Commentary

Social Security Is Sicker Than Some Politicians Believe

There are none so blind as those who will not see. Even as the evidence of Social Security’s looming financial problems mounts, Social Security commissioner Shirley Chater disappointingly perpetuates the myth that Social Security is sound. (See, for example, “Social Security is Healthier Than Some Pundits Believe,” Dallas Morning News, May 26, 1996).

Here are the facts. As Ms. Chater says, Social Security taxes currently bring in more revenue than the system pays out in benefits. The surplus theoretically accumulates in the Social Security Trust Fund. However, beginning as early as 2012, the situation will reverse. Social Security will begin paying out more in benefits than it collects in revenues. To continue meeting its obligations, it will have to begin drawing on the surplus in the Trust Fund.

At that point, we will discover that the Social Security Trust Fund is really little more than a polite fiction. For years, the federal government has used the Trust Fund to disguise the actual size of the federal budget deficit, borrowing money from the Trust Fund to pay current operating expenses and replacing the money with government bonds. Half the Trust Fund now consists of those bonds. The other half is simply an accounting entry, interest attributed to those bonds.

Beginning in 2013, Social Security will have to start drawing on the Trust Fund, first spending down the interest, then turning in the bonds to obtain the cash needed to finance benefits. But the government has no cash or other assets with which to make good on these obligations. That is not to say that the government is likely to default on the bonds. It does mean that we can expect a massive tax increase to finance the payments.

Even if Congress can find a way to redeem the bonds, the Trust Fund surplus will be completely exhausted by 2030. At that point, Social Security will have to rely solely on revenue from the payroll tax. But such revenues will not be sufficient to pay all promised benefits. To continue paying all the benefits promised under both Social Security and Medicare, payroll taxes will have to be increased to as much as 28 percent, almost double today’s 15.3 percent FICA tax rate. Otherwise benefits will have to be reduced by as much as one-third.

Social Security’s financing problems are a result of its fundamentally flawed design, which is comparable to the type of pyramid scheme that is illegal in all 50 states. Today’s benefits to the old are paid by today’s taxes from the young. Tomorrow’s benefits to today’s young are to be paid by tomorrow’s taxes from tomorrow’s young.

Because the average recipient today takes out more from the system than he or she paid in, Social Security works as long as there is an ever-larger pool of workers paying into the system compared to beneficiaries taking out of the system. However, exactly the opposite is happening.

Life expectancy is increasing, while birth rates are declining. As recently as 1950, there were 16 workers for every Social Security beneficiary. Today there are only 3.3. By 2030, there will be fewer than two. The Social Security pyramid is unsustainable.

Moreover, even if Social Security’s financial difficulties can be fixed, the system remains a bad deal for most Americans, a situation that is growing worse for today’s young workers. Payroll taxes are already so high that even if today’s young workers receive the promised benefits, such benefits will amount to a low, below-market return on those taxes. While today’s retirees will generally receive back all they paid into Social Security, plus a modest return on their investment, when today’s young workers retire, they will actually receive a negative rate of return—less than they paid in. A young worker today would actually be better off stuffing his Social Security taxes in a mattress than counting on benefits from the program.

Those workers can now get far higher returns and benefits through private savings, investment and insurance. In fact, a study by financial analyst William Shipman demonstrates that, if a 25-year-old worker was able to privately invest the money he or she currently pays in Social security taxes, he or she would receive retirement benefits 3 to 6 times higher than under Social Security.

There is, of course, no reason to panic. There is time to make the reforms necessary to ensure that both today’s and tomorrow’s elderly will be able to retire with dignity. Increasingly, the public, the media and politicians from both parties are recognizing this. Its a shame that Shirley Chater is not among them.

Michael Tanner is director of health and welfare studies at the Cato Institute.