On March 27th of this year, the current laws that allow the federal government to operate will expire. Unless Congress approves spending and taxing policies to take effect beyond that date, the government will shut down.
One of the major sticking points in ongoing negotiations between House Republicans and the White House is so-called entitlement programs. The Tea Party-dominated Republican Party’s official position is that “Spending is the problem,” and that Medicare, Medicaid, and Social Security are growing monsters whose rising budgets must be severely cut. The White House and Congressional Democrats have tried (successfully) to find ways to cut health care costs, only to be attacked by Republicans, in the 2012 elections, for “taking money away” from Medicare.
As I argued have argued many times (including in a column here on Verdict last June), Social Security is not in crisis, and it is not facing an unsustainable future. We should celebrate that fact, but a large number of Republican politicians have committed themselves to the idea that Social Security must be cut or even eliminated. To bolster that false contention, they use a series of misleading arguments and half-truths, which are mostly designed to scare younger people into believing that Social Security is a “scam” that will be bankrupt before most current workers are even able to collect their promised benefits.
In this column, I will explain the basic financial workings of the Social Security program. This will make it clear why the aging of the Baby Boom generation will not inexorably harm younger citizens. It will also show why Democrats should not give ground on Social Security, as President Obama has often tried to do, but should instead leave Social Security alone—for the good of both the young and the old.
Social Security and Bank Accounts: Is the Money That Is Taken From Our Paychecks Being “Saved” for Us?
Many people think that Social Security maintains a series of deposit accounts, similar to savings accounts in a bank or credit union, from which retirees “withdraw” their money. When they find out that that is not how it works, many people become enraged, thinking that the money, since it is not being kept in deposit accounts, is being wrongly diverted by politicians to pay for something illegitimate. The reality, however, is that, although Social Security does not put deposits into a vault, to be withdrawn later, that is not how banks work, either.
When a person deposits money into a bank account, only a tiny fraction of that money is kept in the bank’s vault. For that matter, almost none of the deposit is held even in an electronic form of cash. Instead, the bank will (in order to earn profits, which allow it to pay interest to depositors) loan out the money to businesses and families, who will then use it to build factories, buy houses, and so on.
Some readers will surely remember the scene in the classic holiday movie, “It’s a Wonderful Life,” in which Jimmy Stewart’s character, George Bailey, who is a manager of a small bank, faces a crowd of angry depositors who want to know “where our money went.” Stewart explains that their money is all over town, because he loaned it to people who wanted to buy houses. When people pay back their mortgages, the bank has the money to give to other people who want to withdraw money from their accounts.
The problem that Bailey faced was a classic bank run, where a panic caused everyone to try to withdraw their money at once, only to discover that the bank could not pay them all at once. But when there is no panic, oddly enough, there is no reason to panic. As long as the money flowing in and flowing out are in balance, then the relatively paltry amount of cash in the vault is more than enough to keep the system running smoothly.
When Social Security was founded, President Franklin Delano Roosevelt decided to describe the system as if it were a series of private accounts. In some ways, that was not quite right. Rather than collecting deposits and crediting them to a bank-like account that earns interest on every dollar deposited, Social Security collects deposits and uses a formula to determine the benefits to which a person will later be entitled. Because that formula is designed to be economically progressive (that is, it is more beneficial to lower-income workers than it is to upper-income workers), there is no set interest rate applied to every account.
Even so, Social Security really does work like a bank, in that it accepts funds and later pays people according to legal rules that it must follow. Because bank accounts themselves are not what many people think they are, it is true but meaningless to say that Social Security is not what many people think it is. Both banks and Social Security are legal institutions that take money in and send money out, holding little or nothing in-house on a daily basis.
There is, therefore, nothing sinister about the fact that current Social Security taxes are used to pay benefits for current retirees, rather than being “saved” for current workers. Even if we saved the money in a bank, the bank would use the money to make loans that people would immediately spend. Asking “where our money is” makes no sense, in either case.
