Does Paul Krugman Understand Finance?

When it comes to the ‘framing’ of public discourse on entitlements, Paul Krugman is accustomed to writing columns that are more about issuing commands than making arguments; he has railed in the past even against President Obama for admitting that yes, we do have a problem paying for the explosive present and future growth of entitlements. But even for this genre of “there is no crisis” column, his latest is a head-scratcher:


Social Security’s attackers claim that they’re concerned about the program’s financial future. But their math doesn’t add up…

About that math: Legally, Social Security has its own, dedicated funding, via the payroll tax (“FICA” on your pay statement). But it’s also part of the broader federal budget. This dual accounting means that there are two ways Social Security could face financial problems. First, that dedicated funding could prove inadequate, forcing the program either to cut benefits or to turn to Congress for aid. Second, Social Security costs could prove unsupportable for the federal budget as a whole.

So far, so good; it is a fact that Social Security keeps an independent set of books, and also a fact that if it runs out of money from those books, it will turn to the general federal budget for assistance. Although his second point is just another way of restating the consequences of the first, i.e., what happens to the general federal budget when Social Security comes knocking for aid. As I’ll explain in a second, that’s not a hypothetical; because of the nature of the trust fund, it’s about to start happening.

But neither of these potential problems is a clear and present danger. Social Security has been running surpluses for the last quarter-century, banking those surpluses in a special account, the so-called trust fund. The program won’t have to turn to Congress for help or cut benefits until or unless the trust fund is exhausted, which the program’s actuaries don’t expect to happen until 2037 – and there’s a significant chance, according to their estimates, that that day will never come.

…So where do claims of crisis come from? To a large extent they rely on bad-faith accounting. In particular, they rely on an exercise in three-card monte in which the surpluses Social Security has been running for a quarter-century don’t count – because hey, the program doesn’t have any independent existence; it’s just part of the general federal budget – while future Social Security deficits are unacceptable – because hey, the program has to stand on its own.


Actually, it’s Krugman who is trying to have it both ways here; I leave to the reader whether the Nobel Prize winning economist is actually this ignorant of basic finance or whether he is yet again attempting to deliberately mislead his readers. As Krugman himself notes, the program has run an operating surplus in the past, which is coming to an end. In the near future, Social Security begins running an operating deficit, which requires it to draw down its ‘savings’ in the “trust fund.”

But what are those savings? The problem, as I have explained previously, is that the trust fund’s only assets are IOUs from the federal government. If we stay for the moment with the fiction of treating Social Security as indeed an independent entity, that means that for years it’s been lending money to Congress that was used to prop up the budget at no real economic cost (it’s not like the federal government needed to lay out money to pay interest on those debts – all it did was make accounting notations). Whereas now, Social Security will begin asking for its money back – and all of a sudden Congress in one fell swoop both loses a cost-free source of funds and has to start laying out cash from the general budget to repay those debts so that Social Security can make payments to beneficiaries. That’s not “aid,” it’s precisely how the trust fund mechanism is designed to work. And it’s going to take a ferocious bite out of the budget. Saying this is not a problem for Congress is like saying your fortunes haven’t taken a turn for the worse when your interest-only mortgage suddenly starts requiring principal payments, or when you’ve been borrowing from a loan shark and spending the money for living expenses and suddenly have to start repaying him. Basically, Congress took the money and spent it, and now it has to tighten its belt to repay it. You’d go broke very quickly trying to follow Prof. Krugman’s financial advice.


Krugman pooh-poohs the size of that bite, saying that “an aging population will eventually (over the course of the next 20 years) cause the cost of paying Social Security benefits to rise from its current 4.8 percent of G.D.P. to about 6 percent of G.D.P.” – which is another way of saying that it will increase 25% even if we buy his numbers (and bear in mind that while we can project trends on a general level, any projection that goes 20 years out is worthless – we can estimate what benefits we’ll owe based on demographics, but there’s no way to accurately predict GDP growth that far out) and even if we ignore the loss of a cost-free source of funds. Krugman’s reliance on speculation that the trust fund may never run out is just pure hot air, and his analysis overlooks half the problem. For some perspective, in Fiscal 2010, interest on the federal debt is 1.3% of GDP – if you assume that the cost of paying benefits rises by 1.2% of GDP and that’s all funded by Congress repaying its debts to the trust fund, all else being equal, you’ve doubled the cost of interest on debt. And this is before we even get into the question of whether we can grow payrolls as fast as we would like so as to avoid an even worse shortfall from FICA receipts.

If you look at Social Security as just part of the federal budget, the whole trust fund accounting business reveals itself as an even more obvious sham. IOUs you write yourself are really an “I owe me.” A corporation that wrote itself IOUs backed only by its general credit and housed them in a special purpose vehicle with no other assets couldn’t legitimately count those IOUs as an asset – that is, to oversimplify, one of the things that got Enron in trouble. But Krugman seems to think the Enron model works just fine for Uncle Sam, who needn’t worry about his future expenses because he’s been saving up all of those IOUs…from himself.


One way or another, Social Security’s operating deficit will be paid for not by any store of savings set aside for a rainy day, but by money that you and me and our kids and grandkids earn in the future. Don’t let Paul Krugman tell you otherwise.


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