Trust fund’ financing makes Social Security and Medicare needlessly costly.As congressional Republicans search for ways to rein in federal spending, Senator Mitt Romney (R., Utah) has sought to revive the Time to Rescue United States Trusts (TRUST) Act. That bill would force Congress to consider legislation to restore the solvency of trust funds associated with America's largest entitlement programs by balancing long-term expenditures and the payroll-tax revenues dedicated to them.
While some view the coupling of entitlements to dedicated taxes as promoting fiscal restraint, in practice it has served to bloat entitlement programs by absolving them of the need to justify their expenditures relative to other fiscal priorities. This has caused benefits for the wealthy retirees and taxes on low-income workers to become inflated far beyond levels that otherwise would have prevailed.
And with the Congressional Budget Office projecting that the cost of current federal spending commitments will increase from 21 percent of GDP in 2019 to 30 percent in 2050, those levels are only likely to increase. Two-thirds of our national spending is automatic — Congress doesn't even get to vote on it, Senator Romney rightly notes. Mandatory spending funds programs like Medicare and Social Security, and it is where most of the national debt originates from.
The TRUST Act would establish a bipartisan super-committee to draft legislation to replenish trust funds for programs facing insolvency – either through entitlement reforms or tax increases. Both chambers of Congress would be required to consider the proposed legislation without amendment.
Yet, the TRUST Act is unlikely to have much effect. It would not make it any more popular to raise taxes or to cut benefits for programs that are each hard enough to reform in isolation. And senators of either party could still obstruct its passage with a filibuster. Moreover, the super-committee would not be able to rely on the threat of automatic sequestration cuts to force acceptance of it proposals, as with the 2011 Budget Control Act.
But the more fundamental problem with Romney's TRUST Act is that entitlement trust funds are harmful institutions that shouldn't be preserved. They serve to mislead the public, distort the structure of entitlements, and impede attempts to make programs more cost-effective.
Social Security was originally designed as a substantially pre-funded pension system. But congressional Republicans, led by Senator Arthur Vandenburg, feared that giving the federal government control over an accumulating capital reserve would serve as a perpetual invitation to the maintenance of an extravagant public debt, whose burden payroll taxes would transfer to the shoulders of the lowest income group. Following major GOP gains in the 1938 midterms, Republicans joined with Democrats who wanted benefits paid out immediately, to turn the Social Security Act into an entirely pay-as-you-go system.
As a result, no reserve would ever be accumulated and invested. Yet, Congress sought to set payroll tax rates such that revenues from them would balance benefit payments over the long run. Initially, many more workers paid payroll taxes than had become eligible for retirement benefits, and so a short-run surplus was generated. Congress spent this surplus on other items and promised to pay future beneficiaries an equivalent amount from other revenues in the future: an accounting fiction which it would label a trust fund.
This fiction proved politically useful – enabling huge payroll-tax increases to be packaged as retirement plans offering returns on investment that no honestly managed private business could promise. The initial generation of retirees would receive $12 for every $1 they paid in. But subsequent cohorts would find themselves paying for earlier generations as well as their own benefits. The generation born in the 1950s will receive only 70 cents for every $1 it paid in.
In the immediate post-war era, as the economy surged and women entered the workforce, payroll-tax revenues swelled to generate an unanticipated trust fund surplus. Congress took advantage to increase the size and scope of Social Security benefits – with bigger payments for wealthier beneficiaries, to maintain the illusion that this was justified by contributions.
In 1965, the Johnson administration sought to repeat the trick to finance health care for seniors with Medicare. John Byrnes, the ranking Republican on the House Ways and Means Committee, objected that it was entirely inappropriate to establish a non-wage-related benefit with the most regressive tax that anybody can figure out. A compromise was reached whereby a dedicated payroll tax would be established to pay for hospitalizations (Medicare Part A), while physician and outpatient services (Medicare Part B) would be funded by general revenues, as Byrnes proposed.
By the early 1970s, Social Security's bills came due: The share of elderly Americans entitled to benefits had caught up with the proportion of workers paying in payroll taxes. At the same time, inflation caused the cost of benefit payments to surge, while stagnant real wages and unemployment caused payroll-tax revenues to fall below levels that were being counted on. Furthermore, life expectancy had increased and birth rates declined, so the ratio of workers to contributors fell from five-to-one in 1960 to three-to-one in 1980.
To make up the shortfall, Congress would use the fictions of trust-fund finance to excuse payroll-tax increases, which were concentrated on low-income workers. By 2019, payroll taxes would take 3.1 percent of the incomes of the richest 5 percent of Americans, but 11.5 percent of the incomes of the poorest 50 percent.
But these have still proved inadequate to ensure the solvency of trust funds. The cost of Medicare alone has increased from 0.6 percent of GDP in 1970 to 3.1 percent in 2021 and is expected to double again over the coming generation. Medicare's expenditures are projected to increase indefinitely as a share of GDP due to its commitment to pay for whatever medical technologies are developed, and yet its tax base is stable or declining.
Nonetheless, increased attention to Medicare's Part A Trust Fund would do little to slow the program's cost growth – three-quarters of which is produced by the expansion of outpatient services under Part B. Even though it has no associated trust fund, Congress has just as often cut Part B payments over recent decades, simply out of concern for its impact on the general federal budget.
Supporters of the TRUST Act believe that trust funds are a mechanism to force entitlement cuts. But the opposite is true.
Whereas most government programs must justify their expenditures relative to other spending priorities and taxes every year, entitlements with their own dedicated revenue streams can point to them to defer any pertinent questions about cost, value, or equity. Despite great changes in the world and the workforce over the past 40 years, Social Security has not seen any real reform since its trust fund last faced depletion in 1983 – and will surely remain exempt from legislative scrutiny until it runs dry again a decade from now.
Trust-fund finance ossifies entitlements' funding structures and sidelines reforms that would otherwise be substantively justified and politically potent. For instance, adherence to the principle that entitlements should be self-financed through payroll taxes prevents the coupling of benefit cuts for wealthy retirees with tax cuts for ordinary workers from even being considered.
No one has suffered more from this mindset than Mitt Romney, who was attacked throughout his 2012 presidential campaign for lamenting that 47% of Americans pay no income tax. So our message of low taxes doesn't connect. That remark entirely ignored the option of cutting payroll taxes, which are the largest federal tax paid by nine out of ten Americans.
Entitlement costs are best reduced by improving the degree to which programs are targeted at needs that individuals can't meet by themselves. Earlier generations of Republicans recognized the trust-fund principle as a fiction that feeds the expansion of benefits for those who least need them by inflating taxes on those who can least afford to pay them. Today's generation would find entitlements easier to reform if they adopted a similar attitude and allowed trust fund financing to perish.
Chris Pope is a senior fellow at the Manhattan Institute.