When news came that we had not, like lemmings, jumped over a Cliff, celebrations broke out across the nation. Nearly a million people jammed the streets around Times Square, and the party lasted well after dawn. As the sun rose—coincidentally the first day of a new year—revelers quietly rejoiced over the $62 billion a year in tax increases and $1.2 billion in spending cuts that had resulted from weeks of pitched battle in the bowels of the Capitol.

That’s billion with a B. Last year the nation raised $2.4 Trillion in taxes, and spent $3.5 Trillion. We’ve never raised $3.5 trillion in taxes, either in dollars or as a percentage of GDP. Not even in World War II!!  So, in 2013 Congress will continue to massively stimulate the economy, at a trillion-dollar-a-year rate, even as the Federal Reserve stimulates massively by printing money and holding interest rates near zero.

Consumers have responded by purchasing autos and homes, and factories are humming. But it seems clear that the Cliff Jump should be an annual event, in which the voters are asked whether they really want to borrow another trillion dollars to juice the economy for a mere 12 months.

Greece, Italy, Spain, Portugal, France (new to the club, recently added by the IMF) and Japan have also been overspending for decades, so it’s clear that you can’t count on the political class to step up to its responsibilities. All of us are flailing around at the tail end of a global super-cycle of debt accumulation, in which we consumed more—at both the personal and government levels—than we could afford.

For the most part consumers have cleaned up their acts, but governments are another story entirely. Japan is the country to watch. The island nation’s debt–a quadrillion yen—is the biggest in the world; worse than Greece, Iceland, Portugal, Eritrea, Sudan, or Zimbabwe, and actually bigger in dollar terms than our own. It was able to reach that lofty level because Japan’s citizens—some of the world’s most diligent savers—were willing to lend the government as much as it wanted. Now the hard-saving older generations are retiring, and the government is beginning to borrow from foreigners.

Japan’s economy is shrinking, and the former export powerhouse has become an importer. The electronics industry is reeling from a long series of bad decisions, missing the entire wireless revolution and instead betting on cameras and the hypercompetitive TV market. Sharp has warned of looming bankruptcy.

How did it get this bad? The spending binge started in 1991, in response to the simultaneous bursting of gigantic bubbles in the stock market and in real estate. Stimulus seemed like a reasonable thing in the first couple of years—they said they were “priming the pump”—but the bridges to nowhere quickly morphed into vote-buying and all manner of social spending, undermining the national work ethic even as it pulled ever-greater chunks of the economy under the thumb of bureaucrats and politicians. Year by year Japan’s innovation, entrepreneurialism, and drive were slowly crushed by the weight of government, as spending and budget deficits grew larger and larger.

Spending is now twice as large as revenues, but the best idea the political class can come up with is to spend more. The newly-elected government plans to build more bridges to nowhere and increase defense spending to pick a fight with China. Yes, China; Japan’s largest trading partner and home to a thousand Japanese manufacturing plants. Really?

The new prime minister also wants to push up the inflation rate to 2%, to give consumers a reason to buy today rather than waiting for lower prices tomorrow. That might be worth a shot, apart from the fact that a 2% interest rate on Japan’s debt would mean that half the nation’s tax revenue would be consumed by interest payments. As debt gets larger, a nation’s options and policy choices shrivel to nothing.

Japan is probably beyond the point of no return, but it didn’t have to be this way. In 1993, as the land of the rising sun was steadily ramping up her deficit spending, Canada’s debt had grown to the point where interest was consuming more than a third of all tax revenue. The Canadian dollar had been nicknamed the “northern peso”, and The Wall Street Journal called Canada an honorary member of the Third World. The nation went on a crash diet under the leadership of a Jean Chretien, a Liberal who was well-positioned to resist the pleas of the many constituencies created by the overspending of his predecessors.

It was a remarkable act of courage. As time passes those constituencies—votes purchased by government spending—become larger and more powerful. The debt grows, the interest on the debt rises, and the required spending cuts become more and more severe. Yet Canada’s GDP grew—it accelerated—over the course of the next four years, even as her budget went from massive deficits to surplus.

