Social Security is an expensive program. But it is not about to explode, not now nor when the bonds in the Trust Fund run out. Nor is it broke, bankrupt, a Ponzi scheme or any of the other alarming pejoratives often used to describe it. Costs are not rising at a frightening pace that will lead to its demise in a few decades.
It should not be lumped in with the Medicare program, where costs are rising out of control, largely because the health care costs it insures against are rising fast.
Expensive and working as planned. As our nation looks for ways to cut the national budget, all government programs should be subject to review. It is important to determine which programs are expensive and not working versus those that are expensive and working just as planned. Social Security is among the latter. And with minor adjustments in retirement age and qualifications for early retirees, it can be made less costly. But there is no emergency looming.
Social Security is designed so that each generation pays for the generation that precedes it. However, it should be viewed as much more than a simple one-way transfer of money from younger workers to older retirees. There is a reciprocity that should be recognized.
Each generation's productivity is enhanced by the efforts of preceding generations; each generation pays a part of that increased productivity in the form of retirement benefits for the generation that made it possible. In effect, the young pay the old out of enhanced productivity made possible by the old when they were young.
This "pay-as-you-go" plan will work as long as the number of workers is sufficiently large relative to the number of retirees. Such a system has trouble whenever there is unsteady growth in the population, as in the present case of the baby boom generation. The boomers, the 77 million people born between 1946 and 1964, are followed by the baby busters, the 47 million people born in the following 18 years. The busters will have to pay the Social Security payments for the boomers despite their much smaller population size.
Is this cause for hand-wringing and worry? No. This "boomer bulge" is a temporary disruption in normal patterns — the ratio of worker to retirees will rise again as the busters will be followed by a generation numbering 57 million citizens (plus an unknown number of immigrants) paying into the system. Of current concern is the need to bridge the period in which the boomers are retiring in large numbers and living longer than anticipated.
Social Security Trust Fund. In 1983, Congress recognized the disruption that would result from the retirement of the baby boom generation and voted to increase payroll taxes in order to accumulate a surplus to meet these future funding needs. The surplus payroll tax revenues are turned over to U.S. Treasury and, in return, Social Security receives interest-bearing bonds that are placed in an account known as the Social Security Trust Fund.
The Treasury then uses the revenues to fund a variety of governmental programs unrelated to Social Security as well as to reduce the national debt or for tax cuts. This use of Social Security dollars reduces the current amount of general tax revenue or borrowing that would otherwise be required to fund these activities.
The plan is that as baby boomers retire and payroll tax revenues fall short of the cost of providing their retirement benefits, bonds in the Trust Fund will be "redeemed," that is, sold back to Treasury to make up the cash shortfall. This is happening now due to the severe recession and is planned to happen regularly starting around 2018. Since these bonds are general obligations of the Treasury, their redemption will be paid for in the same way Treasury pays for anything: taxing and borrowing. When the Treasury redeems Trust Fund bonds, it will use general tax revenue, or it will issue new government bonds to replace the retired Social Security bonds, or it will do some of both.
So what happens when the bonds run out? The bond redemption system is a bookkeeping step; when the bonds are gone, the society that invented this system can continue its payments without facing a fiscal crisis. Nothing sudden or "explosive" need occur when the bonds run out, and there will be many choices available: no crisis.
To illustrate, compare the year before and the year after the bonds run out. The Social Security trustees estimate that in the year before the bond fund is exhausted, retirement benefits will be financed 21 percent by bond redemptions and 79 percent by payroll tax revenues. What would happen in the next year — the year when there are no more Social Security bonds?
The choices range from reducing benefits and relying solely on payroll tax revenue, to keeping the benefits on schedule and finding a way to finance 21 percent of them. While at present the system is required to be self-funding, Congress could change the law and decide to pay the scheduled benefits. Let's explore both possibilities:
Congress keeps the self-funding requirement. If the self-funding requirement remains intact after the bonds run out, benefits would have to be reduced so that the income of the system is provided by payroll tax revenue alone, which would support 79 percent of scheduled benefits. A person retiring in 2040 after contributing the maximum for at least 35 years of working life is scheduled to receive $41,572, but under this calculation would receive only $32,841. The difference, $8,730, would be available for debt or tax reduction, government spending, or some combination.
Congress decides to retain scheduled benefits. This would require a change in the law to permit funding from outside the system. If Congress decided to make such a change, no increase in tax rates is required to fund the scheduled benefits.
To recap: The choice is between reduction in benefits to gain a revenue stream for debt reduction, expenditures and tax reductions or keeping taxes and Social Security benefits unchanged.
The crisis is the budget as a whole. Social Security should be considered in future budget-cutting exercises, not because the system is broken, or rising in cost explosively, but because it ought to be on the table with all other expensive government programs.
Charles Kroncke is associate dean in the University of South Florida College of Business. William Holahan chairs the Department of Economics at the University of Wisconsin-Milwaukee.