By Charles F. O'Donnell and Robert Strittmatter
Mixing Politics and Budgeting
Throughout its long history, the Social Security program has been a political football. It can balance the Federal budget or make it appear out of balance--creating a huge government budget deficit or surplus--with a shift of political viewpoint.
Most Americans know relatively little about the history and evolution of the Social Security program and the government's accounting for its trust funds. The details of the accounting provide a perspective on the massiveness of the program and its long-term implications. Much of the excitement over a budget "surplus" overlooks the fact that the money belongs to Social Security trust funds.
From 1939, when the Old Age and Survivors Insurance (OASI) program was established, until 1983, the OASI trust fund operated on a current-cost-financing (pay-as-you-go) basis, with current benefits financed by current payroll taxes and interest earned on the trust fund's investments. A contingency reserve was supposed to equal 612 months' expenditures so that, in the event of a recession, the trust fund balance would make up for a shortfall in current income.
This funding concept worked reasonably well until high levels of inflation and unemployment during the late 1970s and early 1980s steadily drained the OASI trust fund--from $37.8 billion in 1974 to $21.5 billion in 1981. In October 1982, the trust fund balance was $10 billion--about $1 billion less than the amount needed to pay the November benefits. For the first time in history, the OASI trust fund borrowed money from the Disability Insurance trust fund and the Health Insurance trust fund, and for all practical purposes the OASI trust fund was bankrupt.
During the Reagan era, the newly appointed National Commission on Social Security Reform delivered a report that called for changes in the program to solve short-term problems and address long-term concerns, including creating a surplus to help fund the retirement of the baby boomers. The commission's most significant action was changing the OASI trust fund from a pay-as-you-go system to an advanced-funding system, which provided for the large buildup of reserves that occurred in the 1980s and 1990s and which is expected to continue for the next decade. At the end of 1983, the OASI trust fund balance was $19.7 billion. By the beginning of 1999, it had increased to $682 billion. From 1999 to 2008, the trust fund is projected to grow to $2.122 trillion.
Trust Fund Receipts, Assets, and Disbursements
Each year, the board of trustees of the Federal OASI and Disability Insurance trust funds publishes a comprehensive report that includes detailed short- and long-range actuarial estimates and analysis. The report also includes information on trust fund financial operations. The OASI trust fund statement of operations for the fiscal year ending September 30, 1998, shows in detail the receipts and disbursements of the fund. All employees and employers in covered employment are required to contribute based on employee wages and tips, and self-employed persons are required to contribute based on their net earnings from self-employment. Net payroll tax contributions for the year were $364.9 billion, which represents 87.8% of total receipts.
From 1984 to 1994, up to 50% of a recipient's Social Security benefits was subject to Federal income tax if specified income and benefit levels were exceeded. The percentage was increased to 85% in 1994. Additional tax revenues resulting from this increase are transferred to the Hospital Insurance trust fund. The tax revenues appropriated to the Social Security trust funds are based on income taxes paid on the benefits from each fund. Receipts from taxation of benefits for fiscal year 1998 were $8.6 billion, which represents 2.1% of total OASI trust fund receipts. For fiscal year 1998, the OASI trust fund was credited with net interest of $42.2 billion, which represents 10.1% of total receipts. This interest was earned on trust fund investments.
The portion of the Social Security trust funds that, in the judgment of the managing trustee (currently, Treasury Secretary Lawrence Summers), is not required to meet current expenditures for benefits and administration is invested on a daily basis in interest-bearing obligations of the U.S. government with maturity dates ranging up to 15 years. These obligations are special public-debt obligations that may be purchased only by trust funds. The trustees' annual report shows OASI trust fund net total assets at September 30, 1998, of $653.1 billion. All debt issues are purchased and redeemed at par (face) value and are backed by the full faith and credit of the U.S. government.
Legislation and Budget Presentation of the Trust Funds: Why Here?
Discussions on the use of recent and projected Federal budget surpluses often consider the importance of the Social Security program but ignore the budgetary effects of the massive accumulations in the OASI trust fund.
The practice of including the trust funds in any proposals related to the Federal government's budget surpluses and deficits is seldom questioned. Federal law requires that the revenues and spending of two Federal programs, Social Security (including the OASI trust fund) and the Postal Service, be excluded from budget totals, that is, categorized as "off-budget." To satisfy this requirement, the Federal budget displays on-budget, off-budget, and unified budget totals.
From Social Security's inception, operations of the OASI and other trust funds had not been included in the Federal administrative budget. To give an example of how confusing this became, beginning in 1967, budget documents included three sets of totals. The Johnson Administration, congressional Republicans, and the media each used and emphasized different sets of totals, showing deficits of $2.1 billion, $4.3 billion, and $8.1 billion, respectively, for fiscal year 1967.
To remedy the confusion, President Johnson created the President's Commission on Budget Concepts. The commission's report recommended a unified summary statement to replace the three competing and confusing budget concepts. Using this statement, all Federal trust funds, including the OASI trust fund, would be shown together with other governmental programs in a single budget. The first unified budget was presented for fiscal year 1969. The effect of including the Social Security trust funds was to transform a $1 billion deficit into a $3 billion surplus.
