Commentary

Social Security: The Shoebox Approach

By Brooke Oberwetter
February 14, 2005

Every so often, a letter to the editor in a small local paper will catch my eye: “George W. Bush plans to plunder the Social Security trust fund with his privatization scheme that will throw seniors into poverty and benefit his fancy-pants friends on Wall Street.”

That’s a paraphrase, but it captures the tone and tenor of the rants. Sometimes there is a tale of woe in the letter about a parent or grandparent whose retirement savings were ravaged by the Great Depression. If only there had been a Social Security trust fund for their relatives, letter writers complain, things would have worked out.

But the reality is that just as there was no trust fund then, there is no trust fund now. Many people naively believe the government is just sitting on their payroll taxes, waiting for the workers to retire. Columnists and editorial boards of respectable newspapers pen columns that continue to inspire belief in the myth that the trust fund contains real assets.

Social Security benefits are paid from current payroll tax revenues—so today’s workers finance the retirement benefits of current retirees. Since the system’s inception, there have always been more workers paying taxes than retirees receiving benefits. When the payroll tax was raised in 1983, sizeable yearly surpluses in the system began accruing, which created the illusion of a trust fund. But by law, the surpluses are not saved.

It seems logical that the government would stow surplus money away for the future. After all, if there were enough workers to generate the surpluses, it shouldn’t have taken much foresight to realize that someday those workers would themselves be making claims against the system.

But foresight is not something for which governments are typically regarded. By law, the government must use the surplus cash flow to buy treasury bonds from itself. The proceeds from the sale are mixed in with general revenues, spent on everything from highway maintenance to faith-based initiatives to sea lion recovery in Alaska. The money that hapless letter-to-the-editor writers are so concerned about being pillaged by personal accounts is actually pillaged every year already.

The treasury bonds are what constitute the “trust fund.” These bonds are essentially IOUs, promises that the government will pay the system back. Right now, the government owes the system $1.7 trillion, and the number grows every year by roughly $200 billion, including interest.

In less than 15 years, as the baby boomers begin retiring en masse, the bonds will start to come due. The dwindling worker to retiree ratio is set to cause Social Security to begin spending more in benefits than it takes in from tax revenues beginning in 2018. And that will be problematic.

If left unchanged, the system will start cashing in those treasury bonds in just 13 years, putting enormous pressure on already strained budgets. It will continue to draw money from the general revenue until the government’s obligations to the trust fund are met, sometime between 2042 and 2052. It’s likely that income taxes will be raised during that time to make up for the ever-growing annual shortfalls of Social Security.

Once the treasury’s obligations to the trust fund have been met, the system will only be able to pay 73 percent of projected benefits with its annual income. The people whose benefits will be slashed when that date arrives would be the same people who endured twenty some-odd years of higher income taxes to pay off the government’s debts.

More likely though, the payroll tax will increase as benefits are gradually reduced, making Social Security a pretty terrible investment, with negative returns to most participants.

Workers will pay more in taxes for less in benefits. Some experts suggest that today’s college graduates will be paying $1 in every $6 they earn to Social Security by the time they retire. That is the legacy that the folks writing horror stories about the Great Depression to the local newspapers would leave for their children and grandchildren.

Today’s young workers can learn a valuable lesson from those who survived the Depression—if the choice for retirement savings is between Social Security and a shoebox full of money under the bed, money under the bed isn’t a bad way to go.

Brooke Oberwetter is a research assistant for the Cato Institute.