POLITICS, DEFICITS, AND DEBT

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POLITICS, DEFICITS, AND DEBT

• The social security debate
• Its the demography stupid!

2
Social Security and Lockboxes

• Because the government uses a cash flow
  accounting system, statistics do not adequately
  describe the actual surplus.
• Cash flow accounting system an accounting
  system entering expenses and revenues only when
  cash is received or paid out.

3
Social Security and Lockboxes

• The Social Security System is currently running a
  large surplus in its portion of the budget.

• Some politicians have argued that a lockbox
  should be created to use the surplus to pay down
  the debt held by the public.

4
Pay-as-You-Go System

• The Social Security system was set up as a
  pay-as-you-go system.
• Pay-as-you-go system payments to current
  beneficiaries are funded through current payroll
  taxes.

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Pay-as-You-Go System

• The Social Security system is a partially
  unfunded pension system.

• Funded pension system the contributions plus
  interest paid by workers are used to fund those
  workers pensions.
• Unfunded pension system payments to current
  beneficiaries are funded through payroll taxes.

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Pay-as-You-Go System

• An unfunded pension system works smoothly as long
  as the populations age distribution, the annual
  death rate, and the number of people working do
  not change much.

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The Effect of the Baby Boom

• An unfunded system presents a potential problem
  if the amount paid in differs from the amount
  paid out.
• With a baby boom, the size of the retired
  elderly, the workers, and the very young who are
  not working, are no longer equal.

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The Effect of the Baby Boom

• When baby boomers retire, there will not be
  enough new entrants into the work force to pay
  their benefits.

• Payments per beneficiary must decrease, real
  contributions per worker coming in must increase,
  or some combination of the two must occur.

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Projection of Workers Compared to Retirees
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Projection of Workers Compared to Retirees
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The Social Security Trust Fund

• In 1983 legislation was passed to aid Social
  Security.
• It raised the age of eligibility slightly.
• Social Security tax rates were raised.
• Social Security payments became subject to
  taxation for some beneficiaries.

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The Social Security Trust Fund

• The social security system currently accounts for
  nearly all the government surplus.

• The portion of surpluses held by Social Security
  is not available for spending it is saved for
  the Trust Fund.

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The Social Security Trust Fund

• Because the elderly use significantly more
  medical services than younger people, the
  Medicare program will also experience significant
  funding problems in the future.

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The Real Problem and the Real Solution

• The real problem and the real solution are
  different from the financial problem.
• Even a fully funded Trust Fund will not solve the
  Social Security problem.

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The Real Problem and the Real Solution

• The reason is that the Trust Fund is simply a
  financial solution, not a real solution.

• A real solution would deal with the supply and
  demand of real resources, not with nominal
  amounts.

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The Real Problem and the Real Solution

• When the baby boomers retire in 2030

• Workers must produce enough goods for themselves
  and their families.
• They must also produce enough for the retired
  baby boomers.

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The Real Problem and the Real Solution

• Workers will have to produce enough both for
  themselves and for the large number of retirees.

• Real output per worker must increase but the real
  consumption of workers must not increase.

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The Trust Fund Illusion

• The Trust Fund is an accounting illusion.
• It backs one government obligation with another
  government obligation.

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The Trust Fund Illusion

• The Trust Fund has a positive effect on the
  problem, even if it does not solve the problem
  completely.

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Politics and Economic Policy

• Politics affects economic policy.
• A proposal to help the elderly with their drug
  expenses will, in 2020, make the situation worse
  for those still working.
• Another proposal is to invest the Trust Fund in
  the stock market the argument for this is
  dubious since the market can always fall.

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Politically Unpopular Policies

• Politically unpopular policies may be needed.
• The real solution is any policy that brings the
  real forces of aggregate supply and demand into
  equilibrium.
• The real amount baby boomers spend when they
  retire must be reduced otherwise taxes on those
  still working must be increased.

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Politically Unpopular Policies

• There are a number of ways this can be done, none
  of them politically appetizing.

• Increase taxes on those working in 2020.
• (since you dont vote this is what is happening!)
• Cut benefits once baby boomers start retiring.
• Make Social Security means tested.
• Increase the retirement age to 72.

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Summary

• A deficit is a shortfall of revenues over
  payments.
• A surplus is an excess of revenues over payments.
• Debt is accumulated deficits minus accumulated
  surpluses.
• Deficits and surpluses are summary measures of a
  budget.
• Whether a budget is a problem depends on the
  budgeting procedures that measure it.

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Summary

• A structural deficit is that part of a budget
  deficit that would exist even if the economy were
  at its potential income.
• A passive deficit is the part of the deficit that
  exists because the economy is below its
  potential.
• Structural deficit Actual deficit
  
  Passive deficit
• A real deficit is a nominal deficit adjusted for
  inflation.
• Real deficit Nominal deficit (InflationxDebt)

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Summary

• Government debt and individual debt differ in
  three major ways
• Government is ongoing and never needs to repay
  its debt.
• Government can pay off its debt by printing
  money.
• Most of the government debt is internal owed to
  its own citizens.
• Deficits, surpluses, and debt should be viewed
  relative to GDP because this ratio better
  measures the governments ability to handle the
  deficit and pay off the debt.

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Summary

• The Economic Growth and Tax Relief Reconciliation
  Act of 2001, an economic slowdown, and the war on
  terrorism contributed to a return to budget
  deficits in 2002.
• Beginning in 2017, the Social Security system
  will run deficits.
• The real problem is not the solvency of the
  Social Security system but the future mismatch
  between real production and real expenditures.

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Review Question 15-1 Distinguish between a
structural deficit and a passive deficit.
A structural deficit is the part of the budget
deficit that would exist even if the economy were
at its potential level of income. A passive
deficit is the part of the deficit that exists
because the economy is below potential.
Review Question 15-2 What are some of the
possible solutions to the problem of Social
Security solvency?
Increase taxes on those working in 2020. Cut
benefits to baby boomers when they retire. Make
Social Security means tested. Increase the
retirement age to 72. Privatization will not
solve the solvency problem because Social
Security is a partially unfunded pension system.
Funds diverted to private accounts would not be
available to pay as benefits to current retirees.