Defaulting on Social Security Trust Fund Would Mean Massive Upward Transfer of Wealth
For Immediate Release: January 27, 2005
Contact: Debi Kar, 202-387-5080
Many proponents of privatizing and/or cutting
Social Security benefits have implied or explicitly asserted that the Social
Security trust fund does not exist. While it is true that the trust fund is
"an accounting entry" and consists of "IOUs," this is true
of most stores of wealth in a modern economy. The world is long past the day
when wealth was primarily held as a physical asset, such as gold.
An implication of the claim that the trust fund
does not exist is that the bonds held by the trust fund should not be repaid. In
effect, this would mean defaulting on U.S. government debt. Such a default would
have substantial redistributive consequences, shifting income from Social
Security beneficiaries, most of whom are middle and lower income workers, to the
mostly higher income taxpayers who are liable for the tax revenue that would be
needed to repay these bonds.
Dean Baker, the co-director of the Center for
Economic and Policy Research (CEPR) examined the distributional implications of
such a default in 2001, when the leaders of President Bush's Social Security
commission implied that a default was a possibility. The study, entitled
"Defaulting on the Social Security Trust Fund Bonds: Winner and
Losers," examined the distributional effects arising from what would be an
unprecedented default on $6 trillion in government bonds.
The taxes collected to buy the government bonds
held by the trust fund came primarily from the payroll taxes of low- and
moderate-income workers. The Social Security payroll tax is a regressive tax on
wages. It does not apply to interest and dividends and other forms of capital
income. It is also capped at $90,000 so that high-end wage earners pay a smaller
share of their income in taxes. The regressive nature of the tax is offset by
the progressive nature of Social Security's benefit formula. However, this
progressive benefit formula would become irrelevant if the government defaults
on the bonds accumulated by the trust fund.
In the event of a default, it would be necessary
to raise revenue through the regressive Social Security tax revenue that would
have otherwise been provided by payments of interest and principle from the
bonds held by the trust fund. Assuming that benefits are held constant, the
default implies a large increase in the payroll tax, compared to a situation
where the government honored its commitment to the trust fund. Alternatively,
benefits could be cut, in which case workers pay for the default through reduced
While typical workers will lose if the government
defaults on the bonds held by the Social Security trust fund, those wealthy
individuals who pay most of the individual and corporate income taxes will gain.
They will retain the money that otherwise would have been used to repay the
bonds in the trust fund.
Based on the Congressional Budget Office's model
of tax incidence, this study estimated that a default in 2002 would have lead to
a net transfer of nearly $370 billion from households in the bottom 95 percent
of the income distribution to the households in the top 5 percent. Further, the
richest 1 percent of households would have a net gain of more than $270 billion,
or an average of $300,000 per household. The net loss from default to households
in the bottom eighty percent of the income distribution would be approximately
equal to 10 percent of a year's income.The upward redistribution from a default
increases if the trust fund is allowed to continue to accumulate bonds prior to
the default, with the default occurring at the point when Social Security is
first projected to need revenue from these bonds in 2018. In this case, the
redistribution from the bottom 80 percent of households to the richest 5 percent
would exceed $1 trillion (in 2001 dollars).