A primer on Social Security
“It [Social Security] is a monstrous lie. It is a Ponzi scheme to tell our kids that are 25 or 30 years today you’re paying into a program that’s going to be there.”
--Texas Gov. Rick Perry (R), Sept. 8, 2011
When the front-running presidential candidate for the Republican Party makes such an inaccurate statement about such a fundamental government program during a debate, it’s time for a primer on Social Security. Here are some answers to basic questions about the program, which is frequently mischaracterized in political discourse.
What is Social Security?
Social Security was created in response to the pervasive poverty during the Great Depression. It is designed to provide workers with a basic level of income in retirement, as well as disability pay and life insurance while they work.
Just over 60 percent of the 54 million beneficiaries are retired workers; the rest are disabled workers, dependents or survivors. The benefits are progressive, meaning lower-income workers get a relatively better deal than higher-income workers; however, workers making above a certain salary ($106,800 this year) don’t have to pay as much of their income into the system. The benefits are inflation-adjusted, a feature that is almost impossible to find in the U.S. annuity market.
How is Social Security financed?
About 96 percent of workers must pay a certain amount of their paycheck, generally 6.2 percent, to the system, an amount that is matched by their employers. (Some state and local workers don’t participate in Social Security.) Normally the employee rate is 6.2 percent of salary, but it was reduced to 4.2 percent this year as part of a “payroll tax holiday.”
Social Security is a pay-as-you-go system, which means that payments collected today are immediately used to pay benefits. Until recently, more payments were collected than were needed for benefits. So, Social Security loaned the money to the U.S. government, which used it for other things. In exchange, Social Security receives interest-bearing Treasury securities. The value of those bonds is now about $2.6 trillion.
Why do some people, such as Perry, label Social Security a “Ponzi scheme,” meaning that it will eventually collapse?
The baby boom generation has begun to retire, reducing the number of workers per retiree. Meanwhile, people are living longer and thus would collect benefits longer, while parents are not having as many children, which limits the pool of new workers. Largely because of the recession, payroll collections now are not covering all benefit payments, and in 2010, Social Security started to tap its trust funds. Most experts predict the demographic, life expectancy and fertility trends will continue even after the baby boom generation passes -- though some say the assumptions are too pessimistic.
Indeed, after years of running a cash surplus, Social Security now has a negative cash flow. And that means that this year the Treasury has to go into the private market and issue bonds to investors on Wall Street and overseas in order to to make good a relatively small percentage of benefit payments — about $45 billion.
Why do some people say the trust funds have nothing but IOUs?
IOU is just a pejorative way of saying “bond.” These bonds are backed by the full faith and credit of the U.S. government. Until the debt ceiling debate, one could not imagine that any president or Congress would risk defaulting on these bonds because it would damage the nation’s financial standing. Still, the bonds are considered a good bet--deemed to be one of the safest places to keep money.
But, then, doesn’t the government have to pay for them somehow?
This is where it gets confusing. The bonds are a real asset to Social Security, but they also represent an obligation of the rest of the government. Like any entity that issues debt, such as a corporation, the government will have to make good on its obligations, generally by taking the money out of revenue, reducing expenses or issuing new debt. The action taken really depends on the resources available at the time. There is nothing particularly unusual about this, except that the U.S. government is better placed to make good on these obligations than virtually any other debt-issuer.
Why wasn’t the surplus cash generated by Social Security placed in stocks or something else?
That has been an option discussed from time to time, though people were concerned about government control of corporate assets and having retirement funds subjects to market swings. But it’s important to remember that if the $2.6 trillion now in the Social Security trust funds had been invested in some other security, not only would the value of the trust funds be subject to more volatility, but all things being equal, the publicly held debt of the United States would be $2.6 trillion higher today. That’s because for years the Social Security surpluses were used to help fund government operations, thus reducing the overall budget deficit.
Is there anything wrong with issuing new debt as benefits exceed tax revenue?
There is nothing fundamentally wrong, especially since the national debt is lower today than if Social Security had not been running surpluses. But issuing new debt is a choice with certain consequences. It is one thing to issue debt to build schools; it is another thing to build up debt to finance the expenses of the elderly. Every time the government issues new debt to facilitate consumption, it crowds out capital formation and ultimately passes on a smaller economy to future generations.
Policymakers will have to decide whether it is more important to worry about people alive 20 years from now or people alive 50 years from now. Some believe future generations will be richer and more productive, and thus able to afford the bill. In the end, the ability to pay benefits will be determined by how big the economy is at the time, not necessarily what kinds of assets are held by Social Security. At the moment, the government’s finances are such that it has no choice but to issue more debt to make payments.
Would creating individual accounts, such as recommended by GOP presidential candidate Herman Cain, also also require more debt?
Yes. If the accounts are funded out of existing payroll taxes, which was favored by former President George W. Bush when he attempted to overhaul the system, creating such accounts would require Social Security to tap the trust fund even faster. That is because the system would need to keep paying current beneficiaries, while also funding nascent accounts for people who likely will not retire for decades. If no new source of revenue is added, some sort of loan, potentially worth trillions of dollars, may be needed to help bridge the financing gap in the early decades of the program.
Are there other ways to deal with a financing gap in Social Security?
In the past, payroll taxes have been increased and benefits have been reduced (such as raising the retirement age).
It’s important to remember that Social Security does not run out of money or go “broke” even when its trust funds are exhausted in 2036, as projected in the most recent Social Security trustees report. The report says that tax income would be sufficient to pay about three-quarters of scheduled benefits through 2085.
So Perry is wrong when he says, “It is a Ponzi scheme to tell our kids that are 25 or 30 years old today, you’re paying into a program that’s going to be there.” Even at current trends, the program will be there, though with reduced benefits if absolutely no changes are made—which is not politically likely.
It seems like I put a lot of money into Social Security and won’t get a lot back.
You are not only paying for retirement benefits, but also disability and life insurance. Moreover, wealthier people are helping subsidize poorer workers. We also are paying for the fact that as the system was set up and expanded, earlier generations of retirees got much more in benefits than they contributed in payroll taxes.
The rate of return earned by the Treasury bonds in the trust funds is pretty good. But to talk about the rate of return for individual workers is a bit misleading because Social Security was never intended to generate wealth, but rather to supply an income floor.