Social Security: A Tale of Two Problems

Those with a vested interest in the current setup of the Social Security system are holding to the strategy of, "Confusion is the best defense."

But our Social Security crisis can be best understood by ignoring all the confusing "fixes" and focusing on the two distinct problems at its core.

The first problem is that the federal government collects more, a lot more, contributions to Social Security than what it needs to pay the current retirees. The excess contributions are spent on other government programs and not really saved to pay for the retirement of the workers who are making the contributions. All the surplus paid into Social Security over the past 20 years has already been spent. Over the past 20 years, $1.7 trillion in surplus Social Security taxes have been used for other programs, and in the next ten years another $2.2 trillion will be similarly spent.

The second problem is that demographics are such that, in the future, the federal government will collect less, a lot less, in contributions than what it will need to pay the retirees of that day.

What about the trust fund? The Social Security "trust fund," currently at $1.7 trillion, contains no hard assets. It represents money the federal government owes to itself. Congress has spent the surplus money and promises to pay it back someday.

This situation is equivalent to you using your retirement savings to buy a car, and then writing an IOU to yourself and filing that in a folder called "Retirement Fund" in a safety deposit box at the bank. The following year you do the same to pay for your vacation. You pay for your kids' college education the same way. Every year you assure your spouse that your joint retirement fund is growing, safe and secure, in a lock-box. If you tear up those pieces of paper, it has no economic impact.

David Walker, head of the Government Accountability Office (GAO) said of the trust fund:

" doesn’t have any economic significance whatsoever. There are no stocks or bonds or real estate in the trust fund. It has nothing of real value to draw down."

When a new federal bond is issued, it is printed on an office printer at the Bureau of the Public Debt in Parkersburg, West Virginia. Someone then carries it across the room and puts it in a fireproof filing cabinet. That filing cabinet is your Social Security trust fund. If you tear up those pieces of paper, nothing changes economically.

The second problem with Social Security is that the system is structured like those infamous pyramid schemes. Workers do not pay for their own retirement; those coming behind will pay for it. But Americans are living longer and having fewer children. In 1937, 42 workers paid 2% in payroll tax to support every retiree. Today three workers pay 12.4% in payroll tax for each retiree. Before long there will be only two workers per retiree.

Social Security has become a poor deal for workers. When the program started the rate of return on a 40-year worker's investment was about eight percent. Today someone that age can expect a dismal one percent. Our children’s rate of return will be negative if the program remains the same. But it can’t stay the same, it can only get worse.

Personal savings accounts are the only solution being discussed that goes to the core of these problems. It proposes to solve the second problem by fixing the first. Private accounts, in essence, move some of the burden of supporting future retirees to current workers (to the future retirees themselves) and go to the core of the problem (change the ratio of workers to retirees).

If personal accounts are such a good idea, why do some people oppose them? The biggest reason is we have gotten used to spending our retirement funds now. If you decide to stop writing IOUs to yourself and start putting real assets into your retirement fund, how are you going to pay for the new car, the vacations, the kids' college?

The status quo means Congress will spend the surplus $2.2 trillion of the next ten years, keep writing those IOUs and reassuring us that our trust fund is safe in that file cabinet in West Virginia. Personal accounts, on the other hand, are the way to make sure our retirement funds are worth more than an empty promise in a lock box.