Thursday, December 23, 2010

Bad News, Good News, and Really Bad News for Social Security's Political Future

-- Posted by Neil H. Buchanan

All of the signs point to 2011 being an important year for Social Security. The Obama Administration seems intent on taking some hacks at the program, with the President's temporarily-forgotten Deficit Commission providing cover for those who want to cut Social Security. (Their mission statement did not even include Social Security reform, but the commission nonetheless decided to weigh in on the program's future. And the Administration applauded.)

Some in the Congressional leadership also seem to want to go after Social Security. Last week on C-SPAN, I caught a few moments of an appearance by Steny Hoyer, the current House Majority Leader. Someone posed a question that was essentially what I would have asked: With the Social Security shortfall not even being a sure thing, and with any problem lying decades in the future, why spend time now on Social Security? Hoyer basically admitted that there was no meaningful connection between any proposed changes to Social Security and substantial long-term deficit reduction. Even so, he simply repeated the assertion that now is the time to address the program's supposed long-term shortfall. I did not watch the rest of the event, so he might have addressed the question more directly. At least his initial answer, however, was simply non-responsive. Moreover, he was not saying anything that we have not heard frequently from fiscal hawks for years. Despite a nonexistent case for doing so, there is an eager constituency among some Democrats for beginning the process of undermining Social Security.

Until a few weeks ago, I thought that this state of affairs meant that something bad would surely happen to Social Security soon. Obama seemed ready to triangulate, and the mainstream press could be counted upon to praise him for his "pragmatism" in dealing with the new Republican majority in the House. What has changed, I think, is that the unsuccessful revolt against the recent Obama-Republican tax bill raises the serious possibility of a full-on rebellion among the Democratic base, should Obama make a move against Social Security. As nasty and condescending as Obama was about the negative reaction to the tax deal, he has to have noticed that the majority of his party is really, really angry with him. Yes, some good things happened this week that will restore some goodwill; but there seems to be at least a strong possibility that the political calculus has changed. I hope that this will cause the White House to steer away from Social Security entirely. I suspect that the odds are still in favor of a sell-out, but those odds have changed (in a good way).

On the other hand, the tax cut deal itself will create some room to mess with Social Security that was not there before. Many analysts have (correctly) noted that the cost of the tax bill will play into the conventional wisdom about deficits, resulting in arguments that big-ticket items like Social Security must be cut. My concern, however, is with the temporary reduction in the payroll tax for Social Security in 2011. The 2% reduction will save a $50,000/year earner $1,000, with a total loss to the system of almost 1/6 of its non-interest revenues. The question is, how will that lost revenue be accounted for within Social Security?

Because Social Security has a dedicated tax source, FICA taxes are supposed to go entirely into Social Security's coffers. The accounting distinction between Social Security and the rest of the government is thus statutory, rather than economic, which means that next year's loss of Social Security tax revenue can either result in less money being credited to Social Security, or in general revenues being used to replace the lost Social Security revenues. The change in the federal government's overall deficit is no different in either case. However, because the tax holiday would otherwise change the projected depletion date of the retirement trust fund, it is politically necessary to enact the tax holiday without formally costing Social Security any money. That means that the non-Social Security deficit must be increased, to pay for the 2% Social Security tax cut.

As much as I applaud both the effort to target a tax cut to the lower ends of the income scale, and to do so in a way that does not change Social Security's funding picture, there is a larger danger here. Earlier this year, there was a big stink about the short-term change in the path of Social Security's annual surplus or deficit, with the Great Recession turning a few years of projected small surpluses into small deficits. This was all very unimportant, but it provided an opening for people to describe the long-planned transition from annual Social Security surpluses to annual deficits as proof that Social Security is fundamentally bankrupt.

The correct response to this argument is that Social Security really should be thought of as a separate system, because the decades of annual Social Security surpluses (memorialized in the trust fund) can only be credited meaningfully to the system by allowing benefits to be paid both from annual payroll tax collections and general revenues. Again, however, this only makes sense if we treat the payments from general revenues as a repayment to the system for all those years in which Social Security taxes were higher than was needed to pay for concurrent benefits.

The 2011 tax holiday, however, makes this programmatic separation much easier to attack. As easy as it is for Social Security's opponents to try to distort the debate with half-truths about the "empty" trust fund, the public continues to be comfortable with the idea that the system will be solvent at least so long as the annual flow from general revenues is tied directly to the repayment of accumulated credits in the trust fund.

We now, however, have enacted a much more blatant transfer of funds between these two tubs of money. We are using general funds to make Social Security whole, even though the tax cut is specifically a break for those who are paying into the system. This is not compensation for previous (or future) overpayment; it is a simple matter of using general revenues to support a system that is supposed to be (in the aggregate, over time) independent of the rest of the federal government.

There is a very real danger that this will change the debate for the worse. There are plenty of legal fictions that have very practical consequences in the real world. The corporate form of business comes to mind. If people were to start treating that legal fiction as non-binding, our system would be shaken to its core. The legal fiction of Social Security's separate financing is also extremely important to maintain. This year's tax cut compromise may fatally undermine that distinction.