Is Social Security in Crisis?

By on August 25, 2010

Is Social Security in financial straits? Two experts debate.

robert-murphyRobert P. Murphy, Ph.D.
Pacific Research Institute

Robert P. Murphy has a Ph.D. in economics from New York University and is Senior Fellow in Business and Economic Studies at Pacific Research Institute. He runs the blog Free Advice.


david-rosnickDavid Rosnick, Ph.D.
Center for Economic and Policy Research

David Rosnick is an economist at the Center for Economic and Policy Research. He has a Ph.D. in computer science from North Carolina State University and an M.A. in economics from George Washington University.

Part 1: Robert P. Murphy, Ph.D.: Social Security In Crisis

Since its inception in the 1930s, Social Security has been a giant Ponzi scheme administered by the government. In the beginning, retirees, widows, and other beneficiaries received payments in excess of what they had paid into the system. Each succeeding cohort of retirees would then be supported by the fresh crop of new workers who had replaced them in the workforce.

This dubious arrangement could stay afloat so long as the proportion of workers to retirees remained constant. However, in the United States (and other industrialized nations), the population has gradually aged over time, so each worker had to support a growing number of dependents. The combination of falling birthrates and rising life expectancies means that the current Social Security system is bankrupt.

To call Social Security bankrupt is not a mere metaphor; it is bankrupt in the strict accounting definition. Specifically, the present value of the system's assets–including the payroll contributions of future workers–is less than the present value of the system's promised benefits to current and future retirees. In other words, Social Security's assets are smaller than its liabilities. That's what it means to be insolvent.

The degree of its insolvency is enormous. According to a U.S. Treasury report (p. 50), the 2009 estimated unfunded liability for Social Security was $7.7 trillion. In other words, when the government's actuaries estimate the projected outflows to future beneficiaries and compare them to projected inflows from future workers, after adjusting for the time-value of money the deficiency is almost $8 trillion. (If we include all of the federal government's "social insurance" programs, the total unfunded liability is a shocking $46 trillion.)

Even more alarming, this deficiency between benefit payments and tax collections is not some far-off problem. This year the Social Security system is experiencing a cash-flow deficit. For the first half of 2010, Social Security has paid out $347.3 billion in benefit payments while taking in only $346.9 billion in tax collections.

The Congressional Budget Office (CBO) projects that Social Security will once again return to an operating surplus in 2014 before plunging permanently back into the red by 2018. Yet even this sliver of optimism may be misplaced, as the CBO's model assumes that the economy gradually recovers from the recession. If, contrary to the CBO forecast, the economy plunges back into a "double dip"–as many analysts fear–then the currently configured Social Security system may never see a cash-flow surplus again.

The Myth of the "Trust Fund"

Some progressive pundits–such as Paul Krugman and Dean Baker–argue that there is no cause for alarm. After all, because of the huge surpluses piled up since the 1980s, the Social Security administrators are sitting on some $2.6 trillion in assets. Therefore, even though benefit payments will exceed tax collections in the coming decades, Social Security can draw down these accumulated assets to make up the deficit each year. By this measure, Social Security won't hit a crisis until 2043.

There are two major problems with this defense: First, even though it has significant assets, the system is still bankrupt. To repeat, even accounting for the "trust fund" the government's own actuaries project that the program will not be able to make its scheduled future benefit payments. That is the definition of insolvency. When major corporations file for bankruptcy, they often have significant assets at their disposal. The point is that these assets are smaller than their liabilities.

Second, the "trust fund" is an accounting gimmick from the taxpayer's point of view. The Social Security system's assets consist of I.O.U.s issued by the Treasury. Since the 1980s, the excess receipts of the Social Security system have been taken and spent by the federal government. That money is gone. The only thing showing for it now are pieces of paper promising payment from the U.S. government.

For any individual corporation or household, U.S. Treasury securities are indeed financial assets that strengthen the net worth of the owner. But from the viewpoint of the American taxpayers, it doesn't matter whether the Social Security trust fund is $2.6 trillion or $2.60. Either way, taxpayers will have to make up the difference between Social Security's outgoing benefit payments and incoming tax receipts.

Consider a silly scenario: Suppose an intern working at the Social Security Administration accidentally tips the drawer holding the trust fund notes into a paper shredder. She looks on in horror as $2.6 trillion in bonds issued by the U.S. Treasury are destroyed.

