The Social Security Trust Funds
Contrary to popular belief, workers paying Social Security payroll taxes today are not contributing to their own Social Security benefits in the future. There is no Social Security account in a worker’s name that contains cash or investments. There is only a bookkeeping record of an individual’s yearly earnings and payroll taxes. Today’s workers are financing Social Security benefits for today’s beneficiaries. This is referred to as a pay-as-you-go system.
Social Security’s trust funds do not contain cash or saleable assets. They represent the amount of Social Security taxes collected in the past beyond the amount needed to pay benefits. The excess funds were converted by law into special-issue Treasury bonds that pay interest at the same rate as other bonds issued for sale to the general public. These bonds cannot be sold and can only be repaid through higher taxes on future workers. The annual surpluses that many thought were being used to build up a reserve for baby boomers have been spent to fund other government programs.
The OASI and DI Trust Funds. Social Security has two trust funds: the Old-Age and Survivors Insurance (OASI) Trust Fund and the Disability Insurance (DI) Trust Fund. These two trust funds are linked and are often referred to as a single trust fund, the Old-Age, Survivors, and Disability Insurance (OASDI) Trust Fund.
Despite the fact that there are two trust funds, most of the estimates of Social Security’s finances use the combined OASDI Trust Fund, which is an important distinction. For instance, according to the 2013 trustees report, OASDI spent $43.7 billion more in benefits than it took in through its payroll tax. This deficit is in addition to a $45 billion gap in 2010 and an expected average annual gap of about $103 billion between 2012 and 2018. These deficits will quickly balloon to alarming proportions. After adjusting for inflation, annual deficits will reach $153.6 billion in 2020 and $331.3 billion in 2030 before the trust fund runs out in 2033. Considered separately, the OASI Trust Fund spent $9.6 billion more than it took in that year with the remainder of the combined deficit resulting from the financially plagued DI Trust Fund. In addition to the two Social Security trust funds, there is a Hospital Insurance (HI) Trust Fund that partially funds Medicare. The HI Trust Fund is managed and invested in the same way as the OASI and DI Trust Funds but is outside the scope of this paper.
The Trustees and Their Annual Report. The same trustees manage the OASI, DI, and HI Trust Funds. Three of the six trustees are Cabinet officials: the Secretary of the Treasury, the Secretary of Labor, and the Secretary of Health and Human Services. The Secretary of the Treasury serves as the managing trustee. In addition, the Commissioner of Social Security is a trustee, and two public trustees are appointed by the President and confirmed by the Senate for four-year terms.
Currently, the two public trustees are Charles Blahous and Robert Reischauer. Every year, the trustees are required to issue a report that details both the financial activities in the trust funds and the long-term and short-term outlooks for Social Security’s programs. Available from the Social Security Administration both online and as published copies, these annual reports contain a wealth of numbers, statistics, and predictions. In addition to the numbers from the most recent year, the reports predict Social Security’s financial status for both the next 10 years and the next 75 years. The trustees have also developed a perpetual measure that extends well beyond the 75-year measure, because a 75-year measure alone could leave the system on a path that would result in huge new deficits just one year beyond that 75-year horizon.
The report includes predictions based on the most likely economic scenario as well as both more optimistic and more pessimistic outcomes. Some analysts make the mistake of assuming that the three outcomes are equally likely to happen. A deeper analysis shows that there is only an extremely small chance (about 5 percent) that either the optimistic or the pessimistic outcome will happen, while there is a very high chance (about 95 percent) that the most likely outcome will occur. For that reason, the most recent trustees reports include a stochastic analysis that shows the probabilities of each outcome’s occurring.
Often, press reports focus on the simplest statistics, such as the year in which the trust funds are predicted to run out of assets. A more careful examination reveals other important information, such as the amount that the Social Security program owes in promised benefits beyond what it can pay with payroll taxes. The report also indicates the year in which the programs must begin to spend more than they receive in payroll taxes. These are actually more important to determining the programs’ ability to meet the needs of those who depend on them.
The OASI Trust Fund. The Old-Age and Survivors Insurance Trust Fund—by far the larger of the two Social Security trust funds—pays retirement and survivors benefits. In 2012, the OASI Trust Fund had a total income of $731.1 billion. Of that total, $503.9 billion (68.9 percent) came from payroll taxes; $26.7 billion (3.7 percent) came from income taxes paid on higher-income retirees’ Social Security benefits; and $102.8 billion (14.0 percent) came from interest paid on special-issue Treasury bonds in the trust fund. The interest payment comes from general revenue tax dollars and is actually paid only to the extent that the money is needed to cover cash-flow deficits. The remainder is merely credited to the trust fund in a paper transaction.
During 2012, the trust fund paid out $637.9 billion in benefits (101.5 percent of tax receipts) and $3.4 billion (0.54 percent) for administrative expenses. Excluding the interest, the retirement and survivors program took in $628.3 billion but paid out $637.9 billion in benefits and other expenses, leaving a cash-flow deficit of $9.6 billion for 2012. The trust fund’s assets grew from $2.524 trillion at the beginning of the year to $2.61 trillion at the end of 2012.
The Disability Insurance Trust Fund. The DI Trust Fund—the smaller of the two Social Security trust funds—pays disability benefits. In 2012, the DI Trust Fund had a total intake of $109.1 billion. Of that total, $85.6 billion (78.5 percent) came from payroll taxes; $600 million (0.55 percent) came from income taxes paid on higher-income workers’ disability benefits; and $6.4 billion (5.87 percent) came from interest paid on special-issue Treasury bonds in the trust fund.