Yes, they had help from a strengthening US economy, and we’re too large to ask that they return the favor when we tighten our own belts. We’re going to have to do this on our own, but it can be done and must be done. The first step is to tell the voters the truth.

Outraged by partisan gridlock, corporate CEOs have become central players in the fiscal cliff negotiations — and the far larger effort to tame the nation’s deficits and debt.

Friday’s Wall Street Journal (“Honeywell CEO in the Middle of Cliff Standoff”, Monica Langley, December 14, 2012) gave a behind-closed-doors look at the key role of David Cote, CEO of Honeywell, who started in 2010 with the President’s Simpson-Bowles debt reduction commission.

Mr. Cote was assigned by President Obama to be one of the many representatives from the private sector on the debt reduction commission.  The commission’s assignment was to come back with recommendations to the president on how to address the nation’s burgeoning debt.

Monica Langley writes, “After months of partisan warfare . . . Mr. Cote took off his coat and told the group: ‘Who are you people?  Is this the way you do the nation’s business?  I’d fire all of you.’”

Analogies of Nero fiddling while Rome is burning come to mind, or of Three Mile Island’s management group, during the middle of that nuclear crisis, spending their meeting time discussing what they were going to tell the media instead of managing the meltdown (note: only the threat of Congressional subpoena brought those minutes to light).

“We’re not confident that our guys can govern anymore,” says the Honeywell CEO.  ”I meet people on both sides I like and find reasonable, but they aren’t working together.”

Rome is burning. Government is spending 46% more than it is taking in as tax revenue; and tax revenue has never exceeded 20.9% of GDP (table 1.2).

President Obama, while a U.S. Senator in 2006, described the problem well, and came out against profligate government spending; see John Lumbard’s post on these pages, “The Bipartisan Debt Machine”, Oct 4, 2012, for the full text of Mr. Obama’s speech.

We have an obligation to address and resolve the debt issue; we cannot continue to pass it down from one generation to another, to be solved later.

Where is the national resolve that so defined our parents’ and grandparents’ generations?

According to the National Debt Clock, the US is currently collecting about $2.4 trillion in taxes, and spending about $3.5 trillion.

Put another way, we’re collecting 16% of GDP in taxes and spending 23% of GDP on government programs.  Entitlement programs such as Medicare/Medicaid and Social Security are almost 16% of GDP by themselves  (see page 174), so “mandatory” programs are most of the budget and almost all of what we’re raising in taxes.

The only years in which we were able to collect tax revenue greater than 20% of GDP (20% and a fraction, in each case) were 1944, 1945, and 2000.   You can find the whole truth at http://www.whitehouse.gov/omb/budget/historicals/.   The first table gives you more than a century of federal spending and revenue—what we spent, and what we raised in taxes, for every year—and table 1.2 gives you the same numbers as a % of GDP.  Fabulous stuff, and right from the White House Budget Office.  If you’re wondering about the ”Off Budget” column, it’s the spending and  revenue (FICA) collected by Social Security and Medicare;  they’re still running a small surplus, which is used to make the “total” deficit look smaller.  (If you thought that the Social Security Trust Fund was a “lock box”, you should read Jim Schaefer’s ‘The Debt The Government Owes Itself For Raiding Social Security”, which includes a link to the Social Security Administration web site.)

Bill Clinton collected more tax than any other president, with a top personal tax rate of about 40%.  In those years all Americans, at every income level, had higher tax rates than they have today.  If we let the “Bush tax cuts” expire we’ll be able to collect 18% – 19% of GDP in taxes (we don’t have as many people employed today as we did in the Clinton years, and we’re not getting as much “help” from the Social Security and Medicare trust funds), but that would mean higher taxes for everybody—and a recession.  And we’d still be spending 23% of GDP.

