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| An Analysis of the President's Budgetary Proposals for Fiscal Year 2001 April 2000 |
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As the population ages, the nation will devote more of its resources to the needs of older people. Within the federal budget, increases in the number of people ages 65 and older will cause spending for Social Security and Medicare to grow faster than the economy. Because policymakers are concerned about the future of those programs, many focus on the status of the Social Security and Medicare trust funds and identify the solvency of those funds as an important policy objective.
In the public debate, "solvency" means keeping the trust funds from exhausting their balances and ensuring the ability of the funds to finance promised benefits. Defined that way, however, trust fund solvency is not a meaningful measure of the government's ability to meet its future obligations, for two reasons:
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The federal government accounts for its activities through
two broad groups of funds: federal funds and trust funds. All such funds
include both receipt and expenditure accounts. About 43 percent of federal
spending and 51 percent of federal receipts now fall within the trust fund
category. Over the past 50 years, those percentages generally have been
growing (see the figure below). Social Security, Medicare, federal employees'
retirement benefits, unemployment compensation, and many transportation
activities are conducted through trust funds.
Trust funds are simply accounts labeled that way in law. The funds are established to record collections that are earmarked in legislation for the specific purposes for which the funds were established. That characteristic is not unique to trust funds, however. Some categories of federal funds--special funds, revolving funds, and public enterprise funds, for example--also record receipts that are dedicated by law to specific activities. There are over 150 trust funds, but fewer than a dozen account for the vast share of trust fund dollars. Annual spending from such funds ranges from $1 million or less for activities like the Eisenhower Exchange Fellowship and the Israeli Arab Scholarship Trust Funds to more than $350 billion for Social Security's Old-Age and Survivors Insurance program. Federal government trust funds differ from private trust funds in significant ways:
Although a trust fund can use its income only for the purposes designated in law, the strength of the linkage between its earmarked receipts and its expenditures varies. Some funds spend their income as soon as it is collected, and the relationship between receipts and spending can be readily viewed. In other funds, many years may elapse before their income is spent. In those cases, the linkage becomes less direct. In addition to receipts from the public, trust funds record credits from federal funds. Those intragovernmental transfers take the form of interest earnings and other federal contributions. (For example, the general fund contributions to Medicare's Supplementary Medical Insurance, or SMI, Trust Fund cover about 75 percent of its costs.)3 Whereas spending from some trust funds may be limited to their income and available balances, other trust funds are authorized to borrow from the Treasury if they do not have sufficient income to finance their activities. Trust fund balances indicate that the government may provide
funding in the future for certain programs, but they do not have direct
economic significance. The government can only "prefund" future obligations--that
is, make it easier to meet them--by taking actions that enhance economic
growth. Reducing debt held by the public is one of the most effective means
of increasing saving and investment. Thus, the economy is the true "trust
fund" because it forms the pool from which future consumption--public
and private--will come.
1. Budget of the United States Government, Fiscal Year 2000: Analytical Perspectives, p. 337. 2. The federal government serves as a fiduciary trustee for some trust funds (such as the Thrift Savings Fund for federal employee) that are owned by their beneficiaries. The government accounts for those funds as deposit funds, which are nonbudgetary. Transactions between deposit funds and the government are treated as though they were transactions with the public. 3. Unlike the SMI trust fund, Medicare's Hospital Insurance (HI) Trust Fund does not have a backstopping contribution from general funds. One of the objectives of the Balanced Budget Act of 1997 (BBA) was to extend the solvency of the HI trust fund, which at that time was projected to become depleted in 2001. To help accomplish that goal, the BBA transferred certain spending for home health care services from the HI fund into the SMI fund. The transfer did not alter the federal government's costs, but it helped extend the life of the HI fund. |
The President's budget for fiscal year 2001 contains three proposals that the Administration asserts will postpone the insolvency of certain trust funds. The two largest proposals affect Social Security and Medicare trust funds. Another, much smaller proposal would appropriate general funds to the Black Lung Disability Trust Fund.
The President's budget would transfer amounts from general funds to the two Social Security trust funds (Old-Age and Survivors Insurance and Disability Insurance) and to Medicare's Hospital Insurance Trust Fund. The transfers to Social Security are intended to credit that program with a portion of the projected on-budget surpluses in 2011 and later years, as calculated by the Office of Management and Budget (OMB) on the basis of the President's 2001 budget request. According to the Administration's estimates, the first of those transfers would be for $100 billion in 2011, which is well beyond the time horizon that is being used during this year's budget deliberations. The transfers would grow to about $211 billion in 2015 and would be capped at that level through 2050. The transfers to the Medicare HI trust fund would add $299 billion to fund balances over 10 years--also by earmarking portions of projected on-budget surpluses. Transfers would take place in 2001 and 2002 and again in 2006 through 2010.
