Social Security Trust Fund
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The United States Social Security Administration collects payroll taxes and uses the money collected to pay Old-Age, Survivors, and Disability Insurance benefits. This is done by way of "Trust Funds". There are two trust funds which the Social Security Administration controls: Old-Age and Survivors Insurance (OASI) and Disability Insurance (DI).
When the program runs a surplus, there will be excess funding available for the Social Security Administration that year. The excess funds are diverted to one of the trust funds. The money in the trust fund is used by the treasury in the form of treasury bonds. The treasury bonds provide interest on the money in the trust funds, and if the program sees a deficit, the excess funds from previous years plus any interest earned is used to pay beneficiaries. At the end of 2011, the Trust Fund contained (or alternatively, was owed) $2.7 trillion, up $69 billion from 2010. The fund is required by law to be invested in non-marketable securities issued and guaranteed by the "full faith and credit" of the federal government.
The trust funds do not represent a legal obligation to Social Security program recipients, and Congress could cut or raise taxes on such benefits if it chooses, and are considered "intra-governmental" debt, a component of the "public" or "national" debt. As of April 2012, the intragovernmental debt was $4.8 trillion of the $15.7 trillion national debt.
According to the Social Security Trustees, who oversee the program and report on its financial condition, program costs are expected to exceed non-interest income from 2011 onward. However, due to interest (earned at a 4.4% rate in 2011) the program will run an overall surplus that adds to the fund through the end of 2021. Under current law, the securities in the fund represent a legal obligation the government must honor when program revenues are no longer sufficient to fully fund benefit payments. However, when the trust fund is used to cover program deficits in a given year, the Trust Fund balance is reduced. By 2033, the fund is expected to be exhausted. Thereafter, payroll taxes are projected to only cover approximately 75% of program obligations.
There is controversy regarding whether the U.S. government will be able to borrow sufficient amounts to honor its obligations fully to recipients or whether program modifications are required. This is a challenge for the federal government overall, not just the Social Security program.
The "Social Security Trust Fund" comprises two separate funds that hold federal government debt obligations related to what are traditionally thought of as Social Security benefits. The larger of these funds is the Old-Age and Survivors Insurance (OASI) Trust Fund, which holds in trust special interest-bearing federal government securities bought with surplus OASI payroll tax revenues. The second, smaller fund is the Disability Insurance (DI) Trust Fund, which holds in trust more of the special interest-bearing federal government securities, bought with surplus DI payroll tax revenues.
The trust funds are "off-budget" and treated separately in certain ways from other federal spending, and other trust funds of the federal government. From the U.S. Code:
EXCLUSION OF SOCIAL SECURITY FROM ALL BUDGETS Pub. L. 101-508, title XIII, Sec. 13301(a), Nov. 5, 1990, 104Stat. 1388-623, provided that: Notwithstanding any other provision of law, the receipts and disbursements of the Federal Old-Age and Survivors Insurance Trust Fund and the Federal Disability Insurance Trust Fund shall not be counted as new budget authority, outlays, receipts, or deficit or surplus for purposes of - (1) the budget of the United States Government as submitted by the President, (2) the congressional budget, or (3) the Balanced Budget and Emergency Deficit Control Act of 1985.
The trust funds run surpluses in that the amount paid in by current workers is more than the amount paid out to current beneficiaries. These surpluses are given to the U.S. Treasury (and thus become part of the general federal budget) in exchange for special U.S. government securities, which are deposited into the trust funds. If the trust funds begin running deficits, meaning more in benefits are paid out than contributions paid in, the Social Security Administration is empowered to redeem the securities and use those funds to cover the deficit.
The Social Security system is primarily a pay-as-you-go system, meaning that payments to current retirees come from current payments into the system.
In 1977, President Jimmy Carter and the 95th Congress increased the FICA tax to fund Social Security, phased in gradually into the 1980s. In the early 1980s, financial projections of the Social Security Administration indicated near-term revenue from payroll taxes would not be sufficient to fully fund near-term benefits (thus raising the possibility of benefit cuts). The federal government appointed the National Commission on Social Security Reform, headed by Alan Greenspan (who had not yet been named Chairman of the Federal Reserve), to investigate what additional changes to federal law were necessary to shore up the fiscal health of the Social Security program. The Greenspan Commission projected that the system would be solvent for the entirety of its 75-year forecast period with certain recommendations. The changes to federal law enacted in 1983 and signed by President Reagan and pursuant to the recommendations of the Greenspan Commission advanced the time frame for previously scheduled payroll tax increases (though it raised slightly the payroll tax for the self-employed to equal the employer-employee rate), changed certain benefit calculations, and raised the retirement age to 67 by the year 2027. As of the end of calendar year 2010, the accumulated surplus in the Social Security Trust Fund stood at just over $2.6 trillion.
