What you need to know about the Social Security Trust Fund. When going bust is no big deal (according to some people).

Is Social Security sustainable? What a silly question, of course we will always make it sustainable and likely keep pushing more and more of a financial burden on a smaller and smaller younger population. Social Security started as a relatively modest way to provide a safety net of income in old age. Back in 1935, age 65 was truly old age. Today, not so much (a decidedly nice thought given I am 67). What began as a modest effort was “improved” by successive Congresses adding new benefits, a COLA and an array of other goodies going far beyond the original intent. Take a look at the text from the 1936 pamphlet below, the promise that the “most you will ever pay” is three percent on each dollar earned up to $3,000 a year…oops. Today that three percent is 6.2% and the $3,000 is $106,800 and rising.  However, despite the financial situation of the program we get a break in 2011 and only pay 4.2%.

Careful planning apparently allows for just about any assumptions you like.

From the 1936 Government Pamphlet on Social Security

YOUR PART OF THE TAX

The taxes called for in this law will be paid both by your employer and by you. For the next 3 years you will pay maybe 15 cents a week, maybe 25 cents a week, maybe 30 cents or more, according to what you earn. That is to say, during the next 3 years, beginning January 1, 1937, you will pay 1 cent for every dollar you earn, and at the same time your employer will pay 1 cent for every dollar you earn, up to $3,000 a year. Twenty-six million other workers and their employers will be paying at the same time.

After the first 3 year–that is to say, beginning in 1940–you will pay, and your employer will pay, 1.5 cents for each dollar you earn, up to $3,000 a year. This will be the tax for 3 years, and then, beginning in 1943, you will pay 2 cents, and so will your employer, for every dollar you earn for the next 3 years. After that, you and your employer will each pay half a cent more for 3 years, and finally, beginning in 1949, twelve years from now, you and your employer will each pay 3 cents on each dollar you earn, up to $3,000 a year. That is the most you will ever pay.

There is much talk about the so-called “trust fund.” When I think of a trust fund I think of a pile of money placed in some investment designated only for a specific purpose (like a private pension trust fund that cannot be touched by a corporation for other purposes), a giant savings account if you will in this case, backed by the full faith and credit of the U.S. Government. So, is there really a trust fund? Not in the above sense, but in a government sense and certainly payment of Social Security benefits is back by the federal government, trust fund or not. But there are consequences to that promise and that may be what we should worry about.

Incoming Social Security taxes are used to buy special U.S. Treasury Bonds; these bonds are also sold to pay the monthly benefits to those of us collecting Social Security. For now, the taxes exceed the benefit payments (except as noted in the second bullet below) and thus there is a net increase in the bonds (investment) held by the Trust. We are near the point where rather than a net increase in the bonds held by the trust; there will be a sale of bonds to pay benefits (2015 as noted below). That means the federal government has to provide the cash as the Trust redeems the bonds. But by 2037 there are no more bonds to redeem and absent any changes, the Social Security payroll taxes that are incoming will pay only 78 percent of the benefits to beneficiaries. Of course, the people paying the taxes then as today are not the people collected the benefits; it will be your children and grandchildren who have the dubious distinction of paying more and more for less and less. Let’s keep this in perspective, 2037 is only twenty-six years away, slightly more than twice the time we have been fighting wars in the Middle East…how time flies.

From the 2010 Social Security Trustees Report

In the 2010 Annual Report to Congress, the Trustees announced:

• The projected point at which the combined Trust Funds will be exhausted comes in 2037-the same as the estimate in last year’s report. At that time, there will be sufficient tax revenue coming in to pay about 78 percent of benefits.
• The projected point at which tax revenues will fall below program costs comes in 2010. Tax revenues will again exceed program costs in 2012 through 2014 before permanently falling below program costs in 2015-one year sooner than the estimate in last year’s report.
• The projected actuarial deficit over the 75-year long-range period is 1.92 percent of taxable payroll-0.08 percentage point smaller than in last year’s report.
• Over the 75-year period, the Trust Funds would require additional revenue equivalent to $5.4 trillion in present value dollars to pay all scheduled benefits.

