Saving the Surplus

Policy Reports | Social Security

No. 241
Wednesday, January 31, 2001
by Dr. Liqun Liu, Dr. Andrew J. Rettenmaier, and Thomas R. Saving


"Prepaying Social Security benefits with personal retirement accounts directs Social Security taxes toward their intended purpose."

The first question that must be addressed in the debate over the budget surplus is whether the Social Security surpluses should be used to pay down the debt held by the public or to prepay Social Security benefits. We limited our analysis to this question. How any non-Social Security surpluses are spent is another matter. We have suggested that prepaying Social Security benefits with personal retirement accounts is the best use of the Social Security surpluses. This directs Social Security taxes toward their intended purpose - to fund retirement benefits - rather than toward paying down debt. Establishing personal retirement accounts also gives back a share of the surplus to the taxpayers. Over the long run, investing the Social Security surpluses in stocks and bonds will enhance the government's fiscal position relative to using the surpluses to reduce the debt held by the public. Further, prepaying part of Social Security's future expenditures reduces the required payroll tax relative to maintaining the status quo.

To honor the commitments made to Social Security participants, we must acknowledge that these commitments are as much real debt as is the recognized national debt. Hence, in assessing the government's fiscal position under the alternative policy options for the Social Security surplus, we should look at their respective impact on both explicit and implicit debts, both on- and off-budget.

"The government will not improve its fiscal position more by using the Social Security surplus to pay down debt."

As we have seen, the total budget surplus is composed of the Social Security surplus and the non-Social Security surplus. How Social Security surpluses are spent affects the future sizes of non-Social Security surpluses. Using Social Security funds to retire the debt held by the public reduces interest payments and thereby increases the amounts that can be spent on tax cuts and spending initiatives. However, this does not mean the government's fiscal position would improve more by using the Social Security surplus to retire the explicit debt instead of allowing private retirement accounts. Although setting up private accounts will not have direct impact on the on-budget position, it will reduce future off-budget deficits.

"If private accounts are funded, Congress will have a hard time taking this investment opportunity away."

Both funding private accounts and paying down the national debt are splendid ideas that will enhance the nation's capital stock and ensure greater output in the future. However, the economic consequences of the two options really rely on their differing levels of credibility. As workers see their personal accounts grow, they will expect the opportunity to make the same investment next year. Congress will have a hard time taking this freedom away. But if Congress decides to spend some of the surplus rather than paying down the debt, few taxpayers will notice and the potential for increased national income simply will evaporate.

NOTE: Nothing written here should be construed as necessarily reflecting the views of the National Center for Policy Analysis or as an attempt to aid or hinder the passage of any bill before Congress.

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