What if we raise the top tax rate even higher?  Since World War II we’ve had top tax rates ranging from 28% to 70% to 91%, but the only year in which we were able to collect 20% of GDP was 2000, with a top rate of 39.6%.  England just tried raising its top tax rate from 40% to 50%, and the number of people in that top bracket (those earning more than a million pounds a year) shrank from 16,000 to just 6,000.

Congress created the fiscal cliff to force the reluctant media and the unwilling public to look closely at these issues.  Spending will naturally rise as the Baby Boomers retire and begin to draw Medicare and Social Security (which, btw, is a lot easier to fix than Medicare).   The nightmare scenario for the federal debt is that foreign investors will become skittish, and interest rates will rise until the interest on our debt is a trillion dollars a year.   The good news is that interest rates have gone down rather than up, because the Fed has been printing money and buying bonds and mortgages of all kinds.  Who says there’s no such thing as a free lunch?!!?

Alexander Hamilton argued that one of our nation’s greatest assets is its ability to borrow during a crisis.  We no longer have that ability, because we’ve issued so much debt in ordinary times.  Our debt is now larger than our GDP—just about where Greece’s debt stood in 2006—and it’s growing much faster.  Next year our debt will be at the level of Greece 2008. Perhaps we should start thinking about selling off some of our islands . . .

Below you’ll find the text of a speech that Senator Barack Obama gave in the Senate in March of 2006 (you want page S2237, if you’d rather read it there) regarding our debt and deficits—which at the time were growing rapidly under President Bush.  Now they’re growing rapidly under President Obama . . .

This is a bipartisan problem, and it’s going to require a bipartisan solution at a time when the voting public seems to be drifting toward the extreme right and left—two “polar opposites” which look pretty much the same from where we sit.  Uncompromising purity will bankrupt us all . . . The President’s text is below.

“Mr. President, I rise today to talk about America’s debt problem. The fact that we are here today to debate raising America’s debt limit is a sign of leadership failure. It is a sign that the U.S. Government can’t pay its own bills. It is a sign that we now depend on ongoing financial assistance from foreign countries to finance our Government’s reckless fiscal policies.

Over the past 5 years, our federal debt has increased by $3.5 trillion to $8.6 trillion. That is ‘‘trillion’’ with a ‘‘T.’’ That is money that we have borrowed from the Social Security trust fund, borrowed from China and Japan, borrowed from American taxpayers. And over the next 5 years, between now and 2011, the President’s budget will increase the debt by almost another $3.5 trillion.

Numbers that large are sometimes hard to understand. Some people may wonder why they matter. Here is why: This year, the Federal Government will spend $220 billion on interest. That is more money to pay interest on our national debt than we’ll spend on Medicaid and the State Children’s Health Insurance Program. That is more money to pay interest on our debt this year than we will spend on education, homeland security, transportation, and veterans benefits combined. It is more money in one year than we are likely to spend to rebuild the devastated gulf coast in a way that honors the best of America.

And the cost of our debt is one of the fastest growing expenses in the Federal budget. This rising debt is a hidden domestic enemy, robbing our cities and States of critical investments in infrastructure like bridges, ports, and levees; robbing our families and our children of critical investments in education and health care reform; robbing our seniors of the retirement and health security they have counted on.

Every dollar we pay in interest is a dollar that is not going to investment in America’s priorities. Instead, interest payments are a significant tax on all Americans—a debt tax that Washington doesn’t want to talk about. If Washington were serious about honest tax relief in this country, we would see an effort to reduce our national debt by returning to responsible fiscal policies.

But we are not doing that. Despite repeated efforts by Senators CONRAD and FEINGOLD, the Senate continues to reject a return to the commonsense Pay-go rules that used to apply. Previously, Pay-go rules applied both to increases in mandatory spending and to tax cuts. The Senate had to abide by the commonsense budgeting principle of balancing expenses and revenues.

