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The Social Security

Social Security is headed for bankruptcy!  Benefits for future generations of retirees will have to be cut unless something is done soon!  This alarmist view is offered by pundits as well as politicians who should know better.  It is a mixture of myths and half-truths. 

How the Trust Fund Works

Payroll taxes not needed for Social Security benefit payments are used to buy non-negotiable Treasury bonds which earn interest at a market rate.  The bonds are held in the Social Security Trust Fund.  The proceeds from the sale of the bonds are credited to the Treasury general fund and are thus available to spend on other government programs.  

The Trust Fund has no bank account of its own.  All payments to SS beneficiaries are made out of the Treasury general fund, which is held in commercial bank accounts.  The Treasury continually replenishes the general fund with the proceeds from taxes and the sale of securities to the public when tax revenues fall short.  The Treasury does not seek to accumulate balances in its general fund.  It holds only what it needs to cover near term outlays.

As long as SS tax revenues exceed payouts, the Trust Fund balance will increase.  When the revenues are no longer sufficient to cover benefit payments, the Trust Fund balance will be debited by the amount of the shortfall. while the Treasury continues to pay the beneficiaries out of the general fund. 

What Happens When the Trust Fund is Depleted?

Will SS benefits be reduced when the Trust Fund is depleted?  No, because the benefits are established by law which sets the rules for how much individual retirees are paid.  Those rules are independent of the Trust Fund balance.  Unless Congress changes the rules, the Treasury will continue to pay retiree benefits according to existing law.  

Then what is the significance of the Trust Fund?  In effect, nothing.  It is an essentially meaningless exercise.  The balance simply reflects the excess of total SS tax revenues over total benefit payouts.  The interest paid on the bonds merely extends the period before the Trust Fund is depleted.  If the Trust Fund were abolished, it would have no effect on SS benefits.

The public should recognize that the Treasury will have to borrow what it needs to pay SS benefits when SS tax revenues are insufficient.  There will be a bulge in the outstanding debt as baby boomers draw their maximum benefits.  Other things equal, the peak level of the debt/GDP ratio during that period could be reduced only by increasing taxes from any source, reducing SS benefits, or increasing the growth rate of the GDP.

Proposed Fixes for the Social Security 

In the rush to "fix" Social Security, many proposals have been offered.  One is to invest some of the trust assets in the stock market based on the belief that the assets would earn a higher average return.  Presumably that would reduce the projected funding gap when the baby boomers start drawing benefits.

Investing the trust fund in the stock market would increase the budget deficit since the funds would no longer be available to the Treasury for current expenditures.  Other things equal, the shortage would have to be covered by the net sale of Treasury bonds to the public.  In effect, the public would simply be swapping some of its equity holdings for new T-bonds.

The Potential Future Problem 

While Social Security is not in any real trouble, social security (small s) could become a problem some day.  The problem has nothing to do with trust fund accounting or payroll taxes.  Rather, it relates to the size of the working population producing goods and services relative to those who are not in the labor force.  Due to the baby boomer effect and improved longevity, the ratio of retirees to workers will be increasing.  Whether that will reduce average living standards depends on the rate of increase of worker productivity.  

Ultimately how well we live as a nation depends upon the productivity of the work force and the number of dependents that force supports.  Retirees cannot eat stocks or bonds in trust funds.  What people need to live on must be produced by their contemporaries.  In a real sense, retirement benefits for the economy as a whole are supplied on a pay as you go basis.  The solution then for potential future shortages is to provide long term capital investment in infrastructure and R&D to enhance productivity, not to simply build up artificial trust fund balances.  

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