Social Security: Is This Creative Accounting?

For much of the summer, America’s political leaders have argued about the impact of a failure to raise the federal government’s debt ceiling. Treasury Secretary Tim Geithner, Federal Reserve Bank Chair Ben Bernanke, and a host of others have warned that a default on the nation’s debt would lead to unimaginable economic catastrophe, although other representatives have questioned whether a default would do any significant damage at all.

Now that we’re actually arriving at the original August 2nd default date, it may be instructive to reflect back on one of the harshest exchanges between political leaders during this debate. It involved America’s national system of Social Security, and its ability to “make good” on financial guarantees that have been made to its senior citizens.

Three weeks ago, during an interview with CBS Evening News Anchor Scott Pelley, President Obama warned that he could not guarantee the issuance of monthly social security checks in early August if the nation defaults on its debt. The following day, though, former Republican Vice Presidential candidate Sarah Palin publicly retorted that Obama’s comment was “shameful.” Other critics noted that the Social Security system’s Trust Fund is fully solvent, and is expected to remain so for many years to come.

Which political leader was telling the truth? Surprising, they both were … which reveals quite a bit about the confused state of America’s federal budget system.

A Little History

The Social Security system was first instituted during the Great Depression in order to provide seniors with income at the ends of their natural lives. During that era, many Americans spent their lives working on farms and in factories, performing backbreaking manual labor for relatively low wages. By the time they reached the retirement age of 65, many were physically incapable of full-time work; furthermore, given that in 1930 only 54% of all 21 year old American males could expect to live more than 65 years, most citizens did not spend extended periods receiving Social Security payments.

Today, of course, most Americans spend their working lives in far more physically accommodating surroundings. They remain physically fit well into their 70s, and can live for decades beyond then. But the Social Security system’s retirement age has barely budged beyond 65, and has begun to exhibit actuarial stresses on its state of long term solvency.

During the era of Ronald Reagan’s presidency, America’s federal government reached an agreement to guarantee the solvency of the Social Security system well into the 21st century. It accomplished this task by a variety of means, one of which involved increasing the Social Security taxation rate to a level that was significantly above what was required to finance annual payments. The plan was to deposit those excess tax payments into a Trust Fund for two or three decades, and then — once the surging retiree population of the 21st century overwhelmed the annual tax receipts — to finance the shortfall by withdrawing funds from that same Trust Fund until it was liquidated.

Obama’s critics, and the Social Security Administration itself, have correctly noted that the Trust Fund will not be fully liquidated for many years. Nevertheless, President Obama was indeed speaking truthfully when he noted that the Trust Fund would hold no cash if the American government defaults on its debts.

A Little Creative Accounting

How can the President and his critics simultaneously be correct? Well, the Trust Fund has never truly held its deposited funds for significant periods of time. Instead, the United States Congress has always borrowed monies from the Trust Fund to pay for routine expenditures, and has deposited IOUs into the Trust Fund to serve as Congressional promises to repay those borrowings in the future.

How does the Congress actually intend to repay those borrowings and “make good” on those IOUs? By increasing taxes if necessary, and by issuing more federal government debt if needed to make up any shortfalls. But now the federal government is approaching its debt limit; thus, without issuing additional debt (and without increasing taxes), it will be unable to raise the cash to repay the IOUs.

In other words, the Trust Fund may not be technically insolvent at the moment, but only because America’s creative budget accountants have decided to treat those IOUs as fully valued investment assets. There are no other monies in the Trust Fund, and if the United States government defaults on its debts, those IOUs become worthless … or, at the very least, of highly uncertain value.  On the one hand, as long as the federal government remains solvent, the Trust Fund will remain fully funded with guaranteed government securities; however, as soon as the government defaults on its debts, America’s seniors will be transformed into unsecured creditors.

The long term fiscal health of the Social Security system will not be resolved in the near future, regardless of how the current budget battle plays out during the days and weeks ahead. Nevertheless, the process of transforming America’s opaque budget system into one that transparently characterizes levels of fiscal solvency can certainly begin today.