February 25, 1997

Dire Consequences of Democrats' Social-Security-Exclusion Budget

Opponents of the bipartisan balanced budget constitutional amendment (BBCA) have tried to take the country for a ride with their so-called balanced-budget proposal, which removes Social Security's receipts and outlays from the picture. This crafty proposal has propelled its proponents to new levels of demagoguery, and right on past the need to admit that they have no real interest in balancing the budget at all. With a ride that smooth, it is not surprising that they want everyone to stay on board. The vehicle this year is S.J.Res. 12, sponsored by Senator Dorgan (D-ND). Yet, this amendment if adopted would amount to a fiscal roller coaster.

In short, the actual impact of S.J.Res. 12 would be the opposite of its proponents' claims. The positive economic effect provided by a real balanced budget requirement would not materialize under S.J.Res. 12. The consequences of enacting this legislation would be negative: it could be worse than doing nothing because of the high probability of massive tax increases that would destroy economic growth. Simultaneously, S.J.Res. 12 would damage Social Security because Social Security's existence depends on a growing economy to meet its growing commitments.

What Excluding Social Security Really Means

Here's the wild 30-year ride S.J.Res.12 would provide: we'd start with decreasing deficits -- have a breathtaking moment of surplus (that would require hundreds of billions in new taxes or spending cuts to achieve) -- then to decreasing surpluses -- to a possible one-year balance -- and, then back to skyrocketing deficits. This proposal amounts to:

• Creation of $2.3 trillion in "gimmick deficits" between 1998 and 2018.
• Corresponding real tax hikes or spending cuts of $1.935 trillion between 2002 and 2018.
• Less than two decades of nondeficit spending, and at best one year in which the federal budget actually would balance.

• No possibility for a tax cut or spending increases unless a recession occurs.
• Absolute spending cuts in five of the first six years after the amendment, and a return to huge federal deficits in little more than two decades -- $700 billion from 2019-2024 and $2.474 trillion from 2019-2028, all perfectly off-budget and constitutionally legal.
• And, perhaps, most perverse of all, S.J.Res. 12, by hiding the Social Security crisis off-budget, would actually forestall a real solution to Social Security's long-term imbalance.

Perhaps, We'd Never Come to Balance

While the economic impact of the off-budget Social Security accounts would be artificial, the huge, annual transfers in excess of $100 billion ($2.3 trillion from 1998-2018) between on- and off-budget accounts would be very real. These transfers in turn would have an enormous impact on fiscal and tax policy. The economy would be whip-sawed by the legislation's requirement of multiple budgets (that is, on-budget, off-budget, and the unified federal budget that is the combination of the two) in the near-term and hidden deficits in the long-term, with at best a one-year period when the federal budget actually would be balanced. Adopting S.J.Res. 12 ultimately could mean that the budget is never balanced due to the adverse fluctuations it would induce. Is that exactly what opponents of S.J.Res. 1, the bipartisan BBCA, hope for?

The Scope of the Problem

[See attached tables as you read this section.]

The key to understanding S.J.Res.12's complicated sham transfers requires understanding the three phases of the Social Security trust fund, which will transpire over the next three decades.

• First, Social Security is, and has been for some time, running a surplus of revenues over outlays. This will end in 2012.
• Second, because there has been a long-time revenue surplus, there is a trust fund balance that is growing continually through 2018. This balance will generate continually growing interest payments that will more than offset the revenue shortfall between 2013 and 2018.
• Then, beginning in 2019 neither income stream will be able to offset the demographic wave of baby boomers retiring -- and the system rapidly will consume its balance until it is exhausted in 2029.

According to CBO's latest projections, the cash flows will be as follows in the 1996-2007 period:

	1996	1997	1998	1999	2000	2001	2002	2003	2004	2005	2006	2007	TOTAL 98-01	TOTAL 02-07	TOTAL 98-07
SS Revenue Surplus	29	35	33	35	36	35	35	33	32	31	31	28	139	190	329
SS Interest Surplus	37	43	48	53	58	63	69	76	82	89	96	104	222	516	738
SS Total Surplus	66	78	81	88	94	98	104	109	114	120	127	132	361	706	1067

According to the Social Security trustees' latest (1996) report, the impact from 2008-2018 would be even larger -- $1.228 trillion in surpluses.

Interest Would Go Off-Budget, Too

Currently, only the surplus revenue of Social Security has an impact on the federal budget, with the interest payment merely being a shift between budget accounts. However, because S.J.Res. 12 would mandate a separate off-budget entity and require balance in the remaining on-budget accounts, this interest would have to be transferred off-budget -- therefore having to be offset within the remaining on-budget accounts. In comparison to the budgetary fiction under which they would be necessitated, the transfers would be all too real and would mean either additional taxes or additional spending cuts on top of those already needed to eliminate the real deficit.

