Why We Should Abandon the Myth of the Social Security Trust Fund

For years, few things have been so sacred to Democrats at the myth of the Social Security trust fund. Working age people pay a regular tax that goes into the trust fund and is invested in U.S. Treasury bonds (the safest investment there is!) and receive their payments back, with interest earned, upon retirement. Democrats would obsessively worry about its health (Reagan is raiding the Social Security Trust fund! ) and urge that it be protected (let’s use the Clinton surpluses to shore up the Social Security trust fund!). Now Rick Perry is leading a whole chorus of Republicans denouncing Social Security as a Ponzi scheme because current retirees are being paid out of current income, and warning that without drastic the system will go broke. The CBO warns that the trust fund will go broke in 2037. And suddenly its defenders are having to explain why Social Security can be simultaneously pay-as-you-go and a trust fund.

And really, we had it coming for obscuring the true nature of Social Security. The myth of the Ponzi scheme is simply a variant on the myth of the trust fund – pointing out how poorly the trust fund model applies. But once you drop the trust fund model, and the claim that it is a Ponzi scheme loses its credibility.

What is really happening is simple. Social Security is a tax-and-transfer system. People of working age are paying taxes to support retirees. When today’s working people retire, a younger generation of works will be taxed to support them. And so on. So long as everyone pays in and everyone expects to live long enough to benefit, there is little resistance to such a system. All advanced industrial countries in the world have such a system in one form or another.

So where does the trust fund come into the picture? Until extremely recently, Social Security ran a surplus, i.e., it took in more than it paid out. And what became of the surplus? It was used to fund other government operations. But the general fund, when it used Social Security funds to run operations, would say that it owed Social Security a certain amount to be paid back in the future. Critics called that raiding the Social Security trust fund. Anti-critics called it investing in U.S. treasury bonds. But raiding the Social Security trust fund and investing it in treasury bonds are exactly the same thing. Either one just means using Social Security tax revenue to fund current operations. The "trust fund" is nothing but an accounting gimmick, a theoretical promise that when Social Security falls into deficit, other taxes will be used to pay the benefits. Talk of the trust fund running out just means that this theoretical promise will expire and the government will no longer be obliged to use non-Social Security taxes to pay Social Security benefits.*

I can understand why supporters would want to encourage the myth of the trust fund. Fearing that people would not be willing to pay a tax during their working lives to support current retirees, and that retirees might have misgivings about asking working people to foot the bills for their own retirements, advocates of Social Security proposed the fiction that really people were paying into a trust fund ad receiving their investments back. Such arguments remove the usual resistance to a tax-and-transfer system, but the play into the hands of people who claim it is a fraud or in danger of failing.

Why? Well, for one thing, since there isn't an actual trust fund, it is very easy to make the case that no such trust fund exists or, if it does, that it is being egregiously mismanaged. Real trust funds start with a lump sum and have bunch of financial experts looking for the best investments. Real retirement accounts and pension funds have to have actual money and investments to cover future payments. Social Security simply takes the incoming revenues, pays current obligations, and then spends the surplus on other government operations. You would, indeed, never be able to get away with running an actual trust fund that way (hence the accusation that it is fraudulent). All of which is irrelevant once you concede that there is no trust fund, but only a simple tax-and-transfer system.

But even more significant is the scary talk of the trust fund running out in 2037 (or whenever). If you treat Social Security as a real trust fund that means (a) that we can keep making payments with no trouble up till then, but then (b) that once the trust fund runs out, Social Security will run out of funding and payments will cease.

The real situation is both more and less alarming. It is more alarming in the sense that the shortfall has begun right now and we are already obligated to start cutting into everything else to pay for the gap in Social Security. Maybe the thought that everything but Social Security having its funding cut to pay for Social Security doesn't bother you, but it definitely bothers me. On the other hand, expiring of the trust fund does not mean that all funding will collapse. It means the theoretical oblitgation to strip everything else to pay for Social Security will cease. Revenues will continue to come in. They will merely fall about 25% short of obligations. Cut Social Security obligations by 25% for everyone born after (say) 1956 and the problem will be solved. Or, if you don't like that approach, there are any number of other alternatives to match revenues to obligations.

But pretending there is a trust fund in the light of all evidence to the contrary does nothing to protect the program. It simply exposes the embarrassing contradictions.**
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*So what would have happened if we had followed Bill Clinton's advice and used his surpluses to "shore up the Social Security trust fund"? Assuming the surpluses would have continued and the economy had not crashed (two dubious assumptions), we would have continued to un surpluses until Social Secuity obligations began exceeding revenues. Then the surpluses would gradually have dwindled. This would mean using non-Social Security taxes to pay for Social Secuity benefits, on an indefinite basis. But so what?
**And I can't resist a link to Paul Krugman, bless his heart, defending the concept of a Social Security trust fund. His logic is most unpersuasive (at least to me). He points out that Ronald Reagan cut income taxes while raising Social Security taxes. This had the practical effect of not actually cutting total taxes, but merely making them more regressive, but it sold well as a plan to protect Social Security. "[I]f you say that there is no link between the payroll tax and future Social Security benefits – which is what denying the reality of the trust fund amounts to – then Greenspan and company pulled a fast one back in the 1980s: they sold a regressive tax switch, raising taxes on workers while cutting them on the wealthy, on false pretenses." To which I can only say, "Well, DUH!" I've known that all along.