1. POLITICS, DEFICITS, AND DEBT The social security debate It’s the demography stupid!

2. Social Security and Lockboxes Because the government uses a cash flow accounting system, statistics do not adequately describe the actual surplus. Because the government uses a cash flow accounting system, statistics do not adequately describe the actual surplus. Cash flow accounting system – an accounting system entering expenses and revenues only when cash is received or paid out. Cash flow accounting system – an accounting system entering expenses and revenues only when cash is received or paid out.

3. Social Security and Lockboxes The Social Security System is currently running a large surplus in its portion of the budget. The Social Security System is currently running a large surplus in its portion of the budget. Some politicians have argued that a lockbox should be created to use the surplus to pay down the debt held by the public. Some politicians have argued that a lockbox should be created to use the surplus to pay down the debt held by the public.

4. Pay-as-You-Go System The Social Security system was set up as a pay-as-you-go system. The Social Security system was set up as a pay-as-you-go system. Pay-as-you-go system –payments to current beneficiaries are funded through current payroll taxes. Pay-as-you-go system –payments to current beneficiaries are funded through current payroll taxes.

5. Pay-as-You-Go System The Social Security system is a partially unfunded pension system. The Social Security system is a partially unfunded pension system. Funded pension system – the contributions plus interest paid by workers are used to fund those workers’ pensions. Funded pension system – the contributions plus interest paid by workers are used to fund those workers’ pensions. Unfunded pension system – payments to current beneficiaries are funded through payroll taxes. Unfunded pension system – payments to current beneficiaries are funded through payroll taxes.

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

7. The Effect of the Baby Boom An unfunded system presents a potential problem if the amount paid in differs from the amount paid out. An unfunded system presents a potential problem if the amount paid in differs from the amount paid out. With a baby boom, the size of the retired elderly, the workers, and the very young who are not working, are no longer equal. With a baby boom, the size of the retired elderly, the workers, and the very young who are not working, are no longer equal.

8. The Effect of the Baby Boom When baby boomers retire, there will not be enough new entrants into the work force to pay their benefits. When baby boomers retire, there will not be enough new entrants into the work force to pay their benefits. Payments per beneficiary must decrease, real contributions per worker coming in must increase, or some combination of the two must occur. Payments per beneficiary must decrease, real contributions per worker coming in must increase, or some combination of the two must occur.

9. Projection of Workers Compared to Retirees

10. Number of workers per beneficiary 30 25 20 15 10 5 0 1960198020002020204020601940

11. The Social Security Trust Fund In 1983 legislation was passed to aid Social Security. In 1983 legislation was passed to aid Social Security. It raised the age of eligibility slightly. It raised the age of eligibility slightly. Social Security tax rates were raised. Social Security tax rates were raised. Social Security payments became subject to taxation for some beneficiaries. Social Security payments became subject to taxation for some beneficiaries.

12. The Social Security Trust Fund The social security system currently accounts for nearly all the government surplus. The social security system currently accounts for nearly all the government surplus. The portion of surpluses held by Social Security is not available for spending – it is saved for the Trust Fund. The portion of surpluses held by Social Security is not available for spending – it is saved for the Trust Fund.

13. The Social Security Trust Fund Because the elderly use significantly more medical services than younger people, the Medicare program will also experience significant funding problems in the future. Because the elderly use significantly more medical services than younger people, the Medicare program will also experience significant funding problems in the future.

14. The Real Problem and the Real Solution** The real problem and the real solution are different from the financial problem. The real problem and the real solution are different from the financial problem. Even a fully funded Trust Fund will not solve the Social Security problem. Even a fully funded Trust Fund will not solve the Social Security problem.

15. The Real Problem and the Real Solution The reason is that the Trust Fund is simply a financial solution, not a real solution. The reason is that the Trust Fund is simply a financial solution, not a real solution. A real solution would deal with the supply and demand of real resources, not with nominal amounts. A real solution would deal with the supply and demand of real resources, not with nominal amounts.

