Sunday, January 08, 2006

Invest or Divert

Let's do both.

Social Security financing projected forward is complicated by a confusion of first and second order income streams. Now Cost is pretty fixed, it varies depending on your assumptions about Real Wages, CPI and various demographic figures but is conceptually easy. Each month a certain number of checks in certain amounts have to be mailed out. But income is conceptually more difficult and requires some breakdown.

The simplest component is Payroll Tax. 12.4% of every paycheck up to about $90,000 flows to the Treasury each pay period. No one questions that this is real money really extracted from the real economy. A lesser known component is taxation on benefits. In some cases higher earning beneficiaries pay tax on their benefits. This gets a little murkier. If this tax was applied across the board as a simple reduction in benefits at the top end of recipients this would not show as an economic extraction from the real economy at all. It is only because it is applied to checks actually mailed out that it even appears as an extraction from the real economy. A third component is interest on excess payroll tax invested in Special Treasuries. This money is pretty real as well. To the extent that borrowing from the Trust Fund just replaces other borrowing (a question for another day), these are just dollars the Treasury would have been paying out to some other investor. But then comes the dread Interest on Interest

Now there are Papa Bear scenarios which would have payroll tax and taxation of benefits fully capable of covering costs forever, and then some. See Goldilocks and the Three Social Security Bears. If this happens our conceptual course forward is pretty simple. We invest the interest on the existing bonds and any principal payment in alternative economic vehicles (my choice would be Municipal and School bonds) and then direct the returns from that back into the income stream. But if payroll is more than handling cost what do we do with the overage? One answer is to split it in thirds: one third to be reinvested, one third in payroll tax cuts, and another third diverted to Medicare (others might balance the ratios otherwise). Now given that the General Fund under this scenario is gamefully kicking in its $100,000,000,000 in interest owed, or even making additional payments on the principal, we end up with a portfolio that is not only steadily reducing payroll tax but kicking in substantial amounts to Medicare besides. All while capping the General Funds responsibility to actual interest owed.

There are other Papa Bear scenarios that are not so rosy. But they all have the same end benefit to the General Fund. If we just started paying out interest in full in the form of buying alternative instruments for the Trust Fund and keep economic productivity anywhere above Baby Bear's 2.1% ultimately we just dig ourselves out of the hole. Depending on how close we get to Baby Bear we may end up having to tap some proportion of the Alternative Portfolio. But in each case we evade the Interest on Interest trap.

Sounds like a fairy tale? Put on your green eyeshades and run the numbers.

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