The Federal Budget
Social Security Reform: The Budget Surpluses and Social Security
Research Report
John Gist, AARP Public Policy Institute
April 1998
Table of Contents: Introduction | The
Surpluses and Social Security | How to Use
Budget Surpluses? |
Should We Count on Surpluses? | References | Footnote
Introduction
President Clinton's FY 1999 budget, submitted February 2 of 1998, projected a budget surplus for FY 1999 and for every year thereafter out to 2008 (see Figure 1). In March, the Congressional Budget Office (CBO) projected a surplus of $8 billion even sooner, in FY 1998 (CBO, 1998b). By April, CBO was projecting a surplus of $50 billion or more. If a surplus occurs in either 1998 or 1999, it would be the first time the federal budget has been in the black since 1969, when a tax increase was enacted to finance the Vietnam War. A series of annual surpluses would be a welcome reversal in fiscal policy from the years of triple-digit deficits (FY 1982 through FY 1996), when a cumulative deficit of $2.9 trillion was amassed.
The projection of future surpluses has transformed the annual budget ritual from deficit reduction rhetoric to proposals to spend the looming surpluses. Some members of Congress want to spend the surpluses on new initiatives such as highways and infrastructure, others want to spend them on tax cuts, and still others want to save them by retiring outstanding government debt.
The President, in both his State of the Union address and in his budget message, proposed to "save Social Security first," by "reserving every penny of surplus" until solvency is restored to the Social Security system for future generations. Since then, the Speaker of the House has also advocated using the surpluses to "save" Social Security by setting up personal retirement accounts. The goals of the President and the Speaker may sound similar, but their approaches are quite different. To see the difference requires an understanding of the relationship between Social Security and budget deficits or surpluses.
Top of PageThe Surpluses and Social Security
To say that surpluses should be reserved until we "save Social Security," as the President proposed, might suggest that the surpluses are somehow separate from Social Security. In reality, any budget surpluses that occur over the next decade will be due almost entirely to the annual surpluses (i.e., the difference between income and outgo) in Social Security.
In 1998, the annual Social Security surplus 1 is expected to be about $100 billion, and it will double by 2008. The unified federal budget, which includes annual net Social Security outlays and receipts, projects net overall budget surpluses of $1.1 trillion over 1999-2008, thanks to even larger net Social Security surpluses over that period of more than $1.5 trillion. Without Social Security, there would still be unified budget deficits of up to $100 billion until 2007, as shown in Figure 2.
Any surplus funds (i.e., those not needed to pay current benefits) are, by law, invested in Treasury securities, which offer a guaranteed and safe rate of return with protection against capital loss if interest rates rise. The Treasury borrows these funds, when needed, to pay for ongoing government programs. If the Treasury did not borrow these funds from Social Security and other federal trust funds in times of deficit, it would have to borrow from the public at higher rates.
Because Social Security is only a partially pre-funded system, future Social Security obligations must be paid out of funds available when those obligations come due. Some of those funds will come from payroll tax revenues, and some from the maturing Treasury securities, which can be redeemed when needed by Social Security.
The Treasury securities are redeemed with regular tax revenue. The stronger the economy, the easier it is to raise the revenue. If the Social Security surpluses that are borrowed by the Treasury are used for investments that promote long-term economic growth, current budget surpluses (due mostly to Social Security) can indirectly improve the long-term outlook for Social Security by making it easier to raise taxes to repay the borrowed funds.
If the projected budget surpluses materialize, the Treasury will no longer need to borrow, and the President and the Congress must decide what to do with "excess" Social Security funds--i.e., funds not needed to pay annual benefits--when the Treasury does not need to borrow them. They can either (1) spend the surpluses directly through increased government purchases or other outlays; (2) spend them indirectly through tax reductions that would return dollars to taxpayers to spend or save (if they are treated as normal income, most would be spent); or (3) save the funds by using the Social Security funds to purchase outstanding federal securities held by private investors, thus reducing the federal debt owed to the public.
Option 3 has an effect similar to that of a household with a substantial mortgage that has some leftover funds at the end of the year. It can choose to spend or to save those funds. By choosing to pay a little more on its mortgage rather than consume the funds, it would reduce the household's long-term debt and its interest costs.
Would a strategy of debt reduction help Social Security? Social Security will continue to hold government securities but the public will hold less. Just as a reduced mortgage makes a household better off, reducing federal debt makes everyone better off because, if the government owes less overall, its borrowing costs come down, and interest rates may follow. If interest rates fall, it will be easier for businesses and individuals to invest in capital that will help the economy grow even larger. A larger economy makes it easier to afford the costs of the Social Security program.
To say that we should reserve the budget surpluses until we save Social Security, as the President has proposed, does not mean that they will have any effect on the current or long-run costs of Social Security. Rather, by saving that money now (i.e., by reducing debt), we will be in a better economic position to fulfill the obligations that Social Security will face in the 21st century.
The Speaker's proposal, on the other hand, would devote the surpluses to establish personal retirement accounts. Whether these accounts would be voluntary or mandatory (e.g., shifting payroll contributions away from Social Security and into personal accounts is unclear. In either case, the government would save less, perhaps exhausting any potential surplus or even returning the budget to a deficit path. National saving might still increase, but if voluntary it would be far less certain than if the government saved the surplus. Any proposal such as that recently offered by Senators Moynihan and Kerrey that includes no mandate to save would yield negligible saving. The economic effects are also likely to be quite different (we will compare the voluntary and debt reductions approaches in an upcoming paper).
There is good reason to be wary of talk about budget surpluses. The rapidity with which the deficit picture has changed over the past few years suggests how quickly the fiscal picture could change from rosy to gloomy again. Consider Figure 3 (above), which shows 10-year deficit/surplus projections reported by the Office of Management and Budget in January 1993 and in February 1998. The 1993 projections show deficits doubling from $300 billion in 1992 to more than $600 billion by 2003. By 1998, the deficit projections for years 2000-2003 were $450 billion to $700 billion lower annually than they were in 1993 (Figure 3).
Figure 4 shows that outlays were approximately $130 billion lower and revenues about $170 billion higher in FY 1997 than projected in 1993. Of the $92 billion reduction in the deficit between March and October, $72 billion was due to increased revenues. Deficit projections have been volatile recently not because estimates have been out of line with historical experience, but because the size of the budget means that small percentage changes result in large dollar changes (CBO, 1998a). The higher-than-expected revenues are due to strong growth in the economy, large amounts of capital gains realizations, and rapid growth in income among higher-income-bracket taxpayers.
The surprisingly good deficit picture could reverse quickly due to the tax cuts enacted in 1997, the near-record length of the current economic expansion, and the domestic economic uncertainty caused by turmoil in Asian economies. CBO's analysis of the President's budget suggests that deficits or surpluses that differ from current projections by upwards of $100 billion are entirely possible. This suggests that caution in the use of budget surpluses is advisable.
Congressional Budget Office (1998a). The Economic and Budget
Outlook, 1997 -2008.
Congressional Budget Office (1998b). Monthly Budget Review,
Fiscal Year 1998.
1 As distinct from the accumulated Social Security reserve, which is currently about $600 billion.
Written by John R. Gist, Associate Director, Public Policy
Institute, AARP Public Policy Institute
April 1998
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