November 10, 2004

November 10, 2004 | Commentary on Social Security

Social Security's Fictitious Trust Fund

President Bush wants Congress to make Social Security reform a top priority. This is because the program is in real trouble -- worse trouble than most politicians and a surprising number of reporters are willing to admit.

Although Social Security will fall into deficit into 2018, some assert that the program's trust fund will make up the shortfall, and therefore delay any tax increases or benefit cuts, until 2042. That is simply wrong. There is a trust fund, but it has no money in it -- and it never did. No money has ever been saved for future retirees.

This means that the common myth that Congress and the president are raiding the trust fund is wrong also. As inventive as politicians are, even they can't steal money that was never there in the first place.

Since 1940, the Social Security benefits received by retirees have been funded by the payroll taxes that workers pay. As long as there are enough workers to pay all the benefits owed to current retirees, the system is fine. Unfortunately, that's about to change.

Today, there are just 3.3 taxpayers for each retiree. This is a sharp drop from 1950, when there were 16 taxpayers per retiree. In order to work properly, Social Security needs about three taxpayers per retiree. But with millions of baby boomers about to retire, and a much smaller number of new workers, by 2018 the program will have fewer than three workers per retiree and begin spending more each year than it takes in. That number will keep dropping until, around 2030, there will be two workers per retiree. At that point, a married couple will have to support themselves, their children -- and their very own retiree.

Supposedly, that's where the "trust fund" comes in. Although it has existed since the 1930s, it got a new purpose back in 1983, when the Greenspan Commission came up with an idea to pay for baby boomers' future retirements by raising the Social Security tax well above the amount currently needed to fund the program, and putting the extra money in the trust fund. Between 2018, when the program begins running a deficit, and 2042, the trust fund is expected to provide $5.7 trillion, about $100,000 per family, to pay benefits.

One problem: the federal government wasn't allowed to actually save this money. Since 1939, federal law has required Social Security to "invest" its extra money in Treasury bonds. In other words, the government lends the money to itself. Those funds are then mixed in with all other tax revenue and spent on programs such as education, foreign aid and defense.

So in 2018, when the Social Security program tries to redeem these bonds, the Treasury (having already spent that money over the previous 35 years) won't be able to repay Social Security from any pre-existing store of cash. Taxpayers will be forced to pay extra taxes in order to fund Social Security's 40 million retiring baby boomers.

It's like a family that borrows money from its retirement fund each year to pay for vacations and expensive dinners. When they finally retire, their retirement fund consists of nothing more than paper IOUs.

Some observers erroneously blame the budget deficits for the empty trust fund. Whether it is President Bush's tax cuts or John Kerry's health-care plan, critics regularly assert that any policy increasing the budget deficit would mean "more money taken from the Social Security trust fund.

That claim is also wrong. The Social Security surplus is spent each year regardless of whether the budget is in surplus or deficit. When the federal budget is in deficit, the Social Security surplus funds current government programs. When the budget is in surplus, the Social Security surplus pays down the national debt. Either way, nothing is saved for future retirees.

The demographics are already set. All of the taxpayers who will exist in 2018 have already been born. One way or the other, Social Security will need extra money starting that year.

Given that, this country faces a choice. It can either condemn future generations to ever-higher taxes or sharply lower Social Security benefits, or it can change the system by allowing younger workers to place part of their taxes in safe, controlled investments. That will cost money also, but the money in those accounts would be really saved -- and grow into pools of money that could pay some of the owner's Social Security benefits.

However, before we can make that choice, we have to stop being distracted by thoughts of trust funds -- especially ones that really have no money in them.

Brian Riedl is the Grover M. Hermann fellow in federal budgetary affairs, and David C. John is a senior research fellow for Social Security, at The Heritage Foundation (heritage.org).

About the Author

David C. John Senior Research Fellow in Retirement Security and Financial Institutions
Thomas A. Roe Institute for Economic Policy Studies

Brian M. Riedl Grover Hermann Fellow in Federal Budgetary Affairs
Thomas A. Roe Institute for Economic Policy Studies

Related Issues: Social Security

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