncle Sam’s income, and he can pretend he stuffs the various cookie jars with those tax receipts — the payroll tax goes into the Social Security cookie jar, and he pretends it pays for Social Security spending. Maybe he pretends capital gains taxes go into the corporate welfare cookie jar. And so on. That is all internal accounting.

Figure 1: Federal Government Internal Accounts

Say Uncle Sam spends more on corporate welfare than he pretends to have in that cookie jar. But he pretends the Social Security cookie jar is overflowing with tax receipts because he runs a huge surplus there. (See Figure 2.) So Uncle Sam writes some IOUs from the corporate welfare cookie jar to the Social Security cookie jar to remind himself. Over time, the Social Security cookie jar accumulates Trillions of dollars of IOUs from Uncle Sam’s other cookie jars.

Figure 2: Trust Fund

That is just the government owing itself, and has no effect on the external accounts. (See Figure 3.) The total spent on Social Security, corporate welfare, transportation and so on equals its total spending for the year. The total it collects from taxes, including payroll taxes, capital gains taxes, gas taxes, and so on, equals its total income for the year. If government spends more than its income, that is called deficit spending. If it spends less, it runs a budget surplus. The cookie jar IOUs cannot change that in any way.

Figure 3: Federal Government External Accounts

Note I’m not saying there is anything wrong with the Treasury Securities held by the Trust Fund-Social Security can count them as an asset. But they will not in any way change the external accounting in 2017 or 2027 or 2041 — when the government’s overall spending will be less than, equal to, or greater than its overall tax receipts. (See Figure 4.) When Social Security begins to run a deficit, the existence of the Trust Fund will not reduce the amount of Treasury Securities sold to the nongovernment sector.

Indeed, comparison of Figure 4a with 4b demonstrates that the external accounts are not changed by existence of a Trust Fund-the implications for the government are the same.

Figure 4a: Social Security Runs $10 Billion Deficit, With Rest of Federal Government Budget in Balance, WITH TRUST FUND

Figure 4b: Social Security Runs $10 Billion Deficit, With Rest of Federal Government Budget in Balance, WITHOUT TRUST FUND


Many economists realize that from the perspective of Uncle Sam, the Trust Fund is just an internal accounting construction. But I’ve had top economic advisors of both Democrats and Unions tell me while that is true, the Trust Fund provides political protection. That is clearly false. It is only because Social Security runs surpluses accumulated in a Trust Fund that we have all these privatizat ion scams. Do you really believe Wall Street fund managers would have any interest in Social Security if it ran deficits?


Social Security is unusual because unlike most other government programs, we pretend a specific tax finances it. That makes it easy to mentally match payroll tax revenues and benefit payments, and to calculate whether the 75 year actuarial balance is positive or negative. No one knows or car es whether the defense program runs actuarial deficits — because we don’t pretend that a particular tax pays for defense. In reality, Social Security benefits are paid in exactly the same way that the government spends on anything else-by crediting somebody’s bank account. Social Security cannot be any more financially constrained than any other government program. Only Congress can establish a financial constraint.


Today OASDI benefits equal 4.5% of GDP; that grows to 7% over the next 75 years. Does anyone doubt that we will be able to afford to devote 7% of our nation’s output to provide a social safety net for retirees, survivors, and disabled persons? That leaves 93% of GDP for everything else. We have easily achieved larger shifts of GDP in the past without lowering living standards of the working generations. I cannot imagine a future so horrible that we won’t be able support OASDI in real terms.


Future beneficiaries cannot eat stocks or bonds, and we can’t dig holes today to bury Winnebagos for future retirees. Whatever beneficiaries consume in 2050 will have to be produced for the most part in 2050. Financial Fixes cannot change that. Whether the stock market outperforms Treasury bonds is irrelevant. Whether future retirees have amassed $100,000 in personal accounts is irrelevant. All that matters is future productive capacity plus a method of distributing a portion of output to the elderly in 2050.

To accomplish that, all we have to do is credit the bank accounts of the elderly in 2050, and then let the market work its wonders. I am frankly shocked that the Cato Institute refuses to trust the market, backing what amounts to tax credits for playing in equity markets.


I also find it ironic that the Bush Commission wants to increase government spending by $40 billion a year to give money away to encourage the poor to save. Hey, let’s give them $80 billion a year. I’d prefer that the poor spend it, but if they want to sock it away in personal accounts, that’s fine by me. But, please, let’s provide Big Brotherly advice that they keep it out of Telecom stocks. And leave Social Security out of it!


Only Congress can decide who deserves support, and what level of support. Only Congress can decide how much of GDP ought to be devoted to support of the elderly. That’s Democracy and I’m willing to live with it. The Bush Commission says this generates insecurity, but I expect the elderly will continue to use the ballot box to hold the feet of Politicians to the fire of Social Security.

