Understanding The Social Security Trust Fund – It’s More A Checking Account and Less of A Trust Fund

Now that the Republican-Democratic budgetary battle that shut down much of the U.S. government earlier this month has been resolved  delayed for 3 months.  Once again the hope of the politicians from both sides is to achieve some kind of “grand bargain” on the budget that continues to reduce the federal budget deficit.  Now the expectations are only for maybe a two-year deal instead of the ten-year deal the President sought in 2011.  But regardless of the length of the deal, the renewed negotiations have put Social Security, and with it, the economic well-being of seniors at risk.  For example, Senater Dick Durbin, an alleged Democrat, has offered up cuts in Social Security claiming:

“Social Security is gonna run out of money in 20 years,” Durbin said. “The Baby Boom generation is gonna blow away our future. We don’t wanna see that happen.”

It is most unfortunate that Senator Durbin, along with many of his colleagues, continue to repeat what is utter nonsense.  They endanger not only the well-being of seniors in the U.S. but all of us. For many years enemies of Social Security and the Wall Street banks that lust to have siphon fees from the hundreds of billions of dollars that currently flow efficiently through the Social Security Administration have propagated the idea that Social Security is going bankrupt – that it won’t be here in 20 years.

Much of the problem comes from people only having a superficial understanding of how Social Security (or any other intergenerational transfer program) works.  Combine a superficial understanding with misunderstood and ill-defined terms and scary but shallow projections of demographics and you get fear and hysteria – exactly what the enemies of Social Security want.  There are many aspects that I could talk about, but the most misunderstood aspect of Social Security is the Trust Fund, so I’ll focus this post on explaining the Trust Fund.

The Social Security Trust Fund is, in fact, actually two separate trust funds, each with its own share of the payroll tax and its own purpose. One fund is involved in the old age and survivors benefits and the other for disability insurance.  Nonetheless, I will lump them together since that’s what most commentators do.  The root of confusion and deception lies in the names of the funds.  They’re called “trust funds”.  And since the largest fund is used in the payment of old age insurance payments, which most folks liken to pensions, they tend to assume that the SS funds work like a private, personal trust fund.  After all, we know about people called “trust fund babies”  – they’re people who live off the interest and dividends of some big pile of money that somebody (usually parents) left them.  We also know that private savings for retirement works in a similar fashion except that we put the money away ourselves during working age and then deplete the account when we’re older – and often retirement accounts are established in some sort of “trust” account.

The people who argue we need to cut Social Security benefits usually claim it is because we are going to deplete the Social Security Trust Fund at some date a couple decades into the future.  They claim that Social Security itself will be bankrupt when that happens.  This is absolutely not true and it plays on a misunderstanding of what the SS Trust Fund is, what it does, and why it exists.

The Social Security Trust Funds are not what enables benefits to be paid.  Current payroll taxes are what enable benefits to be paid, not Trust Fund balances.  Social Security is an intergenerational transfer system.  Each month workers, people who are most likely aged 18-65, and their employers pay a payroll tax.  Then that same month, the money collected is paid out to Social Security beneficiaries.  .  Under current conditions, the payroll tax amounts to a 6.2% tax on worker earnings up to $113,700.  The employer pays a matching amount.  Earnings over $113,700 are payroll tax-free. As long as people are working and getting paid, there are payroll taxes being collected and money available to pay benefits – even if the Trust Fund were zero.  The Trust Fund isn’t really necessary to the basic functioning of Social Security.  This is why Social Security can never go bankrupt and unable to pay benefits.  For Social Security to be unable to pay any benefits, the U.S. would have to have nobody working – zero employment.  If we ever get to the point where there is nobody working in the economy, we have much greater problems on our hands than Social Security – problems like no food to eat.

Social Security Receipts and Benefit Payments by MONTH.So if the Trust Fund isn’t what is funding benefit payments – what is it?  The way to think about the SS Trust Fund is to think of it as a checking account.  This graph which shows the the income (payroll taxes collected) and the outgo (benefit payments) by month illustrates the problem and why the Trust Fund exists.  See how erratic and variable the income is.  This is because it’s a payroll tax and payrolls (employment) varies enormously from month-to-month.  In November and December we employ a lot of people and pay them something extra – it’s called Christmas and bonus season.  In January and February employment drops.  So the income received by the SS Administration varies greatly too.  But this income is used to pay benefits.  But we want benefits to be relatively constant.  Grandma and grandpa should expect the payment each month.  We don’t want to have tell all our senior citizens in January  “hey sorry, but the check’s a little short this month, we’ll make it up next December”.  So what to do when the income is both variable and a bit uncertain but the payments need to be relatively constant and fixed?  The answer is to do the same thing any private individual facing an uncertain and variable income but constant outgo:  keep a nice buffer balance in the checking account.  That’s what the Trust Fund was created for – to keep a buffer balance so that monthly payments can be held constant against variable and unpredictable income.

By law, the law creating the system, Social Security cannot use general funds of the government.  It can only use the payroll taxes it collects for Social Security.  And vice versa.  Social Security payroll taxes cannot be used for other government purposes (although George W. Bush once proposed doing that).  Also by the same law, the buffer balance- the trust fund balance – is supposed to always be at a minimum of 100% of projected one year’s benefit payments.   Today, the SS Trust Fund balance is approximately 350% of each year’s benefits and it’s growing.