Unfortunately, the principle was abandoned, and now the demands of budget discipline apply only to spending. As a result, tax breaks have not been paid for by reductions in Federal spending, and thus the only way to pay for them has been to increase our deficit to historically high levels and borrow more and more money. Now we have to pay for those tax breaks plus the cost of borrowing for them. Instead of reducing the deficit, as some people claimed, the fiscal policies of this administration and its allies in Congress will add more than $600 million in debt for each of the next 5 years. That is why I will once again cosponsor the Pay-go amendment and continue to hope that my colleagues will return to a smart rule that has worked in the past and can work again.

Our debt also matters internationally. My friend, the ranking member of the Senate Budget Committee, likes to remind us that it took 42 Presidents 224 years to run up only $1 trillion of foreign-held debt. This administration did more than that in just 5 years. Now, there is nothing wrong with borrowing from foreign countries. But we must remember that the more we depend on foreign nations to lend us money, the more our economic security is tied to the whims of foreign leaders whose interests might not be aligned with ours.

Increasing America’s debt weakens us domestically and internationally. Leadership means that ‘‘the buck stops here.’’ Instead, Washington is shifting the burden of bad choices today onto the backs of our children and grandchildren. America has a debt problem and a failure of leadership. Americans deserve better.

I therefore intend to oppose the effort to increase America’s debt limit.”

It’s amazing what  can be found on government websites.  The Social Security Administration posts a chart of their annual FICA tax revenue, from 1937 to 2009, a full seventy-two years’ worth (link).  It shows the Trust Fund’s cumulative surplus, and is reproduced below.

From inception to 1987, the Trust Fund surplus never toped $100 billion, and the Fund was in deficit eleven times over the first five decades, with expenditures exceeding FICA receipts.

Then, starting in 1988, as a result of  bipartisan legislation in the early ’80s supported by both Republicans and Democrats that increased the payroll withholdings for both employees and the employer, the Trust Fund went into significant surplus, growing slowly at first, then gathering speed.

In 2000, the Trust Fund surplus topped $1 trillion for the first time.

That massive surplus has remained there for twenty years, taking the Trust Fund surplus from $109 billion in 1989 to $2.5 trillion in 2009.

That money, of course, was invested into special U.S. Treasuries, as required by law.

More significantly, it means that between $40 billion and $190 billion extra revenue went straight into the general fund each and every year.

That tidal wave of money, added to the budget-cutting that began in 1994 and that came jointly from a Republican congress and a Democratic president, saw federal budget surpluses in the years 1998 to 2001, during the administration of President Bill Clinton (Link).

It was paid as FICA taxes by the Baby Boomers and Gen X, at the height of their earning years, and it enabled the government to balance its books for the first time in decades.

The true credit for balancing the federal budget at the end of the ’90s does not go solely to President Clinton, as claimed by the Democrats, or solely to Speaker Newt Gingrich and the Republican Congress, as claimed by the Republicans; credit goes as well to the American public, who made sacrifices, cut their household spending, and paid the additional FICA taxes that enabled that Trust Fund surplus to grow so dramatically.

In the ’80s, under Republican President Ronald Reagan and a Democratic Congress led by Speaker Tip O’Neill, bipartisan legislation changed the withholding tax (FICA) from 5.65% (the rate in 1977) to 7.65% (the rate for 1990 and beyond).

It was bipartisanship again in the 1990s that gave us budget reform that ultimately led to four years of balanced budgets, and in both cases, households did their part to make it succeed.

Solutions will come about when both sides of the aisle work together – working with each other, and with the American public – to live within our means.

It is easy to make promises that we are unable to afford; it is harder to make the tough choices that will leave us solvent as a nation into the future, and, more importantly, will leave a better world for those who follow.

We are in this together.

Some years back, at an annual company off-site retreat, a presenter was elaborating on money.  He gave many definitions, then asked us to think of money in a slightly different way.  Rather than thinking of it as a medium of exchange, he asked us to think of money as “stored work”.

He said that savings, especially robust retirement savings, represented substantial stored work.  We can think of savings, he said, as work that will not have to be done in retirement, because it was done earlier in life.

