NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Are Trust Fund Surpluses Spent or Saved?

The outlays of the U.S. Social Security system are projected to rise dramatically over the next several decades as the baby boomers retire. While benefits today cost about 11 percent of taxable payroll, they are expected to rise to over 15 percent by the time the last boomers retire in 2026.

In order to partially pre-fund these outlays, Congress raised payroll taxes in 1983 beyond the level needed to pay benefits. The large annual Social Security surpluses resulting from the tax increase -- $150 Billion in 2003 alone - are saved in a trust fund to be used in the coming decades when benefit outlays exceed payroll tax receipts. This policy change was intended to spread the cost of financing baby boomers' retirements over multiple generations. Without this reform, large tax increases on future workers would be needed to pay the full benefits promised to retirees.

However, trust funds only help future generations of workers if they raise total government savings, so that future workers have more resources to meet benefit obligations and other spending needs. If the trust fund surplus is offset by increased spending or reduced taxes in the rest of the government, the extra resources will not be there. When the government operates under a unified budget that includes all revenues and outflows, offsetting spending increases or tax cuts may be more likely, as public debate may focus on the unified surplus or deficit rather than the surplus or deficit in the rest of the government excluding the trust fund.

In "Has the Unified Budget Undermined the Federal Government Trust Funds?" (NBER Working Paper 10953), Sita Nataraj and John Shoven explore this issue. The authors point out that although public attention has largely focused on the Social Security trust fund, the federal government also maintains trust funds for Medicare, unemployment insurance, civil service and military retirement, and transportation. The authors examine the relationship between the surplus in these trust funds and the surplus in the rest of the government (federal funds) using annual data from 1949-2003; the two series are shown in Figure 1. In their analysis, the authors account for the effect of other factors that may affect these surpluses, such as the business cycle, the interest rate, and the share of wages that fall below the Social Security payroll tax cap.

The authors find a strong negative relationship between the surpluses: an additional dollar of surplus in the trust funds is associated with a $1.50 decrease in the federal funds surplus. This finding is not significantly different from a $1.00 decrease, which would suggest a dollar-for-dollar offset of trust fund surplus with spending increases or tax cuts; the authors are able to reject the hypothesis that the full dollar of trust fund surplus is saved by the government.

To examine the theory that a unified budget makes offsetting spending increases or tax cuts more likely, the authors examine the relationship between the surpluses before and after the adoption of the unified budget in 1970. They find no effect of trust fund surpluses on federal funds surpluses before 1970 and a strong negative effect after 1970. The authors note "this confirms our argument that the adoption of the unified surplus is the factor that hinders the government's ability to save in the trust funds."

The authors also examine the theory that an increase in the trust fund surplus can raise national saving by raising personal saving. The reasoning is that payroll taxes disproportionately affect low-income individuals and income taxes disproportionately affect high-income individuals, who are more likely to save. Thus if trust fund surpluses are used to fund income tax cuts, personal saving may rise. The authors find that a $1.00 increase in the trust fund surplus may increase personal savings by about 50 cents, although this effect is not always statistically significant.

The authors conclude that the total debt of the government would have been $3 Trillion lower if the goal of government had been to balance the federal funds budget rather than the unified budget. The authors also address the question of whether trust fund assets are "real." They note that "from the perspective of Social Security, the trust fund does represent real claims on the rest of the government," but that "from the perspective of future generations of workers, the trust funds do not represent incremental wealth" and thus will not assist them in coping with Social Security's financial shortfall.

 
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