There has been much talk lately about the projections that the Social Security system may have to slash benefits in 2034 when the current $2.7 trillion Social Security Trust Fund is exhausted. This is a big concern for the 68 million people who count on those retirement, survivor, and disability benefits. The looming 2034 bankruptcy is bad enough, but there are other lesser known aspects of the crisis that will affect us much sooner.
To understand the problem, it helps to first understand how the system is funded. Social Security taxes paid by workers and their employers are deposited into the Social Security Trust Fund, and benefits are paid out of the fund. Technically there are two funds, one for worker and survivor benefits and one for disability benefits, but we will just refer to them collectively.
The trust fund isn’t just a big pile of cash sitting in a vault. When the U.S. Treasury receives the payroll taxes, the law requires that they be credited to the trust fund in the form of “special issue” government bonds, which are a type of government securities that can only be owned by the trust fund and are not marketable. The entire trust fund is made up of these special issue bonds, which are basically just IOU’s from the government to pay back the money when needed. So in effect, the Social Security Trust Fund is just a ledger that keeps track of how much money the government owes the Social Security program. When money is needed to pay out benefits, older bonds are cashed out, providing exactly the amount needed to pay the benefits. So there is a constant cycle of new bonds being purchased with incoming taxes and old bonds being cashed out to pay benefits. In years when there is more cash coming in from Social Security taxes than benefits and expenses paid, the government uses the extra cash for non-Social Security related general budget expenses. Of course they have credited the trust fund with special issue bonds to account for the cash they borrowed.
The bonds do pay interest, which varies from month to month based upon a formula. Since 1980 the annual rate has ranged as high as 11.6% (1984) and as low as 2.9% (2018). When bonds are redeemed to pay benefits or expenses, the interest is also paid by the government. The special issue bonds are backed by the full faith and credit of the U.S. government, but since they aren’t marketable, they are in essence just a written promise from Uncle Sam to pay the money back one day.
Since 1984, the program has brought in more revenue each year than it paid out in benefits and expenses, so the trust fund grew and the government had the borrowed cash to spend on other things. But starting in 2018, Social Security began paying out more than it was bringing in, causing the trust fund balance to decrease. This required the program to cash out bonds, and the government is obligated to redeem these bonds, thereby paying back their loan. So now instead of having borrowed cash to spend, the government is having to come up with cash to redeem the bonds. The money has to come from somewhere, and will likely be money that would have been spent on other government programs. So, we are all suffering the effects of the Social Security crisis right now, and it will continue to get worse each year until the problem is addressed by Congress.
In our next article we will address how we got into this situation.