The End of Social Security's Self-Financing

October 16, 2012

Since its inception, Social Security was intended to be financed by the contribution of workers and not through general revenues. But lawmakers have become less willing to tax workers at the level required to finance rising benefit costs, which culminated in the decision to reduce Social Security's principal financing stream -- the payroll tax -- for economic stimulus and to turn formally to general revenues to subsidize the program, says Charles Blahous, a senior research fellow at the Mercatus Center and public trustee for Medicare and Social Security.

Despite undergoing many reforms since the program started, Social Security remained true to its goal of providing benefits based on workers' contributions so as to prevent lawmakers from interfering with it.

  • In the early 1980s, a bipartisan agreement helped keep Social Security solvent by having interest credits that were funded by the U.S. treasury.
  • In 1999, President Clinton proposed a departure from the self-financing structure, and while it didn't get much attention, it still popularized the concept of ending the self-financing nature of Social Security.
  • In 2010, the payroll tax holiday was enacted, which subsidized Social Security with the general fund.

The payroll tax holiday marks the first time that lawmakers have pivoted from the self-financing structure of Social Security. And while the extension of the payroll tax holiday is yet to be determined, there are severe policy implications for the most recent payroll tax cut. For instance, as more people retire and receive benefits, policymakers have little room to make necessary reforms to put Social Security back on a sustainable track that is self-financed again.

Under the current subsidization of Social Security through the general fund, there are essentially four courses the program can take.

  • First, continuation. Social Security will continue to be subsidized by the general fund.
  • Second, recurrence. The payroll tax cut will expire and put Social Security back on a self-financing structure. But a precedent will be set to allow lawmakers to subsidize Social Security in the future.
  • Third, termination with lasting policy effects. The payroll tax cut will expire but leave the public with the perception that Social Security benefits come from the general fund.
  • Lastly, termination with no lasting policy effects. The general revenue subsidies expire but public awareness of the subsidy is not long lasting, meaning that self-financing of Social Security will be strictly enforced in the future.

Source: Charles Blahous, "The End of Social Security's Self-Financing," Mercatus Center, October 10, 2012.

 

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