Clash of the Titans

The coming collapse of Social Security pits the baby boom against the New Deal -- and the New Dealers have come out swinging.

Carolyn Lochhead from the March 1997 issue

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If the trustee projections are pessimistic, as Baker claims, it would be a first. Throughout Social Security's history, the trustees' forecasts have repeatedly proven wildly optimistic. Eight times in the past 10 years alone, the trustees have had to move the predicted bankruptcy date forward.

In 1983, Social Security was supposed to have been "fixed" for 75 years by a huge payroll tax increase that boosted workers' FICA tax to 12.4 percent of wages. Right now, workers are paying some $60 billion a year more in Social Security payroll taxes than the government is paying retirees; this reserve is deposited in the Social Security "trust fund," where it is supposedly resting until the money is needed to pay benefits to boomers. This so-called trust fund is at the root of Social Security's problems, because it simply does not exist in any real sense. In fact, the trust fund has never been more than an accounting fiction devised to perpetuate the myth of a funded pension. From day one, Social Security has been a pay-as-you-go system, where current workers finance the benefits of current retirees.

Nobel laureate economist Paul Samuelson once described Social Security as the world's biggest Ponzi scheme (no free market enthusiast, Samuelson meant it approvingly). Like any such scheme, it works wonderfully in the beginning, when there are many more people paying into the system than are drawing out of it. Those who get in early pay little and receive big benefits. But for those who get in late, the returns fall sharply and soon turn into losses.

The baby boomers are definitely latecomers. Their numbers present an unprecedented problem for Social Security, greatly compounded by other programs, such as Medicare, that are in even worse shape. Boomers have paid in big taxes that are funding generous benefits and cost-of-living increases for current retirees. But when boomers retire, the much-smaller generations that follow them will be unable to pay those benefits without a major tax increase. The future tax increase for Social Security is expected to raise the program's take to 17 percent of payroll; adding in Medicare and using more pessimistic projections could take it up to 33 percent as the bulk of the baby boom reaches retirement.

Payroll taxes of that magnitude are probably not politically feasible. By eating up paychecks, they would create major economic distortions and would undermine support for the programs. When Social Security started, it cost a modest 2 percent of payroll and churned out enormous returns for beneficiaries, ensuring its public popularity. But now those ratios are beginning to reverse. A 33 percent payroll tax that funds smaller benefits would hardly be as popular or easy to justify. As it is, Social Security payroll taxes are incredibly regressive, hitting relatively poor workers much harder than relatively wealthy ones. Higher rates would only boost that burden and create even more powerful incentives for low-wage workers to go on the dole.

In fact, the returns to Social Security payroll taxes have already fallen sharply, which helps explain why it has become politically possible to criticize the program. Workers who retired 20 years ago received all that they paid in, plus interest, and much more. Those who retire today get roughly a 2.2 percent return, adjusted for inflation. A 30-year-old worker will actually lose money in absolute terms when he or she retires.

The trust fund myth was deliberately perpetrated at Social Security's inception as a way to deceive middle-class taxpayers into thinking that they were contributing to their own retirement. Franklin D. Roosevelt famously crafted the illusion of a funded pension so that Social Security would not look like welfare, ensuring that "no damn politician" could repeal it. Every politician since, Republican and Democrat, damned or otherwise, has happily gone along with the deception.

The money that goes into the so-called trust fund is being spent as fast as it comes in. The current surplus of Social Security taxes over benefits is merely masking the size of the general government deficit. Instead of a pile of money for future benefits, the trust fund consists of a pile of government bonds, or IOUs. The money left to pay them has already been spent to cover government expenses. And the bonds can be redeemed only by more borrowing, higher taxes, or inflation.

The only way the government could set aside money in a trust fund would be to run annual surpluses. But the government instead has been running chronic deficits for the past three decades. As Sen. Daniel Patrick Moynihan (D-N.Y.) pointed out during the 1990 budget brawl between Democrats and the Bush administration, honesty would dictate that the Social Security tax be reduced to cover only current benefits. All that the 1983 "fix" did was massively raise taxes on workers and allow the government to mask the extent of its deficit spending.

The projected trust fund bankruptcy date--which even Social Security defenders concede is at least a minor problem--is 2029. That is when the trust fund is expected to run out of bonds. Defenders say that this faraway date allows ample time to make provisions, hence there is no immediate crisis warranting radical action.

Yet the 2029 date is hardly more relevant than the trust fund itself. Because the trust fund consists only of debt, the date to watch is 2012. That is when Social Security outlays are expected to start exceeding tax revenue. It is also, not coincidentally, when boomers begin retiring. At that point, current taxes will no longer cover current benefits, and the Social Security deficit will begin to escalate very rapidly.

The claim that the government will not explicitly default on its trust fund bonds is a legalistic point at best. The government will be facing unprecedented liabilities, estimated by the Social Security Administration at a present value of $8 trillion just for Social Security. This debt is the crux of the problem. The government has only three ways to finance it: borrow, raise taxes, or inflate away its value. All have terrible consequences for the public, including Social Security beneficiaries. The Congressional Budget Office recently warned that such unsustainable debt burdens pose the threat of economic catastrophe, including spiraling interest rates, inflation, and the collapse of the stock market and the dollar.

Social Security's defenders do have a valid point when they argue that relatively small adjustments such as pushing back the benefit age and lowering or withholding cost of living allowances in the system now could help. Due to compounding, any reduction in benefits now would save huge amounts of money later. However, such action would also worsen the rate of return the baby boom is getting on its "investment" in Social Security.

Tax increases would be even worse because they would go into the nonexistent trust fund and do nothing to remedy the long-term problem unless the government simultaneously begins running budget surpluses. If it does not, any extra taxes would simply mask current deficit spending, as they have been doing since 1983, while leaving less money for workers to save for their own retirement.

Privatization has caught hold with policy makers because it offers a way out of this box. Under a privatized system, workers would pay the same payroll tax, but the money would go into their own personal accounts, rather than into the so-called trust fund. Just like the payroll tax, the savings would be mandatory, but the money would be in annuities and other private financial assets.