The Lock Box and Other Delusions

September 19, 2001 • Commentary

Tactics in the war against Social Security privatization have apparently shifted. Rather than defend the current system and explain how it will pay all the benefits that politicians have promised, critics like the AFL-CIO, the Brookings Institution, House Democratic Leader Dick Gephardt (Mo.) and New York Times columnist Paul Krugman slam President Bush’s “partisan” Commission on Social Security Reform. Never mind that the Commission is composed of eight Democrats and eight Republicans. And the co‐​chair is Daniel Patrick Moynihan (D-NY), who was the Senate’s leading authority on Social Security.

On substantive issues, the Commission’s detractors offer lots of reasons why privatization won’t work, but no program for avoiding the system’s inevitable collapse. The obvious solutions — tax increases and decreased benefits — are political hot potatoes that neither Republicans nor Democrats seem willing to touch. Instead, the anti‐​privatizers promote the harebrained notion of a trust fund and its imaginary assets. Then they deride anyone who attempts to explode that myth.

For example, cynics scoffed at Commission member Thomas Saving when he argued at a Cato Institute conference that the Social Security trust fund would be better off with foreign bonds than U.S. bonds. Yet Saving’s argument makes perfect sense. If the trust fund held foreign bonds, they would represent a claim against foreign assets. But U.S. bonds are simply a claim against our own assets. That is, U.S. bonds are simultaneously an asset of the trust fund and a liability of all taxpayers, thus representing no net increase in U.S. wealth. The critics know that, of course. But they choose to obfuscate the issue.

Another widespread misconception is that the Social Security surplus can somehow be secluded in a “lock box” by using it to pay off government debt. Lower debt, so the argument goes, means lower future interest payments. Wrong. The trust fund receives interest‐​bearing government bonds when its surplus is commandeered to retire other government bonds. There is no net change in indebtedness and, therefore, no change in interest obligations. Yes, federal debt will be lower than it would have been if the surplus had bankrolled more government spending. That’s good; but past Social Security surpluses have been spent, not used for debt retirement. And future surpluses will soon disappear.

The financial principles are fairly simple. Assume, first, that the trust fund has U.S. bonds that mature — timed to pay specific Social Security benefits. Those bonds must be redeemed. Government has four options. It can raise taxes to generate the money. It can cut other spending. It can float new bonds. Or it can cancel the benefits, which, by the way, are backed by a commitment that can be revoked at any time. Beneficiaries have no enforceable legal right to collect anything.

Next, assume that benefits are due, but the trust fund is empty — no bonds at all. To pay the benefits, government has the same four options: raise taxes, cut other spending, float new bonds, or cancel the benefits. In other words, the existence or non‐​existence of government bonds in the trust fund makes absolutely no difference.

Equivalently, suppose you had extra money in your savings account budgeted to pay next month’s American Express bill. But instead of keeping the money there, you transfer it to your checking account and spend it. To memorialize the transfer, you issue to your savings account an IOU from your checking account. Next month, you have to pay the American Express bill. Do you think the IOU makes you one penny better off? Is the IOU a real asset in your savings account? If so, perhaps you can convince American Express to accept the IOU in lieu of cash.

Over the next few months, as the presidential commission grapples with an unsustainable Social Security system, defenders of the status quo will ignore the coming crisis and join what Sen. Bob Kerrey (D-NE) has called the “Do Nothing Club.” They will resist all efforts toward serious reform while demonizing the reformers. As a result, a generation of future retirees will discover that Social Security is an empty promise. And every year we delay means more costly and painful changes for the very people that Social Security was intended to protect.

For decades, administrations of both parties have been using the trust fund surplus to supplement general revenues. That process will hasten the demise of Social Security. Yet most people have been misled by politicians and their allies into believing that funds taken from Social Security are merely “borrowed.” After all, the politicians say, the trust fund has U.S. bonds, and that proves the money will be repaid. Nonsense!

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