In our last installment, we examined the "Stop the Raid on Social Security Act of 2005," a bill introduced in the Senate by South Carolina's colorful Jim DeMint. We read the bill and looked at its actual effects -- while juggling around future trust fund assets, we would wind up after forty years with a trillion dollars in new debt (that's in addition to the debt the general fund would have had to the Social Security trust fund anyway), along with some small "personal accounts" and a costly new investment bureaucracy.

But DeMint's bill was never meant to be read seriously. It is a red herring -- from the moment it was introduced, Privateers (even those who recognize how idiotic the bill is) have been crowing about how it's a "compromise," and how it's going to make Democrats look bad. In truth, you would be hard pressed to find more than a handful of Republicans to support the outlandish scheme, unless it's for a tactically doomed vote. As DeMint himself put it: "If the Republicans take this to a vote and the Democrats try to stop us, I think we end up the winners. It'll help convince Americans in 2006 that we need a few more Republicans."

In reality, perhaps we needn't have bothered with the text of the bill. We could have kept to the title: "Stop the Raid on Social Security Act of 2005." Those words encapsulate all of the misdirection and confusion contained in this miniature offensive.

This is a myth we have seen from the very beginning, that the Social Security trust fund is not "real." The climax of absurdity was when the president took a special trip to West Virginia to get a photo op with some printouts of Treasury bonds, saying "There is no trust fund -- just IOUs that I saw firsthand." This despite the fact that his own privatization proposals depend on cashing in those "IOUs," and needless to say, despite the fact that, as public debt, they are backed by the "full faith and credit" of the United States.

With all the obfuscation and blown-up rhetoric, it's certainly easy to get the wrong idea. As reader K.D. wrote to us:

I do really enjoy your fact based reports. However, I am still coming up short in one area. Since its inception, Social Security has been raided for funds to support other programs. I would like to see a time line showing what parties(how they voted), and what these funds were used for.

See, I think that the public needs the hard facts, not half truths concocted by individual parties.

This is not the case. While we have alluded to the larger story of the trust funds many times -- it's a long and pretty boring story -- we've never fully explained how they work. We'd like to clear this up, once and for all.

Kinds of debt

Public debt, also called national debt, is "[f]ederal government debt incurred by the Treasury or the Federal Financing Bank by the sale of securities to the public or borrowings from a federal fund or account." (From the House Rules Committee.)

As this definition makes clear (as clear as government-speak gets), there are two categories of public debt. The first is confusingly called debt held by the public, or publicly-held debt, and consists of securities available for purchase and trade on the open market. For example, U.S. bonds held by China's and Japan's central banks are publicly-held debt.

The second category is intragovernmental debt, which consists of securities held by "Government trust funds, revolving funds, and special funds" -- including the trust funds of Old-Age and Survivors Insurance and Disability Insurance, together known as Social Security.

According to the Bureau of the Public Debt, out of the $7.8 trillion of public debt, $4.5 trillion is held by the public and $3.3 trillion is intragovernmental. All of that debt is protected under the Fourteenth Amendment, which states: "The validity of the public debt of the United States, authorized by law ... shall not be questioned."

How Social Security operates

Since its inception in the late 1930s, Social Security has functioned financially as a pay-as-you-go program apart from the general budget. A specially-marked payroll tax (a fundamentally different tax base than the income tax) on current workers feeds into the trust fund, from which the system draws to pay out benefits for current retirees. In this way, we were able to establish the program and begin paying out benefits, even in a time of economic uncertainty, and we are assured that the system will grow with the economy as long as people are still working.

For example, in 2004, the trust fund took in $657 billion in payroll taxes (and interest on the fund's assets) and paid out $501 billion. The remainder, $156 billion, remains in the trust fund, earning interest. By law, trust fund assets are held in bonds issued by the U.S. Treasury.

Historically, Social Security has not had significant surpluses or deficits. But in 1983, facing a looming strain on the system when the Baby Boom generation retires, President Reagan, Alan Greenspan, Pat Moyhihan, Bob Dole and others put forward a payroll tax increase to partially "prefund" those lean years. As planned, surpluses will continue to accrue until the Boomers begin to retire, and the trust fund will gradually be drawn down back to a pay-as-you-go system.

The effects of the "prefunding" plan can be seen in this chart -- income will exceed outgo as we built up reserves, then the reverse as Boomers enjoy retirement, culminating roughly in a return to stable demographics. As of the end of 2004, the trust fund held nearly $1.7 trillion in Treasury bonds and certificates.

Where does the money go?

As with all public debt, in exchange for Treasury bonds the money goes into the general fund, which is spent by Congress and the president on all programs in the budget.

Say what?

That's right. That's how bonds work -- the borrower (Congress, the general fund) gets the cash, and the lender (trust fund, China, your uncle) gets the security note.

The line Privateers like to use is that the government is "writing itself an IOU" when it issues a bond to Social Security. It's true that there aren't any vaults filled with gold bars, but the same goes for your personal savings account at your local bank. "IOUs" are how the global economy works.

These bonds are valid debt. And if you don't believe the Fourteenth Amendment of the Constitution that bonds held by Social Security "shall not be questioned," then watch as hundreds of billions of dollars in these bonds get cashed every year in the regular operation of the program.

And what will happen in ten or fifteen years, when the Boomers start to retire and the Social Security trust fund needs to redeem its bonds? One of two things: if the general fund budget is running a surplus (e.g. if a Democrat is in office), that surplus will go toward the debt to Social Security. Or -- more likely -- as the Treasury Department redeems those intragovernmental securities, it will sell new debt to the public for the same amount. This process will be automatic, since it will not increase the size of the public debt as a whole (which is limited by law). Column A to Column B.

