EVERYTHING YOU NEED TO KNOW ABOUT SOCIAL SECURITY BUT ARE AFRAID TO ASK – PART 2
What’s the matter with Social Security? The Great Deception and its consequences.
Faced with the immiseration of millions of senior Americans during the Great Depression of the 1930s, the Roosevelt Administration proposed, and Congress passed the Social Security Act of 1935. The collection of taxes (ahem, “contributions”) to fund the program commenced in 1937 and payment of benefits began in 1940. A 1939 amendment to the Act created the Social Security Trust Fund (officially the OASDI, “Old Age Survivors and Disabilities Insurance” Trust Fund). The Fund’s purpose was to segregate the revenues and payments from the General Fund, in effect, to reflect the “self-financing” aspects of the program (ergo, it’s not an “entitlement” program) and the application of the Trust’s revenues to their intended objective of providing financial support to the elderly and disabled. (For the complete history of Social Security published by the Social Security Administration click here.)
The Act, as amended, requires the Trust Fund to invest in 1) outstanding federal government bonds purchased from the public at the market price; 2) securities on original issue at par (in other words, newly issued, marketable government bonds straight from the Treasury, bypassing the market); and 3) "special obligation bonds" issuable only to government trust funds, including the Social Security Trust Fund and redeemed only by the Treasury. The full faith and credit of the U.S. Government stand behind all these investments. The first two types of bonds, being marketable, represent legitimate stores of value, real assets convertible immediately to cash by sales to the public. While the first of these, can be converted to cash without increasing the national debt, the remaining two require the Treasury to borrow additional funds through the General Fund to be passed on to the Trust, thereby increasing the national debt. The newly issued, marketable bonds represent an immediate increase in the national debt whereas the “special obligation bonds” represent commitments to future increases in the national debt. Here’s why.
Very few people understand the concept behind the “special obligation bonds.” Most folks, including some members of Congress and media commentators, mistakenly think they are real assets, a store of value equivalent to bonds purchased on the open market, capable of underwriting Trust Fund deficits until 2035. Others, more cynical, noting that they are “non-marketable,” perceive them as “worthless IOUs.” The truth lies somewhere in between.
What makes non-marketable bonds “special” is the Trust Fund’s inability to sell them directly to the public to raise cash for payments to Social Security recipients. The Fund can redeem them for cash only by tendering them to the Treasury. And here’s the part most people miss: Where does the Treasury get the cash to redeem the Trust Fund’s special obligation bonds? There are only two possible sources: the current tax revenues of the General Fund or from issuance of new bonds. The General Fund has no surplus cash, and, in fact, consistently runs deficits, thanks largely to under-taxation of the wealthy and bloated military spending (at the insistence of wealthy Republican donors). Therefore, in the likely absence of a tax increase on the wealthy (anathema to Republicans) or significant cuts in discretionary spending (resisted by Democrats), the Treasury can only raise the cash through additional borrowing. That’s the fundamental difference between non-marketable special obligation bonds on the one hand, and marketable bonds either purchased from the public or newly issued to the Trust Fund by the Treasury on the other. Marketable bonds are stores of value, non-marketable bonds have no intrinsic value. They serve only as markers or memos indicating how much the government intends to borrow when the time comes to fill in the deficit between how much the Trust Fund takes in and pays out. That’s a huge difference of which the public is unaware, being unable to distinguish between the two. Think about it: Which would you rather have in your 401k account, a marketable bond or your own IOU?
Accordingly, most folks err by taking comfort in the assumption that the $2.7 trillion in special obligation bonds within the Trust are real assets convertible to cash like an equivalent amount of bonds purchased on the open market. Special obligation bonds are fictitious assets, an accounting device expressing only how much the government 1) has drained from the Trust Fund over the years, and 2) will have to borrow to underwrite the Trust Fund’s deficits until 2035, according to current projections. After that, without further borrowing or tax increases, the Trust funds will only be able to pay out about an estimated 78 cents on every dollar owed to beneficiaries according to the current formula for benefits.
Had the Trust Administrators invested the surpluses in government bonds purchased on the open market, they could have underwritten the Fund’s deficits until 2035 and, perhaps, beyond without the need to borrow. However, Congress, in its wisdom, thought otherwise and, under the Unified Budget concept, promptly spent the surpluses on current government operations, leaving nothing in the fund other than the government’s promise to repay from the General fund as needed, the cumulative surpluses withdrawn from the Trust Fund, now totaling $2.7 trillion.
In this day and age of unending $1-$2 trillion General Fund deficits and smaller, yet significant Trust Fund deficits; Republican refusal to raise taxes on corporations and rich Republican donors, eager to dismantle the New Deal and Great Society; threats by nihilistic House Republicans refusing to raise the debt ceiling without draconian cuts in discretionary social spending (opposed by Democrats), ignoring the specter of a government shutdown and default; such promises must necessarily be regarded as highly uncertain at best and unlikely at worst.
