How the Social Security Trust Fund Actually Works
We know that the federal government, in order to finance deficit spending, borrows money. Most of that money is borrowed from entities outside the federal government - called the public debt. About a third of our national debt, however, is financed by the government's own trust funds, including social security. Here's a graphic depiction of the total gross debt vs the public debt, followed by an actual estimate, as of July 20, 2010, 1 am Pacific time.
First, a graphic depiction:
Now with actual numbers:
Credit: Zfacts.com. Steve Stoft, Ph.D., Economics.
But wait a minute. This $2.5 trillion "saved by the Social Security Trust" looks awfully close to the $2.4 trillion in assets the Social Security Trust fund had at the end of 2008 (we can safely assume that the current value of the social security trust fund is just a bit over $2.5 trillion. What's going on here? Is the federal government raiding the entire trust fund? Well, not exactly. The trust fund was never designed to have a bunch of cash sitting in it. It was, rather, designed to loan the surplus to the federal government, which issues treasury bonds backed by the full faith and credit of the US government.
That is in fact how social security operates, and that is how it has always operated, since its establishment in 1939 (from 1935-1939 was the only time a social security "account" had cash). All incoming social security taxes are invested in "special issue" bonds, and all benefits are paid out by cashing existing bonds. The Social Security Administration explains:
Tax income is deposited on a daily basis and is invested in "special-issue" securities. The cash exchanged for the securities goes into the general fund of the Treasury and is indistinguishable from other cash in the general fund.As you can see, the social security trust fund constantly buys bonds with incoming revenue (as well as issued more for interest payments), and sells the same to pay benefits. Social Security earned a 4.860% annual interest in 2009 from these bonds.
Money to cover expenditures (mainly benefit payments) from the trust funds comes from the redemption or sale of securities held by the trust funds. When "special-issue" securities are redeemed, interest is paid. In fact, the principal amount of special issues redeemed, plus the corresponding interest, is just enough to cover an expenditure.
The bonds currently issued to social security trust fund are redeemable at any time at face value. Even though social security is its own item, it's often treated as a "unified budget" item for the purpose of calculating the overall deficit - and for that purpose only. Using it merely makes the actual debt obligations of the government (net or public debt) look smaller, but it does not make any actual changes on how social security surpluses and the trust fund are treated.
By law, at the moment, social security is "off-budget" and cannot be used to calculate the deficit. However, administrations often produce two sets of numbers, one using it as part of the budget, and one without - I suspect mostly for political talking point purposes. For more, see the budget treatment of the social security trust fund over the years. What is important to remember is that no matter how one treats it, the actual way the trust fund operates and the federal government's obligations to it are unchanged.
This idea that there is this mass conspiracy to steal your social security under the guise of treasury bonds is absolutely without merit. There is no attempt - indeed no possibility - to "hide" the federal government's debt obligations, including and especially to social security. What's more, the government has never failed to pay social security with interest and to redeem the bonds for cash when needed to pay benefits.
The President's Deficit Commission and Social Security
Now that we have debunked the myth of the great conspiracy to steal social security, let's look at the accusations that the National Commission on Fiscal Responsibility and Reform is a "cat food commission" that is out to steal from the middle class and gut social safety net programs. Those accusations are preposterous. First of all, this commission is designed after the commission that the Senate voted on and got 53 votes - 7 Republican sponsors shy of passage. Progressive icons like Sens. Barbara Boxer, Pat Leahy, Russ Feingold and Chuck Schumer all voted in favor. Did I miss something or do all these people want us to eat "cat food?"
The structure of the commission includes 18 members: 10 Democrats and 8 Republicans. According to the bylaws, six members are appointed by the President (4 Democrats, 2 Republicans), and three each by Speaker Pelosi, Majority Leader Reid, Minority Leader Boehner and Minority Leader McConnell. Unless the idea is that President Obama as well as Harry Reid and Speaker Pelosi (who led the Democratic opposition against Bush's privatization plan) all want us to eat cat food, the idea that the commission is trying to gut social security doesn't make much sense. One of the members is Andy Stern, the outgoing President of SEIU.
Andy Stern spoke to Huffington Post about the commission's work and the cynicism directed towards it from the left and the right. He thinks the commission is doing serious work with serious people. Stern warned Congress to "sober up to the reality that the financial path it was on is no longer sustainable," and called for eliminating waste, un-bloating defense programs, and simplifying the tax code. Stern also addressed entitlement spending, in a sensible way. Some reforms in entitlement spending is needed, though the line must be held on providing an effective social safety net.
