A $7.7 Trillion National Debt?

When someone claims that the US has a $7.7 trillion national debt, this claim can be backed up by sites such as this.

What we see is that the Gross National Debt of $7.7 trillion is made up of $4.5 trillion in debt held by the public and about $3.2 trillion in debt held by the government, mostly in various Trust Funds, with $1.7 trillion of that held by the Social Security Trust Fund, in particular.

What we don't see is that the word 'gross' in Gross National Debt really is descriptive in that there is no real economic debt of $7.7 trillion dollars, but that the only real economic debt is the $4.5 trillion held by the public. ( This assumes that all of the Trust Funds function in an equivalent manner to the Social Security Trust Fund, which may or may not be true).

In any year in which Social Security runs a surplus of tax receipts over benefits paid, the surplus is used to help pay for current government spending and to redeem currently maturing general government debt. Pseudo-bonds are issued to the Social Security Trust Fund for the amount of the surplus 'borrowed.' It is commonly thought that the only difference between these bonds and the normal bonds sold to the public is that there is no secondary market for the SSTF bonds. Nothing could be further from the truth, as I will attempt to demonstrate below.

The Difference Between Normal US Treasury Bonds Sold to the Public and Trust Fund Bonds

A normal US Treasury Bond sold to the public has a face or principal value, an interest rate or yield, and a maturity date. The interest rate is typically set in an auction market. Between the time of purchase and the maturity date, the Treasury will typically make a series of coupon payments of interest to the holder and, at maturity, a last payment to redeem the bond for its face value. (This description should serve for purposes of demonstration, even if it may not be completely and exhaustively correct.)

In exchange for the initial sale proceeds that the Treasury receives, it becomes obligated for the future payments of interest and principal to the holder, who may or may not be the original purchaser, as intervening sales of the bond on the secondary market may have occurred.

Under almost all circumstances, with the exception of possible Acts of God, or War, the Treasury will indeed make all of the promised payments, funding these payments from taxes, new bond sales to the public, or possibly, newly printed fiat money. At the time of the initial bond sale, both the Public Debt totals and the Gross National Debt are increased by the face value of the bond. At the time of redemption, both of these increases are reversed.

As described above in the prior section, the Social Security Trust Fund pseudo-bonds come into existence in any year that social security tax receipts exceed benefit payments. At this time, both the Government Debt and the Gross National Debt are increased by the full amount of the surplus. The entire surplus must, by law, result in pseudo-bonds of the same dollar amount. As with normal bonds, the pseudo bonds have a face or principal value, an interest rate or yield, and either a maturity date or a time duration. What is different at this early stage is that the interest rate is set effectively arbitrarily, without the benefit of an auction market, although the results of markets may be used, and that the maturity date or duration is only a formality, and not a controlling factor. I believe that the duration is initially set to 15 years, but that it is simply extended as needed if there is no need to redeem the bond at the end of the 15 year duration.

Although the differences seen above can be significant, the real key to understanding the SSTF pseudo-bonds is to concentrate on their redemption.

If we do so, then the surprising conclusion must be that, in any practical, effective sense, the pseudo-bonds are NEVER actually redeemed.

Let's consider the possibilities.

1. If social security is in surplus in a given year, pseudo-bonds are being created, not redeemed, and the Government Debt and Gross National Debt are increased.

2. If social security is in deficit in a given year, the Treasury sells new normal bonds to the public for the full amount of the deficit and the proceeds are paid out in SS benefits to make up the SS shortfall. This increases both the Public Debt and the Gross National Debt.

2a. If the SSTF has been previously exhausted, then all that happens is that both the Public Debt and the Gross National Debt are increased as above.

2b. If the SSTF still has pseudo-bonds, or their accumulated pseudo-interest, then an appropriate quantity of pseudo-bonds and pseudo-interest is cancelled. This results in a decrease in both the Gevernment Debt and the Gross National Debt.
Combining this result with 2. above, the net result is that Government debt has been converted to Public Debt and the Gross National Debt remains unchanged.

