Brad Setser

Brad Setser: Follow the Money

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Who is in more financial trouble: social security or the rest of the government?

by Brad Setser
September 20, 2004

There is a common sense that social security is bankrupt and people now in their 20s and 30s won’t get anything from it. That is false. Social security can fund all projected benefits until sometime around 2042, though the forecast is subject to a substantial margin of error. After that, projected revenues of about 5% of GDP will cover about 75% projected expenditures. That is a problem, but a manageable one.

The real problem is with the rest of the government, including the other big entitlement program — Medicare. Just compare social security’s finances to those of the rest of the government. Right now social security is running a surplus and has substantial assets, while the rest of the government is running a huge deficit and has substantial debts (including debts to the social security system). In 2003, social security took in $469 billion in tax revenue, and spent only $406 billion. It lent the surplus — $63 billion, or 0.6% of GDP – to the right of the government and also got credited $75 billion in interest on its existing assets. During the course of the year, its assets rose from $1217 billion to $1355 billion, 12.3% of GDP). Social security is expected to continue to add to its assets until around 2015.

The rest of the government, shorn of social security, took in $1382 billion in 2003,12.6% of GDP, and spent $1864 billion, 17.0% of GDP — my numbers come from the data on the federal governnment in the flow of funds, adjusted to take out social security taxes and benefits. The rest of the government had a cash flow deficit of $482 billion (4.4% of GDP) while social security has a cash flow surplus of $63 billion (0.6% of GDP). It seems that interest paid to the social security trust fund is not included in the reported total annual deficit. Add that in and the deficit would have been $557 billion. The federal government ended 2003 with debts of $6998 billion (64% of GDP), and ended August, 2004 with debts of $7351 billion. The debt to revenue ratio of the government shorn of social security is around 500%, not a good number.

We don’t need to fix social security half as much as we need to fix the rest of the government! Social security has a projected cash flow deficit of about 1% of GDP only after 2042. The rest of the government had a cash flow deficit of around 4.4% of GDP in 2003 (and more in 04). Social security taxes cover about 75% of projected future benefits even after the system runs out of assets in 2042. The rest of the government is only taking in about 75% of what it needs to cover its current spending, and already has substantial debts. By every measure, the federal government today is in worse shape than social security is expected to be in 2050 (assuming the government keeps its promise to the social security system).

The basic bargain behind the social security reform was that the relatively regressive social security payroll tax would take in more than it needed to pay current benefits until roughly 2015, and lend the proceeds to the rest of the government. That in turn has let the more progressive income tax be lower than it otherwise would need to be to pay for the other operations of the government. In return, as the baby boom starts to retire and the social security system’s costs increase, the regressive payroll tax will be lower than it otherwise would need to be as some of the burden of paying social security benefits would be shifted to the income tax. But that only works if the rest of the government can pay back the money that is now borrowing from social security: the bonds held in the trust fund, like the Treasury’s marketable debt, are claims on the rest of the federal government’s future tax revenues.

Nouriel is right about the U.S. fiscal train wreck. You cannot run a 17-18% of GDP federal government with a 12-13% of GDP revenue base (taking social security out of both the revenue and the spending numbers). We can only do it know because the central banks of China, Japan, India, Taiwan, Korea and Russia are generously willing to join the social security trust fund in financing the rest of the federal government. Get rid of the social security trust fund, and one of the following has to happen: the rest of the government has to cut back, other taxes have to go up, the government has to run a larger cash deficit (squeezing private investment), or the government has to borrow even more from the rest of the world.

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