‘Trust Fund Surplus’ Isn’t, but Notion Should Make Us Consider Some Alternatives

Over the next 40 years, payroll taxes and interest earnings paid into the Social Security system will exceed the amount paid out to recipients by a total of about $12 trillion. There has been a great deal of confusion about the economic effects of the “trust-fund surplus.” Here are some short, straightforward answers to questions I am most frequently asked about Social Security and the “surplus.”

Does the $12 trillion really go into a trust fund that will pay Social Security benefits from here on out?

There is no Social Security trust fund in the sense that individual contributions are held in trust to pay individual benefits. The promise of generous Social Security benefits is conditional on the willingness of the working population to tax itself to provide for the elderly population. That willingness is the real “trust fund.” In 1950 there were 16.5 payroll-taxpaying workers for every recipient. Benefits were modest. By 1980 the ratio of workers to recipients had dropped to 3.2 and benefits had increased much faster than wages, although by 1983 the per-capita income of the over-65 population had come to exceed that of the working-age population. The 1983 Social Security “crisis” loomed and payroll taxes were raised sharply. In 40 years, the ratio will drop to just two workers per retiree. Thus, the $12-trillion surplus (about $2.7 trillion in today’s dollars) is necessary to avoid a doubling of payroll taxes about 25 years from now.

Actually, there would be no $12-trillion surplus without an accounting trick employed by the federal government. In years when the payroll taxes earmarked to pay Social Security benefits exceed the benefits paid, the Social Security system acquires special government bonds. The system is credited with the interest on the bonds. The interest on the bonds, which will accumulate to $12 trillion between today and 2030, will be paid by the U.S. Treasury out of general revenues collected from American taxpayers. Thus, the $12-trillion “surplus” just measures another increase in taxes earmarked over the next 42 years to pay Social Security benefits.

Should the trust fund surplus be counted as deficit reduction?

Currently, the surplus is included when calculating the federal budget deficit, and therefore the deficit looks smaller. And this makes two things happen. For the present, the borrowing requirements of the federal government are reduced. In the future, when benefits come due, either taxes will have to be raised again, the government will have to borrow more money or benefits will have to be cut. In short, we will face a Social Security crisis all over again.

Doesn’t the big trust fund surplus mean that the national savings rate will be increased?

Aside from the basic question of whether the federal government should try to increase the national savings rate, there exists a real controversy among economists about whether it can. If individuals see a significant reduction in their take-home pay as a result of higher payroll taxes that they are told will be earmarked to finance retirement benefits, why should they reduce current consumption by the amount of the increase in the payroll tax? Studies have shown that Social Security contributions are viewed by many Americans as a substitute for savings.

Is the Social Security system fair?

By most standards, it would be judged unfair. The payroll tax is levied at about 15% on the first $45,000 of income, half of which is paid by employee and half by employer. For someone earning $45,000 or less, the payroll tax is 15% of income. For someone earning $90,000, the payroll tax is only 7.5% of income.

The Social Security system is also unfair across generations. Current beneficiaries receive about $3 for every $1 contributed. By the time the baby boomers--those who now are between 24 and 45--retire, the ratio will be down to about $1 per $1 contributed. For the children of these baby boomers, there currently are no dollars available to pay retirement benefits.

Maintaining a healthy growth rate of Social Security benefits exempted from any cuts in an era of budget stringency has added to the unfairness of the Social Security system. Federal outlays unprotected from Gramm-Rudman budget cuts include those on education and programs for prenatal and early childhood health care. We count on younger workers to increase productivity growth. So the transfer from investment in young future workers to consumption by former workers will retard long-term economic growth.

How does the payroll tax affect businesses?

The payroll tax is a tax on the act of employing labor to produce goods and services. Businesses respond to additional labor costs by economizing on the use of labor in three ways. First, businesses will substitute capital wherever possible for labor. Second, businesses will import assembled components of products like automobiles and computers as a way of importing cheaper foreign labor. Third, more production facilities will be moved offshore to areas like Mexico, Korea, Taiwan and Hong Kong, where labor costs are low.

What are the options for policy changes on Social Security?

A safety net for elderly Americans, the original intent of Social Security, could be provided by a negative income tax. Under that plan, any American over age 65 with an income that was below the poverty line would receive a check from the federal government raising his or her income to the poverty level or slightly above. Although the program would be financed out of general revenues, such a negative income-tax approach would cost less than one-fifth what the current program costs, and would eliminate the payroll tax that discourages employment of American workers and still achieve the original goal of social security.

The best thing about the attention grabbing $12-trillion Social Security “trust-fund surplus” is that it has encouraged some fresh thinking about attractive alternatives to achieve income security for elderly Americans. While the consequences of today’s decisions lie far ahead, one fact is certainly true: We can make Americans under age 45 a great deal better off while not harming either current retirees or those within 10 years of retirement by returning Social Security to a safety-net system and allowing Americans to do more of their own retirement planning.