IX. HONESTY IS THE BEST POLICY (Convenient Fictions About Finances Cannot Help)

In spite of all the complex financial fictions, the truth is simple. In 2041, Social Security’s beneficiaries will have to rely on the working population, just as they do today. No financial scams can change that. Trust funds, actuarial balances, privatization, and relative rates of return don’t change it. There ain’t no crisis; there ain’t no urgency. We’ve got two generations to increase our capacity to produce.


In 1960 it might have made some kind of twisted logic to levy a tax on payrolls and to pretend this paid for Social Security benefits. There were few benefits to be paid, but lots of payrolls to tax, so the tax rate was low. Today, and increasingly in the future, there are more benefits to pay relative to taxable payrolls. In just a few years, only 1/3 of National Income will be subject to the payroll tax- hence ever-higher payroll tax rates will be required to maintain the delusion.

Let’s stop pretending. Payroll taxes simply discourage work-which is as perverse as policy can get. We need people to work to provide all the goods and services the elderly need. Abolish the payroll tax, abolish the Trust Fund, abolish actuarial gaps, and let’s recognize that Social Security is an intergenerational assurance program.

Social Security: Another Case of Innocent Fraud?

By Warren Mosler* and Mathew Forstater**

In his recent book, The Economics of Innocent Fraud, John Kenneth Galbraith surveys a number of false beliefs that are being perpetuated among the American people about how our society operates: innocent (and sometimes not-so-innocent) frauds. There is perhaps no greater fraud being committed presently—and none in which the stakes are so high—as the fraud being perpetrated regarding government insolvency and Social Security. President Bush uses the word “bankruptcy” continuously. And the opposition agrees there is a solvency issue, questioning only what to do about it.

Fortunately, there is a powerful voice on our side that takes exception to the notion of government insolvency, and that is none other than the Chairman of the Federal Reserve. The following is from a transcript of a recent interview with Fed Chairman Alan Greenspan:

RYAN… do you believe that personal retirement accounts can help us achieve solvency for the system and make those future retiree benefits more secure?

GREENSPAN: Well, I wouldn’t say that the pay-as-you-go benefits are insecure, in the sense that there’s nothing to prevent the federal government from creating as much money as it wants and paying it to somebody. The question is, how do you set up a system which assures that the real assets are created which those benefits are employed to purchase. (emphasis added)

For a long time we have been saying there is no solvency issue (see C-FEPS Policy Note 99/02 and the other papers cited in the bibliography at the end of this report). Now with the support of the Fed Chairman, maybe we can gain some traction.

Let us briefly review, operationally, government spending and taxing. When government spends it credits member bank accounts. For example, imagine you turn on your computer, log in to your bank account, and see a balance of $1,000 while waiting for your $1,000 Social Security payment to hit. Suddenly the $1,000 changes to $2,000. What did the government do to make that payment? It did not hammer a gold coin into a wire connected to your account. It did not somehow take someone’s taxes and give them to you. All it did was change a number on a computer screen. This process is operationally independent of, and not operationally constrained by, tax collections or borrowing.

That is what Chairman Greenspan was telling us: constraints on government payment can only be self-imposed.

And what happens when government taxes? If your computer showed a $2,000 balance, and you sent a check for $1,000 to the government for your tax payment, your balance would soon change to $1,000. That is all—the government changed your number downward. It did not “get” anything from you. Nothing jumped out of the government computer into a box to be spent later. Yes, they “account” for it by putting information in an account they may call a “trust fund,” but this is “accounting”—after the fact record-keeping—and has no operational impact on government’s ability to later credit any account (i.e., spend!).

Ever wonder what happens if you pay your taxes in actual cash? The government shreds it. What if you lend to the government via buying its bonds with actual cash? Yes, the government shreds the cash. Obviously, the government doesn’t actually need your “funds” per se for further operational purpose.

Put another way, Congress ALWAYS can decide to make Social Security payments, previous taxing or spending not withstanding, and, operationally, the Fed can ALWAYS process whatever payments Congress makes. This process is not revenue constrained. Operationally, collecting taxes or borrowing has no operational connection to spending. Solvency is not an issue. Involuntary government bankruptcy has no application whatsoever! Yet “everyone” agrees—in all innocence—that there is a solvency problem, and that it is just a matter of when. Everyone, that is, except us and Chairman Greenspan, and hopefully now you, the reader, as well!

So if solvency is a non-issue, what are the issues? Inflation, for one. Perhaps future spending will drive up future prices. Fine! How much? What are the projections? No one has even attempted this exercise. Well, it is about time they did, so decisions can be made on the relevant facts.

The other issue is how much GDP we want seniors to consume. If we want them to consume more, we can award them larger checks, and vice versa. And we can do this in any year. Yes, it is that simple. It is purely a political question and not one of “finance.”

If we do want seniors to participate in the future profitability of corporate America, one option (currently not on the table) is to simply index their future Social Security checks to the stock market or any other indicator we select—such as worker productivity or inflation, whatever that might mean.

