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January 4, 1990 ALTHOUGH 1990 is barely newborn, the relationship between Social Security and the rest of the federal budget is already making its bid to be the most misunderstood issue of the year. Here is the background: Because Americans are living longer and retiring sooner, it became apparent in the early 1980s that Social Security was headed for bankruptcy. If it didn't go broke almost right away, it would surely sink in red ink when the baby-boom generation began to retire in the second and third decades of the 21st century. A bipartisan commission proposed and Congress adopted a laundry list of fixes for the system, of which two steps were particularly important. The first notable change was to hike up the payroll tax rate for Social Security and Medicare. The first column of the table below shows the increase in Social Security tax rates. Because the tax is paid by both the employee and the employer, the total payroll tax rate is twice as high as shown here. The payroll tax is imposed on all income earned up to some maximum dollar amount, shown in the second column of the table. The third column multiplies the first two columns, showing the highest dollar amount an individual could pay directly in Social Security taxes. Finally, the fourth column illustrates that even when the amounts paid in the 1950s and 1960s and 1970s are adjusted to account for inflation, the payroll tax was still much lower than it has become today. The second major change enacted in 1983 was to stop Social Security from being a "pay-as-you-go" system. Social Security had traditionally been a program that broke even in any given year, collecting money from workers and distributing checks to retirees. Contrary to popular belief, Social Security did not invest your money, collect interest on it, and then return it to you. To avoid bankruptcy in the 21st century, it was agreed to build up a reserve in the Social Security trust fund. The current generation of workers would not only pay for the retirement of the current generation of retirees, but it would help to pay in advance for its own retirement, too. There were many ironies in the way that Social Security was saved. For example, just as the federal government was patting itself on the back for the Tax Reform Act of 1986, which made sure that millions of poor and near-poor workers would not owe income taxes, it was sharply raising the Social Security payroll taxes paid by these low-income workers. Similarly, just as Ronald Reagan and George Bush fought against income tax increases, they happily endorsed a steady rise in payroll taxes which has offset the effect of the other income tax cuts. The total federal tax take, combining income and payroll taxes, was 19.4 percent of GNP in 1980, and will be about 19.3 percent of GNP in 1990. But the biggest irony of all is that while the federal government seemed unable to cope with the huge budget deficits of the 1980s, it was simultaneously agreeing to increase its spending on Social Security and Medicare dramatically (as shown in the table at right) and also to accumulate hundreds of billions of dollars in the Social Security trust fund. The biggest myth about Social Security and Medicare is that accounting sleight-of-hand can keep it separate from the rest of the budget. Under current federal law, for example, Social Security is not officially part of the budget, but the surplus in Social Security helps to reduce the official deficit. Sometime this year, Congress will probably act on proposals that the "official" deficit should be calculated without using the Social Security surplus. From a purely economic point of view, accounting tricks like these make no difference. The budget deficit is not a problem because it is badly defined, but because it collects savings (whether domestic or foreign) that might be used for long- term investment, and uses that money for immediate government consumption. Economists measure federal debt "held by the public"; and if the government can borrow from the Social Security trust fund, it has less need to borrow from the public and the impact of the budget deficit is smaller. I heard a radio deejay a few days ago complaining that the federal government was taking our Social Security money and spending it. That's just wrong. In fact, the rest of the government is borrowing money from the trust fund, but promising to repay with interest. However, a promise to repay the debt to the Social Security and Medicare trust fund can be broken, just as a promise to continue paying the current levels of benefits to retirees can be broken. The real issue is whether the U.S. economy will be wealthy enough in the future to support its elderly at the level to which they are intending to become accustomed. Those who propose excluding the Social Security surplus when calculating the budget deficit have a hidden agenda; they hope to use the Social Security surplus as a behind-the-scenes method of deficit reduction. Excluding the trust funds from the "official" deficit would make the deficit appear bigger, and thus might add to political pressure for reducing it. In turn, reducing federal borrowing means that America could borrow less from abroad, invest more at home, and achieve greater economic growth, the fruits of which could be spent on future retirees and everyone else. But it does not speak well for the maturity and sophistication of the American political system that these sorts of accounting games may be necessary to reduce the deficit.
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© 2010 Timothy Taylor |