The Black Lung Disability Trust Fund records the collection of excise taxes on coal and expenditures for benefits paid to eligible coal miners and their survivors. The budget proposes to refinance the debt that the fund owes to the Treasury at a lower interest rate and to repeal a reduction in the excise tax rate scheduled for 2014. The trust fund would receive an appropriation that it would pay to the Treasury to compensate for lower annual interest payments. Because its operating expenses would be lower, the program's annual borrowing would be reduced. Eventually, the program might be able to cover its full costs and begin to pay off its accumulated debt.
The three proposals share a common characteristic: none of the transfers
would directly affect the government's ability to pay its obligations.(2)
The only way that today's lawmakers can make a given set of future obligations
more affordable for future generations is by taking actions to increase
national saving and investment. (See Box 3-2 for a discussion of how that
decision would affect different generations.) In the short term, economists
generally agree that the most effective action would be to maintain projected
budget surpluses and pay down debt held by the public. That action would
enhance economic growth and strengthen the nation's ability to pay for
all types of goods and services--whether they are provided through the
public or the private sector and benefit older citizens or other segments
of the population.
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Policy options for allocating budget surpluses--which the Congressional Budget Office estimates will total $3.2 trillion to $4.3 trillion over the 2001-2010 period, depending on the path assumed for discretionary spending--would affect different age groups differently. For that reason, it may be useful to consider the disposition of surpluses against the background of the Social Security and Medicare programs, whose benefits are largely provided to older people but whose financing comes mainly from younger, working people.1 Maintaining the projected surpluses by paying down debt held by the public, rather than dissipating them through increased spending or tax cuts, would allocate some of the responsibility of paying for the baby boomers' benefits to current workers. That action would help to reduce the burdens Social Security and Medicare will impose on future taxpayers because paying down debt will increase national saving and investment, thus enhancing economic growth. Those benefits, however, would be gained by increasing obligations on current workers. Running total budget surpluses forces current workers to finance part of their own future health and retirement costs. Because Social Security and Medicare are designed as pay-as-you-go systems--which means that payroll taxes go to finance current benefits--current workers "pay twice," once for the benefits of current retirees and once for a portion of their own future retirement costs. The alternative to maintaining surpluses--dissipating them--is unlikely to increase the ability of today's workers to collect future benefits. Although some tax cuts and some spending increases could enhance the economy's rate of growth, the legislative process makes it difficult to limit the use of surpluses to changes that are considered economically productive. Most of the current proposals for using the surplus are more likely to boost consumption than to increase saving and investment. In the absence of enhanced economic growth, future taxpayers
may be unwilling to pay for the baby boomers' benefits at current rates,
thereby prompting cuts in benefits. Whatever the shifts in burdens among
generations, one certainty is that actions promoting economic growth help
people of all ages.
1. More than 82 percent of federal revenues derive from individual income and payroll taxes. Workers under the age of 65 pay virtually all of the payroll taxes; the income tax burden also rests largely on people in that age group. The Congressional Budget Office estimates that taxpayers ages 65 and older contribute 14 percent of the revenues from individual income taxes. |
The Administration's proposals would create transactions between government accounts, but such intragovernmental transfers do not by themselves increase the resources available to the government. The budget's trust fund proposals could, however, have an indirect impact on budget outcomes:
In short, if the transfers were made, more debt might eventually
be paid off, but that gain could jeopardize needed reform. The consequences
could--over the long run--prove to be detrimental, not beneficial, to Social
Security, Medicare, and the government overall.
The President's Social Security and Medicare Trust Fund Proposals
The budget identifies solvency of the Social Security and Medicare trust
funds as among the President's top priorities and suggests measures that
it claims will help address the long-term challenges posed by an aging
population. Between 2010 and 2030, according to the intermediate assumptions
of the Social Security trustees, the number of older people in the United
States will increase by 72 percent while the number between the ages of
20 and 65 will grow by only about 4 percent. As the proportion of workers
to retirees declines, payroll tax revenues and other earmarked receipts
will cover a shrinking share of the Social Security and Medicare benefits
projected under current law (see Figure 3-1).