The work that is stored away — as money and savings — will originate, of course, from whatever we do for a living.  We can think of it as teeth filled, hours on the assembly line, fields plowed and planted and harvested, sermons given, investment analyses done — that will not have to be done in the future, because they have been done already.

If money is “stored work”, then savings, or cash reserves, are “work reserves” that we can draw from when we retire.  In one sense, we are continuing to work, and are simply using the credits from previous work.

It gives a different twist to the expression, “I’m calling in my marker”.  We get to call the marker, in a positive way, against the credits we have created.

The flip side of savings, of course, is debt; and – here is where it gets ugly — the logical extension, the corollary of savings being “work stored”, is that in truth, debt is “work owed”.  It is work to which we have obligated ourselves in the future.

Gotta have that new SUV, that bling?  How much are we willing to place a debt burden of future work on ourselves to have them?  How many hours on the assembly line, building widgets or meeting with clients or treating patients, are we willing to obligate ourselves to?

Debt creates a burden for future work that must be paid.  ”I’m calling in my marker” is the demand from the lender when the debt becomes due.

For individual debt and business debt, we are regulated in part by how much we can borrow, and in part by how we individually distinguish between “I need” and “I want”.

For government debt, it is also regulated to some degree by how much it can borrow.  The problem with government debt is that it does not have to be paid back by the entities creating it, and in many case, by the entities receiving the benefits.

We need to understand the enormous burden, the “work owed” obligation, that is represented by our annual budget deficit ($1.17 trillion), our cumulative debt ($15.7 trillion), and our unfunded future liabilities ($114 trillion) — promises that we have made to ourselves that we, and our children and grandchildren, will have to pay.

One hundred and fourteen trillion dollars:  that’s a lot of “work owed.”

When we launched this blog in January of 2010 the federal debt stood at $12 trillion.  The debt owed to the public (not including, that is, the US Treasury bonds held in the Social Security and Medicare trust funds—which Congress doesn’t have to pay interest on or pay back) was about $7 1/2 trillion.  We were collecting 15% of GDP in taxes, and spending 25% of GDP.

This was four months after the end of the recession, as defined by the Bureau of Economic Analysis.  High time to be talking about a bi-partisan effort to put the nation onto a sensible and responsible path.  We proposed several remedies to the dysfunctional budgeting process in Washington, ultimately paring the list down to three.  First was a balanced budget amendment to the Constitution which would allow deficits in time of recession or war.  Next was a line-item veto, because it’s incredible that congressmen are allowed to buy votes by inserting irrelevant pork-barrel spending into any old piece of legislation.  The third was a limitation on federal spending, splitting the difference between our 15%-of-GDP tax collections and our 25%-of-GDP spending.  It happens that we have never collected more than 20% of GDP in taxes, so that seemed to be a really good place to draw a line in the sand.

Nobody talks about the line-item veto any more;  President Clinton signed a bill into law in 1996, but it was declared unconstitutional in 1998 by the Supreme Court, and nobody has had the energy to try again.   The other two ideas, however, have gained a lot of traction;  and they’re usually bundled together in a single amendment to the Constitution that garners majority support but falls short of the 2/3 majority needed before it can be sent to the states for ratification.  The constitutions of most of the states demand balanced budgets, so we’re not worried about ratification . . .

Last year there were several of these bills in the House and Senate, and the ones that called for a 20%-of-GDP limit on federal spending received bipartisan support.  Since then there have been several similar bills calling for an 18% limit, but no Democrats have signed on.  It appears that Republicans are putting a stake in the ground for negotiating purposes, knowing that most Democrats will push for a figure above 20%.  In fact, the President’s budget proposals for the next 5 years would peg spending at 22.5%.

His challenger in the November elections has laid out budget plans that would spend at 20% of GDP.  The purpose of this post is point out that we’re not endorsing a Republican plan;  it just happens that most of Washington—a solid majority of congressmen and senators that includes politicians from both sides of the aisle—has come around to the recommendations we made two-and-a-half years ago.  During those two-and-a-half years the nation’s debt has grown to almost $16 trillion.

