Revised April 21, 1999
The Abraham-Domenici Lock-Box Legislation
by Robert Greenstein
Table of Contents
I. How the Lock-Box Would Work
II. Why the Legislation Could Lead to a Squandering of the Opportunity to Pay Down Most or All of the Publicly Held Debt
IV. The Effects of the Lock-box Proposal
V. Increasing the Risk of Government Default
In Senate floor action on April 20, Senators Spencer Abraham and Pete Domenici offered a Social Security "lock-box" proposal as a substitute for another budget process bill. The Abraham-Domenici proposal (the "Social Security Surplus Preservation and Debt Reduction Act"), which is a revised version of a lock-box proposal these Senators circulated in March, is now being debated on the Senate floor. A first vote related to this legislation is expected April 22.
Backers of the legislation promote it as preserving and protecting Social Security (and doing more for Social Security than the Administration's proposals), while promoting fiscal responsibility and debt reduction. Close examination indicates, however, that the lock-box proposal would likely have quite different and deleterious effects. The legislation could lead to little debt reduction actually occurring, would risk making recessions more frequent, and would increase the risk of a government default.
Treasury Secretary Robert Rubin identified these and other problems with the version of the proposal that its sponsors circulated in March, and the proposal's sponsors have since modified it in an attempt to address some of these criticisms. While the degree of risk the current legislation poses is not as high as the risk that last month's version would have posed, the modifications fall far short of solving the serious problems the legislation raises. The problems stem from the proposal's basic structure.
- The legislation could lead to little debt reduction taking place. It authorizes the use of Social Security surpluses for purposes other than paying down debt or providing Social Security benefits, such as the creation of private retirement accounts. If much of the Social Security surplus is used to fund private accounts while most of the non-Social Security surplus is used to finance large and growing tax cuts as the Congressional budget resolution approved last week envisions little debt reduction will occur.
- The legislation poses a danger for the economy; it would risk making recessions more frequent and deeper. The legislation would establish debt limits requiring the non-Social Security budget to be in balance through April 30, 2010. The Treasury would be barred from borrowing funds if a deficit materialized, unless three-fifths of the Senate and a majority of the House passed legislation to raise the debt limit and thereby allow borrowing to occur.
Budget cuts or tax increases consequently could be required if the economy weakens. When the economy slows, expenditures for programs like unemployment insurance rise, while revenues fall or grow more slowly. As a result, a slowdown in the economy could cause the debt limits the legislation establishes to be breached. To avoid such a breach, budget cuts or tax increases would be needed. But cutting government expenditures or raising taxes when the economy is slowing is the opposite of what sound economic policy would prescribe; such actions would risk pushing a weak economy into recession.
To address this concern, the legislation's sponsors have added a provision that suspends the debt limits after two consecutive quarters in which real GDP growth is below one percent. While helpful, this provision falls substantially short of what is needed to prevent the proposal from having a damaging effect on the economy.
The economy could weaken considerably and be heading toward a possible recession before real GDP growth falls below one percent for two consecutive quarters. During such a period, a budget otherwise in close balance would threaten to become unbalanced, necessitating budget cuts or tax increases to prevent the debt limit from being breached. Such austerity measures, however, would steepen the economy's descent.
Furthermore, when economic growth fell below one percent, Congress would not know it for about half a year, and still larger budget cuts or tax increases could be required during that time. If real economic growth is below one percent in the first quarter of a calendar year (i.e., January through March) and remains below one percent in the second quarter, the first point at which Commerce Department data will show that there have been two consecutive quarters of below-one percent growth will be at the end of July. From January through the end of July, the debt limits would remain in place. The budget cuts or tax increases the legislation could require during that period could tip the faltering economy into recession.
Adding to these problems, Commerce Department data on GDP growth rates often are revised. Data released in late July might show a growth rate of between one and two percent, but then be revised downward a few months later to below one percent. In such a case, the "escape hatch" in the legislation for a weak economy would take even longer to become effective.