There is a tendency to consider the above as merely a semantic play on words, with 'cancel' being used instead of 'redeem'. However, the key point is that the level of new public borrowing is set by the degree to which social security is in deficit for any given year, independent of whether any pseudo-bonds remain in the SSTF or not.

Thus we see that the SSTF contents have no control whatever over how much new Public Debt is created. If, unlikely as it may seem, some year is reached after which social security is perfectly in balance forever, then whatever total of pseudo-bonds are then held in the SSTF will remain constant forever, never being redeemed or cancelled.. The pseudo-bonds cannot be used for any purpose whatever unless a social security deficit exists. If social security is in surplus forever, then the pseudo-bonds will increase forever without limit, but be of no more value then than they were under any other condition.

I don't have a great deal of confidence that the above is clear and convincing enough, but I can quote the Budget of the United States Government
Fiscal Year 2006

In Analytical Perspectives, Budget of the United States Government, Fiscal Year 2006 (2.7 MB pdf) , page 260 of 442 --

...However, issuing debt to Government accounts does
not have any of the economic effects of borrowing from
the public. It is an internal transaction of the Government,
made between two accounts that are both within
the Government itself. It is not a current transaction
of the Government with the public; it is not financed
by private saving and does not compete with the private
sector for available funds in the credit market; it does
not provide the account with resources other than a
legal claim on the U.S. Treasury, which itself obtains
real resources by taxation and borrowing; and its current
interest does not have to be financed by taxes
or other means....

end

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I think your analysis is

I think your analysis is essentially correct as far as it goes, but this is not to say that the SSTF has no impact.

One minor adjustment is that the balance point is not reached when Social Security is perfectly balanced, but instead when it has a deficit that equals the interest on the "pseudo-bonds". At that point the general fund payments of interest will be offset by the Social Security deficit and this will keep the total "pseudo-bonds" constant. When the Social Security system is exactly in balance, the accrued interest on the pseudo-bonds would result in more pseudo-bonds being issued to cover the interest that is not transferred to Social Security. Although this adjustment is minor in terms of your overall argument, since these new pseudo-bonds don't affect any of the cash flows, it does show that the pseudo-bonds, to the extent that they are honored, act in some ways like real bonds.

But I think that the more worthwhile conclusion to be drawn from an analysis such as yours is that the SSTF should be considered an unfunded obligation, and should thus be added to the $11.1 trillion present value of the anticipated accrued deficit in the system. As your analysis shows, it behaves exactly like an unfunded liability in what needs to be done when the SSTF is "drawn down". Also note that the $11.1 trillion unfunded liability reported by the actuaries will, if the status quo is maintained, grow from year to year at the internal rate of return that was used to compute its present value.

The real answer is that, far from helping make the system solvent, the SSTF *and* the $11.1 trillion unfunded liability have a combined negative impact on the solvancy of the system. From the point of view of SSTF, the pseudo-bonds appear to be an asset, but that is the same kind of illusion I might have if I were to save for a car not by living on less of my available income but instead by writing myself IOUs. From the standpoint of the car fund the IOUs appear to be an asset, but they are an unfunded liability.

The inescapable conclusion is that if the system is to be maintained, the only way to develop a "war chest" or "lockbox" of funds for this purpose is to make investments outside the government.

If we were in a long-term situation where our public deficits were large, one could concievably fund a Social Security trust fund by borrowing less than would otherwise be prudent, and the accrued savings in external interest payments could then be considered much like income ("a penny saved...").