Why is the Trust Fund so much bigger than it is (was) supposed to be originally?  Because in the early 1980’s it wasn’t so big.  In the 1970’s Congress increased Social Security benefits by indexing them to inflation (a good move), but they didn’t increase the payroll tax enough to pay for it.  The moment of truth came in the early 1980’s when the Social Security had to dip into the Trust Fund to help pay some of the current benefits.  The Trust Fund then stood at less than the legally-mandated 100% of projected benefits.  A commission was appointed by President Reagan and Congress to develop a solution.  The resulting deal increased the payroll tax from the then 5.4% gradually until in 1990 it stood at the present 6.3%.  By the early-mid 1990’s, the Social Security Trust Funds were well-replenished and beginning to significantly exceed the 100% of benefits level.  Yet the payroll tax was kept at the 6.2% level ever since even though it has generated a significant surplus every year.  Every year since, the Trust Fund has grown as payroll taxes collected have significantly exceeded benefits paid.

Since the mid-1990’s Social Security has, in effect, been over-taxing workers compared to what was needed to pay current benefits. One option in the 1990’s would have been to cut the payroll tax slightly – perhaps not back to the 5.4% level but maybe to 5.9%.  But the decision was made to keep “over-taxing” so as to deliberately build up the Trust Funds to extremely high levels in anticipation of an eventual wave of baby boom retirements.  That has happened. As mentioned above, today’s Trust Fund includes both the 100% of benefits buffer balance and another 2.5 years worth of benefits.  The additional money will be drawn down to help pay for baby boomer retirements.  Instead of bankrupting the Social Security system, the baby boomers are effectively the first and only generation to not only pay for their elders’ benefits but to also pre-pay a portion of their own benefits.  The baby boom generation may be faulted for man things but bankrupting Social Security is not one of them!

So what about all these scary projections of the Trust Fund depleting at some time in the future?  At the present, the Trust Fund continues to grow.  All projections about the future of Social Security are subject to some uncertainty and the farther out you project the more uncertain they become.  To project the precise future balances of Social Security funds, benefits, and taxes, we need to project and know with a high degree of certainty changes in the  following:  birth rates, death rates, changes in productivity and wages, labor force participation, retirement age preferences, and even immigration.  Nonetheless, the Trustees of the Social Security Administration take a stab at updating their projection of the future for the next 75 years. In fact, they make at least 3 projections: an optimistic, pessimistic, and most expected case.  In looking at recent expected case projections, the Trust Fund will continue to grow until somewhere around 2019.  Then the “wave” of baby boomer retirements combined with expected lower labor force participation will result in monthly benefits that exceed monthly taxes collected.  Withdrawals from the Trust Fund will make up the difference to pay the promised level of benefits.  Then, somewhere a decade or so later, the Trust Fund will be back down to it’s legally mandated minimum. Of course this is only once scenario.  If the optimistic scenario happens (slightly faster economic growth between now and then, more labor force participation, and more folks delaying retirement), then there is never a problem in the entire 75 year horizon.

But let’s suppose the expected case happens, at that point a choice must be made: Reduce the benefits paid below the promised level? Or increase the payroll tax?  Or, remove the earnings cap on the payroll tax so that high-income earners pay taxes on amounts above the $113,700 cap.  How much of a tax increase would be needed?  Approximately a 1% increase in the payroll tax would make the system totally solvent and ensure minimum balances in the Trust Fund for the entire 75 year horizon.  That’s not much really.  It’s easily doable and more important, we can delay the time to raise the tax until the mid-2020’s when we have a much clearer picture.

It’s very important to realize that Social Security is not going bankrupt.  Even if we refuse to raise the payroll tax in 2030 and even if the expected case happens and we have to cut benefits in early-mid 2030’s, we won’t have to eliminate the program.  Benefit payments will still happen.  They will simply have to scaled back.  How much?  We will still be able to pay 75-80% of what we are currently projecting the benefit payments to be at that time.  And our currently projected benefits for that time period are greater in real dollars than today’s benefits because people will be earning more money entitling them to larger benefits.

Social Security is not going bankrupt. It can’t.  It will be there for my current students when they age and retire, and it will be there for my students’ kids.  The only reason Social Security might not be here is because politicians surrender to an anti-Social Security ideology and the desires of Wall Street banks to get their hands on billions more.

For those interested, here are some good references for continued explanation on this topic:

No Social Security Is Not Going Bankrupt from Center on Policy and Budget Priorities

Five Huge Myths About Social Security from Daily Finance

Why Social Security Can’t Go Bankrupt from Forbes

Social Security Trustees Report 2013

 

 

 

Social Security Receipts and Benefit Payments by MONTH.

A Look at Government Spending Trends. Not What the Deficit-Fearers Claim. It’s Really A Jobs Deficit.

