Why SS Is Not “Broke” And How The Trust Fund Works

For at least two decades the “very serious people” in Washington have insisted that the Social Security system is “broke”. They’ve been screaming “bankrupt, bankrupt I tell you!” for so long that unfortunately an entire generation of young people and even middle aged workers are convinced that Social Security won’t be there for them when they retire.

If true, it would be seriously problematic especially since it’s true that to some degree people are living longer (though not as much as the screamers would have you believe). The absence of Social Security would be disastrous since those same young and middle-aged people are finding it near impossible to save adequate amounts for their retirement through private savings and 401K’s. It’s not really their fault they can’t save enough since their real wages have been stagnant or declining for decades and periodic financial markets collapses like the 2001 dot-com bubble and 2008 total Wall Street meltdown decimates their feeble retirement accounts.

decorative image of "no"So let’s look at the question of the viability of Social Security. The short answer is NO. No it’s not broke. No it’s not bankrupt. And no, it’s not going broke in the future. And in fact, it cannot go “bankrupt” in the sense that most people understand “bankrupt”.  The idea that the Social Security system will collapse – will go “bankrupt” – and not be able to pay benefits to beneficiaries is simple false. It is a lie told either from ignorance or to further another less popular agenda. is

The claims that Social Security will go “bankrupt” are based upon three premises that taken together, would appear to bring impending doom.  Closer examination reveals a gross misunderstanding of how the SS system works and a deliberate attempt to play on words to exploit people’s fears. The doom-and-gloomers essentially argue that the following syllogism:

  1. SS is a retirement pension system that depends upon the monies retired workers paid in while younger in order to pay benefits when retired. This fund of monies is called a “trust fund”.
  2. The SS Trustees annual report regularly projects that the Trust Fund will be “insolvent” at some point in the future – usually 18 to 25 years away.
  3. The doom-and-gloomers twist the on woirds to transform two technical government accounting terms “trust fund” and “insolvent” to play on fears of “bankruptcy” and zero balances in retirement accounts.

In reality, only #2 above is true and it doesn’t mean at all what people think it means. The reality is that the fear mongers misrepresent how the Social Security system works. The reality is there are only two ways that today’s workers and young people will not have Social Security benefits available to them when they retire:

  • Congress deliberately decides to break promises to them and end the Social Security program for ideological or class war reasons while the program is still feasible.
  • The U.S. GDP and employment drop to zero. Nobody is working and nobody is producing anything. No food. No shelter. No heat. No nothing being sold. If that happens then payrolls drop to zero and with it payroll taxes for Social Security drop to zero. But that’s probably the least of our worries under this kind of post-apocalypic Mad Max scenario. So this isn’t worth discussing.

diagram of flow of payroll taxes through SS Administration to beneficiariesThe reality is that Social Security in the U.S. is an intergenerational transfer program. It is not dependent at all on the “trust fund”. In fact, if the trust fund were zero, zilch, empty, the system would still be able to pay benefits every month. That’s because Social Security benefits this month are paid from the taxes that workers and employers paid this quarter. Yes, it’s a basically a flow-through transfer system. We take money from today’s workers to pay today’s older people. Yes, so-called millenials (the generation currently in their 20’s) if they are fortunate enough to have found a job in this slack economy and the millenials’ working parents pay taxes each paycheck. To be precise, 6.2% is deducted from their paycheck and then matched with an equal amount from their employer’s pockets. Their tax money is sent to Washington each quarter by their employer.  That money then goes straight to pay the grandparents of those millennials (and anyone else eligible of that generation). The tax money paid this quarter goes directly to pay the monthly benefits of this quarter.

