Social Security Insecurity
FORECASTS & TRENDS E-LETTER
IN THIS ISSUE:
1. Background – On-Budget vs. Off-Budget
2. Is Social Security in the Red?
3. Social Security and the National Debt
4. Does Social Security Affect the Budget Deficit?
5. AARP Reverses its Reversal
6. Proposals to Tax Retirement Assets…Again!
This week, I’m going to attempt to clarify some very confusing issues now being debated by our congressional representatives and the White House. The issues being tossed around like a political football are of vital importance to all of us Baby Boomers, especially those near retirement.
I’ll begin by looking into the recent controversy regarding Social Security and its effect on the federal budget. Specifically, is Social Security actually running a deficit? If so, will this deficit increase the national debt? What about the overall federal government budget deficit?
Our federal government’s system of accounting has become so complex and burdensome that it’s very difficult to figure out what the statistics you hear really mean. I’ll give you some clues on how to interpret some of this gobbledygook.
In another Social Security related controversy, I’ll cover a recent flip-flop by AARP regarding Social Security cuts as they relate to the ongoing debt ceiling discussion. Suffice it to say that AARP has had to do some major damage control over the past week or so. Last year, many conservatives cut up their AARP membership cards due to its support of Obamacare. Now, it’s the liberals who are unhappy.
After that, I’m going to look into some talk about limiting the tax benefits on retirement plans. The ability to deduct contributions and enjoy tax-deferred growth has been the cornerstone of retirement planning for many years. There are those in Congress who would take a wrecking ball to your retirement security for the sake of reducing the deficit.
This is an E-Letter that you need to read and pass on to your friends and relatives because everyone needs to get busy and contact their Congressmen to make sure they don’t use short-term solutions that will create long-term problems.
On-Budget vs. Off-Budget
Before launching into today’s Social Security discussion, it’s important to note the concept of “on-budget” revenues and expenses vs. “off-budget” items. In the magical world in which our elected representatives dwell, it’s possible to segregate the income and expenses of certain programs from the “real” budgetary accounts. These “off-budget” expenditures are deemed to be self-funding, so they need no special authorization from the government to operate. At present, the only off-budget categories are Social Security and the US Postal Service.
Though Social Security is technically off-budget, many federal budget discussions today refer to something called the “unified” budget, which combines both on-budget and off-budget programs. The use of the unified budget was introduced by President Lyndon Johnson in 1968. At the time, it was advertised as a way to help clarify the government’s total budgetary picture, including the various programs with trust funds established for their funding.
As a practical matter, however, the ability to discuss budgetary statistics without being fully clear on exactly which budget they’re talking about is a politician’s dream. For example, the switch to a unified budget allows on-budget deficits to be offset by off-budget surpluses (mostly Social Security in years past), resulting in a lower overall budget deficit, and this is what most news media and politicians quote.
Talk about having the best of both worlds. Social Security is an off-budget program that pays its own way, but politicians can use any surplus to offset on-budget spending deficits. A recurring theme throughout this article is to encourage you to make sure you know exactly what kind of budget figures are being talked about when listening to the latest drivel from Washington. The numbers may be technically accurate, but also very misleading.
Social Security Taps the Trust Fund
You’d have to be living under a rock to not have heard that Social Security is now operating in deficit territory…or maybe it’s not. I have seen articles that argue the issue both ways. Some say that the latest Social Security Trustees Report claims that there was a $49 billion deficit in 2010, while other sources claim that the very same Trustees Report indicated that there was a $68.5 billion surplus.
Surprisingly, both statements are correct, so you must look further into exactly what is being said. Social Security is funded through two different trust funds, the Federal Old-Age and Survivors Insurance trust fund and the Federal Disability Insurance trust fund. While these are separate funds, they are usually aggregated into a single “OASDI” trust fund.
In 2010, Social Security paid out $712.6 billion in benefits while collecting $663.6 billion in payroll taxes and other non-interest income. Thus, when considering only income other than interest paid on the special Treasury bonds held by the trust fund, Social Security ran a deficit in 2010 of $49 billion ($712.6b - $663.6b = $49b).
