Chairman Ben and the Long-Term Budget

Dean Baker's post this week criticizing Fed Chairman Bernanke's Senate Budget Committee testimony has generated quite a buzz (see here, here, here, and here). I don't think the criticism is reasonable.

First, let's start with the testimony. This is almost exactly what I would have given as testimony in Bernanke's position (assuming I had his staff of excellent economists to help me prepare it). You should read the whole thing, but if I had to pick out my favorite two paragraphs, here they are:

An important element in ensuring that we leave behind a stronger economy than we inherited, as did virtually all previous generations in this country, will be to move over time toward fiscal policies that are sustainable, efficient, and equitable across generations. Policies that promote private as well as public saving would also help us leave a more productive economy to our children and grandchildren. In addition, we should explore ways to make the labor market as accommodating as possible to older people who wish to continue working, as many will as longevity increases and health improves.

Addressing the country's fiscal problems will take persistence and a willingness to make difficult choices. In the end, the fundamental decision that the Congress, the Administration, and the American people must confront is how large a share of the nation's economic resources to devote to federal government programs, including transfer programs such as Social Security, Medicare, and Medicaid. Crucially, whatever size of government is chosen, tax rates must ultimately be set at a level sufficient to achieve an appropriate balance of spending and revenues in the long run. Thus, members of the Congress who put special emphasis on keeping tax rates low must accept that low tax rates can be sustained only if outlays, including those on entitlements, are kept low as well. Likewise, members who favor a more expansive role of the government, including relatively more-generous benefits payments, must recognize the burden imposed by the additional taxes needed to pay for the higher spending, a burden that includes not only the resources transferred from the private sector but also any adverse economic incentives associated with higher tax rates.

The first sentence of this excerpt is what motivates me on matters of national fiscal policy. So what's got Dean so agitated? You should read his whole post, but I think these two paragraphs capture his argument:

The most recent projections from the non-partisan Congressional Budget Office show that Social Security will have enough money between projected taxes and the bonds in the trust fund to pay all benefits through the year 2046, with no changes whatsoever.

This is very important to understand when someone like Federal Reserve Board Chairman Ben Bernanke proposes cuts to Social Security. Workers have already paid for these benefits. The Social Security tax is very regressive. Its regressivity can be justified by the progressive payback structure of the program. However, if the benefits are cut, at appoint when the program can still easily afford the benefits (e.g. 10-20 years), then the government has effectively stolen from the people who paid Social Security taxes.

You will note that in Bernanke's testimony, he never mentions the magnitude of the Social Security trust fund as a guide to budget policy. Dean leads with it. That's a big difference. Dean's statement in the first paragraph that uses the phrase "has enough money ... to pay benefits" would more appropriately be stated as "has the authorization ... to pay benefits." By law, the Social Security Administration can continue to pay full benefits on schedule for as long as there is a positive balance in the trust fund. When that balance goes to zero, it can only pay benefits as it gets in tax revenues. Dean is describing what will happen to benefit payments. Ben's discussion focuses on what it will take for future generations of workers to actually make those payments.

As I discuss in this previous post, the Social Security trust fund balance represents the current value of the Social Security surpluses that have been run to date. When the surpluses are run, the trust fund is augmented with special issue Treasuries, and over time, the trust fund is credited with appropriate interest on those Treasuries. However, the magnitude of this trust fund balance does NOT represent the extent to which debt held by the public is now lower because of these historic surpluses. That would only be the case if every special issue Treasury bond put into the trust fund was associated with the repurchase of a Treasury bond from the public.

In practice, that's not what happens. The federal government simply puts a new Treasury in the trust fund and spends the Social Security surplus on things other than buying back its existing debt from the public, as if the Social Security surplus were just like any other tax revenue at its disposal. How can I assert this? The federal government targets the unified budget deficit, which treats the Social Security surplus in this way. In my memory (which may not be perfect), the only time in the last 25 years when we did not do this was when the on-budget deficit tipped into balance and then surplus in the Clinton Administration. President Bush did it when he pledged "to cut the deficit in half in 5 years" (see this earlier post.) His Administration is doing it again with the more recent statements about budget balance by 2012. In all cases, the deficit in question is net of the Social Security surplus, and thus the policy presumes that the Social Security surplus is available to spend on general government expenditures.

I have in an earlier post argued that the government should be targeting the on-budget deficit and have Social Security in long-term balance. Bernanke stops short of saying this. That's the first way in which his testimony was not exactly what I would have said. There are two other things that I hope he stresses in his future public statements:

First, it is inconsistent for would-be Social Security reformers to be preoccupied with the debt burden placed on future generations due to Social Security's projected annual deficits but not with the debt burden placed on them by continued deficits in the General Fund. What is the rationale for running any deficit in the on-budget account when the economy is in the up side of a business cycle?

Second, it is inconsistent for would-be Social Security reformers to be preoccupied with the debt burden placed on future generations due to Social Security's projected annual deficits while at the same time enacting legislation, like Medicare Part D, that will generate even larger annual deficits to be financed by these same future generations.

Readers of this blog know that I don't exhibit these inconsistencies. I have precious few compatriots among would-be Social Security reformers on the political right.

Returning now to Dean's second paragraph, he regards cutting Social Security benefits as theft, asserting that "workers have already paid for these benefits." I might believe that if the Social Security surpluses were actually being saved rather than spent. But they aren't. It would be more appropriate to say that what the workers--Dean, me, you, all of us--have paid for is all of the government services that the Social Security surpluses have purchased in the past 20 years. We've already consumed them. We have no compelling justification to assert that future generations of workers, who were not party to these decisions, should have to pay higher taxes to honor promises that our generation has made to itself.

But something has to be done, and the sooner it happens, the less disruptive it will be. As always, I recommend that policy makers start here.