Analyzing the 2002 Social Security Trustees Report

Brief Analyses | Social Security

No. 394
Monday, April 15, 2002
by John C. Goodman

The Evolution of Private Pensions.

Is Social Security in financial trouble? If you believe a press release issued by the Trustees of the Social Security and Medicare Trust Funds, the answer is no. If you go to the fine print of their annual report, however, the answer is a resounding yes.

Why the difference? The press release treats the Social Security and Medicare trust funds as if they hold real assets, when in fact they are only accounting devices that hold IOUs the government has written to itself. By contrast, in recognition that Social Security and Medicare are pay-as-you-go programs, the fine print shows the rates future taxpayers will have to pay to keep the system going. And those tax rates are astronomical.

Social Security Is Pay-As-You-Go.

Despite misleading rhetoric from the Social Security Administration, we have never had a funded program. Every dollar collected in (FICA) payroll taxes is spent the very minute, the very hour, the very day it comes in the door. Payroll tax revenues are mainly spent on Social Security benefits and Medicare expenses. If any funds remain, they are spent on other programs or used to pay off the national debt. Nothing is saved. No money is stashed in bank vaults; no investments are made in real assets.

That means taxes taken from today's workers primarily pay benefits the government provides to today's retirees. Because there are more workers today, when they retire their benefits will be paid only if higher taxes are collected from the next generation of workers. How high will those taxes be? The tax rates needed to support the elderly will grow continuously-as far as the eye can see. [See Figure I .]

  • When today's 19-year-olds become eligible for retirement in 2050, their children and grandchildren will face a payroll tax of 17 percent to pay Social Security and disability benefits, currently funded by a 12.4 percent tax.
  • If Medicare Part A (which mainly covers hospital expenses) is added, the payroll tax burden will be 24 percent by mid-century-about a fourth of all income that workers will earn that year.
  • Although Medicare Part B (which mainly covers outpatient services) is funded from general revenues, if it too is expressed as a percent of payroll the burden will climb to 28 percent.
  • Add the other ways in which the federal government pays medical bills for the elderly (Medicaid, the Veterans Administration, etc.) and the total burden rises to 32 percent. [See Figure II .]

Thus almost one-third of future workers' incomes will be needed to pay benefits to today's teenagers. That burden will come on top of all the other services taxpayers are expected to fund-from national defense to salaries for teachers and police officers.

Nor is this the worst that can happen. These numbers are based on the intermediate (most likely) projections of the Social Security Board of Trustees. Under the trustees' pessimistic projection, by 2050 the total taxes needed to support elderly benefits will climb to 53 percent of taxable payroll. On this projection, we have already pledged more than half of the incomes of future workers - most of whom are not yet born and none of whom have agreed to be part of a chain-letter approach to funding retirement benefits.

The Trust Funds Cannot Pay Benefits.

The problems for Social Security and Medicare are just around the corner: 2016 for Medicare and 2017 for Social Security because the trust funds, which supposedly hold the accumulated surpluses of both programs, cannot pay benefits. The so-called trust funds for Social Security, Disability Insurance and Medicare Part A are trust funds in name only. They serve no economic function. They exist purely for accounting purposes - to keep track of surpluses and deficits in the inflow and outflow of funds.

The accumulated Social Security surplus is reflected in paper certificates (nonnegotiable bonds) kept in filing cabinets in the Social Security offices in West Virginia. The bonds cannot be sold on Wall Street or to foreign investors. They can only be returned to the Treasury. In essence, they are nothing more than IOUs the government writes to itself.

Every payroll tax check written by employers is written to the U.S. Treasury. Every Social Security benefit check comes from the U.S. Treasury. The trust funds themselves do not receive, spend or borrow money. Every asset of the trust funds is a liability of the Treasury. Summing accounts over all agencies of government (the trust funds plus the Treasury), the balance is zero. For the Treasury to write a check, the government must first tax or borrow.

The late economist Robert Eisner put it best: With the stroke of a pen, the government could double or triple the number of IOUs in the trust funds-or even abolish them-with no effect on the government's bottom line. Either option would allow us to dispense with the artificial crisis and focus on the real issue: How is the U.S. Treasury going to pay the government's bills?

A Funded System Would Be More Desirable.

The alternative to a pay-as-you-go system is a funded system. On this approach, payroll tax contributions are saved and invested, so that each generation of workers saves the funds needed to pay its own retirement benefits. Under a fully funded system, each generation pays its own way. The virtue of a funded system is that we do not have to worry about how many children women will have or what tax burden those children will be willing to bear once they begin working.

Most Social Security reform proposals would allow workers to invest a portion of their payroll taxes in a personal retirement account. The higher long-run rates of return offered by the capital markets would allow individual workers to earn more on their investment than Social Security pays. Over time, the personal accounts would grow, assuming an increasing portion of the government's Social Security burden.

John C. Goodman is president and Matt Moore is a policy analyst of the National Center for Policy Analysis.

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