Social Security benefits are paid from a combination of social security payroll taxes paid by current workers and interest income earned by the Social Security Trust Fund. According to the projections of the Social Security Administration, the Trust Fund will continue to show net growth until 2022 because the interest generated by its bonds and the revenue from payroll taxes exceeds the amount needed to pay benefits. After 2022, without increases in Social Security taxes or cuts in benefits, the Fund is projected to decrease each year until being fully exhausted in 2033. At this point, if legislative action is not taken, the benefits would be reduced.
2011 activity and financial status
The 2011 Trustees Report Press Release stated:
- "Income including interest to the combined OASDI Trust Funds amounted to $805 billion in 2011. ($564 billion in net contributions, $24 billion from taxation of benefits, $114 billion in interest, and $103 billion in reimbursements from the General Fund of the Treasury—almost exclusively resulting from the 2011 payroll tax legislation.)
- Total expenditures from the combined OASDI Trust Funds amounted to $736 billion in 2011.
- Non-interest income fell below program costs in 2010 for the first time since 1983. Program costs are projected to exceed non-interest income throughout the remainder of the 75-year period.
- The assets of the combined OASDI Trust Funds increased by $69 billion in 2011 to a total of $2.7 trillion.
- During 2011, an estimated 158 million people had earnings covered by Social Security and paid payroll taxes.
- Social Security paid benefits of $725 billion in calendar year 2011. There were about 55 million beneficiaries at the end of the calendar year.
- The cost of $6.4 billion to administer the program in 2011 was 0.9 percent of total expenditures.
- The combined Trust Fund assets earned interest at an effective annual rate of 4.4 percent in 2011."
Some basic equations for understanding the fund balance include:
- Fund ending balance for a given year = Fund starting balance + program revenues + interest - program payouts
- Program annual surplus (or deficit if negative) = program revenues + Interest - program expenses
- Program annual cash surplus (or deficit if negative) = program revenues - program expenses
"Program revenues" has several components, including payroll tax contributions, taxation of benefits, and an accounting entry to reflect recent payroll tax cuts during 2011 and 2012, to make the fund "whole" as if these tax cuts had not occurred. These all add to the program revenues.
Under George W. Bush
On February 2, 2005, President George W. Bush made Social Security a prominent theme of his State of the Union Address. One consequence was increased public attention to the nature of the Social Security Trust Fund. Unlike a typical private pension plan, the Social Security Trust Fund does not hold any marketable assets to secure workers' paid-in contributions. Instead, it holds non-negotiable United States Treasury bonds and U.S. securities backed "by the full faith and credit of the U.S. government". The trust funds have been invested primarily in non-marketable Treasury debt, first, because the Social Security Act prohibits "prefunding" by investment in equities or corporate bonds and, second, because of a general desire to avoid large swings in the Treasuries market that would otherwise result if Social Security invested large sums of payroll tax receipts in marketable government bonds or redeemed these marketable government bonds to pay benefits.
The Office of Management and Budget has described the distinction as follows:
These [Trust Fund] balances are available to finance future benefit payments and other Trust Fund expenditures – but only in a bookkeeping sense.... They do not consist of real economic assets that can be drawn down in the future to fund benefits. Instead, they are claims on the Treasury that, when redeemed, will have to be financed by raising taxes, borrowing from the public, or reducing benefits or other expenditures. The existence of large Trust Fund balances, therefore, does not, by itself, have any impact on the Government’s ability to pay benefits. (from FY 2000 Budget, Analytical Perspectives, p. 337)
Other public officials have argued that the trust funds do have financial and/or moral value, similar the value of any other Treasury bill, note or bond. This confidence stems largely from the "full faith and credit" guarantee. "If one believes that the trust fund assets are worthless," argued former Representative Bill Archer, then similar reasoning implies that “Americans who have bought EE savings bonds should go home and burn them because they’re worthless because the money has already been spent.” At a Senate hearing in July 2001, Federal Reserve Chairman Alan Greenspan was asked whether the trust fund investments are “real” or merely an accounting device. He responded, “The crucial question: Are they ultimate claims on real resources? And the answer is yes.”
Like other U.S. government debt obligations, the government bonds held by the trust funds are guaranteed by the "full faith and credit" of the U.S. government. To escape paying either principal or interest on the "special" bonds held by the trust funds, the government would have to default on these obligations. This cannot be done by executive order or by the Social Security Administration. The Congress would have to pass legislation to repudiate these particular government bonds. This action by Congress could involve some political risk and, because it involves the financial security of older Americans, seems unlikely.
An alternative to repudiating these bonds would be for Congress to simply cap Social Security spending at a level below that which would require the bonds to be redeemed. Again, this would be politically risky, but would not require a "default" on the bonds.