During 2012, the trust fund paid out $136.9 billion (159.9 percent of tax receipts) in benefits and $2.9 billion (3.39 percent) for administrative expenses. As a result, the trust fund’s assets shrank from $153.9 billion at the beginning of the year to $122.7 billion at the end of 2012.
The disability program’s separate trust fund and tax structure, combined with the completely different eligibility criteria for receiving disability benefits, distinguish it from the retirement and survivors program. The disability program is a true insurance program, while the retirement and survivors program is much closer to a universal entitlement.
How the Social Security Trust Funds Differ from Real Trust Funds. Private-sector trust funds invest in real assets, ranging from stocks and bonds to mortgages and other financial instruments. Assets are held only for a specific purpose, and the fund managers are liable if the money is mismanaged. Funds are managed in order to maximize earnings within a pre-agreed risk level. Investments are chosen to provide cash at set intervals so that the trust fund can pay its obligations.
The Social Security trust funds are very different. As explained by the Office of Management and Budget (OMB):
The Federal budget meaning of the term “trust” differs significantly from the private sector usage…. [T]he Federal Government owns the assets and earnings of most Federal trust funds, and it can unilaterally raise or lower future trust fund collections and payments, or change the purpose for which the collections are used…. [T]he Social Security trust funds are “invested” only in a special type of Treasury bond that can only be issued to and redeemed by the Social Security Administration. These bonds cannot be sold to the public to raise money. They are only a measure of what the government owes itself.
As the Congressional Research Service noted: “When the government issues a bond to one of its own accounts, it hasn’t purchased anything or established a claim against another entity or person. It is simply creating a form of IOU from one of its accounts to another.”
As a result:
These [trust fund] balances are available to finance future benefit payments and other trust fund expenditures—but only in a bookkeeping sense. These funds are not set up to be pension funds, like the funds of private pension plans. They do not consist of real economic assets that can be drawn down in the future to fund benefits. Instead, they are claims on the Treasury, that, when redeemed, will have to be financed by raising taxes, borrowing from the public, or reducing benefits or other expenditures. The existence of large trust fund balances, therefore, does not, by itself, make it easier for the government to pay benefits.
In short, the Social Security trust funds are really an accounting mechanism. They show how much the government has borrowed from Social Security but do not provide any way to finance future benefits.
How Money Goes to and from the Trust Fund. An employer pays taxes to the Treasury by periodically sending a check (or making an electronic transfer) that includes both income taxes and payroll taxes. The amount is sent without distinguishing between payroll and income taxes. There is also no indication of which individual employee’s taxes are being paid or how much that employee earned in income.
On a regular basis, the Treasury estimates how much of its aggregate tax collections are due to Social Security taxes and credits the trust funds with that amount. No money actually changes hands: This is strictly an accounting transaction. These estimates are corrected after income tax returns show how much in payroll taxes was actually paid in a specific year. In addition, the Treasury credits the trust funds with interest paid on its balances and with the amount of income taxes that higher-income workers pay on their Social Security benefits.
The Social Security Administration directs the Treasury to pay monthly benefits, and that amount is subtracted from the total in the trust funds. Any remainder is converted into special-issue Treasury bonds, which are really nothing more than intra-governmental IOUs.
After the trust fund has been credited with the IOUs, Social Security’s extra tax revenue is then spent by the Treasury just as any other taxes are spent. If the federal budget is running a surplus, that amount could be used to repay federal publicly held debt. Otherwise, it is spent on any other type of federal program, ranging from aircraft carriers to education research.
Special Securities Issued to the Trust Funds. The Social Security trust funds consist solely of special-issue Treasury bonds. These bonds are special in that they can only be issued to and redeemed by the Social Security trust funds. They cannot be sold in the open market.
The Social Security trust fund bonds pay the same interest rate as regular Treasury bonds issued on the same day with the same maturity date. When the bonds mature, they are rolled over into new bonds that include both the original issue amount and any interest due. The new bonds also pay the same interest rate as comparable Treasury bonds.
Because these are special-issue bonds that are payable only to the Social Security Administration, the Social Security Administration cannot sell them to a third party to raise money to pay benefits. They can only be repaid with general revenue tax dollars that would otherwise go to pay for other government programs. This reinforces the fact that these bonds are really nothing more than IOUs from one branch of government to another. They are not a real financial asset.
Until relatively recently, these bonds existed only as entries in a record book. Now, when a new bond is issued, it is printed on a laser printer located at the Bureau of the Public Debt in Parkersburg, West Virginia. The bond is then carried across the room and put in a fireproof filing cabinet. That filing cabinet is the Social Security trust fund.
How Trust Fund IOUs Would Be Repaid. In 2010, Social Security began to pay more in benefits than it received from payroll taxes. At that point, it began to spend a portion of the interest that was credited to the special-issue bonds in its trust funds. According to the most recent trustees report, this situation will continue until 2020, when Social Security will need a larger amount of additional income than it will receive from interest payments. Starting in 2020, Social Security will redeem about $2.7 trillion (in 2012 dollars) in special-issue bonds, cashing the first special-issue bond in 2020 and the last bond in 2033.
According to the OMB, there are only four ways that Congress can repay these bonds: (1) raise other taxes; (2) authorize the Treasury to borrow the needed funds from the public; (3) reduce spending on other federal programs and use the savings to redeem Social Security’s bonds; or (4) simply reduce Social Security benefits. None of these options is easy or attractive.