Playing the Social Security Trust Fund Shell Game

There’s a simple way to calculate the size of the federal government’s debt at any point in the future:

D’ = D – R + S – T

Where,

D’ = Amount of debt at a future date

D = Present debt

R = Federal government’s revenues from all sources (including Social Security taxes), from the present to the future date

S = Federal government’s spending for all purposes (including SS benefits), from the present to the future date

T = Value of Treasury securities redeemed by the SS trust fund to defray the gap between SS taxes collected and SS benefits paid

(For an explanation of how the redemption of securities by the trust fund can reduce the debt, see below.)

The present level of debt (D) is approximately equal to the debt ceiling. Therefore, as long as the deficit (R – S) is greater than the value of securities redeemed by the trust fund (T) to pay current benefits, the debt ceiling must rise or spending must be cut. (Aside: The ability of SS trustees to redeem trust fund holdings and pay benefits is simply a mechanism for ensuring the payment of full benefits until the trust fund is exhausted, regardless of any budget crunch. The trust fund, itself, is nothing more than a set of numbers in a government ledger. It isn’t an asset, any more than swampland is an asset to a sucker who buys it sight unseen.)

In theory, the trust fund could be exploited to get around the ceiling, by redeeming more holdings than required for the payment of current benefits. It’s a ploy was used in the past but is now illegal, Michael McConnell explained it in 2011:

The Social Security Trust Fund holds over $2 trillion [now over $2.7 trillion] in special Treasury securities, which it is legally entitled to redeem when necessary for the payment of benefits. When the Treasury redeems those bonds, the public debt will correspondingly be reduced, which will enable it to auction new bonds to investors, without violating the debt ceiling. This is precisely what happened during the debt ceiling crisis in 1985. Then, it was a Democratic House of Representatives that refused to raise the ceiling at the behest of a Republican President (an episode conveniently forgotten by those who wish to paint the Republican House today as uniquely evil for insisting that a debt ceiling increase be accompanied by spending reductions). The Social Security trustees cashed in some $9 billion in special Treasury securities for the payment of benefits, and the Treasury auctioned off the same amount in new U.S. bonds, without violating the debt ceiling. Here is how the Comptroller General described the event:

The Treasury Department estimated that it would have insufficient cash on November 1 to pay social security benefits and other government obligations. In order for these payments to be made, the Treasury needed to borrow money from the public, and in order to borrow the money, Treasury had to reduce its outstanding debt below the statutory limit. Therefore, on November 1 the Secretary redeemed $9.613 billion of the Trust Funds’ long-term securities, and $1.9 billion of securities held by certain other government-managed trust funds, to permit public borrowing of about $13 billion.

In this way, the Reagan Treasury was able to continue to pay Social Security benefits without interruption, despite the failure of Congress to raise the debt ceiling at the time.

The Comptroller General ruled that these redemptions were lawful, except that the trust fund redeemed more securities than were actually necessary for the payment of benefits. Some years later, Congress passed a statute codifying the Comptroller General’s decision. Public Law 104-121, section 107(a), prohibits redemption of special securities held by Social Security prior to maturity for any purpose other than the payment of benefits or administrative expenses. This statute is significant for two reasons. First, it confirms that the trustees have authority to redeem the special securities prior to maturity for the payment of benefits, and second, it prevents the executive from using the trust fund as a massive kitty to avoid the effect of the debt ceiling.

What could happen if the law were repealed? This:

1. Given the estimated size of the trust fund at the end of 2014 (as reported here), trust fund holdings could be liquidated as follows: FY 2015 — $469 billion; FY 2016 — $536 billion; FY 2017 — $576 billion; FY 2018 — $627 billion; FY 2019 — $722 billion; FY 2020 — $144 billion. The payout in FY 2020 would exhaust the trust fund. The total ($3.1 trillion) exceeds the estimated value of the trust fund at the end of 2014 ($2.8 trillion) because the trust fund would be credited with interest on its remaining holdings while those holdings were being drawn down.

2. The redemptions in 2015-2019 would entirely offset projected budget deficits for those years; the redemption in 2020 would offset about one-fifth of that year’s projected deficit. (See Table 1 here.) Thus it wouldn’t be necessary to reduce federal spending from currently projected levels until some time in 2020.

3. Under present law, however, depletion of the trust fund means that SS benefits must then be cut to a level that can be sustained by SS taxes. The cuts would be relatively small at first, but would grow steadily through the years. (Go here and compare the columns “non-interest income” and “cost” for the years 2020 and beyond.) For example, benefits in 2021 would have to be reduced to 90 percent of the level currently planned for that year; by 2030, benefits would have to be reduced to 80 percent of the planned level.

The good news — if the ploy could be executed — is that the Social Security crisis would be brought forward to the near future, instead of being deferred until 2033, when the trust fund is now expected to vanish. The undeniable urgency of the situation might compel Congress and the president to act — and perhaps to do something about the federal government’s entire fiscal mess — instead of continuing to kick the can down the road.

The bad news is that the federal government would run huge deficits for the next several years (at least). Programs that are unaffordable in the long run would be kept alive to acquire larger constituencies. Accordingly, it would be harder to curtail or kill them.

The real solution, of course, isn’t fiscal trickery; it’s fiscal responsibility. Let’s hope that 2017 brings with it a Congress and White House controlled by the non-RINO wing of the GOP.

*     *     *

Related posts:
Economics: A Survey (also here)
Why Are Interest Rates So Low?
Estimating the Rahn Curve: Or, How Government Spending Inhibits Economic Growth
America’s Financial Crisis Is Now
“Social Insurance” Isn’t Insurance — Nor Is Obamacare
The Keynesian Multiplier: Phony Math
The True Multiplier