So why would today’s workers give up part of their incomes to pay money to older people?  Simple. Because it’s in their best interest and because the society, through the government, has given them a solemn promise to make sure that no matter what happens in the uncertain future the government will ensure that when today’s workers get older they will be partially supported by the next generation after them. In addition, there are numerous other benefits such as a faster growing economy, more entreneurship, and risk-free retirement accumulation, but I’ll detail those benefits in another post. The key is the intergenerational promise. As long as there are workers and payrolls in the economy, there is money to pay social security benefits. “Bankruptcy” in the popular sense of an enterprise that is no more, that is defunct, and that cannot pay anything is a lie. The claim of impending Social Security bankruptcy is fear mongering at its worst.

But you, the skeptical reader, might ask “what about the Social Security trustees’ assertions of insolvency in 15-20 years”? The Social Security Administration Trustees in their annual report do frequently report of projected “insolvency” of the trust fund – not the system itself. And “insolvency” has a specific legal definition in this context that is vastly different from the popular understanding of bankrupt or broke.

In a nut shell, Social Security is a government entitlement benefit program with a dedicated tax stream. As an entitlement program, people who pay and meet the currently legal defined requirements acquire the legal right to be paid benefits later. Because these benefit levels are legally defined, it is possible to project, albeit with a very fuzzy and changing forecast, what total benefits will be necessary in the future. At the same time, it is possible to project the future tax receipts of the dedicated tax (the FICA payroll tax) assuming no changes to the tax levels in the future and assuming a wide range of guesses about future payrolls in the U.S.  If, these projections indicate that at some point in the future the dedicated tax flow at today’s tax rate and projected future payrolls should result only enough money to pay less than 100% of the amount projected needed to pay the full currently promised benefit, then we have the technical warning of “insolvency”. The most recent report, the 2014 report, projected that this point where payroll taxes will be short of promised future benefits will come in 2033. This is a few years earlier than projected a few years ago, but that’s because Congress lowered the payroll tax for two years in 2013.

The projected “insolvency” means that, assuming all the projections actually come true (a tricky business by itself), Social Security will find itself in 2033 with payroll taxes only being enough to pay for 78% of the benefits we currently project/promise we will pay in 2033.

Even if we do nothing AND all the projections come true exactly as predicted, Social Security will continue paying 78% of the benefit that we are currently promising to people who will retire in 2033. People should keep in mind that the average benefits we are currently promising for retirees in 2033 are substantially larger in real terms than the benefits today’s average new retiree is receiving. So even if we do reach the “insolvency” point, Social Security will continue to pay benefits at a very substantial level when compared to today’s benefits. The future benefit, in real terms, would be greater than 78% of today’s average real benefit.

So what’s all this talk and concern about the trust fund? The trust fund isn’t necessary to pay benefits. The trust fund serves two purposes. The first and primary purpose is it’s the Social Security “checking account” and it’s good practice to have a cushion – especially when outgoing payments might not match incoming taxes each period. And that’s what happens. We like to keep benefit payments a level amount each month. Iimagine grandpa’s panic if the SS check changed each month! But remember that taxes are collected quarterly. The trust fund exists so we can cushion a quarterly income flow against a monthly payment flow.

However, in the last two decades, the trust fund was allowed to build up to very large balances, balances much larger than necessary to match quarterly cash inflow against monthly cash outflow. This was done deliberately. The Social Security system was facing “insolvency” back in the early 1980’s. In fact, it was at one point, only approximately 3 months from technical insolvency, the same kind of insolvency we now project is 15-16 years away. The reason for the impending insolvency in 1983 was because Congress had raised benefit calculation levels in the early 1970’s but didn’t adjust payroll taxes to sufficiently cover them. In particular benefit levels got adjustments for inflation but the payroll tax rate and the cap on taxable payrolls wasn’t adjusted.

