Why Unfunded Mandates Cannot Be Effectively Funded in Advance

Imagine that the 2004 Congress mandates the building of a covered bridge between San Francisco and Honolulu. Construction will commence in 2051 and continue through 2055, a total of five years. Over that five year period, it is projected that the project will consume 50% of the construction materials available in the US at that time. To finance the project, Congress neither allocates funds, nor authorizes borrowing, nor raises taxes, but expects the US Treasury to print enough new dollars starting in 2051 to both buy materials and pay for labor.

A new Presidential Administration comes in with the next election. The new President has been educated as an acountant and has made election promises to voters in both California and Hawaii to not cancel the bridge project, and in general, to make sure that future government obligations are actually funded. After election, the President introduces a tax bill to Congress raising current taxes and saving the cash proceeds in a Pacific Bridge Trust Fund virtual lockbox. This Trust Fund will start to be tapped in 2051 to acquire materials and labor. No new dollars will be printed by the Treasury. Congress goes along and in the next State Of the Union Address the President brags that he has eliminated all unfunded mandates and put the country on a path of honest accounting.

Does the President deserve bragging rights?

In a word, no. What he has actually done is solve an apparent accounting problem at the expense of making a real economic problem worse.

If the President had done nothing, the largest problem would have been a collapse of the pre-bridge construction industry starting in 2051 as the new Treasury dollars were used to massively bid up the prices of construction materials as they are used to attempt to buy up half of the available supply.

After the Trust Fund is brought into existence, the only thing that has changed is that in 2051 the dollars that bid up the prices of construction materials come from the Trust Fund rather than from the Treasury printing presses. The pre-bridge construction industry still collapses in 2051 just as before.

In addition, the current taxes have their own economic effect. Since the tax proceeds are placed in the virtual lockbox of the Trust Fund, the effect is the same as a contraction of the money supply, i.e. falling prices. Since the effect of neither taxes or money supply changes can ever be neutral, purchasing power is transferred from those who pay a relatively greater portion of the new taxes to those who pay relatively less. In addition, while the overall price level falls, meaning that the purchasing power of the dollar rises, relative prices change in response to the non-neutral shifts in purchasing power that occur. This then requires both the creation of new specific capital (plant and equipment, for example) to meet new demand and the destruction of old specific capital that no longer is useful to meet demand that no longer exists. In any case, the taxes have resulted in economic damage with no benefit at all.

The only way that current taxes are not a total economic loss is if they are used to purchase and accumulate over time actual construction materials that will be used in the making of the bridge, effectively increasing the 2051 supply of construction materials and doing less damage to the existing construction industry. This is very difficult, if not impossible.

In 2051, the pre-bridge construction industry will collapse no matter where the dollars come from, including private savings, if the supply of construction materials is not increased.

All of this applies to Social Security shortfalls as well. If current taxes are not used to buy and store Grandma's canned cat food for future consumption, these taxes only produce inferior economic results to simply printing new dollars to make up for the SS shortfall. For a given supply of goods and services, increases in the quantity of the dollars that are used to bid for them will cause prices to rise, independent of the source of the dollars. Looked at in another way, when SS payments only come from payroll taxes, the burden is concentrated on a limited supply of future workers. Deliberate monetary supply inflation distributes the burden more widely over the entire economy. If the monetary supply inflation is directly targeted at the SS recipients, the overall negative economic effects are reduced. The lesson is that once an unmanageable mandate is carved in stone, there is no magic accounting method of meeting it.

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My mom should live forever,

My mom should live forever, but you parents are nothing but an horrible expense.:behead:

Part of the problem that Europe has been facing is they have been doing this a lot longer than we have, so they have been dealing with the issues longer. The results have been eliminating the military or euthenasia by inptitude or both.

Lot of people have been howling at the number of casualties imposte by 9/11. But last Summer France took a hit on their population 10x worse just because they couldn't manage a simple first aid problem like Heat Stroke.

The politicinas choices happen in real time. Unless they raise the retirement age over the life expectancy, there is no way this system can surve past 2014. A lot of things are going to have to give.

Basically it seems like you

Basically it seems like you are comparing two different methods of taxation. One is payroll taxes (or bridge taxes), and the other we should call "The Inflation Tax", so as not to sugar-coat its thievish nature. The latter is much broader, and probably better.

One thing I especially prefer about the inflation tax to the payroll tax is that the former taxes from the retirees as well as others, hence effectively decreasing their benefits.

