1. What do the Social Security trust funds consist of?
The Social Security trust funds are United States Treasury bonds. These bonds
are issued by the U.S. Treasury to raise money to pay for budget deficits. The
total value of all outstanding Treasury bonds is the national debt. The Social
Security trust funds own part of the national debt.
The trust funds have been accumulating Treasury bonds since the mid-1980s because
Congress, at the recommendation of Alan Greenspan and Ronald Reagan, decided
to collect more in taxes than were needed to pay current benefits. That decision
was made in order to build up reserves against the retirement of the baby boomers.
As workers, baby boomers have been accumulating Treasury bonds to help pay for
their retirement.
Figure 1 shows how the total national debt increased from March 1994 through
March 2005 and who owns the Treasury bonds that constitute the national debt.
The total national debt did not grow steadily over this period. In the seven
years between 1994 and 2001, the national debt increased by a little more than
a trillion dollars. In the four years since 2001, it has increased by two trillion
dollars. When budget deficits were small or there were surpluses (as in the
late 1990s), debt grew little. When they were large (as in recent years), total
national debt rose rapidly.
Source: U.S. Department of Treasury, Ownership of Federal Securities, Table
OFS-2, available online at
http://www.fms.treas.gov/bulletin/b25ofs.doc.
In contrast to the growth of total national debt, between 1994 and 2005, the
Social Security trust fund holdings of Treasury bonds (see the bottom segment
of the bars in Figure 1) increased at a steady pace. But in spite of the steady
increase in Social Security trust fund purchases of Treasury bonds, the trust
funds still own less than a quarter of the total debt. Other federal agencies,
and, in recent years, foreign central banks each own more of the debt than the
Social Security trust funds. Private U.S. investors (pension funds, mutual funds,
wealthy individuals), the owners of more than half of the debt in 1994, today
own only 23 percent, about the same as the Social Security system. In recent
years, Treasury bonds have not been an attractive investment for those with
private wealth to invest.
2. How have we benefited from the Social Security trust funds?
To date, the Social Security trust funds have accumulated about $1.7 trillion
worth of U.S. Treasury bonds. This means that the Treasury has had to borrow
less from other lenders to finance our budget deficits. Consequently, the Treasury
has not had to raise the rate of interest on its bonds to attract private investors,
and it has had to rely less on foreign lenders such as the Central Banks of
China and Japan. Private investors have put their saving into assets such as
stocks, corporate bonds, and housing instead of Treasury bonds, which has led
to construction of new buildings and purchases of new equipment in the United
States, contributing to economic growth.
3. How secure are the Treasury bonds in the trust funds?
Any bond represents a promise by the borrower to pay the lender. In the past,
some private borrowers and even nations have defaulted on their debts. Enron,
Pan Am, Polaroid, and Bethlehem Steel went bankrupt. Debt issued by Argentina
and Ecuador can be purchased for far less than its face value because many investors
doubt that it will be repaid. And bonds issued by the Confederate States of
America are suitable for framing, but for little else; they will never be repaid.
The United States, too, could default on its debt. The country could lose a
war or a plague could decimate the population. Or our government could simply
announce "We will no longer honor our promises to the Central Bank of China
or the Federal Reserve Bank or the Social Security trust funds or anybody unlucky
enough to have trusted us at our word."
How likely is it that the U.S. government would renege on its promises to its
creditors? One way to determine the likelihood of such a thing happening is
to see how Treasury promises are valued in financial markets. After all, debt
issued by Argentina and Ecuador are available at fire sale prices in international
financial markets. Is any debt issued by the U.S. Treasury similarly discounted?
Absolutely not. Markets treat promises by the Treasury as essentially risk free.
What is more, it would be quite impossible for the Treasury to announce "we
are only defaulting on this portion of our national debt" without infecting
all markets in which Treasury debt is sold. It is as if a person were to say
"only my left leg has gangrene; the rest of me is fit and healthy."
The fact that a default on any part of the national debt is almost unthinkable
is underlined by the reaction of financial markets when former Treasury Secretary
Paul O'Neill and President Bush announced in speeches that the Social Security
trust funds are nothing but paper. If markets really believed that the U.S.
government would fail to redeem its bonds, there would have been an immediate
rise in the risk premium on Treasury bonds, with interest rates spiking upward.
But nothing happened. Everybody knows: it is only political talk.
4. Where will the money come from when the Treasury must redeem the bonds
in the Social Security trust funds?
The U.S. government gets funds in three ways. It can look for increased revenues
(through higher taxes). It can look to cut expenses (through lower spending).
Or it can borrow by issuing new Treasury bonds. Replacing old bonds with new
bonds is called "rolling over the debt," and it is done every day
by households, businesses, and governments.
The ability of the government to service its obligations to the Social Security
trust funds (that is, to future retirees) is inseparable from its ability to
service the entire national debt. The question is not whether the Treasury will
be able to repay the 22 percent of the national debt that is owed to the Social
Security trust funds. The real question is whether the entire national debt,
the sum of all the borrowing from all lenders, is getting out of control. Will
the federal government be able to tax and borrow and scrimp in the future to
meet its commitments?
One way to evaluate our nation's debt burden is to see what is happening to
the size of the national debt relative to the nation's ability to pay. This
ability to pay is closely tied to income, that is to the size of our national
economy. Is our debt growing relative to our income? Figure 2 shows the answer
to this question for the past half century.
Source: Economic Report of the President 2005 Table B-78, available online
at http://a257.g.akamaitech.net/7/257/2422/17feb20051700/www.gpoaccess.gov/eop/2005/B78.xls.
The surprising message of Figure 2 is that every Democratic president (Kennedy-Johnson,
Carter, and Clinton) left office with the ratio of national debt to income below
where it was at the beginning of his administration, while the last three Republican
administrations (Reagan, George H.W. Bush, and George W. Bush) have presided
over explosive growth of the national debt relative to national income. Since
1960, Republican administrations have added 38 percentage points to the national
debt/GDP ratio, while Democratic administrations have subtracted 23 percentage
points from that ratio. This record stands on its head all the clichés
about who is fiscally responsible.
Ultimately, the ability of the Treasury to keep its promises to pay bondholders
what they are owed depends on government's ability to control its taxation and
spending policies, in other words, to keep the entire national debt manageable
relative to the size of the economy.
There is no special obligation or special problem posed by the Social Security
trust funds. That debt is part of the national debt. The nation's ability to
honor its commitments to its seniors is part of the larger effort to honor its
commitments to all bondholders.
In historical perspective, the national debt relative to the nation's ability
to pay is lower today than it was in the early 1950s (coming off the Second
World War), but it is much higher than it was in the 1970s. Over the past three
decades, Republican administrations have issued new debt much faster than the
economy has grown. To meet its commitments to all its creditors, including the
Social Security trust funds, future U.S. governments will have to control the
fiscal policies that have produced such huge deficits-such rapid growth of the
national debt. Will they? For the next few years, with the administration repeatedly
asking for supplementary appropriations to fund the wars in Iraq and Afghanistan
while striving to make the tax cuts permanent, it seems unlikely. Any decline
in the national debt/GDP ratio would represent the first such decline under
a Republican president since 1974.
There is no special problem of meeting the Treasury's obligations to the Social
Security trust funds. The fundamental problem is the larger one of servicing
the national debt. And the solution lies in controlling federal deficits.
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