What Is the Social Security Trust Fund, Exactly?

I have to confess that I’ve never understood the Social Security trust fund, and I suspect that you don’t either. Some people say it’s real and other people say it’s a fairy tale—an accounting trick. This is a big ol’ two-trillion-dollar he said/she said.

But I’ve seen some pieces recently that helped clarify some things.

Michael Hiltzik had a column in the Los Angeles Times the other day that makes a lot of sense to me. He forcefully argues that the trust fund is very real (and in the process takes the Peterson Foundation to task. I should disclose up high that they’re an Audit funder).

The trust fund contains $2.5 billion trillion worth of bonds set aside because of huge surpluses in the program over the last quarter century. They were put aside to sell when Social Security started running deficits. Problem is, those are U.S. government bonds and U.S taxpayers have to pay them. The right says the trust fund is not much more than accounting fraud. Hiltzik says no:

Despite what Social Security’s enemies love to claim, the trust fund is not a myth, it’s not mere paper. It’s real money, and it represents the savings of every worker paying into the system today…

The truth is that there are two separate tax programs at work here — the payroll tax and the income tax — and they affect Americans in different ways. The first pays for Social Security and the second for the rest of the federal budget…

Since 1983, the money from all payroll taxpayers has been building up the Social Security surplus, swelling the trust fund. What’s happened to the money? It’s been borrowed by the federal government and spent on federal programs — housing, stimulus, war and a big income tax cut for the richest Americans, enacted under President George W. Bush in 2001.

In other words, money from the taxpayers at the lower end of the income scale has been spent to help out those at the higher end. That transfer — that loan, to characterize it accurately — is represented by the Treasury bonds held by the trust fund.

The interest on those bonds, and the eventual redemption of the principal, should have to be paid for by income taxpayers, who reaped the direct benefits from borrowing the money.

Hiltzik, alas, doesn’t tell us how much income taxes would have to be raised to make Social Security payees whole. But Social Security’s trustees say the trust fund will be empty by 2037, after which payroll taxes will be able to fund only 78 percent of benefits. As Hiltzik says, sometime between now and then, the program will have to be restructured somewhat, as it was in 1983.

But think about it this way, we have to raise income taxes or cut spending $2.5 trillion over the next twenty-seven years to pay for those trust fund IOUs. That’s about $92 billion a year, plus interest.

Iconoclastic conservative Bruce Bartlett says making Social Security whole in perpetuity (meaning, forever) would entail a 13 percent overall increase in income taxes. Of course, that’s too high, because nobody expects Social Security not to be restructured by the time the trust fund runs out in 2037.

And of course, since much of this money has been transferred from lower- and middle-class workers to rich folks (you quit paying payroll taxes on income over $106,000), as we’ll see below, you could also raise or eliminate the cap on the payroll tax. For all the talk about how high taxes are on the rich, I’ll bet you didn’t know the effective income tax rate on those with adjusted-gross incomes of $2,000,000 is just 22 percent, not 35 percent.

Pulitzer winner David Cay Johnston says that the government deciding not to pay these bonds would be a form of default. He puts it more convincingly than anyone I’ve seen, so I’ll quote him at length from the comments at Dean Baker’s site, too (emphasis mine):

… if the Congress fails to provide full benefits to those who have paid for them in advance because of the excess FICA tax it would be a form of default on US government debt.

THAT is the issue that needs a great deal of attention: reducing benefits paid for in advance is a form of default.

At its peak the excess tax equaled 4 percent of wages subject to FICA. That excess tax took away half of the savings capacity of the vast majority of Americans.

Factor in the time value of money and the effect of Reagan’s and Greenspan’s excess FICA tax was enormous and helps explain why so many Americans are mired in debt today. Fewer than half of taxpayers have ANY cash savings, while more than half did before Reagan took office.

Because of to Reaganomics, Social Security was converted from a pay-as-you go system into a subtle way to subtle way to overtax wages and thus finance tax cuts for the rich. The integrated federal budget (SS used to be accounted for separately) made this sleight-of-tax possible.

Without overtaxing workers Reagan would not have been able to persuade Congress to give massive tax relief to the few who paid the 70 percent (and later 50 percent) marginal rates.

In other words, this money is owed to Social Security as surely as money is owed to the Chinese for the hundreds of billions of dollars they’ve lent us in the form of bonds.

Note that Johnston says there’s a reason we don’t know this stuff:

it is very hard to introduce into an article history even from as recently as 1983 when the second most valued word in newsrooms is “yesterday,” exceeded only by “early this morning.”

And many or most newsrooms don’t have the institutional knowledge going back that far, much less the journalists who know their history.

Some more reporting on the history of the Social Security trust fund would be helpful.

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Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at rc2538@columbia.edu. Follow him on Twitter at @ryanchittum.