Assume nothing is done to change the state of Social Security, then what? Well, as we have said this promise is backed by the full faith and credit of the United States, a promise a tad less comforting than perhaps fifty years ago, but pretty solid nevertheless.

What happens in 2015 when the Trust needs its money back or later when the Trust is exhausted? Where does the money come from? Keep in mind that there is no pool of money held in reserve. Each time the Trust purchases new bonds from the Treasury the proceeds of that sale are used by the government to, well, spend on all the other promises made by the government, like roads, and the military and farm subsidies, to help you buy a Volt, to meet everyone’s special needs; all stuff like that.

Nevertheless, a promise is a promise so where does the money come from to pay the Social Security benefits? The Treasury has to sell more bonds to others such as China, American investors, etc. which of course means more debt and the assumption someone wants to buy this new debt. Not only does the government have to raise the money to pay the promised Social Security benefits, it must sell other bonds so that it has the income to spend that was previously generated by the purchase of bonds by the Social Security Trust Fund.

Just imagine, some Chinese fellow making computer components for a U.S. company has to invest in U.S. government bonds so that we can pay our elderly their pensions…and you were opposed to free trade!

Think of it all this way:

You and your employer pay your taxes = the taxes are used to pay benefits = excess taxes are loaned to the Treasury = Treasury uses the loan proceeds for the operation of the government…then…less taxes are available to loan to the Treasury because they are needed to pay benefits = eventually not only is there no extra money to invest, but the previously loaned money is needed to pay benefits = the Trust cashes in its bonds = Treasury needs to come up with the money = Treasury sells new bonds to someone else (borrows more) to pay Social Security benefits (remember we are talking trillions of dollars over just 75 years) and to run the government.

Or, the government simply prints more money thereby creating inflation. Either way we seem to be getting into a deeper hole along the way of keeping a promise made in 1935.

Given the above scenario beginning shortly, it is hard to understand the argument made by some politicians that Social Security does not (or will not) affect the deficit in a quite dramatic way.

Nobody knows the real consequences of all this, some dismiss the additional borrowing as no big deal and hey, we are talking years from now. Today the argument is made that borrowing money is cheap because of low interest rates, but there is no guarantee that rates will always be low. Others see the solution as higher taxes…on the wealthy of course. 

For example, see what Sen. Bernie Sanders says:

Although Social Security will be strong for more than a quarter-century, Congress should strengthen it for the longer term. That is why I agree with the president, who has called for raising the cap on taxable income. Today, that cap is at $106,800; no matter how much money you make, Social Security taxes are only deducted on the first $106,800. But by removing the cap on incomes of $250,000 or more, we can make Social Security fully solvent for generations to come.  [NOTE: Americans reporting adjusted gross income of more than $250,000 to the IRS are projected to make up roughly 2 percent of households. Those folks will earn about 24.1 percent of all income, and pay 43.6 percent of all personal federal income taxes, according to the Tax Policy Center.]

Even with no change, the fact is that Social Security has a $2.6-trillion surplus that is projected to grow to more than $4 trillion in 2023. Is this surplus, as some have suggested, just a pile of worthless IOUs? Absolutely not!

Social Security invests its surpluses, as it should, in U.S. Treasury bonds, the safest interest-bearing securities in the world. These are the same bonds that wealthy investors and China and other foreign countries have purchased. The bonds are backed by the full faith and credit of the U.S. government, which in our long history has never defaulted on its debt obligations. In other words, Social Security investments are safe.

So now you know where Social Security stands. Where do you stand? Is this all no big deal; are all the promised benefits safe? Can the U.S. afford business as usual except for taxing those really wealthy people who earn more than $250,000 a year (who by the way are already being taxed an extra amount to pay for Medicare and health care reform)?

Let’s all hope there is a big pot of gold at the end of this rainbow or it will be a very rainy day for our children and grandchildren?