The Congressional Budget Office projects that the budget deficit will total $1.342 trillion in fiscal 2010 (which is a pretty firm projection since the year ends on September 30th). That is $71 billion less than fiscal 2009, and $27 billion lower than what it projected last time it did the numbers in March.
For 2011 and beyond, the CBO is required by law to assume that current law remains in place, which means that all of the tax cuts of 2001 and 2003 expire on schedule. That is unlikely to happen, as the current political fight is if we should extend all of the tax cuts, or just the tax cuts that impact 97% of all people. If all the tax cuts were to expire, we would see a dramatic decline in the budget deficits over the next few years. The on-budget deficit would drop from $1,550 billion in fiscal 2009, and $1.419 billion in 2010 to “just” $766 billion in fiscal 2012.
The CBO projects that over the next few years, the off-budget surplus, which is mostly the build-up of the Social Security Trust Fund (it also includes some smaller trust funds, and some of the cash flows of the postal service) will rebound, but will take until 2015 before it gets back to its fiscal 2009 level. After 2018, they start to decline again, and will do so rapidly and as the surplus turns to deficit, the trust fund will start to dig into principal. As it does so, it will be redeeming the bonds that it holds and the trust fund is expected to be exhausted in 2037.
At that point the Social Security system will be back on a pay-as-you-go basis, the same basis it was on before the Greenspan Commission of 1982 resulted in a big increase in the payroll tax in 1983. (That’s right: Reagan raised taxes). The off-budget surplus includes the interest payments on the assets that the Social Security trust fund has already accumulated.
How It All Works
The most widely quoted numbers on the deficit are the total deficit numbers, not the on-budget ones. Consistently over the last quarter century, the off-budget numbers have been in surplus, and that has served to “hide” the true amount of the deficit. That is not going to be the case forever.
The whole point of the trust fund was to collect more money from the payroll tax than was needed on a pay-as-you-go basis during the peak earnings years of the Baby Boomers so there would be a reserve there when the Boomers retired. That money was invested in one of the safest investments around (at least if you hold until maturity), namely T-bonds and T-notes. In effect, the government was lending money to itself.
However, there are two different revenue streams. There is the income tax, both corporate and individual, which is supposed to fund the normal operations of government, things like wars and food inspectors and the FBI. Then there is the payroll tax (FICA on your pay stub), which pays for Social Security (half you see on your pay stub, half is paid by your employer, at least in theory. The economic reality is that it really doesn’t matter which side you apportion it to -- the wedge between what it costs an employer to keep you on the job and what you see in your paycheck is the same regardless if it were completely hidden from you by putting it all on the employer, or completely open by putting it all on your pay stub.
The income tax is primarily paid by the rich and upper middle class. The payroll tax is mostly paid by the poor and lower middle class. It is assessed on the first dollar of income, and stops being assessed when you income for the year goes over $106,000. The rate is the same on the first dollar as it is for the 105,999th.
There are many that moan about the something like 50% of the population that don’t earn enough to have to pay income taxes, with the implication that all the people who are working 45 hour weeks at $12 an hour are nothing but freeloaders. But those people do pay payroll taxes.
The Poor Are Lending to the Rich
With the Payroll side consistently running a surplus, and the Income tax side of the government consistently running a deficit, it not so much a case of the government borrowing from itself, as the income tax side borrowing from the payroll tax side. In other words, the poor are being forced to lend to the rich through the tax system.
For that reason, I find the current efforts to cut future Social Security benefits to be extremely troubling. In effect, what is being proposed is for the income tax side of the government to welch on its debt to the payroll tax side of the government. That would be a massive transfer of wealth from the poor and lower middle classes to the rich -- perhaps one of the greatest swindles in all of economic history.
Raising the retirement age (it has already gone up from 65 to 66 and is scheduled to go up to 67) is simply an across-the-board cut in Social Security benefits. Yes, life expectancy at birth has increased dramatically since the Social Security system was introduced 75 years ago, but most of that came from a reduction in infant mortality rates, which have no bearing on Social security. If a child died from polio at age five, he neither paid into Social Security nor got any benefits from it.
Life expectancy at age 65 has only increased by about 4 years since Social Security was introduced. Cynically, the best thing to happen from the point of view of the Social Security system would be to go back to the 1960’s when people smoked like chimneys. The “best” thing possible from the point of view of Social Security solvency would be to have large numbers of people going to meet their maker in their early 60’s.
