Understanding Social Security|
Social Security is a social insurance program designed first of all to reduce poverty among the elderly and then expanded to include support for the dependents of retirees, for the spouses and children of deceased workers, and for those who qualify as disabled. Begun in 1935, it has been repeatedly expanded, has repeatedly increased the benefits for those served, and has repeatedly raised the payroll tax by which the program is funded.
Social Security has largely reached its initial goal of reducing poverty among the elderly. The elderly poverty rate has dropped from 35 percent in the 1950s to about 10 percent today. Currently about 47 million people receive some benefit from Social Security. 40 million retirees and their dependents receive an average payment of $10,000 a year. Social Security provides more than half of the income for about two-thirds of elderly households.
How It Works
Social Security is paid for by a 12.4 percent tax on wages up to a maximum of $87,900 in 2004. The maximum increases annually in response to inflation. Payment of the retirement benefit is according to a formula that gives some advantage to those with lowest incomes but is also weighted to pay higher benefits to those who paid in higher payroll taxes. While the current political focus is on issues of retirement, it should be remembered that the benefits paid to the disabled, to the survivors of deceased workers, and to the spouses of retired workers are a critical part of the anti-poverty effort of the United States.
The basic operation of Social Security is extremely cost-effective because the income is gathered inexpensively through the annual income tax structure, the investment process is very inexpensive because the trust funds are fully invested in the equivalent of treasury bonds, and the payout system is inexpensive because all beneficiaries are paid according to nationwide formulas. The main operational challenges are running the Social Security centers that register participants and dealing with issues in record keeping.
How The Money Is Handled
The tax revenue comes into the U.S. Treasury and is distributed to the two Social Security Trust Funds: the Old Age and Survivors Insurance Trust Fund and the Disability Insurance Trust Fund, jointly called the OASDI Trust Funds. $533.5 billion dollars was collected in tax revenue in 2003. The trust funds also increased by $84.9 billion from interest payments by the U.S. Treasury for the Social Security investment in the equivalent of Treasury Bonds, and by $13.4 billion from the income tax paid on Social Security benefits. Total income was $631.9 while benefits cost $474.5 billion, and the administrative expense was $4.6 billion. The net income of $152.8 billion was invested in additional equivalents of U.S. Treasury bonds. At the end of 2004 the OASDI Trust Funds were worth more than $1.6 trillion dollars.
If the time comes, as expected, when benefits and administration cost more tax revenues, then the trust funds will be reduced to pay the difference. Since the trust funds are expected to grow to a sufficient amount, over $6 trillion in the 2020s, to pay for the influx of "Baby Boomers" born in the late 1940s and 1950s into the retirement program, the long range question is about the relationship of the longevity of retirees to the level of the U.S. economy that generates the payroll income upon which the Social Security system is based. There are many factors that affect the economy. One rule of thumb is that if the economy stays as strong as it has been for the last decade, including the downturn since 2000, there would be no long term problem. If the economy turned bad, and stayed bad, then there would eventually be problems.
From 1935 to 1983 the trust funds stayed close to zero. Income was only a little higher than benefits and administrative costs. Since the changes made in 1983 the trust funds have sharply increased so that current generations are partially forward funding their own retirement. Social Security financing is stronger than it has ever been and so it is quite surprising that the scary rhetoric by opponents of Social Security has gathered significant political strength.
Those promoting the idea that Social Security is in economic crisis overlook the unpredicted improvement in the OASDI trust funds since 1983 and focus on the prediction of the Social Security Trustees that the funds will run out of money in the 2040s with reduced payments to today’s younger workers.
First of all, it should be noted that the prediction of the Trustees are made on assumptions about the birth rate and the general economy that are worse than the experience of the last dozen years, and in the case of the economy, worse than the average U.S. economy since 1960.
Furthermore, those promoting fear assume that the federal government would not do anything to correct problems that would show up decades before they became serious. This assumes that future governments would be far more hard-hearted than all the governments from 1935 to the present that have improved, expanded, and strengthened the core Social Security programs.
The several privatization plans promoted as "saving" Social Security are all wolves in sheep’s clothing. They would take money out of the general Social Security accounts and trust funds and turn them into private investment accounts that individuals would own. This approach undercuts the fundamental social insurance concept of Social Security, that makes the benefit formulas come out so nicely because the money goes to those who live long enough to get it and not to the heirs of those who died at a younger age. Social Security is an anti-poverty program for all U.S. elderly and a floor of income for those fortunate enough to have pensions and/or savings. Because of the social insurance design, even with the weighting of benefit formulas to those with lowest incomes, surviving elderly get their money’s worth in benefits for their tax payments into Social Security compared to average pension investments.
The financial problems facing the elderly come from breakdowns in the private sector from pension troubles and a lack of adequate savings, not from any problem with Social Security. Things could be done to strengthen pensions and savings but that can be done in addition to, not by attacking, Social Security.
Written by Pat Conover (January 2005) The numbers in this document are dated but the concepts are still relevant as of February, 2008.