We must face the reality that the Trust Fund has been insolvent ever since it began running deficits around 2010, entirely dependent upon a dysfunctional House of Representatives (now apparently run by Marjorie Taylor Greene taking telephoned orders from Donald Trump) to make up Trust Fund deficits by piling yet more debt on top of a national debt already exceeding that of World War II as a percentage of GDP. If that’s not reason enough to panic, I don’t know what is.
The government, under both political parties, perpetrates this deception, as previously stated, by relying on the public’s inability to distinguish between marketable and non-marketable government bonds. Official pronouncements by the Social Security Administration do little to dispel this misperception, and, in fact, perpetuate it, stating only that:
“Money flowing into the trust funds is invested in U. S. Government securities. Because the government spends this borrowed cash, some people see the trust fund asset reserves as an accumulation of securities that the government will be unable to make good on in the future. Without legislation to restore long-range solvency of the trust funds, redemption of long-term securities before maturity would be necessary.”
“Far from being "worthless IOUs," the investments held by the trust funds are backed by the full faith and credit of the U. S. Government. The government has always repaid Social Security, with interest. The special-issue securities are, therefore, just as safe as U.S. Savings Bonds or other financial instruments of the Federal government ‘backed by the full faith and credit of the United States Government.’” (Click here.)
Nothing to see here, folks. It’s a bit like “If we had ham we could have ham and eggs . . . if we had eggs.”
The reassuring statement, “The government has always repaid Social Security, with interest,” carries with it the questionable implication that it always will. However, filling in the Trust Fund’s recurring deficits (since about 2010) until 2035 by redeeming $2.7 trillion in special obligation bonds will depend entirely on the willingness and ability of the Federal Government to borrow that amount. This assumption cannot be taken for granted if the government does not borrow due to the previously stated perilous financial conditions of the U.S. government and political headwinds, notably Republican unwillingness to raise the debt ceiling without draconian cuts in social spending (food stamps, welfare, and other programs relieving poverty) unacceptable to Democrats – an impasse that if not resolved, would result in a government shutdown and default in a monumental game of chicken.
The obvious solution to the deficit problem, raising taxes on the rich (where the money is), does not occur to Republicans. Instead, they insist on squeezing blood from a stone by slashing what remains the relatively small portion of the discretionary budget they haven’t “taken off the table,” (like military spending, Veterans’ Administration, accounting for slightly more than half the discretionary budget, which is only 30 percent of the total federal 2023 budget to begin with.) Default or even a temporary government shutdown raises the possibility that the government either cannot borrow or can do so only at exorbitant rates of interest due to lender resistance due not only to the $31.46 trillion already borrowed, but also the recurring stalemates in Washington over future borrowing adding to the likelihood of significant downgrading of U.S. government creditworthiness and/or devaluation of the dollar. Obviously, such outcomes pose serious problems for the government and the American people at a time when seemingly irreconcilable division in the country may freeze the government into inaction and trigger the population to violence. (See: David L. Smith’s Cassandra Chronicles.)
The first hint of such dire outcomes emerged with Standard & Poor’s downgrading of U.S. government bonds from AAA to AA+ in the wake of the 2011 standoff between the Obama Administration and the Republican-dominated House of Representatives. Further downgrades may be in store if the government continues racking up debt exponentially, steadily eroding U.S. Government debt capacity, as it has (with a brief exception during the Clinton Administration) ever since the “deficits-don’t-matter” days of the Reagan Administration (See here). [1],[2]
Supported by its traditional role as a reserve currency by most governments, multitudes of individuals, the International Monetary Fund, and other organizations following World War 2, the U.S. dollar remains vulnerable to the ongoing trend within these institutions to diversify their reserves with a basket of other major currencies and gold. China, in particular, seems eager to put forth the yuan as an alternative reserve currency. Skyrocketing federal debt, resurgent inflation, and ongoing trade deficits further weigh on the dollar’s value and, hence, on the government’s ability to borrow.
Who knows? Stranger things have happened, as in Argentina, once the world’s 7th largest economy (thanks to beef and grain exports to combatants in both world wars), now a debt pariah following its massive defaults and debt restructuring in 2001 and 2020, cursed with a languishing economy, runaway inflation, widespread poverty, and a plunging peso to the present. These conditions can be attributed to Peronismo in the immediate Postwar period and beyond. Perón, deposed by the military in 1955, left an enduring negative fiscal legacy resulting from the nationalization of key industries mismanaged by Perón’s cronies and subsidized by the government, plus costly concessions to powerful labor unions to curry political support, and later the catastrophic pegging of the peso to the dollar and “a wave of privatization creat{ing] conditions that proved impossible for average Argentine to manage,” all resulting in erratic lackluster economic growth, too much government spending, too little taxation, with the resulting deficits financed by printing too much money, fueling rampant inflation. In the (hopefully) improbable event of the U.S. government following similar extreme fiscal and monetary policies (even without the expropriations), then failing to redeem the Trust’s special obligation bonds would prove the cynics right about “worthless IOUs.”