However, we also know that the Treasury bonds held by the OASDI Trust Funds earn interest. According to the Trustees report, this interest amounted to $117.5 billion in 2010. Adding that amount into the mix results in a surplus of $68.5 billion after subtracting benefits paid.
So, the Social Security system ran both a deficit and a surplus in 2010. Confused? Good. That’s exactly where they want you to be. Various writers and politicians will selectively use these statistics in an effort to try to prove whatever point they want to make. Some articles (like this one) include the accrued interest on the bonds, while others (like this one) quote only non-interest income. This helps to explain why you can see numbers all over the map when reading articles about the health (or lack thereof) of the Social Security system. You can check out a summary of the Trustees Report for yourself at the following link:
Why are these numbers important? Because the fact that more benefits are being paid out than taxes collected means that Social Security is no longer covering the cost of benefits on an ongoing basis. Yes, the accounting gimmick known as the “trust fund” will continue to allow benefits to be paid in the future. However, the money to redeem the bonds held by the trust funds will eventually have to be borrowed from the public, as I will discuss in more detail below.
Social Security and the National Debt
Another controversy brewing in relation to the debt ceiling negotiations is whether or not funding Social Security adds to the “national debt.” In light of the fact that Social Security is paying out more in benefits than it raises in taxes, will Congress need to account for this when (not if) the debt ceiling is raised?
As with most questions involving government statistics, the answer is that it depends on which national debt figure you’re looking at. The total national debt, the one usually mentioned in most news stories, includes both intra-governmental debt (primarily made up of the special bonds held by the various governmental trust funds) and debt owed to the public (debt owed to individual investors, institutions and foreign countries).
However, sometimes news stories and politicians will just mention the debt owed to the public since the intra-governmental debt is just “money that the government owes itself.” At present, the total national debt is $14.3 trillion while the debt owed to the public is around $9.7 trillion.
By law, any surplus of payroll taxes over and above Social Security and Medicare benefits paid must be invested in special non-marketable Treasury securities. In addition, any other income to the trust fund must also be invested in these special Treasury bonds.
Thus, any surplus in the trust funds becomes additional Treasury debt which must, in turn, be accounted for when raising the debt ceiling. Even though payroll tax revenues no longer result in a surplus, interest income will still cause the trust funds to grow in the future, meaning additional investment in the special Treasury bonds. The bottom line is that to the extent that Social Security runs surpluses, even if just from interest earnings on the special bonds, it will add to the total national debt.
Trust Fund Redemptions
A similar question has been raised regarding the redemption of trust fund Treasury bonds as they begin to run larger and larger deficits as Baby Boomers retire. Since the trust funds have been described as nothing more than the authority to spend money, redemption of these bonds would require the government to borrow from the public, thus increasing the national debt, right?
Well, not exactly. As I noted above, the total national debt is conveniently subdivided into that owed to the trust funds (intra-governmental) and that owed to the public. When Social Security decides it has to redeem some of these bonds to pay benefits, they tell the Treasury to send them a check. To do so, the Treasury must sell more bonds to the public.
The net effect is that the portion of debt held by the public goes up, while the amount of debt owed to the Social Security trust funds goes down. Since both public and intra-governmental debts are included in the total national debt figures, the act of redeeming trust fund bonds and replacing them with debt held by the public results in a wash.
That’s not to say, however, that there are no possible effects from the transfer of debt from internal to that held by the public. Since the trust funds represent debt that the government owes to itself, it’s conceivable that Congress could reduce, suspend or even eliminate interest payments on the special bonds held by the trust funds to help control federal budget expenditures. I’m sure some will say that Congress would never do this, but I learned a long time ago to never say never, especially in relation to what Congress might or might not do.
Of course, you could never take this kind of drastic action with debt held by the public as it would be deemed to be a default on the debt. The conversion of intra-governmental debt to debt held by the public may also affect the amount of debt service paid by the federal government (more about this later on.)
