AARP Bulletin

January 2000 Feature

Interview With Robert D. Reischauer

After months of partisan rhetoric in which leaders of each party accused the other of "raiding" Social Security, many Americans were left with the feeling that their Social Security taxes have been stolen over the years.

AARP Bulletin Editor Elliot Carlson last month asked Brookings Institution economist Robert D. Reischauer to discuss the raiding issue and the impact of congressional action on the Social Security trust fund. Reischauer served as director of the Congressional Budget Office (1989-95) and recently was named president of the Urban Institute, a leading Washington research group, effective February.

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BULLETIN: GOP House Speaker Dennis Hastert said on "Face the Nation" in September that House Republicans were not going to "dip into Social Security or raid the Social Security trust fund." Has the fund been raided--its money stolen?

REISCHAUER: The raiding notion is based on a misperception; the government has never raided the trust fund. The Social Security system lends its surpluses to the Treasury, which uses these resources to finance other government activity and thereby avoid going into public debt markets to borrow. All the money lent to the Treasury will be paid back with market-based interest when Social Security needs the funds to pay benefits.

BULLETIN: When these surpluses are loaned to the government to finance other programs, is the trust fund made weaker as a result?

REISCHAUER: Not in the least. Such lending does not affect current or future benefits, or current or future program revenues or the balances in the trust fund. And it therefore has no [negative] impact at all on the strength and security of the system. The Social Security system has to do something with its surpluses. By lending them to the Treasury, it is investing them in the most secure of assets-namely U.S. government bonds.

BULLETIN: Now the last Congress, in its appropriations for fiscal year 2000, exceeded the spending caps by about $35 billion or $37 billion, leaving the non-Social Security portion of the budget about $17 billion in deficit. Presumably this deficit will be financed by tapping the Social Security surplus. Will the trust fund be poorer by this amount?

REISCHAUER: No. This will not affect the strength of the trust fund in any way.

BULLETIN: We now have a standoff in Washington in which the leaders of both parties are pledging they won't touch the Social Security surplus to finance either increased spending or tax cuts. From an economic standpoint, is this a good development for Social Security?

REISCHAUER: Yes. Both parties have pledged to use surpluses in Social Security only to reduce the debt that the federal government has issued to the public. That does not constitute fundamental reform of Social Security. But it will strengthen our economy and our budget in ways that indirectly will benefit Social Security.

For example, redeeming national debt will free up resources that the private sector can use for productive investments that will boost economic growth. If the economy is larger, the unavoidable burden of supporting benefits for ever larger numbers of retirees will be easier to bear.

BULLETIN: So the standoff between the parties is a good thing.

REISCHAUER: Yes. It's not a substitute for fundamental Social Security reform, which at some point will be required. But far as Social Security is concerned, it's certainly a lot better than using these resources to finance tax cuts or more spending.

BULLETIN: I wonder if some of that surplus couldn't be used for investment in such areas as education and medical research without doing damage to the picture you outlined?

REISCHAUER: In theory, the surplus could be as effectively invested in activities that are thought to boost economic growth and raise living standards such as educational opportunities, improved health or infrastructure.

The problem is that the mechanism for allocating resources to these activities is based on political, not economic, factors. The projects that are selected often aren't true investments. The money is distributed around the country because political interests are diffuse. Every area has to get its own bridge, highway, educational assistance, or health project. Some of these resources simply replace state and local government monies.

BULLETIN: We now have Republican leaders--and many Democrats joining them--calling for a "lockbox" mechanism that would seal off the Social Security surplus from being used to pay for other government activities. Can this be done?

REISCHAUER: There's no effective procedural way to create a lockbox. Nevertheless, we have recently adopted a psychological lockbox that may be more effective than any new formal budget rules. For at least the three decades before 1999, we regarded the measure of fiscal rectitude to be: Balance in the overall budget. Counted as part of the overall budget was everything from Social Security to defense on the spending side and from payroll taxes to gas and income taxes on the revenue side.

About a year ago we changed our measure of fiscal rectitude to be: Balance in the budget, not counting the surpluses in the Social Security program.

This means there is a political imperative to wall off the surpluses that develop in Social Security and use them for debt reduction.

BULLETIN: If enacted, would the "lockbox" make the Social Security trust fund any safer than it is now?

REISCHAUER: No. It would have no impact on the security of the trust fund. The trust fund is as secure as possible right now.

BULLETIN: What, then, would be the net effect of adopting a lockbox?

REISCHAUER: If an effective lockbox could be devised, it would ensure that the revenues in the non-Social Security portion of the budget were always sufficient to pay for all of the activities in the non-Social Security portion of the budget.

BULLETIN: If they fail to adopt a lockbox, will this negatively affect the trust fund?

REISCHAUER: No, it will not.

BULLETIN: So the average Social Security enrollee will wonder why they are making this effort?

REISCHAUER: What politicians are telling the average participant in Social Security is that they will try to maintain balance in the non-Social Security portion of the budget. Then the surpluses in Social Security will be used exclusively to pay down national debt.

BULLETIN: How did the government's increased fiscal rectitude work in practice last year?