Rebecca Wilder at AngryBearBlog.com explains why the current deficit hysteria that has gripped Washington is misplaced (and offers some great graphs of historical spending patterns).  A little terminology for some readers.  “cyclically endogenous” means the cause of the spending/revenue is not from some budget decision of this year’s Congress or President, but rather that the spending or revenue amount is the result of whatever the GDP and the economy did.  If GDP goes down and that causes some spending to go up, for example unemployment compensation, then that’s cyclically endogenous. (The bold emphasis is mine. You can click on graphs to enlarge them)

Readers here will know more about the US federal government income statement than I. However, given the near ubiquitous deficit hysteria, I wanted to illustrate the truth about the budget deficit. …

First things first, the fiscal deficit – receipts minus net outlays as a % of GDP – is big [by historical comparison]. In June 2011, the 12-month rolling sum of net receipts (the budget deficit) was roughly 8.5% of a rolling average of GDP. This is down from its 10.6% peak in February 2010, but the level of deficit spending clearly makes some nervous.

Why should they be nervous about the ‘level’ of the deficit? I don’t know, since recent ‘excess’ deficits are cyclically endogenous. The chart below illustrates the spending and tax receipt components of the US Treasury’s net borrowing (see Table 9 of the Monthly Treasury Statement). Weak tax receipts and big spending are driving the federal deficits (spending, as we will see below, has surged on items directly related to the business cycle).


In June, the 12-month rolling sum of tax receipts – mostly corporate and individual income taxes and social insurance and retirement receipts – was 15.6%, which is up from its 14.5% cyclical low in January 2010. On the spending side, net outlays in June 2010 were a large 24.2% of GDP and down just slightly from the 25.3% peak in February 2010.

Deficit hysteria should be more appropriately placed as “lack of jobs and tax receipts hysteria”. At this point, the budget could just as easily worsen as it could improve, given the fragile state of the US economy (see Tim Duy’s recent post at Economist’s View).

Why the wrong hysteria?

Reason 1. Taxes. Some would love to increase taxes – but the fact of the matter is, that tax receipts remain well below their long-term average of 18% of GDP. Tax receipts will not improve without new jobs since individual income taxes account for near 50% of total receipts.

Reason 2. The spending has been on cyclical items.

The best time to ‘worry’ about government spending is NOT when the economy is barely moving.

The chart below illustrates the big ticket items of the monthly outlays – roughly 87% of total outlays. The broad spending components are listed in Table 9 of theMonthly Treasury Statement. The long-term average shares of total spending are indicated in the legend.


The items health, medicare, and income security (inc security) are all above their respective long-term averages. But spending on income security outlays is the only spending component to have broken its trend, i.e., surge. According to the GAO’s budget glossary (link here, .pdf), this item includes the following cyclical spending:

Support payments (including associated administrative expenses) to persons for whom no current service is rendered. Includes retirement, disability, unemployment, welfare, and similar programs, except for Social Security and income security for veterans, which are in other functions. Also includes the Food Stamp, Special Milk, and Child Nutrition programs (whether the benefits are in cash or in kind); both federal and trust fund unemployment compensation and workers’ compensation; public assistance cash payments; benefits to the elderly and to coal miners; and low- and moderate-income housing benefits.

It’s spending on unemployment and food stamps that’s driving spending at the margin.

The same deal exists with the ‘smaller ticket items’. Of these <5% of total spending items, energy, environment, and veterans have arguably broken trend. I would surmise that some of the ‘veterans’ spending is tied to the business cycle, given the timing of the surge.

OK – so deficit hysteria is about, but it’s misplaced. One could argue for more, not less, spending to get the jobs growth, hence tax receipts, up.

But What About National Debt-to-GDP Ratio? Not a Problem, Really

In the comments to my post on the extraordinarily weak 2nd qtr 2011 GDP numbers a reader asks for my thoughts about debt-to-GDP ratio and “how can we afford more stimulus”?  Since my response will be a little long and others might be interested, I’ll post it here.

Reader AZLeader asks:

Here are some other GDP indicators I’d value your comments on…

Government spending now is somewhere around 28% of GDP, well above the 60 year average of 18.6% or so.

Spending as a % of GDP is indeed up, but it’s not primarily as a result of discretionary spending going up.  In other words, the so-called Stimulus spending bill didn’t do the damage.  The ratio is up in large part because the denominator (GDP) shrunk.  We lost a huge chunk of GDP.  That has a double effect on the ratio.  When the economy goes into recession and doesn’t recover it reduces the denominator by a big chunk.  But a recession also automatically increases government spending through automatic stabilizers.  Spending on unemployment compensation, welfare, Medicaid, SS disability claims, etc. automatically increases, thus increasing the numerator as well.

Krugman shows this graph from the St.Louis Fed using non-partisan Congressional Budget Office data that compares the changes in spending to changes in the potential GDP over 60+ years.  Potential GDP is the GDP that would be produced if we were at full employment.  It indicates our capacity to produce if we choose to put all our resources (labor) to work.  Any value that’s above 1.0 indicates that spending is rising faster than potential GDP. A value less than 1.0 indicates that spending is might be increasing in total dollars, but it’s increasing less than what the potential GDP is.  When the value is less than 1.0 it means that government spending is having a contractionary effect on the economy. As you can see, the issue in the last few years is that despite the increase in dollars of spending, it’s been peanuts compared to the damage done by the banks’ financial crisis and the ensuing recession with high unemployment.  This part of the reason why I’ve (and a lot  of others) have said the stimulus program was too little and too short.

