Government Trust Funds:
How they Really Work

by Mark Adkins   (date about 1995-6)

Medicare and Social Security benefits, like all other government outlays, must be paid for each year either by tax receipts, proprietary receipts (e.g., premiums paid into Medicare Part B), borrowing (i.e., deficit spending), or some combination. When a federal trust fund is credited with more income than outgo (as is the case with Social Security), the trust fund "balance" increases. What exactly does that mean? Consider: In fiscal year 1994 the federal government ran a $203 billion deficit. That means that it spent every nickel of tax receipts and proprietary receipts, PLUS $203 billion it borrowed by issuing Treasury securities to the public; that is, it sold Treasury bills, notes, and bonds to any entity outside the federal government, including domestic individuals and companies, banks, and state and local governments, as well as foreign individuals and central banks.

The obvious question is, if it spent everything it received and spent an additional $203 billion of borrowed money, how could it "credit" a trust fund balance? The answer is, by writing itself IOUs. That is, the government issues its own securities -- to itself. Unlike debt to the public (when it sells securities to outside entities to raise money to cover deficit spending), the bonds which constitute the trust fund "balances" are neither debts nor assets. An IOU from me to you is a debt for me and an asset for you. An IOU from myself to myself is neither. The same is true of the federal government, or any other entity.

In the case where a trust fund program spends more than it takes in, as Medicare does, the outlays are still funded the same way that all government outlays are: by tax receipts, proprietary receipts, and borrowing from the public (deficit spending) to make up the difference. But the trust fund balance is reduced by the amount of shortfall.

What does that mean? It means that the federal government cancels its debt to itself by "redeeming" the bonds it issued to itself. Just as I incur no debt by writing myself an IOU, neither do I decrease my liabilities (or increase my assets) by cancelling such an IOU. I can write myself IOUs all day long, tear some of them up, and my personal finances remain unaffected. The same is true of the federal government. The government admits as much in the FY 1996 Budget document entitled "Analytical Perspectives," p. 258:

"These balances are available to finance future benefit payments and other trust fund expenditures -- but only in a bookkeeping sense. Unlike the assets of private pension plans, they do not consist of real economic assets that can be drawn down in the future to fund benefits."

So, what happens when the Medicare trust fund balance reaches zero, or becomes negative? Nothing. Because the trust fund balance does not pay for Medicare program outlays. Current tax receipts, proprietary receipts, and borrowing from the public (deficit spending) pay for contemporaneous Medicare program outlays. Future benefit payments must be paid for with future collections and borrowing: the government does not salt away real economic assets to pay for future Medicare outlays.

Furthermore, the amount spent by Medicare is determined by the Medicare beneficiary formulas written into the law. If XXX number of people qualify for YYY number of Medicare dollars, then unless and until the formulas are changed by amending the law, the federal government must make good on those obligations. The trust fund balances are irrelevant, both financially and legally.

The very use of the term "trust fund" when applied to federal trust funds like Social Security, Medicare, and others, is misleading. As the government itself puts it (Analytical Perspectives FY 1996, p. 251):

"The Federal budget meaning of the term 'trust' differs significantly from its private sector usage. In the private sector, the beneficiary of a trust owns the income generated by the trust and usually its assets. A trustee, acting as a fiduciary, manages the trust's assets on behalf of the beneficiary. The trustee is required to follow the stipulations of the trust, which he cannot change unilaterally. In contrast, the Federal Government owns the assets and earnings of Federal trust funds, and it can raise or lower future trust fund collections and payments, or change the purpose for which the collections are used, by changing existing law."

Once you understand the basic operation of the federal trust funds, you can begin to make other useful distinctions. One of the most important is the difference between public transactions and intragovernmental transfers.

Public transactions consist of all income to the government from the public (e.g., taxes and voluntary premiums collected), and of all outlays from the government to the public (e.g., benefit payments).

Intragovernmental transfers consist of "payments" (accounting shifts) from one government account to another. The two main types of intragovernmental transfers are interest payments to trust funds and government "contributions" to trust funds.

Recall that the balances of trust funds consist of special government bonds issued by the government to itself. Since these are interest bearing bonds, the government must then pay itself interest! This is effected by an intragovernmental transfer from a different government account to the trust fund account. Of course, such a transfer has no affect on total government spending or receipts, any more than shifting $10 from my right pocket to my left pocket affects my personal spending or receipts: it only affects my internal accounting systems, should I choose to keep separate books on each pocket. Thus, intragovernmental transfers have no affect on the deficit.

