This Week:

 

Economics of Social Security for Beginners

Greetings,

Please do not read the following essay now. Read the other E-mail I just sent you entitled "Stop the attack on Iraq!" That's more important right now.

Just as I was about to send out this edition of the Notes, the United States began bombing Iraq again. So I will only send along the essay that I just finished. I think it's very easy to understand, and quite important. Just don't read it right now. Take action on Iraq. For more information, try checking out these websites: The Iraq Foundation: http://www.iraqfoundation.org/ American Arab Anti-Discrimination Committee: http://www.adc.org/

It may be too early for them to have anything yet. If I get any more info, I'll forward it to you. Even as I type this, I hear the voice of Madeline Albright on the radio, saying that "We will take all measures to minimize civilian casualties." When will this madness end? Take action now.

‘Til next week,

Nygaard

Economics of Social Security for Beginners

[or Everything You Know is Wrong]

My nephew gave me a surprised look the other day when I said, "Mathematics is interesting to me." Maybe I'm an unusual person, but I not only think that math is interesting, but also understandable, even for those with little aptitude for the sorts of math things most of us had to study in high school. I'm not talking about equations and all that other technical stuff; I'm talking about what gives numbers meaning, and why we care about them. Why am I saying all this? Because this week's Nygaard Notes is all about numbers. And not just any numbers, but the numbers that everybody gets all wrong when they talk about Social Security going "bankrupt." The odd thing is, I not only expect most readers to understand these things, but actually to find them INTERESTING! Impossible, you say? Read on.

Pete, my barber, told me today that just last week he had a man in his shop who was going on and on about how screwed-up the Social Security system is, and always has been. One of the things that bugs him the most, Pete said, is that the money in the Social Security trust fund has just been frittered away by the government, so that there is now no money in there to pay for future benefits. Not only that, he told Pete, but the trust fund has been mismanaged since the program began in the Thirties, which explains why it's finally going broke!

This fellow is certainly not alone in having these opinions, and he's not the only one who's angry. Now, if you are one of those folks who is angry about government mismanagement of your retirement funds or you know someone who is then reading the following information should help to reduce some of this unnecessary stress.

What is the Trust Fund?

First of all, there has only been a "trust fund" of any consequence since 1984. For the previous 57 years Social Security was almost a pure "pay-as-you-go" system. What that means is that Social Security previously only collected enough taxes each year to pay for the benefits in that same year. (Although a small amount was always kept in reserve for cash-flow purposes.) In 1983 the law was changed so that it now takes in more in taxes than is needed to pay current benefits, thus creating what we know as the "trust fund." So the trust fund couldn't have been mismanaged since the Thirties, because there was no such thing until the Eighties.

Why did the Congress create a trust fund for Social Security in 1983? The reason is that the Social Security Trustees were anticipating the retirement of the famous "baby boomers" S that big group of Americans born between 1946 and 1964. They looked ahead and saw that the retirement of such a large group would be hard to pay for on a strict "pay-as-you-go" basis, so they increased payroll taxes to make the system be partially "pre-funded." And it worked. Current projections are that the system will be 100% funded until at least the year 2032, when the youngest baby boomer will be 68 years old, and already retired.

Here's how the numbers add up: Current taxes will cover everything just fine until about the year 2013. From 2013 to about 2022 we will pay full benefits by using the income from current taxes plus the interest the trust fund has earned. The trust fund will be huge by this time, about $3.8 trillion - yes, TRILLION. That is a huge number, true, but it needs to be put in perspective: the interest that the government will owe to the Social Security trust fund at its highest point in the year 2015 will be less than one-third as large (in proportion to the size of the economy) as the interest burden the government bears in 1998.

From 2022 to 2032, current taxes, plus the interest and the principal in the trust fund, will be sufficient to pay 100% of promised benefits through those years. Then, if the (pessimistic) economic projections of the Trustees are true, the trust fund is projected to be all used up, and we will have to depend entirely on current taxes, which will at that time only cover about 72% of promised benefits. This does not pose a "crisis." Relatively modest changes can be made in the next ten years that will make the system solvent for the next 100 years or more. If we wanted to, we could even make substantial changes that would bring the system more in line with that of other wealthy countries. There is no shortage of ideas, only of political will. [See Nygaard Notes #11 for a few of these ideas.] All of the above numbers are contained in the report of the Social Security Trustees.

No Money in the Trust Fund?