In 1997 a balanced-budget amendment came within of single vote of garnering 2/3 majorities in both houses of Congress.  This time it’s going to happen, via a bill created in the House, one created in the Senate, or one created by the states.  It will happen because it has to happen;  it’s one sure way to promise investors that our nation will embrace fiscal responsibility at some point in the next few years.  We can , alternately, reassure them by balancing the 2013 budget, but that doesn’t seem likely . . .

Our nation’s debt, as a percentage of GDP, is larger than that of Spain.  Investors have nevertheless lost confidence in Spain, and their refusal to buy that nation’s bonds (that is, their reluctance to lend money to Spain) has caused interest rates to rise.  Spain can’t afford to pay those higher rates of interest, and needs help from the other nations of Europe to avoid bankruptcy.  If you’ve read this far you already understand the problem;  if investors get nervous and interest rates rise, we won’t be able to afford to pay  a higher rate of interest on our own debt.  Even if you think it’s OK to stiff the Social Security and Medicare trust funds, a 10% interest rate on the other $11 trillion in debt would be more than a trillion dollars a year in interest!

Interest rates in the United States were quite a bit higher than 10% in the 1980s.  Don’t think it can’t happen here.

The legislatures of seventeen states have recently passed a bill calling for a constitutional convention that would be focused solely on the drafting of a balanced budget amendment to the Constitution.  Each of these bills explicitly states that it will be declared null and void if the Supreme Court rules that the convention cannot be limited to the drafting of a balanced budget amendment (BBA).

Next up is New Hampshire, where the bill has already passed the House.  Tomorrow, May 9, it will be taken up in the NH Senate (http://www.gencourt.state.nh.us/bill_status/quick_search.html — type in HCR 40).

No this would not mean budget cuts in time of recession, and no it’s not a mandate to leave spending untouched while raising taxes to cover unlimited wants;  there must have been a hundred of these bills proposed in the last two or three decades, and they’ve figured all those things out.  In 1997 an amendment came within a single vote of capturing 2/3 majorities in both houses of Congress, but the balanced budgets of the late 90s caused the passion to flare out.  Since then our debt has grown from 5.5 trillion to 15.5 trillion.  If interest rate were to rise anywhere near their highs of the last few decades we’d have to pay more than a trillion dollars a year in interest alone.  At that point a vicious spiral becomes almost inevitable.

A supermajority of American voters is already in favor of a BBA, and in recent months BBA bills have been filed in Washington with huge numbers of co-sponsors stepping forward from both sides of the aisle.

If you still have questions about the pros and cons of an amendment read this article, and then start writing letters to your representatives.  We’re only 3 or 4 years behind behind Greece, Portugal, and Spain, if investors take a pessimistic view, and we can’t look to Germany to bail us out.

And thy grandparents, and great-grandparents . . .

So often, we forget the sacrifices that have been made by those who came before us — those in our own families, and in so many other families — who gave so much of themselves to leave a better world for us who followed.

This author had grandparents born at the turn of the 20th century, over a hundred years ago, and a great-grandmother born just a dozen or so years after the Civil War; he had  a father and two uncles who fought in Europe and the Pacific, who helped overthrow tyranny and secure freedom for the world — freedom from totalitarian governments ruling close to a billion people, in the middle of the tumultuous twentieth century.

We owe an enormous debt to them, not just for the personal sacrifices they made, but for their sense of right and wrong that led them to believe in, and to do, the right thing.  It is a sense of right and wrong that they have tried to pass down to us.

I came of age in the mid-1960s, during the height of the Viet Nam War, and like so many of my contemporaries, I ended up in uniform, opposing what I believed to be a very political war, but loving my country, and the beliefs that have made it great, and the rights guaranteed in our Constitution — rights that cannot be taken away by a vote of the people.

My parents and grandparents taught us to be frugal and careful with what we earned, not because they didn’t want us to have good things in life, but because their lives had been forged, as children and young adults, in the furnace of the great depression.  Their lives were forged by scarcity; and they knew that to persevere, they needed to make wise decisions about spending.