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Figure 3-1. Projected Expenditures and Receipts for Social Security and Medicare Combined |
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| SOURCE: Congressional Budget Office using data from 1999 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds (March 30, 1999) and Annual Report of the Board of Trustees of the Federal Hospital Insurance Trust Fund (March 30, 1999). |
| NOTE: Data are plotted at five-year intervals. |
| a. Includes payroll and income taxes, premiums paid by beneficiaries, and other noninterest receipts. |
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Any attempt to measure the solvency of the Social Security and Medicare trust funds outside the context of the rest of the budget provides an inadequate perspective on their financial status. The ability of the government to meet its obligations to Social Security and Medicare beneficiaries depends on the government's overall fiscal condition. Under current policies, as the population ages, funding for those programs will shift from payroll tax collections to general revenues and, eventually, proceeds from borrowing. That will be true whether or not there are trust fund balances. Thus, whatever the balances in the trust funds, future policymakers will have to decide how much to tax, spend, and borrow not only for Social Security and Medicare benefits but for the rest of government as well.
The budget does not address the long-term fiscal imbalance of the current situation. Instead, the Administration's plan would simply assign amounts to the Social Security and Medicare trust funds based on projected budget surpluses.
The President's Social Security Plan
Although Social Security currently brings in more in taxes than it pays out in benefits, that pattern will reverse as the baby-boom generation retires. The change will occur beyond the present 10-year horizon for budget projections and is barely apparent in the Congressional Budget Office's current baseline. CBO estimates a Social Security surplus under current policy of $166 billion in 2001, growing to $293 billion in 2010. Virtually all of that increase stems from growth in interest credited to the trust funds, not the excess of payroll and income tax receipts over benefits.
Shortly after 2010, surpluses will begin to decline as the ratio of workers to beneficiaries decreases. According to the March 1999 report of the Social Security trustees, under the intermediate set of assumptions, payroll taxes and other noninterest income (including income taxes on Social Security benefits) will exceed expenditures until 2014. Beginning in that year, financing from non-payroll-tax revenues or public borrowing will have to supplement payroll taxes to meet current-law benefit payments. The trustees estimate that the gap between benefits and payroll taxes will be almost 0.5 percent of taxable payroll in 2015 (roughly $19 billion in today's dollars) and will grow to nearly 5 percent of taxable payroll (in today's figures, $190 billion, or 2 percent of gross domestic product). The Social Security trust funds will have balances to pay benefits until 2034 (the projected year of trust fund depletion). But after 2014, Social Security will stop making positive contributions to the government's bottom line and instead will impose net costs on the total budget.
The President's budget expressly recognizes that the government's ability to pay benefits "does not arise from the building up of large trust fund balances in and of itself" (emphasis in the original) and instead is "related to the health of its overall fiscal position and of the economy as a whole, rather than a simple function of trust fund balances."(3) However, because the budget does not propose policies to address the imbalance between tax income and benefit costs, it would not actually change the programs. Instead, it would just postpone the date when the trust funds became insolvent on paper.
The President's plan for Social Security consists of the following measures:
"Saving" the Social Security Surpluses. Under its baseline assumptions, CBO estimates Social Security surpluses of $2.3 trillion and total budget surpluses of between $3.2 trillion and $4.3 trillion (depending on which path is assumed for discretionary spending) for the 2001-2010 period.(5) The President's budget would result in on-budget surpluses, CBO projects, that would be between $470 billion and $1,525 billion lower than the levels projected under CBO's baseline variations, and all available debt held by the public would be redeemed by 2010.
Although details are not provided in the budget, the proposed "lockbox" would seek to ensure that debt held by the public shrank by at least the amount of the Social Security surpluses. Such mechanisms are intended to create procedural hurdles that would make it more difficult to enact legislation that might lead to on-budget deficits. The perceived need for such constraints reflects the view that policymakers will be tempted to put projected surpluses to other uses. But unless the mechanism actually had a strong influence over decisionmakers' behavior, it would have no direct effect on taxes and spending or on the economy. Experience with the fixed deficit targets enacted in the Balanced Budget and Emergency Deficit Control Act of 1985 shows that achieving bottom-line targets is a more difficult task than setting them.
"Interest Savings" Transfers to Social Security. As surpluses accrue to the budget, debt held by the public falls and the government's interest costs shrink. The Administration states that because total surpluses include large Social Security surpluses, the trust funds should be credited with "all of the interest savings that we get from saving the Social Security surplus."(6) The Social Security trust funds already receive credits for interest on their accumulated balances under current law. CBO estimates that $1.2 trillion, or 53 percent, of Social Security's projected surpluses for the 2001-2010 period will be in the form of interest. The proposed transfers would simply add extra interest credits on top of those that will be provided anyway. Carrying out such transfers would require legislation to override section 710 of the Social Security Act, which prohibits any payments from the general fund to the trust funds and payments from the trust funds to the general fund that were not authorized as of December 12, 1985 (the date the Deficit Control Act was enacted).
