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Last week I quoted President Bush telling reporters that “There is no trust fund. Just IOUs that I saw first-hand.” He's not the only one who likes to say that. If you type the phrases “There is no trust fund” and “Social Security” into your handy-dandy Internet search engine, you'll get several thousand references.
Why Do We Have a Trust Fund?
For the first 50 years of its existence, the “Social Security Trust Fund” functioned more or less like my checking account. In my case, I deposit the money I earn this month, and almost all of it will go out at the end of the month to pay my bills. Likewise, for 50 years all of the Social Security taxes coming into the system each month were used to pay benefits that same month. Just as with my own checking account, the Social Security account would never balance exactly, and the money that didn't go out in any given month went into a “Trust Fund” and got used the next month, or when needed. It was tiny and inconsequential. Until 1983.
In that year, when there was a genuine crisis facing Social Security, a bipartisan group led by Alan Greenspan got together and proposed some serious changes to Social Security. One of the changes was to increase Social Security payroll taxes to a rate high enough not only to cover current benefits (as they had always done), but high enough to set aside some extra money, to be saved up and used to help fund the anticipated retirement of the large “Baby Boom” generation. (The first of the Boomers is set to be eligible for Social Security benefits in 2008.) This “extra money” went into the “Trust Fund,” and suddenly it started getting big. It's a trillion-and-a-half dollars now, and will be over $3 trillion by 2018, when we'll need to start drawing it down to help pay for the Boomers.
[Editor's aside: I think this reform was a mistake, as it transformed a “Pay-As-You-Go” system (that's what you call it when current revenues are used to pay current benefits) into a partly “Pre-funded” system (which is what you call it when you set aside money now to pay for your own benefits later). To put it another way, it moved the system away from the social insurance plan it had been toward a more conventional pension plan. Now people are all confused, and they talk about “rates of return” and investments and all kinds of wacky stuff. But that's for another article.]
The Trust Fund Explained
When you deposit money into your savings account at your bank or credit union, do you think they hold on to your money, perhaps keeping it in a vault somewhere? They do not. They loan it out. That's how banks make money. So, most of the money that is supposedly “in” people's accounts is not actually at the bank at any given time. So, if there were to be a “panic,” and everyone were to go to the bank for their money at the same time, that would be what is called a “run on the bank.” That's a problem because banks only have a small percentage of your money on hand at any given moment, since most of it is loaned out, earning money. Fortunately, the only times there are “runs” on banks is when a bunch of people freak out and try to go get their money, because they have lost faith in the system. This doesn't happen too often. (Plus, since 1933 your bank account has been insured by the Federal government.)
It's the same deal with the Social Security Trust Fund. Lots of people apparently think that the Trust Fund consists of a big pile of money stashed away in some vault somewhere. But, just like with your bank, that's not how it works. The payroll taxes that come in to Social Security that are not used to pay current benefits (that's about 10 percent of your taxes at the moment), are invested in Treasury Bonds.
Now, remember what “bonds” are: When you “buy a bond” from the government, this means that, in effect, you are loaning the government money. The government “sells bonds” as a way of borrowing money, just like anybody who sells bonds. Bonds are – by definition – “IOUs.” When you “buy a bond” (that is, loan someone money), you get a promise to be paid back, with interest. So, when the Social Security Trust Fund buys bonds, it is loaning the rest of the government money. This is neither a secret, nor a scandal, despite some people's efforts to paint it as such.
When the government borrows money by selling bonds – whether they are sold to Social Security, or to China, or to your uncle Ted – the government turns around and spends the money. Again, this is how most loans work. I mean, who borrows money and just hangs on to it? People borrow money so they can spend it on something. In the case of the government, the money it borrows by selling bonds is spent on congressional salaries, roads, weapons, tax cuts, or whatever government decides to pay for.
Then, when the time comes to pay off the bonds, the government comes up with the money in some way. One way is to raise taxes (see above). But, don't forget, the federal government can also print money (unlike you and me!), or it can simply borrow more money from someone else and use that money to pay off the T-Bonds that are due.
So, when people say “There is no Trust Fund,” they are wrong in the sense that there is, indeed, an agreement on the part of the government to pay back the loans it has taken. They are correct in the sense that there is no pile of money sitting around that will be used to pay my Social Security benefits in 15 years. But they're not really correct, because nobody who knows anything about government borrowing ever thought that there was a pile of money in the first place. So, really, anybody who says “There is no trust fund” is either ignorant, or they are trying to put something over on you. Which do you suppose it is in the case of the President of the United States?
Next week: The Baby Boomers are retiring! And, Where are those missing trillions? |
