Saving the Surplus
Wednesday, January 31, 2001
by Dr. Liqun Liu, Dr. Andrew J. Rettenmaier, and Thomas R. Saving
Table of Contents
- The surplus estimates vary in accordance with assumptions concerning growth in discretionary spending on such items as national defense. More importantly, surplus estimates depend on using the surpluses in the early years to reduce government debt.
- The CBO notes that the reduction in debt held by the public is not exactly equal to the budget surplus. The reasons include changes in the government's cash balances and other borrowing requirements. From the projection in which discretionary spending grows at the inflation rate, the total surplus in 2000 is expected to be $232 billion, with the debt reduced by $224 billion. Also, beginning in 2007 a new line item representing accumulated excess cash appears in the projections. In 2007 $281 billion in cash is held in this account, and $1,081 billion in debt remains outstanding because not all of the debt is available for redemption at that time. Subtracting the excess cash account from the publicly held debt identifies the net explicit government indebtedness. By 2009 the accumulated excess cash is $1.2 trillion; the debt held by the public is $887 billion and the government is out of debt. If the Social Security surpluses are taken off-budget from this day forward, in the sense that they are invested in real assets like stocks and bonds, they are no longer available to reduce the debt and thereby reduce the interest payments that service the debt. It is typically stated that Social Security surpluses are being used to pay down national debt, but because money is fungible, we could equivalently say that the Social Security surpluses are being used to fund national defense and that general revenue funds are being used to pay down the debt.
- Instead of or in addition to investing in domestic equity markets, we could invest in other nations' capital or bonds. In either case, when we need additional output to allow workers to continue to enjoy the fruits of their labor - while at the same time providing for the growing number of retirees to maintain their standard of living - we could use the increased domestic or foreign output. Whether we invest in our nation's capital or that of other nations, real investments produce real income. Alternatively, the Social Security surplus can be invested in domestic government bonds, in paying current publicly held federal debt or in buying the debt of other countries. When Social Security expenditures begin to exceed revenues, the real assets in the Trust Fund can be sold. If these assets consist of equities, the Trust Fund will be selling their ownership of corporate America back to the public. If the assets consist of federal government bonds previously held by the public, the sale of these bonds will bring the publicly held debt back to its former level. If the assets consist of the bonds of foreign governments, the additional resources will come from those foreign nations.
- This definition differs from the concept of Social Security wealth as defined by Feldstein (1974). In that definition Social Security wealth is the sum of the net promises, in terms of the present value, to all the participants of the system. It is the difference between the present values of retirement benefits for the adult population and the present values of lifetime payroll taxes. In 1995 this net liability was estimated to be $7 trillion [Feldstein(1998)].
- Past changes to the program such as taxing benefits, increasing the retirement age and raising the taxable maximum are evidence of uncertainty. Current proposals to further increase the retirement age and to raise the taxable maximum make the returns earned by current and future taxpayers appear even more uncertain.
- This does not rule out the possibility that in any particular year the return on stocks and private bonds may fall below the interest rate on government borrowing. Indeed, MaCurdy and Shoven (1999) show that for a 10- or 20-year period, government bonds outperform a typical stock portfolio 25 percent of the time.
- In either case, the correct measure of additions to the capital stock is the capitalized value of the budget surpluses.
- The analysis that follows is based on the CBO's Long-Term Budget Outlook released on October 6, 2000. The CBO presents three forecasts that differ by how the budget surpluses are used. The most optimistic variant assumes that the total surpluses are saved. For this forecast, all surplus funds are used to pay down the federal debt. Once the net debt is retired in 2008, the government is assumed to hold assets that earn a rate of return equal to that earned on Treasury securities. Under this scenario, by 2030 the government holds assets equal to 49.5 percent of GDP. These asset holdings are used to finance future expenditures and persist until 2050. From then, new debt must be issued or taxes raised above their projected levels. The intermediate variant assumes that only Social Security surpluses are saved and used to retire debt and then buy assets once debt is zero. Under this scenario the net debt is zero by 2013. Between 2013 and 2027 the government holds assets, growing to 7.2 percent of GDP by 2020. By 2027 the assets are exhausted to cover deficits. The least optimistic variant assumes that none of the surpluses are saved, and all are spent on new programs or used to cut taxes. In this case the nominal debt held by the public does not rise and thus declines as a share of growing GDP. We use the intermediate variant as the baseline for our forecasts. We obtained the annual revenue and expenditure estimates from the CBO based on their "Save the Off-budget Surpluses" assumption. The CBO's annual series ends in 2049. The appendix describes how the forecasts are extended to the year 2070. We modify the CBO's forecast in one significant way: we assume that government does not hold assets. We make this adjustment due to the historical aversion to government holdings of financial assets. In the surplus years we assume either that taxes are cut or that surpluses are used on temporary spending programs.
- Over the duration of the CBO's long-term forecasts, until 2049, their estimates of Social Security expenditures are less than the Trustees. We calculated the rate of return that would be required to make the system solvent using both the CBO's and the Social Security Administration's forecasts. We calculate that a real rate of return of 5.37 percent is required to make the system solvent indefinitely using the CBO's forecasts and that a real rate of return of 6.29 percent is necessary to make the system solvent using the Social Security Administration's forecasts. Again, we assume that a constant interest payment is paid from the rest of the budget to Social Security based on the Trust Fund interest payment in 2000. For consistency with the rest of the expenditure projection we use the CBO's forecast. See the appendix for further details.