It is hard to find any topic that causes greater confusion than Social Security “trust funds.” Not only are these funds widely misunderstood, but many people also apparently think that they have been deliberately misused since big balances began to accumulate 20 years ago.
The basic source of confusion stems from what philosophers call a “fallacy of composition” — mistakenly assuming that what is true for an individual is necessarily true for a large group or for government.
Simply put, for a national government to “save” or “lock up” money is quite different from an individual doing the same thing. Government is so much larger relative to the whole economy than is one person. Even more importantly, government controls the money supply.
These two factors mean that for government to “save up” money in a “trust fund” is quite different from how an individual would do it. Journalists have a hard time understanding this and often add to the confusion rather than bring clarity.
The result is articles like one in last Sunday’s New York Times that breathlessly report failure to achieve the impossible as malfeasance. Readers get excited, and economists struggle to correct misconceptions.
This article correctly noted that since 1983, U.S. taxpayers paid $1.8 trillion more into Social Security than was paid out in benefits. It continues: “So what has happened to that $1.8 trillion? The advance payments have all been spent. Congress did not lock away the Social Security surplus, as many Americans believe. Instead, it borrowed the surplus, replacing the cash with Treasury notes, and spent the loan proceeds paying the ordinary expenses of running the federal government.”
The assertion is entirely correct yet highly misleading. At this point, Times readers need to ask themselves “OK, just what would locking away the surplus consist of?” The Times would have done its readers a service if editors had asked the reporter the same question.
The problem is there is no way a national government can take in funds and “lock them up” without resorting to something called “privatization,” which would evoke even greater shock and anger in the media and among the public.
Go back to the beginning. People pay FICA taxes out of their wages. These effectively get deposited into a Social Security Administration account at some Federal Reserve Bank. The Fed, as “fiscal agent for the government,” processes all federal receipts and disbursements.
Because receipts exceed payments, Social Security has a surplus with which it must do something. It could do any of the following:
— Convert the balance at the Federal Reserve into $20 bills and store millions of pallets of such currency in a guarded vault like the gold bullion depository at Fort Knox. (Don’t laugh: Some people adamantly believe that this is the only “honest” way for the government to “lock up” the surplus.)
— Deposit the funds in commercial banks such as Wells Fargo, Wachovia and the State Bank of Chandler, Minn. The government would earn interest like any other large depositor.
— Buy stocks and bonds like any state or private pension plan, thus earning interest, dividends and capital gains.
— Buy U.S. Treasury bonds, as would state or private pension plans, and earn corresponding interest.
— Keep the funds in some form of special account with the Federal Reserve.
The two options of depositing the funds in private banks or buying nongovernment bonds and stocks might avoid much of the confusion engendered by the government lending money to itself. But, while not involving personal accounts, it would constitute the “privatization” of funds that liberals abhor and that the general public fears. Suggest this in a speech or article and a negative reaction is guaranteed.
Congress briefly considered this option 21 years ago, but quickly rejected it as being too risky. Funds as important as Social Security should not be exposed to private capital markets. They should be put into something safe, and what could be safer than U.S. Treasury Bonds?
That belief, of course, is another huge fallacy of composition. What legitimately is the safest investment for an individual is not necessarily safe when the government is lending to itself.
But senators and representatives who voted for this alternative could and did go home and tell their constituents that their FICA submissions were invested in the safest of all possible alternatives.
At this point frustrated citizens often say, “Well, we should just keep the funds in currency or in an account at the Fed. We at least would know where the money was.” Perhaps this is what New York Times staffers would understand as “locking away the surplus.”
It is, however, another fallacy of composition. If I put a wad of $20s under my mattress, it effectively drops out of the money supply. The Fed can print an infinitely greater amount of new money to make up for my stash. If I spend my stash 30 years later, returning that amount to circulation has no perceptible effect.
If the Social Security Administration, however, keeps $1.8 trillion in bills or in some idle account at the Fed, the effect would be a substantial decrease in the money supply, one that the Fed would quickly offset by issuing new money to keep liquidity and interest rates at desired levels.
As more Social Security benefits are paid, funds would flow back into the money supply and the Fed would destroy money to avert inflation. There still would be no “saved-up real resources” to pay benefits to baby boomers.
Even under the “privatization” options, if federal spending (excluding Social Security payments and FICA collections) exceeded revenues, the Treasury would borrow from the private sector at the same time the Social Security Administration would put money in private-sector stocks, bonds and bank accounts. The net effect would be little different from what we have now.
© 2004 Edward Lotterman
Chanarambie Consulting, Inc.