Interview with Alan Auerbach: Federal Debt and Social Security

David A. Price of the Federal Reserve Bank of Richmond interviews Alan Auerbach “On the federal debt, the Social Security trust fund, and how Uncle Sam discourages seniors from working” (Econ Focus, First/Second Quarter 2025). Here are a few of the points that caught my eye.

The US Has Lost its Debt-Restraint Religion

It’s the case, as I’ve said in recent years, that the U.S. doesn’t pay any attention to the national debt. That was not true if you go back, say, 20, 25 years or more. If you look, for example, during the Reagan administration as well as the first Bush and Clinton administrations, it was the case that when debt or projected deficits went up, government undertook actions to reduce them, either by increasing taxes or by cutting spending.

That ended sometime in the early 2000s. In the last 20 years or so, it’s just not there. If we went back to the way we were behaving then, the kinds of shocks that are going to keep hitting the budget, either because of interest rates or pandemics or financial crises or other things, could be dealt with by those kinds of government reactions.

So it’s both good news and bad news. It’s good news in the sense that we’ve been there before. It’s not as though we have to undertake an approach that’s never been contemplated or practiced. But on the other hand, we lost religion sometime in the last 20 to 25 years. And it’s not exactly clear how we’re going to get that back because we lost it in a bipartisan way. There used to be bigger constituencies in Congress and in the White House for dealing with national debt, at least when problems became more apparent.

How Inflation, and Limited Inflation Adjustments, Reduces US Deficits

[T]here are different ways in which inflation interacts with the fiscal system to affect the taxes that people pay and the benefits that they receive. It could help them or hurt them; it mostly hurts them.

Some things are not indexed for inflation at all. … [T]he threshold over which you’re taxed on your Social Security benefits … has been fixed in nominal terms since it was implemented. That means that the more inflation we have, the more people are going to be subject to tax on some or all of their Social Security benefits.

Where we do have indexing for a lot of elements of the tax system and benefits, there are delays before the system catches up. For example, once you’re receiving Social Security, your benefits go up every year because of inflation. On the tax side, the federal tax brackets are indexed for inflation so that if your income goes up by 10 percent because inflation is 10 percent, it’s not going to change your bracket because the bracket’s indexed for inflation. However, there’s a delay in the indexing. What that means is that if there’s a sudden surge in inflation, the first year or so is going to happen before the brackets and the benefits start reacting to it. For example, if we went from an inflation rate of zero to an inflation rate of 10 percent on a permanent basis, that would cause a 10 percent decline in people’s Social Security benefits because it would happen once and then we’d be forever one year behind.

The final thing is that capital income — interest, capital gains, things like that — are mismeasured because of inflation. For example, if I buy an asset for $100 and the price level doubles over the period that I hold it, and I sell the asset for $200, my real gain is zero. But I’d be taxable on a gain of $100, because we don’t index capital gains for inflation. We don’t index interest income. If the inflation rate is 4 percent and I’m getting 4 percent nominal interest, my real interest is zero, yet I’m still taxable on the 4 percent.

So through lack of indexing, delayed indexing, mismeasurement of capital income, as well as similar effects on the benefits side in terms of delayed indexing, people in general — not every person — have a reduction in resources as a result of inflation. In one sense, that makes inflation a more effective tool for dealing with the deficit. … I don’t think it’s a particularly attractive way to do it because it’s quite arbitrary. If you look at the distribution of effects, it varies a lot across households depending on the type of income they have. We wouldn’t say it’s very well designed.

Might Social Security Switch to Relying on General Tax Revenues?

It’s true that in 1983, which was the last time the Social Security trust fund was nearing exhaustion, we had the Greenspan Commission that recommended changes in Social Security, which were then adopted, which raised the retirement age very slowly and increased payroll taxes. That put the Social Security system on a better financial footing for many decades.

That could happen again. But it could also be the case that Congress and the government don’t have the appetite for providing this kind of bad news to people in the Social Security system. They could just say, well, we’ll use general revenue funding to cover the shortfalls of Social Security. We already do that for Medicare Part B, the health insurance, and Medicare Part D, the drug benefit. They are not self-sustaining; we have premiums paying for a small part of the benefits and the rest comes from general revenues.

Some of the traditional supporters of Social Security say it’s good to have it be a self-financing system because it makes people feel that they have a stake in it when they’re paying their payroll taxes and so forth. But if the choice of the government is to cut benefits, raise payroll taxes, or use general revenue funding, given their behavior in recent years, I’m fearful that they’ll choose general revenue funding and just kick the can down the road.

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