Two Ways to Look at Social Security
Put another way, there are two ways to look at the Social Security system, either as part of the overall federal budget, or as a stand-alone entity. There is substantial validity to each point of view. The problem comes when people switch back and forth between the two views. If one sees it as all one package, then Social Security is simply another government program, and there is really no trust fund.
However, in that case, there is no way that the Social Security system can go bankrupt. Talk of it doing so is just plain silly. Does anyone talk about the Justice Department going bankrupt, or the Pentagon having to file Chapter 11? Of course not -- they are simply government programs, and as long as the federal government is borrowing in dollars and owns the printing press, it (and by extension the programs) cannot go bankrupt.
If Social Security is just another program, then talk about it going bankrupt is as silly as talk of the Pentagon going bankrupt. It also would be an acknowledgement that both the payroll tax and the income tax are both means of funding the same overall government budget. Thus, claims that the rich are the only ones really paying taxes are just plain BS.
On the other hand, it you view them as two separate programs, then the trust fund is real, and the bonds that it holds are every much an obligation of the government as are the ones held by T. Rowe Price (TROW) or Franklin Templeton (BEN), or for that matter the Peoples Bank of China.
It also means that it is possible for the Social Security system to go bankrupt. Come 2037 when the trust fund runs dry, it would be back on its pay-as-you-go footing, and could only pay out 78% of the currently scheduled benefits. Also from that point of view, the argument about the wealthy funding most of the government has a lot more validity, and the payroll tax is effectively not a tax, but a form of forced savings.
Keep the Two Perspectives Straight
In any discussion of the future of Social Security, make sure that you keep the two perspectives straight and know which point of view you are looking at the situation from. Be prepared to call BS on those who mix and match the perspective to suit their political agenda (also, if you start to mix them up, be prepared to call BS on yourself).
Personally I believe in a progressive income tax and feel it is fair for people earning $300,000 a year to pay a higher percentage of their income in taxes than those who only earn $30,000 a year. In large part, that is simply a value judgment on my part -- my feelings about what a just society should look at. However, I also think that within reason, a progressive income tax leads to a stronger economy.
Yes, marginal taxes can get so high that they discourage work and thus hurt the economy, but there is no evidence that we are anywhere near that point now, or would be if the top tax bracket (which only kicks in over about $400,000 per year) were to go back to the Clinton-era rate of 39.6%. I thus have no problem with large numbers of poor and working people paying no income tax.
After all, when the 16th amendment to the Constitution was passed, the one that allowed for an income tax, it was only supposed to apply to the very rich. In 1914, right after the Amendment became law, less than 1% of the population had to pay it.
Reading the Chart
Projections for the long-term are on the optimistic side, since they assume not only that all of the Bush tax cuts go away, but also that Congress takes no action to prevent millions more people being pushed by inflation into the Alternative Minimum Tax (AMT) system. They also assume that no further action is taken to spend anything to help stimulate the economy.
Those assumptions are clearly unrealistic. Still, the report highlights just how much the current big deficits are caused by falling revenues due to a weak economy (also responsible for the big drop in the off-budget surplus; fewer people on the payroll means less payroll taxes coming in).
As the graph shows, revenues as a share of GDP (both payroll and income tax revenues) have fallen precipitously as a share of GDP, while spending is up sharply. Spending is expected to dip a bit over the next few years but is projected to remain high, while revenues are expected to recover to their historical average share of GDP by 2020, but that assumes all the tax cuts go away, not just the ones on top earners.
The structural budget deficit, or the budget deficit that is expected to remain after the economy is fully recovered (assumed to be 2013), is seen to be between 2.5% and 3.0% of GDP, which is what it is projected to be between 2014 and 2020.
Federal debt held by the public (which means everything the government owes to the outside, but not to the trust funds or held by the Fed) is expected to rise to 61.6% of GDP in 2010 from 53.0% in 2009. In 2011 it is expected to rise to 66.1%, and is expected to continue to rise after that, but at a much slower pace as the deficit shrinks as a share of GDP, and GDP grows. If GDP grows faster than the size of the budget deficit is as a share of GDP, then debt as a percentage of GDP will tend to fall.