Even entitlement systems -- which are fiercely protected by progressives in any discussion of deficit reduction -- need to be reexamined, Stern said, before stressing that "there's a certain amount of money it needs to spend on safety nets and taking care of people who otherwise have issues they can't deal with."Now, is Andy Stern trying to gut social security? Is he trying to bring about a great heist that will steal social security trust fund money and hand it to the rich? You can believe that if you wish, but I don't think so.
The plain fact of the matter is that the commission is looking at the entirety of the federal budget, and everything is (and should be) on the table. Your favorite portion of the budget or mine (be it defense or social security) will not - and should not - be spared the fine comb. We must keep the social contract we have established in social security, and that means updating and modifying the program to best fit current situations. Today, people live longer and have less children.
This browbeating going on here among the ideologues reminds me of the haydays of the 2004 Democratic primaries, when John Kerry and Dick Gephardt and the rest of the Democratic establishment demagogued Howard Dean for suggesting that entitlements would be on the table should he have been elected President and try to balance the budget. They intimated that it meant that Dean would cut social security.
Personally, I feel the simple solution to any future shortfalls to social security is to eliminate the cap on social security taxable income, without increasing benefits (if you increase benefits correspondingly, the long term shortfall remains unresolved). But notice what we're doing here if that is the solution. If we eliminate the cap, for high income earners (currently people with earnings of $108,000 a year or more), we are making them pay more (their fair share) and as a result, collect relatively less (as a ratio of paying-in vs. benefits). Is there another way of doing this?
There is, and the funny part is that the same ideologues who will agree with me about raising or eliminating the income cap for social security taxes will probably not like the following idea, even though the two essentially have the same end-result.
Progressive indexing, thought of by Robert Pozen, might be one idea for the commission to consider. For high income earners, it would index the increases in benefits to prices rather than wages. Pozen explained how it would work in a memo to the President published by the Progressive Policy Institute:
The initial calculation of Social Security benefits at retirement is based on wage indexing -- not price indexing. Upon a worker's retirement, the government calculates his or her average annual earnings over a 35-year career, and then increases that average by the rise in wages over his or her career (not the rise in prices).Sure, one can argue that such indexing would reduce the appeal of social security to high income earners, since they wouldn't get increases as fast as the rest - and some progressives tend to hang onto that. But that is also essentially an argument against raising the income cap, which would make social security less attractive to high income earners since they will have paid much more and yet be restricted by a maximum level of benefit. Either way, the relatively well-off would be asked to do their part to make the system more solvent - either by paying in more or by having their benefit increases indexed to the CPI (Consumer Price Index).
This little-known fact helps explain how price indexing could save Social Security. In the United States, wages have historically risen over 1 percent faster per year than prices. Therefore, the purchasing power of Social Security benefits in 2045 is projected to be roughly 50 percent higher than in 2005 for a comparable worker (in constant dollars).
That is a substantial increase in purchasing power. It would be great if we could afford to offer that boost to all American workers. Unfortunately, we cannot. We can only afford to offer it to some workers, and social equity demands that we reserve it for the lowest 30 percent of wage earners -- workers who generally do not have other sources of retirement income. Under progressive indexing, their benefits would not change.
By contrast, most median-wage and high-wage earners receive retirement benefits from private plans -- including 401(k) programs -- as well as Social Security. Under progressive indexing, the Social Security benefits of high earners (over $90,000 per year in average career earnings) would grow with inflation, while those of middle earners would grow at a rate somewhere between inflation and the rise of wages.
Setting the growth of benefits this way for high- and middle-wage earners would make a real difference, saving literally trillions of dollars. It would reduce the present value of the 75-year deficit of Social Security by somewhere between $2.6 trillion to $3.2 trillion, depending on the precise design of the progressive-indexing program.
Now, I'm not saying this is what the commission is going to do. But this is certainly much more likely than an out-and-out cut in social security benefits, which the Democrats will oppose, or raising the social security tax (or SSI taxable income) too much, which the Republicans are hell bent against.
Bottom line, solution need to be explored, and tough decisions will need to be made - not just on entitlements but programs like defense, tax-subsidies and so forth. We will not solve any problems by acting out of hysteria. Let the commission do its work and present its findings. Follow them on the news, but stop freaking out about "cat food." We can have a debate about what to do about our fiscal situation - but we won't get anywhere if the ideologues on the right constantly scream about the need to protect every last dollar of the bloated defense budget and the ideologues on the left scream just as loudly about unsubstantiated claims of gutting social security.