Debt vs Unfunded Liability: Entitlement Commission Bait and Switch
by Bruce Webb
A bipartisan group of Senators is making a push to tie an increase in the debt ceiling to establishment of a Commission whose focus in on reducing the growth of entitlements. Now clearly Medicare spending growth at its current rate is not sustainable, which fact makes the current full-throated defense of that spending by Republicans fairly ironic, but something should be done and in fact is being done via the current HCR proposals. But pointing to the Debt Clock is not a good reason to slash away at Medicare or Social Security, because those slashes actually make that Clock run the wrong way by increasing and not decreasing Public Debt.
Why cutting spending increases debt explained under the fold.
When the Peter G Peterson people claim that Social Security and Medicare are in crisis they tend to use Unfunded Liability over the Infinite Future Horizon as the measure and so produce figures like $105 trillion. Which they then divide by current population to produce a debt per person figure as in every man, woman and child owes $33,000 or whatever. But this is to confuse two very different things. Because at the bound Unfunded Liability and Public Debt move in opposite directions.
In FY 2000, the last full FY of the Clinton Administration, the United States ran a Unified Budget surplus of $235 billion. Hurrah! But the Public Debt Clock showed an increase in debt of $18 billion. Oh noes! Why the disconnect? Because Trust Fund surpluses score as debt for the purpose of total Public Debt. If we go to the Treasury’s Debt to the Penny web application and insert a starting point of Sept 30, 1999 and an end date of Sept 29, 2000 we see that on the first day of that Fiscal Year Debt held by the Public, which included the Chinese Central Bank was $3.636 trillion. By the final day that was down to $3.405 trillion. This was unequivocal good news, not only did the US open up that much more borrowing room for FY 2001, it also cut $10 billion a year off of projected debt service going forward. But if we shift our eyes two columns to the right we see that total Public Debt went up from $5.656 trillion to $5.674 trillion. And the reason is simple, investing Social Security surpluses in Special Treasuries adds to Intragovernmental Holdings which with Debt Held by the Public makes up Public Debt.
All of which leads to some paradoxical results. Currently Social Security is running a moderate but shrinking cash surplus from excess FICA collections plus tax on benefits. That cash surplus (which CBO calls ‘Primary surplus’) plus the amount of accrued interest makes up the total Social Security Surplus which is then combined with a General Fund surplus/deficit to create a Unified Budget surplus/deficit, making large SS cash surpluses a good thing. On the other hand each of those dollars gets converted to an interest earning Treasury so adding a dollar to total Public Debt plus some 3-5% compounded interest so ticking the Debt Clock up. Under current revenue and spending models the Primary Surplus is set to dwindle and then disappear in 2017 at which point the Trust Fund would have to start taking a portion of its accrued interest in cash rather than Special Treasuries and so causing the rate of increase in Public Debt due to Social Security to slow down. Some six years later those same projections show that paying full scheduled benefits will require all accrued interest which so caps the Trust Fund balance and so the maximum amount of Public Debt due to Social Security. In succeeding years this draw down extends to TF principal and so starts reducing Public Debt until sometime after 2039 the Trust Fund is exhausted and no longer contributing to Public Debt at all.
But what happens if we convene an Entitlements Commission and simply adjusted the scheduled benefit so that current year tax revenues met current year outlays? Well two things. One unfunded liability goes to zero. Two Public Debt skyrockets at whatever rate the compounded interest mounts up. So when Senators point to the Debt Clock and proclaim that $12 trillion in Public Debt is a reason to cut Social Security they are wittingly or not confusing Unfunded Liability and Public Debt which for Social Security move in opposite directions.
There are reasons to fix Social Security by putting it on a glide path to Long Term Actuarial Balance, which is to say a system whose overall financing pays 100% of whatever scheduled benefits may be while maintaining a minimum of 1 year in projected reserves in each of the next 75 years, and in principle this could be done with minor tweaks on either the revenue or benefit side. Coberly has long proposed fixing it on the revenue side and so ran the numbers for what we call the Northwest Plan http://spreadsheets.google.com/pub?key=r49_nOHQG4QdHuwcbMGmP0Q, I following Professor Rosser have been willing to entertain the risk of small benefit cuts because we believe that the current economic model of Intermediate Cost is too pessimistic, but either way the argument doesn’t turn on specific figures on the Debt Clock which for the purposes of this discussion are irrelevant.
Under the Northwest Plan the Social Security Trust Funds will have a combined balance of $33 trillion in 2085 which will score as such on the Debt Clock. And servicing the Trust Funds will require some transfers from the General Fund to keep that balance from compounding out of control, a transfer that will grow every year, but on balance by a more or less steady share of national income growth. Leaving Social Security with an Unfunded Liability of $0.
