Saturday, July 23, 2011

Does Obama Have a $2.7 Trillion Get Out Of Jail Free Card?

In a recent post, based on a WSJ piece by Thomas Saving, I pointed out some implications of the status of the Social Security Trust Fund. My point in that post was that Obama appeared to be either deliberately lying about the implications of the debt limit for Social Security or strikingly ignorant of them. 

It now occurs to me that, if one accepts the interpretation Saving offers of the Supreme Court decision in Helvering v. Davis (1937), there is another implication: Obama may have a $2.7 trillion dollar get out of jail free card, a way of spending that much additional money without exceeding the debt limit.

When Social Security revenue is more than expenditure, the excess is loaned to the federal government and used to help pay for its expenditures. The result is a debt of the federal government to the Social Security system, a debt that is included in the total of the national debt. If Social Security revenues fall below expenditure, the treasury is required to pay back the difference, thus redeeming some of the bonds that make up the trust fund. Doing so lowers the national debt, since it includes intergovernmental obligations, so the treasury could borrow the amount it has just paid without exceeding the debt limit.

Under Helvering, at least as Saving interprets it, the receipts from the Social Security tax are not earmarked; they are income of the federal government that can be spent on anything the federal government wants to spend them on.

Revenue from Social Security is about $800 billion/year. Suppose no agreement is reached on raising the debt limit. Obama instructs the relevant people to spend the income from Social Security on the war in Afghanistan, bailouts, whatever he thinks needs money. He then instructs the Social Security system to cash in as many bonds as are required to meet its obligations to Social Security recipients, say $700 billion. He then instructs the treasury, since the national debt is now $700 billion below the debt limit, to borrow $700 billion. The net effect is that he has increased total expenditure, Social Security included, by $700 billion without exceeding the debt limit. The trust fund is currently at about $2.7 trillion, so he can do it for four more years.

And if an extra $700 billion isn't sufficient for his purposes, it isn't clear to me that he couldn't simply instruct the Social Security administration to ask to cash in some more of the trust fund, instruct the Treasury to agree to do so, and then instruct Social Security to hand over the money to whatever part of the federal government requires it.

There are obvious PR problems with this sort of solution to the present problems, both because it is so obviously gaming the system and because the part of the system it games is Social Security, which is a politically highly visible target. But are there any legal problems?

[Later note]

Some readers seem puzzled as to where the Treasury, in my story, is to find the $700 billion that it is to pay to the Social Security Administration, once the debt limit is reached. The answer is straightforward. With or without a debt limit, the federal government is continually collecting money and spending it. In my scenario, the government takes (say) $50 billion that it was supposed to pay as salary to federal employees, pays it to SSA instead. SSA cancels $50 billion in trust fund bonds. The national debt, which includes the debt owed by the federal government to the SSA, is now $50 billion below the limit, so the Treasury borrows $50 billion and pays out salaries to federal employees. Rinse and repeat as many times as necessary.

[Still later note]

A friend who knows much more law than I do writes:
It turns on, on further research, that Congress anticipated and prevented the very trick you have devised. Public Law 104-121, section 107(a), prohibits redemption of Social Security trust fund securities prior to maturity for any purpose other than the payment of benefits or administrative expenses.
So it's still true that the debt limit cannot block social security payments, at least until the trust fund runs out. But my multi-trillion dollar get out of jail free card has been cancelled.

Curses, foiled again.

22 Comments:

At 4:33 PM, July 23, 2011, Blogger VangelV said...

Is there a surplus from SS that can be used for spending? Some of the material that I have read claims that the payments are now slightly higher than the premiums. And we know that there are no bonds in the so-called trust fund.

 
At 4:38 PM, July 23, 2011, Blogger VangelV said...