16. The Real Problem and the Real Solution When the baby boomers retire in 2030: When the baby boomers retire in 2030: Workers must produce enough goods for themselves and their families. Workers must produce enough goods for themselves and their families. They must also produce enough for the retired baby boomers. They must also produce enough for the retired baby boomers.

17. The Real Problem and the Real Solution* Workers will have to produce enough both for themselves and for the large number of retirees. Workers will have to produce enough both for themselves and for the large number of retirees. Real output per worker must increase but the real consumption of workers must not increase. Real output per worker must increase but the real consumption of workers must not increase.

18. The Trust Fund Illusion The Trust Fund is an accounting illusion. The Trust Fund is an accounting illusion. It backs one government obligation with another government obligation. It backs one government obligation with another government obligation.

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

20. Politics and Economic Policy Politics affects economic policy. Politics affects economic policy. A proposal to help the elderly with their drug expenses will, in 2020, make the situation worse for those still working. A proposal to help the elderly with their drug expenses will, in 2020, make the situation worse for those still working. Another proposal is to invest the Trust Fund in the stock market – the argument for this is dubious since the market can always fall. Another proposal is to invest the Trust Fund in the stock market – the argument for this is dubious since the market can always fall.

21. Politically Unpopular Policies Politically unpopular policies may be needed. Politically unpopular policies may be needed. The real solution is any policy that brings the real forces of aggregate supply and demand into equilibrium. The real solution is any policy that brings the real forces of aggregate supply and demand into equilibrium. The real amount baby boomers spend when they retire must be reduced otherwise taxes on those still working must be increased. The real amount baby boomers spend when they retire must be reduced otherwise taxes on those still working must be increased.

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

23. Summary A deficit is a shortfall of revenues over payments. A deficit is a shortfall of revenues over payments. A surplus is an excess of revenues over payments. A surplus is an excess of revenues over payments. Debt is accumulated deficits minus accumulated surpluses. Debt is accumulated deficits minus accumulated surpluses. Deficits and surpluses are summary measures of a budget. Deficits and surpluses are summary measures of a budget. Whether a budget is a problem depends on the budgeting procedures that measure it. Whether a budget is a problem depends on the budgeting procedures that measure it.

24. Summary A structural deficit is that part of a budget deficit that would exist even if the economy were at its potential income. A structural deficit is that part of a budget deficit that would exist even if the economy were at its potential income. A passive deficit is the part of the deficit that exists because the economy is below its potential. A passive deficit is the part of the deficit that exists because the economy is below its potential. Structural deficit = Actual deficit – Passive deficit Structural deficit = Actual deficit – Passive deficit A real deficit is a nominal deficit adjusted for inflation. A real deficit is a nominal deficit adjusted for inflation. Real deficit = Nominal deficit – (InflationxDebt) Real deficit = Nominal deficit – (InflationxDebt)

25. Summary Government debt and individual debt differ in three major ways: Government debt and individual debt differ in three major ways: Government is ongoing and never needs to repay its debt. Government is ongoing and never needs to repay its debt. Government can pay off its debt by printing money. Government can pay off its debt by printing money. Most of the government debt is internal – owed to its own citizens. Most of the government debt is internal – owed to its own citizens. Deficits, surpluses, and debt should be viewed relative to GDP because this ratio better measures the government’s ability to handle the deficit and pay off the debt. Deficits, surpluses, and debt should be viewed relative to GDP because this ratio better measures the government’s ability to handle the deficit and pay off the debt.

26. Summary The Economic Growth and Tax Relief Reconciliation Act of 2001, an economic slowdown, and the war on terrorism contributed to a return to budget deficits in 2002. The Economic Growth and Tax Relief Reconciliation Act of 2001, an economic slowdown, and the war on terrorism contributed to a return to budget deficits in 2002. Beginning in 2017, the Social Security system will run deficits. Beginning in 2017, the Social Security system will run deficits. The real problem is not the solvency of the Social Security system but the future mismatch between real production and real expenditures. The real problem is not the solvency of the Social Security system but the future mismatch between real production and real expenditures.

27. 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.