That it takes a long time to recognize economic downturns is borne out by the experience of the last recession. Economic data show the recession started in July 1990. It was not officially declared a recession until 10 months later, on April 25, 1991, after the recovery had already started.
- The legislation also would increase risks of a government default. A breach of the debt limit could loom as a result of a slowing economy, lower-than-expected revenue growth (which could occur as a result of a drop in the stock market) or other factors such as higher-than-forecast health care costs (which could occur, for example, if a major flu epidemic broke out among the elderly). If such an event occurred and Congress and the President could not agree in time on budget cuts or tax increases to avert a threatened debt limit breach and a three-fifths majority could not be amassed in the Senate to raise the debt limit crisis would loom. The Treasury would have to default on government obligations or hold up various government payments, possibly including Social Security payments. (Note: The lock-box legislation would require Treasury to "give priority" to paying Social Security benefits in such circumstances. If the debt limit has been breached and the Treasury is forbidden to borrow, however, the Treasury may not have sufficient cash to pay all Social Security benefits on time.)
In the past, it has proved hard enough to secure a simple majority in Congress to raise the debt limit, even when no feasible alternative existed; securing a three-fifths majority in the Senate could prove excruciatingly difficult. The proposed lock-box legislation consequently would increase the risk of a government default, an event unprecedented in U.S. history. (In response to criticisms that the bill could precipitate debt limit crises, Senators Abraham and Domenici have moved the date at which the debt limit is reduced from the start of every other fiscal year to May 1 of every other year, after the Treasury has received April revenue collections. This may reduce the number of circumstances in which a crisis would develop. It would not, however, solve the basic problem that a slowing economy, lower-than-forecast revenue growth, or other unforeseen factors could trigger a debt limit crisis and create the risk of a government default.)
- Requiring a three-fifths majority in the Senate for an increase in the debt limit also would be unwise because it would confer on minority factions in the Senate an unprecedented degree of leverage over national economic and fiscal policy.
It may also be noted that although some proponents of this legislation describe it as preserving Social Security for future generations, that is not the case. Without the legislation, Social Security is projected to become insolvent in 2034. With the legislation, Social Security still will be projected to become insolvent in 2034. It also is not accurate to describe the legislation as doing more for Social Security than the Administration's proposals.
In short, this analysis finds the lock-box proposal to have significant deficiencies and to pose large risks, even with the modifications its sponsors have made. The proposal's shortcoming do not mean, however, that proposals to lock away Social Security surpluses are inherently unwise. Carefully crafted lock-box legislation, designed so it does not risk pushing a weak economy into recession or triggering a government default, could serve a useful purpose.
But this particular proposal remains deeply flawed. Using debt limits enforced by supermajority voting requirements and backed by threats of default is an unwise way to achieve the goal of preserving Social Security surpluses.
Since 1990, the nation has used other mechanisms to enforce fiscal discipline rules requiring that the costs of tax cuts and entitlement increases be offset, and rules imposing caps on discretionary spending. These mechanisms have been highly effective. They have operated without threatening budget cuts or tax increases when the economy weakened and without creating risks of government defaults. Mechanisms can be fashioned to enforce fiscal discipline and prevent inappropriate use of Social Security surpluses, building on the successes of the past decade's budget enforcement mechanisms, without posing the grave risks that the lock-box legislation now before the Senate would carry.
How the Lock-box Would Work
The proposed legislation would establish steadily declining statutory limits on the publicly held debt. These limits would essentially equal the current Congressional Budget Office projections of what the debt levels would be over the next 10 years if the non-Social Security budget is balanced and all Social Security surpluses are used to pay down debt.(1)
These debt limits could be raised only by a three-fifths vote in the Senate and a majority in the House. This means that if the non-Social Security budget threatened to fall out of balance and the Treasury consequently faced a need to borrow funds, no borrowing could occur unless a supermajority could be assembled in the Senate to pass legislation allowing it.