Government deficit spending last year was about 10.9% of GDP, way over the sustainable comfort level of 2.6%.

There’s two issues here.  First, There’s nothing that says 2.6% deficit as % of actual GDP is “sustainable” and greater than that isn’t.  “Sustainable” in the sense that we can operate at that level indefinitely might be less than 2.6% or it might be greater than 2.6%.  For private sector entities (you,me, households, corporations, state governments) there’s a real meaning to “sustainable”.  But that’s because ultimately our spending ability is limited by the combination of our earning and borrowing ability.  Borrow too much and eventually lenders say “I don’t think you can pay it back, so pay higher interest rates, the debt begins to spiral up, etc.”.  But for a sovereign national government that creates it’s own currency, borrows using bonds denominated in that currency, and doesn’t strap itself to some fixed exchange rate system (like gold standard), there is no financial limit to the borrowing.  All of the nations that are having debt crises now (or in the past) have either strapped themselves to somebody else’s currency (Greece & Ireland with the Euro, Argentina in 2000 with the dollar) OR they borrowed their money in somebody else’s currency (less developed countries borrow in $ not their own currencies) OR they have  a fixed exchange rate (under the old gold standard 80 years ago).

What matters for “sustainability” is the ability of the economy to produce.  Does it have the  real resources to produce what the government is willing to spend on?  In this sense we see that even a 1-2% deficit-to-GDP ratio might be too high if we were at full employment and had no excess resources.  But the U.S. today has more than 10% of it’s labor force (even more since many would be workers aren’t looking) sitting on it’s hands doing nothing.

Another way of looking at the sustainability and desirability of deficit spending is to compare the interest rate the government has to pay to borrow now vs. the long-term growth rate of the economy.  If interest rates on government bonds were in the 6-8% range or higher (like in Greece and Italy), then large deficit spending might not be sustainable. But the U.S. is borrowing at near record low interest rates, less than 1% for a year.   Borrow at low rates, spend to invest in those things that grow your economy and get paid back later in larger GDP.

That brings me to my second point on “sustainability”.  The budget, government spending, is dynamic.  What GDP is the greatest determinant of what the deficit actually ends up being.  The budget discussions in Washington about 10 year projections are usually static projections.  They assume they can change the spending amounts while keeping the projected path of GDP the same.  Doesn’t work that way.  Running a large deficit relative to GDP, the kind of stimulus I think we need, will raise the deficit-to-GDP number immediately, but the ratio will then automatically decline. Again it’s the automatic stabilizers mentioned earlier.  As people go back to work and unemployment declines, the GDP rises faster.  Those people also pay taxes, so government revenues increase.  Spending in the form of unemployment comp, welfare, disability payments, Medicaid, etc all drop as people go back to work.  The deficit automatically shrinks relative to GDP.  This was how Clinton managed to produce a narrow government surplus at the end of this second term.  He eliminated the deficit completely.  It wasn’t by cutting spending. It was because the economy grew enough to reach full employment.

Government debt is just under 100% of GDP, the highest level in our economy that we’ve seen since WWII where it briefly spiked well above that.

Yeah, so what? Japan’s debt is around 200% of GDP and has been for over a decade.  Government debt is not like private debt.  It doesn’t have to be paid off. Government bonds are really just like government issued paper currency that pays interest.  This is why banks and investors love government bonds.  It’s a way to hold large amounts of cash and still earn interest.  A growing economy also needs a growing money supply and a growing supply of government bonds.  In the early part of this past decade (I forget the year), Australia was running a surplus for a few years.  It was paying down it’s national debt.  The bankers went to the Australian Treasury and the Australian central bank and asked the government to borrow and issue bonds anyway because they needed a larger volume of bonds in existence in order to run the banks.

Through “Intergovernmental Holdings” the U.S. government owns about 1/3rd of its own debt.

Yes.  $4.6 trillion, approximately 1/3,  of the $14.3 trillion total US government debt is “owned” by various other parts of the government.  The biggest chunk is the Social Security trust fund, $2.7 trillion.  The rest is in various other government “trust funds” such as Railroad employees retirement fund, government employees pension plans, highway building trust fund (paid by gas taxes), etc.  These funds reflect special taxes or fees that have been collected that are by law dedicated to a particular purpose, but the government hasn’t spent the money on that purpose  yet.  The accumulation of money in these funds (think of them as pre-payments of special taxes) must by law then be “invested” in the safest interest bearing assets available, which happen to be U.S. government bonds.  Let’s take a brief look at one of these funds: the Social Security trust fund.  The way SS works, dedicated SS payroll taxes are collected each month to pay for this month’s benefits.  (FICA taxes).  Obviously we want benefits to be relatively constant month-by-month.  Grandma wants to know just how much her check will be next month.  But the payroll taxes collected each month vary greatly. So, by the original law, SS Admin was supposed to make sure it always had enough liquid cash on hand to pay 1 year’s anticipated benefits.  This is the trust fund.  In the 1980’s the trust fund was too low – nearly depleted because benefits had been increased.  So payroll taxes were increased.  When the trust fund had fully recovered (circa 1991), the decision was made to continue to collect extra payroll taxes from workers in the 1990’s and early 2000’s in anticipation of the baby boom.  The current $2.7 trillion trust fund represents way more than the law said was necessary.  It represents the baby boomers having already pre-paid their own retirements.

