There is a widespread belief that the Social Security Trust Fund is going
bankrupt. Thus, while OASDI is currently accumulating large financial
surpluses, the fear is that Social Security faces a financial crisis because
post-2020 program expenditures are expected to exceed the revenues that will
be generated from a shrinking tax base.1 The solution, many argue, is
to "use" (current and future) budget surpluses to "save"
Social Security from financial collapse.2 The idea, according to these
"saviors," is that by "depositing" the surpluses into a
Trust Fund, the Treasury can be prevented from "spending" them.
These "saviors" typically also insist that the rest of the
government’s budget must remain balanced, for otherwise the Treasury would be
forced to "dip into" Social Security reserves. We examine these
points by first providing an analogy.
Can a trust fund help to provide for future retirees? Suppose the New York
Transit Authority (NYTA) decided to offer subway tokens as part of the
retirement package provided to employees -- say, 50 free tokens per month (for
life) upon retirement. Does this mean that the City should attempt to run an
annual "surplus" of tokens (on average collecting more tokens per
month than are paid out) in order to accumulate a trust fund to provide for
future NYTA retirees? Of course not. When tokens are needed to pay future
retirees, the City will simply issue more tokens at that time. Not only is it
unnecessary for the City to accumulate a hoard of tokens, but it will not in
any way ease the burden of providing subway rides to future retirees. Whether
the City can meet its real obligation (to convert tokens into rides)
will depend solely on the future carrying capabilities of the transit system.
Its financial commitment, in contrast, can always be met
merely by issuing tokens to future retirees as benefits come due.
Note, also, that the NYTA does not currently attempt to run a
"balanced budget," and, indeed, consistently runs a subway token
deficit. That is, it consistently pays-out more tokens than it receives, as
riders hoard tokens or lose them. Attempting to run a surplus of subway tokens
would eventually result in a shortage of tokens, with customers unable to
obtain them. Instead, the transit system always sets its price (say, $1.50 per
token) and lets the quantity of tokens it issues
"float".3 Again, this typically
results in a deficit, as the NYTA issues more tokens than it receives, but
this practice does not in any way impinge on the its ability to make token
payments in the future. Moreover, it would be impossible for the NYTA to
consistently run surpluses because the only revenue source of tokens is the
NYTA’s own "spending" of tokens.
Just as an accumulation of subway tokens cannot help to provide subway rides
for future retirees, neither can the Social Security Trust Fund help provide
for the (real) consumption needs of babyboomer retirees. Whether their future
consumption needs are realized will depend solely on society’s ability to
produce real goods and services (including subway rides) at the time that they
will be needed. Thus, an accumulation of credits to a Social Security Trust
Fund is neither necessary nor efficacious. Moreover, as was the case in the
NYTA analogy, it does no good to run a budget surplus -- which simply reduces
the demand for currently produced goods. Just as a NYTA token surplus would
generate lines of token-less people wanting rides, a federal budget surplus
will generate jobless people desiring the necessities of life (including
While the analogy with a subway token retirement system is not a perfect one,
it does make the important point that the issuer of the token (or
dollar) never needs to collect tokens (dollars) before making payments.
Indeed, it cannot initially -- as a simple matter of logic -- do so. It must
first "emit/issue" (spend) before it can "collect" (tax).
This also means, as a matter of logic, that it makes no sense to attempt to
accumulate a trust fund for the purpose of paying-out tokens (dollars) in the
How Well Do the "Saviors" Understand the
The above is intended to clarify two points, which, if misunderstood, preclude
any sensible discussion of Social Security. The first point concerns the
building up of financial resources as a means of providing for the
needs of future retirees. This, as we argued, is both unnecessary and
ineffectual since the availability of financial resources by no means
guarantees the availability of sufficient real resources.4 Second, it makes no sense to support
balanced budgets (much less surpluses) as a means of "protecting" the trust
fund since this, also, does nothing to augment real resources. That this is
not understood, even by those who ought to have a better grasp of the
fundamentals, is evidenced in an excerpt from a document issued by the U.S.
House of Representatives Budget Committee, which states that:
Every penny that is taken out of America’s paychecks for Social
Security should be locked in a safe-deposit box so it can only be
used to pay for Social Security benefits.
