Friday, February 08, 2008

Debt in the White House

Greg Mankiw posts an e-mail from a colleague in the White House regarding "Debt and the Real Threat." Some elements are correct (like the need to scale debt or deficit figures by GDP and the challenges presented by future entitlement programs). One element is not correct, and it is reflected in a couple of instances regarding whether it is appropriate to include the Treasury bonds in the Social Security trust fund in the measure of total indebtedness or whether the right deficit measure is the unified deficit (which includes the Social Security surplus) or the on-budget deficit (which excludes it). Here's the key excerpt:

2. gross debt vs. debt held by the public - (this is the hard part) What we care about is how much the US Government owes to the American public and the rest of the world (meaning to those who buy Treasury bonds). This is commonly known as "debt held by the public". To this amount, the Chairman adds debt that one part
of the government owes to another part of the government, to get what budgeters call "gross federal debt". If you use funds from your savings account to pay down a credit card, you have decreased your "debt held by the public". For comparison, if you borrow from your savings account and put it into your checking account, and leave in your savings account an IOU from you to you, Chairman Conrad's metric would say that you have "increased your gross debt." This is economically meaningless.

Not so fast. The difference between Total Debt and Debt held by the Public is the bonds held in the Social Security trust fund. Those bonds represent a claim on future tax revenues just like bonds held directly by the public. The taxpayers in 2025 will not care whether the additional income taxes they are paying are to pay off an American citizen who holds a Treasury bond or the Social Security beneficiaries who have presented a bond from the trust fund to the Treasury for redemption so that they can collect benefits. It's the same to them--it should be the same to us.

The only way the trust fund is equivalent to "using funds from your savings account to pay down a credit card" is if the Social Security surplus is used to repurchase Debt from the Public as an equivalent amount of special issue debt is placed in the trust fund. Debt held by the Public should go down, but Total Debt should stay constant if we are operating the trust fund as it was intended.

In 2025, we get the reverse. As beneficiaries make their claims, bonds come out of the trust fund. Either taxes go up, or new debt must be issued to the public to generate funds to pay off those bonds. Debt held by the Public goes up, but Total Debt stays the same. In both cases, it is Total Debt that is telling you accurately about the size of the liabilities being passed on to future generations. Debt not currently held by the public will eventually be held by the public.

The honest budget policy is to target the on-budget deficit or Total Debt/GDP. Anything else leaves you open to the charge that you are spending the Social Security surplus, raiding the Social Security trust fund, etc. You can ignore the debt held in the trust fund only if you don't intend to honor its redemption. Let's not go there.

For more on these issues, see these earlier posts: "Chairman Ben and the Long-Term Budget" and "Which Budget Deficit to Target?"


ProGrowthLiberal said...

I've been meaning to object to this as well. Rather than writing my objection - I'm about to post this over at Angrybear as it is exactly what I wanted to say, but you have done this so eloquently, there is nothing else to add!

ErikR said...

I'll second ProGrowthLiberal's praise. Well said!

When I read the comment on Mankiw's blog, I wanted to object along similar lines, but Mankiw does not allow comments anymore. Bummer!

Patrick R said...

Whenever you've got PGL agreeing with you you'd best rethink your logic, Prof. Samwick.

If the govt. defaults on bonds held by the public, there would be serious ramifications in the credit markets. If congress simply changes the rules on collecting benefits, say by raising the age limit for retirement--which would be default in all but name--that might improve the Federal credit rating.

ProGrowthLiberal said...

Patrick R. Sullivan tries to insult again. Whatever. But he really think slight changes in SS benefits will allow the SS Trust Fund to bail out the General Fund fiasco. Patrick - are you following what Andrew is saying? Do you have a clue as to large the present value of the General Fund deficits really are? Didn't think so.

Richard said...

Patrick R is exactly right. Future claims of Social Security beneficiaries are statutory transfer payments that can be changed freely by Congress. The government is not obligated to make these payments in the way it is obligated to make good on its debt.

Andrew Samwick said...

