Why should you care about this historical quirk? Because it typifies the hit-or-miss way that Social Security has evolved from a modest program into something that threatens to devour the federal budget. Even if you think you’ll never see a dime of Social Security benefits, your stake in the program is immense, societally and personally. With annual expenditures of more than $400 billion, it dwarfs the Pentagon’s annual budget of $283 billion. One third of seniors get virtually all their income from Social Security, and another third get more than half. Most U.S. workers pay more Social Security tax than income tax.
Understanding Social Security’s quirky history is critical to understanding the program’s current travails. Social Security’s history and mystery have helped create the miasma of myths, misinformation and financial fog that obscure its inner workings.
Now that Social Security has become a major campaign issue, the miasma and fog allow George W. Bush and Al Gore to pretend to be debating Social Security’s future when they’re actually courting the crucial bloc of young voters in much the same way politicians have traditionally used Social Security to pander to oldsters. Bush and Gore have both recently introduced major proposals to fix the system. Both proposals are short on details–intentionally so, because that makes them harder to attack. But it’s clear that neither confronts Social Security’s looming problem: how to pay for baby boomers’ retirement without bankrupting the country or setting off intergenerational warfare between boomers and their kids. “The legitimacy of Social Security has become frayed,” says Social Security Commissioner Kenneth Apfel. “The debate is not only about the level of benefits that’s appropriate, but also about the sustainability of our institutions over time.”
Here’s the problem. What started in 1935 as a modest plan to keep seniors from having to subsist on cat food has morphed into a massive program that also covers disabled workers and workers’ survivors, and is now being promoted as a wealth-building program, to boot. Social Security protects you if you’re disabled, or if your parents die while you’re young. (Which, by the way, offers Gen-Xers all sorts of protections they probably don’t know they have.) But unless you increase the money going into the system, trim the growth of beneficiaries’ payments or both, the system will end up on the rocks before most baby boomers hit retirement age. Compounding the problem, people live lots longer than they did in 1935.
So what do our two major candidates plan to do? Bush wants to solve Social Security’s problems by giving workers the option of investing 2 percent of their 12.4 percent Social Security payments into individual stock-market accounts. He also wants to refer Social Security’s long-term problems to a bipartisan commission that will produce solutions in the sweet by and by. Given the financial industry’s lust to peddle stocks to millions of Social Security payers, Wall Street wags suggest that Bush is actually proposing “bipartisan commissions.” “Commissions” as in the fees that stockbrokers receive, get it? Bush’s chief economic adviser, Larry Lindsay, candidly admits that people who choose to have individual accounts would get a lower guaranteed benefit. “Reductions in the guaranteed amounts of benefits that will go to plan participants are absolutely obvious. So I will say it,” he told NEWSWEEK. In his public utterances, Bush doesn’t exactly stress this. Or the fact that if you pick the investment option and do badly, your combined stock and guaranteed benefit would be less than the regular Social Security package. Or that the average worker would have all of $517 a year to invest.
Gore’s plan is more disingenuous than Bush’s, because Gore is promising the moon and the stars and using smoke-and-mirrors accounting to “pay” for it. To match Bush’s private-account plan, Gore proposes “Retirement Savings Plus”: a new, huge entitlement plan allowing lower-paid people to set up investment accounts with a fat federal match. He puts the cost at $200 billion over 10 years, but provides no details. You can bet the real cost would be higher. Rather than scaling back future benefit increases, which is inherent in Bush’s commission proposal, Gore wants to enhance benefits. He’d pay for this by diverting trillions of tax dollars into Social Security.
Surprisingly, Social Security has gotten sexy since Bush made it an issue in May without being electrocuted by the so-called third rail of American politics. As a result, people are venturing into the looking-glass world of Social Security, where terms like “surplus” and “solvency” and “trust fund” have different meanings than they do in the rest of civilization. The biggest obstacle to understanding Social Security is the myth of the Social Security trust fund. The fund’s byzantine workings and weird accounting have helped create decades of confusion about what Social Security is, and how sound (or unsound) its finances are. Social Security taxes you pay are credited to the “trust fund,” and the checks you ultimately get are charged against the fund. Why run money in and out of a “trust fund” instead of just in and out of the U.S. Treasury? Thank President Franklin Delano Roosevelt, the father of Social Security, who believed that the trust fund made Social Security look like an earned benefit, not something the government gave you. He wanted Social Security to look like a pension plan, which it’s not, rather than a government handout, which it is.
