Social Security isn't a ticking time bomb—it exploded last year. That was when the System spent more than it took in for the first time since it was "fixed" in 1983. For nearly 30 years accounting gimmicks have hidden, in plain view, the fact that Uncle Sam has long since spent the so-called Social Security "surplus." To provide a needed dose of reality and urgency to the ongoing debate over entitlement reform and craft a workable and fair solution, we must begin with a clear-eyed view of the real financial state of the Social Security System.
Despite providing $800 billion in annual benefits, Social Security is not complicated. On the revenue side, the System is credited with all Social Security taxes 12.4% (split between employers and employees) up to the first $106,800 (indexed) earned plus federal income taxes payments on benefits received by higher income retirees. (For simplicity, I'm combining the technically separate pension "OSAI" and disability "DI" programs that make up the Social Security System.) That money pays for all Social Security retirement, disability, survivor, and dependent benefits to covered workers and their families plus the roughly 0.9 percent administrative fee assessed by the federal government. The size of the check depends largely on career average wages, years of work, and the retirement age when payments begin.
While Social Security was established as a pay-as-you-go system, in a given year the amount of money coming in naturally will be somewhat more or less than the level of payouts. To keep the System running smoothly, from its earliest days any annual surplus has been held in a bookkeeping account called the Social Security Trust Fund, which is controlled by the Secretary of the Treasury. By law, the Trust Fund must be invested in non-tradable US Government securities and the interest paid on those securities is added to the Trust Fund.
The securities in the Trust Fund are not assets with real value, but a promise by the government to repay the System (which is really just another arm of the federal government) the funds when needed at a later date. Essentially, the Trust Fund functioned as a means to even out the System's cash flow in years when its revenue was not enough to cover costs. For years, this worked reasonably well because Social Security operated more or less in equilibrium: cash in was not substantially different from cash going out.
That financial equilibrium was shattered in 1975 when increasing longevity, and thus a steadily proliferating population of retirees, caused the System to begin hemorrhaging money. President Reagan and Democratic House Speaker Tip O'Neill, acting on the advice of Alan Greenspan, worked out a compromise to reform Social Security by raising taxes and gradually raising the retirement age, in effect lowering benefits.
The 1983 Reformers realized that those changes meant that Social Security would initially run at a surplus, and believed those extra funds could be "locked-boxed" away to cover the inevitably ballooning payouts to Baby Boomers when they retired. While technically Social Security and all other Government programs with dedicated revenue streams (like Medicare!) are off-budget, meaning that they aren't supposed to figure in the Government's day-to-day finances, the Treasury and the GAO (General Accounting Office) lump all on and off-budget government revenues and spending together when they report the bottom-line deficit and budget numbers.
This was the fatal flaw in the 1983 reform: Washington could not resist treating the extra billions taken in annually by Social Security as a virtual ATM. And so the entire Social Security surplus—a total $5.4 trillion in 2010 dollars—has been spent.
This is how it happened. Except for a few years during the Clinton Administration, the federal government has consistently spent more money than it took in. Each year, the Treasury has dutifully transferred the surplus Social Security taxes from its coffers to the Trust Fund, and reported Social Security's annual finances as if the surplus has been safely tucked away to pay future benefits. In fact, the Trust Fund "buys" government bonds that are "sold" by the Treasury. Once the proceeds from the bond sale hit the Treasury's books, they are considered fair game in Washington. Indeed, the surplus Social Security taxes collected during the first 26 years (1984–2009) after the reform helped Democrats and Republicans alike make their profligate spending appear a little less egregious.
And the beat goes on. Although last year's compromise tax reduction bill lowered employees' share of Social Security taxes by 2 percent, the new tax law "covered" that loss by transferring the lost revenue value to the Trust Fund in the form of meaningless Treasury IOUs. Bernie Madoff would approve.
That means the now $2.5 trillion Trust Fund investment in Treasury securities is an illusion. And, as the oldest of the baby Boomers hit retirement age, the lack of a real trust fund is critical. In 2010, Social Security had negative cash flow: the System paid some $41 billion more in benefits than it collected in taxes. For 2011, the shortfall in revenue is projected at a bit under $9 billion. (In 2012, cash flow is expected to briefly turn positive with an $11 billion surplus for three years, after which, in 2015, it will be in permanent deficit.)
Nevertheless, the Treasury cheerfully reports that there is enough in the Trust Fund to cover the shortfall until 2037 by "selling" some of the Trust Fund's Treasury securities back to itself. There's no other way to say it: this is a bald-faced lie.
The Trust Fund illusion has convinced the public that Social Security is in okay financial shape and enabled Congress to keep a safe distance from this political third rail. In a recent Wall Street Journal /NBC News poll, a majority of people did not rank fixing Social Security as a top priority and supported leaving the System pretty much as is. Clearly, Americans are unaware of how bad things really are.
Ponzi schemes, speculative frenzies, and other financial illusions eventually collapse of their own weight. To begin a truly meaningful debate over how to fix Social Security, the President and Congress must first acknowledge that the Trust Fund is empty and Social Security is in the red. (They can blame prior Administrations.) This urgent problem must be properly addressed, first by an honest reporting of the facts.
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