Naturally the intern's boss is furious. He doesn't know what to do, since the Social Security system is now $2.6 trillion poorer. They have nothing to sell off to cover their operating deficits.

On the other hand, officials at the Treasury Department are elated. Tim Geithner himself calls up the intern and congratulates her on reducing the national debt by $2.6 trillion. The incoming federal tax receipts that would have previously been used to pay the interest and principal on those outstanding bonds can now be spent on something else (or returned to the taxpayers).

But while one set of government officials is distraught while another is delighted, from the point of view of taxpayers, it makes no difference. They'll still have to make up the $2.6 trillion gap either way.

Our hypothetical scenario illustrates the silliness of counting Social Security's holdings of Treasury securities as genuine assets. In fact, when Krugman and Baker discuss the size of the U.S. government's debt, they count only Treasuries held by the public. In other words, they are trying to have it both ways: They count the $2.6 trillion of Treasury securities as assets owned by Social Security, but they don't count them as liabilities of the U.S. government.

Regardless of whether we count the "trust fund" as legitimate or notif we do choose to solve the Social Security crisis by pointing to its stockpile of assets, then we have merely transformed the Social Security crisis into a federal debt crisis. This is because the discussion of the federal debt typically excludes "intragovernmental debt" or debt that various branches of the government owe each other. So the size of the federal debt will be that much larger if we treat the trust fund assets as genuine.

There is one sense in which the trust fund assets would be economically meaningful: If the federal government had spent Social Security's surpluses over the years on productive investments that raised total economic output, then the tax base would have grown and the federal government would have larger tax receipts with which to pay off the I.O.U.s held by the Social Security Administration. In this scenario, the federal government would have acted as a giant corporation, issuing new bonds in order to build more factories (say) and thereby increase future revenues. In this scenario, issuing the new debt would "pay for itself."

But who really wants to describe the federal government's spending from 1984 to the present as frugal investments? Unfortunately, what happened is that politicians saw a boatload of new money after the Reagan-era "fix" and spent more money than they otherwise would have. There is nothing to show for the trust fund assets except the memories of high living.

Can't They Just "Reform" the System Again?

Some observers shrug off the dire warnings of the ticking demographic time bomb–which has already begun to explode–by pointing to the Social Security Reform Act of 1983. Following the recommendations of the so-called Greenspan Commission (which was chaired by Alan Greenspan), the payroll tax was increased in order to close the shortfall that Social Security had experienced at that time.

No one denies that Congress will act before the full projections of the system's insolvency come to pass. But the point is that the only way to "fix" Social Security is to increase the tax bite on current and future workers and reduce the total benefits paid out to future retirees. This latter may include a postponement of retirement age and/or a reduction in benefit checks. It should hardly reassure citizens to hear that such a "solution" is waiting in the wings.

A Crisis If There Ever Was One

Barring a demographic miracle, the trends are unavoidable. The current configuration of payroll taxes and benefit schedules is unsustainable. From a long-run accounting perspective, Social Security is literally bankrupt. Even on a short-term cash-flow perspective, the system is paying out more than it takes in.

The so-called trust fund is an accounting gimmick that doesn't represent genuine saving and investment. The politicians squandered the Social Security surpluses over the years. At this point, easing the burden on Social Security by cashing in the trust fund assets simply increases the burden on the government's general fund.

Current workers need to prepare for tax hikes, and they had better not count on Social Security as the basis of their retirement. If this system isn't in crisis, what is?

Part 2: David Rosnick, Ph.D.: Social Security: The Sky Is Not Falling

Robert Murphy argues that Social Security as an institution is nothing more than an accounting fiction–merely government operations that happen to take in tax revenue with one hand and also happen to pay out benefits with another. At the same time, he argues that Social Security is bankrupt. As it makes no sense for an accounting fiction to be bankrupt, he must settle on what he thinks Social Security really is.