If the $1 trillion of assets in the “trust fund” were useful, fixing Social Security would be a lot less painful and expensive than it’s going to be. When people hear the term “trust fund,” they think of assets like stocks and bonds that are in a fund that lucky beneficiaries can tap to pay for four years at Harvard or a week skiing at Gstaad. But Social Security’s fund isn’t like that. It consists of Treasury bonds. When the time comes to convert those bonds into cash, the government will have to redeem them by borrowing from private investors, cutting expenses or increasing income. Which is exactly what it would have to do if there were no trust fund. “It’s called a trust fund, but there’s no asset value in it,” Sen. Daniel Patrick Moynihan of New York says. “It’s just chits.” That’s a view shared by even the president’s Office of Management and Budget.
So forget the trust fund and start worrying about who’s going to pay for your benefits. The problem is that there are fewer and fewer workers for each person getting monthly checks. (One of Social Security’s major myths is that the money you pay gets set aside for you. Actually, your Social Security taxes pay present retirees’ benefits, and future generations will pay yours.) In 1945, there were 42 payers for each recipient. In 1950, 17. Now, 3.4. In 15 years, 2.8. Combine the shrinking base of payers with an increasing array of benefits, and you have a problem. Survivors and disabled people now get more than a third of Social Security payments. Which means a third of the money you pay in isn’t available for retirement benefits, yours or anyone else’s.
These mounting burdens explain why Social Security tax has risen from an annual maximum of $60 a worker when the program started to the current $9,448. If you say that the employer’s Social Security contribution is really the employee’s money, which many economists believe, some 80 percent of U.S. workers pay more Social Security tax than federal income tax.
The “no problemo” types say that it’s silly to worry about Social Security, because the trust fund can carry us for the next 34 years. But the real problem starts much sooner. By 2015, by current projections, Social Security’s cash income will fall below its cash outflow. When the cash shortfall comes, you have to tap general revenues or the capital markets to redeem the trust fund’s securities. The annual cash shortfall approaches $200 billion five years after the cash crunch hits, and then takes off like a moon rocket. Social Security will look more and more like a welfare program than an earned benefit. And we all know what happened to welfare a few years ago: the benefits were radically reduced.
The changes that skeptics among us expect–such as heavily taxing Social Security benefits of “rich” people who’ve prudently provided for their retirement–would undermine the system’s political support, already feeling crumbly. Switching to a system in which most or all of your benefits are in individual investment accounts, as many rabid market types want, would change the program from “social security” to “getting rich.” The current system is progressive, which means that lower-paid people get a bigger relative benefit than higher-paid ones. That’s only fair in a “don’t let old people be poor” plan. Benefits range from 90 percent of covered wages for the lowest paid to 27 percent for the highest paid. Change to a system in which your entire benefit is based on how well you invest, and this poverty-destroying feature is lost. The more you divert Social Security funds to individual accounts, the more you have to skew the remaining payments to keep redistribution going. Or else you benefit the better paid at the expense of the less well paid. And you may end up sharply scaling back desperately needed disability and survivor payments.
Social Security has done a marvelous job of reducing poverty among the elderly, the disabled and the young children of deceased workers. But it’s horribly expensive and horribly resistant to change. When it was created 65 years ago, there were virtually no pensions from employers, no 401(k) or IRA-type retirement plans, little stock-market investment by individuals.
Unless we want to spend endless tax money on retirement benefits, logic suggests we change Social Security in the traditional way: by raising the retirement age and tinkering with various benefit formulas to leave current benefits alone, but reduce future payment increases. Allowing young workers the option of opening individual accounts–which had better be administered by Uncle Sam to make sure Wall Street doesn’t pillage naive investors with fees, costs and crummy performance–gives them a stake in the system and a feeling they’re not being totally ripped off to support us boomers who aren’t exactly needy. And it makes the program look less dinosauric.
If we have to keep the trust fund, let’s change the law and start investing Social Security’s cash surpluses in debt securities, such as mortgages, student loans and corporate bonds. That way, money from those sources, not the Treasury, will cover cash shortfalls, and buy time for other solutions.
And now, a final history lesson. Want to know where your Social Security number comes from? Flash back to all those filing cabinets in the old Coke plant in Baltimore. The first five digits, which are based on your address when you apply for a number, were designed to identify the filing cabinets containing your records. The last four digits are random. Let’s hope that the way we finally fix the system isn’t.
