POLITICS, DEFICITS, AND POLITICS, DEFICITS, AND DEBTDEBT

The social security debateThe social security debateIt’s the demography stupid!It’s the demography stupid!

Social Security and Social Security and LockboxesLockboxes

Because the government uses a Because the government uses a cash flow accounting system, cash flow accounting system, statistics do not adequately statistics do not adequately describe the actual surplus.describe the actual surplus.

Cash flow accounting systemCash flow accounting system – an accounting system entering – an accounting system entering expenses and revenues only expenses and revenues only when cash is received or paid when cash is received or paid out.out.

Social Security and Social Security and LockboxesLockboxes

The Social Security System is The Social Security System is currently running a large surplus currently running a large surplus in its portion of the budget.in its portion of the budget.

Some politicians have argued that a Some politicians have argued that a lockbox should be created to use the lockbox should be created to use the surplus to pay down the debt held by surplus to pay down the debt held by the public.the public.

Pay-as-You-Go SystemPay-as-You-Go System

The Social Security system was The Social Security system was set up as a pay-as-you-go set up as a pay-as-you-go system.system.

Pay-as-you-goPay-as-you-go system – system –payments to current payments to current beneficiaries are funded through beneficiaries are funded through current payroll taxes.current payroll taxes.

Pay-as-You-Go SystemPay-as-You-Go System

The Social Security system is a The Social Security system is a partially unfunded pension partially unfunded pension system.system.

Funded pension systemFunded pension system – the – the contributions plus interest paid by workers contributions plus interest paid by workers are used to fund those workers’ pensions.are used to fund those workers’ pensions.

Unfunded pension systemUnfunded pension system – payments to – payments to current beneficiaries are funded through current beneficiaries are funded through payroll taxes.payroll taxes.

Pay-as-You-Go SystemPay-as-You-Go System

An unfunded pension system An unfunded pension system works smoothly as long as the works smoothly as long as the population’s age distribution, the population’s age distribution, the annual death rate, and the annual death rate, and the number of people working do not number of people working do not change much.change much.

The Effect of the Baby The Effect of the Baby BoomBoom

An unfunded system presents a An unfunded system presents a potential problem if the amount potential problem if the amount paid in differs from the amount paid in differs from the amount paid out.paid out.

With a baby boom, the size of With a baby boom, the size of the retired elderly, the workers, the retired elderly, the workers, and the very young who are not and the very young who are not working, are no longer equal.working, are no longer equal.

The Effect of the Baby The Effect of the Baby BoomBoom

When baby boomers retire, there When baby boomers retire, there will not be enough new entrants will not be enough new entrants into the work force to pay their into the work force to pay their benefits.benefits.

Payments per beneficiary must Payments per beneficiary must decrease, real contributions per worker decrease, real contributions per worker coming in must increase, or some coming in must increase, or some combination of the two must occur.combination of the two must occur.

Projection of Workers Projection of Workers Compared to RetireesCompared to Retirees

Projection of Workers Projection of Workers Compared to RetireesCompared to Retirees

Num

ber o

f wor

kers

per

ben

efici

ary

30

25

20

15

10

5

01960 1980 2000 2020 2040 20601940

The Social Security Trust The Social Security Trust FundFund

In 1983 legislation was passed to In 1983 legislation was passed to aid Social Security.aid Social Security. It raised the age of eligibility It raised the age of eligibility

slightly.slightly. Social Security tax rates were Social Security tax rates were

raised.raised. Social Security payments became Social Security payments became

subject to taxation for some subject to taxation for some beneficiaries.beneficiaries.

The Social Security Trust The Social Security Trust FundFund

The social security system The social security system currently accounts for nearly all currently accounts for nearly all the government surplus.the government surplus.

The portion of surpluses held by Social The portion of surpluses held by Social Security is not available for spending – it Security is not available for spending – it is saved for the Trust Fund.is saved for the Trust Fund.

The Social Security Trust The Social Security Trust FundFund

Because the elderly use Because the elderly use significantly more medical significantly more medical services than younger people, services than younger people, the Medicare program will also the Medicare program will also experience significant funding experience significant funding problems in the future. problems in the future.

The Real Problem and The Real Problem and the Real Solution**the Real Solution**

The The real problemreal problem and the real and the real solution are different from the solution are different from the financial problemfinancial problem..

Even a fully funded Trust Fund Even a fully funded Trust Fund will will notnot solve the Social Security solve the Social Security problem.problem.

The Real Problem and The Real Problem and the Real Solutionthe Real Solution

The reason is that the Trust Fund The reason is that the Trust Fund is simply a financial solution, not is simply a financial solution, not a real solution.a real solution.

A real solution would deal with the A real solution would deal with the supply and demand of real resources, supply and demand of real resources, not with nominal amounts.not with nominal amounts.

The Real Problem and The Real Problem and the Real Solutionthe Real Solution

When the baby boomers retire in When the baby boomers retire in 2030:2030:

Workers must produce enough goods for Workers must produce enough goods for themselves and their families.themselves and their families.

They must also produce enough for the They must also produce enough for the retired baby boomers.retired baby boomers.