Until now, it has taken a simple majority of Congress to raise the debt limit. On numerous occasions, it has been difficult to amass a simple majority for this purpose. Votes to raise the debt limit typically are surrounded by high-stakes political maneuvering. Securing a three-fifths vote in the Senate to raise the debt limit could prove extremely difficult.
The idea behind this legislation is that if the non-Social Security budget threatened to fall out of balance, Congress and the President would have to reach agreement on ways to reduce government expenditures or increase tax collections to keep the non-Social Security budget in balance. It is possible, however, that such an agreement could not be reached, and a supermajority in the Senate would not vote for legislation to raise the debt limit. If that occurred, the Secretary of the Treasury would have to default on financial obligations of the U.S. Government or withhold government payments, including payments to beneficiaries of government programs, government contractors, and Medicare providers. The Secretary would have to take these actions without regard to whether the unified budget (i.e., the total budget, including Social Security) remained in surplus.
Why the Legislation Could Lead to a Squandering of the Opportunity to Pay Down Most or All of the Publicly Held Debt
The Abraham-Domenici lock-box proposal is sometime described as a measure to ensure that Social Security surpluses are used to pay down the $3.6 trillion in debt held by the public rather than to fund other programs. But the lock-box proposal contains a large loophole. It is constructed so Social Security surpluses can be used to establish a large new entitlement in the form of individual accounts, rather than to pay down debt. Under the lock-box proposal, if Social Security surpluses are used to fund individual accounts rather than to pay down the debt, the debt limits are automatically adjusted upward.
The lock-box legislation has been designed in this manner to accommodate Social Security legislation that Republican leaders are developing, which is expected to use the bulk of Social Security surpluses over the next decade for private accounts. The Social Security proposal that Reps. Bill Archer and Clay Shaw are expected to unveil next week, as well as the plan Senator Phil Gramm has crafted, are expected to establish individual accounts without reducing Social Security benefits. Plans of this nature require large amounts of additional funding. These new funds could not come from the non-Social Security surplus, since the budget resolution Congress passed last week sets aside the vast majority of that surplus for tax cuts. This leaves only one source for funding these accounts the Social Security surpluses.
Under the approach the Republican leadership apparently envisions, the Treasury would borrow the Social Security surpluses each year, provide Treasury bonds to the trust funds in return, and then use most of these surpluses to fund deposits into private accounts. (This is essentially the same type of financial maneuver that some Members of Congress have criticized as "double counting" when discussing the Administration's Social Security plan.) To allow for this maneuver, the lock-box legislation provides for automatic increases in the debt limits if Social Security surpluses are used to finance private accounts.
This feature of the lock-box proposal means that despite the rhetorical homage paid to debt reduction, there could be very little of it. The non-Social Security surplus would go primarily for tax cuts rather than debt reduction. The Social Security surplus would go primarily for private accounts rather than debt reduction.
The picture would worsen after 2009. The tax cuts reflected in the budget resolution would mushroom so rapidly from $142 billion in cost over the first five years to $636 billion in the second five years (and $177 billion a year and still climbing by 2009) that their cost would almost certainly exceed the entire non-Social Security surplus within a few years after 2009, bringing back deficits in the non-Social Security budget at that time. Aggravating this problem, if the government placed an amount equal to two percent of each worker's wages into private accounts each year an approach espoused by economist Martin Feldstein and likely to be included in the Archer-Shaw plan the cost would exceed the entire Social Security surplus not long after 2009. If the government still had to pay approximately $200 billion a year in interest payments on the debt at that time because we had used the surpluses for tax cuts and private accounts rather than debt reduction, the budgetary squeeze would be even more fierce and the resulting deficits higher.
This is a picture of fiscal irresponsibility rather than fiscal prudence. Pursuing fiscally responsible policies would entail seizing the unique opportunity we now face to eliminate much or all of the publicly held debt before the baby boom generation has retired in large numbers and the nation again faces a fiscal crunch. Although the lock-box legislation gives the appearance of requiring debt reduction, it actually paves the way in conjunction with the budget resolution for policies that would squander the historic opportunity the nation now has largely to rid itself of the debt. (It should be noted that the lock-box proposal would require all Social Security surpluses to be devoted to debt reduction if no agreement is reached on Social Security legislation.)