Today, the business catchphrase is “smart money”; but to them, it was simply common sense.

“Live within your means”, we were told.  ”If you want something, save your allowance, save your paper route money, until you have enough to buy it with cash — it’ll be there, and if you still want it, buy it then.”

My mother understood well the psychology of saving: that I would be less likely to buy something if I had to save for six months before I could get it: because the effort and sacrifice of saving would then have an intrinsic value of its own, a value that would far exceed the perceived worth of whatever it was I “had to have”.

They knew  intuitively what we now explain with spreadsheets and  algorithms: that a person who saves, a person who spends wisely, will have at least as much over the course of a lifetime — and likely much, much more — than one who immediately spends everything he earns on things he wants but doesn’t need.

The wisdom of the ages comes to us from those who have gone before us.  We owe a debt of gratitude to those who have bequeathed this great nation to us.

There is an enormous cost to taxpayers — and to the American economy, and to government — by having the Social Security system structured and administered the way it currently is.

Holding the Social Security Trust Fund in safe but low-yield U.S. Treasuries — “backed by the full faith and credit of the United States government” — is expensive relative to other options available.  It will cost taxpayers vastly more than it did to create the $2.5 trillion Social Security surplus in the first place.

1)  America’s Taxpayers Will Pay $2.5 Trillion Twice to Fund the $2.5 Trillion Surplus 

The trust fund was created from surplus FICA taxes above and beyond what was needed by the Social Security Administration to pay immediate monthly benefits.

How are the taxpayers paying twice?

Taxpayers pay the first time as FICA taxes levied on wages.  The surplus FICA revenue, by law, must be invested in special U.S. Treasury bonds.  Your FICA taxes go into the Social Security and Medicare trust funds, but they are immediately loaned to the federal government—which spends the money and promises to repay it at some far-future date.  A Treasury bond, after all, is a loan to the federal government, which only borrows when it needs money to cover a shortfall.  Nothing is actually saved for Social Security;  instead, the cash is immediately spent elsewhere, and all that remains in the trust fund vaults is an IOU saying that the government will some day pay the debt off—with cash raised from the taxpayers.

This has been occurring since 1935, when the Social Security system was set up.  Over the past 76 years, the surplus account has accumulated $2.5 trillion in IOUs issued by the Congress that carry the fine title of U.S. Treasury bonds.

(In 1969, the process was made more visible when Lyndon Johnson, Richard Nixon and the 1969 Congress created the Unified Budget, essentially acknowledging publicly what had been going on for the previous 34 years).

Taxpayers will pay $2.5 trillion a second time when the Social Security Administration goes to the U.S. Treasury and exchanges the Treasuries for cash to pay benefits.  The Treasury, in real time, will collect the money needed to redeem them from America’s taxpayers.

Thus, America’s taxpayers will pay $5 trillion to provide $2.5 trillion in benefits; some of the taxpayers will be different people, but many Americans will be paying their FICA taxes twice in their lifetimes, first as FICA payroll taxes, and later as income taxes to redeem the Treasuries.

2)  Taxpayers Will Pay the Interest on the Trust Fund

The federal government pays the Social Security Administration interest on the Trust Fund; and the interest rate is currently around 4.62%.

Translation: the taxpayer is paying the interest, because the government only has money that it collects, directly or indirectly, from taxpayers.

3)  Taxpayers Will Pay the Opportunity Cost

The foregone opportunity of the Trust Fund to earn a return on the stock market is enormous.

If we take the actual FICA surplus, year by year from 1937 to 2009, and calculate the market growth or loss, year by year, for the same years, we would now have a Social Security Trust Fund worth $3.02 trillion.

That $3.02 trillion is very close to the current size of the Trust Fund; as of the end of 2009, it was $2.54 trillion.  However, there is a significant difference.

Had the surplus been invested, the Trust Fund would be real assets in real companies; and it could still be drawn on as needed to pay Social Security benefits.