Even if U.S. government finances do not deteriorate to the extent experienced by Argentina, the climbing national debt coupled with higher interest rates prompted by the recent resurgence of stubborn inflation will significantly increase the government’s cost of borrowing, thereby crowding out discretionary spending programs in the absence of payroll, personal and/or corporate income tax increases. Here are the numbers from the February 2023 Congressional Budget Office (CBO) Budget Outlook (click on table 1 at the bottom of the Excel sheet) projecting annual federal budget totals by 2033:
· Total deficit: $1.3 trillion currently rising to $2.8 trillion by 2033 – as a percent of GDP: 5.5% rising to 7.2%.
· The discretionary budget, currently $1.662 trillion rising to $2.380 trillion – as a percent of GDP 6.6% rising to 6.7%
· Of these totals, net interest accounts for $475 billion currently, trebling to $1,429 billion in 2033 – as a percent of GDP 1.9% rising to 3.6%
Notice, while the projected discretionary budget as a percent of GDP remains virtually unchanged (6.6% rising to 6.7%), net interest (excluding interagency interest payments to the various trust funds) nearly doubles as a percent of GDP (1.9% rising to 3.6%)! Even today, at 8 percent of the total federal budget, net interest exceeds every other category of discretionary spending except for military spending. Net interest expense yields no present or future value to today’s taxpayers, reflecting only the residue of government benefits to earlier generations to be paid for by future generations. And here’s the kicker: the projected net interest mandatory expense as a percent of discretionary spending, totaling 27% of the 2023 discretionary budget, will climb to an alarming 42% by 2033 crowding out almost every government agency but Defense unless taxes are raised! An inescapable conclusion: these trends cannot be sustained indefinitely. Political action must follow to avoid catastrophic consequences of debt service consuming virtually the entire discretionary budget if allowed to continue unchecked. (See Part 4 of this series.) Compound interest is a bitch for borrowers.
There are only 3 ways to pay for the higher debt burden: raise taxes, cut expenses, or “print” new money. A fourth alternative, of course, is not to pay interest or principal at all through default. Each of these alternatives inflicts its peculiar kind of pain on different constituencies – taxpayers, beneficiaries, savers, government employees, and investors – each with differing political repercussions. Pain is the common denominator. Economic instability and political discord and violence are the common results.
In broad strokes, Republicans, engaged since 1981 in the greatest upward redistribution of wealth in history under the rubric of Reaganomics, refuse to raise taxes on their rich donors, won’t cut military spending, and insist on cuts in programs benefitting everyday Americans. These programs, have roots in Roosevelt’s New Deal and Johnson’s Great Society, like Social Security and Disability Insurance, Medicare/Medicaid, Unemployment Insurance, and other trust funds, often mislabeled as “entitlements,” and within the discretionary budget, social spending (welfare, nutritional support for the poor and such).[3] [4] Democrats generally want just the opposite: raise taxes on the rich, cut military spending, and preserve the status quo on trust fund outlays and social spending. Congress remains closely divided between the two.
So an impasse prevails, muddied by culture wars, most likely leaving it to the Federal Reserve bank to pay for budget deficits with a flood of new money, producing inflation. This source of inflation, added to the present inflationary forces unleashed by the Covid-19 pandemic, suggests the Argentine experience may not be as far removed from America’s future as it might seem.
Coming next: Part 3 — How did Social Security get into this predicament?
Footnotes:
[1] In an attempt to assuage alarm over exponential increases in the national debt, some economists, led by amply credentialed Prof. Stephanie Kelton, have come up with “Modern Monetary Theory” (MMT). Federal deficits incurred to pay for infrastructure, expanded plant and equipment, research and development, and other productivity-enhancing projects, according to Kelton can be funded with new money injected into the banking system with a few computer keystrokes at “The Desk” at the New York Federal Reserve Bank, without producing inflation because these investments will increase output by as much or more than the increase in the money supply, thus avoiding the inflationary formula of “too much money chasing too few goods.” Stay tuned for a post on this subject.
[2] Note: Deficits don’t matter to Republicans only when they are in charge. However, they suddenly become a paramount concern to Republicans when power shifts to the Democrats. Not surprisingly, the greatest deficits occur during Republican administrations. Click here and here.)
[3] A recent article by Paul Krugman explains how cuts to social programs may backfire politically, angering a substantial portion of the Republican base who depend on them. (See “Wonking Out: Conservatives Face a Rude Fiscal Awokening,” N.Y. Times Feb. 24, 2023)
[4] For an eloquent and concise account of Republican objectives, listen to Thom Hartmann’s podcast “The GOP’s ‘Better Deal’ Is All About Privatizing Our Safety Net & ending the Middle Class.”
A very well reasoned and convincing article that should concern all Americans. It's interesting that the otherwise progressive and complete Biden budget addresses Medicare but not Social Security. I'm looking forward to Dr. Smith's answer as to how to save Social Security.