THE BANANA REPUBLIC OF THE UNITED STATES

Why the Consensus to Leave Social Security and Medicare Untouched During Budget Negotiations Is Worse Than January 6, 2021

What do President Biden, Donald Trump, Mitch McConnell, Chuck Schumer, and Kevin McCarthy all have in common?

All of them agree that there will be no discussions about cuts to Social Security and Medicare in 2023.

For this post, I’ll discuss Social Security and leave Medicare for another day.

Leaving Social Security untouched is equivalent to supporting inevitable reductions mandated by the current law.  Refusing to do anything today is equivalent to consenting to drastic cuts in the future. Refusing to explain to voters today how the government should respond to the mathematical certainty that our current tax revenues and borrowing levels are nowhere close to being able to pay for future retiree benefit demands is a fundamental abdication of political responsibility.

When the Social Security Trust Fund is exhausted in 2035, then Social Security benefits will automatically be reduced by 23%.  The Democrats know this, and they will simply propose raising taxes in 2035 to maintain the current benefit levels and dare the Republicans to stop them.

The Republicans currently holding office know this, but they dare not speak this truth and challenge the Democrats to specify precisely how they plan to pay for these mounting expenditures before agreeing to raise the Debt Limit.

However, absent any alternative, Trump, McConnell, and other Republicans who demand that Social Security benefits remain untouched are condemning future Republicans to cave into the inevitable tax increases after Trump and McConnell have left the political stage.  Republicans are running inside the maze that the Democrats skillfully constructed to lead future Republicans to a political dead end with no choice but to succumb to higher and higher percentages of taxes being extracted from the economy.

Government’s Primary Responsibility

This bi-partisan refusal to plan for this inevitable drive off of a fiscal cliff will likely lead to calls for dictatorial powers for a President who would seize budgetary controls from a Congress that refuses to perform its Constitutional duty.

This is a far greater threat to democracy and an international embarrassment than the invasion of the Capitol on January 6, 2021.

In a future post, I will propose a politically palatable solution for Republicans that could divert the Congressional Clown Car, which is currently headed full speed ahead towards the fiscal cliff. For now, I wanted to provide some background to explain the Social Security Trust Fund and how we got into this mess.

Social Security Trust Fund

This background report provides a detailed explanation of how the Social Security Trust Fund operates. I want to cut through the legalese and get to the fundamental political reason that the 1934 Social Security law created a Trust Fund.

Federal programs like defense, agriculture, education, housing, the Judiciary, and Homeland Security are subject to annual review and appropriations by Congress to authorize spending every fiscal year. However, Social Security and Medicare programs bypass this annual scrutiny and appropriation process because their benefit payments are drawn from their respective Trust Funds.

Using this Trust Fund device allows expenditures for Social Security and Medicare to be categorized as equivalent to debt payments made to persons holding US Treasury Bonds. These expenditures are legal obligations (“entitlements”) instead of garden variety budget items subject to annual scrutiny by Congress.

For every dollar of Social Security payroll tax revenues sent to the US Treasury’s General Fund, an equivalent amount of “nonmarketable” federal public-debt obligations called special issues (i.e., securities available only to the trust funds, not to the general public) are credited as assets for the Social Security Trust Fund and liability for the US Treasury. Because the US Government owns both the US Treasury and the Social Security Trust Fund, these accounting entries have no material economic significance. They are merely legalistic devices allowing Congress to evade its responsibility to evaluate Social Security and other budget priorities annually.

When Social Security payments are made from the general fund, an equal amount of U.S. government obligations are redeemed from the Social Security trust funds, depleting the Trust Fund. The amount of Special Issue, non-marketable bonds that are assets for the Trust Fund is reduced when the net outflows of payments to retirees exceed the inflows of payroll taxes.

In another way, the holdings of the Social Security trust funds (the asset reserves) represent the accumulated total of surplus Social Security tax revenues collected for the program over the years, plus the interest earned on securities held by the trust funds. Over its 87-year history, the program has collected $25.2 trillion and paid out $22.3 trillion, leaving trust fund reserves of about $2.9 trillion available for future program spending. As long as the trust funds have a sufficient balance, they represent the authority and an obligation for the U.S. Treasury to issue benefit payments scheduled under current law.

If you were wondering about the rate of interest paid on these Special Issue Bonds, the average rate of return across the entire Trust Fund in 2021 was 2.5% The rate is set by the Treasury Secretary, supposedly based upon a blended yield of outstanding Treasury Debt held by the public.

