Topic: Social Security

Note to Larry Summers: The Government Borrows for Transfer Payments, Not Investment

“It is time for governments to borrow more money,” according to former treasury secretary Larry Summers.  He is not peddling this advice to Greece and Spain, but to countries like the United States and Japan that can still sell long-term bonds at very low interest rates. Summers urges the United States, in particular, to borrow more for “public investment projects” that are presumed to raise the economy’s future output. He offers the hypothetical example of “a $1 project that yielded even a permanent 4 cents a year in real terms increment to GDP by expanding the economy’s capacity or its ability to innovate.”

Even if such promising projects were easy to find, however, that is not the way the current government has been inclined to spend borrowed money. Despite all the rhetoric about “shovel-ready projects,” about 95 percent of the 2009 stimulus bill consisted of government consumption (salaries), refundable tax credits, and transfer payments which, as Robert Barro notes, “dilute incentives to work.”

Summers says, “Any rational chief financial officer in the private sector would see this as a moment to extend debt maturities and lock in low rates — the opposite of what central banks are doing.” Locking-in low borrowing costs would indeed make sense if the money from selling long bonds were used to retire short-term Treasury bills, but that would not involve borrowing more as Summers proposes.

For both government and households, it is certainly more prudent to use borrowed money to finance investments that will yield a stream of income in the future—either actual income (such as toll roads) or implicit income (the benefits from living in a mortgaged home).

Apostles of the Keynesian doctrine, such as Larry Summers, Paul Krugman, and Alan Blinder, invariably use hypothetical public works examples to make the case for more and more national (taxpayer) debt. Keynesian forecasting models, used by the Congressional Budget Office (CBO) to warn of the looming fiscal cliff and defend the fiscal stimulus of 2009, likewise assume the highest “multiplier” effect from tangible government investments.

In the real world of politics, however, Congress and the White House use borrowed money to placate constituencies with the most political clout. Federal spending on investment projects has essentially nothing to do with the huge 2009-2012 budget deficits (only 29 percent of which can be blamed on the legacy of recession, according to the CBO).

The Table shows that transfer payments and subsidies account for 63.8 percent of estimated spending in 2012, while federal purchases account for 28.4 percent. Also, most federal aid to states is for transfer payments like Medicaid.  Within federal purchases, only 7.6 percent of the spending ($152.5 billion) was counted as gross investment in the first quarter GDP report, and two thirds of that was military equipment and buildings. Net investment, minus depreciation, is smaller still.

If borrowing more for investment was a genuine political priority, rather than an academic conjecture, the government could do that by borrowing less for government payrolls, transfer payments, and subsidies.  At best, Larry Summers has made an argument for spending borrowed money much differently, not for borrowing more.

Dealing with Fiscal Challenges

I was recently asked the following:

You gotta figure:

  1. States defaulting on pension obligations through bankruptcy and/or action by legislatures. Some de facto defaults will likely be to promise payment at age 90 or whatever.
  2. National governments, including the US, also likely defaulting on everything, gov’t bonds and so-called “entitlements.”

So, pensioners, city, state and national get at least a huge haircut on what they expected and Medicare and Medicaid just aren’t viable over time.

What are the economic implications and possible other implications?

Here’s my response:

Many US states are facing pension fund insolvency and will have to impose heavier burdens either on taxpayers, employees, or retirees, or some combination thereof. There is a precedent, although not a direct one, for a federal bailout of state and local governments: The Emergency Relief and Construction Act of 1932 provided $300 million to be lent to the states (and onward to cities and counties) for relief. Everybody understood that these loans probably would never be repaid and, in fact, they were eventually written off. This statute was the first breach of the federal “relief dam” – one that burst after FDR took office in March 1933. Despite it, three states-Arkansas, Louisiana, and South Carolina-defaulted on their debts. By the end of 1933, approximately 1,300 local governments also had defaulted and many other state and local governments verged on default.

Recently, Ben Bernanke has ruled out a bailout of states via the Fed (who believes him, given what he’s already done?) and Eric Cantor recently wrote that the states have the tools to deal with their fiscal challenges, including renegotiating agreements with public-sector unions. In his opinion, there is no reason for federal involvement in state government fiscal problems, but how policymakers will respond when the chips are down (or there’s “blood on the streets”) is anyone’s guess. Some states are in pension trouble because they assumed highly risky investment strategies that failed when asset values sank during the 2001 and 2008-09 recessions. One favorable element for some states - Arizona, Utah, Texas, NM, etc. – is their favorable demographics that could help them to slowly improve their pension and fiscal conditions.

At the federal level, the default must also occur through a “renegotiation” of entitlement promises. The Medicare actuaries have clearly indicated that the so-called Medicare fix enacted through ObamaCare is untenable. So, whether or not ObamaCare is repealed, we’re still at square one and a renegotiation must happen soon. The problem is that we always wait for the people to deliver a “clear verdict” through elections, and elections usually don’t. Leadership on this issue is sorely needed but is not forthcoming for understandable reasons. The political game is to push the adjustment costs out into the future – but eventually it will imply significantly reduced living standards for future generations. How that will come about – whether through a crisis as in Greece and Spain, or through a gradual erosion of living standards is difficult to say. The inevitability of one or the other is not in doubt. All we could say is that the probability of a resolution through a violent crisis increases the longer we continue to push the costs out.

