Social Security's Death Knell Is Ringing. Can You Hear It?

Social Security is, barring an immediate and massive overhaul in how benefits are paid to the back-end of the Baby Boomer generation and beyond, on its deathbed.  There can be no mistaking that fact.

Veronique de Rugy explains at Reason:

Since 2010, [Social Security] has been running at a cash-flow deficit – meaning that the Social Security payroll taxes the government collects aren't enough to cover the benefits it's obliged to pay out.  That should have been a signal that the time had come to look at reform.

Instead, we've spent the last seven years ignoring the problem.  To get by, the program started tapping into assets set aside beginning in the 1980s for rainy days.  Prior to 2010, the program collected more in payroll taxes than was needed to collect benefits at the time.  The leftovers were "invested" in Treasury bonds through the Old-Age Trust Fund, which is now being drawn down.

The 2010 mark for this cash-flow deficit didn't occur willy-nilly.  It could be argued that our government hastened, or at the very least exacerbated, this cash-flow deficit with its "payroll tax holiday," a bipartisan effort instituted in late 2009 that persisted until 2013.  This political maneuver slashed payroll taxes by roughly one third, from 6.2% to 4.2%.  The uncollected 2% (not peanuts in a country the size of ours) happens to coincide with the moment in time in which the government's payroll tax receipts couldn't cover its Social Security liabilities.  The cost of this "payroll tax holiday" is estimated to be $240 billion in tax revenue, some of which, at least, would have otherwise gone to pay out Social Security's beneficiaries.  Much of this $240 billion in uncollected revenue necessarily became issued federal debt.

I wrote in 2013, and I still maintain, that ending the payroll tax holiday was a sober and responsible measure to correct an irresponsible and stupid attempt at economic stimulus.  But it didn't really matter after the fact.  That 2% was reinstated in 2013, and in 2014, Social Security still suffered a $39-billion deficit in its annual balance sheet when you consider receipts versus liabilities.

The circumstances appear dire when framed this way, to be sure.  But advocates of Social Security argue that the manner in which I and Veronique de Rugy describe the "deficit" between receipts and liabilities is not entirely accurate, because the federal government's interest payments to Social Security currently cover that discrepancy, and amount to trillions in "reserves."

And interestingly, despite the intent, the circumstances appear just as dire when framed that way. 

For example, Matthew Frankel argues at USA Today that "there are several trillion dollars in Social Security's reserves," but he admits freely that those reserves are not "just a pile of cash sitting in a warehouse somewhere."  The Social Security Administration "invests the money it has in special U.S. government bonds.  This is a win-win for the government and for Social Security.  The government gets to use Social Security's excess cash to fund its operations, and Social Security generates "extra income" via interest paid by the Treasury.

In other words, the U.S. Treasury "owes" the Social Security Administration interest on its purchased debt, as well as the principal that it "lent" to the Treasury throughout the years.  These – the principal and the interest – are the "trillions" of reserves that Frankel cites.  But the U.S. Treasury is currently running at a massive deficit and is over $20 trillion in debt, so, for it to repay the principal of the debt and the interest owed to the Social Security Administration when payroll tax receipts fail to meet Social Security's obligations, the Treasury has to borrow more money to pay those obligations.

And how do they do that?  By issuing more federal debt, of course.  Billions upon billions of debt.

This is what Veronique de Rugy means when citing that the unused annual receipts from payroll taxes were "invested" in Treasury bonds over the years.  The quotation marks are sarcastic emphasis meant to highlight that this is not "investment," but rather the perpetual issuance of government debt to pay for other government debt.

Excess payments to Social Security have never been placed in an "investment."  It is the financial equivalent of opening a second credit account to pay off a longstanding debt for a credit account that had been building for decades.  It's simply more debt, with a curiously devised bookkeeping mechanism hiding the fact that the creditor and the debtor are one in the same.

The government cannot, and could never, "invest" excess payroll taxes, and to suggest that the government does so is only clever semantics.  The Social Security Administration can, by law, only buy new debt from the Treasury with any excess revenue.  As of today, the Treasury has long since used the money it has borrowed from the excess collection of taxes for Social Security payments over the years and is now relegated to borrowing more money in order to pay its obligations when payroll tax collection falls short of Social Security liability. 

In the plainest terms, the government has borrowed money from itself for decades while promising interest payments and principal repayment to itself.  It spent the money it has borrowed for its own separate purposes, and is now borrowing more money in order to pay itself back the principal and interest it owes.

Government was fine with this arrangement in decades past.  In fact, government couldn't have been happier about it.  It was free money in exchange for IOUs that some other schmucks (i.e., me, my kids, and my grandkids) will have to pay for.  But now the reckoning for Social Security is nigh.  The debt is coming due, and the fiscal irresponsibility of the past is becoming ever more exposed.

No one has a perfect answer about what to do to fix Social Security.  When something is so fundamentally broken, so fiscally incomprehensible, so distant from the intended form of governance among a free people, and when such a thing has existed for so long, how might one seek to fix it?

Perhaps the only answer is to undo its wrongs to the greatest extent possible.  Veronique de Rugy has a fairly simple suggestion:

Congress should make it easier for all Americans to save.  One way to do that is through the creation of Universal Savings Accounts, or vehicles that allow people to invest money without all the complicated rules that now apply to IRAs and 401(k)s.  In addition, Congress should boost the maximum contributions people can make to Health Savings Accounts, so that more Americans can afford the medical expenses most of us inevitably incur in our old age.

More broadly, Congress should shift away from Social Security into a "funded" system based on real savings, much as Australia and others have done.  The libertarian economist Daniel J. Mitchell notes that, starting in the '80s and '90s, that country has required workers to put 9.5 percent of their income into a personal retirement account.  As a safety net – but not as a default – Australians with limited savings are guaranteed a basic pension.

That program has generated big increases in wealth.  Meanwhile, Social Security has generated big deficits and discouraged private saving.  Who would you have emulate the other?

Who, indeed?

We should do all we can reasonably do, while respectfully considering the contributions of and obligations toward existing beneficiaries, to allow working Americans the means to invest as they would have their own money be invested, rather than force them to continually and increasingly provide life support to this dying government slush fund.  That's as simple a start as we might find.

William Sullivan blogs at Political Palaver, and can be followed on Twitter.