The Risks to the Economy
Later this year, Congress and the President may enact legislation that uses most or all of the projected non-Social Security surpluses for a combination of tax cuts and discretionary and other programs. As a result, little, if any, of the projected non-Social Security surpluses may remain.
(The Congressional budget resolution calls for using most of these projected surpluses for tax cuts. Some tax cuts are likely to pass this year. In addition, the Administration and many Members of Congress of both parties are calling for using a portion of the surpluses to ease the unrealistic caps on discretionary spending; some easing of these caps appears likely, especially in light of the bipartisan support for defense spending increases and the need to pass appropriations bills.)
If Congress and the President pass legislation this year that consumes the projected surpluses in the non-Social Security budget, but the economy subsequently weakens, the non-Social Security budget is likely to slide back into deficit. The resulting deficits could be substantial. CBO estimates that a downturn of the size of the recession of the early 1990s, not a severe recession as recessions go, would increase the budget deficit (or reduce surpluses) by approximately $85 billion a year after the recession hits bottom.
CBO also cautions that its surplus forecasts could be off by larger amounts if revenues grow more slowly than it has forecast. Analysts do not fully understand why revenues have grown more rapidly than projected in recent years, and they do not know the extent to which the factors that have caused this unexpected revenue growth are temporary or permanent. Revenue growth in future years could be either lower or higher than CBO currently projects and by substantial amounts. If revenue growth is significantly lower and legislation consuming most of the currently projected surpluses in the non-Social Security surpluses has been enacted deficits in the non-Social Security part of the budget would be likely to return.
In addition, a drop in the stock market would result in lower-than-expected revenue collections, since less would be collected in capital gains taxes. That, too, could push the non-Social Security budget back into deficit.
CBO this year devoted a full chapter of its annual report on the budget and the economy to the uncertainty of its projections. It warned that "considerable uncertainty" surrounds its budget estimates "because the U.S. economy and the federal budget are highly complex and are affected by many economic and technical factors that are difficult to predict. Consequently, actual budget outcomes almost certainly will differ from the baseline projections..." (2) CBO reported that if its estimate of the surplus for 2004 proves to be off by the average amount that CBO projections made five years in advance have proven wrong during the past decade, the forecast for 2004 could be too high or too low by $300 billion.
The Effects of the Lock-box Proposal
The lock-box provision would not permit deficits in the non-Social Security budget unless three-fifths of the Senate and a majority of the House voted to allow them or there had been two consecutive quarters in which real GDP growth was below one percent. In the absence of such Congressional approval or of real GDP growth below one percent, the Treasury would be barred from borrowing funds in excess of the debt limits the legislation establishes.(3) As noted above, these debt limits assume the non-Social Security budget will be in balance through the next 10 years.
In years when economic growth is sluggish, revenue growth slows appreciably, and costs for programs like unemployment insurance automatically start to rise. Forecasts of budget balance can be overtaken by events, and deficits can emerge.
Since the lock-box proposal would bar such deficits until official government data demonstrate there have been two consecutive quarters of real GDP growth of less than one percent, fiscal retrenchment in the form of program cuts or tax increases could be required in periods when the economy begins to slow. The retrenchment would continue during the first two quarters in which growth is below one percent, since no data showing that growth had been that low would be available until at least one month after the second such quarter was over.
Imposing austerity measures when the economy slows is the reverse of how fiscal policy should function. The lock-box proposal risks tipping a sputtering economy into recession. This is why most economists who favor strong debt-reduction measures oppose legislative requirements that mandate the budget be balanced each year, as the lock-box legislation essentially would do.
