Social Security Trust Fund IOU's: Do Assets and Liabilities Cancel?

I hear repeatedly that defaulting on the debt in the Social Security Trust Fund is not a problem because the government owes the money to itself.

In so far as that explanation goes, it is correct. But an important part of the story has been left out.

As an example of this line of thought, there’s an Op-Ed in the NY times advocating a Value-Added Tax (VAT) by Bruce Bartlett, a senior fellow at the National Center for Policy Analysis (NCPA). If you go to this group’s web site, and click here, you will find an example of the claim that defaulting on the Trust Fund debt is inconsequential. This says the government won't default, but it wouldn't matter if it did:

The Trust Fund does hold bonds that are a legal obligation of the government, and the government will not default on these obligations. However, the bonds in the Trust Fund cannot pay a single Social Security benefit. If for accounting purposes, you consider these pieces of paper “assets,” you must also note that they are Treasury “liabilities.” Summing over both agencies of government, assets plus liabilities net out to zero.

Here’s an analogy to illustrate what’s been left out (I put this in the comments to this post earlier). Suppose I have $10 saved in the bank for a future expenditure. A friend borrows the $10 and replaces it with an IOU. Because I have an asset (my friend owes me $10) and my friend has a liability (because he owes me $10), it nets out between us - assets plus liabilities equal zero. But what about the $10 that was borrowed, where did it go? It's in my friend's pocket. My friend will use it, and then pay it back in the future so that I may pay may bills when they come due.

But what if my friend takes the $10 and spends the money foolishly or recklessly, or engages in other behavior such that later it will not be possible to pay me back? Yes, the assets and liabilities still cancel; but there remains a broken obligation to pay back the money that was borrowed.

If you borrow from the Trust Fund, as the government has done by issuing the IOU's Bush looked at yesterday, you have an obligation to pay it back. This is the missing piece of the story, the broken obligation which is a liability that is not being counted. It’s called a Trust Fund for a reason, because we trust that any money borrowed from it will be returned.

It's true, as the quote above states, that the bonds cannot pay a single dollar of Social Security benefits. But the money that gets put back into the Trust Fund when it is repaid can. The net effect of the assets and liabilities is zero only when you are willing to ignore the government's obligation to repay the Trust Fund. Reversing the changes in fiscal policy this administration has made since taking office that have led to such large budget shortfalls would be a start.

[Update: A comment reminds me of another aspect of this I should have touched upon, the potential for income to be redistributed:

The trust fund is an overpaid account, which payroll workers agreed to overpay with excess taxes, so it would be there for a certain purpose. So the first immorality is Not Keeping Promises. But also, regardless of government spending, the only taxpayers who got money BACK were the income tax payers. This redistributed money upwards, away from the payrollers whose taxes created the trustfund--while claiming the promised old trustfund is broke!

One way to redistribute income is to lower taxes on one group now thereby creating a crisis. Then, because of the crisis, be "forced" to raise taxes on another group later. This redistributes the burden of refunding the Trust Fund from the first group to the second.

Thus, creating a crisis by lowering taxes on one group now, the raising taxes on another group later to make up the shortfall would redistribute income.

[Update #2: Maybe this will help. When people think of interagency government debt, they are generally thinking of T-Bills held by the Fed obtained through open market operations. Here, money is “printed” and used to purchase the T-Bills. In this case the government obligations, an asset for the Fed and a liability for the Treasury, cancel because the printing of the money does not incur any additional obligation.

The Trust Fund is fundamentally different. The money used to purchase the T-Bills is not simply printed, it is collected through taxation. When this money is borrowed, it comes out of accumulated taxes and there is an obligation, explicit or implicit, to pay it back.

Think of two lockboxes of money. Fill one up with brand new money hot off the press. Fill the other up with taxes. When you take money out of the tax collection box it is money that comes from payroll taxes earmarked for Social Security payments in the future. There is an obligation to repay the workers the taxes that have been borrowed. No such obligation exists when the money has been printed. When the money is obtained by printing more of it, no one needs to be paid back.

Many people are confusing the two lockboxes and what they represent. One is earmarked for Social Security. The other is just a box of newly printed money. There is no need to earmark it because more can always be printed; borrowing it does not incur an obligation to pay it back.]