First, a Little Background

Social Security–or more precisely in this discussion, the Old-Age and Survivors Insurance (OASI) and Disability Insurance (DI) programs–provides income to more than 50 million Americans each year. Among those sixty-five and older, Social Security benefits accounted for more than half of their total income in 1997. Since then, the S&P 500 has grown at a rate of only 0.3 percent per year after adjusting for inflation. Worse, the housing bubble distorted savings decisions to the point that among households nearing retirement, some 14 percent have so little equity in their homes that they would have to bring in outside money to sell. Our research projects that the bottom two quintiles of households age fifty-five to fifty-nine will have less than $600 per month, on average, in retirement income outside of Social Security.

These programs are funded by a combined payroll tax of 12.4 percent of wage income up to a certain amount (currently $106800), but this cap rises each year with the average wage. Treasury credits all of this tax revenue to the OASI and DI "trust funds" in the form of government debt. As money is required to pay current beneficiaries, these bonds are redeemed at face value. To repay these loans, Treasury sends out checks to beneficiaries.

Normally, the trust funds (often discussed in combination as the OASDI Trust Fund even though the programs are distinct) loan enough money to Treasury that the assets are sufficient to pay a year's worth of benefits. In order to compensate for longer life expectancies–and thus provide larger real lifetime benefits–it has been necessary in the past to raise the payroll tax with some regularity. The OASDI tax rate was raised in the 1950s, '60s, '70s, and '80s. Because these taxes were linked directly to program benefits, the voting public did not penalize lawmakers for requiring these additional contributions.

In anticipation of the retirement of the baby boomers, the payroll tax rates were, beginning in the early 1980s, raised higher than necessary in order pay current benefits. The idea was to build up the assets of the OASI Trust Fund so that the baby boomers would help pay for some of their own future benefits and not rely entirely on the next generation. Thus, on net, these workers have been forced by law to lend to the government for a quarter of a century.

Just as with any other money the government borrows, it is free to do most anything with it. It may build roads and schools, or it may give tax breaks to the wealthy elite. Also just as with any other money the government borrows, Congress must find a way to pay the money back. There is no more reason to think that the government will default on the bonds held by Social Security than it will on bonds held by Bill Gates, Warren Buffett, Pete Peterson, or Goldman Sachs. Workers are owed their money back (with interest) just as surely.

Curious Notions of Insolvency

Fortunately, Social Security does have significant income, and its assets were $64 billion greater at the end of June than they were at the start of 2010. It is either ignorance or dishonesty that brings forth an argument that Social Security is in cash-flow deficit. Murphy cites an opinion piece by Michael Barone to support his argument, but that piece was written before the end of June. The timing is of critical importance, because the trust fund does not get credited for income evenly on a monthly basis through the year. Almost all interest on the trust fund is credited in June and December. Lesser amounts from taxation of benefits arrive at the start of every quarter. Thus, to say Social Security is in cash-flow deficit is really no different than saying I am in cash-flow deficit because I bought my lunch this afternoon and I haven't received a paycheck since last month. I am earning income even between deposits to my bank account.

In any case, nobody should have been surprised in June 2010 that Social Security contributions were lower than projected a year or two ago. It is not a sudden onset of retirement, death, or disability shrinking the Social Security surpluses but rather the deepest economic downturn since the Great Depression. Age-adjusted unemployment has for some time been worse than it had been during the worst of the recession of the early 1980s. Only economists who failed to see the impact of the housing bubble on the economy could possibly fail to see that fourteen consecutive months of unemployment over 9 percent might suggest lower payroll tax revenues.

If, on the other hand, we ignore the way OASDI actually operates and declare that Social Security is a mere accounting fiction in the scheme of the entire federal government, then the OASDI taxes–and therefore any potential shortfall–are entirely irrelevant. In this view, the program cannot be insolvent, bankrupt, or otherwise in crisis unless Congress cuts off funding. We do not say that the U.S. Army is bankrupt even though it has considerable expenses despite zero dedicated revenues. Nor do we say that the federal government is bankrupt for having run a deficit twenty-six of the last forty years. What sense is there in saying this line in the budget is "bankrupt" but not this other?

Murphy might like to argue that including the debt to Social Security simply turns a crisis for Social Security into a crisis for the federal government. The gross federal debt of the United States is about 90 percent of GDP, but gross debt for Japan reached 215 percent last year. The Japanese are not struggling to service their debt.