Welcome to the "Multi-Budget World" of S.J.Res. 12

To fully grasp the fiscal implications of this change, we need to look at the rapid and large changes over time. We also must identify the effects that would take place in the confusing new world of S.J.Res.12's "multi-budget world" of on-budget, off-budget, and the real, unified federal budget that is the combination of the two. Finally, we need to look at the impact on the economy, which is influenced not by artificial constructs and gimmicks but by the full scope of federal borrowing and spending in the true, unified federal budget.

1998-2001: The Transition to "Gimmick Deficits"

Even though S.J.Res.12 would not require balancing the remainder of the budget excluding Social Security until 2002, the effects would begin to be felt prior to this because of the steep acceleration in the deficit. Between FYs 1998 and 2001, $361 billion in additional deficits would enter the baseline. Without prior modifications to smooth the path toward balance, the drop-off would be too dramatic -- a deficit of $292 billion, which would be the largest deficit ever recorded -- to accommodate in 2002.

	1996	1997	1998	1999	2000	2001	2002	2003	2004	2005	2006	2007	TOTAL 98-01	TOTAL 02-07	TOTAL 98-07
Federal Deficit	107	124	120	147	171	167	188	202	219	254	266	278	605	1407	2012
SS Total Surplus	66	78	81	88	94	98	104	109	114	120	127	132	361	706	1067
Federal Deficit w/o SS TF	173	202	201	235	265	265	292	311	333	374	393	410	966	2113	3079

The transition would work like this. Social Security would continue to run both its revenue and interest surpluses as before and still be counted as they should be within the true, unified budget totals. The whole unified budget would begin its movement to balance with declining deficits. However, it would have to do so at a greatly accelerated pace in order to begin accommodating the transition to Social Security's exclusion.

The effect would be much steeper taxes or spending cuts than would be necessary to achieve true balance. If the deficit reduction took place on the federal spending side, the overall economic impact would be favorable as the government reduced its demand in the credit markets. However, if all or a significant portion came from tax increases, the already weak economy would be jeopardized.

How difficult would this be? Consider that:

• This would deepen the deficit by $361 billion between 1998-2001.
• While there would be no constitutional requirement that this deficit be eliminated entirely, a steeper glide-path would have to be taken in order to reach balance by 2002.
• For the whole 1998-2002 period, Clinton's latest budget proposes just $252 billion in overall savings -- far less than the $361 billion that would have to be accommodated under S.J.Res. 12.

2002-2012: Full Impact of the "Gimmick Deficit"

In contrast to the preceding favorable four-year period, the next decade would begin to show the full negative economic potential of S.J.Res.12, as the true, unified budget overshot balance. Again, Social Security would continue to have both surplus revenue and interest receipts. Not only would both swell in nominal dollars, these now would have to be fully offset in the on-budget accounts. The effect would be an excess balance in both the on-budget accounts (as even the phony interest transfers now would have to be offset) and in the off-budget. With balance in the on-budget accounts (despite the Social Security interest transfer) and surplus in the off-budget, the true, unified budget actually would be in substantial surplus.

At first glance running a surplus in the federal budget might not seem a bad idea, until the astronomical sums and the short time-frame in which they would have to be generated are considered. In just the first six years (2002-2007), $706 billion would be required. Over the whole 2002-2012 period, the "gimmick deficit" would amount to $1.935 trillion. These enormous sums make the prospect of tax hikes even greater than during the pre-2002 period and the prospects would only increase thereafter as the sums in the "gimmick deficit" increase.

That $1.935 trillion is more than eight times Clinton's largest-ever 1993 tax hike of $240 billion and almost five times the amount of CBO's estimated savings ($423 billion) of what it will take to reach balance between today and 2002. While surpluses are not bad per se, the enormous level of the surplus in the short duration would put massive strains on fiscal policy.

How Could It Not Result in Raising Taxes?

If all the deficit reduction (or even a significant part of it) came from tax increases, the negative economic impact would be obvious. And, it should be remembered that this growing "gimmick deficit" continually increases the likelihood that taxes will be raised. Further, it reduces the possibility that taxes ever can be reduced -- since doing so would require not only filling the "gimmick deficit" hole but offsetting the tax cuts on top of it.

How difficult would it be to eliminate $1.395 trillion between 2002 and 2018? Consider that:

• Spending literally would have to be cut in five of the six years in the 2002-2007 period, even under CBO's most recent baseline spending estimates for a balanced budget assumption. This means spending would decline in absolute terms -- not just "cuts" from a presumed rate of growth.
• How rare are absolute spending cuts? Only nine times since 1933 have they occurred. Eight were due to severe economic contraction or the ending of wars: 1935, 1937, and 1938 during the Depression, the first three years following World War II, and the first two years after the Korean War.
• Congress's vetoed 1995 effort to balance the budget merely slowed the rate of growth in spending.

• The rate of the increase in the "gimmick deficit" likely would lead to more absolute spending cuts after 2007, too. (Since CBO's baseline extends only to 2007, it is impossible to calculate now.)