From the point of view of the Social Security trust funds, the holdings of "special" government bonds are an investment that returned 5.5% to the trust funds in 2005. The trust funds cannot resell these "special" government bonds on the secondary bond market, although the interest rate is determined based on market interest rates. Instead, the "specials" can be sold back to the government at face value, which is an advantage when interest rates are rising.
The week after his State of the Union speech, Bush downplayed the importance of the Trust Fund:
Some in our country think that Social Security is a trust fund – in other words, there's a pile of money being accumulated. That's just simply not true. The money – payroll taxes going into the Social Security are spent. They're spent on benefits and they're spent on government programs. There is no trust.
These comments were criticized as "lay[ing] the groundwork for defaulting on almost two trillion dollars' worth of US Treasury bonds".
However, even right-leaning politicians have been inconsistent with the language they use when referencing Social Security. For example, Bush has referred to the system going "broke" in 2042. That date arises from the anticipated depletion of the Trust Fund, so Bush's language "seem[s] to suggest that there's something there that goes away in 2042." Specifically, in 2042 and for many decades thereafter, the Social Security system can continue to pay benefits, but benefit payments will be constrained by the revenue base from the 12.4% FICA (Social Security payroll) tax on wages. According to the Social Security trustees, continuing payroll tax revenues at the rate of 12.4% will enable Social Security to pay about 74% of promised benefits during the 2040s, with this ratio falling to about 70% by the end of the forecast period in 2080.
Under Barack Obama
In 2011 and 2012, the federal government temporarily extended the reduction in the employees' share of payroll taxes from 6.2% to 4.2% of compensation. The resulting shortfall was appropriated from the general Government funds. This increased public debt, but did not advance the year of depletion of the Trust Fund.
An economic perspective
The trust fund represents a legal obligation of the federal government to program beneficiaries. The government has borrowed nearly $2.7 trillion as of 2011 from the trust fund and used the money for other purposes. Under current law, when the program goes into an annual cash deficit, the government has to seek alternate funding beyond the payroll taxes dedicated to the program to cover the shortfall. This reduces the trust fund balance to the extent this occurs. The program deficits are expected to exhaust the fund by 2033. Thereafter, since Social Security is only authorized to pay beneficiaries what it collects in payroll taxes dedicated to the program, program payouts will fall by an estimated 25%.
The trust fund is expected to peak in 2021 at approximately $3.0 trillion. This means that from 2022 through 2033, the government will have to find approximately $3 trillion in other funding to pay beneficiaries beyond program revenues. If the parts of the budget outside of Social Security are in deficit, which the Congressional Budget Office and multiple budget expert panels assume for the foreseeable future, there are several implications:
- Additional debt must be issued to investors to obtain the funding necessary to pay this obligation. This will increase "debt held by the public" while simultaneously reducing the "intragovernmental debt" represented by the trust fund.
- Investors may be unwilling to fund this shortfall unless considerably higher interest rates are offered, if at all.
- Other parts of the budget may be modified, with higher taxes and lower expenditures in other areas to fund Social Security.
- Debate regarding whether the proper debt to GDP ratio for evaluating U.S. credit risk is the "debt held by the public" or "total debt" (i.e., debt held by the public plus intragovernmental debt) will be rendered moot, as the amounts will converge substantially.
On the other hand, if other parts of the budget are in surplus and program recipients can be paid from the general fund, then no additional debt need be issued. However, this scenario is highly unlikely.
Some commentators believe that whether the trust fund is a fact or fiction comes down to whether the trust fund contributes to national savings or not. If $1 added to the fund increases national savings, or replaces borrowing from other lenders, by $1, the trust fund is real. If $1 added to the fund does not replace other borrowing or otherwise increase national savings, the trust fund is not "real." Some economic research argues that the trust funds have led to only a small to modest increase in national savings and that the bulk of the trust fund has been "spent." Others suggest a more significant savings effect.
According to some,[who?] the "value" of the Social Security Trust Fund hinges on the federal government's ability to pay back the money that it has borrowed from Social Security. This issue was highlighted during the debt limit crises of 1985, 1995–96 and 2011. Ability to repay is a key driver of the secondary market for third world debt. During debt limit crises of 1985, 1995–96 and 2011, Social Security faced a potential inability to redeem the trust fund assets. This had nothing to do with the perceived value, legal or otherwise, of the trust funds' assets, instead the problem revolved around Treasury's lack of cash in the general fund. Treasury's lack of cash, and its inability to borrow above the debt ceiling, put into question Treasury's ability to redeem the trust fund assets with the cash Social Security needed to pay benefits. The same redemption problem could also potentially have affected investors trying to redeem Treasury's marketable debt for cash, or persons trying to redeem non-marketable savings bonds for cash.