I don’t know if every Senator pushing for an Entitlements Commission understands that at the bound Public Debt and Unfunded Liability move in opposite directions, that solutions aimed at the latter actually potentially exacerbate the former but certainly you would expect that a former Comptroller General of the United States would understand the budgeting mechanism. For him to point at the Debt Clock as a reason to move on Social Security is just special pleading and playing games with with incommensurate numbers. What we have is two big numbers that in different ways represent some sort of forwarded shifted liability. Which doesn’t mean we can wander from one to the other at will.
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BTW the same argument holds to a limited degree for Medicare Part A (though not B & D). Any act which extends the life of the HI Trust Fund equally serves to increase Public Debt relative to the baseline over that period. Kind of a “No good deed goes unpunished” deal.
Bruce
Of course the Senators don’t understand that. If they did, they’d have to be lying through their teeth. And we know a Senator would never do that.
Just to muddy the waters a bit… in the name of good mental hygiene… it is not exactly true the Medicare is “unsustainable.” If the cost of Medicare grows — because the cost of medical care grows — some time around 2085 or so the cost of Medicare will be 6% of payroll… about three times what it is now as a percent.
But if the economy grows… as projected by the same Trustees… the absolute cost of Medicare — that is medical care in old age — will be much much less than the increase in incomes. Such that the average worker will have twice as much money AFTER taxes as he has today, plus he will have paid in advance for his longer expected life and his much more expensive medical care.
It’s a choice you see. Do you want to spend the money on a second trip to Disneyland every year or do you want to spend it to live longer in reasonable health?
Don’t get me wrong. I think that the cost of medical care can be brought down, and should be. But even if it is not, it is hardly “unsustainable.” Besides, if the cost of medical care is going to go up, is that the time to cut your insurance?
Well no. On the other hand we might decide not to spend some of that insurance money on gold-plated bedpans. 😛
A nit, but the same argument has not held true for Medicare Part A for 6 years. The trust fund is shrinking, reversing you math.
Putting a problem which should have been addressed 7 to 10 years ago (Yes, Clinton should have done so) in the same breath with a problem that needs to be solved about 15 years from now is ridiculous.
Medicare should not be using its trust fund. It should have income and costs balanced, now! If taxpayers cannot agree to increase (payroll) taxes, then benefits have to be held down. Numerically, the trust fund interest is small and the principal should be zero.
The case is quite different for SS. Bruce laid it out, but the conclusion is simple. The loan (trust fund balance) has to be repaid and that requires increasing income taxes, not payroll taxes.
This shows a fundamental problem: governments devoting particular revenue streams to particular expenses, primarilly on (generally unstated) “fairness” grounds.
We should have the most efficient/fair taxation scheme we can come up with (understood: efficient/fair are often in complex conflict), and we shoud have the most efficient/fair spending we can come up with.
Earmarking particular revenue streams for particular spending, while politically necessary, results in unhealthy distortions of those revenue/spending decisions.
For instance, pretending that there is a SS trust fund, when the government has borrowed and spent it, causes people to think that payroll taxes should be raised and directed to that trust fund. Since payroll taxes are not only nonprogressive but decidedly regressive, I’m here to say that raising them is both unfair and inefficient. (The former seems obvious; the latter is my contention given our current national tax scenario.)
So, agree with Arne: income taxes (but more progressive). Pigovian taxes, i.e. energy taxes of some sort, would be better, if progressivity can be built into it. Consumption taxes, ditto.
The commission we should seriously consider is one to rewrite the whole federal tax system–payroll, income, estate, corporate, etc. It needs to take into account the horribly regressive nature of state and local taxes, and compensate for that.
http://www.asymptosis.com/most-regressive-taxes-my-home-state.html
One caveat.
Social Security surpluses had to be parked somewhere. If they had been invested in munis the state or city would have taken the money and spent it. If the money had been deposited in a private bank that bank would have taken the money and invested (I.e. spent). It is pretty much in the nature of ANY investment in anything that someone takes your money and spends it.
The idea that investing that money in Special Treasuries was somehow nefarius only makes sense if you adopt some version of Phony IOU. Where should they have stashed the money that would have been better?
Borrow and Spend is operationaly the same as Buy a Bond. the Chinese buy a Treasury, the US spends it while giving them an IOU. Basically people are falling for a semantic trick.
Steve
Bruce is much kinder to you than I will be. it’s not that there’s anything wrong with you. But your understanding of Social Security is insufficient. Instead of thinking of it as a “tax,” think of it as an insurance premium, or even forced savings with insurance. Progressivity has nothing to do with it, anymore than you would charge a rich person more at the grocery store because “it’s more fair.”