One of the nation's most respected economists, Robert Reischauer of the Brookings Institution, made a number of these points in testimony before the House Budget Committee in 1992 in his capacity as director of CBO. Reischauer was referring in that testimony to a constitutional balanced budget requirement, but the issue is essentially the same as the one the lock-box proposal raises. "[I]f it worked," Reischauer warned, "[a balanced budget requirement] would undermine the stabilizing role of the federal government." He explained that the automatic stabilizing that occurs when the economy is weak "temporarily lowers revenues and increases spending on unemployment insurance and welfare programs. This automatic stabilizing occurs quickly and is self-limiting it goes away as the economy revives but it temporarily increases the deficit. It is an important factor that dampens the amplitude of our economic cycles." Under a requirement for budget balance each year, Reischauer observed, these stabilizers would no longer operate automatically and hence would be less effective.(4)
Some proponents of the lock-box proposal respond that if growth is slowing but Congress does not yet have an official report showing growth to be below one percent for two consecutive quarters, three-fifths of the Senate and a majority of the House could vote to raise the debt limit. This, however, is not a sufficient response. It is unlikely a three-fifths majority would materialize until after the economy was already in or very near a recession and overly restrictive fiscal policies already had caused economic damage.
Moreover, Congress would be unlikely to have a clear signal that a recession was coming. The Office of Management and Budget and the Congressional Budget Office have rarely, if ever, forecast a recession before one started. We usually do not know we are in a recession until the downturn is at least several months old.
Adding to this problem, it could be difficult to garner a three-fifths majority if the economy was weakening but the slowdown was regional rather than national in nature. That usually is the case in the early stages of economic downturns; past downturns generally have begun in some regions and taken time to spread. In the last recession, New England and the mid-Atlantic states began experiencing declines in employment by the second quarter of 1989, a full year before employment turned down in most of the rest of the country. If rising unemployment insurance costs and falling revenues in several regions threatened to push the federal budget out of balance, would enough Members of Congress from states where economic problems were not yet evident be willing to raise the debt limit and allow the non-Social Security budget to run a deficit? If not, fiscal retrenchment would be required, which could make the ensuing downturn deeper.
For these reasons, the lock-box proposal would likely lead to the stiffest austerity measures being taken in years when the economy was weakening but not yet in recession, including during quarters when growth had fallen below one percent but we did not yet have economic data showing this to be the case. Such actions would make recessions more likely.
Increasing the Risk of Government Default
The proposal also is likely to make crises in which a government default threatens more frequent and to heighten the risk that a default could actually occur. As noted above, it has proved difficult on a number of occasions to secure a simple majority to raise the debt limit. Securing a three-fifths vote in the Senate to raise the debt limit could prove very hard.
As explained earlier, a non-Social Security budget balanced at the start of a fiscal year could slip out of balance during the course of the year for a number of reasons beyond policymakers' control, such as slower-than-expected economic growth or smaller-than-expected revenue collections. If such a development occurred with part of the fiscal year gone, the budget cuts or tax increases that would be required to avert a need for borrowing might be unattainable. To enact and implement measures that produce large budget savings generally takes some time. Moreover, even if such measures could somehow be enacted quickly, the savings they would generate would not begin to appear for a while. Yet only a limited number of months might remain in the fiscal year. Budget cuts or tax increases deep enough to produce the necessary savings in just a few months' time could prove very difficult, if not impossible, to secure.
The alternative allowing a deficit in the non-Social Security budget and borrowing the funds to cover it would require a three-fifths Senate vote. If budget cuts or tax increases large enough to avoid breaching the debt limit could not be enacted in time and a three-fifths majority to raise the debt limit could not be secured, a default crisis would loom.
The Consequences of a Default
CBO has warned that even a default lasting only a few days could have lasting consequences, because it could erode confidence in the binding nature of the financial obligations of the U.S. Government and consequently raise government costs. The national debt is financed at relatively low interest rates because those who purchase government securities are confident they will be repaid in full and on time.
Similarly, federal defense and highway contracts are less costly than they would be if contractors lacked confidence of being paid in full and on time. If a default occurred, even if only for a brief period, confidence in the U.S. Government's ability to make payment in full and on time could be shaken. The interest rates the government must pay on securities the Treasury issues could rise, as could the costs of government contracts.