But recent history, showed us a different problem. But for tax cuts and a recession, we came dangerously close to a budget in which the government had larger surplusses than it had mature bonds to redeem. At such a point, the government has no way to invest these surplusses in debt reduction and so, in the resulting crisis of cash, there is a great tendency to want to spend them. This was a large part of the reasoning behind the tax cuts of 2001. Because of the Social Security surplusses, we reach balance in public borrowing while we still have a sizeable on-budget deficit so on-budget surplusses are unsustainable. Thus, in recent years Social Security, rather than allowing us to invest in debt reduction has actually been forcing the government to take on more debt than it otherwise would--either spending more, cutting taxes more, or both.

In a sense, these patterns of behavior could also be considered as helping to fund the trust fund. That is, if the public would accept taxes at 20% of GDP, then taxing at 18% of GDP provides a cushion of taxation that could be applied to funding the Social Security deficit when the time comes. That is, if we live with 18% taxation then we maintain the extra 2% for use by Social Security when it goes into deficit. By contrast, if we taxed at the maximum rate the public would bear then the payment of the Social Security deficit would be less easy, since we could not raise taxes to do it. So in that respect the reduced tax rates act as a Social Security reserve--they even have much of the nature of an investment for Social Security since they will stimulate the economy in a manner similar to an investment.

A similar, but less sound in my opinion, argument might be made about spending increases beyond that which the public would normally demand or accept. The spending is somewhat stimulative and later reductions in this "frivolous spending" would be possible in order to fund the Social Security deficit. This argument is less sound both because it is easier to raise taxes than it is to cut spending and also because it is harder for the government to spend money as efficiently as the public does, so it does less to advance the economy.

However, nothing acts like investment quite so much as investment does. So the closest to optimal answer to funding the Social Security deficits appears to be privatization--allowing government to invest surplusses (such as the Social Security surplusses) in the private sector. I think that the public ought to be suspicious, however, of government plans to acquire ownership of the means of production, as privatization alone would imply.

We have seen recently in the case, for example, of the ouster of Dick Grasso from the NYSE where the controllers of pension trust funds for states such as New York, California, and North Carolina were able to use their positions as shareholders to make demands that would have been unavailable to them under the constraints of disinterested fair play that apply to regulators. By contrast, I think the public has an interest in keeping the arm's-length relationship between the public and private sector, so that the public does not place the profitability of its investment above the broader public interest and also so that it doesn't have the arbitrary power of a shareholder with respect to the companies in which it is invested.

A partial answer to this objection to privatization appears to be "personalization", in which the shares are beneficially owned by individuals rather than by the government. Perhaps it is not a complete answer, but certainly something must be done to keep government trustees from voting shares as though the government were the owner of the securities.

But if Social Security is to survive, we certainly need to find some way to fund the currently-unfunded liability (including the SSTF) as the Social Security system goes into deficit. Clearly any system we develop for doing this will appear to come at an additional cost to the government--that cost arises from the funding that we are devoting to solving the problem. The only way to avoid additional cost is to avoid doing anything to solve the problem. So any solution that works will entail either increasing debt, increasing taxes, or reducing spending, although none of these changes need be permanent if the solution works.

There may be better arguments to be made by the opponents of personalization/privatization, but thus far they seem to be taking a three step approach to solving the problem. Step 1--do nothing, don't change the system in any way and continue with the fiction that the SSTF represents an asset of some kind. Step 2--this step is a little unclear. Step 3--problem solved!

This is the position taken, for example, by the AARP--it is as though they want tomorrow's seniors to be needier than today's, perhaps so they will find more need for an "advocate" like AARP. Something like going to a quack doctor who induces a disease so that expensive treatments will become necessary.

And the sad part is that Social Security reform is just a trial run for the much greater unfunded liability problem with Medicare. If Social Security is not easy to solve, then Medicare will prove nearly impossible. The only real hope for Medicare at this point is the hope that the economy will grow disproportionately in non-health-related fields. But this hope seems slim as the costs of medical care are increasingly externalized. And indeed compassion requires externalizing many costs. I believe that hope for solvency is possible under some form of a compassionate system, but that is a topic for another time.