There is a Trust Fund. It has been “invested” just like every other damn trust fund on the planet. And the way you pay it back is to pay it back. If it bothers you that the “taxpayers” have to pay it back, try to think of them as “citizens” or “shareholders” in a corporation that borrowed the money to make itself stronger. Whether it used the investment wisely or not, it still has to pay back the money it borrowed. It might help you to recognize that whatever you think of our current and past leaders the country is stronger and richer than it used to be. if nothing else, the people who got the benefit of the borrowing by having their taxes cut, used that money for private investments and now they are richer and can afford to pay the small tax increase needed to repay the money. Or instead of a small tax increase, maybe a small cut in some other program. Or maybe just keeping the tax rate the same but dedicated the increased revenue from growth in the economy to paying down the debt.
Stop worry about “regressive” taxes and just pay your insurance premium. The rich pay more taxes than you, as they should. The whining from the “advocates for the poor” really does not help us reach a sane tax policy. Not “efficient,” not even ‘fair’ by your lights or theirs, but sane.
small note on “the regressive payroll tax.”
aside from the fact that its not really a “tax” but an insurance premium..
the huge fact that “liberals” often overlook is that the return on a poor persons payroll tax is something like 10% per year, while the return on a richer persons payroll tax is more like 1 or 2% per year (both returns “real”… above inflation).
sadly there are “liberals” just as thought-deficient as some “conservatives.” they look at the payroll tax and discover that “rich” people don’t pay any tax on the amount of their earned income over a hundrd thousand (or so) and none on their “unearned” income. so they, the thought-deficient liberals, start running around screaming “regressive tax! regressive tax.” living in a one-thought universe must be so hard on them. as it is on their opposites.
don’t mean to be mean to anyone personally here, but it does not help to save social security by thinking of it as “welfare” and that “the rich” are under some moral obligation to pay for it. that is exactly what “the rich” are afraid of. and that is why FDR saw to it that social security was NOT “the dole”. It is a savings and insurance plan for workers paid for by the workers themselves, “so no damn politician can take it away from them.” Roosevelt did not quite allow for the persistence of politicians and the stupidity of the masses.
if we don’t learn to understand what we are talking about the politicians will take it away from us, them. And then we’ll find out that paying for our own retirement was not such a bad idea after all, if we could get the government to manage the insurance aspect, especially insurance against inflation by the magic of “pay as you go” financing.
so why should “the rich” “invest” in social security for only 2%/yr real return on investment.
first, because they don’t know they will be “the rich” when they retire. something bad could happen to them or their money. then they’d get the 10% or more. much more if they are so lucky as to die or gte disabled. (remember, the only thing that matters in life is “return on investment.”)
second, the rich do better in a society where the poor have enough “security”that they can afford to take chances: like buy a new car instead of saving against poverty in old age. or changing jobs instead of keeping a “safe” job. or even investing a little in the stock market. something they can “afford to lose” if social security has their back.
third, the rich do better in a society where the old have enough money to spend.
fourth, without social security, the rich would have to pay taxes for “welfare.” in this case they would end up paying the whole cost of a poor persons retirement. with social security, the poor person pays for most of his own costs.
and fifth… from what i read, getting 2% above inflation is not something even moderately rich people can always expect to get, especially when its fully insured. i realize there are investment professionals who will disagree with me about this. but they are wrong. another case of thought deficiency… this time on the right.
Good lord – do we know what we are talking about?
A private investor has excess dollars – so they buy a Treasury security. Once this security matures, the investor takes it over to the Treasury and gets his money + interest.
The boomers (through their representatives) agreed to have their payroll taxes increased and purchase Treasury securities with these excess dollars. As these securities mature, they take it over to the Treasury and what happens?
Will the Treasury decide to not honor these notes?
Will the Treasury say “Congress has to increase the debt limit so that we cash these out?”
Will the Treasury say “We will just monetize these and here’s your money?”
Bruce is exactly right – if the surplus had been “invested” in gold, that means gold sellers would have been paid trillions due to this spending. Probably would have raised the price of gold a bit – great until the gold has to be sold.
If taxes have to increase, it would be to cover the interest expense on any debt increase, and even then wouldn’t necessarily have to increase to cover the full amount.
I’m still trying to figure out how much of my 2009 income taxes were used to retire Civil War debt.
PE Bird
good point about that Civil War debt. at some point money lost ceases to exist. unless you’ve got a trunk full of Confederate money and are waiting for it to be good as gold again.
