Chicago, Athens, and Jerusalem

Last month, I highlighted the comments of economist Arnold Kling regarding the Social Security (and Medicare) trust fund. I recently finished reading Kling’s book Unchecked and Unbalanced: How the Discrepancy Between Knowledge and Power Caused the Financial Crisis and Threatens Democracy. Chapter 1 of that book contains the best discussion of the causes of the financial crisis that I have read, and I highly recommend it, even though I do not endorse all of Kling’s diagnosis of or prescription for what is wrong with American democracy. Today, I am more interested in his comments on Social Security, which appear on pages 99-100 of the hardcover edition of Unchecked and Unbalanced.

Social Security does not incur investment risk. That is because Social Security taxes are not invested at all. They are paid to beneficiaries. Until this point, taxes have exceeded benefits, and excess revenues have been spent on other government programs. This excess spending is tracked in an account called the Social Security Trust Fund, which can  be thought of as a collection of IOUs from the rest of the Federal government to Social Security recipients.

Within a few years, Social Security benefits will start to exceed tax revenues, and the government will have to make good on its IOUs. Later this century, depending on how demographic and productivity trends play out, the Trust Fund will be exhausted, and the government will have to raise additional taxes to pay for Social Security benefits.

I would go so far as to say that thinking about Social Security with the image of money (or bonds) in a trust fund somewhere is downright pernicious. There isn’t any money stored away to pay for Social Security–just a promise by the government to repay the money it “borrowed” from Social Security excess revenues and in fact spent on other things. As I wrote in my previous post on this subject, Thomas Sowell once said that no one can borrow and save the same money simultaneously. To the extent that the Social Security Trust fund exists, it is a promise by the government (specifically Congress) to take money out of general revenues and spend it on Social Security benefits when the time comes that–as Kling described–benefits start to exceed revenues. I will conclude by stating what many others have written, namely that if you’re in your twenties or younger, don’t expect the government to keep its Social Security promise to you. One or both of the following will be the experience of my generation: 1) substantially higher taxes during our peak earning years as we (via the government) pay for the retirement and health care of our Baby Boomer parents, and 2) drastically reduced benefits from government programs like Social Security and Medicare when we’re old enough to receive those benefits.

ADDENDUM: Gregg Easterbrook lays out the facts on Social Security here. Also, in the October 2010 issue of The Atlantic, Michael Kinsley argues that the Baby Boomers should redeem themselves by turning down the Social Security largess about the be lavished on them and by helping to pay the way out of our nation’s fiscal hole.