It is true that something about the Social Security system could be changed (higher taxes or lower benefits) so that the claims in the trust fund are drawn down more slowly than what is currently projected. In the limit, they may not be needed at all.

Do either of you think--given what we saw in 2005, for example--that this is remotely likely?

Concerned citizen said...

Patrick R COMPLETELY MISSES THE POINT of this post. The point is that TOTAL Federal Debt represents an intergenerational transfer of lower taxes today for higher taxes tomorrow. Higher taxes tomorrow can take the form of lower benefits of SS to future generations.

The big point is clear: our fiscal mess means that on SS alone, taxes will have to go up or benefits will have to go down. And forget about Medicare. That situation is much worse than SS.

Samwick is completely right. Our government has mislead us totally in focusing on the unified deficit. We should take the current SS surplus OUT of the report of the current deficit.

JG said...

Three components of the debt:

1) The debt held by the public. Payment of this is guaranteed by the Constitution.

2) The intra-governmental debt represented by the bonds in the SS, Medicare and other trust funds. There is no legal guarantee of payment of this. Congress can, if it wants, just change the programs to avoid having to pay them.

3) The implicit debt, which is the projected cost of SS, Medicare & other government expenditures over projected future tax receipts, at present value.

The distinctions:

[] Legally, there is a huge distinction between 1 & 2.

[] Practically and politically, there is no distinction at all between 2 & 3. That is, #3 is the real cost of these programs while #2 is just an arbitrary small portion of that cost.

E.g., when the Medicare trust fund runs out of bonds shortly, is anyone planning to cut Medicare benefits because those bonds will have been paid off? I don't hear anyone talking about that. And when the SS trust fund bonds run out in 204x, does anyone really expect SS benefits to be cut 20% the next day because those bonds have been paid off?

So if one objects that it is unrealistic not to count #2 in "the real debt" because reality is that we have these programs to pay for and Congress doesn't have the will to deal with cutting their cost, then it is equally unrealistic and entirely arbitrary to count only #2 in the debt and not count #3 - because that's the real cost of these programs.

Thus the meaningful distinction is between...

1) The debt owed to the public: $5.1 trillion, and

3) That plus the implicit debt embodied in gov't program promises, $55 trillion as per the Treasury.

(With anyone who still wants to vote for #2 as being the real measure of the debt having to explain why it makes sense to include $4 trillion of gov't program promises in it but not the other $46 trillion.)

This means there's plenty of disingenuous spinning all around. The Bush Administration shouldn't be pretending that today's deficits are just fine when both S&P and Moody's project the credit rating of the US government to start falling in 2017 on current law -- and S&P projects it will fall all the way from AAA to "Junk" in just the ten years to 2027.

That's less than 2/3rds the length of one home mortgage away! Any kind of responsible government would be dealing with that right now.

OTOH, the Democrats and liberals are even worse -- saying nothing has to be done about SS until the trust fund runs out in the 2040s ("nothing" being an across-the-board income tax hike approaching 20% to service the trust fund bonds) ... and hey, lets add national health care and so much more without a word about how existing health programs have already given us $35 trillion of implicit debt, with an across-the-board income tax hike of 50% or the equivalent coming by the 2030s to finance it ... but with endless words about how Bush has added a comparatively trivial amount to the govt's operational deficit.

The #1 campaign issue by far in this election should be those S&P and Moodys projections of the US's credit rating starting to plunge only nine years from now, and what to do about it. But all the candidates in both parties have already agreed what to do about it --- "Don't mention it!"

Who says bipartisanship is dead in US politics? ;-)

Anonymous said...

Debt can be an absolute nightmare when it starts to spiral Out of control. It best to get some debt consolidation advice if it starts to affect your health through the stress of it all. Then when your finally out of debt try and make sure it does'nt happen again!

andersonsmith said...

The nations of the world have foolishly traded hard assets like oil, minerals, timber, high valued goods for this huge mountain of worthless paper dollars. Furthermore, the US has made it clear that it will not allow foreigners to buy American corporations etc. outright with these worthless dollar assets.
Anderson smith