Remember, the government imposes a 30% corporate income tax, which is at least as good as owning 30% of all the equity, and has at least that same present value. If the government wants to take a larger or smaller bite from corporate profits, all it has to do is alter that tax—it has the direct pipe. After all, equity is nothing more than a share of corporate profits. Indexation would give the same results as private accounts, without all the transactional expense and disruption.

Now on to the alleged “deficit issue” of the private accounts plan. The answer first—it’s a non-issue. Note that the obligation to pay Social Security benefits is functionally very much the same as having a government bond outstanding—it is a government promise to make future payments. So when the plan is enacted the reduction of future government payments is substantially “offset” by future government payments via the new bonds issued. And the funds to buy those new bonds come (indirectly) from the reductions in the Social Security tax payments—to the penny. The process is circular. Think of it this way. You get a $100 reduction of your Social Security tax payment. You buy $100 of equities. The person who sold the equities to you has your $100 and buys the new government bonds. The government has new bonds outstanding to him or her, but reduced Social Security obligations to you with a present value of about $100. Bottom line: not much has changed. One person has used his or her $100 Social Security tax savings to buy equities and has given up about $100 worth of future Social Security benefits (some might argue how much more or less than $100 is given up, but the point remains). The other person sold the equity and used that $100 to buy the new government bonds. Again, very little has changed at the macro level. Close analysis of the “pieces” reveals this program is nothing but a “wheel spin.”

Never has so much been said by so many about a non-issue. It is a clear case of “innocent fraud.” And what has been left out? Back to Chairman Greenspan’s interview—what are we doing about increasing future output? Certainly nothing in the proposed private account plan. So if we are going to take real action, that is the area of attack. Make sure we do what we can to make the real investments necessary for tomorrow’s needs, and the first place to start for very long term real gains is education. Our kids will need the smarts when the time comes to deal with the problems at hand.


Galbraith, John Kenneth, 2004, The Economics of Innocent Fraud: Truth for Our Time, Boston: Houghton Mifflin.

Wray, L. Randall, 1999, “Subway Tokens and Social Security,” C-FEPS Policy Note 99/02, Kansas City, MO: Center for Full Employment and Price Stability, January, (

Wray, L. Randall, 2000, “Social Security: Long-Term Financing and Reform,” C-FEPS Working Paper No. 11, Kansas City, MO: Center for Full Employment and Price Stability, August, (

Wray, L. Randall and Stephanie Bell, 2000, “Financial Aspects of the Social Security ‘Problem’,” C-FEPS Working Paper No. 5, Kansas City, MO: Center for Full Employment and Price Stability, January, (


[*] Associate Fellow, Cambridge University Centre for Economic and Public Policy;
Distinguished Research Associate, Center for Full Employment and Price Stability

[**] Associate Professor and Director, Center for Full Employment and Price Stability, University of Missouri-Kansas City

Subway Tokens and Social Security

There is a wide-spread belief that Social Security surpluses must be “saved” for future retirees. Most believe that this can be done by accumulating a Trust Fund and ensuring that the Treasury does not “spend” the surplus. The “saviors” of Social Security thus insist that the rest of the government’s budget must remain balanced, for otherwise the Treasury would be forced to “dip into” Social Security reserves.

Can a Trust Fund help to provide for future retirees? Suppose the New York Transit Authority (NYTA) decided to offer subway tokens as part of the retirement package provided to employees—say, 50 free tokens a month after retirement. Should the city therefore attempt to run an annual “surplus” of tokens (collecting more tokens per month than it pays out) today in order to accumulate a trust fund of tokens to be provided to tomorrow’s NYTA retirees? Of course not. When tokens are needed to pay future retirees, the City will simply issue more tokens at that time. Not only is accumulation of a hoard of tokens by the City unnecessary, it will not in any way ease the burden of providing subway rides for future retirees. Whether or not the City can meet its obligation to future retirees will depend on the ability of the transit system to carry the paying customers plus NYTA retirees.

Note, also, that the NYTA does not currently attempt to run a “balanced budget”, and, indeed, consistently runs a subway token deficit. That is, it consistently pays-out more tokens than it receives, as riders hoard tokens or lose them. Attempting to run a surplus of subway tokens would eventually result in a shortage of tokens, with customers unable to obtain them. A properly-run transit system would always run a deficit—issuing more tokens than it receives.

Accumulation of a Social Security Trust Fund is neither necessary nor useful. Just as a subway token surplus cannot help to provide subway rides for future retirees, neither can the Social Security Trust Fund help provide for babyboomer retirees. Whether the future burden of retirees will be excessive or not will depend on our society’s ability to produce real goods and services (including subway rides) at the time that they will be needed. Nor does it make any sense for our government to run a budget surplus—which simply reduces disposable income of the private sector. Just as a NYTA token surplus would generate lines of token-less people wanting rides, a federal budget surplus will generate jobless people desiring the necessities of life (including subway rides).