[Penner et al. 1999, 1; emphasis added]
Three fundamental misconceptions, each indicated in boldface, exist in the
If the safe-deposit box is meant to represent the Social Security Trust Fund
(and we believe it is), then the first misconception is revealed. There are no
pennies -- or nickels, dimes, quarters, or bills of any denomination,
for that matter -- in the Trust Fund; it is not a piggy bank and should not be
likened to a safe-deposit box. Eisner recognized this, calling the Trust Funds
"merely accounting identities" [1998, 80]. What these accounting
identities actually represent are non-marketable US Treasury liabilities that
have been credited to the Social Security Trust Fund (a US Treasury asset). In
other words, the Trust Funds are recorded on the same balance sheet as
both an asset and a liability -- an unconventional accounting practice
to be sure. Putting it somewhat crudely, the Trust Funds are an accounting
The second misconception follows from the idea that payroll taxes that are
taken out of current workers’ paychecks must be locked up the so
that they will be available when it is time to pay out benefits in the future.
In fact, in practice, the goal is to collect and "lock up"
more funds than are "needed" to service current commitments.
The idea is that by "advance funding" the system, the surplus can be
drawn down as the number of retirees begins to swell. The problem with this
argument, as we have already argued, is that the ability to pay out benefits
does not depend upon the balance in the Trust Fund.
The government makes payments to retirees in the same way that it pays a
postal worker for her services or Alan Greenspan for his -- by writing a check
on one of the Treasury’s accounts at the Federal Reserve. Figure 1 shows the
balance sheet entries that correspond to the payment of Social Security
benefits and the collection of payroll taxes.
Step A: Withholding Payroll Taxes in Excess of Benefits
- Balance at Commercial Banksa
+ Balance at Commercial Banksb
- Balance at Federal Reserve
+ Balance at Federal Reserve c
- Balance owed to Non-Bank Public
+ Balance owed to Non-Bank Public
+ Balance at Federal Reserve
- Balance at Federal Reserved
- Balance owed to Commercial Banks
+ Balance owed to Commercial Banks
Step B: "Disposition" of the Surplus
+ Balance owed to Banks
- Balance owed to Treasury
- Marketable Government Securities
+ Balance at Federal Reservee
- Balance at Federal Reserve
+ Social Security Trust Fund
- Marketable Government Securities
+ Non-marketable Government Securities
- The deposits of bank customers decline as taxes are paid.
- The deposits of bank customers rise as Social Security checks are
- The net effect is a decline in aggregate bank reserves
because we are assuming current withholdings exceed current benefits.
- The budget surplus results in a net increase in the
Treasury's balance at the Federal Reserve.
- When Treasury debt is retired, the banking system recovers lost
As this figure indicates, our payroll taxes are not credited to any trust
fund, nor are our benefit checks drawn on any such fund. Benefit checks are
always drawn on one of the Treasury’s accounts at the Federal Reserve, and
payroll taxes are received into one of the Treasury’s accounts. Thus, with our
government currently running a surplus, mainly due to the "advance
funding" of Social Security, there will be a net increase in the
Treasury’s balance at the Fed. This is the case in Step A. At this point, the
additional balances could simply be left in the Treasury’s account. But, if
the goal is to "lock up" some portion of the surplus in order to
"shore up" Social Security, then the Federal Reserve, which is
charged with managing the Treasury’s outstanding debt, will arrange for some
portion of the Treasury’s maturing obligations to be retired. Simultaneous
with the reduction of privately held (marketable) Treasury bonds, as
shown in Step B, the Treasury will issue additional (non-marketable)
debt to be held by the Social Security Trust Fund.
But what do all of these balance sheet entries really mean? In short, they
show that the Treasury has traded a portion of its balance at the Federal
Reserve for credits to the Social Security Trust Fund (i.e. it has swapped one
asset for another) and it has traded marketable debt for non-marketable debt
(i.e. it has swapped one liability for another). Is this balance sheet
adjustment really necessary in order to ensure the survival of the Social
Security program? The answer, of course, is no.
Unfortunately, our government seems to misunderstand that as long as it
retains certain powers (e.g. the power to tax, the power to declare public
receivability, the power to create and destroy money and the power to buy and
sell bonds), it can never be constrained in its ability to make money
payments. This means that the government never needs to collect a surplus of
dollars today in order to make money payments in the future. As the monopoly
issuer of dollars, the government will always be able to make Social Security
payments as required under the law.