Moreover, Social Security and banks each carry risks—risks that things will not work as planned. Just as George Bailey’s bank was not able to pay depositors when they expected to be able to withdraw their funds, it is possible that Social Security could someday not be able to pay what people currently expect it to. Possible, but definitely not inevitable.
What makes Social Security risky, today, is that too many politicians are telling us that it is risky. A political panic threatens to create a run on Social Security, not because the Social Security system is fundamentally unsound, but only because panics can be self-fulfilling. President George W. Bush, in 2005, staged a famous photo-op at a Social Security administrative office in West Virginia, standing next to a file cabinet that, he said, contained nothing but a bunch of pieces of paper, mere I.O.U.’s, rather than real money. He was, fortunately, unable to create enough panic to stampede people into abandoning the system, because enough people understood that the system is fundamentally sound.
The good news is that our financial system’s legal underpinnings were changed in a way that has made bank runs a thing of the past (because the federal government legally guarantees deposits, allowing depositors to remain calm about repayment). The better news is that we do not even need to change the law governing Social Security. There is no basis for panic, notwithstanding the high volume of political rhetoric.
Confronting Myths About Social Security and the Aging Population
Many misinformed pundits and politicians claim that Social Security is financially unsustainable. At least one former Republican presidential candidate even refers to Social Security as a “Ponzi scheme,” absurdly suggesting that there is no way for the system to balance revenues and benefits. This is dangerous and wrong.
Concerns about whether Social Security deposits are sitting in a vault are, as I described above, simply based on a naive misunderstanding about how basic finance works. The more sophisticated question is whether Social Security’s long-term commitments can be matched by its long-term revenues. People’s understanding of even that question, however, is often based on similarly naive misconceptions about demographics and economics.
Perhaps the most common misconception that I hear is that there are now too many old people compared to the number of young workers. And it is true that the ratio of workers to retirees has shrunken over the decades, as the working-age population has been reduced by the decline in birth rates in the decades after the Baby Boom ended. If we go from, say, four workers per retiree in one time period, to two workers per retiree in a later time period, it might seem that the later workers will have to pay twice as much in taxes to support the people who are retired at that point, or else those retirees will have to live on only one-half of the benefits that current retirees receive. (Some combination of benefit cuts and tax increases, of course, is also possible.) Doing nothing, then, we are led to believe, would bankrupt the system.
What this logic ignores is that workers’ productivity has risen over time. If each worker who is employed in the later time period is able to produce twice as many goods and services as her earlier counterpart did, then neither the workers nor the retirees in the later period need to reduce their living standards.
The Social Security system also maintains trust funds. These funds, like bank accounts, represent the system’s net savings. That is, a 1983 law mandated that the system collect more in revenues than it paid out in benefits, for several decades, and then mandated that the system pay out more in benefits than in revenues, for several subsequent decades. During the period when benefits exceed revenues, the system will be repaid money that it loaned to the U.S. Treasury during the earlier decades.
Will the Trust Funds Be Depleted? Will We Care If They Are?
Politicians and pundits gleefully exploit misunderstandings about Social Security’s trust funds. They point to annual projections by the Social Security trustees and the Congressional Budget Office, who provide an estimate of the date on which the trust funds’ net savings will reach a zero balance. The most recent estimate is that the depletion date could be in 2033. One recent headline referred to this as a Social Security “shocker.” Is that a reason to panic, or at least to calmly cut benefits or increase taxes? Actually, the answers to both of those questions is no.
The first thing to remember is that these are forecasts, with ranges of error. Under one plausible set of assumptions that Social Security’s trustees have published, the main trust fund is never depleted. Even if it did reach a balance of zero, however, the trustees estimate that the system could still cover three-fourths of the benefits that would be due under the formula that it uses. That formula, moreover, would set payment levels for most future retirees that are actually higher—even after a 25% cut, and adjusted for inflation—than benefits are today.