We have a friend, let's just call him 'Yoda'* because he knows everything there is to know about Social Security and then some.
You ever hear that something is not 'rocket science'?
Well, apparently, understanding the convoluted and byzantine cash glows of Social Security is 'rocket science'. No mere mortal average citizen understands it all and very few people in Congress or the White House understand it either.
Yoda not only graduated from Princeton but has a Ph.D in computational quantum chemistry from Berkeley.
He needs it. He is one of three Trustees on the Board that oversees the operations and health of Social Security and Medicaid.
We posted our last musing on the fact that SS payroll taxes do not cover 100% of all the cash that goes to senior citizens in their monthly SS check. We were trying to make the point that it is not a pay-as-you-go program as many think nor is it a true financial vehicle whereby every dollar you pay in SS payroll taxes goes into some individual interest-bearing and capital-appreciating account at Fort Knox with your name on it.
Which is true.
However, the chart we posted confused some, us included, when it had the largest share of indirect payments to SS recipients coming from 'interest' instead of direct payroll taxes.
So, of course, we contacted Yoda for assistance.
Here is his reply below. Read it and see what you think and we will conclude with some remarks at the end.
'The basics of SS Trust Fund operations are available at this link:
The second table, showing the components of Soc Sec trust fund receipts, is probably most relevant to your question. Interest payments have actually been made from the beginning. They didn’t just start in 1983 (when the Alan Greenspan Commission on SS raised payroll taxes not only to cover current SS expenses but also to buy up the national debt (see Moynihan) – it’s just that starting in 1983 they became much more significant.
They’d never been more than $3 B a year until 1983, then they jumped to $8 B, and by 1991 they were topping $20 B a year and rising.
Basically any surpluses Soc Sec runs result in a bond being issued to the trust fund, and that bond earns interest which is paid from the general fund. Pretend that we just started the program from scratch and in its first year we collected $10 B in payroll tax revenues and paid out $8 B in benefits. That would result in $2 B in Treasury bonds being issued to the trust fund.
Those bonds earn interest. Those interest payments are made from the general fund, just like any other interest payments the federal government makes on Treasury bonds.
I do think you’re right to think of the interest payments from 1983-2010 as basically being “imputed” in a sense because all that was involved was crediting the trust fund with interest and causing its balance to grow.
It’s not like the government had to go out and raise this money, it just issued a credit from the general government accounts to the trust fund accounts, adding to Social Security’s future spending authority.
Though, those interest credits DID count against the government’s statutory debt ceiling, because the debt ceiling includes debt held by the social security trust funds.
But starting in 2010, the interest payments became more “real” in the sense that payroll taxes were no longer sufficient to finance benefit payments. So part of the interest payment from the general funds to the trust funds went immediately out the door in cash to pay benefits. The remainder of the interest payments just added to the trust fund balance the way that they had historically, but since 2010 the federal government has been supporting benefit payments with cash payments of interest from the general fund.
Basically, since 2010, Soc Sec has been supported in part by payments from the general fund and it has added to the federal deficit because payroll taxes are now insufficient to finance benefit payments. To the extent that benefits are financed by incoming payroll taxes, they don’t add to the federal deficit.
But to the extent that benefit payments are financed by interest payments from the general fund, they do add to the federal deficit because those interest payments are made from the government’s general fund and have no external revenue source.'
See what we mean about having a Ph.D in quantum computational physics when it comes to understanding Social Security cash flows? It is complicated. Very complicated.
Two points to keep in mind:
The huge annual Social Security 'Surplus' you may have heard about being paid into the Trust Funds each year is gone. At one time, the excess receipt of SS payroll taxes over outgoing expenses was expected to last until well into the second decade of the 21st century, 2026 or so was the targeted expiration date.
At some point or another, sooner now rather than later as planned in 1983, your payroll taxes will have to go up or your parent's (or maybe even you) Social Security benefits will be cut by 5%, 10% or up to 25% to make up for the fact that the Social Security 'Trust Fund' (sic) will be completely depleted.
When it comes time to 'redeem' the bonds held in the SS 'Trust Fund' account, the only way to do that is to raise taxes or cut benefits. No other way. Unless you want the Fed to make up fake money again and bail SS out to the tune of multiple trillions of dollars again.
We still maintain that the Social Security 'Trust Fund' (sic) still needs to asterisked just to differentiate it from the traditional 'true' trust funds you think of where money goes into some money manager's company; is invested in a wide array of bonds and stocks or real estate; grows in economic value; collects interest and dividends for the duration and, when the time to tap into the trust fund comes around, those segregated funds are available for you to use in your retirement, etc.
But at least we all now more fully understand the cash flows in Social Security. Yes?
*Chuck Blahous is the director of the Spending and Budget Initiative, a senior research fellow at the Mercatus Center at George Mason University and a public trustee for Social Security and Medicare.
Blahous is the author of Social Security: The Unfinished Work and Pension Wise: Confronting Employer Pension Underfunding and Sparing Taxpayers the Next Bailout, as well as the influential study,“The Fiscal Consequences of the Affordable Care Act.”
He was formerly the deputy director of President Bush’s National Economic Council, special assistant to the president for economic policy, and executive director of the bipartisan President’s Commission to Strengthen Social Security.
He worked in Senator Alan Simpson's office where we met him during the 1994 Bipartisan Commission on Entitlement and Tax Reform set up by President Clinton.
Blahous received his PhD in computational quantum chemistry from the University of California at Berkeley and his BA from Princeton University.