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Social Security money stock photo
It’s a frequent refrain: Social Security is “running out of money” and will “go broke” when the Trust Fund exhausts its supply of bonds around 2033, requiring a reduction in the size of benefit checks. However, it is unlikely that Congress will allow cuts in retirement benefits. George F. Will describes how reform of the system will keep scheduled benefits flowing: “With just a few words, the law can be amended to say that Social Security’s revenue shortfall will be filled with general revenue, which means enlarging the now-constant borrowing binge.”
Not quite: Yes, the required reform will be simple but no, it will not require “enlarging the now-constant borrowing binge.”
To see this, we must review how Social Security gets its money and spends it. Through its “Pay-as-you-go” mechanism, current workers pay a fixed percentage of wage income up to a cap (in 2026 that percentage rate is 6.2 and the cap is $184,000). Today’s workers support today’s retirees, expecting to enjoy the same support when they retire.
The Role of Bonds: Smoothing Payroll Tax Revenue
The designers of the system recognized that the expansions and recessions of the economy would cause payroll tax revenue to fluctuate; during economic expansions revenue would be more than what would be needed to pay scheduled benefits but during recessions revenue would fall short. To smooth out these surpluses and deficits, the system included a bond fund.
During expansions: surplus payroll tax revenue is paid to Treasury to buy bonds. For example, suppose in a given year revenue is $900 billion but only $800 billion is required to pay benefits. The extra $100 billion is used to buy Treasury bonds. During recessions: bonds are sold to Treasury in exchange for cash to cover revenue shortfalls. For example, if benefits are $1.6 trillion but revenue is only $1.3 trillion, Social Security sells $300 billion worth of bonds to the Treasury in exchange for the cash needed to pay full scheduled benefits. Treasury buys those bonds from Social Security using cash obtained from the same sources it always uses, taxation and borrowing as approved by Congress.
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Adjusting for the Boomers' Retirement
In 1983 President Reagan's Commission on Social Security Reform recognized a large demographic boom and bust cycle would hit the system 30 years into the future: 77 million born between 1946 and 1964, followed by just 47 million during the succeeding18 year period. This would mean that by about 2012 a very large retirement boom would begin, supported by much smaller workforce.
To meet this anticipated retirement/worker boom‑and‑bust they raised the payroll tax rate to buy more bonds while the boomers were working, planning to cash in those bonds as the boomers retired. They projected those bonds would be all sold out by the year 2060 when all but the most persistent baby boomers would be gone.
Investing the Cash
The cash was not meant to sit idle in a vault at Treasury. In order to foster economic growth, it was to be invested through two channels:
- Private-sector investment: The surplus cash would reduce federal public borrowing, allowing interest rates to be lower than they otherwise would have been, encouraging investment in equipment, buildings, training and many other productivity-enhancing capital assets.
- Public-sector investment: The cash was also intended to finance growth-enhancing public goods: transportation infrastructure, water and sewer systems, education and workforce training, environmental protection, disaster recovery and enforcement of laws that keep markets functioning efficiently.
The investment made by retirees when they were working increases the productivity of future workers. This mechanism forced boomers to invest in part of their own social security benefits.
Why the Bonds Are Running Out Early
Major shocks and policy choices slowed growth and sped up bond sales, disrupting the Reagan plan: the large increases in defense spending in the aftermath of 9/11, the expensive wars in Iraq and Afghanistan, the 2008 financial crisis and slow recovery and Covid-19 all consumed resources rather than investing them. Consequently, the trust‑fund bonds are being cashed faster than planned and will be exhausted around 2033 rather than the originally anticipated 2060.
Needed Reform Does Not Require a New Tax and Borrowing Binge
When the bonds run out in 2033, Congress will order Treasury to continue to supplement the payroll tax revenue shortfall, i.e., the difference between scheduled benefits and payroll tax revenue. Neither of those amounts depend on the method of financing. The supplement will be calculated in the same way both before and after the bonds run out. This reform will not require a dramatic increase in federal taxes and borrowing.
