Ignore the hyperbole surrounding entitlement reform. Get the facts.
In a recent Post, I argued that the 2040 Matters community should assess presidential candidates based on their plans for repairing the American Dream, particularly their commitment to generational justice. I went on to note that one of the most tangible commitments a candidate could make in this regard would be to propose reforming the so-called “entitlement” programs – Medicare and Social Security.
There is no question that these programs are important and worth preserving. They reduce poverty and improve the quality of life for our elderly. For these reasons, they are also enormously popular, even with younger generations that do not believe they will receive their promised future benefits.
But there is also no debate that these programs constitute truly massive inter-generational wealth transfers from the young to the old. They are, 
moreover, indisputably under-funded today. Within two decades, these programs will be unable to pay scheduled benefits without substantial (payroll) tax increases – tax increases that will be imposed on members of the 2040 Matters community and our children.
Social Security is complicated
The longer we wait to reform Social Security, the worse our options for ensuring its solvency are going to be. Don’t just take my word for it. This is what the Trustees have been telling us for years:
“If substantial actions are deferred for several years, the changes necessary to maintain Social Security solvency would be concentrated on fewer years and fewer generations. Much larger changes would be necessary if action is deferred until the theoretical combined trust fund reserves become depleted in 2034.”
We in the 2040 Matters community need to listen and take action to change the status quo. Start today by learning more about Social Security and its finances.
Key Fact #1: Social Security is an “insurance” program, not an “entitlement.”
The formal name for the portion of Social Security that provides retirement benefits is “Old-Age and Survivors Insurance.” Referring to Social Security as an “entitlement” confuses current and future beneficiaries as to the purpose of the Program and makes it harder to build public support for reform efforts.
Key Fact #2: Social Security is a “pay as you go” program, not an investment program for individual workers.
“The [payroll] taxes paid by today’s workers and their employers don’t go into dedicated individual accounts (although 32% of Americans think they do, according to the 2014 Pew Research survey). Nor do Social Security checks represent a return on invested capital, though you might be forgiven for thinking so [given that we refer to Social Security as an entitlement and] the personalized Social Security statements . . . detail your payment history and projected monthly benefits. Rather, the benefits received by today’s retirees are funded by the taxes paid by today’s workers; when those workers retire, their benefits will be paid for by the next generation of workers’ taxes. [This is “pay as you go.”] Your benefit amount is based on your earnings history and age at retirement, not on how much you and your employer paid in Social Security taxes.”
Key Fact #3: People now live much longer after the normal retirement age than they did when Social Security started.
In 1940, the normal retirement age for Social Security was 65. At that time, the average life expectancy for a man was 61.4 years; for a woman, it was 65.7 years. If a man lived to be 65, he had an average remaining life expectancy of 11.9 years; for a woman, it was 13.4 years.
At program inception, therefore, many people might not live long enough to collect Social Security. For those that did, they would collect for an average of roughly 12.5 years.
In 2014, the average life expectancy for a man was 76.8 years; for a woman, it was 81.4. If a man lived to be 65, he had an average remaining life expectancy of 18.1 years; for a woman, it was 20.6 years.
The normal retirement age is rising to 67, partly as a response to this trend and the need to keep Program costs down. Of course, the average life expectancy is now much higher than this retirement age. Moreover, the average remaining life expectancy after retirement is much longer, roughly 17 years – more than 4.5 years longer than when Social Security started.
As a result of these increases in longevity and the failure of the normal retirement age to increase at a commensurate rate, “individuals will be living longer in retirement.”
Key Fact #4: There are far fewer workers for each Social Security beneficiary than there were just 30 years ago.
At program inception, there were roughly 159 workers for every Social Security recipient. By 1986, that ratio had dropped to 3.3:1. Today, it stands at 2.8:1, and it is still dropping. Therefore, “[t]he aging of America has created a situation in which relatively fewer workers will be asked to support a growing retired population.”
Key Fact #5: Social Security is the largest program in the federal budget.
The U.S. Government spends more on Social Security than any other program. It eclipses both Defense and Medicare spending by wide margins. In 2014, the U.S. Government spent $859 billion on Social Security. This amount was almost four times what the Government spent on education, transportation, environmental programs, and research and development, combined!