If these increasing amounts lead to increasing taxes -- as they surely must -- S.J.Res. 12's effect would be a real economic drain on the private sector. That is precisely the opposite of what a legitimate balanced budget requirement should produce.

2013-2018: Transition Toward Balance, Part 2

Once again, the true, unified budget would approach balance -- only this time from the side of declining surplus. Social Security's revenue surplus would disappear as its outlays surpassed its revenues. The overall effect on the unified budget would be to eliminate the surplus it would have to maintain in order to offset the earlier Social Security revenue surplus. In short, the unified budget would be moving toward balance. However, it still would be necessary to offset the "gimmick deficit" created from interest payments to the trust fund -- $539.4 billion over the six-year period.

Let's not forget the dilemma created by the fiction of Social Security's separateness which could well serve to mask, via the on-budget's interest payment transfer, the scope and ultimate government responsibility, thus delaying a solution to the Social Security crisis.

How hard would eliminating the last of the gimmick deficits be? Consider that:

• The "gimmick deficit" from 2013-2018 would be $539.4 billion.
• For comparison, CBO estimates the savings needed to eliminate the current deficit by 2002 is $423 billion.

2019: Momentary Balance at Best

At best, for one brief year, the true, unified budget would be in balance as the on-budget transfer of the Social Security interest payment almost exactly offset the off-budget deficit between Social Security outlays and receipts. Of course, one-year balance would have virtually no real economic effect -- being a mere pause before the roller coaster plunged once again. And even this momentary balance would only occur if there were a slight surplus in the on-budget to offset the slight $2.6 billion off-budget deficit in 2019.

As the gap between Social Security revenues and outlays widened, even the Social Security interest transfer from the on-budget accounts would not be sufficient to bridge the distance after 2019 and the federal budget again would return to deficit.

2020 and Beyond: The Gimmick's Denouement and Skyrocketing Deficits

Artificially masked for two decades, the true nature of S.J.Res.12's fiction would become apparent. Balance in on-budget accounts still would be constitutionally required but would be meaningless as far as any positive economic impact. This is because the true, unified budget would lapse back into deficit once more as Social Security's spending outstripped all its resources -- revenue and interest -- until the trust fund bankrupted in 2029.

These deficits would amount to $700.6 billion in the first five years (2019-2024); $2.474 trillion in the first ten years (2019-2028); and $3.122 trillion by the trust fund's bankruptcy in 2029 (2019-2029). And every dime of these deficits would be perfectly constitutionally legal!

Because the deficits occurred on the off-budget side of the ledger, there would be no requirement that these deficits had to be eliminated. Borrowing again could suffice to pay these costs because it would not be prohibited by S.J.Res.12 (there are at least three plausible scenarios: see attached table 3). The draining of funds from the credit market would have the same negative impact it always has had on the economy.

Adopting the Dorgan Amendment: Worse Than Doing Nothing

All told, if S.J.Res. 12 is taken at its face value, there would be less than two decades (2002-2019) of nondeficit federal spending. During that short period, balance in the true, unified budget would take place for at most one year -- 2019. During the entire time the American economy would have to tip-toe through the minefield of potentially lethal tax increases. The overall scenario would be one of uncertainty, the worst possible situation for financial markets.

S.J.Res.12 with its required fiscal contortions is likely to cause economic recessions that true balanced budgets would minimize. Furthermore, should a recession occur, there would be no possibility for a tax reduction to aid the private sector as was provided by both Presidents Kennedy and Reagan. If anything, the prospect would have to be large tax hikes in order to fill part of the succession of hundred-billion-dollar "gimmick deficits" occurring year after year. In fact, S.J.Res.12 virtually guarantees that a tax cut could never take place. Until then, the on-budget accounts would be struggling to offset the Social Security surplus transfer -- there would be no room to offset this and a tax cut on top of it.

In effect, S.J.Res.12 would lock-in the current tax burden as a floor with only the (increasingly) likely prospect that the ceiling would be raised over the next two decades. Such is S.J.Res.12's perverse nature that only a cut in the Social Security tax would be possible, as these tax cuts would not be counted in the constitutional deficit.

Endangering Social Security

Nor would S.J.Res.12 provide any additional support for Social Security. The trust fund would run deficits just seven years after its outlays began exceeding revenues in 2012 -- exactly the current estimation. The trust fund would be bankrupt just ten years after that (2029) -- exactly the current estimation. The trust fund balance sheet would not change by a dime and its solvency calendar not altered by a day. Rather, S.J.Res.12 would maintain the fiction that Social Security is not the pay-as-you-go system it has always been. By pretending there exists some hidden balance, S.J.Res.12 actually would forestall a real solution to Social Security's long-term imbalance.

The Democrats' alternative balanced budget constitutional amendment would put America on a fiscal roller coaster of huge swings that would amount to trillions of dollars in increased deficits during the next three decades. It's a ride America can't afford to take.

Copies of three charts used in this paper are available in SR-347