These intra-governmental bonds cannot be traded on the public market, but they are regular debt obligations of the Treasury nonetheless.  To not pay these bonds is to renege on previous promises that people have relied upon.  It also might not be legal, although that is outside my experise.

In addition to the $4.3 intragovernmental holdings, there’s $1.6 trillion in government bonds held by The Federal Reserve.  These are ordinary bonds that The Fed bought from banks (that’s where banks get reserves).  Any interest paid on these bonds goes to The Fed who then sends it back to the Treasury as Fed profits.  This amount could easily be reduced by maybe 1/2 without consequences.

Given these constraints, where can we get the money to fund spending programs like the “stimulus” to create jobs and recover the economy?

As I attempted to describe above, it’s a fallacy to think of the government as having a financial constraint on it’s resources.  Government (again, a sovereign, fiat money, floating exchange rate, government that borrows in it’s own currency) faces no financial constraint.  Government is not like a household no matter how often misguided politicians say it.  You, I, households, firms, corporations, and state and local governments must obtain cash from either income or borrowing before we spend it.  Government does not face that constraint.  Government defines and creates the reserves that can become our spending money.  It has a monopoly on the creation of money.  And money today can be created as fast a somebody at the central bank can type (although we may not want to create it that fast).

Let’s consider what actually happens when the government spends.  The Treasury writes a check and sends it to a contractor, or SS beneficiary, or someone.  That check is drawn on an account at The Fed Reserve bank.  Let’s suppose you get the check.  You got income from the government. You take the check to your bank, let’s say it’s Chase.  You deposit it in your checking account.  You go out and spend the money by using your debit card to buy dinner, thereby helping to create a job and employ a waiter and kitchen staff.  But what happens at the bank?  Chase takes your check and sends it to The Federal Reserve. The Federal Reserve takes the government check and credits Chase’s account at The Fed.  This creates bank reserves.  The Federal Reserve has no limit on how much bank reserves they can create.  They can create all they want.  In the barbarous old days of the gold standard (before 1971), The Fed would have had to make sure it had enough gold on hand before issuing any reserves.  No such limit now.

So why doesn’t the government just spend endlessly with no limit?  Well, there’s no financial constraint on the government spending, but there’s a real resource constraint.  When the government attempts to increase deficit spending it is in effect placing orders for work to be done, things to be produced, and people to be employed (you do the same thing when you spend).  As long as there are unemployed resources to be put to work, the deficit spending is OK.  It stimulates more activity.  But if there are no idle resources then increased deficit spending will produce inflation because the government would be bidding against everybody else for resources.  At nearly 10% unemployment we have plenty of idle resources and that’s why there’s no threat of inflation despite the worries of those who don’t understand the gold standard ended 40 years ago.

There’s one other aspect of deficit spending that’s important.  This is not the result of theory, but rather is pure accounting.  I’ll just give a very brief mention of it here, but there’s a full tutorial here by Randall Wray.  A one page view of this idea is here.  Basically, government deficits are the mirror of the private sector.  There’s three “balances” that must add up to zero.  There’s the government spending vs. taxes balance, called the budget deficit.  There’s the question of whether the private sector (all households and firms together) are accumulating financial assets.  This is called “net private financial wealth”.  It’s the difference between what our private incomes each year and our private spending.  If we spend less than our income, then we are accumulating net financial assets, or in plain language, we’re putting money away in our bank accounts and investment accounts.  There’s a third balance which is the external capital account balance.  Basically it’s like the private net financial asset accumulation except it records how much foreigners are accumulating U.S. denominated financial assets.  If imports are greater than exports (trade deficit), then foreigners are collecting U.S. financial assets, typically government bonds.

Now there’s no way the private sector can create net any new financial assets. If I loan money to you, yes, I create a financial asset on my books.  But you’ve created an exactly offsetting private debt on your books.  In aggregate, the private sector cannot create new financial assets.  That’s because financial assets are things like money, currency, and bonds.  And they can only be  created by government. They can also be gotten from foreigners by selling more exports than imports, but that ain’t gonna happen anytime soon.  By accounting, these three balances must equal zero.  This means that when the government runs a deficit it creates net financial assets that the private sector can accumulate.  If the government creates a surplus.

In simple language, this means that, assuming we run a trade deficit, that a government deficit means the private sector can accumulate financial assets.  If the government runs a surplus, though, it means the private sector must go deeper into debt itself.  See the answer to question 1 here for another explanation. There’s a dramatic historical graph that beautifully illustrates this relationship over the last 60 years.  Unfortunately, I can’t put my hands (mouse, really) on it right now.  When I find it again I’ll update.  The point is that government surpluses, the kind that the Tea Party and many Republicans claim they want as being responsible, can only happen if the private sector as a whole goes deeper into debt.  It’s private debt that got us into the Great Recession/Financial Crisis, not public debt.  In fact, the Clinton surpluses were a small part of it because to create those Clinton surpluses the private sector had to go deeper into private debt – which we did. It was called mortgages, corporate debt, credit cards, student loans, etc.

