From one point of view this is just more money in the bank, but depending on what level you let it rise to you create more and more tension between the General Fund and those who pay into FICA. Because how much Reserve is enough? Two years? Four and a half years (2005 Baby Bear). Eight years? At some point people are going to demand that they stop paying so much in and insist that the Trust Fund Ratio levels out.

And that is the rub. In order you have the Trust Fund Ratio flatten you would have to pay all of the interest due in that year plus the interest on the interest and then some of the principal. Its just like a credit card. And just like a credit card it is best to get a handle on the situation early, the longer you wait the harder it gets to actually make it to the principal. If Papa Bear is prowling the economic woods, we need to start making some contingency plans now.

But Low Cost does not mean no cost. The Demographic bulge represented by the Boomers is real and this model requires that the General Fund start paying a portion of the interest due starting in 2023, about 12% of it. Over time this becomes an increasing dollar amount, though not necessarily faster than the overall economy. But it does mean real General Fund dollars flowing into the Trust Fund year in and year out. And the only way to mimimize or eliminate that flow is to slow the flow on non-General Fund money into the Trust Fund. And there are only two other sources for that money.

One is tax on Social Security earnings. Higher income recipients pay taxes on a portion of their earnings. In 2004 that totalled $14.3 billion and that is expected to rise to between $34 and $42 billion by 2014.

The other is payroll tax. Now we know that the Republicans would push first for the tax cut on the wealthy, but that is not a big piece of the pie. Once the Trust Fund reaches a certain point the only way to actually reduce it is to slash all income below total interest earned, meeting that with increased flows from the General Fund. Depending on your numbers it gets pretty expensive pretty fast and potentially gets to the point where the majority of funding for Social Security comes in transfers from the General Fund because they can't get ahead on the interest being earned on the interest.

Well there is a way out that saves the General Fund over the long run while requiring some short term pain. If Papa Bear shows up there is a way of keeping him from the door.

Instead of simply crediting earned interest to the Trust Fund, you use real dollars from the General Fund to invest in non-Treasury instruments as a dollar for dollar replacement. I would suggest Municipal and School Bonds, for their general reliability and safety and because of their overall social utility. But the key is establish a portfolio whose returns don't have to come from the General Fund. Note there is no suggestion of Private Accounts here, just non-Federal note assets. Presto your costs are being covered by your non-interest income right up to the point of shortfall, if shortfall ever happens, your interest burden never goes up, and inflation adjusted actually goes down. If you want to drive your General Fund burden down even farther you just pay off a nother portion of the $1.7 trillion and invest the proceeds into the other portfolio.

But it does mean ponying up real dollars starting very, very soon. Hey you borrowed the money. Time to start paying it back. Before the economy baloons the balance to point where you can't pay it back.

BTW Papa Bear is coming. We are soundly thrashing Baby Bear's numbers and have for years. And we won't even talk about Mama Bear's.

Numbers aplenty at my blog or on the Economists' sites. See ya.

The truth is that the military/police sector takes up half the budget. If this was put back at a level similar to other industrialized countries more money would be available for social programs.

After all Europe and Japan get all the oil they need without a huge standing army and military infrastructure to ensure supplies. They just pay market rates. Who else is the Middle East going to sell the oil to?

For a graphic picture of budget allocations:
http://www.warresisters.org/piechart.htm

Any rate of productivity growth above 2.0% gets Papa growling, a continuation of the 2.6% average rate we have been experiencing over the last decade gets Papa roaring, a continuation of the 3.0% plus rate of the last three years means 'Katy bar the door! and bring me my 10 gauge!!'.

Well what does this mean. If we assume a rate of productivity growth between 2.1% and 3% (and why not) we extend the period when income excluding interest continues to exceed cost. Now in order to avoid the ever expanding Trust Fund it is not only necessary to divert the interest on the current $1.8 trillion into alternative investments, it would also be necessary to invest all of the surplus income. Now this quite literally pays for itself except to the degree that it raises borrowing costs for the General Fund by denying it a source of cheap financing.

At this point you are putting $150 billion or more annually into a portfolio and not drawing down a penny. In a relatively short time it becomes financially prudent to start tapping it to pay for a portion of current costs, which in turn means slowing the flow of your other income streams, which means payroll tax cuts. But how do you balance the inherent uncertainty of future economic events with policy decisions today? Answer: you use Baby Bear as your baseline and current year productivity as Papa Bear and split the difference.

Here is how it works. Baby Bear gives you fully funded Trust Fund with flat ratio. Extending current year productivity by even one year gives you a predictable surplus over and above projected needs. Take two thirds of that surplus and apply it towards payroll tax rates for that year only. You still take out 12.4% but a certain amount of that remains in a separate pool. Now there are a couple of choices of what to do with that cash, which might be pretty modest in the initial year. You could rebate it, or you could divert it to Medicare. (What you wouldn't do is set up an expensive government bureaucracy to set up private accounts. If the decision is to rebate it, let the people decide where they want to spend the money.)

In this model if the economy does as well in the current year as it did in the previous year the Trust Fund still gets an extra bump, which has the effect of driving down the numbers needed to achieve Baby Bear. Which means keeping a flat trust fund ratio requires a bigger bump in the diversion. If the economy underperforms by 33% you get the same diversion, if the economy seriously underperforms you get less. But what you have is a self correcting mechanism with a conservative economic bias.

This model requires no projections whatsover. Baby Bear to be sure will have some theoretical pieces built in: the relation between productivity and real wage growth is hugely important and in recent years has broken down, but once the relations are established Baby Bear is just a model that produces a specific outcome. Whether an outside observer would see it as wildly optimistic or wildly pessimistic is besides the point, the outcome is fixed as is the just completed year, the amount of the diversion is just a matter of arithmetic.