Another argument is that the trust fund is irrelevant in any case because taxpayers "still have to make up the $2.6 trillion gap" if the bonds were put through the shredder by a careless intern. On this we agree: The physical presence of the bonds means nothing. When was the last time a bond trader actually held an actual paper bond? Is there some poor bike messenger every business day tasked with the receipt and delivery of billions of dollars in stock certificates? What of the trillions of dollars in currency exchanged every trading day?

It is unfortunate that Murphy might be unaware–or worse, pretend not to know–that if one can establish ownership of a lost savings bond, the government will simply issue a replacement. On the other hand, a good fantasy might give ordinary workers the idea that the trust fund is a fragile thing–easily lost–and the best thing to do is to get used to the idea of getting along without it.

More Murphy Mistakes

More seriously though, if taxpayers owe money to themselves, then what difference does it make? Well, it matters in the same way it matters to Warren Buffett if the government failed to honor the bonds he holds. That is, it matters which taxpayers are owed and which taxpayers must pay. In the case of Social Security, those bonds were bought using payroll taxes. The OASDI tax does not apply to salary in excess of $106,800–earnings over the cap are not taxed at all on amounts above that. Yet the government surpluses that the OASDI tax revenue helped generate were used as justification for lowering the top marginal income tax rates and eliminating the estate tax–to the great benefit of high-income earners. To then say that taxpayers may now pay themselves back the money they lent and call it a wash is clearly unjust to workers.

Murphy also raises the question of whether or not the federal government used the surplus payroll taxes productively in ways that raised total economic output. This is totally irrelevant. If you view Social Security as a distinct enterprise, then it holds real bonds like any other bondholder–and bondholders view their bonds as real no matter how the money is used. If you view Social Security as just another part of the federal government, then the taxes are just taxes like any other with no particular economic meaning that depends on how the revenues are spent.

Then there is the question of the long-term shortfall in Social Security revenues. First, it bears noting that even if nothing is done and the trust fund runs out in 2039, the program will still pay 80-85 percent of promised benefits on the basis of payroll taxes alone. These future retirees will have been much more productive over their working lives and so are scheduled for much larger benefits than those received by today's retirees. Even accounting for any projected shortfall, the lifetime benefits of those entering the workforce over the next ten years will be more than 46 percent larger than the lifetime benefits of current retirees.

At the same time, the shortfall is simply not very large–in the context of the economy or otherwise. The Congressional Budget Office predicts that the projected seventy-five-year shortfall in Social Security is less than one-half of 1 percent of GDP over that time–the equivalent of $70 billion today. By comparison, extension of the Bush tax cuts (not including an AMT fix) would cost $116 billion in 2011 and $221 billion in 2012.

Everyone Calm Down

There is no reason for workers to be unable to count on Social Security–they need only fear a Congress hell-bent on taking it away.

Part 3: Robert P. Murphy, Ph.D.: Uncle Same Is Broke

In my opening essay in this debate, I argued that Social Security is in crisis. David Rosnick concludes his first rebuttal by claiming, "There is no reason for workers to be unable to count on Social Security–they need only fear a Congress hell-bent on taking it away."

In my view, Rosnick is being very naive in his conclusions, and he seems to have missed most of my points. Despite Rosnick's arguments to the contrary, I still maintain that Social Security is in crisis and that present workers–particularly those under 40–should harbor no illusions that Uncle Sam will be there to take care of them down the road.

Accounting Gimmicks

Right off the bat, Rosnick mischaracterizes my position when he writes:

Robert Murphy argues that Social Security as an institution is nothing more than an accounting fiction–merely government operations that happen to take in tax revenue with one hand and also happen to pay out benefits with another. At the same time, he argues that Social Security is bankrupt. As it makes no sense for an accounting fiction to be bankrupt, he must settle on what he thinks Social Security really is.

But I never claimed that Social Security itself was an accounting fiction. If I had, Rosnick would be right–it would be silly for me to claim that a fiction were bankrupt.

On the contrary, I said that Social Security was insolvent and that the trust fund was an accounting gimmick. These are two separate points, although they both point toward the same conclusion: Current workers had better start saving for their own retirement, because the government is broke.

What Does It Mean to Be "in Crisis"?

Before proceeding further, let's stop for a second and ask: What does the average American mean when he wonders, "Is Social Security in crisis?" I think we can all agree that this question means, "Can the current system be maintained?" In other words, is the current arrangement of Social Security sustainable, or is it digging itself deeper and deeper into a hole?