Here you go:

Social Security expenditures exceeded the program’s non-interest income in 2010 for the first time since 1983. The $49 billion deficit last year (excluding interest income) and $46 billion projected deficit in 2011 are in large part due to the weakened economy and to downward income adjustments that correct for excess payroll tax revenue credited to the trust funds in earlier years. This deficit is expected to shrink to about $20 billion for years 2012-2014 as the economy strengthens. After 2014, cash deficits are expected to grow rapidly as the number of beneficiaries continues to grow at a substantially faster rate than the number of covered workers. Through 2022, the annual cash deficits will be made up by redeeming trust fund assets from the General Fund of the Treasury. Because these redemptions will be less than interest earnings, trust fund balances will continue to grow. After 2022, trust fund assets will be redeemed in amounts that exceed interest earnings until trust fund reserves are exhausted in 2036, one year earlier than was projected last year. Thereafter, tax income would be sufficient to pay only about three-quarters of scheduled benefits through 2085.


I am assuming that by income they mean premiums plus the make-believe interest paid by the non-marktable securities in the 'trust fund.' If I am wrong I would appreciate a reference to a credible source.

 
At 4:52 PM, July 23, 2011, Blogger Thomas said...

I'm afraid that the "get out of jail free card" has no value in the real "game" of government finance. My analysis is here

 
At 5:19 PM, July 23, 2011, Blogger David Friedman said...

No surplus is needed for the tactic I describe. Revenue may be less than expenditure, but that doesn't matter. The revenue is handed over to the Treasury to spend on other things. That leaves SSA short of money, so it goes to the Treasury and cashes bonds for the required amount. The trust fund is part of the debt, so cashing bonds for (say) $800 billion reduces the debt by that amount, so Treasury can now borrow an additional $800 billion without exceeding the limit.

Why does it matter whether the Social Security system is on net in surplus or deficit--it isn't the surplus that Treasury is taking, its the revenue.

 
At 6:13 PM, July 23, 2011, Blogger VangelV said...

David. Since I am not all that smart let me break down your statement and take it one sentence at a time. Please tell me where I am wrong.

No surplus is needed for the tactic I describe.

This will be determined below.

Revenue may be less than expenditure, but that doesn't matter.

I don't see how this can be correct. SS has a cash flow process. Some cash comes in from premiums while other cash is paid out as benefits. Each month you have more money going out than coming in. That seems to matter as far as I am concerned. And I think that the market, which is bigger than Obama, will agree.

The revenue is handed over to the Treasury to spend on other things.

No. The revenue goes out as payments.

That leaves SSA short of money, so it goes to the Treasury and cashes bonds for the required amount.

Here you lost me. What bonds? There are no bonds in the trust fund. How can the Treasury issue new bonds if the debt ceiling is not increased?

The trust fund is part of the debt, so cashing bonds for (say) $800 billion reduces the debt by that amount, so Treasury can now borrow an additional $800 billion without exceeding the limit.

No. There is no real trust fund. The Treasury has issued IOUs to the fund, which have to be made good to make up for the shortfall. When the US government is broke and has to be able to borrow it cannot pay back the SS 'trust fund.'

Why does it matter whether the Social Security system is on net in surplus or deficit--it isn't the surplus that Treasury is taking, its the revenue.

The revenue is needed to pay the benefits. Unless you have a Madoff type run the system, it can't be borrowed and paid out at the same time.

 
At 6:43 PM, July 23, 2011, Blogger Mark Horning said...

SS Tax is tax. It's no different than any other tax. I agree it is not earmarked despite the funny accounting methodology.

 
At 8:09 PM, July 23, 2011, Blogger David Friedman said...

Vangel:

Do you agree that if there were no debt ceiling, the federal government could continue to spend more than it takes in by borrowing? It can't do that without limit, because at some point people will refuse to lend it money, but it can do it for a while--which is why there is currently an argument over raising the debt ceiling.

Once you recognize that, the rest of the argument should be clear. For accounting purposes, the trust fund is money that the federal government owes the Social Security Administration--intergovernmental debt. Such debt is included in the total U.S. debt, which is what there is a limit on.

So any time the Treasury "pays off" part of the trust fund--i.e. hands SSA some money in exchange for SSA cancelling a part of what Treasury owes it--the debt goes down. Any time the debt goes down, Treasury is free to borrow some more. Hence the device I describe appears to let the government borrow even after it has reached the limit, via an accounting trick that makes some expenditures look like payment of (intergovernmental) debt.

 
At 8:31 PM, July 23, 2011, Anonymous David Tomlin said...

