Dear Angry Bear

Reader Steve writes in with a good question about Greenspan’s 3-Card Monte:

Love your site and have been following the various articles about Social Security. Admittedly, my understanding of the system is very raw as is probably the case with most people who are not economists. My question is therefore very basic. How does the Trust Fund “bail out” the General Fund? If the Trust Fund holds General Fund bonds, won’t the General Fund have to eventually pay the Trust Fund?

My response:

The trust fund bails out the general fund in the following sense (the numbers are made up, but the point will hopefully be clear):

1. The government spends $1.4 trillion on everything but social security.

2. The government collects $600 billion in non-social security taxes.

3. So the deficit is $800 billion, seemingly.

4. Now suppose that social security collects $800b in payroll taxes while spending only $600b in payments to retirees. So Social Security has a $200b surplus which it uses to buy bonds from the U.S. Treasury (had Gore won in 2000, said bonds would, apparently, have been put in a lockbox of some sort).

Now, here’s how the deficit you typically hear about is computed:

  • Total money in is $600b (income taxes) + $800b (payroll taxes) = $1.4 trillion
  • Total money out is $1.4 trillion + $600b = $2 trillion.
  • Deficit = $600b (Not $800b!)

So while the operating deficit is $800b (see 3, above), the total deficit after counting Social Security’s surplus is only $600b. Thus, the trust fund has “bailed out” the general fund and in the process mitigated some of the outrage and political problems that accompany large deficits. In principle, the general fund will eventually have to repay the trust fund, but that’s a long time away. And, if we instead privatize social security or otherwise cancel the program, then that time may never come.

The result of this has been that for the last twenty-plus years payroll taxes have been higher and income taxes have been lower. Of course, payroll taxes are regressive while income taxes are progressive, so this has been a big transfer of wealth from the lower and middle classes to the upper class. That transfer was premised on the idea that, someday, the social security system would stop running surpluses and start running deficits. And those deficits would be made up by cashing in the accumulated Treasury Bonds, which would be paid off by raising income taxes, thereby reversing the transfer.

We’ve already had, and still have, the upwards wealth transfer part. Whether the implicit promise will be honored remains to be seen.