The 1940s ushered in an era in which federal budget surpluses have been tiny, rare, and cumulatively swamped by deficits that have driven a rising national debt. Explosive growth of government debt has been dwarfed by growth of private debt, with U.S. saving rates being relatively low compared to many other industrialized countries.

 

            In part, private saving rates were depressed by family formation among "baby-boomers," many of whom borrowed heavily to acquire the houses and other amenities that have become the norm for those who pursue the American Dream. By the 1980s, private domestic saving fell far short of the funds needed for adequate domestic investment and to finance record federal deficits. As we have indicated, the result was that U.S. federal deficits were covered by imports that allowed foreigners to invest heavily in the United States.

 

            Many people are concerned that our deficits have effectively "sold our country to foreigners at cut-rate prices." Others worry that some future day of reckoning will usher in financial catastrophe and economic collapse. Are there natural economic limits to the size of our national debt? Do any natural forces exist to offset our national momentum toward infinite debt? One force that soon may relieve swollen deficits and rising debt is projected growth of the Social Security Trust Fund.

 

            The Social Security system ran large deficits from the 1970s into the early 1980s. Deficits during this era, when each retiree was supported by about four active workers, threatened to bankrupt the Social Security Trust Fund when post--World War II "baby-boomers" begin retiring in 2010. Demographers predicted that by 2030, each retiree would be backed up by only about two active workers. A "blue ribbon" panel was appointed to find a solution to this problem.

 

            This panel based its recommendations on relatively pessimistic forecasts about unemployment rates and rates of economic growth; it wanted to ensure that another crisis would not arise from a temporary Band-Aid solution to the problem. The resulting 1983 reform of the Federal Insurance Contribution Act (FICA) more than doubled the FICA tax. Consequently, FICA revenues exceeded Social Security benefit payments by a healthy $155 billion in 1992, with even heftier surpluses on the horizon.

 

            Social Security surpluses are legally required to be placed in "reserves" that are based on "investments" in long-term U.S. Treasury bonds. This seems, on the surface, to be both prudent policy and a good way to ensure a healthy market for government securities. Figure 9 reflects Social Security Administration long-term forecasts of its expected outlays (benefit payments), income (FICA tax revenues), and reserves (holdings of U.S. Treasury bonds). The Social Security Trust Fund Reserve, based on expected cumulative surpluses, is anticipated to mount to roughly $12 trillion by 2030. A wave of "boomer" retirements should begin around 2008, however, and last until about 2030. Reserves will gradually be dissipated until, by 2050, they are completely exhausted.

 

Figure 9  Long-Term Forecasts for Social Security Outlays, Income, and Reserves

Source: Social Security Administration estimates (1988), updated by authors. [Note: When FICA revenue exceeds benefit payments (up to point a), total FICA reserves grow (until point b). Thereafter, payments exceed revenue, so FICA reserves decline.]

 

            The enormity of the financial flows into and out of the Social Security Trust Fund will require major macroeconomic adjustments based on careful planning. The $12 trillion in total reserves expected by 2030, for example, is about 10 times as large as the level of privately held federal debt in 1990. 

 

            One effect of the imminent surge of FICA revenues may be a powerful reversal of federal deficits and national debt. Every dollar of surplus in the Social Security system will slash the federal deficit by a dollar. If the Social Security system's surpluses are, as is expected, larger than the rest of the U.S. Treasury's deficits, then the federal government will run a net surplus. Anticipated surpluses will undoubtedly absorb all outstanding national debt by the upcoming turn of the century.

 

            In a sense, public saving (through the Social Security Administration) may become so enormous that real interest rates in private financial markets will plummet. This should facilitate both domestic investment by U.S. companies and substantial investment abroad. If these developments occur as expected, the United States, which moved from being the world's largest creditor nation in the 1980 to being its greatest debtor by 1986, could easily revert to being the world's largest supplier of investment funds.

 

            The Social Security surpluses expected over the next 40 years are, in a sense, a nest egg that could, if invested properly, support our retirement system permanently. A major issue is: Into what should these funds be invested? Even if our national debt were to double by 2000, it would only amount to $8 trillion---and total reserve funds are expected to mount to $12 trillion. As you might expect, answers from all over the political spectrum have been offered to the question of how these retirement funds should be used.

 

            Some critics argue that the expected Social Security surpluses justify huge current expenditures to fix our roads, enrich our educational system, or cure poverty everywhere. Others want to defend Social Security from any spending binge. Rep. Andrew Jacobs of the House Social Security Subcommittee has characterized this task: "It'll be like walking through a bad neighborhood with a diamond ring."

 

            Others assert that this public saving (Social Security) is just a distortive shift away from what should be decisions by private individuals. According to this line of reasoning, FICA taxes should be slashed so that private individuals could choose their own retirement plans. A variant of this approach would be to allow individuals to specify for themselves the types of investments into which their taxes would be placed. This approach has been described as "privatization."

 

            "Baby-boomers" flooded our educational system in the 1950s and 1960s and invaded the labor market in the 1970s and 1980s. The depressed saving rate of the 1970s and 1980s reflected their attempts to borrow huge amounts so that they could buy their way into the good life. It is predictable that the aging and then retirement of this bubble of humanity will have profound social and economic consequences. A burst of saving (albeit public saving) for retirement by this group will probably transform persistent federal deficits into surpluses, and national debt into national "credit." The precise ways in which this occurs will be determined by how macroeconomic policymakers choose to cope with the issues we have addressed in this chapter.