by Bruce Webb
Are the Special Treasuries that make up the Social Security Trust Funds real? Absolutely, quite apart from legal and historical arguments the DI Trust Fund will be cashing in some $23 billion of them in 2010 along with taking some $9 billion  in interest, their reality is affirmed every time a SS Disability check gets credited to a beneficiaries account each month. QED.
But does that mean that all of those Special Treasuries in the combined Trust Funds will get paid back? Or need to be paid back? Well no, if we fix Social Security in precisely the right way, those Trust Funds get converted into a discounted interest only loan, and the principal simply rolls over forever. To understand why this should be we can start with the following from Steve Goss, the Chief Actuary of Social Security in his recent article for the Social Security Bulletin The Future Financial Status of the Social Security Program
However, the occurrence of a negative cash flow, when tax revenue alone is insufficient to pay full scheduled benefits, does not necessarily mean that the trust funds are moving toward exhaustion. In fact, in a perfectly pay-as-you-go (PAYGO) financing approach, with the assets in the trust fund maintained consistently at the level of a “contingency reserve” targeted at one year’s cost for the program, the program might well be in a position of having negative cash flow on a permanent basis. This would occur when the interest rate on the trust fund assets is greater than the rate of growth in program cost. In this case, interest on the trust fund assets would be more than enough to grow the assets as fast as program cost, leaving some of the interest available to augment current tax revenue to meet current cost. Under the trustees’ current intermediate assumptions, the long-term average real interest rate is assumed at 2.9 percent, and real growth of OASDI program cost (growth in excess of price inflation) is projected to average about 1.6 percent from 2030 to 2080. Thus, if program modifications are made to maintain a consistent level of trust fund assets in the future, interest on those assets would generally augment current tax income in the payment of scheduled benefits.
The first thing needed to understand this is how the Trustees define Trust Fund solvency. For them ‘solvency’ means ‘one year of cost equivalent in the Trust Fund at the end of each year’. So if we take the OAS (Old Age/Survivors) Trust Fund in isolation from the DI Trust Fund we get the following projection Table IV.A1.—Operations of the OASI Trust Fund, Calendar Years 2005-19 we can see that OAS TF Balances not only vastly exceed OAS Cost for 2011, they also project to continue to do so for the next ten years. Which is why the Trustees are able to report that OAS in isolation meets the test for ‘Short Term Actuarial Balance’. And if you scrolled down the page from that link to Table IV.A3 you would see the same thing is true for combined OASDI. On the other hand if you paused at Table IV.A2 you would see that is decidedly not the case for the DI Trust Fund, it projects to go to a 91% of cost reserve at year end 2014 and to total exhaustion in 2018. Not only does DI fail the ten year test for solvency, it has for some years. So it needs to be fixed and as it turns out we know what the cost of that fix would be over 25 years and over 75 years thus handily achieving short term (10 year) and long term (75) actuarial balance, it would require an increase in FICA devoted to DI of 0.30%.
But that is not the focus of the post. Instead I want to explore how “a perfectly pay-as-you-go (PAYGO) financing approach” is consistent with “negative cash flow on a permanent basis”. Well Steve explains it but in somewhat condensed fashion. If the U.S. enters a period that experiences an extended period of real growth then Social Security costs increase every year. That is on a nominal dollar basis increases in population, real wage, and inflation, however moderate, add to total program costs. This may or may not also mean an increase in GDP devoted to Social Security which could remain flat, but the year end balances needed to maintain solvency need to be bigger year over year. The following table shows us income excluding interest and cost for the 75 year projection period Table VI.F9.—OASDI and HI Annual Income Excluding Interest, Cost, and Balance in Current Dollars, Calendar Years 2010-85 and tells us that projected cost under Intermediate Cost projections will increase from $710 billion in 2010 to $27 TRILLION in 2085. Meaning that for the combined Trust Funds to be judged solvent there would need to be an equivalent $27 trillion in Special Treasuries to offset that.