The transfers themselves would have no economic significance because they would flow out of one government fund and into another. Transferred amounts would be limited by the on-budget surpluses currently computed by OMB on the basis of the President's 2001 budget, but they would take place whether or not projected on-budget surpluses were actually achieved. OMB estimates that $100 billion would be transferred in 2011. The transfers would grow each year through 2015 and remain frozen at that year's amount through 2050. Half of the transferred amounts would be invested in corporate equities until 15 percent of trust fund holdings were invested in private equities. (The Social Security actuaries estimate that the transfers and earnings from private securities would extend the trust funds' solvency through 2054.)
The additional transfers, like the interest credited under current law, would be charged against the general fund and credited to the trust funds. But such bookkeeping entries do not provide actual resources to the government. The proposed transfers would be nothing more than intragovernmental accounting transactions--although they would reduce on-budget surpluses and increase off-budget surpluses by the same amounts. Total budget surpluses would be unaffected, and the burden of paying future benefits would be unchanged.(7)
Other Proposals Included in the President's Social Security Plan. The budget proposes to raise and extend the current statutory caps on discretionary spending and to extend the pay-as-you-go requirement for changes to mandatory programs and tax law. Those provisions, which were designed to enforce budget targets and reduce deficits, will expire after 2002. As long as the Congress and the President remain committed to budgetary discipline, extending budget enforcement laws may make it more difficult to dissipate on-budget surpluses. But if policymakers' priorities change, procedural barriers will lose their effectiveness.
The President's plan also urges the Congress to work with the Administration on reforms to keep the Social Security trust funds from exhaustion for the next 75 years. (That is the period used by the actuaries to evaluate the program's financial health.) However, the budget does not propose any specific measures to reduce the gap between earmarked receipts and projected costs. Indeed, it demonstrates that the actuarial goal could be achieved, at least on paper, through additional transfers rather than substantive changes in program benefits or revenues. Those transfers would permit benefit levels to be maintained through greater infusions of general funds, but future taxpayers would still have to pay the bills.
The President's Medicare Transfers
Medicare benefits are financed through two trust funds. Payroll taxes and other receipts are credited to the HI trust fund to pay for inpatient hospital stays, certain home health and nursing home services immediately following a hospital stay, and hospice care. The Supplementary Medical Insurance (SMI) Trust Fund pays for physicians' services, other ambulatory treatment, home health services that do not immediately follow a hospital stay, and other outpatient services. Beneficiaries' premiums pay for 25 percent of SMI costs. An annual infusion of general funds to the SMI trust fund covers the remaining 75 percent.
There is a structural imbalance between Medicare spending and the revenues that are specifically dedicated to the program. CBO estimates that under current law, the gap between noninterest Medicare receipts (including SMI premiums but excluding general fund transfers) and spending will grow from 0.8 percent of GDP in 2000 to 2.7 percent in 2030, a shortfall larger than that projected for Social Security.(8) (That estimate also assumes that the annual growth in Medicare costs eventually moderates, as the Medicare trustees project.) The President's budget, however, proposes to increase spending for Medicare by $69 billion between 2001 and 2010, CBO estimates. Those additional costs would grow in future decades and widen the long-term gap between receipts and spending.
Extending the Solvency of the Hospital Insurance Trust Fund. Instead of proposing specific policy measures to close the long-term gap between Medicare HI costs and noninterest receipts, the budget proposes to assign an extra $15 billion in 2001 and $13 billion in 2002 to the HI trust fund. Another $271 billion would be credited to the fund between 2006 and 2010. The Administration projects that those transfers and the additional interest credits associated with them (which CBO estimates would total $43 billion) would help keep balances in the HI trust fund until 2025--10 years longer than the estimates of when the fund would be depleted provided by Medicare's actuaries in March 1999. Since those amounts would not be needed immediately to pay benefits, the transfers would add to trust fund balances and make the HI program appear stronger financially. However, because such transfers would provide no new resources to the government as a whole, they would neither affect projected on-budget or total surpluses nor change the government's ability to meet future Medicare obligations.