In 1983, the Greenspan Commission concluded that the trust funds should be removed from the unified Federal budget. This proposal was enacted by the Social Security Amendments of 1983, which provided that Social Security and Medicare be more prominently displayed in the budget until fiscal year 1992 and removed completely for fiscal year 1993.
The off-budget status of the Social Security trust funds was reestablished when President Bush signed the Omnibus Budget Reconciliation Act of 1990. Section 13301 provides that operation of the OASDI trust funds, incorporating the OASI and the Disability Insurance trust funds, not be counted as new receipts, new budget authority, outlays, deficit, or surplus for purposes of the presidential or congressional budget. The intent is to keep Social Security trust fund surpluses or deficits from obscuring the annual deficit or surplus in other government accounts and to reduce pressure to use the Social Security program to cure Federal budget problems.
How Including (or Excluding) the Funds Affects the Budget
Exhibit 1 presents Congressional Budget Office (CBO) summaries of government receipts and outlays for 1998 and 1999. Exhibit 2 is CBO's illustration of the deficit-reduction/surplus-enhancing effects of including the Social Security trust funds in the unified budget. For fiscal year 1998, the $30 billion deficit was converted to a $69 billion surplus by inclusion of the trust funds; for 1999 the $1 billion deficit became a $123 billion surplus.
For 2000 and following years, the CBO projects increasing surpluses, but as Exhibit 3 indicates, baseline total surpluses are increased substantially by including Social Security. Analysis of revenue and spending summaries prepared by the Office of Management and Budget (OMB), Executive Office of the President, indicates similar beneficial effects from including the trust funds in OMB budget calculations.
Numerous proposals, including those of the President and members of Congress, both Democrat and Republican, have focused on appropriate use of the current and projected Federal budget surpluses.
President Clinton, in his 1999 State of the Union Address, proposed using 11% of the projected budget surplus to establish universal savings accounts, a type of subsidized savings account for low- and middle-income workers. These accounts would be controlled by individuals, with the government matching workers' own savings. This proposal was part of a larger plan for Social Security reform that included transferring part of the budget surplus to the trust funds and investing a portion of trust fund assets in equity securities.
Harvard economist Martin Feldstein criticized parts of the proposal as a complex accounting sham. Feldstein claimed that the proposal involved double-counting of Social Security trust fund surpluses, with the required sale of bonds after 2032 increasing the budget deficit and the national debt.
Another proposal by President Clinton, introduced in the House during fall 1999 as H.R. 3165, would provide transfers from the general fund, equal to the interest on cumulative trust fund surpluses, to extend the solvency of the Social Security trust funds through 2050. The plan contains changes in congressional procedural rules to make creating on-budget deficits or reducing on-budget surpluses more difficult.
The President argued that this new accounting would reserve a portion of the on-budget surplus and make it more difficult to use the funds for other purposes. CBO Budget Director Dan Crippen, testifying before the House Ways and Means Committee in November 1999, responded:
The new procedural hurdles that the President proposes would limit congressional action on future legislation that might reduce projected on-budget surpluses.... The perceived need for such constraints reflects the view that the Federal government finds it difficult to operate effectively with persistent surpluses. Unless the mechanisms actually influence behavior, however, they would have no direct effect on taxes and spending or on the economy.
In March 1999, congressional Republican leaders discussed dipping into the Social Security trust funds over the next several years to pay for their tax-reduction and spending proposals. After these proposals were complete, the retirement system's funds would be "walled off" from the rest of the Federal budget.
But this gradual approach of continuing to allow some trust fund monies to be spent puts Congress in the position of explicitly endorsing its long-standing failure in dealing with Federal fiscal problems. Republicans are sensitive to attacks by Democrats that they are endangering Social Security. Although some Senate Republicans favor walling off Social Security immediately and completely to insulate the party from this criticism, the practice of spending trust fund monies continues. The CBO has recently reported that fiscal year 2000 spending bills draw $17 billion from the Social Security surplus.
Facing Political Realities
Removing Social Security from the budget equation entirely has repeatedly proved politically impossible. Senator Ernest Hollings has said that "the surplus everyone talks about belongs to Social Security already."
Despite the recommendations of the Greenspan Commission (and subsequent legislation) that Social Security reserves be maintained to take care of the baby boomers when they retire and that Social Security be accounted for outside the annual budget, Congress has already spent the reserves on other things. Senator Hollings recommends freezing the budget and leaving the "surplus" where it belongs--in the Social Security trust funds. The off-budget status granted to the OASDI trust funds does not and should not protect the Social Security program and the trust funds from presidential and congressional review. But continued media attention and political discussion of a Federal budget surplus is deceptive and misleading without full disclosure of the impact of the trust funds' receipts and expenditures. *
Charles F. O'Donnell, PhD, is a professor of economics and Robert Strittmatter, CPA, an associate professor of accounting, both at the Hagan School of Business, Iona College.
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