I’d add that the arguments about using Social Security to pay down the debt are not unlike
say, you had a credit card account and a home mortgage at the same bank. you have been making your mortgage payments faithfully. then one day the bank comes to reposess your home. but whatabout all those payments, you ask. oh, we appllied those to your credit card, says the bank. money is fungible and anyway it all goes to the same bank.
It will NEVER be a question of whether or not our government can make medicare or social security payments………….NEVER.
The only question will be how will we distribute possibly scarce health care services? What share of (possibly) limited healthcare services will we allot to people over 65 or more accurately what % will they demand? Will grandparents insist they get their angioplasty at the expense of their grandchilds tonsillectomy? I for one do not EVER think health care services will be scarce, especially since most health care services simply require caring people.
SS the same. We will always be able to make the payments. The only question is will the payments be enough to actually buy anything worth having.
Problem is we started this SS program in the gold standard currency era. We are still stuck in that paradigm when thinking about SS and it definitely does NOT help us.
Greg
doesn’t help you much anyway. Social Security benefits are wage indexed. That means they are not affected by inflatioin. that’s the beauty of pay as you go. 12% of this generations wages are a lot more money than 12% of the last generatioins wages, so they can pay benefits appropriate to the present standard of living, with inflation fully accounted for. wha’s more, this will always be true whether wages are paid in gold, greenbacka dollars, or martian groks. though probably not for Randian Galts… for wholly different reasons.
Health care is always going to be rationed. No one wants to die. And a lot of people want the doctor to look at that little pain that’s always bothering them after they sit in a chair for eight hours. the question is whether we can find a way to pay for serious, expensive illnesses so that no one goes without effective treatment or is reduced to poverty to pay for it. And that is easily doable. Heck, even the Brits have figured it out. The question is not betwen old folks getting treatment at the expense of young folks. The question is whether working age folks are smart enough to put aside enough money for their expected health care when they get too old to work. Or will they need that second vacation in Vegas every year.
Arne
it will also, as you know, require raising the payroll tax a tiny amount if the next generation lives longer than the last. about twenty cents per week per year while wages are going up ten dollars per week per year.
as for Medicare… for sure we need to find a way to control costs. but we also need to raise the medicare tax to cover the costs we are seeing today. Medicare needs some kind of a trust fund, just the way Social Security does… to bridge recessions like today’s… and to allow for a gradual transition to the probably higher costs from people living longer and demanding more expensive medicine in each successive generation.
as for controlling costs. first, limit the costs to serious illness that would break a person financially. for retired people this might need to be more generous than it needs to be for working people. but more than that, if Medicare is a federal program, and “providers” won’t provide services at the price Medicare says is fair, then it’s time for the federal government to get into the provider business. I think it should be easy enough to open and staff local clinics for routine health care, using doctors who are just as happy to work for a wage as to try to earn country club profits. those doctors might be kids who got their medical school paid for by uncle sam.
I agree Coberly. My comment was meant fort hose who fear SS or medicare might go bankrupt, that is an impossibility from a FINANCIAL point of view, politically………….well there is no limit to our possible stupidity.
Health care will be rationed but not restricted per se. Everyone should get what they NEED. Beyond what you need, you can pay for it yourself. My scenario about grandma/grandchild was onlt meant to illustrate the choices that would have to be made in a world of scarce resources. I for one think we are a long way from scarce health care resources since most of the resources are human. Weve got plenty of those, they just need learnin’.
Greg
thanks for helping me understand what you said. i agree. there is a political problem. not a financial one. i don’t always read good either.
btw
that 33 trillion Trust Fund Bruce mentions is in inflated dollars. in constant dollars it would be more like 3 trillion, roughly one years Social Security expenses for an elderly population twice the size of the present, whose incomes (and taxes and benefits) will be roughly twice the size as today’s, per capita.
[and i hope i didn’t just open a can of worms, which is what the people who think the elderly 75 years from now shold be living at today’s poverty level ought to have to eat.]
I’m not sure Steve is really agreeing with me. In the long run SS taxes need to balance SS benefits, so having a separate stream for SS makes total sense. Trying to cover the need to repay the money loaned from the SS TF to the general fund by increasing payroll taxes does not make sense. The money to repay the loan needs to come from the general fund, which means from income taxes. It should be obvious, but I will say itn anyway, the amount coming from income taxes should not exceed the amount required to repay the loan and the interest.
In the future if (when) the SS TF is shrinking, then payroll taxes should be raised. By current projections the right time is in the mid-2020s when the trust fund balance is about equal to one year’s worth of benefits.
Medicare may have as simple a solution, but it should have been implemented at least 6 years ago.