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Explaining the Social Security Trust Fund   August 18th, 2010
It's not complicated, but even nobel prize-winner Krugman seems to misunderstand it       

 
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The alleged Social Security "trust fund" really isn't that difficult to understand, but from time to time I get emails telling me my article on the Myth of the Clinton Surplus is wrong because the individual apparently doesn't understand how the Social Security trust fund works. And I'm ok with that.

But when nobel prize-winning Keynesian economist Paul Krugman writes an article that conclusively demonstrates that he doesn't understand how the trust fund works, I've found a topic to write about.


I've written about the foolishness of Keynesian economist Paul Krugman on several occasions, but his recent article on Social Security takes the cake. He demonstrates such a lack of understanding of how Social Security works that one must wonder whether, at some point, even his fans will realize he's either ignorant or lying.

He wrote:

Social Security's attackers claim that they're concerned about the program's financial future...

Social Security has been running surpluses for the last quarter-century, banking those surpluses in a special account, the so-called trust fund. The program won't have to turn to Congress for help or cut benefits until or unless the trust fund is exhausted, which the program's actuaries don't expect to happen until 2037 -- and there's a significant chance, according to their estimates, that that day will never come.


The fact is that Social Security hasn't been "banking those surpluses in a special account." It has been loaning its extra money to the Federal Government, getting IOUs in return, and the Federal Government has spent all that money. There is no trust fund. There is no money. All there is is a mountain of IOUs that the Federal Government has to pay back to Social Security.

Each year Social Security takes in more money in taxes than it has in benefits, it is required by law to loan the extra money to the Federal Government. This provides "extra" money to the Federal Government which it can spend as if it were general tax revenue.

This was especially pronounced under Clinton when the Social Security surpluses were what allowed Clinton to claim a surplus when there was really a deficit. During the Clinton administration, all those Social Security surpluses were transferred to the Federal Government; and the Federal Government proceeded to use it to, among other things, pay down its debt held by the public.

Social Security claims a $2.5 trillion trust fund. One could conclude that, somewhere, it has $2.5 trillion set aside to dip into. It doesn't. There is no $2.5 trillion account anywhere. What Social Security has is $2.5 trillion in IOUs from the Federal Government.

So when there are more benefits to pay than there is Social Security tax revenues, Social Security will need to draw on its "trust fund" balance. That will happen this year. That's what Krugman calls "turning to Congress for help." It's not really "help," of course. Social Security just wants to cash in the IOUs it got when it loaned $2.5 trillion to Congress. But since Congress already spent that money on something else and there is no $2.5 trillion account, it's going to have to raise the money somewhere.

As was explained in a CNN article a week ago:

Today, let's talk about one of the world's biggest piles of funny money -- the $2.54 trillion Social Security trust fund. The trust fund matters now, because Social Security revealed last week that it plans to tap it for $41 billion this year, and will begin tapping it on a regular basis in less than five years.

This year's cash deficit, the first since the early 1980s and the biggest ever, means the Treasury will have to borrow money to redeem some of the trust fund's Treasury securities. Even at a time when Uncle Sam is borrowing $1.5 trillion a year to keep his checks from bouncing, $41 billion is real money.

Here's why the trust fund has no economic value. Let's say I begin taking Social Security when I hit the full retirement age of 66 later this year. Because its tax revenues are below its expenses, Social Security would have to cash in about $3,400 of its trust fund Treasury securities each month to get the money to pay my wife and me. The Treasury, in turn, would have to borrow $3,400 from investors to get the money to pay Social Security. The bottom line is that the government has to borrow from investors to pay me, regardless of how big the trust fund is.


In short, for every dollar Social Security falls short this year, the Federal Government will have to borrow a dollar to pay back the money it previously borrowed from Social Security. So the Federal Government will now have to effectively use one credit card (public debt) to pay another credit (debt to Social Security). Every dollar which Social Security comes up short is a dollar that will be added to the deficit and the public debt.