Finally, there is a misconception that follows from the belief that withheld
payroll taxes can be used to finance retirees’ benefits. While it is
certainly true that withholdings are credited to one of the Treasury’s
accounts, it would be highly deceptive, in a world where money has been
effectively divorced from commodities, to suggest that the money that is
transferred from the private to the public sector can be "used" to
pay (current or future) benefits. A careful analysis of the accounting reveals
First, it must be recognized that Federal Reserve notes (and reserves) are
booked as liabilities on the Fed’s balance sheet and that these liabilities
are extinguished/discharged when they are offered in payment to the federal
government. In other words, the collection of payroll taxes leads, through the
clearing process, to a loss of bank reserves and a concomitant destruction of
Federal Reserve liabilities. Second, it should be recognized that as the
liabilities of the Federal Reserve are discharged, both narrow money and
high-powered money are destroyed -- narrow money (M1) is destroyed when demand
deposits are used to pay taxes, and high-powered money is destroyed as the
funds are placed into the Treasury's account at the Fed. Clearly, then, it
would be impossible to "use" payroll tax receipts to pay for
The "Problem" With Social Security and its Popular Reform
The philosophy behind the current wave of hysteria surrounding Social Security
is based on the belief that the program faces a long-range financing problem.
Since the problem is perceived to be a financial one, the goal of most reform
proposals is to prolong the day of reckoning -- the day the OASDI trust funds
become "insolvent." Unfortunately, most of these analyses, including
those published by the Trustees, have confused financial issues with the real
burden of caring for retirees in the future. Indeed, as we have argued, the US
government can always meet its obligation to make money payments. The real
concern is whether, as a consequence of our shrinking workforce, our society
faces any "real" production problems in the future. If we do, then
this can be resolved only by increasing productive capacity between today and
the future. Let us move to an examination of some of the more popular
proposals on the reform agenda to see whether any of them are likely to ease
the real burden that future workers might face.
We begin with President Clinton's plan. The President has
proposed that $2.8 trillion, or 62% of the $4.5 trillion in projected budget
surpluses over the next 15 years, be "used" to shore up the OASDI
Trust Fund. The plan consists of taxing current workers about 2 percent more
than they would forfeit under a pay-as-you-go system. Unless a larger Trust
Fund is likely to augment our productive capabilities, however, the
President’s plan will do nothing to ease the "real" burden of
providing for the consumption needs of retirees. Thus, a reasonable
justification for building up the Trust Fund today (i.e. "advance
funding" Social Security) is a belief that the increased national savings
will stimulate investment demand. However, for reasons that are familiar to
all Institutionalists, the notion that saving determines investment is
logically flawed; saving is only the pecuniary accounting of investment
[Foster 1981]. Moreover, it makes no sense to penalize current workers simply
to allow the government to increase its debt to itself in order to maintain
the subterfuge that it is necessary to save dollars today in order to pay out
dollars in the future. In fact, we believe that current workers could enjoy a
tax cut now and that this would have no impact whatsoever on the government's
ability to finance Social Security in the future.
Next, we consider the proposal to privatize the Trust Funds. The belief is
that by allowing workers to invest (all or part of) their withheld payroll
taxes in the stock market, they would earn higher returns. Again, notice that
the goal of this proposal is to augment "financial" resources. The
"real" burden placed on future generations would remain unchanged
unless privatization somehow increased the economy’s long run growth rate. As
Eisner has argued, however, privatization is likely to have "little or no
real effect on the economy" because, in the end, "it would merely
change the identity of those who hold government bonds as against stocks"
Finally, we consider a host of cost-reducing reforms such as: reducing
cost-of-living-adjustments, increasing the retirement age, cutting benefits
payments and adopting means-testing criteria. These reforms share a common
theme -- each seeks to reduce the volume of benefits payments relative to
contributions. However, none of these proposals is likely to improve society’s
productive capabilities. Instead, they are designed to help the government
cope with a perceived "financial" problem, which we have already argued is a
Thus, none of the major Social Security reforms advocated -- whether by
the President or by his critics -- will significantly reduce the real
burden that future workers might face. Indeed, many of these proposals would
merely increase the burden on today’s workers and retirees without reducing
the future burdens at all.
At best, the reforms advocated by Social Security "saviors" have an
ambiguous probability of easing the "real" burden that may be
experienced in the future. This is because most proposals focus on increasing
the size of the Trust Fund (by some combination of reduced benefits or
increased tax rates) or increasing the rate of growth of the Fund (for
example, by investing it in the stock market). As we have already argued, the
current philosophy behind the operation of OASDI is the belief that a large
Trust Fund can help to ease the burden created by demographic changes combined
with slow projected growth of taxable real wages. But, as we have said, the
availability of financial resources in no way ensures the availability of
sufficient real resources.