A long response, but I hope it was worth it and helps.

The Public Debt Is Rising Because Of Tax Cuts and Wars

In past posts, I’ve emphasized that tax cuts don’t really generate greater revenues for the government except under the most unusual circumstances.  Tax cuts do exactly that, they cut the taxes available to the government.  And that is one of the three big reasons why the U.S. government is running large deficits today and has a rising public debt.  The three big reasons are Bush-era tax cuts, wars, and an economic recession which cuts revenue. It wasn’t the stimulus spending or the bailouts.  From Chad Stone at the CBPP:

As we’ve noted, my colleagues Kathy Ruffing and Jim Horney have updated CBPP’sanalysis showing that the economic downturn, President Bush’s tax cuts, and the wars in Afghanistan and Iraq explain virtually the entire federal budget deficit over the next ten years.  So, what about the public debt, which is basically the sum of annual budget deficits, minus annual surpluses, over the nation’s entire history?

The complementary chart, below, shows that the Bush-era tax cuts and the Iraq and Afghanistan wars — including their associated interest costs — account for almost half of the projected public debt in 2019 (measured as a share of the economy) if we continue current policies.

Tax Cuts, Wars Account for Nearly Half of Public Debt by 2019

Altogether, the economic downturn, the measures enacted to combat it (including the 2009 Recovery Act), and the financial rescue legislation play a smaller role in the projected debt increase over the next decade.  Public debt due to all other factors fell from over 30 percent of GDP in 2001 to 20 percent of GDP in 2019.

If we just let the Bush-era tax cuts expire on schedule and nothing else, we can get the public debt stabilized relative to GDP.  If we also end these multiple wars (Iraq, Afghanistan, Libya, where else?), things get much better.  We could easily afford to stimulate the economy back to full-employment.  We could pay for everybody’s healthcare bills into old age.  Just sayin’.

 

Debt Ceiling: Kabuki Theater of the Absurd

Tuesday evening the House of Representatives voted on whether to raise the so-called “debt ceiling”.  It was pure charade.  No, it’s worse. It’s kabuki theater of the absurd.  First off, the House Republican leadership knows it’s only for show.  The reality is that Congress will vote to raise the limit later this summer.  They have no choice.  The whole concept of the debt ceiling is absurd and likely unconstitutional. Let’s see the news itself, this taken from ABC News:

The House of Representatives rejected an increase to the statutory debt limit in a move chastised by Democrats as “a political charade,” “political cover” and “political theatre.”

The measure, which failed by a vote of 97-318 with seven members voting present, stated that “the Congress finds that the President’s budget proposal, Budget of the United States Government, Fiscal Year 2012, necessitates an increase in the statutory debt limit of $2,406,000,000,000,” and would have raised the debt limit to $16.7 trillion.

All 236 Republicans voted against the increase – joined by 82 Democrats. 97 Democrats voted yes for a debt limit increase, while 7 Democrats voted present.

The bill required a two-thirds majority to pass.

Why was it a charade? Because the Republican leadership designed it to be a fake.  This from Time mazazine’s website (bold emphasis is mine) just before the vote:

Not be a spoiler, but Tuesday evening’s House vote to increase the federal borrowing limit by $2.4 trillion without preconditional spending cuts will fail. It was designed that way by the Republican leadership: They used a procedural trick to require a 2/3 majority for passage and told every member of their caucus to vote against it. The idea, they say, was to prove to the world (and congressional Democrats) that raising the debt ceiling won’t happen without a package of accompanying spending cuts.

Mission accomplished: President Obama has been admitting as much for weeks and House Democratic Whip Steny Hoyer on Tuesday recommended that Democrats join Republicans in voting down the “clean” debt limit measure. “My advice to them would be not to play this political charade,” he said. Of course, the failed vote is the charade. Time to play spoiler again: Congress will raise the debt ceiling by the end of the summer. Tuesday’s failed vote only serves to provide political cover for members of Congress who will eventually back the incredibly unpopular increase in borrowing capacity.

Now supposedly Wall Street and the financial markets understand that Congress isn’t really serious about intentionally defaulting on U.S. bonds.  The New York Times in it’s report on the vote:

“Wall Street is in on the joke,” said R. Bruce Josten, executive vice president of the U.S. Chamber of Commerce.

So the whole point is so that members of Congress can claim on the campaign trail that they voted against the debt ceiling increase when in fact they are also going to vote for it later this summer.  Absurd.  Pure theater. It’s all political pretend.

Beyond the politics, though, the economics is even more absurd.  First, the concept of a “debt ceiling”, a law that saws the government cannot borrow more than say $x dollars is absurd.  How much the government needs (or chooses) to borrow is basically already decided by legislation already passed that goes by the name “budget”.  Congress voted a budget not two months ago that requires, under current rules, more borrowing.  Now Republicans are claiming they don’t want to borrow the money they already committed themselves to borrow.  Got that? So are you following so far?  The House Republican leadership schedules a vote that it knows must fail (that’s why the special 2/3 requirement).  Why? So it can tell one thing to voters on the campaign trail while letting Wall Street “in on the joke”.  We have the best government Wall Street can buy.