I’m placing a high probability on the dissolution of the Euro by the end of this year. With the election results in France, Greece, and Germany, the debt roll-over requirements that Greece, Spain and Italy are facing, and the impossibility of external sources of credible “bailouts” I don’t see how it can be any other way. Some people wonder whether the periphery states will opt out first or whether Germany and stronger northern states will move first to kick them out. There are no formal exit strategies included in the European Stability and Growth Pact. I think, though, that it will be the former – the southern countries are facing austerity with, or chaos without, the Euro and now the perceived difference between the two is not very large.

To answer the last question “And then what?” I would simply say that the developed nations will all be poorer – have lower living standards, more unemployment, less growth, etc, until the boomers pass away. I predict as much in my book that examines the implications of demographic and economic trends in developed nations (it does not deal with business cycle related events). Future generations will have to re-think the state-citizen relationships – a process that we can influence.

Social Security ‘Calculator’

One of the first things I did upon joining Cato in 2004 was to develop a Social Security benefit calculator. That work would later contribute to my book on the outcomes of different Social Security reform proposals.

The Social Security Administration used to have a benefit calculator on its website, but it was cumbersome to use. Now the SSA has a portal that enables you to view your personalized earnings and benefits information. This is in lieu of the paper statement that was recently suspended for those younger than age 60.

For the SSA calculator, you can register here (after answering some identifying questions) and look at the benefits that the system is promising to give you (lots)—and then compare them to what you really can expect to receive (not so much, and even less the younger you are).


Sometimes, Governments Lie (6th Anniversary Ed.)

(This blog post first appeared at Cato@Liberty following the release of the 2006 Medicare and Social Security trustees’ reports. I repost it, with updated links and “exhaustion dates” because sadly nothing else has changed.)

Sometimes, Governments Lie

Year after year, federal officials speak of the Social Security and Medicare trust funds as if they were real.  Yesterday Today, the government announced that the Social Security trust fund will be exhausted in 2040 2033 and that the Medicare hospital insurance trust fund will be exhausted in 2018 2024— projections that the media dutifully reported.

But those dates are meaningless, because there are no assets for these “trust funds” to exhaust.  The Bush administration wrote in its FY2007 budget proposal:

These balances are available to finance future benefit payments and other trust fund expenditures—but only in a bookkeeping sense. These funds…are not assets…that can be drawn down in the future to fund benefits…When trust fund holdings are redeemed to pay benefits, Treasury will have to finance the expenditure in the same way as any other Federal expenditure: out of current receipts, by borrowing from the public, or by reducing benefits or other expenditures. The existence of large trust fund balances, therefore, does not, by itself, increase the Government’s ability to pay benefits.

This is similar to language in the Clinton administration’s FY2000 budget, which noted that the size of the trust fund “does not…have any impact on the Government’s ability to pay benefits” (emphasis added).

I offer the following proposition:

If the government knows that there are no assets in the Social Security and Medicare “trust funds,” and yet projects the interest earned on those non-assets and the date on which those non-assets will be exhausted, then the government is lying.

If that’s the case, then these annual trustees reports constitute an institutionalized, ritualistic lie.  Also ritualistic is the media’s uncritical repetition of the lie.

Dignity in Retirement

In his 2005 open letter to Karl Rove, Ed Crane defended Cato’s proposal for private retirement accounts thus: “You want to get people excited about personal accounts? Tell them about the 1960 Supreme Court case, Flemming v. Nestor, which explicitly says Americans have no ownership rights to the money they pay into Social Security. It is, the Court ruled, a social program of Congress with absolutely no contractual obligations. What you get back at retirement indeed, when you can retire and receive benefits is entirely up to the 535 members of Congress. Where is the dignity in such a system?”

President Bush’s reform of the Social Security went nowhere, but Ed Crane’s warning is no exaggeration. Yesterday, Dimitris Christoulas, a 77-year-old retired pharmacist killed himself in front of the Greek Parliament. “A suicide note found in his coat pocket blamed politicians and the country’s acute financial crisis for driving him to take his life, police said. The government had ‘annihilated any hope for my survival and I could not get any justice. I cannot find any other form of struggle except a dignified end before I have to start scrounging for food from rubbish bins,’ the note said.”

According to The Telegraph, “One in five Greeks are unemployed, depression is on the rise and there is a growing feeling of despair across the country. The [Greek] government said last year that suicides had increased 40 per cent over the previous two years. The high-profile suicide [of Dimitris Christoulas] came a day after a 78-year-old Italian woman threw herself from the balcony of her third-floor apartment in protest against a cut in her monthly pension from 800 euros to 600 euros.”