Baby boomers pre-paid part of their own retirements by paying excess payroll taxes into trust fund in 1990's and 2000's

Baby boomers pre-paid part of their own retirements by paying excess payroll taxes into trust fund in 1990’s and 2000’s

We survived that brush with insolvency. Politicians from both parties at that time agreed to make an adjustment. They effectively doubled (approx) the payroll tax rate and phased it in. By the late 1980’s and early 1990’s the trust fund had fully recovered to comfortable levels. A comfortable trust fund level is defined as having a cushion in the “checking account” of enough money to pay 12 months’ of projected benefits. But once the trust fund recovered, we had switched to the opposite “problem”. Instead of not collecting enough taxes each quarter to cover benefit payments, we were now collecting too much in payroll tax due to the higher payroll tax rates. In effect, the Social Security system was over-taxing in the 1990s’ and up until today. The result is a skyrocketing “cushion” in the trust fund. Right now the trust fund has over $2.8 trillion dollars of US government bonds in it. That’s a “cushion” equal to approximately 4 years worth of benefits!.  That’s hardly “broke”.

So why didn’t the government lower the payroll tax rate in the 1990’s when the trust fund had recovered? The idea was that the Baby Boom generation, which was working and paying taxes at the time, would start to retire around 2010 and that for a 20-25 years, the period 2010-2035, demands for benefit payments would be higher than they would be after 2040.

Trust fund balance scenarios. A lot depends on assumptions of future growth, population, retirement age trends, productivity, and even technology. - The percent vertical axis represents the trust fund balance as a % of one-year's benefits.

Trust fund balance scenarios. A lot depends on assumptions of future growth, population, retirement age trends, productivity, and even technology. – The percent vertical axis represents the trust fund balance as a % of one-year’s benefits.

In truth the problem was not that there so many baby boomers, but rather that baby boomers didn’t have as many children as their parents. So it was decided that the baby boom generation would be the exception to the solemn promise of younger workers pay for their elders benefits. Instead, the children of baby boomers would partially pay for their elder boomer parents’ benefits and the boomers themselves would partially “pre-pay” their own benefits from their own over-tax payments in the 1990’s and 2000’s. Thus the bubble in the trust fund. It was always intended to rise way up until around now and then to deplete back down to ordinary “cushion” levels.

But now we’re facing a situation where the planned return of the trust fund to more ordinary “cushion” levels has become the basis for a fear mongering campaign designed to convince voters to accept the reduction or elimination of the very successful Social Security program. The reality is there may be a problem in 18-20 years, if all the assumptions about population, labor force participation, unwillingness to adjust tax rates, productivity, retirement trends, and real wage levels all come true. But we dealt with this problem once before when it was only 3 months away. There’s no need to move now to address a moving, uncertain problem in 15-20 years. Further, the rhetoric about “we need to cut benefits NOW in order to avoid cutting benefits in the future” doesn’t make sense.  The reality is we have many options to address, what will in likelihood be a necessary “tweak” to the system. But that is for another post.

Myth Busting the Fears of Social Security and Medicare Insolvency

On April 1, 2015 I’m presenting at the Area Agency on Aging 1-B sixth annual Judith J. Wahlberg Lecture.  I’ll be taking another whack at these zombie ideas that Social Security and/or Medicare are unsustainable, that they’re going BANKRUPT, and that we must cut benefits now to prevent cutting benefits later.  As you can tell, these myths aren’t true.  Here’s the Powerpoint slides I’ll be using.  Stay tuned to this post over the next week, though, because I intend to add a series of shorter posts with some video explaining the key points of the presentation in case you can’t be there.

UPDATE and for more explanation:

 

China, Growth, and the Weakness of Real GDP

Sara Hsu asks if All Growth is Good? The Case of China Of course, not all growth is good. It makes little difference, whether it’s economic or human tissue growth. Edward Abbey famously wrote that “growth for the sake of growth is the ideology of the cancer cell”. Obesity is another form of high-growth, yet it hardly improves well-being or health.