Thus, rather than adopting policies that are designed to deal with a perceived
financial problem, we make the following recommendations:
Finally, we believe that reforms such as increased taxation, privatization,
reduction of benefits, or an extension of the retirement age have no place in
the reform of Social Security. Appropriate policies to cope with the
demographic changes that will be experienced in the coming years must not be
motivated by concerns over the availability of financial resources.
- OASDI should be returned to a pay-as-you-go system. We see no
reason to suppose that the burden of providing for the real consumption needs
of future retirees will be eased by accumulating an enormous Trust
- We should reconsider immigration policy. As our
nation moves to negative natural population growth, we may wish to
significantly increase the numbers of legal immigrants in order to provide us
with a growing labor force.
- General fiscal policy should be biased to encourage faster
growth, greater employment, and higher labor force participation (especially
Each year the trustees of the Social
Security Trust Funds (Old-Age and Survivors’ Insurance Fund and Disability
Insurance Fund, or OASDI) make three sets of projections: high cost,
intermediate cost, and low cost. According to their low-cost projection in
1999, the estimated income rate (revenue from payroll taxes expressed as a
percentage of taxable payroll) will exceed the estimated cost rate (payments
to beneficiaries expressed as a percentage of taxable payroll) over the next
25-year, 50-year, and 75-year periods. The intermediate-cost projection
anticipates sufficient revenues over the 25-year period and a shortfall of
income thereafter, while the high-cost estimate projects a shortfall even in
the first 25-year period. These projections provide the basis for the current
claim that Social Security faces a financial crisis. Although it is fair to
question the (perhaps overly pessimistic) assumptions underlying the
projections, it must be emphasized that even under the most pessimistic
assumptions there would be no "financial" crisis. We will return to this
As Wray  points out, however, the
surpluses that are anticipated through 2008 will be achieved mainly thanks to
huge "off-budget" surpluses – $119 billion in 2003 and $159 billion
in 2008 – that will be run by Social Security!
federal government does not generally exercise the right to set prices, it
certainly could do so. The NYTA is, in effect, buying dollars (i.e. selling
subway tokens for dollars). The difference between the NYTA and the federal
government is that the former sets the price it is willing to pay for dollars
(i.e. 1 subway ride per 1.5 dollars) and lets the quantity of tokens it issues
float, while the latter sets the quantity of dollars that will be issued (via
the Congressional budget) and lets the price of the goods and services it buys
float (via market determination). The government’s power to set prices is
discussed in Wray 1998.
Foster recognized this point, stating
that "[t]he community at large cannot‘save money; it can save only by
investing, and its savings are constituted by that investment" [1981,
Payroll taxes are not unique here.
Personal income taxes, quarterly business taxes, the proceeds from bond sales,
etc. are equally ineffectual in this regard. None are capable of providing the
government with money that can be ‘used’ to finance future spending. In fact,
the government actually finances all of its spending through the direct
creation of new (high-powered) money. For more on this, see Bell 2000.
We might add that it is unnecessary to
seek higher returns from the stock market since the government can always
choose to pay a higher return on its non-marketable securities (i.e.
the government could credit the Trust Funds with a higher interest rate).
Although this would resolve the accounting "problem" that may be faced twenty
years from now, it, too, would accomplish nothing in "real" terms.
Bell, Stephanie A. "Do Taxes and Bonds Finance Government Spending?"
Journal of Economic Issues, forthcoming.
Eisner, Robert. "Save Social Security from its Saviors." Journal of Post
Keynesian Economics 21, no. 1 (Fall 1998): 77-92.
Foster, J. Fagg. "The Reality of the Present and the Challenge of the Future."
Journal of Economic Issues 15, no. 4 (December 1981): 963-968.
Penner, Rudolph, Sandeep Solanki, Eric Toder, and Michael Weisner. "Saving the
Surplus to Save Social Security: What Does it Mean?" Urban Institute,
Brief Series, no. 7 (October 1999): http://www.urban.org/retirement.
Wray, L. Randall. Understanding Modern Money: The Key to
Full Employment and Price Stability. Cheltenham, UK: Edward Elgar,
Wray, L. Randall. "The Emperor Has No Clothes: President Clinton's Proposed
Social Security Reform." Jerome Levy Economics Institute, Public
Policy Note, no. 2 (1999).