CBO Clears Up Confusionon Social Security

August 5, 2002

A new Congressional Budget Office policy brief focuses on how Social Security is treated with relation to the rest of the federal budget, finding that many aspects of its financing structure can confuse the public and may not contribute to efforts to prepare the program for baby boom retirements and beyond. CBO begins with a discussion of Social Security's "off-budget" status, which was designed to separate the program from the remainder of the federal budget (denoted the "on-budget" portion) and thereby protect Social Security surpluses from being spent on other government programs.

While the use of on-budget and off-budget categories is designed to distinguish Social Security's finances from those of other government programs, CBO points out that "the distinction can be confusing when it leads people to think of Social Security as an independent financial entity. Social Security is a federal program, and as such, all of its taxes are received by and its outlays dispensed from the U.S. Treasury…. Treating some federal programs as off-budget can obscure the government's total financial picture and its impact on the economy." The CBO concludes that, "Few people can understand how Social Security can be off-budget and part of the budget at the same time. To reflect it as off-budget is to suggest that it is an independent financial entity, which it is not."

The CBO brief also discussed other related aspects of Social Security financing.

Trust Funds

In addition to being "off-budget," Social Security's trust fund may increase confusion regarding the program's financing status and its relation to the rest of the budget:

Focusing on an accumulating balance in the Social Security trust funds can also be misleading. The only economically significant way that the government has a surplus is if there is a unified budget surplus—when total receipts are greater than total outlays. Although separate taxes are collected for Social Security, the money left over after benefits are paid is used to fund other government programs or to pay down the debt held by the public. Moreover, in the future, those separate tax receipts will become insufficient to maintain the program once the post-World War II baby boom generation begins drawing federal entitlement benefits. Social Security and other entitlement programs will then be dependent on the federal government to cover their costs—at the same time that the government must pay for its many other functions.

Regardless of how any federal program is financed and accounted for—and whether it is presented as on- or off-budget—a full understanding of the government's looming fiscal strains and the potential economic impact of its fiscal condition requires that all government functions be considered together. It is the federal government's total claims on the nation's resources that affect the economy—not the individual components that make up those claims.

Legal Right to Benefits

Like other government programs, Social Security's financing flows through the Treasury. And also like other government programs, Congress and the President can change the terms that Social Security operates under via legislation. In a footnote, CBO repeats a point that Cato analysts often have made: "Although often described as such, Social Security does not represent a 'contract' in the conventional sense in that neither party has entered into an agreement establishing enforceable obligations." In other words, Social Security benefits are not legally guaranteed, as would be the guarantee on a consumer product or a financial obligation.

Effect on National Saving

Debate continues over whether Social Security's trust fund constitutes real saving or simply "phantom IOUs" the government has issued to itself. While the CBO document does not settle the question, it does argue that the co-mingling of Social Security with other government funds makes distinctions between the two more difficult to justify.

The concept of federal "trust funds" also contributes to misunderstanding. The conventional view of private trust funds leads many people to believe that the government takes an arms-length approach to the management of federal trust funds—that somehow trust fund money is kept separate from that for the rest of the government. To the contrary, while the accounting for such federal programs is distinct, their cash flow is not segregated.

Even though Social Security's surplus funds have been off-budget for nearly two decades, the effect on the net amount of government savings is uncertain. In fact, overall budget deficits characterized most of the period. Even when a clear consensus exists to put surplus federal revenues toward debt reduction—whether they are attributed to Social Security or any other federal program—that posture can be difficult to sustain, as recent experience has shown.

It is for this reason that many favor personal accounts as a superior means to save money for the future. Since personal accounts would be distinct from the rest of the budget, and inaccessible to both the government and to individuals (prior to retirement), it would be more difficult for these funds to be "raided" to pay for other programs.

Baselines of Comparison

In 2041, under current estimates, "the balance of the Social Security trust funds is depleted, causing the program to lose its legal authority to pay full benefits." CBO goes on to explain that:

The trust funds are credited with federal securities when income is recorded to them, and those securities are written off when benefits and other expenditures are paid from the Treasury. Under the law, as long as a balance is posted to the trust funds, the Treasury has the legal authority to continue paying benefits. However, if the balance fell to zero (as is projected for 2041), the program's spending authority would end or be constricted because only incoming receipts would be available to make the payments.

This point can be significant to the policy debate, as it illuminates charges of "benefit cuts" under reform proposals, including those from the President's Commission.

Those proposals would at certain times and for certain individuals pay benefits lower than those scheduled by the current program. But as the CBO points out, Social Security can pay full benefits only so long as it has a positive balance in the trust fund. Hence, the proper baseline of comparison for the benefits (and costs) of reform plans is to what the current program can and would pay if we did not raise taxes.

Some argue that drastic benefit cuts in 2041 are politically unrealistic, and they are right. Yet maintenance of full benefits past 2041 is mathematically unrealistic: if political pressure would ensure full benefit payments, then taxes would be increased, other government spending reduced, or deficits be incurred to do so. There are no other choices. It is easy to determine the size of these tax increases, spending reductions or debt, so honesty demands that personal account opponents include these additional costs when they compare benefits scheduled by the current program to the costs and benefits of reform proposals.

Impact on Other Government Programs

Many are concerned that if Social Security and other age-related entitlement programs are allowed to grow out of control, other government activities might be squeezed out. The CBO apparently shares this concern:

Social Security and Medicare, by their size, are poised to crowd out other government spending and limit the availability of funding for other government functions. If one assumed that the benefit commitments now embedded in current law were to be fully met, Social Security and Medicare expenditures together would increase as a percentage of gross domestic product (GDP) from 7 percent today to 12 percent in 2040 and 15 percent in 2075. However, the separate revenues for the programs would remain at around 7 percent of GDP. Absent a policy change, the money to cover the difference would have to come from other government receipts or borrowing.

If crowding out in the future is to be avoided, we can either reduce the benefits that entitlement programs pay, or prefund them so they may pay benefits without placing larger strains on the remainder of government budgets.

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