Understanding The Social Security Trust Fund – It’s More A Checking Account and Less of A Trust Fund

Now that the Republican-Democratic budgetary battle that shut down much of the U.S. government earlier this month has been resolved  delayed for 3 months.  Once again the hope of the politicians from both sides is to achieve some kind of “grand bargain” on the budget that continues to reduce the federal budget deficit.  Now the expectations are only for maybe a two-year deal instead of the ten-year deal the President sought in 2011.  But regardless of the length of the deal, the renewed negotiations have put Social Security, and with it, the economic well-being of seniors at risk.  For example, Senater Dick Durbin, an alleged Democrat, has offered up cuts in Social Security claiming:

“Social Security is gonna run out of money in 20 years,” Durbin said. “The Baby Boom generation is gonna blow away our future. We don’t wanna see that happen.”

It is most unfortunate that Senator Durbin, along with many of his colleagues, continue to repeat what is utter nonsense.  They endanger not only the well-being of seniors in the U.S. but all of us. For many years enemies of Social Security and the Wall Street banks that lust to have siphon fees from the hundreds of billions of dollars that currently flow efficiently through the Social Security Administration have propagated the idea that Social Security is going bankrupt – that it won’t be here in 20 years.

Much of the problem comes from people only having a superficial understanding of how Social Security (or any other intergenerational transfer program) works.  Combine a superficial understanding with misunderstood and ill-defined terms and scary but shallow projections of demographics and you get fear and hysteria – exactly what the enemies of Social Security want.  There are many aspects that I could talk about, but the most misunderstood aspect of Social Security is the Trust Fund, so I’ll focus this post on explaining the Trust Fund.

The Social Security Trust Fund is, in fact, actually two separate trust funds, each with its own share of the payroll tax and its own purpose. One fund is involved in the old age and survivors benefits and the other for disability insurance.  Nonetheless, I will lump them together since that’s what most commentators do.  The root of confusion and deception lies in the names of the funds.  They’re called “trust funds”.  And since the largest fund is used in the payment of old age insurance payments, which most folks liken to pensions, they tend to assume that the SS funds work like a private, personal trust fund.  After all, we know about people called “trust fund babies”  – they’re people who live off the interest and dividends of some big pile of money that somebody (usually parents) left them.  We also know that private savings for retirement works in a similar fashion except that we put the money away ourselves during working age and then deplete the account when we’re older – and often retirement accounts are established in some sort of “trust” account.

The people who argue we need to cut Social Security benefits usually claim it is because we are going to deplete the Social Security Trust Fund at some date a couple decades into the future.  They claim that Social Security itself will be bankrupt when that happens.  This is absolutely not true and it plays on a misunderstanding of what the SS Trust Fund is, what it does, and why it exists.

The Social Security Trust Funds are not what enables benefits to be paid.  Current payroll taxes are what enable benefits to be paid, not Trust Fund balances.  Social Security is an intergenerational transfer system.  Each month workers, people who are most likely aged 18-65, and their employers pay a payroll tax.  Then that same month, the money collected is paid out to Social Security beneficiaries.  .  Under current conditions, the payroll tax amounts to a 6.2% tax on worker earnings up to $113,700.  The employer pays a matching amount.  Earnings over $113,700 are payroll tax-free. As long as people are working and getting paid, there are payroll taxes being collected and money available to pay benefits – even if the Trust Fund were zero.  The Trust Fund isn’t really necessary to the basic functioning of Social Security.  This is why Social Security can never go bankrupt and unable to pay benefits.  For Social Security to be unable to pay any benefits, the U.S. would have to have nobody working – zero employment.  If we ever get to the point where there is nobody working in the economy, we have much greater problems on our hands than Social Security – problems like no food to eat.

Social Security Receipts and Benefit Payments by MONTH.So if the Trust Fund isn’t what is funding benefit payments – what is it?  The way to think about the SS Trust Fund is to think of it as a checking account.  This graph which shows the the income (payroll taxes collected) and the outgo (benefit payments) by month illustrates the problem and why the Trust Fund exists.  See how erratic and variable the income is.  This is because it’s a payroll tax and payrolls (employment) varies enormously from month-to-month.  In November and December we employ a lot of people and pay them something extra – it’s called Christmas and bonus season.  In January and February employment drops.  So the income received by the SS Administration varies greatly too.  But this income is used to pay benefits.  But we want benefits to be relatively constant.  Grandma and grandpa should expect the payment each month.  We don’t want to have tell all our senior citizens in January  “hey sorry, but the check’s a little short this month, we’ll make it up next December”.  So what to do when the income is both variable and a bit uncertain but the payments need to be relatively constant and fixed?  The answer is to do the same thing any private individual facing an uncertain and variable income but constant outgo:  keep a nice buffer balance in the checking account.  That’s what the Trust Fund was created for – to keep a buffer balance so that monthly payments can be held constant against variable and unpredictable income.