Intragovernmental "contributions" are similar transfers which are required by law (e.g., transfers into federal employee retirement trust funds).

When determining the trust fund balances, the government normally considers both public transactions and intragovernmental transfers. But in determining whether a trust fund program contributes to the deficit, it can be useful to consider just the public transactions. For example, in FY 1994 the Social Security Trust Fund took in $335.0 billion in tax receipts from the public. It spent $317.6 in benefit payments to the public. This gave it a public transactions accounting basis surplus of $17.4 billion. That was a real surplus, which Congress spent. However, when intragovernmental interest and contributions transfers are included, the Social Security Trust Fund had a surplus of $56.8 billion. This is the amount of bogus bonds the government issued to itself for that trust fund.

The real surplus, $17.4 billion, was used as an offset to general expenditures. While it's true that "a trust fund must use its income for purposes designated by law" (Analytical Perspectives, p. 251), this law requires any surplus to be "invested" in Treasury securities. Never mind that spending the actual cash surplus on general expenditures while writing yourself an IOU does not constitute an "investment" in any meaningful sense of the term: Congress interprets the law in this manner and the public lacks legal standing to challenge this interpretation, since by law it is the U.S. Government, not the public, which owns the trust funds' income and assets.

Why, then, does Congress talk about "saving" the Medicare trust fund from insolvency? Some members of Congress may not be any better educated than the general public (or the media). But all of the congressmen who serve on the committees dealing with such matters, and a great many more, know better. The charade is of convenience to both parties. In the past, the Democrats have argued in favor of tax increases to extend solvency. They are not only trapped by their own past rhetoric, but may find such arguments useful and effective again in the future. More recently, the Republicans have argued in favor of benefit cuts, using the same trust fund solvency argument. They too find it useful to advance their own agenda. Neither party is going to expose the other because it would mean admitting that both parties have misled the public for years. It would mean admitting that Congressmen are either fundamentally ignorant, or outrageously deceptive. As far as I can tell, this little shell game has gone on since the beginning of the trust funds, including those years when the federal government was running annual total-budget surpluses instead of deficits. A historian might know the precise disposition of such funds, but the important question to remember is this: what did the government do with the cash it paid itself when it purchased its own Treasury securities? Answer: spent it.

Of course, in future years, demographic shifts may result in larger beneficiary populations, and this will need to be funded either by increased taxes, decreased benefits, or increased borrowing (deficit spending). But this has nothing to do with the solvency of the trust fund "balances," and neither tax increases nor benefit cuts implemented NOW will affect the financial condition of the programs in FUTURE years of increased use: they will simply give Congress more money to spend on other things TODAY.

The lapdog media, unfortunately, are either unwilling to read the Budget of the United States Government (and other government documents) closely enough to learn the truth, or are simply unwilling to challenge Congress. They tend to accept what the power players are saying as truth, even if easily available evidence proves otherwise.

They think that if the United States Congress, and in particular those members with expertise on the matter, are all discussing the need to keep the Medicare trust fund solvent, then by virtue of that fact, Congress must be both correct and honest in its representations.

Now you understand how this aspect of the system works. Here is what you can do: the next time you hear politicians -- of either party -- discussing "saving the trust funds from bankruptcy," write a letter to those politicians accusing them of ignorance or deceit. Simply point out that Social Security, Medicare, etc., are pay as you go programs, and the concept of bankruptcy simply doesn't apply. Point out that our federal budget has been running in the red for decades, so that even on the most general level, the concept of bankruptcy doesn't apply.

If you don't know the address, call your local library's telephone reference section and ask them for it. And if the media fails to challenge this kind of nonsensical rhetoric, write the reporters or pundits -- and the head of the network or magazine/newspaper they appear on/in, and make the same point. Accuse them of ignorance or complicity.

I GUARANTEE you that if enough people complain regularly and vigorously about this kind of Establishment propaganda, they'll worry. You don't have to be a majority, because in their eyes (accurately or not) every letter represents a much larger number of silent but similar individuals. Through this multiplier, you can act with the power of 100 or 1000 men. Take the time to get involved. Don't worry about how many other people are committed, because the outcome will be based upon the aggregate of *individual* actions, not on collective action.

Just do it. Your silence will be interpreted by those in power as evidence of your stupidity and malleability. Metaphorically kick the bastards in the teeth.