Without a doubt, a full employment deficit of 2.5% or 3.0% of GDP is way too high, and steps will need to be taken to bring it down. However, they are a lot less scary than the current deficits of over 9% of GDP. A chronic, not an acute disease -- but one that, over time, has the potential to be debilitating.
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The CBO projects that over the next few years, the off-budget surplus, which is mostly the build-up of the Social Security Trust Fund (it also includes some smaller trust funds, and some of the cash flows of the postal service) will rebound, but will take until 2015 before it gets back to its fiscal 2009 level. After 2018, they start to decline again, and will do so rapidly and as the surplus turns to deficit, the trust fund will start to dig into principal. As it does so, it will be redeeming the bonds that it holds and the trust fund is expected to be exhausted in 2037.
At that point the Social Security system will be back on a pay-as-you-go basis, the same basis it was on before the Greenspan Commission of 1982 resulted in a big increase in the payroll tax in 1983. (That’s right: Reagan raised taxes). The off-budget surplus includes the interest payments on the assets that the Social Security trust fund has already accumulated.
How It All Works
The most widely quoted numbers on the deficit are the total deficit numbers, not the on-budget ones. Consistently over the last quarter century, the off-budget numbers have been in surplus, and that has served to “hide” the true amount of the deficit. That is not going to be the case forever.
The whole point of the trust fund was to collect more money from the payroll tax than was needed on a pay-as-you-go basis during the peak earnings years of the Baby Boomers so there would be a reserve there when the Boomers retired. That money was invested in one of the safest investments around (at least if you hold until maturity), namely T-bonds and T-notes. In effect, the government was lending money to itself.
However, there are two different revenue streams. There is the income tax, both corporate and individual, which is supposed to fund the normal operations of government, things like wars and food inspectors and the FBI. Then there is the payroll tax (FICA on your pay stub), which pays for Social Security (half you see on your pay stub, half is paid by your employer, at least in theory. The economic reality is that it really doesn’t matter which side you apportion it to -- the wedge between what it costs an employer to keep you on the job and what you see in your paycheck is the same regardless if it were completely hidden from you by putting it all on the employer, or completely open by putting it all on your pay stub.
The income tax is primarily paid by the rich and upper middle class. The payroll tax is mostly paid by the poor and lower middle class. It is assessed on the first dollar of income, and stops being assessed when you income for the year goes over $106,000. The rate is the same on the first dollar as it is for the 105,999th.
There are many that moan about the something like 50% of the population that don’t earn enough to have to pay income taxes, with the implication that all the people who are working 45 hour weeks at $12 an hour are nothing but freeloaders. But those people do pay payroll taxes.
The Poor Are Lending to the Rich
With the Payroll side consistently running a surplus, and the Income tax side of the government consistently running a deficit, it not so much a case of the government borrowing from itself, as the income tax side borrowing from the payroll tax side. In other words, the poor are being forced to lend to the rich through the tax system.
For that reason, I find the current efforts to cut future Social Security benefits to be extremely troubling. In effect, what is being proposed is for the income tax side of the government to welch on its debt to the payroll tax side of the government. That would be a massive transfer of wealth from the poor and lower middle classes to the rich -- perhaps one of the greatest swindles in all of economic history.
Raising the retirement age (it has already gone up from 65 to 66 and is scheduled to go up to 67) is simply an across-the-board cut in Social Security benefits. Yes, life expectancy at birth has increased dramatically since the Social Security system was introduced 75 years ago, but most of that came from a reduction in infant mortality rates, which have no bearing on Social security. If a child died from polio at age five, he neither paid into Social Security nor got any benefits from it.
Life expectancy at age 65 has only increased by about 4 years since Social Security was introduced. Cynically, the best thing to happen from the point of view of the Social Security system would be to go back to the 1960’s when people smoked like chimneys. The “best” thing possible from the point of view of Social Security solvency would be to have large numbers of people going to meet their maker in their early 60’s.
Two Ways to Look at Social Security
Put another way, there are two ways to look at the Social Security system, either as part of the overall federal budget, or as a stand-alone entity. There is substantial validity to each point of view. The problem comes when people switch back and forth between the two views. If one sees it as all one package, then Social Security is simply another government program, and there is really no trust fund.