It has, nonetheless, been argued that the economic question is not whether the U.S. bonds held by Social Security represent legal obligations that will be fulfilled but whether the Trust Fund represents savings that help preclude a need to raise taxes in the future even if current taxes collected cannot support the benefits paid. This may not settle the economic question, however, since it has been contended that if the government would have paid as much or more to borrow from other sources were it not for the Fund, lower government spending was not enabled and there was accordingly no economic contribution to government savings. Complicating an analysis is the point of view adopted (if the fund lends to the rest of government at a below-market rate of interest, it represents a loss to future Social Security beneficiaries under a narrow view, but possibly a gain under a larger view since the government gains from the low cost funding and the fiscal health of the government stands behind the ultimate solvency of Social Security). Comparative borrowing assessments may also affected by crowding out effects.
Was the money added to the fund in 1980, for example, saved so that it could be spent on a retiring baby boomer in 2020 without a tax increase? If the only way for the federal government to repay the bonds held by Social Security is by raising taxes in 2020, this suggests that the excess money collected in 1980 was spent on other government activities, not saved by Social Security. However, if bonds are repaid by other borrowing, then the fund could be viewed as just one of many potential lenders to the federal government. Using this point of view, having to replace the Trust as a lender because it is recalling its loan is not evidence that the money was simply spent, but rather that lenders have shifted. If there are tax increases, those who believe the trust fund is real might also note that tax increases could have been even higher without the trust fund.
The following two scenarios help illustrate the concept. Depending on which scenario is right, Social Security is either an accounting fiction or represents real economic savings.
Scenario 1 (Trust Fund is an accounting fiction):
- 1978: $1 payroll tax collected in 1984
- 1978 $1 lent by Social Security to the federal government
- 1978: Federal government increases spending on government programs by $1
- 2020: Federal government raises taxes by $1 plus interest to repay the loan to Social Security
- 2020: $1 plus interest transferred from federal government to Social Security.
Scenario 2 (Trust Fund represents real economic savings):
- 1978: $1 payroll tax collected in 1984
- 1978: $1 lent by Social Security to the federal government
- 1978: Federal government borrows $1 less from other sources and increases spending on government programs by $0
- 2020: Federal government raises taxes by $0, but may borrow from other sources, to repay the loan to Social Security. Any tax increases that occur in 2020 would have happened anyway without Social Security.
- 2020: $1 plus interest transferred from federal government to Social Security.
It is instructive to note that the $2.5 trillion Social Security Trust Fund has value, not as a tangible economic asset, but because it is a claim on behalf of beneficiaries on the goods and services produced by the working population. This claim will be enforced by the United States Government although the precise monetary mechanism of enforcement is yet to be determined. In order to repay the Trust Fund, the United States government has two options, which may all be pursued to varying degrees.
(1) The government may issue debt by selling treasuries. Thus, $1 in debt to the Social Security Trust fund is replaced with $1 in debt to a different lender. This scenario would increase the tax burden on future generations if the interest rate is higher on the new debt. If the new debt is more expensive and government revenues do not increase sufficiently either through taxes or economic growth, then the government would be forced to cut spending on other programs (such as Defense, Education, Research) or else default on all or part of the debt.
(2) The government may monetize trust fund obligations by transferring the treasuries held by the Trust Fund onto the Federal Reserve balance sheet. In such a transaction, the bonds would become "assets" on the Fed's balance sheet, and the Fed would create money "out of thin air" to purchase the bonds from the government. Under such a scenario, the bonds are converted into cash, which would then be used by the government to cover social security payments. This scenario would likely lead to increased inflation, as it would inflate the money supply without directly increasing the amount of goods and services produced by the economy as a whole.
While there are many options for financing social security in the short- and long-term, there is no existing government program which can instantly change the demographic aspects that affect the sustainability of social security. The program's sustainability depends upon the payout rates and Social Security tax rates, the number of workers supporting each retiree, the rate of productivity growth among the remaining workers and the mechanics of how the excess contributions to the Trust Fund are handled (e.g. a "lock box" and for what sort of asset). In order to support the same living standard as before, as the ratio of retirees to workers temporarily increases due to the retirement of the Baby Boomers, the productivity among the working population must increase and/or Social Security Trust fund savings must be used. Productivity has consistently increased, but it is unclear if the rate of increase will be adequate going forward. This productivity growth, and/or consumption of savings, is required because there are fewer workers available to produce the same amount of goods and services. If productivity does not rise fast enough to offset the loss of productive workers, and if accumulated savings in the trust fund are not adequate to fill this gap, then per-capita benefits would decline.
The most difficult hurdle for claiming that the Trust Fund is not a fiction is the fact that redeeming Trust Fund bonds will be indistinguishable from how the federal government finds any other new revenues: raises taxes, borrows more, or uses surpluses from other programs.
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