May 3 2010
Social Security's Straightforward Math
Carrie L. Lukas
Supporters of the health care overhaul benefited from the bill's scope and the medical system's complexity. Who could know if they personally would be better or worse off in the short term from the law's passage? Seniors saw big proposed cuts to Medicare, but were assured that closing the "doughnut hole" in prescription drug coverage would save them a couple hundred dollars. Families knew that proposed insurance mandates would increase policy premiums, but would income-based federal subsidies offset those higher costs?
Despite these nuances, most Americans understood that the health care bill fundamentally changes our health care system for the worse. They realized that by adding bureaucracy, creating costly new mandates, and expanding coverage while trying to squeeze down costs, the health care law will ultimately create a less innovative, lower quality, more expensive health care system.
If politicians couldn't confuse Americans into supporting health care reform (a majority opposed the bill at passage and continue to do so today), they're certainly in for trouble with Social Security reform. Compared to health care, Social Security is a straightforward issue.
All working Americans pay Social Security taxes. Though technically employers and employees split the burden, most people recognize that Social Security consumes 12.4 percent of their total compensation, because the deduction is visible on their paychecks. Social Security taxes are capped at a certain income level ($106,800 in 2010). And when someone reaches retirement age, Social Security begins paying a monthly benefit, which is based on total lifetime earnings. Therefore, the amount you get back relates to how much you pay in.
The most complex part of the program is the "Trust Fund." For decades, Social Security payroll tax revenues exceeded required benefit payments. The Social Security Administration (SSA) took this extra revenue and loaned it back to the general treasury, receiving in return government bonds that accrued interest.
Periodically, politicians would howl that Congress was "raiding" Social Security's Trust Fund, because the extra payroll tax money ultimately was used for general government spending and masked the size of the deficit. Members of Congress would introduce laws that claimed to somehow wall off Social Security's surplus, with Al Gore most famously (and disingenuously) calling for a "Lock Box," as if such a thing could have really been crafted.
In reality, SSA and Congress had no choice but to use the money this way. Ideally, in a retirement system, contributions are used to buy assets that are then available to pay future benefits. This government-run pension system, however, couldn't buy actual assets in private companies, but could only collect IOUs from itself. Essentially this was the government loaning money from one pocket to the other. It never made sense outside of the accounting office and had no real effect other than to give Social Security a first claim on future taxpayer dollars.
The real limitations of the Trust Fund became clear this year when Social Security's balance sheet turned negative. Instead of running a surplus, Social Security actuaries predict that payroll tax revenue won't be enough to cover benefits in 2010. Social Security will have to use its famed Trust Fund assets to cover the shortfall. Taxpayers are now learning once and for all that those assets are of no comfort: Congress will have a new line item in its budget, and will have to either issue new debt, raise taxes, or cut other spending to pay SSA back. That's exactly what would have happened absent the Trust Fund, unless politicians wanted to do the unthinkable and cut current Social Security benefits.
Social Security's finances are only going to get worse, given the pending retirement of millions of baby boomers. But this time, there's no disguising the problem.
When Congress begins debating Social Security reform, Americans will know that what's being discussed is a mix of benefit cuts for future retirees and higher taxes for current workers. Undoubtedly, Congress will try to make the math tricky. Tax increases will tilt toward those with high incomes, so politicians can claim to protect average Americans, ignoring how the effects of those higher taxes will trickle through the economy. Benefit cuts will also be progressive. Yet the vectors will be obvious: the American people will be paying more and getting less.
The silver lining is that perhaps Americans will take a fresh look at the Social Security system. Does it really make sense for the federal government to run what is essentially the world's largest Ponzi scheme, in which the ability to pay benefits rests entirely on the ability to raise enough revenue from current workers? Increasingly risk-averse Americans have come to appreciate sound financing: They know it's best to have money in the bank to cover future liabilities. Instead of just tinkering around the edges of Social Security, policymakers should act more boldly. True, sustainable Social Security reform would embrace the principles of sound financing and private property, by creating a system of personal retirement accounts.