The answer to these questions is quite clearly that Social Security is now on an unsustainable path. If the government keeps extracting the same portion from every worker's paycheck and keeps paying beneficiaries according to the current schedule, then the Social Security system will eventually run out of money.

This will happen for the simple reason that the population of retirees is growing faster than the workforce needed to sustain them. This demographic shift will be catastrophic for the Social Security system, because it is fundamentally a Ponzi scheme in which each generation of workers pays for the current generation of retirees. (In contrast, a private-sector retirement system has each worker set aside savings for his her own future retirement. In this setup, it doesn't matter what happens to the demographics, because at any given time, each retiree is drawing down the funds that he or she personally built up over a working career.)

Two Different Ways of Seeing the Crisis

Now there are two different ways of judging whether Social Security is "in crisis." One way is to look at the current projections of its long-run sustainability. The federal government's own actuaries report that on this score, Social Security is insolvent or bankrupt. Specifically, if we take into account all the future payroll taxes into the system and all the future benefit payments and then adjust for the time-value of money, we find that as of 2009, the Federal Old-Age, Survivors, and Disability Insurance–what we popularly call "Social Security"–had an accounting value of negative $7.7 trillion. (See page 50 of this Treasury report.)

The second way is to ask when the "crunch" will actually hit. Previously, analysts had been warning of this demographic time bomb for some time. Everybody knew that eventually, the aging population would require a revamp of Social Security–by either raising payroll taxes, cutting benefits (perhaps by postponing the retirement age even further than is currently scheduled), or some combination of the two. Yet the day of reckoning had always appeared to be down the road, because after the "fix" to Social Security instituted in the early 1980s after the famous Greenspan Commission, every year Social Security ran large surpluses. In other words, it took more in from dedicated payroll taxes than it paid out in benefits.

All of that has changed this year. From January through June 2010, the government took in $346.8 billion in dedicated Social Security payroll taxes. However, during the same time the government paid out $347.7 billion in Social Security benefits. This is why many analysts have said that Social Security this year is "cash-flow negative."

Now it's true, as Rosnick points out, that if you include the interest earned from its assets (such as Treasury bonds), then the Social Security system actually saw its net worth increase during the first half of 2010. (You can see the decomposition of the exact income and outgo figure at the site Rosnick linked, including the numbers I list above.) He is right that from a standard accounting viewpoint, then, Social Security has not been "cash-flow negative" this year, because its investment income was large enough to cover the deficit it ran on the underlying tax-and-benefit schedules.

I apologize for the inaccuracy in my original essay. Even so, my broader point remains: The discrepancy between the benefit payments to retirees and the receipts raised from the dedicated payroll tax is upon us already. This event was not supposed to happen for several more years, but the severe recession has advanced the timetable. Because fewer people are working (and paying into the system) and more people are retiring early (and drawing benefit checks), the underlying demographic time bomb has exploded much earlier than analysts projected during the housing boom years.

Why Is the "Trust Fund" a Gimmick?

When someone claims that Social Security is in crisis, its defenders will point to the massive trust fund consisting of more than $2 trillion in IOUs issued by the federal government. This hefty portfolio of bonds is supposed to reassure workers that their promised checks will come in the mail upon retirement.

I had argued that this was an illusion. To "solve" the mismatch in Social Security income and outgo by relying on $2 trillion owed to it by Uncle Sam merely pushes the crisis away from Social Security and into the general fund. It is crucial for readers to understand that when pundits discuss "the national debt" they typically are not including the Treasury bonds held in the Social Security trust fund. So if we're going to relax over the fate of Social Security because of the huge trust fund, then we need to be that much more alarmed over the government's general finances.

Rosnick thinks I am oversimplifying things. He writes:

If taxpayers owe money to themselves, then what difference does it make? Well, it matters in the same way it matters to Warren Buffett if the government failed to honor the bonds he holds. That is, it matters which taxpayers are owed and which taxpayers must pay. In the case of Social Security, those bonds were bought using payroll taxes. The OASDI tax does not apply to salary in excess of $106,800–earnings over the cap are not taxed at all on amounts above that. Yet the government surpluses that the OASDI tax revenue helped generate were used as justification for lowering the top marginal income tax rates and eliminating the estate tax–to the great benefit of high-income earners. To then say that taxpayers may now pay themselves back the money they lent and call it a wash is clearly unjust to workers.