Those Americans, who rely on Social Security for their retirement, should remember that what the government gives, it can take away. The Social Security system is on an unsustainable path to bankruptcy. The only question is whether Social Security is reformed before it brings about national bankruptcy as well. Every day that our masters in Washington, D.C. dither and refuse to act, the Greek option [i.e.: national bankruptcy] becomes more realistic. The only way to ensure dignified retirement for millions of America’s pensioners is by reforming social security and cutting the size of the government’s future financial obligations.

Are Individual Mandate Critics Showing ‘Bad Faith’?

Paul Krugman is the latest to suggest that advocates of personal Social Security accounts are guilty of hypocrisy in criticizing the constitutionality of Obamacare’s individual insurance mandate.  After all, they contend, are not personal account supporters arguing in favor of a federal government mandate that individuals purchase a specific commercial  product (i.e., stocks, bonds, mutual funds, or whatever)?

No doubt, there is a superficial similarity.  But the analogy significantly misses what personal account proponents are calling for. If there was no current Social Security program and the government were simply to mandate that individuals purchase some form of commercial retirement savings product, that would indeed be analogous to the health insurance mandate, and would be unconstitutional for the same reasons. However, Americans are currently paying a Social Security payroll tax. What personal account advocates propose is simply a tax credit against that tax if individuals contribute to a personal account. That the credit would be equal to the size of the contribution is structurally irrelevant.

The government uses credits to incentivize behavior all the time. For example, it offers a tax credit for the purchase of the Chevy Volt. That may be bad policy, but it is generally agreed to be constitutionally permissible. It is, however, very different from a mandate that every American buy a Volt. Similarly, Congress would have been on much stronger constitutional ground if it had imposed a tax on all Americans to fund uncompensated care, and then offered a credit to anyone who obtained insurance. The same individuals would end up paying the penalty/tax as under Obamacare, but the structure would have been less offensive to the Constitution. The federal government clearly has the power to tax, and it can offer tax credits and deductions. Congress chose not to do it that way for political reasons—they didn’t want to be accused of raising taxes. But political expediency does not justify an unprecedented expansion of federal power.

And, while on the subject of Social Security, it should be noted that several individual mandate defenders—including Justice Ginsburg—have likened it to Social Security, saying that if the government can make us participate in Social Security, why can’t it make us buy health insurance? But in the case of Helvering v. Davis, the Supreme Court ruled that Social Security was constitutional precisely because it was not insurance and did not require citizens to buy a product. Rather, the Court held that the Social Security tax was simply a tax, authorized by the Constitution’s taxing power. Social Security benefits are simply a government spending program, authorized under the General Welfare clause, and unrelated to the tax itself. As the Court pointed out, “The proceeds of both the employee and employer taxes are to be paid into the Treasury like any other internal revenue generally, and are not earmarked in any way.”  One may disagree with the Court’s expansive interpretation of the General Welfare clause in this case, but it clearly distinguishes Social Security (and Medicare or even a single-payer health care system) from the individual mandate constitutionally.

Some might say that these distinctions are just quibbles or nit-picking. But how government does things matters. Constitutional limits are there for a reason. We are, after all, a government of laws, not of men.

The Less-than-Thrilled Case for Extending the Payroll Tax Holiday

When I think about taxes, my first instinct is to rip up the corrupt internal revenue code and implement a simple and fair flat tax.

When I think about Social Security, my first instinct is to copy dozens of other nations and implement personal retirement accounts.

Unfortunately, the political system rarely generates opportunities to enact big reforms that actually solve problems and increase freedom. Instead, we’re stuck with proposals that make things modestly better or modestly worse.

So you can imagine my sense of dissatisfaction that I’m getting peppered with questions about whether the one-year, two-percentage point payroll tax holiday should be extended.

But it’s more complicated than that. The Democrats in the Senate want to make the temporary tax cut even bigger and “offset” that tax cut with some soak-the-rich tax increases. Republicans, meanwhile, are frozen like deer in the headlights. They understandably don’t like the Democrat plan, but they seem reluctant to support anything else, not even a “clean” extension of the current policy.

Here are a handful of observations.

  • The Democrat’s proposal for a one-year payroll tax cut financed by a permanent income tax hike on investors, entrepreneurs, and small business owners would be a big net negative for U.S. job creation and competitiveness.
  • A “clean” extension of the payroll tax holiday would modestly improve incentives for work, but the temporary nature of the tax cut substantially weakens pro-growth effects.
  • Ideally, the extension of the tax holiday should be financed by reducing the growth of federal spending.
  • There are other tax cuts, such as permanent reductions in marginal income tax rates and/or permanent reductions in the double taxation of saving and investment, that would have a better impact on the economy.
  • There are other tax cuts, such as expanded credits, deductions, preferences, exemptions, and shelters, that have no positive impact on the economy.
  • A payroll tax holiday does not undermine Social Security since the Trust Fund is nothing but a big pile of IOUs.
  • The best incremental reform would be a permanent reduction in the payroll tax, with the money channeled to personal retirement accounts. This would lower the tax burden of work while reducing the long-run burden of entitlement spending.

So what does all this mean? Simply stated, there are many other fiscal reforms that are preferable, but a temporary extension of the payroll tax holiday is better than nothing—assuming, of course, it is not poisoned by accompanying class-warfare tax hikes.