@VangeIV

The non-marketable securities in the Social Security not-a-trust-fund count toward the debt limit because Congress says they do. That is true regardless of what anyone calls them.

I was going to say 'It doesn't matter what anyone calls them.' Then I remembered you seem to have a problem understanding the expression 'it doesn't matter' in context.

 
At 12:02 AM, July 24, 2011, Anonymous jadagul said...

I believe the ratings agencies have said they'd count any social security trust fund shenanigans as a partial default. But I don't remember where I read it, so I could be totally wrong.

 
At 6:36 AM, July 24, 2011, Blogger VangelV said...

David. Since I am not as clever as you are I like to keep things simple. Let me go over this one point at a time as before.

Do you agree that if there were no debt ceiling, the federal government could continue to spend more than it takes in by borrowing?

Of course. As long as bond holders continued to buy treasury bonds the government could continue to borrow. But there would be a problem as the increased risks would cause many of the holders of UST debt to hedge their position or to refuse to roll over maturing paper. The Clinton/Bush strategy was to decrease duration to save on interest payments but that strategy increased duration risks. And the increased debt would cause the USD to lose purchasing power and drive up the price of commodities.

It can't do that without limit, because at some point people will refuse to lend it money, but it can do it for a while--which is why there is currently an argument over raising the debt ceiling.

I agree. My points would not be important over the short term until some type of tipping point were reached. (Of course, deciding to kick the can down the road could bring about that tipping point but that is a subject for another thread.

Once you recognize that, the rest of the argument should be clear. For accounting purposes, the trust fund is money that the federal government owes the Social Security Administration--intergovernmental debt. Such debt is included in the total U.S. debt, which is what there is a limit on.

Are you sure that the special issue debt securities held by the Social Security trust funds considered a part of the debt? At the end of 2010 the Old-Age and Survivors Insurance (OASI) and Disability Insurance (DI) Trust Funds held $2,609,537,218 of special issue securities. Are these really considered part of the debt?

I understand the accounting fiction that would be used to pay off the SI debt with SS premiums and use the cash to pay off the recipients but that would create another crisis by increasing the unfunded liabilities off SS and bringing forward the SS default date. Not only would seniors and current contributors revolt I suspect that the markets would do the same. The accounting fraud would be so transparent that there is no way that it could be pulled off without causing debt holders to demand much higher rates.

So any time the Treasury "pays off" part of the trust fund--i.e. hands SSA some money in exchange for SSA cancelling a part of what Treasury owes it--the debt goes down. Any time the debt goes down, Treasury is free to borrow some more. Hence the device I describe appears to let the government borrow even after it has reached the limit, via an accounting trick that makes some expenditures look like payment of (intergovernmental) debt.

As I wrote above, I understand how this would work. But I do not see how anyone buys the fraud as anything but fraud. And I do not see how this is any better than Dr. Paul's suggestion to have the Federal reserve destroy its treasury holdings. The debt would go down by $1.5 trillion and the government would be given some time to get its act together. If anyone is worried about the inflationary effects the Fed could simply hike reserve requirements to prevent the cash from flooding into the markets.

 
At 6:42 AM, July 24, 2011, Blogger VangelV said...

I believe the ratings agencies have said they'd count any social security trust fund shenanigans as a partial default. But I don't remember where I read it, so I could be totally wrong.

The rating agencies are not exactly credible when it comes to their activities. But if the government chooses to use the SS premiums for two purposes at the same time the markets will take notice as would seniors and their representatives in Congress. The move that David suggests would be seen as the fraud that it is and would make Madoff look like a decent man in comparison to Obama.

I do not believe that the process described by David is possible unless the government wants a downgrade, a series of lawsuits just as the election cycle is heating up, a seniors revolt, and the end of the two party system in the US.

 
At 7:42 AM, July 24, 2011, Blogger David Friedman said...

"Are you sure that the special issue debt securities held by the Social Security trust funds considered a part of the debt?"

At the beginning of my post, I have a link to a WSJ piece by Thomas Saving, who was a trustee of the Social Security Trust fund so presumably well informed about its status. I suggest that you read it.

 
At 8:02 AM, July 24, 2011, Blogger VangelV said...