Summary of The Trust Fund

This is what has been happening for the last quarter century:
  1. Social Security Surpluses. For a quarter of a century, Social Security has been taking in more money in taxes than it has been paying in benefits. The "extra" money each year was the Social Security surplus.
  2. Social Security Loans Surplus to Government. Social Security has been required by law to loan its surplus each year to the Federal Government.
  3. Social Security Gets Government IOUs. The Federal Government has been taking that money and giving Social Security IOUs in return.
  4. Federal Government Spends the Surplus. Having given Social Security IOUs for its surplus, the Social Security money is then pooled in the government's general fund and spent on whatever priorities Congress had that year. This has allowed the government to spend more money than it otherwise could without borrowing money in the bond market and without raising taxes. It's just been spending our retirement, so to speak.
  5. Trust Fund = IOUs. The reality is that $2.5 trillion "trust fund" is nothing more than $2.5 trillion in IOUs owed to Social Security by the Federal Government. But the government doesn't have $2.5 trillion to pay it back.
Now we've reached the beginning of the days of reckoning. Instead of collecting too much money each year, Social Security isn't collecting enough. In theory that'd be ok, for awhile, since it supposedly has $2.5 trillion in its trust fund. But the problem is the Federal Government spent that trust fund.

So here's what's starting to happen this year:
  1. Social Security Deficit. With more people retiring and fewer people working, Social Security has to pay more money in benefits than it is receiving in taxes. That's a shortfall, or a deficit.
  2. Social Security Cashes in IOUs. Since Social Security is going to come up $41 billion short this year, it needs to cash in some of the $2.5 trillion in government IOUs it holds. Social Security will return some IOUs and the Federal Government should give Social Security its $41 billion.
  3. Government Doesn't Have $41 Billion. The money that Social Security gave to the federal government years ago has already been spent and the government doesn't have $41 billion.
  4. Government Borrows $41 Billion. The government has to borrow $41 billion in the bond market in order to raise the money to be able to pay back Social Security.
  5. Increased Federal Deficit/Interest Rates. This means that the federal deficit will be increased by $41 billion which, in turns, means the total public debt will be increase $41 billion. Since the government is borrowing more money in the bond market, that will create upward pressure on interest rates.

The Fallacy of Krugman's Argument

Paul Krugman, in the article quoted above, wrote "The program won't have to turn to Congress for help or cut benefits until or unless the trust fund is exhausted."

That statement is false. The Federal Government (or "Congress") IS the trust fund. The Federal Government was entrusted with $2.5 trillion that belongs to Social Security and, since it spent the money, it no longer has any of that money to pay back. So when Social Security starts drawing down on its supposed trust fund this year, what that really means is that the Federal Government has to pay back money it doesn't have.

What Paul Krugman said would be true IF Social Security had $2.5 trillion in cash sitting in an account somewhere. Unfortunately it doesn't. All it has is a $2.5 trillion pile of IOUs from the Federal Government.

Mr. Krugman then goes on to state that claims of an impending Social Security funding crisis are false:

So where do claims of crisis come from? To a large extent they rely on bad-faith accounting. In particular, they rely on an exercise in three-card monte in which the surpluses Social Security has been running for a quarter-century don't count -- because hey, the program doesn't have any independent existence; it's just part of the general federal budget -- while future Social Security deficits are unacceptable -- because hey, the program has to stand on its own.


Amazingly, Krugman is correct in part of his statements, but he reaches an incorrect conclusion by either misunderstanding or misrepresenting reality.

Krugman is right that its unacceptable Social Security to run perpetual deficits because the program must be self-sustaining. And Krugman is right that a quarter-century of Social Security surpluses "don't count."

But the reason the surpluses don't count has nothing to do with the program not "having any independent existence." Rather the surpluses effectively don't count because that money has already been spent. Social Security has been depositing its surpluses into its "Federal Government Savings Account" for a quarter of a century but the Federal Government has been raiding that account and spending every penny saved by Social Security on other things.

This is a very real problem. The president's deficit-cutting commission has to look at the issue because, as it stands, Social Security will become a bigger and bigger drain on each year's federal budget. But Krugman suggests it's all fiction, and that these people are "peddling" this because they're ideologically opposed to Social Security. He writes:

It would be easy to dismiss this bait-and-switch as obvious nonsense, except for one thing: many influential people -- including Alan Simpson, co-chairman of the president's deficit commission -- are peddling this nonsense.


Though Krugman zeros in on Republican Alan Simpson, the Democrat co-chair of that committee is Erskine Bowles (Democrat) who also understands the same reality of Social Security. He said, "We're going to mess with Medicare, Medicaid and Social Security because if you take those off the table, you can't get there. If we don't make those choices, America is going to be a second-rate power, and I don't mean in fifty years. I mean in my lifetime."

Contrary to Krugman's claims, the bait and switch on Social Security isn't being pulled by Alan Simpson, Erskine Bowles, by me, by big bad conservatives, or by any other person that recognizes the deficit and Social Security problems we're facing.

The bait and switch is being pulled by people like Paul Krugman who either don't know what they're talking about, or are lying.

And when it comes to Paul Krugman, I'm honestly not sure which it is.

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