Will Social Security "Go Broke" in 2035? No.

         Every year the Social Security Administration issues a trustee report stating the condition of the system, including the "bond fund," or, as it is officially known,  the "Social Security Trust Fund." This year the trustees estimate that the bonds in the trust fund will "run out" in  2035. (Find the report summary here:  https://www.ssa.gov/oact/TRSUM/)  And every year there is confusion about what it means for the trust fund to be exhausted.  Will retiree payments be cut? Will taxes have to be raised? 

         Soon after the Social Security Administration trustees report landed, the Washington Post ran opinion-writer Megan McArdle's June 9, 2022, front-page article under the screaming headline:  "As Our Entitlements Crisis Gets Closer, A Solution Moved Farther Away." She describes the pending "insolvency" of Social Security and the fraught choice that will face the Congress at that time.

         This commonly-held description implies that the country’s most popular government program is in serious trouble. Current retirees, as well as current workers who've paid into the system during their entire work life and who anticipate reliable payments during their retirement, all have reason to be alarmed when such reports appear in leading newspapers.

         Moreover, there is no doubt that this issue will play a role in the election season.  For instance, in the race for the US Senate seat in Wisconsin, two-term incumbent Ron Johnson, now seeking a third term,  has claimed  that Social Security is a "Ponzi scheme" and it's  pending "insolvency" is just another example of "democrat (sic) socialist programs bankrupting the country."

Follow the Money. Follow the Bonds

           Fortunately, the system is not going broke. The correction of this common misunderstanding and the political opportunism derived from it must begin with a review of how the social security system gets its money. As designed in 1935, the chief source of revenue for Social Security is a designated tax: the payroll tax on earned income.   Originally this payroll tax was to be "pay-as-you-go," workers paying for retirees in a rolling obligation, each generation of workers paying for the Social Security benefits of the retirees. But it is easy to overlook this economic reciprocity: each generation of workers inherits the knowledge and physical capital produced in the past, resulting in an average growth of productivity of roughly 1.5% per year.

         No one could have predicted in 1935 that the hugely disruptive World War II would be followed by an 18-year "baby boom" of 77 million people, in turn, followed by an 18-year "baby bust" of 47 million people.          This pattern of boom and bust birth rates predetermined a boom of retirees collecting benefits and a bust of workers to finance those benefits. This meant that the pay-as-you-go system based on payroll tax revenue would place a financial strain on workers when the baby boomers retired.  To avoid this excess burden, beginning in 1985, President Reagan raised the payroll tax above the amount needed to meet the retirement benefits year by year.  That "surplus" amount was used by the Social Security System to purchase special Treasury bonds on behalf of the boomers.  In effect, this combination of taxes on boomer income and investment in bonds forced the boomers to invest in partial payment of their own retirement benefits.  The reserve of those bonds is known as the "Social Security Trust Fund."       The plan was to build up this fund during the working life of the baby boomers, using the cash for the good of the country during those years, and then return the cash with interest during their retirement years.    The sale of the bonds would be the accounting transaction in exchange for the cash.

         The revenue gained from this sale of bonds would be added to the payroll taxes paid by the workers during those years. As a result, the payroll tax rate paid by workers would be set lower than if the workers had to finance the entirety of baby boom retirement benefits.   The System would sell bonds from the Trust Fund back to the Treasury in exchange for cash sufficient to pay for about 1/4 of the retiree Social Security benefits;  the payroll tax paid by workers would pay the other 3/4.

Crisis? What Crisis? 

         According to estimates made in 1985 when the bond reserve was established, the boomers would be forced to save enough to pay their share until the year 2060, and accordingly, the bonds would be sold out by the year 2060.  By then all but a few persistent boomers will be gone and no longer collecting retiree benefits.    As the trustees now report, however, the bonds will run out in 2035 when over half of the boomers will still be very much alive and collecting retirement benefits. Where will that money come from when the bonds are gone?

         The great fear presented by the predicted exhaustion of the bond fund by 2035 is that Congress will have to choose between cutting benefits by 1/4 or raising taxes to pay 1/4 of the benefits. Fortunately, the math shows that fear is unfounded: the retention of the planned benefits schedule will not require an increase in taxes or borrowing after the bonds run out.

         If after 2035 Congress orders the Social Security Administration to maintain scheduled benefits, the amount required will be the financial difference between retirement benefits and worker payroll tax revenue.  The retirement benefits schedule depends upon the summation of the individual retiree's highest 35 years of earnings during their working years. The payroll tax revenue depends upon worker earnings. Neither of these two formulas depend upon past savings; the exhaustion of the bond fund does not affect the difference between them.

          The bonds are going to run out sooner than expected because the savings were offset by expenditures not anticipated in 1985, including cuts in general taxes; increased defense costs; the multi-trillion-dollar response to the economic downturn of 2008/9;  the pandemic–induced economic downturn of 2020.  But such diversions should not be paid for by boomers in the form of reductions in their retirement benefit checks. Like all citizens, they will pay their share of those government expenditures through their general taxes.  They should not have to pay twice; i.e., once through their general taxes and a second time through reductions in their retirement checks.  

            Because the amount to be supplemented is not dependent on the existence of bonds, neither the rate of taxation nor the rate of government borrowing will have to change after the bond fund is exhausted. If in 2035 Congress orders the Treasury to continue to supplement Social Security retirement checks, the Treasury can provide the required supplementary money without raising tax rates or borrowing.   

William L. Holahan is Emeritus Professor and former Chair of Economics at the University of Wisconsin-Milwaukee

    


Showing 1 reaction

Please check your e-mail for a link to activate your account.