Quoting from this background report:

Those reserves are projected to be depleted in 2035 (the 2022 intermediate assumptions reflect the Board of Trustees’ understanding of Social Security at the start of 2022). Following depletion of trust fund reserves, the program would operate with current tax revenues; however, they are projected to cover only about three-fourths of scheduled benefit payments through 2096.

Simplifying the Entitlement Problem

As long as you understand that the Trust Fund is merely a political device rather than something with real economic importance, you will be able to cut through the thicket of jargon obscuring the underlying economic factors driving our budgetary crisis.

A legal device that is a companion to the Trust Fund is the “payroll taxes,” which are segregated from your income taxes.

2022 Combined Employer and Employee Payroll Tax Rates are:

10.6% for Old Age and Survivors Insurance (OASI) regular old Social Security

1.80% for Disability Insurance (DI)

2.90% for Medicare Part A Health Insurance (HI)

15.30% Total Payroll tax rate

Separate from these payroll tax items are Federal and State Income Taxes, disability, and other taxes.

Why is the segregation of payroll taxes important? Because it is a way to segregate these tax revenues to bypass Congressional oversight by placing them into the Trust Fund. That is the sole legal and political utility of this elaborate charade.

However, from the point of view of economic behavior, these payroll taxes are merely income taxes. So when you hear debates about increasing the current maximum amount of income subject to the payroll tax ($160,200 in 2023), this is an argument about increasing contributions into the protected domain of the Trust Fund to escape Congressional scrutiny.

You could just as easily increase the income tax rate instead of the payroll tax rate to pay Social Security benefits, but that would not have the same legal effect to increase the size of the Trust Fund. This is the only reason people make the distinction between payroll and ordinary income tax rates.

The other political reason is that employers technically pay half of the payroll taxes while the employee pays all of the income taxes. In economic terms, the employee is still bearing the entire tax burden paid by the employer through a reduction in after-tax take-home compensation, but if you don’t see it on your paycheck stub, then politicians hope that you won’t understand this basic economic reality.

Wealth Transfers in Social Security

You can use the Social Security Benefits Calculator to determine the monthly benefits you will receive at retirement. I wanted to calculate the earnings of someone who began working in 1970 and planned to retire at age 67 in 2023. I assumed that they made $60,000 in 2023. The inflation-adjusted equivalent in 1970 would have been $7,581 per year. I made inflation adjustments every year between 1970 and 2023 to hold this 2023 equivalent compensation of $60,000.

After plugging these figures into the calculator, the estimated benefit payment was $2,608 per month.

Compare that to someone who earned $60,000 per year (assume no inflation) salary and paid 10.6% of it (the Social Security tax rate) every year to a 401(k) Retirement Plan where they earned 3% compounded monthly. After 53 years, they would accumulate $360,391. If the average remaining life expectancy at 67 was 20 years, and interest earnings were 3%, then they could expect to receive a monthly life annuity equal to $1,823.

Because the Social Security program is a life annuity (monthly payments until death), I replicate the economic outputs of Social Security by combining a Treasury Bond mutual fund with a life annuity at retirement.

This $785/month difference ($2,608 - $1,823) represents the wealth transfer baked into the Social Security program. To most people’s surprise, your Social Security benefits are not proportional to the amount of payroll tax contributions.

If middle and upper-income taxpayers earning between $80,000 and $160,000 paid their 10.6% payroll tax into a mutual fund of Treasury Bonds earning 3%, they would be able to receive larger monthly life annuity payments than the benefits calculated according to the Social Security program rules.

Creating a defined benefit Personal Treasury Account is not the same as the privatization of Social Security, which was proposed by President Bush in 2005. Bush’s plan would have allowed investments in stocks and bonds of private companies. That would have diverted payroll tax revenue away from the Government and increased the budget deficit. However, if all payroll taxes paid by a taxpayer was credited to their Personal Treasury Account instead of the Social Security Trust Fund, the US Government would continue to receive the same amount of tax revenue as they would under the standard Social Security program.

Understanding this disconnect between payroll contributions and benefits payouts is another crucial insight because it proves that Social Security is not like a pension plan where beneficiaries only receive what they contributed. Instead, it is a massive income transfer program masquerading as a pension plan.

My next post will build upon these insights.

David Barulich