REISCHAUER: In fiscal year 1999, the non-Social Security part of the budget was in deficit by about $1 billion, while Social Security recorded a surplus of about $124 billion. So the Treasury Department used $1 billion of the Social Security surplus to finance that tiny deficit in the non-Social Security accounts. The other $123 billion was used to pay down the national debt.

BULLETIN: Was that $1 billion lost to the Social Security trust fund?

REISCHAUER: In return for that $1 billion the Social Security trust fund received $1 billion of Treasury securities. Those bonds were every bit as sound and secure as the $123 billion worth of bonds that the Treasury gave to the trust fund for the surplus that it used to redeem debt held by the public.

BULLETIN: Some critics argue that the interest income the trust fund gets from the government is too small, because the surpluses are invested in nonmarketable bonds. Could the fund do better investing in marketable bonds that pay higher rates?

REISCHAUER: By law, the surpluses generated by Social Security must be invested in government securities, or government-backed securities.

The interest paid on the particular bonds that Social Security is given in return for its surpluses is an average of the interest rates on outstanding government securities with maturities of four or more years.

In other words, the government is paying very close to the prevailing rate for government securities available in the market.

Could Social Security over the long run do better by diversifying its portfolio into equities and corporate bonds? Yes. But the price of doing that would be an acceptance of greater risk.

BULLETIN: Many people trace Social Security's financial ills to President Johnson's decision in 1968 to unify the Social Security trust fund with the general budget. Even lawmakers embrace this idea. Speaker Hastert declared on "Face the Nation" that Congress has spent Social Security trust funds "ever since LBJ in [1968], passed the Great Society and funded the Vietnam War and took the Social Security trust fund and put them on the budget."

REISCHAUER: That is wrong. The unification of the budget had no substantive impact on the way in which Social Security surpluses were invested or the soundness of the Social Security trust fund.

BULLETIN: So the workings of the program continued unchanged?

REISCHAUER: Correct.

BULLETIN: What, then, was accomplished by unifying the budget?

REISCHAUER: This was largely a way of forcing policymakers to consider the entire scope of federal activity. Policymakers should want to know the impact of government on the economy. To do this one has to look at all of the revenues and expenditures of government, whether they are in the admnistrative budget or the trust funds.

This made a lot of sense back in the late 1960s because there wasn't a feeling that Social Security should have large surpluses to build up large reserves for future benefit payments. Social Security was largely a "pay-as-you-go" system, then.

BULLETIN: If Social Security's problems can't be traced to raiding of the trust fund, what is the cause?

REISCHAUER: The problem is largely one of demographics and past decisions to pay previous generations of retirees adequate benefits even though they made very modest contributions to the system. The baby-boom generation will soon be retiring and the smaller baby-bust generation that followed won't contribute sufficient amounts to support the benefits promised to the baby boomers unless payroll tax rates are raised significantly.

In addition, we are living longer. Tomorrow's retirees will receive benefits for more years than today's or yesterday's retirees. Unless we raise the age of eligibility along with the increases in longevity, taxes will have to be raised or benefit levels cut a bit.

BULLETIN: Despite all that, we keep hearing from politicians that the reason the trust fund is in trouble is because it's been raided.

REISCHAUER: While that is not the case, the perception may be a healthy development. Such rhetoric is being used to give politicians the intestinal fortitude needed to achieve and maintain balance in the non-Social Security part of the budget.

If both parties try to score points by accusing the other of "raiding the trust fund" whenever policy proposals threaten to create deficits in the non-Social Security portion of the budget, then it's more likely that fiscal discipline will be maintained.

BULLETIN: So there's a silver lining to the rhetoric on Social Security.

REISCHAUER: Yes.

BULLETIN: But isn't there a downside here in that the rhetoric leads people to think they have been cheated--and that the system is worse off than it is?

REISCHAUER: How people perceive Social Security does create a serious political problem. If policymakers, when they address the system's long-term problems, propose benefit cuts, many participants might argue that the cuts are necessary only because the trust fund has been "raided" and its balances have been spent on other government programs. The task of policymakers becomes more difficult.

BULLETIN: Isn't another consequence public cynicism?

REISCHAUER: Yes. But people don't understand many aspects of the Social Security system. They see the substantial sums that they and their employers have paid into the system, and think that certainly these contributions must be enough to support their benefits in the future.

They don't realize that three out of every four dollars that they and their employers have sent in are going to pay for their parents' and grandparents' benefits. This is so because their parents and grandparents paid in nowhere near enough to support the benefits they have been receiving.

In the 1930s-40s, 50s, 60s and 70s, policymakers made wise decisions to pay early cohorts of retirees adequate benefts to reduce the incidence of poverty among the elderly and make the elderly more self-sufficient and the society stronger. But these decisions came with a price tag which future cohorts have had to pay.

BULLETIN: The other price is that confidence in the system seems to be at an all-time low.

REISCHAUER: Well, you can't expect people to have confidence in the system if the media--and the politicians--are continually saying that the system is headed toward insolvency, and that we are going to have to restructure the program.

We can make some fairly modest changes now that will ensure the long-run viability of the system. Or we can wait until a crisis develops several decades from now and go through much more wrenching adjustments.

A lot of what is going on now is trying to build up a head of steam within the public so they will accept some changes before we get to that point of crisis.