These increased costs could last for years. A default also could lead to a lowering of the U.S. Government's credit rating and a lessening of our effectiveness internationally in prodding other countries to avoid defaults.
Does the Plan Do More for Social Security?
A claim made in support of the proposed lock-box legislation is that it would "do more for Social Security" than the Administrations proposals. For two reasons, this claim is not accurate.
The claim stems from the fact that under the Clinton plan, the Treasury would continue to use a modest portion of Social Security surpluses to help fund other government programs for the next six years. The bulk of Social Security surpluses would go to pay down the debt held by the public during this period, but an average of about $28 billion a year of these surpluses or about $170 billion over the next six years would be used to fund other government operations. The proposed lock-box legislation would forbid such use of Social Security surpluses. This is the basis for the claim that it would do more for Social Security than the Clinton proposals.
This claim overlooks a key point, however that this aspect of the Clinton plan would not reduce trust funds assets. That under the Clinton plan an average of $28 billion a year of Social Security surpluses would help fund other government programs does not mean the trust funds would have $28 billion a year less in Treasury bonds. When the Treasury borrows surplus revenues from the Social Security trust funds, as it does every year, it provides the trust funds with Treasury bonds in return. The trust funds receive the same amount of bonds regardless of whether the Treasury then uses the surplus Social Security revenues to help fund other government programs or to pay down debt. Under the Administrations plan, an average of $28 billion a year for six years would be used to help fund other programs rather than to pay down debt, but trust fund balances would not be directly affected.
To be sure, the fact that not as much debt would be paid down in the next few years because of the use of an average of $28 billion a year for other programs is not without consequence. But this is not a matter that would directly affect the trust funds. It also may be noted that this use of a portion of the Social Security surpluses to fund other government operations would end after the sixth year under the Clinton plan. In years after that, the plan would devote sufficient amounts of the unified budget surpluses to debt reduction to make up for the effects on the debt of using some Social Security surpluses to fund other government programs during the first six years.
The other reason that the claim the lock-box legislation would do more than the Clinton proposals to bolster Social Security is not correct is that it overlooks the Administration proposal to shift $2.8 trillion dollars in additional assets into the Social Security trust funds over the next 15 years, over and above the assets the trust funds otherwise will hold. The Social Security actuaries project these additional assets would extend the year in which Social Security becomes insolvent by 23 years. By contrast, the lock-box proposal does not provide additional assets to the trust funds or extend the year in which Social Security would become insolvent.
Giving Minority Factions Power to Disrupt the Economy
The requirement that the debt must shrink in line with pre-determined debt limits unless three-fifths of the Senate (and a majority of the House) agree to raise these limits would have one other important consequence. It would confer upon minority factions in the Senate an unprecedented degree of leverage over national economic and fiscal policy.
Due to the supermajority requirement, minority factions could withhold support for an increase in the debt limit when the economy slowed but economic data were not yet available to show growth had fallen below one percent for two straight quarters. These factions could effectively threaten to plunge the government into turmoil (and to make a default crisis a real possibility) unless they were granted major policy concessions. Minorities willing to threaten turmoil and disruption to achieve their ends could gain unprecedented power.
For example, one can envision a minority insisting on large tax cuts that do not expire when a slowdown ends as its price for agreeing to raise the debt limit when the economy weakened. The minority might use supply-side arguments and claim the permanent tax cuts would ignite long-term economic growth. When the added long-term growth failed to materialize, still-deeper cuts in basic programs could be needed to offset the ongoing revenue losses the permanent tax cuts would have caused.
1. These debt limits would automatically be decreased or increased to the extent that annual Social Security surpluses proved to be larger or smaller than the current CBO forecast assumes.
2. Congressional Budget Office, The Economic and Budget Outlook: Fiscal years 2000-2009, January 1999, p. 81.
3. The legislation allows borrowing for expenditures designated as emergency spending.
4. Statement of Robert D. Reischauer, Director, Congressional Budget Office, before the House Budget Committee, May 6, 1992.