Demise of Social Security
Richard Glickman and Charles Comer
- After reading in the August 2005 CPA Journal (“Social
Security: Safety Net in Need of Repair”) that “Even
if no changes are made in the law governing Social Security,
the Trust Fund will be able to pay promised benefits until
2042,” we were so startled that we checked our files.
he left office in 2005, Douglas Holtz-Eakin, the sixth director
of the Congressional Budget Office, disagreed, saying: “The
Trust Fund has no real economic resources ... The key moments
for Social Security are in 2016. Cash-flow benefits will
equal cash-flow payroll taxes, and then after that, the
Social Security Administration [SSA] will have to come back
to the rest of the budget for additional resources to pay
promised benefits.” So 2042 is 25 years late.
go back to the roots of the Social Security system. In the
initial collection year of 1937, the Social Security trustees
reported receipts of $267,261,811. That money, which became
the Social Security Trust Fund, was invested in a special
3% U.S. Treasury Bond maturing June 30, 1941.
Trust Fund’s Surplus Has Become the Treasury’s
the past 20 years, the Social Security Trust Fund has built
up a large surplus. That surplus is projected to grow still
larger until about 2016 or 2017, when the nation’s
demographics will shift because fewer workers will be “contributing”
and more beneficiaries (retirees, spouses of workers, etc.)
will be receiving Social Security checks. At that point,
benefits paid out will exceed Social Security tax revenues
coming in, and the SSA will have to begin to draw down the
Trust Fund surplus. The
problem is simply that, over the years, the surplus has
been invested in U.S. government securities, specifically
in special-purpose bonds as required by law. So the Trust
Fund doesn’t have a problem, but the U.S. Treasury,
having spent the money it borrowed, will have to come up
with new cash to redeem the bonds held by the Trust Fund,
currently estimated at $1.7 trillion.
entire amount won’t be needed on January 1, 2017.
In fact, initially the benefit outflow will only slightly
surpass the tax inflow, so the drawdown from the surplus
will be small. But as the years go by, the demographics
are projected to shift still further. Roughly two workers
for every one retiree is the forecast for the year 2030.
In 1950, the ratio was 16 to one. Fewer tax-paying workers
will be supporting the ever-growing number of retirees,
who are likely to be living longer and collecting their
Social Security checks longer. The initial cash outflow
trickle will grow to a torrent, and the U.S. Treasury will
have to fund it.
1983, the trustees explained that the Social Security program
is “essentially on a pay-as-you-go basis. The Trust
Funds serve as a contingency reserve to absorb temporary
fluctuations in income and outgo.… The Trust Funds
are invested in U.S. government securities. After about
the year 2020, outgo will exceed income thus creating substantial
forecast appears to have been pretty accurate. We are much
closer to 2020 today, and the forecast is that income may
be less than outgo as soon as 2017. The American Association
of Retired Persons (AARP) concurs, having stated on its
website that there will be insufficient “cash”
to meet statutory needs.
the issue isn’t a Social Security problem, it’s
a U.S. government problem, which means it’s a problem
for the nation’s taxpayers. To satisfy their constituents,
the members of Congress, with the complicity of the President,
have for decades been spending beyond their willingness
to tax the public, borrowing the difference between receipts
and expenses. The Social Security Trust Fund is just the
largest of the government’s many lenders, accounting
for approximately 22% of the $7.6 trillion in the Treasury’s
cumulative borrowing as of December 31, 2004.
their 1994 Report, the Trustees of the Fund explained another
fund assets are generally invested in special Treasury
securities so that the excess of cash receipts over expenditures
are borrowed from the Trust Funds by the General fund
of the Treasury and used to help meet various Federal
outlays. These securities are backed by the full faith
and credit of the U.S. government, the same as other public-debt
obligations of the U.S. government.… The redemption
of a Treasury security held by the Trust Fund requires
that the Treasury transfer cash—obtained from another
revenue source, such as income taxes or borrowing from
the public—to the Trust Fund.
