Hardy and Warshawsky: When Is a Trust Fund Not a Trust Fund?

Posted June 3, 2010 at 2:24pm

By this time of year, the trustees of Social Security and Medicare have reported on the financial status of these important programs. However, the Obama administration decided to postpone the issuance of these Trustees Reports in order to have them reflect the effects of the new health care legislation. Unfortunately, after years of absence, there are still no confirmed public trustees in office to object. Reports or not, public trustees or not, we think that it is still an appropriate time to reflect on the finances of Social Security and Medicare and what their trust funds actually represent.

[IMGCAP(1)]According to the dictionary definition, a trust fund is “property (as money or securities) settled or held in trust.” Most people probably think of the situations where a worried grandparent puts away a bank account to help pay for the future needs of her disabled grandchild, or a grateful alumnus sets aside a piece of land to benefit his alma mater upon his death. The common characteristic is that the trust fund represents real assets that are set aside, not to be used for anything except a specific purpose, often passing resources from the older to the younger generation.

Many citizens have probably also heard of trust funds held by the federal government. The most famous and largest is the Social Security Trust Funds. They have reportedly grown over the last 25 years to almost $2.5 trillion.

There is also one for Medicare. This trust fund is also reported to have grown over the years, and it will grow even more rapidly with the increases in payroll and other taxes under the recently passed health care reform legislation being counted there. And that same legislation has also established a trust fund for a new long-term care insurance program, with premiums from people buying insurance policies from the federal government being allocated there before benefits are paid out.

These federal government trust funds, however, are not the same as the dictionary definition or as most people would understand trust funds to mean from their common experience.

The trust funds of the federal government are invested in non-negotiable Treasury securities, which the Office of Management and Budget and the Congressional Budget Office do not now consider in their primary reporting and projections of federal debt. Neither do the credit-rating agencies regard these securities in their assessments of the creditworthiness of the United States. In reality, the revenues that are counted as flowing into the trust funds are used to pay for other activities and programs of the federal government.

For example, when President Barack Obama says the new health care reform legislation will reduce the deficit, he means that the new taxes and premiums credited as going to the Medicare and federal long-term care insurance trust funds are going to actually pay for the cost of the new health care entitlement. These streams of revenues can’t be in two places at the same time, so clearly they do not fill trust funds in the way that one would normally assume.

The system works like one happy family where Mom diligently puts money into the Christmas Club account weekly and Dad pays the credit card bill monthly. Only Dad decides to pay the credit card off with the Christmas Club money, with all intentions of repaying the Christmas Club account. But when Christmas comes, the Christmas Club account is depleted and the family has to decide between having no Christmas or borrowing more money to finance it.

Similarly, when some pundits and advocates say not to worry now about the finances of Social Security because benefits can be paid until 2037 when the trust funds run out, they are being naïve, confused or — worse — untruthful. As the chief actuary of Social Security recently stated, there are now more dollars in benefits being paid out than taxes being collected for the Social Security program. In a time of $1.5 trillion annual budget deficits, Social Security is today being supported by the Treasury borrowing from China and other foreign countries.

More broadly, for years, many experts have understood that the government bonds in the Social Security Trust Funds were never saved. The new health care legislation makes this point even easier to understand. The legislation spent all the money generated for Medicare on a new entitlement — in the very same bill! For decades, the federal government has been spending the allocations to the Social Security and Medicare trust funds, but rarely has it been so blatant about it. This debt will have to be repaid by future generations of Americans. This is not the same picture most people have of a benevolent trust fund set up by loving grandparents to help their grandchildren succeed and prosper.

These are painful facts to state. But it will be even more painful for us and for future generations if we continue to be confused by the misuse of words — trust funds — that originally had a meaning of planning for a better future, but actually mean big and growing trouble ahead unless we act responsibly now.

Dorcas R. Hardy was commissioner of Social Security and author of “Social Insecurity: The Crisis in America’s Social Security System” and “How to Plan Now for Your Own Financial Survival.” Mark Warshawsky was assistant secretary for economic policy at the Treasury Department. They are both members of the Social Security Advisory Board.