Social Security and the Budget Deficit
Another area of recent controversy has been in regard to the extent to which Social Security expenditures and trust fund transactions affect the federal government budget deficit. Those who argue that Social Security cannot add to the deficit correctly state that Social Security is a self-funding program and is precluded from borrowing to pay benefits, so it cannot add to budget deficits. This view was probably best expressed by Nancy Altman, co-chair of the Strengthen Social Security campaign, a group that opposes any cuts in Social Security benefits:
This representation is accurate, as far as funding Social Security benefits go. However, it ignores one important point. As I discussed above, Treasury debt held by the trust funds must be replaced with debt issued to the public for these benefits to be paid. This conversion from intra-governmental to public debt has the potential to add to the deficit.
That’s because the trust funds receive interest that is an average of the returns on all Treasury securities, while the debt held by the public gets a market rate. A spike in market interest rates might raise the costs of issuing debt to the public more so than the average rate applied to the special Treasury bonds held by the trust funds. If so, any differential could marginally increase the government’s cost of borrowing.
There’s another way that Social Security funding may affect deficits, or at least how they are reported. Earlier in this article, I noted how presidents since LBJ have used Social Security surpluses to offset the reported amount of on-budget federal deficits. That’s fine and dandy as long as Social Security continues to run a surplus.
However, Social Security will soon cease to run surpluses (even after adding in interest income) and this will have an effect on how the federal budget deficit is reported. The unified budget will go from having Social Security surpluses offsetting on-budget spending to Social Security shortfalls potentially adding to the total combined deficit.
Thus, the mere act of the trust funds redeeming their bonds probably won’t add to on-budget deficits, but the lack of ongoing surpluses will remove an important accounting gimmick used by politicians of both parties since the 1960s. When that happens, I’d look for politicians to abruptly stop using unified budgets and go back to an on-budget/off-budget approach.
I personally think that the above analysis may also provide a clue as to how Congress may propose to fix the Social Security funding problem. Increasing tax revenues by either raising the payroll tax rate or increasing the amount of compensation subject to these taxes (or both) would lead to an immediate renewal of trust fund surpluses and voila, happy days are here again! Off-budget surpluses would again be used to offset on-budget deficits.
Of course, the same result would be likely if benefits were reduced or the retirement age increased, but the effect wouldn’t be as immediate. Most proposals regarding benefit reductions are phased in for those who are under 55 years old, so any effect on the trust funds would take a while to materialize.
AARP Opens Mouth, Inserts Foot
On June 17th, AARP policy chief, John Rother, hinted in a Wall Street Journal interview that AARP had reversed its long-held opposition to cutting Social Security benefits as a means to improve its long-term funding status. A flurry of articles from a variety of sources came out in support of the organization’s newly found recognition of the need to compromise. Liberal organizations and a host of AARP members, however, cried foul.
This action comes on the heels of AARP’s controversial support of Obamacare, which alienated conservative members. The Wall Street Journal article noted that AARP lost about 300,000 members due to that position, claiming that AARP’s support was more monetary than philosophical. Royalties from AARP-branded health and other insurance and financial products accounted for about half of the organization’s $1.4 billion income last year.
The last thing AARP needs is another mass defection of its members, so it was quick to issue a statement that reversed the reversal, so to speak. A statement from AARP CEO, Barry Rand, labeled the Wall Street Journal article as misleading regarding the organization’s policy on Social Security. An excerpt from Rand’s statement said:
I think Rand’s statement is more significant for what it doesn’t say. Nowhere in the press release did he say that AARP was categorically opposed to any benefit cuts for future retirees. He states that AARP’s position hadn’t changed, but wouldn’t it have been easier to come out and say that AARP opposes any and all cuts to Social Security?
When Rand does mention benefit cuts, he qualifies the statement by saying, “First, we are currently fighting some [Emphasis added] proposals in Washington to cut Social Security…” Some, but not all – that’s an important distinction. He also notes that “Any changes to this lifeline program should happen in a separate, broader discussion and make retirement more secure for future generations, not less.” Again, not a word about opposing all cuts.
