March 17, 2005

March 17, 2005 | WebMemo on Social Security

Raising Returns on Trust Fund Bonds: Simple, Easy To Explain, and Completely Wrong

For every complex problem, there is at least one solution that is simple, easy to explain, and completely wrong. One example was a man who wrote his congressman that the way to solve the deficit problem was just to print more money. Surprisingly, this solution has actually been tried by several countries, and in every case the resulting inflation has just about destroyed their economy. However, these simple "solutions" keep appearing.

 

In the case of Social Security, the latest "solution" that completely misses the point comes from Representative Martin Olav Sabo (D) of Minnesota. Rep. Sabo thinks that the way to solve Social Security's approaching financial problems is to have the government pay a higher interest rate on the special-issue bonds-really just IOUs-in the Social Security Trust Fund.[1] Instead of paying 4.1 percent interest after inflation-the average interest rate on these bonds over the last decade-Rep. Sabo wants to pay 4.7 percent after inflation.[2] If that is done, he says, all of Social Security's problems vanish into the mist. Sounds simple doesn't it?

 

Rep. Sabo likes this idea of paying more interest to the Trust Fund so much that he has actually introduced a bill, H.R. 1123, to do just that. The fact that these IOUs are merely promises to pay back money the government borrowed from the Trust Fund, and have no other value, seems to have escaped Rep. Sabo's notice…or maybe not.

 

Usually, people who suggest these simplistic non-solutions have the charm of having no idea what they are talking about. But this does not apply to Rep. Sabo, a former chairman of the House Budget Committee. He knows the facts about Social Security as well as anyone else on Capitol Hill. He also knows that the Social Security's so-called Trust Fund is vastly different from what most of us think when we hear about trust funds.

 

Most of us think that a trust fund is something filled with high-grade stocks and bonds that are carefully managed to produce income. This is not true in the case of Social Security. Even President Clinton's Office of Management and Budget agreed that Social Security's trust funds are filled with nothing but promises to use other federal tax money to pay Social Security benefits once the baby boomers' retirement forces the system to have to pay out more than it takes in.[3] They are IOUs, pure and simple.

 

Starting in 2018, the Treasury is going to have to retire the IOUs by giving Social Security money from other taxes. By 2022, those payments will reach over $100 billion a year (in today's dollars without inflation), by 2027, they will reach over $200 billion a year, and by 2033, they will reach $300 billion annually. The annual cost just keeps going up after that.

 

These annual payments mean that there will be less money available for other programs dealing with such things as education, health, and defense. As the annual deficits rise, our children will have unpleasant decisions to make. Would they rather pay for programs that benefit their kids or their parents?

 

So what good would it do to raise the interest rate on the IOUs as Rep. Sabo proposes? All that it would do is to increase the amount of IOUs. Instead of the IOUs running out in 2042, as they are scheduled to now, they would last for years after that-until 2080 according the Sabo office. Our children and grandchildren would still face the same problems with trying to come up with the money to pay off the IOUs.

 

If Sabo's approach really did work, why stop at 4.7 percent? Why not raise the interest rate on the Trust Fund IOUs to 10 percent and increase retirement benefits? Even better, why not raise them to 30 percent and allow all Americans to retire rich? Either is just as misleading and irresponsible as Sabo's plan.

 

David C. John is Research Fellow in Social Security and Financial Institutions in the Thomas A. Roe Institute for Economic Policy Studies at The Heritage Foundation.



[1] See David C. John, "Misleading the Public: How the Social Security Trust Fund Really Works," Heritage Foundation Executive Memorandum No. 940, September 2, 2004, at http://www.heritage.org/Research/SocialSecurity/em940.cfm.

[3]Office of Management and Budget, Budget of the United States Government, Fiscal Year 2000:  Analytical Perspectives (Wash­ington, D.C.: U.S. Government Printing Office, 1999), p. 337.

About the Author

David C. John Senior Research Fellow in Retirement Security and Financial Institutions
Thomas A. Roe Institute for Economic Policy Studies

Related Issues: Social Security