Trust Fund has not set aside a pile of cash or gold to pay
out to retirees. The Trust Fund consists of pieces of paper
representing promises by the U.S. government to pay itself
(the Social Security Trustees, agents for another U.S. government
entity) approximately $1.7 trillion.
2017, in order to pay retirees their Social Security benefits,
the U.S. government will have to raise cash by:
Printing trillions of dollars of paper money (thereby
destroying the currency’s value);
Selling $1.7 trillion of U.S. assets;
Changing the Social Security system; or
All of the above.
Social Security system was designed to operate on a pay-as-you-go
basis. When the pay-as-you-go approach fails in approximately
2017, the nation will face Problem 1.
2: Insufficient Cash
second issue is that there is no cash in the till to pay
the Social Security beneficiaries after 2017 or 2018. It
is amazing that intelligent readers of SSA reports really
believe that the so-called “Trust Fund” consists
of cash that the SSA will be able to use to pay beneficiaries.
Prior years’ trustees knew that “cash”
was an issue.
real story is that the size of the Social Security Trust
Fund is irrelevant. The U.S. government has the same few
options that we just described whether the Social Security
Trust Fund has a zero balance or a $1.7 trillion paper balance,
because in 2017 or 2018, the government will need to find
the cash to pay Social Security benefits to the extent that
they exceed Social Security tax revenues.
the Trust Fund has assets of $1.7 trillion, and this is
the confusing part to many noneconomists. However, former
President Clinton said: “These Trust Fund balances
… do not consist of real economic assets that can
be drawn down in the future to fund benefits.… The
existence of Trust Fund balances, therefore, does not by
itself have any impact on the government’s ability
to pay benefits.” This is very clear. If the Trust
Fund had hard assets, such as gold, those assets could be
used to pay benefits to retirees.
3: Where to Invest Retirement Funds?
Congress was concerned with preserving the resources needed
to ensure that beneficiaries actually collect, initially
it required that the Social Security Trust Fund be invested
only in special-purpose U.S. government securities. During
the Great Depression of the 1930s, this seemed the most
prudent approach, and the Trust Fund was seen as a contingency
to absorb temporary fluctuations in collections. The early
aversion to financial risk has led to the current problem
of too low a return being earned on investments of the Social
Security funds. The system put in place in the 1930s made
economic sense at the time. Now we see that it will no longer
be operative after approximately 2017.
the inception of Social Security, Congress determined that
the surplus funds should earn a return of 3% per annum,
and over the years two problems have arisen with respect
to the investment returns. In some years, inflation at varying
rates has eroded any real return on the Trust Fund’s
“investment.” In other years, when the SSA needed
to invest its excess reserves in these special-purpose Treasury
Bonds, the ceiling on the national debt inhibited the sale
of bonds to the Trust Fund.
an open mind, we the authors ask: What are equitable ways
to fix the system and possibly improve it?
world has changed so significantly since 1935 that we believe
it is time to revisit the design of the Social Security
system. In the mid to late 1930s, other than certain government
workers, people generally did not have pensions. The social
safety net created made economic sense in the simpler world
of the 1930s, but may no longer be the optimal approach.
The SEC had just been created. Mutual funds were in their
infancy. Portable IRAs, 401(k)s, and 403(b)s did not yet
exist. The development of investment theory was in its infancy.
In 1937, Benjamin Graham and David Dodd had just published
their seminal work on investing, Security Analysis. Mathematician
Harry Markowitz, who subsequently won the Nobel Prize in
economics, had not yet developed the theory of “efficient”
investing, the modern portfolio concept of “diversification”
to minimize portfolio investment risk.
the Social Security Shortfall
for ameliorating the Social Security Trust Fund shortfall
raise complex new issues.
Raising Social Security tax rates could be a partial solution.
