dcw planet

You have a new baby. Congratulations! In 18 years, your young genius will surely attend a prestigious college. Being certain of this future expense, and being the prudent financial planner you are, you resolve to put a small amount of cash into a drawer each month for next 18 years. You expect that, 18 distant years from now, the accumulated funds will reduce what you will have to pay out of your running budget while your child attends college.

Ten years on, you need to replace your aging car, and, while you certainly qualify for a car loan, you actually have enough money in the drawer to buy a new car outright. Congratulations on your diligent saving! Raiding the trust fund for the car is actually prudent, you reason, since you would have to pay interest on the loan, while the money in the trust fund is interest-free. Of course, you realize, the trust fund will have to be re-paid, so you replace any cash you take out of the drawer with a piece of paper on which you have written the amount of your withdrawal.

After 18 years of diaper-changing, temper-tantrums, piano lessons, homework, school dances and test prep courses, your young genius is indeed accepted into a prestigious college. You open the drawer an find... a lot of pieces of paper.

Is the trust fund real? Don't be too hard on yourself. You love your child and you're good for the money, so certainly in that sense the trust fund is real. On the other hand, you didn't achieve your goal of reducing the money that must come out of your running budget during the next four years to pay for your child's college education. Whether you prefer to think that you are paying the college directly, or that you are paying back the trust fund which in turn pays the college, won't make an iota of difference in the amount that must now come out of your paycheck each month.

Democrats and Republicans love to argue about whether the social security trust fund is real. As my parable illustrates, their arguments are entirely beside the point. Receipts from the payroll tax have, for quite some time now, exceeded social security payments to retirees, and are expected to continue to do so until about 2015. The idea was that, by levying a larger payroll tax than was required to pay retirement benefits before 2015, we would reduce the taxes that would have to be levied after 2015 to pay to for the glut of baby boom retirees.

But that excess cash wasn't put into a vault. And indeed, it wouldn't have been fiscally prudent of the government to leave it sitting in a vault while issuing interest-paying bonds to cover large budget deficits. (What would really have been prudent is for the government to loan the excess cash to interest-paying debtor nations while not running large budget deficits. But that is water under the bridge...) So the excess cash was spent, but carefully accounted for. The social security trustees know how much the government owes them and they are counting on it being paid back. If it were not paid back, a significant tax increase would be required to make up for the missing funds. On the other hand, since the government also doesn't have the money in a vault, in order to pay it back a significant tax increase will be required.

Of course, a taxpayer couldn't care less whether he is taxed by the social security trustees or taxed by the government in order to pay the social security trustees. In either case, the only way we can pay retirees their promised benefits is to raise taxes just as much as if we hadn't saved at all. I'm not saying we aren't good for it -- given current demographic trends, and comparing the voting records of old and young people, I'm pretty sure we are going to be good for it. I'm just saying that we haven't succeeded in our ostensible goal of creating a cushion that would have allowed us to make good on our promises without raising taxes.

Stay tuned for more retirement financing conundrums.