Well under Intermediate Cost assumptions that is not going to happen, even after we add interest back in. If we roll back to Table VI.F8.—Operations of the Combined OASI and DI Trust Funds, in Current Dollars, Calendar Years 2010-85 we see interest backfilling the gap and increasing TF balances up to 2027 or so, and then a more or less rapid collapse in balances due to Trust Fund redemption until the TF is exhausted in 2037, exposing SS to a 22-25% cost gap over the rest of the 75 year projection. Note that in this scenario the entirety of the combined Trust Fund principal has to be redeemed over a ten year period from 2027 to 2037 at an average rate of $400 billion a year plus the shrinking yet substantial interest charges. This is what the Wall Street boys really see as the crisis.
But if we look at Low Cost assumptions we see something totally different. Under LC Costs project to be $18 trillion in 2085 but all of that would be offset by $19 trillion of income EXCLUDING interest. This doesn’t mean the income tax payers get off totally scot free here, there is a period from 2026 to 2050 where a portion of interest accrued still has to be taken in cash, but not all of it, instead that retained portion of the interest simply transforms into Trust Fund principal and starts itself earning interest with the result that the Trust Fund balance goes to $119 trillion (Table F8) which equates to a TF Ratio of 1049, or ten times what is needed for solvency. Not only would this be unnecessary, it is actually problematic, and shows the perils of overfixing Social Security.
So where is the happy median? Well it is in what Steve Goss calls ‘sustainable solvency’ which is a Trust Fund with a flat to rising TF ratio at the end of the 75 year period. But what this means in practice is that instead of seeing the TF peak in dollar terms and then go to exhaustion or to have the balance go to ten times what is necessary it would instead need to grow steadily to match the $20 trillion or so in costs for 2085 suggested by that balanced outcome. Which logically means that Trust Fund principal is NEVER cashed in, just rolled over. Moreover and less intuitively it means that income excluding interest has to be maintained enough below cost to drain off enough accrued interest to keep the rest of that interest from exploding the year end balance. Which is how “a perfectly pay-as-you-go (PAYGO) financing approach” = “negative cash flow on a permanent basis”
So while the answer to the question are the Special Treasuries in the Trust Fund real obligations of the US Treasury, the answer is ‘absolutely’, shown not just with the current state of DI which is cashing them in as I type, but also because a steady-state Pay-Go requires at least some of the interest accruing to be paid in cash. But not all, a portion of that interest has to be retained and converted to principal to maintain a steady TF Ratio and so sustainable solvency.
Is the principal on what is in effect an interest only loan really a debt to Treasury or the Public it represents? Well that is more a question of language than anything, but the simple fact remains that small changes in revenue today while creating a permanent obligation in the form of cash interest transfers almost totally removes any need to redeem the principal in the Trust Fund over the next 75 years. For example if you examine the spreadsheet underpinning the NW Plan for a Real Social Security Fix: 2009 OASDI Trigger you will see the Trust Fund balance hitting its first peak of $4964 billion in 2026 but only redeeming $158 billion in principal until its new low of $4826 in 2035 after which it resumes its steady rise. Discount that ten year $158 billion for inflation and you see this would truly be a non-event
Okay in what way does this also make it ‘discounted’. Well simple enough, the interest retained to maintain sustainable solvency is not financed out of the then current economy, instead it comes in the form of newly created Special Treasuries. And since it is then part of the sustainable solvency principal that never has be be cashed in if normal growth continues the real cost to the economy is the difference between the Real Interest Rate of 2.9% and the Real Cost increase of 1.6%, or less than half of the rate on the face of the note.
Under the NW Plan we deliver 100% of benefits, achieve sustainable solvency, and relieve capital of the need to ever pay back the principal they borrowed, all at zero up front cost to the wealthy. All they have to do is to agree to pay heavily discounted to face of the note interest on the money they borrowed and continue to borrow though 2023. Who exactly is sucking the tits of the milk cow in this scenario?