However, in that case, there is no way that the Social Security system can go bankrupt. Talk of it doing so is just plain silly. Does anyone talk about the Justice Department going bankrupt, or the Pentagon having to file Chapter 11? Of course not -- they are simply government programs, and as long as the federal government is borrowing in dollars and owns the printing press, it (and by extension the programs) cannot go bankrupt.
If Social Security is just another program, then talk about it going bankrupt is as silly as talk of the Pentagon going bankrupt. It also would be an acknowledgement that both the payroll tax and the income tax are both means of funding the same overall government budget. Thus, claims that the rich are the only ones really paying taxes are just plain BS.
On the other hand, it you view them as two separate programs, then the trust fund is real, and the bonds that it holds are every much an obligation of the government as are the ones held by T. Rowe Price (TROW) or Franklin Templeton (BEN), or for that matter the Peoples Bank of China.
It also means that it is possible for the Social Security system to go bankrupt. Come 2037 when the trust fund runs dry, it would be back on its pay-as-you-go footing, and could only pay out 78% of the currently scheduled benefits. Also from that point of view, the argument about the wealthy funding most of the government has a lot more validity, and the payroll tax is effectively not a tax, but a form of forced savings.
Keep the Two Perspectives Straight
In any discussion of the future of Social Security, make sure that you keep the two perspectives straight and know which point of view you are looking at the situation from. Be prepared to call BS on those who mix and match the perspective to suit their political agenda (also, if you start to mix them up, be prepared to call BS on yourself).
Personally I believe in a progressive income tax and feel it is fair for people earning $300,000 a year to pay a higher percentage of their income in taxes than those who only earn $30,000 a year. In large part, that is simply a value judgment on my part -- my feelings about what a just society should look at. However, I also think that within reason, a progressive income tax leads to a stronger economy.
Yes, marginal taxes can get so high that they discourage work and thus hurt the economy, but there is no evidence that we are anywhere near that point now, or would be if the top tax bracket (which only kicks in over about $400,000 per year) were to go back to the Clinton-era rate of 39.6%. I thus have no problem with large numbers of poor and working people paying no income tax.
After all, when the 16th amendment to the Constitution was passed, the one that allowed for an income tax, it was only supposed to apply to the very rich. In 1914, right after the Amendment became law, less than 1% of the population had to pay it.
Reading the Chart
Projections for the long-term are on the optimistic side, since they assume not only that all of the Bush tax cuts go away, but also that Congress takes no action to prevent millions more people being pushed by inflation into the Alternative Minimum Tax (AMT) system. They also assume that no further action is taken to spend anything to help stimulate the economy.
Those assumptions are clearly unrealistic. Still, the report highlights just how much the current big deficits are caused by falling revenues due to a weak economy (also responsible for the big drop in the off-budget surplus; fewer people on the payroll means less payroll taxes coming in).
As the graph shows, revenues as a share of GDP (both payroll and income tax revenues) have fallen precipitously as a share of GDP, while spending is up sharply. Spending is expected to dip a bit over the next few years but is projected to remain high, while revenues are expected to recover to their historical average share of GDP by 2020, but that assumes all the tax cuts go away, not just the ones on top earners.
The structural budget deficit, or the budget deficit that is expected to remain after the economy is fully recovered (assumed to be 2013), is seen to be between 2.5% and 3.0% of GDP, which is what it is projected to be between 2014 and 2020.
Federal debt held by the public (which means everything the government owes to the outside, but not to the trust funds or held by the Fed) is expected to rise to 61.6% of GDP in 2010 from 53.0% in 2009. In 2011 it is expected to rise to 66.1%, and is expected to continue to rise after that, but at a much slower pace as the deficit shrinks as a share of GDP, and GDP grows. If GDP grows faster than the size of the budget deficit is as a share of GDP, then debt as a percentage of GDP will tend to fall.
Without a doubt, a full employment deficit of 2.5% or 3.0% of GDP is way too high, and steps will need to be taken to bring it down. However, they are a lot less scary than the current deficits of over 9% of GDP. A chronic, not an acute disease -- but one that, over time, has the potential to be debilitating.
Dirk van Dijk, CFA is the Chief Equity Strategist for Zacks.com. With more than 25 years investment experience he has become a popular commentator appearing in the Wall Street Journal and on CNBC. Dirk is also the Editor in charge of the market beating Zacks Strategic Investor service.
More about Zacks Strategic Investor >>
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