By law, the law creating the system, Social Security cannot use general funds of the government.  It can only use the payroll taxes it collects for Social Security.  And vice versa.  Social Security payroll taxes cannot be used for other government purposes (although George W. Bush once proposed doing that).  Also by the same law, the buffer balance- the trust fund balance – is supposed to always be at a minimum of 100% of projected one year’s benefit payments.   Today, the SS Trust Fund balance is approximately 350% of each year’s benefits and it’s growing.

Why is the Trust Fund so much bigger than it is (was) supposed to be originally?  Because in the early 1980’s it wasn’t so big.  In the 1970’s Congress increased Social Security benefits by indexing them to inflation (a good move), but they didn’t increase the payroll tax enough to pay for it.  The moment of truth came in the early 1980’s when the Social Security had to dip into the Trust Fund to help pay some of the current benefits.  The Trust Fund then stood at less than the legally-mandated 100% of projected benefits.  A commission was appointed by President Reagan and Congress to develop a solution.  The resulting deal increased the payroll tax from the then 5.4% gradually until in 1990 it stood at the present 6.3%.  By the early-mid 1990’s, the Social Security Trust Funds were well-replenished and beginning to significantly exceed the 100% of benefits level.  Yet the payroll tax was kept at the 6.2% level ever since even though it has generated a significant surplus every year.  Every year since, the Trust Fund has grown as payroll taxes collected have significantly exceeded benefits paid.

Since the mid-1990’s Social Security has, in effect, been over-taxing workers compared to what was needed to pay current benefits. One option in the 1990’s would have been to cut the payroll tax slightly – perhaps not back to the 5.4% level but maybe to 5.9%.  But the decision was made to keep “over-taxing” so as to deliberately build up the Trust Funds to extremely high levels in anticipation of an eventual wave of baby boom retirements.  That has happened. As mentioned above, today’s Trust Fund includes both the 100% of benefits buffer balance and another 2.5 years worth of benefits.  The additional money will be drawn down to help pay for baby boomer retirements.  Instead of bankrupting the Social Security system, the baby boomers are effectively the first and only generation to not only pay for their elders’ benefits but to also pre-pay a portion of their own benefits.  The baby boom generation may be faulted for man things but bankrupting Social Security is not one of them!

So what about all these scary projections of the Trust Fund depleting at some time in the future?  At the present, the Trust Fund continues to grow.  All projections about the future of Social Security are subject to some uncertainty and the farther out you project the more uncertain they become.  To project the precise future balances of Social Security funds, benefits, and taxes, we need to project and know with a high degree of certainty changes in the  following:  birth rates, death rates, changes in productivity and wages, labor force participation, retirement age preferences, and even immigration.  Nonetheless, the Trustees of the Social Security Administration take a stab at updating their projection of the future for the next 75 years. In fact, they make at least 3 projections: an optimistic, pessimistic, and most expected case.  In looking at recent expected case projections, the Trust Fund will continue to grow until somewhere around 2019.  Then the “wave” of baby boomer retirements combined with expected lower labor force participation will result in monthly benefits that exceed monthly taxes collected.  Withdrawals from the Trust Fund will make up the difference to pay the promised level of benefits.  Then, somewhere a decade or so later, the Trust Fund will be back down to it’s legally mandated minimum. Of course this is only once scenario.  If the optimistic scenario happens (slightly faster economic growth between now and then, more labor force participation, and more folks delaying retirement), then there is never a problem in the entire 75 year horizon.

But let’s suppose the expected case happens, at that point a choice must be made: Reduce the benefits paid below the promised level? Or increase the payroll tax?  Or, remove the earnings cap on the payroll tax so that high-income earners pay taxes on amounts above the $113,700 cap.  How much of a tax increase would be needed?  Approximately a 1% increase in the payroll tax would make the system totally solvent and ensure minimum balances in the Trust Fund for the entire 75 year horizon.  That’s not much really.  It’s easily doable and more important, we can delay the time to raise the tax until the mid-2020’s when we have a much clearer picture.

It’s very important to realize that Social Security is not going bankrupt.  Even if we refuse to raise the payroll tax in 2030 and even if the expected case happens and we have to cut benefits in early-mid 2030’s, we won’t have to eliminate the program.  Benefit payments will still happen.  They will simply have to scaled back.  How much?  We will still be able to pay 75-80% of what we are currently projecting the benefit payments to be at that time.  And our currently projected benefits for that time period are greater in real dollars than today’s benefits because people will be earning more money entitling them to larger benefits.

Social Security is not going bankrupt. It can’t.  It will be there for my current students when they age and retire, and it will be there for my students’ kids.  The only reason Social Security might not be here is because politicians surrender to an anti-Social Security ideology and the desires of Wall Street banks to get their hands on billions more.

For those interested, here are some good references for continued explanation on this topic:

No Social Security Is Not Going Bankrupt from Center on Policy and Budget Priorities

Five Huge Myths About Social Security from Daily Finance

Why Social Security Can’t Go Bankrupt from Forbes

Social Security Trustees Report 2013




Social Security Receipts and Benefit Payments by MONTH.

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