But it’s doubly worse than just the lies they’re presenting to voters.  It’s all over what should be a non-issue.  Normally, I don’t like analogies between government and a household because such analogies don’t usually hold up very well.  Government, unlike a household, is not inherently budget-constrained.  But let’s try a simple analogy anyway.  Suppose you put together a budget for your household.  You project or know that you are going to earn $1000 per month.  So income is $1000.  Then you decide that you need to spend $1500 per month in outlays.  You have no savings. You are going to have deficit of $500 per month.  No problem, you have a credit card.  You can borrow to finance the deficit*.  Let’s suppose your credit card account has no credit limit.  The bank is saying you can borrow as much as you like.  In fact, the bank right now is telling you that you are such a good credit risk that you only have to pay 3% interest rates.  Under this scenario there’s no problem, right?  You need the extra $500, you borrow it.  The credit card balance goes up.  But there’s no limit to how high it can go.  That would be the government’s ordinary, constitutionally-mandated budget making process.

But sometime ago Congress decided to add another wrinkle.  It passed a “debt ceiling” law.  Supposedly this is another law, that independent of whatever the budget says, will limit how much total debt the government can have outstanding at one time.  Using our analogy, this is like the head of your household saying that they refuse to borrow more than $x on the credit card, regardless of what they previously said was their budget.  So two months ago, Congress passed the budget with a deficit.  It told the government to buy lots of things and not to collect very much taxes.  Now Congress wants to say they won’t pay.  Huh?  In the private world, this is called an unnecessary, voluntary default.

Yes, that’s what this vote says.  The Republican leadership has just told the world that they actually want the U.S. to default on bonds now!  There’s no economic reason why we need to default.  The financial markets are saying they actually want to lend money to the U.S. at record low interest rates.  The financial markets have long been saying they have no fears about the ability of the U.S. to pay in the future.  No matter. The House Republicans want to default just for the heck of it.  Well, actually it’s not for the heck of it.  They are holding the entire U.S. budget hostage, including payments to seniors, soldiers, and Medicare, because they want to change the future of Medicare and Social Security.  They want to end to programs and privatize everything for the benefit of Wall Street.  Such an agenda is hugely unpopular, so the Republicans can’t do it directly.  Instead they have to create a fake crisis about the public debt, hold a fake vote, and threaten national insolvency to get their way in cutting Medicare and Social Security.

*The whole issue is even more absurd when we consider how my analogy breaks down.  The analogy breaks down because the government doesn’t have to borrow to finance a deficit – it can just spend the money by creating new “high-powered money” which are also called bank reserves.  When the government spends, it just writes a check off the Federal Reserve bank.  It doesn’t have to have “money” in the checking account first.  When The Fed “cashes” the check, it pays your commercial bank with “bank reserves”.  Bank reserves aren’t really “money” in the public’s hands yet, but they can be thought of as “potential money”.  Unlike the primitive days of a century ago, there’s no artificial limit on how much can be spent.  There’s no gold standard.  (that’s a good thing!).

I do believe this is all theater of the absurb.  But it’s dangerous theater. I still believe that when the time comes this summer, Wall Street will call the political leaders and tell them enough’s enough, raise the limit and avoid default.  A default is much too dangerous to contemplate.  A default by the U.S. could bring economic disaster globally.  There’s always the possibility that these folks in Washington dig in their heels and let their egos get the best of them.  They don’t understand what they’re playing with, but that’s never stopped them before.
In the meantime, we’re treated to the spectacle of House Republicans claiming they would prefer the U.S. default now because they’re afraid that without big emergency spending cuts the government will end up defaulting at some point in the future.  Default now to avoid default in the future.  Yeah, I call that absurd.

Can We Afford to Raise Taxes On High Incomes? Can We Afford Not To?


Another tax related post.  It appears that taxes, in particular, taxes on the top income bracket will be a major topic of debate propaganda for the next year and  a half until the next presidential election.  Part of the reason is because the tax deal done last December (2010) between Republicans and Obama last December (2010) perpetuated the Bush-era tax cuts until Dec. 31, 2012, just after the election.  Another reason is because the Republicans in Congress, led by Congressman Paul Ryan have passed a proposed budget that will cut the top individual federal marginal income tax rate to 25%, ten points below the even the Bush-era 35%!  (source: Reuters)

The Republicans and Tea Partiers basically offer three arguments for cutting the top tax rates on high-income folks. None of the arguments hold up under examination.  First, they argue that the U.S. is too heavily taxed already. So, let’s compare the U.S. to other countries in the graph at the right from CBPP.  The U.S. is in fact, a relatively low tax country compared with other developed, industrialized nations.  (although to be fair, we should note that the other countries on the graph pay for healthcare for all their citizens and most of it comes from the government budgets).

