Part 1

Social Security Is in Crisis

Robert P. Murphy, Ph.D.

For a long time, analysts have been warning that the Social Security system is in trouble, but the crisis was supposed to be years in the future. The severe recession has accelerated the problem: The crisis is upon us now.

Social Security Is Bankrupt

Since its inception in the 1930s, Social Security has been a giant Ponzi scheme administered by the government. In the beginning, retirees, widows, and other beneficiaries received payments in excess of what they had paid into the system. Each succeeding cohort of retirees would then be supported by the fresh crop of new workers who had replaced them in the workforce.

This dubious arrangement could stay afloat so long as the proportion of workers to retirees remained constant. However, in the United States (and other industrialized nations), the population has gradually aged over time, so each worker had to support a growing number of dependents. The combination of falling birthrates and rising life expectancies means that the current Social Security system is bankrupt.

To call Social Security bankrupt is not a mere metaphor; it is bankrupt in the strict accounting definition. Specifically, the present value of the system’s assets—including the payroll contributions of future workers—is less than the present value of the system’s promised benefits to current and future retirees. In other words, Social Security’s assets are smaller than its liabilities. That’s what it means to be insolvent.

The degree of its insolvency is enormous. According to a U.S. Treasury report (p. 50), the 2009 estimated unfunded liability for Social Security was $7.7 trillion. In other words, when the government’s actuaries estimate the projected outflows to future beneficiaries and compare them to projected inflows from future workers, after adjusting for the time-value of money the deficiency is almost $8 trillion. (If we include all of the federal government’s “social insurance” programs, the total unfunded liability is a shocking $46 trillion.)

Even more alarming, this deficiency between benefit payments and tax collections is not some far-off problem. This year the Social Security system is experiencing a cash-flow deficit. For the first half of 2010, Social Security has paid out $347.3 billion in benefit payments while taking in only $346.9 billion in tax collections.

The Congressional Budget Office (CBO) projects that Social Security will once again return to an operating surplus in 2014 before plunging permanently back into the red by 2018. Yet even this sliver of optimism may be misplaced, as the CBO’s model assumes that the economy gradually recovers from the recession. If, contrary to the CBO forecast, the economy plunges back into a “double dip”—as many analysts fear—then the currently configured Social Security system may never see a cash-flow surplus again.

The Myth of the “Trust Fund”

Some progressive pundits—such as Paul Krugman and Dean Baker—argue that there is no cause for alarm. After all, because of the huge surpluses piled up since the 1980s, the Social Security administrators are sitting on some $2.6 trillion in assets. Therefore, even though benefit payments will exceed tax collections in the coming decades, Social Security can draw down these accumulated assets to make up the deficit each year. By this measure, Social Security won’t hit a crisis until 2043.

There are two major problems with this defense: First, even though it has significant assets, the system is still bankrupt. To repeat, even accounting for the “trust fund,” the government’s own actuaries project that the program will not be able to make its scheduled future benefit payments. That is the definition of insolvency. When major corporations file for bankruptcy, they often have significant assets at their disposal. The point is that these assets are smaller than their liabilities.

Second, the “trust fund” is an accounting gimmick from the taxpayer’s point of view. The Social Security system’s assets consist of I.O.U.s issued by the Treasury. Since the 1980s, the excess receipts of the Social Security system have been taken and spent by the federal government. That money is gone. The only thing showing for it now are pieces of paper promising payment from the U.S. government.

For any individual corporation or household, U.S. Treasury securities are indeed financial assets that strengthen the net worth of the owner. But from the viewpoint of the American taxpayers, it doesn’t matter whether the Social Security trust fund is $2.6 trillion or $2.60. Either way, taxpayers will have to make up the difference between Social Security’s outgoing benefit payments and incoming tax receipts.

Consider a silly scenario: Suppose an intern working at the Social Security Administration accidentally tips the drawer holding the trust fund notes into a paper shredder. She looks on in horror as $2.6 trillion in bonds issued by the U.S. Treasury are destroyed.

Naturally the intern’s boss is furious. He doesn’t know what to do, since the Social Security system is now $2.6 trillion poorer. They have nothing to sell off to cover their operating deficits.

On the other hand, officials at the Treasury Department are elated. Tim Geithner himself calls up the intern and congratulates her on reducing the national debt by $2.6 trillion. The incoming federal tax receipts that would have previously been used to pay the interest and principal on those outstanding bonds can now be spent on something else (or returned to the taxpayers).

But while one set of government officials is distraught while another is delighted, from the point of view of taxpayers, it makes no difference. They’ll still have to make up the $2.6 trillion gap either way.

Our hypothetical scenario illustrates the silliness of counting Social Security’s holdings of Treasury securities as genuine assets. In fact, when Krugman and Baker discuss the size of the U.S. government’s debt, they count only Treasuries held by the public. In other words, they are trying to have it both ways: They count the $2.6 trillion of Treasury securities as assets owned by Social Security, but they don’t count them as liabilities of the U.S. government.

Regardless of whether we count the “trust fund” as legitimate or not,if we do choose to solve the Social Security crisis by pointing to its stockpile of assets, then we have merely transformed the Social Security crisis into a federal debt crisis. This is because the discussion of the federal debt typically excludes “intragovernmental debt,” or debt that various branches of the government owe each other. So the size of the federal debt will be that much larger if we treat the trust fund assets as genuine.

There is one sense in which the trust fund assets would be economically meaningful: If the federal government had spent Social Security’s surpluses over the years on productive investments that raised total economic output, then the tax base would have grown and the federal government would have larger tax receipts with which to pay off the I.O.U.s held by the Social Security Administration. In this scenario, the federal government would have acted as a giant corporation, issuing new bonds in order to build more factories (say) and thereby increase future revenues. In this scenario, issuing the new debt would “pay for itself.”

But who really wants to describe the federal government’s spending from 1984 to the present as frugal investments? Unfortunately, what happened is that politicians saw a boatload of new money after the Reagan-era “fix” and spent more money than they otherwise would have. There is nothing to show for the trust fund assets except the memories of high living.

Can’t They Just “Reform” the System Again?

Some observers shrug off the dire warnings of the ticking demographic time bomb—which has already begun to explode—by pointing to the Social Security Reform Act of 1983. Following the recommendations of the so-called Greenspan Commission (which was chaired by Alan Greenspan), the payroll tax was increased in order to close the shortfall that Social Security had experienced at that time.

No one denies that Congress will act before the full projections of the system’s insolvency come to pass. But the point is that the only way to “fix” Social Security is to increase the tax bite on current and future workers and reduce the total benefits paid out to future retirees. This latter may include a postponement of retirement age and/or a reduction in benefit checks. It should hardly reassure citizens to hear that such a “solution” is waiting in the wings.

A Crisis If There Ever Was One

Barring a demographic miracle, the trends are unavoidable. The current configuration of payroll taxes and benefit schedules is unsustainable. From a long-run accounting perspective, Social Security is literally bankrupt. Even on a short-term cash-flow perspective, the system is paying out more than it takes in.

The so-called trust fund is an accounting gimmick that doesn’t represent genuine saving and investment. The politicians squandered the Social Security surpluses over the years. At this point, easing the burden on Social Security by cashing in the trust fund assets simply increases the burden on the government’s general fund.

Current workers need to prepare for tax hikes, and they had better not count on Social Security as the basis of their retirement. If this system isn’t in crisis, what is?

NEXT: David Rosnick responds to Robert Murphy.