Key Fact #6: Payroll taxes do not cover the current cost of Social Security.
The 12.4% payroll tax that funds Social Security does not cover the Program’s current costs. In 2014, the tax generated $756 billion in revenue. As noted above, the Government spent $859 billion on the Program.
The remaining costs of the Program were covered primarily by taxes on benefits (a portion of Social Security benefits are taxable when the recipient’s overall income exceeds a certain threshold) and interest payments from Treasury securities held in the “Trust Fund.”
Key Fact #7: “Trust Fund” does not mean what you think it means.
As a “pay as you go” Program, Social Security uses its tax receipts to pay benefits. These receipts are not deposited in any type of special fund unless the Program’s revenues exceed its costs. In such years, the excess revenues are “invested,” and these investments constitute the “Trust Fund.”
“The Department of the Treasury invests trust fund[s] in interest-bearing securities issued by the U.S. Government. . . . The trust fund investments provide a reserve to pay benefits whenever [the] total program cost exceeds income.” The income from these reserves can take two forms: (1) interest payments on the securities; or (2) redeeming the securities themselves for their full value.
In essence, the Trust Fund is a U.S. bond portfolio. The Government is obligated to pay interest on the debt Social Security holds and, eventually, pay the bondholder – Social Security – the value of each bond.
The key point to understand with regard to the Trust Fund is that once Social Security purchases a bond from the Treasury, the Treasury is free to use the money it receives from Social Security for any lawful purpose (as it does when it issues other bonds). It does not set-aside the money for Social Security.
Key Fact #8: We are borrowing money to pay for Social Security benefits today, and we will keep borrowing to pay planned benefits through 2034.
Today, the Trust Fund bond portfolio is roughly $2.8 trillion. These are real assets, but the fact that the Social Security Trust Fund invests in U.S. bonds (and Treasury in turn spends the invested funds for a variety of purposes) has two important implications for the annual U.S. deficit and our overall debt. These two implications are regularly misunderstood or ignored when media and politicians discuss the Program’s funding, solvency, and impact on our deficit and debt.
First, in a year when Social Security taxes are insufficient to cover Program costs (as was true in 2014), Social Security is partly funded by interest on its bond portfolio. If the U.S. also runs a deficit that same year (as was true in 2014), then Treasury must make this interest payment with newly borrowed funds, thereby increasing our mushrooming federal debt. (Treasury cannot unilaterally raise taxes or cut spending to balance the government books, leaving it with no choice but to borrow funds to pay expenses, such as interest payments on bonds held by Social Security).
Second, when Social Security redeems a bond in the Trust Fund, the Treasury must borrow the money needed to pay Social Security if the U.S. is running a budget deficit at the time of redemption. This means, in effect, that Social Security has the power to compel the Government to borrow an additional $2.8 trillion over the coming years (if its tax receipts do not cover Program costs and the government is running budget deficits).
And Social Security will exercise this power. According to the Social Security Trustees, “beginning in 2020, cost exceeds total income, and theoretical combined OASI and DI Trust Fund reserves diminish until they become depleted in 2034.” In other words, starting in 2020, Social Security will not only need the interest on its bond portfolio to pay planned benefits, but will also start redeeming the bonds themselves. By 2034, there will not be any bonds left in the Trust Fund – the $2.8 trillion bond portfolio will be exhausted. Given that the U.S. is projected to run budget deficits during this period as well, this means that the U.S. Government will be borrowing quite heavily in the coming years to pay Social Security benefits.
Key Fact #9: In 2034, Social Security will not have sufficient funding to pay scheduled benefits.
After compelling the Government to borrow almost $3 trillion additional dollars over the next 18 years to pay scheduled benefits, the Social Security Program currently estimates that people retiring in 2034 will receive 79% of their scheduled benefits (unless the government raises taxes substantially or borrows even more money to continue paying for scheduled benefits).
Editor’s notes:
1. If you like this Post, please subscribe to 2040 Matters and look for other ways to get involved
2. I have received a number of comments on this Post and, as a result, have updated it slightly to include additional references for Key Facts Nos. 3, 4, and 8.
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