Rosnick is correct that what is going to happen to workers will be unjust. I am not denying that. My point in this debate is not to argue, "We ought to cut Social Security benefits, because that's the only way to give these workers a fair shake."

No, not at all. What I am saying is that the injustice has been occurring since its inception. From the start, workers have had money taken from them involuntarily. (If you doubt that, try not paying your "contribution" to Social Security next month and see what happens.) Then the politicians have spent the money on whatever suited them.

The point is that that money is gone. The mere fact that the government has put IOUs into a so-called "trust fund" doesn't change the situation.

Rosnick does have a point when he says that not every American taxpayer has the same share of ownership in government bonds. In other words, if the U.S. Treasury suddenly announced tomorrow, "We are not paying another cent on our debts; we repudiate it all," then this shocking declaration would help some Americans while hurting others.

But again, I think Rosnick is making a pedantic correction that doesn't change my basic claim: Current workers should not be reassured to learn that there is a huge trust fund consisting of government debt. Even if their payroll taxes weren't raised or their benefits cut, because of the trust fund, they would still find their income tax rates going up in order to deal with the siphoning off of general tax revenues to pay for the Social Security deficit.

Brace Yourself for Higher Taxes and Reduced Benefits

Ironically, Rosnick himself supplies us with the historical precedent for my prediction when he writes:

In order to compensate for longer life expectancies–and thus provide larger real lifetime benefits–it has been necessary in the past to raise the payroll tax with some regularity. The OASDI tax rate was raised in the 1950s, '60s, '70s, and '80s. Because these taxes were linked directly to program benefits, the voting public did not penalize lawmakers for requiring these additional contributions.

The government has done it before, and it will do it again: The politicians will raise the payroll tax that funds Social Security, and they will change the benefit schedule to minimize future payouts. If this were a private pension plan, it would be considered a violation of contract.

Don't Count on It

Social Security is in crisis. Rosnick can claim that tax hikes on rich people will fix everything, but he is being naive. There isn't enough money in the upper brackets to plug the looming hole, and the politicians will stick it to the middle class when push comes to shove.

Current workers should not count on Social Security in their retirement planning. Uncle Sam is broke.

Part 4: David Rosnick, Ph.D.: Social Security Is on Solid Ground

If I move money from my left pocket to my right pocket it is meaningless accounting, but if I move money from my right to my left, it is a crisis. This seems to be the lesson Robert Murphy has for us.

He wants to argue that flows to and from the trust fund have meaning (now that the system is paying out more in benefits than it is taking in from contributions!), but the trust fund itself does not have meaning. These two positions are irreconcilable by any accounting.

Gimmick or Not?

If the flows to and from the fund are real, then the bonds in the trust fund are real and nothing can justify calling the trust fund an accounting gimmick.

On the other hand, if Social Security is just part of the government plus some fancy-pants accounting designed to help politicians "stick it to the middle class," then the flow of money to and from the trust fund are just a gimmick as well, so it is meaningless to say the program is cash-flow negative, insolvent, bankrupt, or otherwise troubled–just as it would be absurd to say that the Defense Department is cash-flow negative, insolvent, or bankrupt.

When Murphy argues that current workers had better start saving for retirement, because the government is broke, he implies that there is a crisis in the financial state of the whole of federal government–whether or nor one wishes to include Social Security in the total. In such a case, all bondholders and taxpayers are at some risk. What does "the government is broke" mean to workers if it does not mean exactly the same thing to the U.S. Navy, or the People's Republic of China, or any holder of U.S. government debt?

To Murphy, it means workers "should not count on Social Security in their retirement planning." This is absolutely preposterous. To write that workers should not count on Social Security, one implies that workers are paying into a system from which they will get nothing back. Thus, Murphy exaggerates the size of the "crisis" many times beyond anyone's projections. Even if nothing is done and the trust fund runs dry a few decades from now, workers should count on significantly larger lifetime benefits than those promised to current retirees. Murphy surely understands this and simply got carried away in his rhetoric.

