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Sunday, July 24, 2011

Contra McConnell's "Contrary to the President"

UPDATE: SEE EDITS BELOW, IN ITALICS.

Citing columns by Thomas Saving and by Mark Scarberry and Nancy Altman, Michael McConnell argues that there is no reason to worry about whether Social Security checks will be payable in the event that Congress does not raise the debt limit. Based on the "Trust Fund FAQs" page maintained by Social Security's Office of the Chief Actuary, though, there is a major hole in the argument McConnell & company make: it ignores the revenue side of the Social Security system, assuming that these revenues can be treated as assets of the Treasury rather than of the trust funds.

Before I detail the McConnell argument, it will be useful to note some basic details of the SS system. Supplemental Security Income (SSI) payments are typically made on the first of the month, and other SS payments are made on the 3rd of the month, which I assume helps explain the importance of Aug. 2, as well as the 2nd, 3rd, and 4th Wednesday. At the same time, the OASDI tax revenues that fund the SS system come in to the Treasury on a daily basis.

Why does this matter? Suppose for simplicity that the system will pay out $80 billion in August, in four equal payments of $20 billion, and suppose that there are 20 business days on each of which $4 billion of OASDI revenue is collected (nothing important hinges on the exact details of these assumptions--they're just for clarity's sake). Effective operation of the SS system requires that the system have a way to make a small number of lumpy payments even as it receives a smooth stream of revenues over a longer number of days. According to the "Trust Fund FAQs" page, trust fund income is immediately invested, on a daily basis, in special Treasury securities. Each dollar of such securities that are issued increases the debt held by the public by one dollar. On the day when checks are to be issued, the trust funds redeem just enough of their Treasury securities to make good on the system's benefit obligations. 

This brings me to the McConnell argument, which boils down to the claim that when the debt limit binds, the SS system can redeem its securities from Treasury in a way that does not increase the net debt held by the public. Since each dollar of principle redeemed will reduce the debt held by the public by one dollar, the argument goes, Treasury can then auction off a standard bond in the amount of one dollar and deliver the proceeds of this bond sale to the SS system. The net effect of these transactions would be to leave the total debt held by the public unchanged, argues McConnell, and voila, the SS system has made good on its liabilities.

The problem with this argument is simple: it ignores the two facts that OASDI revenue belongs to the trust funds, and that that revenue arrives smoothly over time rather than as the system's lumpy liabilities come due.  Consider my example again, with the added assumption that the debt limit exactly binds as of 11:59pm on August 2. Now, on August 3, the SS system will have to make $20 billion in payments but will receive only $4 billion in revenues. This means it will seek to redeem $16 billion in special Treasury securities; a la McConnell, Treasury could finance this redemption via a new issue of $16 billion in standard debt without violating the debt limit.*

Fine.

But what happens on August 4? On that date, the SS system will make no benefit payments and thus redeem no Treasuries. However, another $4 billion in OASDI revenues will come in...and be immediately invested in Treasuries. This means that the debt held by the public will increase by $4 billion, putting Treasury over the debt limit.

The only way that Treasury won't wind up over the debt limit in this scenario is if somehow the OASDI revenues are treated as general federal income tax revenues, so that they are not immediately invested in Treasury securities on August 4. The WSJ column by Saving to which McConnell links assumes this is true, based on Saving's discussion of the 1937 Supreme Court opinion in Helvering v. Davis, but that can be right only if the Trust Fund FAQs page linked above is wrong, which I do not believe to be the case (if you think Saving is right, ask yourself how the current stock of trust fund-held securities got there in the first place). My understanding is that, by statute, these revenues are immediately invested in Treasuries.

Assuming this is correct, the only way to make all SS benefit payments on the regularly scheduled dates in my example would be to reduce the flow of other types of spending sufficiently, ahead of time, to run a general-fund surplus on dates when no SS checks are cut. If the Treasury did that, then it would have a $16 billion cushion on August 3. the SS system would be in balance over the full week, and  But notice that to do this, Treasury would be running a general-fund surplus, in the week before August 3, six days a week whose aggregate savings exactly equaled the deficit incurred by paying SS benefits on the scheduled date. This means that Treasury would have to reduce general-activity spending by an average of $3.2 billion per day the week before August 3. My rough calculations suggest that this is a huge share of Treasury's normal expenditures, causing the approximate equivalent of a one-week shutdown of the federal government's non-SS activities.

I’ll put up another post concerning the impact of such a policy. To conclude for now, Thus, in the absence of other measures, making SS payments on their scheduled dates in the absence of a debt limit increase requires more than the simple accounting trick McConnell and company have suggested: it requires Treasury to run a general fund surplus rather than a balanced budget before August 3. Unless the Office of the Chief Actuary is wrong about the mechanics of the SS system's financing, making these payments as scheduled might therefore lead to a substantial disruption in normal government activities in the non-SS sector. would require Treasury to reduce its other required payments even more than if SS payments were made as OASDI revenues arrive.

There might be an alternative approach, depending on the technical capacity of the SS system's check-cutting facilities. Starting August 4, SS checks could be paid ahead of time, as Treasury receives revenue. The result would be that the SS system would be issued no new Treasury securities on non-payment days, which would keep the debt held by the public from rising as a result of these revenues' receipt.

*I'm ignoring everything else the government pays for, which is beside the point of McConnell's argument.

Posted by Jonah Gelbach on July 24, 2011 at 11:06 AM | Permalink

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