Hey, Big Spender! The Federal Budget: Social Security: A Case in Point

Social Security: A Case in Point

Let's try to clear the air around Social Security, which has become quite cloudy. First, many people seem to think that Social Security is a “welfare” program. It may be one in the sense that it aims to ensure people's welfare. But the term “welfare” typically refers to programs for poor people. There are some extremely well off—even wealthy—people cheerfully cashing their Social Security benefit checks every month.

Why? Because people who receive Social Security typically spent years paying Social Security taxes believing that they were accruing those benefits for themselves by paying those taxes. That is, in fact, the agreement between the government and those who pay Social Security taxes.

Social Security was enacted by Congress in 1935 as a social insurance program in which workers pay into the system during their working lives and earn entitlement to family benefits upon retirement, disability, or death. About 44 million Americans currently receive benefits, including 30 million elderly retirees and their dependents, 6 million disabled workers and their dependents, and more than 7 million survivors of deceased workers. These figures include more than 3 million children.

About 96 percent of U.S. workers contribute to Social Security, currently paying 6.2 percent of their wage income up to $68,400. That amount is matched by the employer, while the self-employed pay the entire 12.4 percent themselves. These payroll taxes are by far the largest source of funding for the program.

Unfortunately, the system operates on a pay-as-you-go basis, which means that the money being paid into the fund by current contributors is going to the people who currently receive Social Security benefits. The system collects more in payroll taxes than it pays out to beneficiaries. Where, you might be wondering, does the rest of the money go?

It goes into the Social Security Trust Fund, which now has about $600 million in it. But that's not entirely accurate. The money is not going into the Trust Fund. The money is being spent on other government expenditures. Government bonds are going into the Trust Fund, in the amount of the excess Social Security taxes collected for the benefits paid each year. In other words, the government is borrowing the money from the Trust Fund.

Problems Ahead

Regardless of political viewpoint, everyone agrees that if no changes to the system are made, at around 2012 or 2014, the Social Security system will be collecting less in revenues that it will be paying out in benefits. That's because the famous baby boomers, the 77 million people born from 1945 to 1964, will be retiring in numbers that will suck up more money than the contributors will be paying in.

One solution to this financial dilemma is to raise the payroll taxes or to lower the benefits at that time, now, or between now and that time. Another is to reduce government spending in other areas. Each of these measures is unpopular and politically difficult. Other proposals abound, but mostly they just reduce benefits, either by raising the retirement age or paying people only the benefits that they need (in other words, means-testing). Another proposal is to partially or completely privatize the system, which would radically alter its character. Besides, doesn't the marketplace already provide thousands of ways to invest privately? Yet another proposal is to invest the money in stocks, but that brings market vagaries into the picture. (What happens, for example, in a multiyear bear market?)

Some people look to the Social Security Trust Fund to make up the shortfall. They say that the fund, which will continue to grow until 2014, will be sufficient to make up the shortfall until 2034. The question those people must answer is this: If the government will not have the money to pay full benefits from taxes being collected at the time, where will it get the money to repay the bonds in the Trust Fund?

In 1983, Congress started taxing the Social Security benefits of high-income retirees, raised the retirement age, and raised the payroll taxes. In raising the payroll taxes, the government promised that the accumulated balances in the Trust Fund would guarantee future benefits. But the government put bonds in the Trust Fund and spent the money on other things. To “take money” out of the Trust Fund to pay benefits, the government must first “put money” into the fund by repaying the bonds (with interest, I might add). There really is no way for the government to do that without raising taxes, cutting spending, or cutting Social Security benefits.

What's the Solution?

Economics can indeed be a dismal science, because ultimately it is about addition and subtraction. No household, business, or society can borrow money to pay for something in the future, spend the money now, and expect the money to be there in the future. That is exactly what the Social Security Trust Fund enables people to expect. The Trust Fund does represent the Social Security system's claim on future government funds. But those funds will have to come from somewhere, and the only source is the taxpayer, who must pay more in taxes or make do with fewer government services.

The “solution” in any situation ruled by economics is for people to face the facts. But, as in many households and businesses, people avoid unpleasant facts. These people eventually go bankrupt. The U.S. government will not go bankrupt, and in all likelihood neither will the Social Security system. But the system will not pay benefits at the current rate to retiring baby boomers without a tax hike or reduced spending on other programs at some point.