Overall, the AARP press release focuses on two major themes: 1) we haven’t changed our position; and 2) AARP supports strengthening Social Security to ensure benefits for both present and future beneficiaries. Again, no absolute opposition to benefit cuts here.
According to the 2011 Social Security Trustees Report, the trust fund is expected to cover payments until 2036 when it is exhausted. Since the program is deemed to be self-funding, payroll tax revenues at that time are expected to cover only about 77% of expected benefits. Any way you look at it, this would be a cut in benefits for both current and future retirees. AARP knows this, so it’s feasible that it may support some kind of smaller cut now to avoid this major cut for all beneficiaries in the future.
I think the AARP press release is pure “damage control” to help nullify the large number of news articles that trumpeted AARP’s position “reversal.” Down deep, I believe the organization knows that any Social Security fix will need to include both tax and benefit modifications, which is why the press release didn’t mention opposition to any cuts.
One thing that AARP does get right in its press release is that any changes to Social Security should be made separate and apart from the debt ceiling and overall budget discussions.
Retirement Assets at Risk
In closing, I want to discuss one other item important to anyone who is saving for retirement. According to various sources, some in Congress are contemplating reducing or eliminating the tax benefits of saving for retirement. This means that the tax deduction for employer and individual contributions may cease to exist, as well as the deferral of taxation on earnings on these programs.
Perhaps Congress didn’t get the memo that there is a retirement crisis in the US, with many Baby Boomers not having saved nearly enough money to retire. Any reduction in the tax benefits related to retirement assets would just make a bad situation even worse. Plus, our congressmen must have forgotten that, except in Roth-type plans, taxes are merely deferred and not forgiven. Most retirement assets will produce a steady stream of tax revenue as retirees stop saving and start withdrawing money to live on.
Some in Congress also must not realize that providing a deduction for contributions helps both employers and individuals contribute more for their retirement, since the contributions are essentially subsidized by the government’s willingness to defer the taxes. Plus, the ability for contributions to grow tax-deferred means that the magic of compound returns can have an even greater effect, producing a larger nest egg than if the earnings were taxed annually.
Unfortunately, this idea is nothing new. You may recall that I wrote about a similar scheme back in 2008. At that time, there were those in government who wanted to confiscate 401(k) balances for the taxpayer’s own good, since many had suffered losses in the stock market. How paternalistic can you get?
Even as far back as 1994, Bill Clinton’s Assistant Treasury Secretary for Economic Policy proposed taxing both the contributions and gains on pension assets, known as the “inside buildup,” and use the money to fund public infrastructure and educational programs. Fortunately, these earlier attempts to raid retirement account balances failed, but recent proposals show the idea wasn’t forgotten.
This time around, the proposal to tax pension contributions and earnings isn’t fueled by paternalism or the desire to fund infrastructure, but rather to fill a huge budgetary hole created by President Obama’s ongoing trillion-dollar deficits. As of the close of 2010, retirement assets (including employer plans and IRAs) amounted to over $15 trillion. Even a relatively small tax on this huge block of money could help patch this hole without drawing much attention.
There is no doubt that there are those in our government who want to move toward a socialist state where a benevolent government takes care of all of our needs via “spreading the wealth.” That being the case, it doesn't take much of a stretch for them to believe that any assets that have received preferred tax treatment can now become government property. All they need is a sufficient crisis to justify their actions. If you don't believe this can ever happen, see the discussion in Special Articles below to see how pension assets are being taxed and even confiscated in some European countries.
I recommend calling or writing your congressmen and urging them to vote against any attempt to remove the tax benefits enjoyed by retirement accounts. The short-term gain in tax revenue would be far offset by the long-term effect on retirement security.
Thankful for the recent rains in Central Texas,
Gary D. Halbert
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Forecasts & Trends E-Letter is published by ProFutures, Inc. Gary D. Halbert is the president and CEO of ProFutures, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, ProFutures, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.