Reserve for Catastrophic Prescription Drug Coverage. The text
of the President's budget identifies a "reserve" of $35 billion to cover
the costs of policies to provide for "protections against catastrophic
drug costs for Medicare beneficiaries, or policies that otherwise strengthen
the Medicare program."(9)
Between 2006 and 2010, the funding for those new benefits would come from
projected on-budget surpluses. However, the surpluses displayed in the
President's budget are not reduced to pay for the new program, and the
budget does not show additional funding in the Medicare accounts. Instead,
the budget uses the $35 billion for debt reduction. If the Congress and
the President agreed to use that amount for catastrophic drug coverage,
surpluses would be $35 billion lower (plus associated debt-service costs)--and
debt held by the public would be that much higher--than the numbers shown
in the budget. (Like the President's budget, CBO's analysis counts the
$35 billion as part of the surplus and the reduction in publicly held debt.)
The President's Black Lung Disability Trust Fund Proposal
The President's budget proposes to provide $1.5 billion to the Black Lung Disability Trust Fund to refinance its outstanding debt to the Treasury. That proposal, although small in comparison with the Social Security and Medicare solvency proposals, helps to illustrate how trust fund accounting can generate complicated bookkeeping transactions that have no economic significance.
The Black Lung Disability Trust Fund records both income from the excise taxes imposed on mined coal and expenditures for benefits to eligible miners and their survivors and for the administrative costs of the program. Excise tax receipts have never been sufficient to cover the program's full cost, but the trust fund has the authority to borrow from the Treasury to make up the difference. Between 1978 and 2000, the trust fund borrowed $6.7 billion. Excise tax collections in 2000 are expected to be sufficient to pay benefits and cover the program's administrative costs, but they fall well short of meeting the $533 million bill for interest. As a result, the fund has to borrow to pay that bill and continues to be mired in spiraling debt and interest costs.
To improve the fund's financial status, the budget proposes to reduce its annual expenses by refinancing its Treasury debt at a lower interest rate and to repeal a reduction in the excise tax rate that is scheduled for 2014. The budget would provide the trust fund with an appropriation of $1.5 billion to compensate the Treasury for any loss in annual interest payments. That appropriation would constitute a general fund subsidy to the trust fund, explicitly recognizing that the tax revenues earmarked for the fund are inadequate to finance payments from it. The program's benefit costs are declining, and if interest costs were lowered and tax revenues were maintained, the program might eventually be able to meet its obligations (including interest expenses) without new borrowing. The proposal's impact would be limited, however. Through 2005, CBO projects that the fund's borrowing and annual interest costs would still rise faster than benefit payments will decline. By CBO's reckoning, even if the budget proposal was adopted, the fund would have to continue to borrow each year through 2010. (Although CBO does not make budget projections beyond a 10-year period, the trends evident in the projection indicate that the trust fund would not begin to cover its operating costs, let alone be able to repay its debt, until far into the future.)
If the Black Lung Disability Trust Fund clearly linked excise tax receipts
with program expenditures, the need to reduce benefits or increase taxes
would be readily apparent. The convoluted flows between the trust fund
and the general fund of the Treasury would be unnecessary if excise tax
receipts covered costs for benefits, administration, and interest. Instead,
the budget proposes to address the fund's insolvency without affecting
coal mine operators or Black Lung beneficiaries. It would use bookkeeping
changes to shift costs away from those who pay excise taxes--initially,
the coal industry--and assign them instead to general taxpayers.
1. The President's budget proposes to invest a portion of the Social Security trust funds in private equities beginning in 2011. That use of resources would depart from the current requirement that the trust funds invest only in Treasury securities. The budget proposal would alter the composition of trust fund holdings but would not necessarily improve the government's overall financial condition.
2. This discussion is limited to the impact of the transfers and does not include the proposal to invest part of the transferred amounts in private equities. That action could have economic consequences and affect the calculation of total budget surpluses and publicly held debt, but it would not necessarily improve the government's overall fiscal condition.
3. Budget of the United States Government, Fiscal Year 2001: Analytical Perspectives, pp. 345-346.
4. The proposals to raise and extend the caps on discretionary spending and extend the pay-as-you-go provisions are addressed in Chapter 1 of this volume.
5. Appendix A discusses the three paths for discretionary spending used in CBO's baseline.
6. Comments by Jack Lew, Director of the Office of Management and Budget (press briefing on the fiscal year 2001 budget, February 7, 2000).
7. This discussion excludes the potential effects of the budget's proposal to invest a portion of the transferred amounts in corporate equities.
8. See the statement by Dan L. Crippen, Director, Congressional Budget Office, before the Subcommittee on Health, House Committee on Ways and Means, September 22, 1999.
9. Budget of the United States Government, Fiscal Year 2001, p. 72.