(What effect this will have on the securities market is a puzzle for economists to ponder. Any and all negative effects can be mitigated by moving the budget towards balance, so that new marketable, publicly-held debt is less and less.)

Bad news

The good news is that Social Security is running surpluses and building up a large warchest to take us through the lean years of Boomer retirement.

The bad news is that our current Congress and president are addicted to debt -- I mean, what do you expect when you cut taxes and increase spending at the same time?!

If one budget is running surpluses (Social Security) and the other is running deficits (general fund budget), which one would you say has the crisis?

Accounting trick

Sometimes Privateers and trust fund-agnostics refer to intragovernmental debt as an "accounting trick" of some kind. Even reform-minded, pro-Social Security people make this claim. But since the Treasury bonds held by the Social Security trust fund are real, backed by the Constitution and redeemed every day in normal operations -- they're even earning interest from the general fund -- it's clear the "accounting trick" is somewhere else.

It's in the "unified budget." Technically, that's the sum of the "on-budget" (general fund programs) and "off-budget" (Social Security) finances. (For the unhealthily curious, see this article from the April 2000 issue of CPA Journal.)

As blogger Calculated Risk explains:

$661,568,870,319.77.

That is $661+ Billion and represents the increase in the National Debt over the last 12 months ... Some readers may be thinking "I thought the deficit was around $400 Billion." Here is an explanation: There are at least three methods of presenting the deficit; the first is the “Unified Budget” that includes the annual surplus from Social Security Insurance (and the miniscule Postal Service Fund) in the total. The second is the “General Fund Budget” (the most used) that excludes the SS Insurance surplus, but includes surpluses from Military Retirement, Federal Employee Retirement and many other smaller trust funds. The third approach (my favorite) is to use the annual increase in the National Debt as the annual deficit. The third approach suffers from timing issues and assumes the Federal Government is on a cash basis.

In other words, the president and the Congress make budget presentations using this "unified budget." These presentations are misleading because they focus on new "debt held by the public" rather than new "public debt." The press, dumbfounded by numbers in general, propagates this confusion. But any citizen with an eye for spreadsheets can find the complete picture.

For example, let's look at fiscal year 2003. Take this October, 2003 news report:

US President George W. Bush's administration posted an unprecedented 374-billion-dollar budget gap in 2003 and warned of a further explosion in the deficit next year. The record budget shortfall for the 2003 fiscal year ending September 30 had more than doubled from a deficit of 158 billion dollars in 2002 as military spending surged, partly to pay for the Iraq war operations, and as income from taxes declined.

But as this chart from the Congressional Budget Office makes clear, that $374 (actually $377) billion figure is merely the increase in "debt held by the public." Revenues were $1.782 trillion, and budget outlays were $2.16 trillion, leaving a deficit of $538 billion -- simple subtraction. We get $156 billion on the plus side by selling bonds to Social Security, and a few billion from bonds sold to the postal fund, giving the "unified" budget deficit of $377 billion.

Hop on over to the Bureau of Public Debt, and see what really happened in fiscal year 2003 (with a few billion difference from timing issues):

	Publicly-held debt	Intra- governmental	Public debt
09/30/2002	3,553 billion	2,675 billion	6,228 billion
09/30/2003	3,924 billion	2,859 billion	6,783 billion
Debt Increase	$371 billion misleading "unified" deficit	$184 billion borrowed from trust funds	$555 billion actual deficit

There's the $370-odd billion in new "debt held by the public," which is reported by the press as "the budget deficit." But over that year, the public debt increased by $555 billion -- 50% more than the newspaper reported. The difference is the debt held by government trust funds, foremost Social Security ($156 billion) but also transportation, veterans, etc.

That's the accounting trick. When the president and Congress speak to the nation about their budget, they use a misleading number, the "unified budget deficit" -- which doesn't include a large portion of new debt.

It's pretty shady -- it dates from the 1960s, when the Social Security trust fund grew very little from year to year, and so it only became a serious problem in the late 80s, as the Greenspan Commission's "prefunding" started to build up large surpluses.

And in fact, in 1990, at least one budget-balancing senator was mad about this accounting trick. Fritz Hollings of South Carolina managed to push through an amendment to the Budget Enforcement Act of 1990 that the Social Security trust funds "shall not be counted as new budget authority, outlays, receipts, or deficit or surplus for purposes of the budget of the United States Government as submitted by the President [or] the congressional budget" (Sec. 13301) -- a law that was ignored by all presidents and congresses since, leaving us with these misleading press reports.

But make no mistake, that's all it is: a misleading presentation of publicly-available information. "Off-budget" Social Security surpluses are still in the trust fund.

Full circle

Hollings was a colorful, iconoclastic Democrat who retired from the Senate in 2004, still ahead of his time on balancing the budget. His replacement was a sorry loon by the name of Jim DeMint -- the very same DeMint who offered up the pitiful bill last week entitled the "Stop the Raid on Social Security Act of 2005."

As we hope we have made clear, the trust fund holds valid debt which is being redeemed today and will be redeemed in the future. In fact, DeMint's bill does the exact opposite of what its title promises -- it takes securities assets out of the trust fund to establish private accounts, and makes a vague promise to cover the difference with cash transfers from the general fund 20 and 30 years down the line. That certainly sounds like a "raid" on Social Security.

(Final note: We hope this article has been informative and complete. If anything remains unclear or if anything is -- god forbid -- inaccurate, please let us know and we will endeavor to correct this page.)