With the possible exception of highways, the federal program that most directly affects the vast majority of Americans is Social Security, so in a rational world we’d all have a pretty good understanding of it.
Yet from discussions I’ve seen on line, it appears that many people mistakenly believe
- that Social Security is (or was at least intended to be) a sort of savings program
- that it’s soon to go bankrupt
- that younger workers will never collect benefits
- that the Trust Fund has been "raided" by Congress and now stands empty
- that it’s effectively a Ponzi scheme
and a lot of other demonstrable nonsense.
Social Security was in fact originally designed as a pay-as-you-go system. That is, this year’s Social Security expenses are paid for by today’s taxes, the way most other government spending is supposed operate (at least when the budget is balanced). The only difference is that Social Security is financed with its own dedicated tax, and unlike the rest of the government, it’s not allowed to run a deficit or borrow money.
Arranging things this way enabled Social Security to start paying benefits of practical significance almost from the beginning. (Remember that Social Security was introduced during the Great Depression, when many people's retirement savings were wiped out.)
Take for example Ida May Fuller (Aunt Ida to her family and friends), who entered the history books when she received Social Security monthly benefit check number 00-000-001, dated January 31, 1940. She never married and had no children of her own to support her in her old age, but thanks in large degree to a combination of Social Security and her personal savings, she was able to stay in her own home almost all her entire long life.
From the time Social Security tax collections began in 1937 through her retirement in late 1939, Aunt Ida's her total contributions amounted to $24.75. By the time she died in 1975 at the age of 100, she had collected $22,888.92 in Social Security benefits, more than 900 times as much as she’d paid into the system. Had Social Security operated as a savings program, her benefits would have been next to nothing.
Most human societies care for their older and infirm members in a similar way, traditionally at the level of family or community. Social Security, born in the desperate times of the Great Depression, elevated the responsibility to the whole nation -- Americans taking care of their fellow Americans -- making old age far more secure.
Most years Social Security taxes are more than enough to cover benefits, and the excess is deposited into a Trust Fund that’s available to make up the difference when taxes fall short. So far the Trust Fund -- in fact only the interest on the Trust Fund -- has been needed in barely a dozen years. But decades ago it was recognized that as we Baby Boomers started drawing benefits, tax receipts were going to fall short. So in 1983 the law was changed to gradually raise the base retirement age from 65 to 67 and to increase the Social Security tax rate a little. (That's also when members of Congress were required to pay in to Social Security like the rest of us, though from chain emails I've seen a lot of people don't realize that.) Consequently, over the last 25 years the Trust Fund’s assets have grown 2,500 percent, from about $47 billion to over $2.6 trillion.
Of course, some will tell you that the Trust Fund is “empty” because its assets are in the form of Treasury bonds. Last year on Sean Hannity’s Fox News show, Representative Michelle Bachmann (R-Crazytown) complained, “All the surplus in Social Security is a big vault stuffed with IOU notes. There’s not one dime sitting in there.” Representative Anthony Weiner (D-Twitter) responded, “Are you surprised to learn, Congresswoman Bachmann, that we don't have a room filled with dimes?”
The guy in the gray underpants had a point. Unless your life savings are in your mattress or hidden in the rafters or stuffed into your pickup truck’s glove compartment (as was true of one poor soul I read about a couple of years ago whose truck had just been stolen), you’re likely not holding any big piles of coins or bills either. The main difference between the Social Security Trust Fund and your investment accounts is that the Trust Fund is limited to holding Treasury Bonds, pretty much the safest investment there is. (In financial economics we refer to the interest rate on short-term Treasury Bills as the “riskless rate.”)
Eventually the Trust Fund will start being drawn down to help pay Boomer benefits, but the Social Security Trustees currently estimate that in about 25 years the fund will run out of money. This is based on the assumption that future U.S. economic growth will be lower than in decades past, with per capita GDP actually falling. Under more optimistic scenarios, the Trust Fund will never run out of money. But assume for the moment that the Trustees are right.
After the Trust Fund runs out, and assuming nothing is done in the meantime, benefits would automatically be reduced to the level supported by incoming taxes. Even after that reduction, those future benefits will average considerably more than current benefits but in inflated dollars. Correcting for inflation, reduced future benefits would be comparable to benefits being paid today, so this is not such a terrible crisis as some imagine.
At present, all investment income is completely free of Social Security tax. So is earned income over $110,100. Raising that cap and slightly adjusting the benefits formula would entirely eliminate the funding problem under the Trustee’s projections.
There are still those who insist that Social Security is a “Ponzi scheme,” apparently based on the common but erroneous idea that what defines a Ponzi scheme is money flowing from later investors to earlier ones. While that indeed sometimes happens in Ponzi schemes, the mere fact of money flowing from newer participants to older ones does not a Ponzi scheme make. If it did, then investing in gold or shares of non-dividend-paying stocks (like Apple until very recently) would amount to a Ponzi scheme as well, because the only way to get back your investment or earn a profit is to sell the asset to another investor, which means money flowing from a later investor to the earlier one. What actually does define a Ponzi scheme is falsifying investment returns, either by paying out invested capital -- your own deposits or somebody else’s -- as a pretended dividend, or else simply reporting fake gains on statements without paying out anything at all. (In practice it’s often a combination of the two.)
The bottom line: There are some modest things that should be done to strengthen Social Security, but despite what you might have heard, there's no looming catastrophe.