So let’s move onto the second argument.  Republicans like to argue that cutting taxes for the top end, for the rich and high income brackets will create jobs.  They repeatedly call these high-end income folks the “job creators”.  Apparently out of some pique, these people refuse to “create jobs” for us lesser people whenever their tax rates exceed some number around 35%.  Unfortunately, this concept has been tried before and found wanting.  Simply put, there’s no empirical support for the idea that cutting tax rates primarily on the top end bracket will create jobs.  See here and here for more details. George Bush and the Republican Congress cut taxes and tax rates in 2001. At the end of the decade, in December 2010, the net increase in jobs (employment) in the U.S. was zero. That’s right. Not a single net new job.  No more people were employed in Dec 2010 than were employed before the tax cuts.  As I’ve discussed before, this doesn’t mean that Keynesian theory that cutting total taxes collected on from the nation has been disproven. Rather it means that how the taxes are cut matters.  Tax cuts only work to stimulate the economy and create jobs when they create new spending.  Tax cuts on the top brackets don’t create new spending, though.  They create a boom market in fixed luxury assets such as mansions in the Hamptons, Vail, or outside the country.  Tax cuts on the top brackets help fuel investments in off-shore funds and overseas entities, but they don’t really drive much spending here at home, at least not the kind of spending that drives good jobs and middle-class incomes.  Let us not make a mistake, while the Bush-era tax cuts included some minor cuts for lower income brackets, the overwhelming benefit accrued to the top bracket, as shown below (again from CBPP).  For more details and to see the real empirical record of tax rates vs job creation/economic growth, see Presimetrics, a site and book well worth the read.

Now let’s consider the third argument often provided as to why we need to cut tax rates for the top bracket.  Strange as it may sound, but the argument is offered that it’s the fair thing to do.  I know when you look at comparable average tax rates by income bracket like I did here and here, that it seems like the tax code is already quite fair to people earning a million dollars or more.  Yet their argument goes that it’s the richest people who pay for most of the government’s total taxes paid.  They cite the fact that the top income bracket people pay the majority of all tax dollars collected by the government.  That’s true.  But they neglect to say that it’s because the top bracket gets the dominant share of income in the U.S, not because the tax rate is too high.  Indeed, the top bracket payers are the only ones who have really benefitted in the last 30 years and seen their incomes grow substantially.  See the accompanying CBPP chart to see how the top 1% has seen it’s income rise 281% since 1979 (as it’s tax rates have been on a long down-hill slide), while the lower 80% barely grew 25% income.  The reality is that the top bracket pays the majority of tax dollars because they get the majority of the nation’s income.  Yes, the income distribution numbers are that out of whack.  The top 1% of households by income get a whopping 17.9% of all national income.  That’s just the top 1%!  Their share was only 7.5% 30 years ago.  (source: CBPP)So, actually the fair thing would be for the top bracket to pay a little more since they’ve benefitted the most from the current tax regime.

During the 30 year time frame that the top bracket has been raking in a larger and larger share of the national income while seeing their income tax rates decline, the lower brackets, the ones with incomes below $100,000 have seen their payroll tax rates double to build a giant Social Security trust fund.

Overall, I think we can afford to raise tax rates on the high income tax bracket.  In fact, if anything, there are good reasons to raise tax rates on the high end. First, since our government persists in it’s belief that it must borrow to finance a deficit (an unnecessary self-imposed constraint) and since many politicians, including those Republicans, think it’s a good thing to reduce the deficit (opinion I do not share), then we should.  As I observed with the post on the do-nothing plan, letting the Bush-era tax cuts expire and letting the existing law take force in January 2013 to raise the top tax bracket to 39%, which it was during the Clinton low unemployment years is a good plan. Let’s see what happens when if we allow the Bush tax cuts to expire and let the top rate go back to the 90’s era 39% vs. keeping the present 35% rate.  Again, CBPP obliges.

A strong argument can be made that the top bracket benefits disproportionately from the work of the government.  It’s not the poorest households that have investments in the middle east and around the world that are protected by the U.S. global military presence. It’s the richest. Time to pay the bill.

U.S. Budget Proposal Analysis Tool (spending)

I missed this when it came out Feb 1, but an alert student pointed me to it.  The NYTimes has an excellent interactive visual breakdown of the U.S. Federal Budget spending.  It very graphically shows where the money goes and how much.

Link: http://www.nytimes.com/interactive/2010/02/01/us/budget.html

A couple of notes.  First, the graphic shows only spending and transfer payments (outlays).  It doesn’t show offsetting receipts. For example, Social Security payments are one of the biggest categories shown. But Social Security doesn’t contribute to the deficit.  Social Security taxes, which aren’t shown, more than exceed payments made.  Similarly, but on much smaller scale, postage sales which help offset cost of the postal system aren’t shown.

Second, it’s tempting to think that programs eliminated would result in a equal deficit reduction. For example, it’s tempting to think that if $400 billion in programs were eliminated then the deficit would drop by $400 billion.  Not so. You have to consider the macro impact on overall GDP and employment of cutting the program.  Cutting $400 billion in programs might (or might not) actually worsen the deficit if the cuts result in net an overall reduction in aggregate demand and employment.  That’s because the resulting drop in tax collections would offset the supposed savings from cutting the spending program.