Yet Murphy asks, "Is the current arrangement of Social Security sustainable, or is it digging itself deeper and deeper into a hole?" The question makes sense only if Social Security's finances are distinct from the rest of the federal government and the trust fund is real. If Social Security is able to dig itself into a deep hole of debt, how is it unable to build up a mountain of assets?

Murphy says his point is that "that money is gone." But this is completely and utterly irrelevant. The money that Bill Gates lends out is gone. The money Goldman Sachs lends is gone. The two bucks my best buddy borrowed from me to buy a drink–all gone. That's the nature of borrowing. Lenders get paid back out of future income, not current.

This line of argument merely pretends that the spending is important. When a corporation issues a bond so it can build a new factory, it spends the money. It relies on its own future revenues to pay back the loan. In the same way, when Treasury issues a bond, it relies on the economy to generate future income. Of course the money was spent–that's why it was borrowed.

Murphy bemoans the fact that, in his view, government spending is not productive. Surely he will concede that if Treasury had spent the OASDI surplus buying into the S&P 500 rather than Treasury bonds, that would not have made the economy more productive. In either case, the purchase of a financial asset transfers ownership, but neither represents a physical investment. Perhaps Murphy is ready to argue that private businesses would have been more productive had the government owned them. But I doubt that.

No Need to Worry

Murphy refers to the "siphoning off of general tax revenues to pay for the Social Security deficit" but he's explicitly discussing the trust fund. What he is saying is that general revenues are required to pay the Social Security debt–which was exactly the point of using payroll taxes to buy the bonds in the first place. There's absolutely zero reason why workers should be worried about paying off the bonds in the trust fund yet not be worried about paying off Warren Buffett. Why is defaulting to workers less shocking than defaulting to Pete Peterson? If defaulting to Peterson offends our sensibilities, then let's just recognize all of the government's debt and stop the silliness.

In fact, if we take Murphy's point that the OASDI contributions are involuntary, it becomes all the more imperative that the money in the trust fund be paid back in full as required under current law. If the government is going to default on some debt, shouldn't it default on those who lent voluntarily before considering a default on those who lent involuntarily? Workers should have greater assurances than other holders of government debt.

Murphy calls the distinction pedantic, but those who pay payroll taxes are simply not the same as those who pay income taxes. In 2007, the bottom 60 percent of taxpayers earned 25.5 percent of all pre-tax income yet paid 32.2 percent of all payroll taxes. The top 1 percent of taxpayers claimed 19.4 percent of all pre-tax income but paid only 4.1 percent of all payroll taxes.

Since Treasury debt is paid out of general revenues, the burden is largely on those who pay income taxes to repay those loans. Unless Congress decides to raise income taxes on low-income taxpayers, workers need not find their income taxes going up. They should be assured that most of the burden of repaying the debt will be borne by the relatively wealthy families who account for a disproportionate share of income tax.

Moreover, shifting the burden of saving for retirement from Social Security to private savings does nothing to change the need for increased savings. The fact is that each succeeding generation is more productive and desires a longer retirement, so the relative share of working-life income needed to support retirement is always increasing. That means an ever-increasing share of income must go to private savings like 401(k) and IRA accounts just as surely as it means a greater share going into Social Security.

In contributing to an IRA, younger workers put money in at the same time older non-workers are taking money out. Each succeeding generation must contribute a greater share of income while working in order to provide for a longer retirement. Still, I feel safe in betting that Murphy would not refer to anyone's private savings as a "Ponzi scheme."

When Push Comes to Shove

Finally, Murphy accuses me of naivete for believing that that it is even possible to "plug the looming hole" with "money in the upper brackets" and "the politicians will stick it to the middle class when push comes to shove." Note, however, that Murphy is making a political argument, not an economic one.

As I pointed out in my first response, the cost of extending the Bush tax cuts alone will be several times more than the amount needed to cover Social Security. It is most certainly possible to let some of the higher-income tax cuts sunset as scheduled and use the money to "plug the hole." Murphy merely argues that the government will cater to the wealthy and not to workers, so workers should just get used to the idea of doing without Social Security.

Get Ready to Shove

So in the end, if workers take Murphy's advice, then when push comes to shove, they will wind up in the mud. It may turn out to be a self-fulfilling prophecy–but that conclusion is by no means foregone. Workers need to ignore such free advice and get ready to shove.