Larry DeBoer
Professor of
Agricultural Economics
Purdue University

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At the Bureau of the Public Debt

On April 5, President George Bush visited the Bureau of the Public Debt in Parkersburg, W.Va. The visit was part of the president's campaign to reform Social Security.

Mostly, he went for a "photo op," to have his picture taken with a filing cabinet. The filing cabinet contains Treasury bonds -- about $1.7 trillion worth. (Let's hope there's a good lock on that filing cabinet.) The bonds are the Social Security trust fund.

Up until 1983, Social Security was a pay-as-you-go system. This means that all of the payroll taxes paid by working people were used to pay benefits to currently retired people. Policymakers in the 1930s saw no other choice but to adopt a pay-as-you-go system. There were millions of retired people in desperate need during the Great Depression. They were pressuring Congress to provide some kind of retirement income.

Those early retirees had not had the chance to pay into the Social Security program, because the program didn't begin collecting payroll taxes until 1937. Congress looked for a source of money for these retirees and found it in the payroll taxes. When the first benefit checks went out in 1940, the money came from the taxes of working people. No trust fund accumulated.

In 1983, though, Congress raised the Social Security payroll tax without increasing benefits. Now the tax generated more revenue than was needed to pay retirees. The excess became the trust fund, invested in Treasury bonds.

In 2017, Social Security will begin drawing on this trust fund. In that year, payroll tax revenue will no longer be enough to cover the benefits promised to retired people. So, the Social Security Administration will dip into the trust fund. It will open the filing cabinet, take out some Treasury bonds, and present them to the Treasury to be redeemed. The Treasury will pay money to the Social Security Administration, which will be used to pay the part of benefit checks not covered by payroll taxes.

The Treasury will pay out of the federal government's budget. As President Bush pointed out after his visit, the Treasury will pay with higher taxes or cuts to other government programs. Or, the Treasury might issue more bonds, to borrow the money it needs from the bond market.

President Bush also said, "There is no 'trust fund,' just IOUs that I saw first hand." In one sense, he's right. There isn't a pot of money or assets assigned to each taxpayer or retired person, which he or she will draw upon in retirement. That's the kind of thing the president would like to create with personal or private accounts.

In another sense, though, there really is a trust fund. The Treasury bonds in that filing cabinet give retirees a claim on the federal government's budget. It's a strong claim. These Treasury bonds are "just IOUs," but they are IOUs from a debtor that has not failed to repay in 229 years. U.S. Treasury bonds are seen as the single most secure, least risky asset the world over. The Japanese and Chinese own almost $1 trillion of these bonds. They don't think that Treasury bonds are "just IOUs." They expect to be repaid.

We'll draw on the trust fund until 2041, but then the filing cabinet will be empty. The trust fund will run out. At that point, we'll be back to a pay-as-you-go system, like we had before 1983. Except in 2041, there will only be enough payroll taxes to pay about three-quarters of the promised benefits. At that point, the Treasury could keep paying the difference out of its budget, with taxes or reduced spending or borrowing. But with the filing cabinet empty, the Social Security Administration won't be able to require the Treasury to pay.

In the end, that's what the trust fund is: a promise made by the Treasury, with its bonds, to pay benefits out of the federal government's budget. We can be as confident as can be that the Treasury will honor that promise. But to honor it, we'll need to pay higher taxes or reduce other programs, or borrow even more.




Writer: Larry DeBoer
Editor: Olivia Maddox