The Real Problem and The Real Problem and the Real Solution*the Real Solution*

Workers will have to produce Workers will have to produce enough both for themselves and enough both for themselves and for the large number of retirees.for the large number of retirees.

Real outputReal output per worker per worker must increasemust increase but the but the real consumptionreal consumption of workers of workers must not increase.must not increase.

The Trust Fund IllusionThe Trust Fund Illusion

The Trust Fund is an The Trust Fund is an accounting illusion.accounting illusion.

It backs one government It backs one government obligation with another obligation with another government obligation.government obligation.

The Trust Fund IllusionThe Trust Fund Illusion

The Trust Fund has a positive The Trust Fund has a positive effect on the problem, even if it effect on the problem, even if it does not solve the problem does not solve the problem completely.completely.

Politics and Economic Politics and Economic PolicyPolicy

Politics affects economic policy.Politics affects economic policy. A proposal to help the elderly with A proposal to help the elderly with

their drug expenses will, in 2020, their drug expenses will, in 2020, make the situation worse for those make the situation worse for those still working.still working.

Another proposal is to invest the Another proposal is to invest the Trust Fund in the stock market – the Trust Fund in the stock market – the argument for this is dubious since argument for this is dubious since the market can always fall.the market can always fall.

Politically Unpopular Politically Unpopular PoliciesPolicies

Politically unpopular policies may Politically unpopular policies may be needed.be needed. The real solution is any policy that The real solution is any policy that

brings the real forces of brings the real forces of aggregate aggregate supply and demand into supply and demand into equilibrium.equilibrium.

The The real amountreal amount baby boomers baby boomers spend when they retire must be spend when they retire must be reduced otherwise taxes on those reduced otherwise taxes on those still working must be increased.still working must be increased.

Politically Unpopular Politically Unpopular PoliciesPolicies

There are a number of ways this There are a number of ways this can be done, none of them can be done, none of them politically appetizing.politically appetizing.

Increase taxes on those working in 2020. Increase taxes on those working in 2020. (since you don’t vote this is what is happening!)(since you don’t vote this is what is happening!)

Cut benefits once baby boomers start retiring.Cut benefits once baby boomers start retiring. Make Social Security means tested.Make Social Security means tested. Increase the retirement age to 72.Increase the retirement age to 72.

SummarySummary

A deficit is a shortfall of revenues over A deficit is a shortfall of revenues over payments.payments.

A surplus is an excess of revenues over A surplus is an excess of revenues over payments.payments.

Debt is accumulated deficits minus Debt is accumulated deficits minus accumulated surpluses.accumulated surpluses.

Deficits and surpluses are summary Deficits and surpluses are summary measures of a budget. measures of a budget.

Whether a budget is a problem depends on Whether a budget is a problem depends on the budgeting procedures that measure it.the budgeting procedures that measure it.

SummarySummary

A structural deficit is that part of a budget deficit A structural deficit is that part of a budget deficit that would exist even if the economy were at its that would exist even if the economy were at its potential income.potential income.

A passive deficit is the part of the deficit that A passive deficit is the part of the deficit that exists because the economy is below its exists because the economy is below its potential.potential.

Structural deficit = Actual deficit – Structural deficit = Actual deficit –

Passive deficitPassive deficit A real deficit is a nominal deficit adjusted for A real deficit is a nominal deficit adjusted for

inflation.inflation. Real deficit = Nominal deficit – (InflationxDebt)Real deficit = Nominal deficit – (InflationxDebt)

SummarySummary

Government debt and individual debt differ Government debt and individual debt differ in three major ways:in three major ways: Government is ongoing and never needs to repay Government is ongoing and never needs to repay

its debt.its debt. Government can pay off its debt by printing Government can pay off its debt by printing

money.money. Most of the government debt is internal – owed Most of the government debt is internal – owed

to its own citizens.to its own citizens. Deficits, surpluses, and debt should be Deficits, surpluses, and debt should be

viewed relative to GDP because this ratio viewed relative to GDP because this ratio better measures the government’s ability to better measures the government’s ability to handle the deficit and pay off the debt.handle the deficit and pay off the debt.

SummarySummary The Economic Growth and Tax Relief The Economic Growth and Tax Relief

Reconciliation Act of 2001, an economic Reconciliation Act of 2001, an economic slowdown, and the war on terrorism contributed slowdown, and the war on terrorism contributed to a return to budget deficits in 2002.to a return to budget deficits in 2002.

Beginning in 2017, the Social Security system Beginning in 2017, the Social Security system will run deficits.will run deficits.

The real problem is not the solvency of the The real problem is not the solvency of the Social Security system but the future mismatch Social Security system but the future mismatch between real production and real expenditures.between real production and real expenditures.

Review Question 15-1 Distinguish between a structural deficit and a passive deficit.

A structural deficit is the part of the budget deficit that would exist even if the economy were at its potential level of income. A passive deficit is the part of the deficit that exists because the economy is below potential.

Review Question 15-2 What are some of the possible solutions to the problem of Social Security solvency?

Increase taxes on those working in 2020. Cut benefits to baby boomers when they retire. Make Social Security means tested. Increase the retirement age to 72.

Privatization will not solve the solvency problem because Social Security is a partially unfunded pension system. Funds diverted to private accounts would not be available to pay as benefits to current retirees.