What's Really Behind The Trust-Fund Gimmickry

Volume VI, Number 7 July 13, 2000

President Clinton has just dusted off and reissued his proposal to shore up Social Security by double-counting its trust-fund interest. Vice President Gore has made the proposal the centerpiece of his own Social Security reform plan. And now both the President and the Vice President want to apply the same idea to Medicare as well. It's tempting to dismiss the proposal as mere gimmickry. The rationale for the double-counting-that the extra credits somehow represent interest savings that the rest of the budget owes Social Security-is nonsensical. And the claimed payoff-higher national savings that will help defray the cost of future benefits-is at best dubious. In fact, the only thing the proposal is sure to accomplish is to increase the IOUs held by the trust funds, thereby increasing their claims on Treasury. But that is precisely the point. Behind the gimmickry, there is a consequential goal: opening the door to general revenue financing. This may seem like an attractive alternative to cutting benefits or raising contributions. But it is a bad idea-and one that would never pass muster if proposed on its own merits. General revenue financing will not only short-circuit fiscal discipline. It will ultimately change Social Security from social insurance into welfare-an ironic outcome for a proposal that aims to preserve the status quo.

A Leap of Illogic

Let's start with the weakest part of the proposal-its ostensible basis in trust-fund accounting. The logic goes like this: The surpluses run by the Social Security and Medicare Hospital Insurance trust funds will henceforth be devoted to paying down the publicly held debt. This will result in a large savings in net interest costs for the budget. Therefore the trust funds, because they made the savings possible, should be credited for it. The credits would extend Social Security's solvency from 2037 to 2057 and Medicare's from 2025 to 2030. However you look at it, this amounts to double-counting. Remember: The trust funds are already credited with interest on the surpluses they lend to Treasury, whether the surpluses are saved or squandered. Why should they be credited a second time based on the use Treasury makes of the money? There is no reason. If future trust-fund surpluses deserve double interest, then past trust-fund surpluses deserved it as well. The closer you look at the proposal, the more arbitrary it becomes. For one thing, there's the timing. Although the budget begins saving on interest costs immediately, the Social Security trust funds don't begin getting credits until 2011. Why? Apparently because up to then the President and Vice President need the interest savings to pay for other spending initiatives. The timing for Medicare is even odder. The credits begin in 2001, are suspended in 2003, then resume in 2008. The proposal also manipulates the credits to get around an inconvenient fact-namely, that Social Security's surpluses are a temporary phenomenon. As Boomers start retiring, the surpluses will turn to deficits. And when they do, the Social Security trust funds will have to be drawn down, adding to the publicly held debt. The credits should decline in tandem-and eventually become debits. But they don't. In a leap of illogic, they are frozen in every year after 2015 at 2015's level.

A Startling Proposition

OK, so the proposal may have a shaky rationale. But doesn't it at least further a crucial objective: raising national savings and prefunding future benefits?

Probably not. Yes, the President and Vice President promise that future Social Security and Medicare surpluses, including the extra interest credits, will be devoted to paying down the publicly held debt. But the proposal includes no credible mechanism for enforcing the promise. The outcome depends entirely on the willingness of future Congresses to run unified budget surpluses at least equal to the enlarged trust-fund surpluses. This is a thin reed on which to rest any reform proposal. True, today's leaders have reached a tacit agreement to keep the budget balanced excluding Social Security's and Medicare's trust-fund receipts. But the fiscal bounty that makes this possible owes little to deliberate policy choices. It is mostly the result of global peace, a record economic expansion, and a temporary slowdown in demographic aging. These favorable circumstances cannot be regarded as permanent. Even the proposal's architects seem to doubt the credibility of their own promise. Though justified as a savings dividend, the extra interest credits do not in fact depend on debt reduction. They would be fixed in advance and paid into the Social Security and Medicare trust funds-adding to their claims on Treasury-whether or not a penny of debt is paid down. Still, let's suppose that the proposal works as advertised. That leaves a deeper question-namely, do we have the right to lay claim to the fiscal dividends that would otherwise accrue to our children? In effect, the proposal assumes that the federal budget has no valid reason to run a surplus, no matter how high the business cycle soars, except to fund the retirement and health-care benefits of today's adults. This is a startling proposition, especially in an era when leaders claim to care so passionately about "stewardship."

Unintended Consequences

Because the proposal is nonsensical within the framework of trust-fund accounting, the credits must be considered equivalent to general revenue financing-that is, paying for Social Security like we pay for most other budget items, from school lunches to stealth bombers. Yet the proposal's architects go to great lengths to hide this fact by clothing the credits in the language of trust-fund accounting. Apparently, general revenue financing makes them uncomfortable. They have good reason to be uncomfortable. For starters, general revenue financing contradicts the whole budgetary purpose of trust-fund accounting, which is to limit spending to dedicated revenues. While this accounting does not prevent Social Security and Medicare from accumulating large unfunded liabilities, it does serve a useful function-namely, as a final backstop against runaway costs. It was the projected insolvency of Social Security that led to the reform acts of 1977 and 1983. And it is the threat of insolvency that keeps leaders focused on Social Security and Medicare today. General revenue financing dismantles this backstop. It doesn't make Social Security and Medicare more affordable. It merely masks their rising cost while allowing leaders to claim they've solved the problem. In the near term, general revenue financing will thus make timely cost-saving reform more difficult. Yet paradoxically, in the long term, it could make benefits less secure-and a collapse of the system more likely. As contributory programs, Social Security and (to a lesser extent) Medicare have always enjoyed a special political status. By severing the link between contributions and benefits, general revenue financing would gradually change the public's perception of Social Security from an earned benefit to unearned welfare. And as welfare, Social Security could be arbitrarily cut. General revenue financing is not a new idea. At the time the original Social Security Act was debated, many on the left argued for it because it was progressive. But the centrist New Deal coalition that pushed the Act through Congress understood that Social Security rested on a delicate compromise. Some redistribution might be possible by tilting the benefit formula. But if the program were to win the acceptance of the American people, it would have to be cast in terms of personal earned rights. It was thus decided that benefits would be funded by earmarked payroll taxes and paid out of a trust fund. As FDR explained, "With those taxes in there no damn politician can ever scrap my social security program." Since then, general revenue financing has been proposed many times. And, on a small scale, it was adopted by the 1983 Reform Act, which credited income taxes on Social Security benefits to the trust funds. But large-scale general revenue financing has always been rejected, mainly because advocates realized on reflection that it would have unintended consequences.

Let there be no doubt: What the President and Vice President propose is large-scale indeed. Redeeming the additional IOUs from the Social Security trust funds between 2037 and 2057 will cost the general taxpayer over $7 trillion in today's dollars-a subsidy amounting to 30 percent of current-law benefits over that period. The proposed new benefits for widows and working moms would come on top of that-as would the cost of redeeming Medicare's additional IOUs.

An Irresistible Temptation

The Clinton-Gore proposal could have unfortunate results. It could prop up an unsustainable status quo until gradual reform is no longer possible-and then open the way to sudden and draconian benefit cuts. This is hardly what the President and Vice President want. But it is the likely consequence of general revenue financing. What they fail to acknowledge is that it's impossible to save Social Security without reducing its cost or explicitly asking the public to pay for it. Unfortunately, in an era of budget surpluses, general revenue financing may prove to be an irresistible temptation-and not just to those trying to preserve the status quo. As we will see in a subsequent alert, general revenue financing can be clothed in the language of personal ownership as readily as that of trust-fund accounting.