At the beginning of my post, I have a link to a WSJ piece by Thomas Saving, who was a trustee of the Social Security Trust fund so presumably well informed about its status. I suggest that you read it.

I did, thank you. And I have no problem accepting the fact that the $2.6 trillion of special issue securities are counted as part of the debt given that the total for intergovernmental holdings is close to $5 trillion.

But that still does not change the argument. It will be very hard to double count the SS contributions without getting hit hard by the rating agencies, hedge funds, seniors and current SS contributors, and members of Congress looking out for an obvious sign of deception and weakness. In comparison the Ron Paul suggestion to have the Fed destroy its own holdings seems much more reasonable even though in the long term both strategies get us to hyperinflation.

 
At 11:25 AM, July 24, 2011, Blogger David Friedman said...

"It will be very hard to double count the SS contributions without getting hit hard by the rating agencies"

As I wrote in my original post:

"There are obvious PR problems with this sort of solution to the present problems"

I'm not arguing that it makes political sense, I'm arguing that it is legal.

 
At 12:00 PM, July 24, 2011, Blogger VangelV said...

I'm not arguing that it makes political sense, I'm arguing that it is legal.

It very well might be legal. But as I have said, the approach would bring forward the SS insolvency date and would trigger all kinds of actions with the rating agencies, in the bond markets, and among the electorate. Both parties would have a hard time surviving the backlash if the action were permitted.

But you are clearly right about the scheme being able to provide cover for the administration for a while. I just don't see how it can be done without destroying the Democrats.

 
At 1:21 PM, July 24, 2011, Anonymous Andrew said...

None of this will ever happen because it's not what corporate america wants. Corporate america wnts the status quo, they all know that the debt limit will be increased because they have the biggest stake in it.

What corporate america wants, corporate america gets. They are the biggest special interests, the biggest employers, and the biggest political contributors.

 
At 1:30 PM, July 24, 2011, Anonymous David Tomlin said...

Would the scheme be a worse PR problem than delaying SS payments, as Obama has already threatened?

 
At 3:55 PM, July 24, 2011, Blogger VangelV said...

None of this will ever happen because it's not what corporate america wants. Corporate america wnts the status quo, they all know that the debt limit will be increased because they have the biggest stake in it.

There is no monolithic Corporate America. Many corporations have totally different goals and some would prefer that the debt limit not be raised and that the government learns to live within its means. Do you really think that Newmont or Exxon have the same views as Bank of America?

 
At 4:03 PM, July 24, 2011, Blogger VangelV said...

Would the scheme be a worse PR problem than delaying SS payments, as Obama has already threatened?

It might be a lot worse. For example, some people might question the legality of the scheme. They would argue that the premiums belong to the fund, not the government. That means that for the government to use those funds to pay off the IOUs it would have to borrow them from the SS trust by providing additional IOUs. As such the scheme put forward by David may not be possible.

And even if it were, the scheme would bring the entire SS solvency issue into focus, something that the government would like to avoid for as long as possible. If there is a misstep you could see the price of gold go up by several hundred dollars in a few sessions and could see a short squeeze that would take silver into triple digits. The signal that the best that could be hoped for was to see the can kicked down the road could be the trigger to hyperinflation that would finally destroy the fiat currency.

 
At 5:14 PM, July 24, 2011, Anonymous David said...

VangeIV:

For example, some people might question the legality of the scheme. They would argue that the premiums belong to the fund, not the government. . . . the scheme would bring the entire SS solvency issue into focus, something that the government would like to avoid for as long as possible.

Diverting new revenues raises the same legal issue, and might draw attention to the solvency issue as well.

 
At 5:16 PM, July 24, 2011, Anonymous David Tomlin said...

Sorry, I screwed up the quoting in the last post. The first paragraph is quoting VangeIV. The second is my response

 
At 5:08 PM, July 28, 2011, Blogger Mark Scarberry said...

Mr. Saving misinterprets Helvering v. Davis. It absolutely did not turn on the nonearmarking of the funds. It's true that in 1937 they weren't earmarked, but, Wikipedia to the contrary, the nonearmarking was not the basis for the Court's upholding of social security. And, in 1939, the law was changed to earmark social security taxes for social security costs.

 

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