Social Security: Whose Money Is It Anyway?

[Note: This post was originally written as a column for the Commentator, the campus's student newspaper. It appears in the Tuesday, March 8, 2005 edition. I wrote it a few weeks ago. Let me just say that I have a lot more respect for skilled columnists now. It is extremely difficult to say anything worth reading in 800-1000 words, especially on such a complex topic as Social Security. The flip side is that it is easy indeed to produce brainless fluff of the type that infests most newspapers. Ah well.]

“In 1960, the Supreme Court of the United States in Flemming v. Nestor ruled that you have no legal right to your Social Security benefits…and that your benefits are part of a government spending program, no different in the eyes of the law than corporate welfare or farm subsidies.” Patrick Hynes, Cato Institute

Right now, the main event in Capitol Hill is the wrangling and arm twisting by President Bush to gather Congressional support for his Social Security reform plan, and by Democrats to defeat it. It is shaping up to be the most apocalyptic legislative battles in recent memory.

But why? What makes Social Security reform so important? And why does it need reform to begin with?

Let’s begin by briefly describing the present system. When you pay income taxes, 12.4% of the portion of your income below a cap (currently at $90,000, and indexed to inflation) goes into the Social Security trust fund. In other words, the most money an individual can currently pay into the fund is about $11,600 per year. From this fund are paid out disability payments and old-age pensions; the average beneficiary receives about $11,000 per year. The trust fund presently takes in more money than it pays out; and the remainder is exchanged for special Treasury notes. The Federal government then uses the excess money to fund general spending, which lets it pad its budget figures and disguise the true state of its finances. (If you tried this in a private firm, you would probably be arrested.)

The problem is that the system depends on a large number of workers to cover the cost of the retirees. And not only are birth rates going down, but life expectancy is going up. So while in 1950 each beneficiary was supported by 16 workers, in 2003 there were only 3.3 workers per beneficiary. In 2030, there will only be 2.2 workers per beneficiary. And the number will continue to decrease.

Moreover, the payment formulas are indexed not to the rate of inflation, but to wage growth. Because of this, benefits are growing more quickly than the general economy.

The results are stark. The Board of Trustees for Social Security reported in 2004: “Annual cost will exceed tax income starting in 2018 at which time the annual gap will be covered with cash from redeeming special obligations of the Treasury, until these assets are exhausted in 2042.”

This is the real problem. Yes, the trust fund is holding a certain value in Treasury notes; but in order to redeem them, the money must come out of the general budget. To do that, either the government must borrow more money, or else aggressively cut spending. So the real date to worry about is not 2042, but 2018. And we have very little time to change things.

How does President Bush want to fix the problem? Several ideas are being considered, but two seem most likely to be part of the eventual proposal. First is to index payments to inflation, not wage growth. This would slow the growth of Social Security obligations, but would not deal with the structural problem.

The second idea, and the most contentious, is the use of private savings accounts. These accounts would be voluntary; taxpayers may decide, on a one-time basis, to opt into the system, and in any event nobody born before 1950 may participate. Those participating may invest up to 4% of their payments in one or more of a handful of approved, conservative mutual funds, administered by the government. The system is modeled on the Thrift Savings Program, a pension program used by Federal employees (including members of Congress).

The plan for private accounts has set off howls from some parties, who would rather see the payroll tax increased in some fashion. The AARP, for example, is advocating that the tax cap be raised from $90,000 to $140,000. President Bush has refused to consider raising taxes of any kind, saying that they would do more harm than good in the long run. He notes that the payroll tax was only 2% when the system was instituted in 1935, and has been raised 20 times since then.

Some opponents have gone further. Dianne Feinstein, senator from California, wrote an editorial in the San Francisco Chronicle on February 4th in which she advocated: “Repealing President Bush’s tax cut for those earning more than $200,000 and transferring the revenues to Social Security, which could save about $2.9 trillion over 75 years.”

Here, even the pretense of fixing the system is abandoned. Sen. Feinstein’s proposal is out-and-out income redistribution. The savings she claims do not exist. After the tax cuts were put in place, Federal receipts actually increased by about 10% year over year. According to the Congressional Budget Office, the budget ran a $12 billion surplus in January. This demonstrates the clear effect of the Laffer Curve, i.e. that high taxes will restrain economic activity. Why is Sen. Feinstein ignoring this?

The answer comes from Noam Chomsky: “[P]utting people in charge of their own assets breaks down the solidarity that comes from doing something together, and diminishes the sense that people have responsibility for each other.” Or, as Pete du Pont wrote for OpinionJournal.com on February 16th, “The government's Social Security system is socialism's last redoubt, and must be preserved at all costs.”

Private accounts would take money out of the hands of the government, and put it under the control of the people who earned it in the first place. And this is a tremendous benefit for younger workers, few of whom expect to receive any money at all from the Social Security Administration when they retire. But it remains to be seen whether President Bush’s proposal will survive Congress.