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Gary M. Galles - Contributor

Mr. Galles is a professor of economics at Pepperdine University. [go to Galles index]


Trust Fund Fakery
Overpromised, underfunded…
[Gary M. Galles] 12/17/04

With the Bush administration apparently serious about touching the third rail of American politics, opponents are ramping up campaigns to undermine the effort by discrediting the idea that Social Security faces a crisis. And one of their most frequent devices is pointing to the apparent reassurance offered by the Social Security Trust Fund.

For instance, the annual report on the status of Social Security released earlier this year concluded that the Social Security Trust Fund would not be gone until 2042. That distant date seems to overwhelm any real sense of urgency and rebut the claim that something must be done now. Unfortunately, however, the Social Security Trust Fund sets aside no resources for future beneficiaries. As a result, it provides no assurance about the program’s solvency.

How can a trust fund with over a trillion dollars “in” it not really exist? When it consists solely of IOUs from the federal government to itself. The federal government borrows any current trust fund surpluses in exchange for special U.S. Treasury Bonds. The dollars are then spent by the government on current programs, leaving a “fund” of Treasury IOUs. But those are not real assets. The result is no different than if you “saved” up to buy something by writing an IOU to yourself and depositing it in a cookie jar each week.

Since the trust fund consists of federal IOUs whose proceeds have already been spent, how will the U.S. Treasury come up with the funds to redeem them when they come due? It will require new taxes, added borrowing (deferred taxes) or reduced spending on other federal programs, because that is the only way the federal government can acquire the necessary resources to live up to its trust fund commitments. As a result, the trust fund essentially amounts to nothing but a commitment to massive future tax increases, but with all the details of who will pay and how much it will cost them conveniently unexplained.

The absence of a real trust fund also means that taxpayer bailouts will be needed far sooner than the fund’s insolvency date, when its balance reaches zero (with assumptions that may well turn out to be over-optimistic). Ironically for those relying on trust funds for financial assurance, that bailout will begin just after the trust fund hits its forecast peak. The trust fund must then start paying out, and the Treasury will have to start making good on its IOUs at that date, not a generation later.

This year’s Social Security trustees’ report estimated that date to be in 2018, 24 years before the forecast date for the exhaustion of its trust fund. That is clearly not too far off to begin dealing with its multi-trillion dollar unfunded liabilities today.

That report also showed that Medicare’s finances were in even worse shape, with its trust fund already forecast to begin shrinking this year, and only worsening after that. By 2078, benefits from these two programs were anticipated to take 20.6% of GDP, nearly triple the 7% they absorb today. The magnitude of that expansion also shows that only major changes, not minor tinkering around the edges, can address those problems.

Backed by trust funds that do not really exist and therefore do nothing to delay the real day of fiscal reckoning, Social Security and Medicare are not nearly as sustainable as reform opponents claim. The status quo is therefore not an option, making the real question that of which alternatives to pursue. And failing to address those questions now is irresponsible.

All of the real options will be painful, because both programs have under-funded promised benefits by trillions and trillions of dollars-. However, before we can really begin an informed discussion of those alternatives, we need some idea of the serious and growing magnitude of what we face. Deluding ourselves with imaginary trust fund security blankets can only prevent that discussion, and guarantee that it will be far more painful when it unavoidably takes place. tOR

copyright 2004 Gary M. Galles




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