There is no reason why the returns under this proposed scenario could not be guaranteed by the federal government, the same way that they’re guaranteed today: as a promise of payment in the the event of market failure, with funds raised from future taxpayers.

The big difference between these two scenarios is that we know  the government will have to make huge future payments to the trust funds under the current system, while it’s unlikely that it would ever have to make any future payments on a gurantee to trust funds that were invested the same way all pension plans are now invested.

The benefit stream with the Social Security surplus invested in Wall Street would be two to three times larger than the monthly Social Security benefits currently offered, and would range from $2,000 to $6,000 per month, instead of the current few hundred dollars to $3,400 per month (this calculation is based on the payouts of the Alternate Plan, the alternative to Social Security that has been in place in three Texas counties since 1982, and which is invested in the market).

4)  Foregone Growth of the American Economy

That $2.5 trillion, had it been invested in stocks, mutual funds, and corporate bonds, would have flowed into the private sector to drive growth of the American economy, in the form of plant expansion, capital projects, product development, sales promotions and marketing plans, new hires, and pay raises and promotions and bonuses.

It would have driven the competitiveness of the American economy.

“But”, you may argue, “wouldn’t that put the government in the position of picking winners and losers?”

Well, the public employee pension funds are currently invested in the stock market, and they have fund managers who function exactly the way fund managers do at the brokerage houses: under the strict requirements of fiduciary responsibility.

CalPERS, the nation’s largest public employee pension fund at $230 billion, has around $80 billion in equities.  The Alternate Plan in Texas invests in the market as well.  Both pay monthly benefits to their retirees that far exceed the benefits paid by Social Security.

If the market is safe for public sector retirement funds, it should be equally safe for all Americans, and for the Social Security Trust Fund.

5)  Foregone Tax Revenue That Would Have Come from Economic Growth

A letter-writer to the Wall Street Journal stated, regarding the basis of a sound currency:

“A strong, growing economy is the only thing that backs the U.S. Dollar.”

Paraphrasing this slightly: a strong, growing economy is the only thing that backs the government’s tax base.

Absent a strong growing economy, the foundation for government taxation is weak, and the economy cannot fully support government programs, let alone growth of government.

Final Thoughts 

If we think of the Trust Fund as a retirement account into which we have invested $2.5 trillion for the past 60 to 75 years, and the fact that $2.5 trillion will have to be paid all over again, then it is no different from investing in the stock market for six or seven decades, losing everything, and having to start all over again.

The equivalent market scenario for investing the Social Security Trust Fund into U.S. Treasuries is a 100% market loss, and having to start over again at zero.

The hypothetical market loss is actually greater than 100%, if one also considers that taxpayers are paying the interest on the Trust Fund.

The hypothetical loss is two times that 100% market loss — if we value the Opportunity Cost at $3.02 trillion as the foregone value of the Trust Fund had it been invested in the market.

CalPERS has used 8% historically to project returns on their investments in the market; they lowered the rate a couple of years ago to 7.75%, and in early 2012 to 7.50%, to reflect current market conditions.  The federal government pays the Social Security Administration 4.62% interest on the Trust Fund.

One of these is paid by the market, and one is paid by taxpayers.

Using Einstein’s “Rule of 72″ (i.e., divide the interest rate or market return into 72 to get the years it will take for the account to double), a 7.50% return will double a person’s investment in 9.6 years; a 4.62% return will double a person’s investment in 15.6 years.

The Social Security Administration, the American taxpayer, the U.S. economy, and the federal government would all be better served if a significant portion of the Trust Fund were invested in the market — yes, into Wall Street — or handed to CalPERS to manage, than to sit in U.S. Treasuries.

It would, of course, be backed by the same government (read: taxpayer) guarantee in the event of a market failure, just as it is now.

In a worse case scenario — a total market collapse — it won’t be any worse than the 100% market-loss-equivalent that is enshrined in current law; and the taxpayer would be on the hook for a lot less than having to pay $2.5 trillion a second time for something that has already been paid for once.

There is a better way.