‘90s Budget Dilemma: How to Spend Surplus : Social Security Reserve Could Vanish if Congress Uses It to Avoid Coming to Grips With Deficits

Should the federal government run a budget surplus?

On its face, the question seems absurd. After all, the United States has chalked up more than $1 trillion in debts over the last six years and last year alone the federal deficit remained higher than $150 billion.

Nonetheless, the possibility is a very real one. Social Security is beginning to accumulate a large reserve that, if left untouched, will soar into the trillions of dollars in the next 50 years. The goal is to help pay the cost of the baby boom generation’s retirement benefits in the 21st Century.

At the moment, these annual surpluses--about $40 billion this year and expected to rise to $77 billion in 1992--are merely offsetting a part of the wider deficit in the rest of the budget. But if Congress can put together a politically acceptable package of modest budget restraints, overall government finances could move sharply into the black within the next decade.

“It is, potentially, an incredible turnaround from what we have been used to,” said Rep. Leon E. Panetta (D-Monterey), who is expected to become chairman of the House Budget Committee next year. “But we’re still a long way from getting there.”

The shimmering allure of budget surpluses, like a desert mirage, could disappear if Congress and the White House rely on the prospect of huge Social Security reserves in the future to avoid coming to grips with today’s deficits. Many analysts fear that the politicians will be sorely tempted to use the Social Security surplus to finance a host of other government programs.

“There is tremendous confusion over this issue, which is the budget dilemma of the 1990s,” said John Cogan, a former associate director of the federal Office of Management and Budget. “There are good reasons why we should be accumulating Social Security reserves, but I’m skeptical that Congress will ever be able to resist the tremendous political pressures to spend the surplus.”

Underlying the issue is a potentially explosive generational conflict between the desires of the elderly and the clamor for increased federal spending from more neglected groups in American society.

80 Million Baby Boomers

If Washington dissipates the projected Social Security surplus on other outlays, taxes will have to soar or long-entrenched federal programs will have to be slashed if the 80 million baby boomers born between 1946 and 1964 are to collect their retirement benefits beginning in about 25 years.

“What is at stake is the implicit social contract between generations, in which each generation bequeaths a higher income to its children, in return for which it expects to be supported in its old age,” Isabel V. Sawhill of the Urban Institute wrote in a new study.

The best way out of the current predicament, according to an odd collection of political bedfellows, is for government policy-makers to move away from the ingrained tradition of deficit spending.

Although the issue has barely crept onto the public agenda, Federal Reserve Chairman Alan Greenspan--a conservative Republican--is already calling publicly for the government to deliberately accumulate budget surpluses.

So is Rep. Byron L. Dorgan (D-N.D.), one of the most liberal members of Congress, who has taken the lead in advocating that Social Security be moved out of the federal budget so that its surpluses would not offset deficits elsewhere in federal operations. That might help protect Social Security benefits from cuts, as Dorgan hopes, but it would also put more pressure on lawmakers to pare the $200-billion deficits remaining in the rest of the budget.

Adding to Savings Pool

Regardless of whether Social Security is counted as part of the federal budget, its growing surpluses may eventually mean that the government will collect more tax revenue than it spends. Thus the government, instead of draining funds from the nation’s savings pool, will actually add to it.

“We’ve got the opportunity of a lifetime to boost the rate of savings in the United States,” said Barry Bosworth, an economist at the Brookings Institution. “And that’s what we need if we’re going to generate the higher standard of living to make good on our future obligations. It would be criminal if we blew it.”

Lawmakers are only now beginning to realize their opportunity, which is an outgrowth of decisions Congress made five years ago to restore the financial health of the Social Security system. In 1983, said Sen. Pete V. Domenici of New Mexico, the top Republican on the Budget Committee, “it was so far in the future that I don’t think we paid much attention to it.”

Payroll Taxes Raised

Dealing in an atmosphere of near-panic, lawmakers agreed then to raise payroll tax rates, trim future benefits and push back retirement ages in the 21st Century, all in the interest of guaranteeing that Social Security would be able to meet its obligations when the baby boom generation retires.

About 87% of the payroll taxes of today’s workers, says Social Security Commissioner Dorcas R. Hardy, is paying benefits to today’s retirees. The rest is going into a reserve, where it is invested in long-term Treasury securities.

“The idea is that we have agreed to pay slightly higher taxes today so that our children won’t have to pay much, much higher taxes in the future,” Hardy said.