Unfortunately, we economists have not (yet?) developed measures that help us or policy-makers distinguish between healthy growth and malignant growth.  The only real comprehensive measure of growth we have is growth of real GDP. We do know better, as Sara notes:

Since the seventies, with the assertion by Gunnar Myrdal that economic development should prioritize equality, economists have increasingly come to believe that not all types of growth are wholly “good.” Growth that ignores human well-being and equality are viewed as problematic.  Certainly growth that results in severe environmental destruction, as in the case of China over the past twenty years, cannot be classified as good, either, despite the country’s much-lauded successes during this period. Real-world views of growth depicted in the mainstream media do not fall in line, however, with the economic development literature. The focus on China’s growth in the news has distracted from a more balanced view of the looming inequality problems or polluting production methods in the world’s most populous nation.  As China’s growth has slowed, headlines have read, “China’s Economic Growth at Stake,” “China’s Economic Growth Slows,” and “China’s Second Quarter Growth Slows.” -

Yes, China’s real GDP growth rate has been spectacular for several decades now. That growth has lifted literally hundreds of millions of people into better lives. Yet, in strange case of the metaphor becoming real, that economic growth has literally brought cancer with it. Specifically, many “cancer villages” along the Huaihe River.

China’s economy illustrates the problem of growth measured in numbers versus measured in real economic change. The surge in fixed asset investment carried out post-global crisis resulted in an inflation of growth figures, despite the creation of uninhabited apartment buildings, or even entire cities. This is socially unproductive growth, wasteful production, “bad” or false growth. Although the distinction between “good” and “bad” growth exists only in theory, it is essential to clarify the difference to the public in order to move along the path of long-term development.

Admittedly, it may be overambitious to request that a more comprehensive view of growth penetrate the media. However, it would benefit our understanding of China’s economic performance; reconceiving growth would increase competition to generate “good” growth and discourage the race to build businesses that produce “bad” growth.

Yes, I agree. It is indeed an ambitious project, the idea that we could create more comprehensive measures of growth that help us to separate healthy improvement in well-being from cancerous, destructive economic growth. But it seems to me no more an ambitious goal than the vision less than 100 years ago to create the national accounts systems and begin collecting the data (from whence we get GDP measures).

Welcome!

Jim Luke

REV:  Oops.  Didn’t mean to post this here.  I meant to post it to the course site.  Oh well. This is what my course will be like this term.

Welcome to Comparative Economic Systems, ECON 260. I’m Jim Luke, your professor for this course and this is the 2012 incarnation of this course. I’m looking forward to our online “conversations” about economic systems.

This course is a bit different from most of the courses I teach. Normally, I teach Econ 201 and Econ 202, the Principles of Micro-economics and Macro-economics courses. In particular, I teach a lot of ECON 202 Macro. Those courses are chock-full of models and theories – and most of it mainstream neo-classical/neo-liberal market economics. There’s a lot of material to cover in each of those courses because, frankly, 4-yr universities require that we cover all those theories and models. The principles courses involve a lot of math, graphs, and analysis. As a result, sometimes in those courses we spend more time “studying the trees” and we don’t get to “study the forest”, the big picture.

In this course, we look at Comparative Economic Systems.  We look at the ways different societies address the fundamental economic questions of what to produce, who produces it, how to produce it, and ultimately who gets that production and why.

This course is also a “connected course”.  That means that while there’s substantial “content” and information that I as the professor am trying to convey to students, it’s primarily about a shared journey of discovery and reflection by the whole class.  Two key features of this course are that, with exception of graded information such as quizzes and grade reports, the whole course is being conducted in public here on the open Web.  The second feature follows from that open Web.  I’m trying to encourage students to develop their own unique voice and perspective.  To that end, students don’t participate in closed discussion groups behind some closed Learning Management System and create disposable written papers that will be read by one person and then disappear into the abyss.  Instead, students all have their own public blogs on the Web where they sharpen their own insights and voice.  They write and publish their insights on their own blog and then those writings are syndicated and linked here.

If you are a member of the general public, you’re welcome to browse and read all the material here. However, keep in mind that the course is intended for registered students of Lansing Community College.  For that reason comments are limited to those LCC students who are registered for the class.