So, the trust fund is doing just what it was set up to do. But is there really any money in this trust fund? Please don't succumb to panic when I say "No, there isn't." There is no money there, no more than the money in your savings account is really "there" in your bank. One of the most common misconceptions about the Social Security trust fund is that there is a huge pile of $100 bills sitting somewhere waiting until people retire. This is not how it works; not with your checking account, and not with the U.S. Treasury. Here's how it does work:

When the Social Security system receives more in taxes than it needs to pay current benefits, it uses that "extra" money to buy U.S. Treasury bonds. Now, what is a "bond?" Here's where you have to think like an economist. Sarah and Jim will illustrate: When Sarah "buys" a bond from Jim, what that means is that Sarah is loaning Jim some money. Sarah loans Jim the money, and Jim gives Sarah a "bond," which is simply a piece of paper that says Sarah will get her money back from Jim, with interest, at a certain point in the future. What she is buying is a promise.

Some promises are better than others, of course. That's why interest rates are not all the same. Since some bonds are very risky, you may never get anything back. To entice you to buy them, the interest rates on risky bonds are higher than the rate on low-risk bonds. In effect, people who are bad investment risks will pay you more money S that is, pay higher interest rates S to get you to loan them money. You can say you "bought a bond" or you can say you "invested your money." It means the same thing.

When Sarah, or anyone else, invests their money in Jim's bonds, Jim does not just pile up that money and jump in it like Scrooge McDuck used to do (maybe he still does; I'll have to ask Huey, Dewey, or Louie). Jim will either 1) loan out Sarah's money to someone who will pay him a higher rate than Sarah paid him, or 2) spend her money on whatever he wants. This is how the credit markets work; it works out fine for both sides, as long as the bonds are redeemed on time and with the proper interest.

U.S. Treasury Bonds are recognized around the world as absolutely the safest investment one can make. When you loan money to the U.S. Government -- that is, buy Treasury Bonds -- you are as sure as you can possibly be that you will get your money back, with interest. Just ask any investor. In fact, when people express concern about the risks involved in privatized Social Security accounts, the proponents will counter with "Well, if you're worried about risk, you can always invest in T-Bonds." This is why the Congress requires that the Social Security trust funds be invested in Treasury Bonds, even though they have relatively low interest rates: they are safe and secure.

Government Spending and Social Security

Critics say, "But the government has spent the money in the Trust Fund!" That is true. And when your Uncle Ted or Aunt Sophie buy Treasury Bonds, the government spends their money, too. The government uses money from bond sales to build roads, to pay clerks, to attack small Third-World countries, or whatever government does. There may be problems with how the government spends our money, but they don't have anything to do with Social Security. The key point for our purposes is that the government pays off its bond obligations. Always has. The Treasury Bonds held by the Social Security trust fund are thus very secure assets.

You can't blame people for being surprised at what I've written so far in this edition of Nygaard Notes. We've all been subjected to plenty of propaganda saying that the trust fund "is a fiction," "is just IOU's," "isn't really there," is nothing but a "bookkeeping device," a "shell game," a "ticking time bomb," and even "thievery." People get pretty worked up about this stuff.

The people who say these things are hoping that you will believe that the United States government is going to default on it's bond obligations, which means that it will refuse to raise sufficient tax revenue to pay its debts. As economist Dean Baker puts it, "More specifically, it means a multi-trillion-dollar gift to the wealthy individuals and corporations who would otherwise be providing most of the needed tax revenue. I can understand why the wealthy would argue that the trust fund is an accounting fiction. If I borrowed a thousand dollars from my neighbor and gave him a promissory note, I might try to persuade him that it was worthless and he should throw it away. But he would be a fool if he followed my advice."

To say that the government will default on its debts is not just to predict the greatest scam in U.S. history -- it's even more serious than that. As the late economist Robert Eisner wrote, "...if Treasury securities or promises by the government to pay are worthless, then so is all our money." This is the conclusion you have to come to if you think about what all these Chicken Littles are saying. But they don't want you to think. They want you to get so scared that their radical privatization schemes start to sound good to you. Fear makes people do funny things.

One last Minnesota note on the subject: Our junior Senator, Rod Grams, likes to say this about our obligations to pay Social Security benefits in the future: "[W]e have made promises but with no money to back it up yet." He says with alarm that we thus have trillions of dollars in "unfunded liabilities." He is correct. It's also correct to say that my mortgage obligates me to pay more than $3,000 to TCF Bank in the year 2019 (and lots of other years). I confess: I have no money to "back that up" yet. My plan is to earn money that year and use some of it to make my mortgage payments. The government has very similar plans to make it's Social Security payments in the future. That is what Mr. Grams means (I guess) when he speaks of "unfunded liabilities." It's true, and it's irrelevant to the current discussion. More on Rod Grams and his Social Security plans in a future Nygaard Notes.

If you really get into the details of Social Security, it can be mind-numbingly complex. It is, after all, the largest government program in the world. But you don't need to know too much more than what you've just read in order to get your Social Security Bullshit Detector (TM) up and running. Lots of people want you to believe that the sky is falling. The last thing they want you to believe is that your best shelter is a universal, public system of Social Security.