Why should we expect

Why should we expect financing SS's unfunded liabilities by inflation-as-a-stealth-tax to be less distortionary than raising payroll taxes?

For one thing, if you just pay out benefits by "printing money," the negative effects fall on exactly the same group: non-retirees. Since the retirees get the money first, most of the unfunded-by-real-resources purchasing power goes to them, with the laboring generation taking it in the shorts as a corollary. Financing benefits with a tax... basically does the same thing. It's true the disincentive patterns are probably different, but I can't hazard a guess as to which are worse.

Secondly, we can't ignore the systemic effects of monetary expansion, as per Austrian Business Cycle Theory. Dumping a bunch of money on the economy caused the whole 1995-2001 episode. Imagine doing that over again, only with Boomer retirees' preferences calling the shots!

Though raising taxes would certainly be painful, there's a twofold silver lining:
1. it probably won't cause an epidemic of capital misallocation
2. it just might discipline the paying generation's thirst for gov't largesse

Noah, When we compare the

Noah,

When we compare the provision of social security payments from direct dollar printing with that from payroll taxes from a much earlier year, the future effect at the time of payment is the same as the same people are bidding up the same goods. The earlier payroll taxes have damaged the past economy to no benefit if they have not increased the future supply of goods and services.

The Austrian Business Cycle is triggered by bank credit expansion aimed at businesses. Simply printing money for social security payments will not do so. Also the credit expansion is subject to reversal as the businesses go into default on their loans. No such monetary contraction will result from newly printed dollars.

Regards, Don

For one thing, if you just

For one thing, if you just pay out benefits by â??printing money,â?? the negative effects fall on exactly the same group: non-retirees. Since the retirees get the money first, most of the unfunded-by-real-resources purchasing power goes to them

This gets tricky. It's true that they get the money first. If you were going to pay them a fixed amount of *resources*, then you'd be right that it wouldn't be different. But if you are going to pay them a fixed amount of *dollars*, there is a difference.

If you steal the money via taxes and give it to the retirees, they do better than if you pay them with new dollars - because the new dollars are worth less! They have the same nominal value, but less real value.

Think of it this way - would you rather be given ten billion stolen dollars, or ten billion dollars that were printed up just for you? The former are worth more, right? The rest of society is gaining by the amount the retirees are getting screwed by because you've payed them back with cheaper dollars.

But, if we make the

But, if we make the assumption (and that's all I'll call it for now) that the government can only safely implement a given level of taxation regardless of whether or not they're saving to build the bridge, every dollar saved is a dollar not spent finding new and creative ways to harass me for my own good.

In reality, of course, the tax dollars "saved" will be spent to buy government bonds, and end up harassing me anyway.

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In reference to a post on my

In reference to a post on my blog, Don asked me to comment on his example. In general, it makes sense to me. Here are some important qualifications:

Social Security's obligations are to transfer money according to a formula, not to make specific purchases of construction materials. There is no particular inflation effect of trying to move the money to the seniors. Even the Social Security COLA is based on the whole population's consumption basket--not just the elderly's. Perhaps Medicare would be a better comparison for the pre-bridge example.

I agree that the prefunding must take the form of capital assets that can be exchanged for the goods and services that the elderly will consume in retirement. Even better, if the prefunding actually increases national saving, the economy will have a greater supply of capital in 2051. That added capital will increase production and thus total output, allowing both the elderly and the non-elderly to consume more.

So the question becomes, "Can we do this in the Social Security trust fund, or do we need personal accounts?" In theory, the Social Security trust fund could do it. However, that would require the trust fund to purchase existing Treasury bonds with its surpluses. The sellers of the Treasury bonds would invest the proceeds in productive capital, in roughly the same way that personal account holders would.

However, the current budget accounting does not encourage this. The budget target is the unified deficit, which includes the Social Security surplus. When the President announced that he would "cut the budget deficit in half" in 5 years, he was incorporating not only the level of the Social Security surplus, but its substantial growth over the 5 years. Thus, running the surplus does nothing to secure Social Security's future--the budget target was weakened to fully accommodate it.

If the new monies go into the personal accounts, then they are an outlay of the government that offset an exact amount of the inflow, and the government cannot use them to fund other purchases. That's the accounting reason to have personal accounts.

Why Unfunded Mandates Cannot

Why Unfunded Mandates Cannot Be Effectively Funded in Advance
Why Unfunded Mandates ...