The main problem is reality. Edward C. Prescott, a 2004
Nobel laureate in economics, said, “Taxes distort
behavior. From this powerful little sentence comes the
key insight that should inform our thinking about setting
tax rates. Any tax, even the lowest and the fairest, will
cause people to consume less or work less. Taxes that
are inordinately high only exacerbate this reaction, and
the aggregate accumulation of these individual decisions
can be devastating to an economy” (The Wall
Street Journal, December 20, 2005). We agree, and
we think raising the rates is a poor solution.
Raising the retirement age again (but exempting those
close to retirement) makes more sense. This step would
reduce the number of workers getting benefits, as well
as increase the number of workers paying into the system.
After all, people are living much longer today than when
Social Security was established; it is forecast that in
the year 2035, 20% of the population will be over age
The federal government has already privatized the pension
plans of federal employees. Privatizing the Social Security
system so that each beneficiary owns a portable retirement
fund is another partial solution. In addition, the federal
government would have less ability to spend the funds
on other programs. Investment returns would likely increase.
Prudent investments with higher returns would provide
retirees with greater benefits. Families would take control
of their own Social Security tax money.
Another possible approach to improving returns, assuming
privatization, is to require Social Security account holders
to diversify their stock and bond investments directly
or indirectly, possibly through indexation or another
prudent investment-management technique. There has never
been a 20-year period in U.S. history during which one
would have lost money in the stock market.
Alternatively, statutory controls and restraints could
be implemented to prevent people from gambling in the
stock market with their privately owned Social Security
taxes and potentially obligating the public sector to
bail them out. One such control might be to limit individuals’
accounts to investing only in U.S. Treasury securities,
thereby containing portfolio risk. Unfortunately, the
Treasury’s cash flow problem would still exist,
although in a different form and timeline.
Adjusting the Social Security inflation indexing formula
has particular merit. Starting benefits for Social Security
beneficiaries are currently calculated using a wage-inflation
index. Per year, this index has grown 1.1% faster than
the consumer price index (CPI). Substituting the CPI for
the wage-inflation index would result in lower starting
benefits for retirees. The Social Security system would
pay out lower benefits even as they rise to account for
CPI inflation. Again, to be fair, this change should be
implemented only for younger people; for example, below
Using a means test to pay Social Security benefits would
be perceived as unfair, we believe. Why should the government
tell taxpayers during their working lives that they will
receive the benefits of the Social Security taxes they
are paying and then take the benefits away because the
workers were too successful? This appears to be another
proposal that would force successful proactive taxpayers
to think about not maximizing their income potential or
perhaps not reporting all of their earnings to the government.
Taxes a Disincentive to Work?
revisit a real-life economic event from the early 1960s.
Four very young, smart, successful businessmen were in the
offices of their CPA firm explaining their business. One
of them had been a farmer. His current job was to buy farms
that the other three assembled to market for commercial
real estate developers. They earned millions of dollars
each year. During the meeting, one of them said that usually
at the end of May each year, they stopped working until
the following January. This
routine of work and not-work, they explained, was due solely
to the fact that by June they each had earned between $1
million and $2 million. At that level, for every dollar
they earned they paid more than 80% in income taxes. They
reasoned: Why work to keep 20 cents on the dollar? They
had already earned more than they needed. So they waited
for the next year. That meeting was an epiphany for this
author: Taxes clearly are a work disincentive.
does this event relate to Social Security issues? Clearly,
higher taxes, both income and Social Security, are not incentives
in our capitalist system. In the words of Edward C. Prescott,
“Taxes distort behavior.”
the Safety Net Now
bottom line: We cannot wait until 2016 to mend the Social
Security safety net. We agree with the headline “Social
Security: Safety Net in Need of Repair.” More than
one change is needed to ensure that the Social Security
system will last. Mending it will let taxpayers improve
their lives and reduce their reliance on “Big Government.”
And Congress will have one less source from which to borrow.
Glickman, CPA, and Charles Comer, CMT,
are principals in Family Office Advisors, LLC, a wealth-management
consulting firm in New York City. For more information, see