Before Uncle Sam can actually become a saver rather than a perennial borrower, however, a number of major political obstacles must be overcome.

Some officials worry, for example, that a budget surplus could be a serious drag on the economy by soaking up money that people would otherwise be free to spend.

Stimulating Economic Growth

Nearly all economists, however, say that such fears arise from a misunderstanding of the role government spending plays in stimulating economic growth.

“The idea that deficits, per se, stimulate the economy is one of those preposterous notions that I suppose economists have only themselves to blame for,” confessed John Makin, a senior economist at the American Enterprise Institute.

The confusion arises because most economists, in advocating deficit spending as a short-term tool for coping with economic downturns, have left many people with the false impression that deficits themselves are a healthy tonic for the long-run health of the economy.

“Far from being a drag on the economy, a policy of generating budget surpluses would be beneficial,” said Rep. Bill Gradison (R-Ohio), one of Congress’ most economically sophisticated members.

‘Master of Our Ship’

“As long as the surplus was achieved in a way that didn’t reduce private savings, the main effect would be to reduce the amount we have to borrow from abroad,” Gradison added. “We’d make Uncle Sam the master of our ship of state again instead of rattling a tin cup in our hand for the rest of the world to fill.”

Since World War II, the rate of savings in the United States has been lower than in most other industrial nations, averaging roughly 17% of the nation’s total economic output. The unprecedented federal deficits of recent years have cut deeply into the amount of domestic savings available to support private investment.

Last year, for example, U.S. businesses and individuals set aside a below-average 15% of the nation’s gross national product. But after the government absorbed its huge share of those savings, just 12.6% of the nation’s domestic output was left to finance not only future private investment but also the cost of maintaining the nation’s existing business infrastructure.

Foreign Capital Inflow

Thus, the United States needed to rely on an inflow of roughly $150 billion in foreign capital to support private investment running at a still-modest level of 16% of the GNP.

Apart from concerns over fiscal policy, the immediate battle in Congress revolves around the seemingly arcane question of whether the Social Security system should be set aside and viewed separately from the rest of the budget.

Separating Social Security from the rest of the budget would have the virtue of focusing attention on how far out of balance the rest of the budget is.

“We are covering up the full dimensions of the situation by creative accounting,” Gradison argued. “It gives too rosy a picture of the budget.”

Many economists favor removing Social Security from the budget as a means of guaranteeing that its benefits will still be available when today’s baby boom workers retire.

‘Pay as You Go’

“Social Security has always been a pay-as-you-go system,” said Brookings’ Bosworth, “but now we need to think of it more like a pension, in which we prudently invest money now so we won’t have to raise taxes so much on workers in the future. Putting the trust fund off-budget would foster that approach.”

Some lawmakers, however, contend that moving the massive Social Security system officially off the government’s books would be little more than a political ploy to exclude that $220-billion-a-year benefit program from future budget cuts.

“Eventually, in dealing with the deficit problem, we can’t isolate such a huge part of the budget from consideration,” Panetta said. “A stabilized Social Security system with the rest of the federal government bankrupt doesn’t make sense. If the ship is torpedoed, we all sink together.”

Support From Analysts

A number of analysts support Panetta’s viewpoint. “In an ideal world, it might make sense to exclude Social Security from the budget so you could build up a big surplus,” said Cogan, who is now at the Hoover Institute in Palo Alto. “But politics is the art of the doable, and including the surplus makes solving the deficit problem more doable.”

Simply reducing Social Security benefits--or at least cutting annual cost-of-living increases--might not help reduce the deficit because Congress would be tempted to cut Social Security taxes to match. More promising as a deficit-cutting measure is the possibility of subjecting more Social Security benefits to the income tax.

Today, the income tax applies only to half of Social Security benefits of recipients with incomes greater than $25,000 ($32,000 for couples). Even if Social Security benefits were treated the same as all other income for tax purposes, more than half of all Social Security recipients would pay no income taxes because their total income is too small. But the total deficit reduction would be about $20 billion a year.

Even if the budget ever works its way from megadeficits to enormous surpluses, Congress will not quit squabbling over it. Some analysts are afraid the battles over whether and how to spend the surplus will be no less fierce than today’s struggles over trimming the deficit.

But few lawmakers express much concern. “I would relish the opportunity to worry about something like that,” Panetta said.