Even as Social Security trustees talk of a day in the future, in which they will run out of money, that day has already passed, and Social Security is already draining the public purse. As this reality sinks in, Social Security cuts will finally be made. The government will announce reduced benefits for Social Security recipients (benefits have already been reduced by stealth by increasing Social Security benefits below cost-of-living increases) and probably raise both Social Security and Medicare taxes (Medicare taxes on high-income earners was already modestly increased as a back-door tax as part of Obamacare.) Another avenue to reconcile the red ink of Social Security may be to further increase the age for full Social Security benefits, just as its previous age increase from 65 to 67 bought the program some extra time to stay profitable.
One way or another (maybe several), Social Security recipients will have to pay for the mistakes made by the Social Security and Medicare programs over the last two generations. These corrections could have been limited if these programs had properly managed their finances during their years of profitability. In the case of Social Security, for all those years in which it was collecting more in tax revenue than paying out in benefits, the profits were not saved and invested, but turned over the federal government to be spent.
Social Security and Medicare earned large profits – but chose the wrong place to save them.
Since its inception in the 1930s, the Social Security program has generally covered its costs, with Social Security tax income exceeding payments to Social Security recipients. And as the population's lifespans and Social Security benefits (retirement, disability, etc.) increased, so too did Social Security revenues, with periodic increases in Social Security tax rates, as well as pushing back the age for full retirement benefits (currently, age 67). As a result, the administration collected large yearly profits, with tax receipts regularly exceeding payments to beneficiaries.
According to the Social Security Administration, over its more than 80-year history the Social Security program has collected $20.9 trillion of tax revenues while paying out $18.0 trillion to Social Security recipients, resulting in a $2.9 trillion surplus. (In reality, program revenues were somewhat less because stated revenues include “accrued interest”, which I'll go into in just a moment). As these surpluses were earned over the years, the assets were “invested” in the Administration's retirement and disability “Trust Funds”. Those trillions of dollars of profits were given to the U.S. Treasury's general fund, which was then combined with other government revenues to pay the various expenses of government.
In return, the Social Security Administration received government securities from the federal government and allocated them in trust funds. However, these were not ordinary government securities. These were non-marketable government bonds. These government IOUs are also called “special issues of the Treasury”. These special issues even included interest that would be accrued (not immediately paid) and that would theoretically increase those Social Security profits, and build those trust funds even more. But the important thing to note is that even the interest the Social Security Administration earned on its trillions of dollars of gains over its program lifespan were not paid in cash, but with more non-marketable bonds.
That term, non-marketable is important, since it indicates that there is no market for the Social Security Administration's bonds. For something to be considered a financial asset, there will be market for it, formal or not, and willing buyers wishing to buy that asset. With traditional government bonds I can buy bonds from the government (or another individual or corporation), and when I want to cash them in, I can sell those bonds back to the government . Before that time I can also easily sell them to another buyer who will then assume ownership until he or she wishes to redeem them from the government or sell them to yet another buyer.
That is not the case with the Social Security Administration's non-marketable, “special issues” bonds. These bonds can only be redeemed by the federal government. If the “reserves” in the Social Security Administration's various trust funds were truly assets, then at any time they could sell those bonds to willing (and uncoerced) buyers at the current market price. But the reality is that no neutral party would pay any such amount because they know there is little chance that the government will actually redeem those bonds, since they don't represent any contractual obligation to do so (and in the case of these special interest bonds, there is legally no other entity allowed to hold them).
The Social Security Administration likes to point out that the non-marketable bonds in its Social Security trust funds are backed by the “full faith and credit of the U.S. government”. But that merely represents an intention and an ability to pay (in this case, credit representing the ability to go out into the marketplace and issue more bonds to redeem the non-marketable bonds held by the Social Security Administration). This does not represent a contractual obligation, as with traditional bonds. The less than $3 trillion in these non-marketable bonds held by the Social Security Administration's trust funds is dwarfed by the more than $15 trillion of outstanding, contractual, marketable bonds, owed to domestic and foreign creditors, an amount that has more than quadrupled in 15 years (see below). If and when the government has the money to redeem its bonds it will start with these in which it is legally obligated.
It is still puzzling to see commentators, and the Social Security Administration itself, speak of the “reserves” in the Social Security Trust fund as if they hold real assets. But the yearly assets the Social Security program generated in past decades, cash, were transferred from the Social Security Administration to the U.S. government (its Treasury) and spent as soon as it was received. Unfortunately now, after giving away all its earnings during its profitable years, the Social Security Administration now generates losses. As a result, it is now completely dependent upon the federal government and its Treasury to cover its losses and keep the program afloat. The Social Security program is not relying upon “assets” within its trust fund to finance its losses, but the U.S. treasury.
While there have long been warnings as to the impending losses of the Social Security program (mainly due to the very large swath of retiring baby-boomers), it is only in recent years that the program has become unprofitable. As to when the Social Security program swung from profits to losses, it's a matter of debate. And a point of deception. According to the Social Security Administration, 2018 will be the first year that Social Security's costs exceed income since 1982. But as the graph below shows, on a cash basis, Social Security has already been running losses since 2010.
This critical difference and disagreement, is because of the way that the decades of yearly profits from the Social Security program are said to have been “invested” in these non-marketable special issue government bonds, and the impact from “accrued interest” on those savings. To use an analogy for an individual, let's say I've been earning $50,000 a year, while living on (spending) $40,000 a year, and have been doing so for 40 years. Let's also say I was continually investing those $400,000 of surpluses in bonds over those years. Let's further say that after 40 years, and after including earned interest, my savings have now grown to $1,000,000.
As I retire this year, my salary income is now $0, and my expenses still $40,000 a year, so I could live for another 25 years on my million dollars ($1,000,000 divided by $40,000; and assuming no further interest is earned during retirement). But what if I found out that my $400,000 in savings from all those years hadn't actually been invested at all, and that the extra interest I thought I had been accruing (and not paid out) were worthless IOUs. In that case I would have earned 0% on my savings, and my $400,000 in savings would still be $400,000. As a result, it would only last 10 years ($400,000 divided by $40,000). Those differences are magnified if it assumed that I will continue to earn interest during my retirement years. In the no-interest scenario I will still run out of money in 10 years, but if I continue to earn interest during retirement, then my money would last even longer than 25 years, perhaps 30 or 35 years dependent on the assumed interest rate.
That is essentially what the Social Security Administration and their trustees are doing when they calculate when the trust funds will run out of money. The current Social Security Trustees' calculations as to when its “trust funds” will run out of money include this computation of accrued interest, both in past “accruals” for growing its trust fund, and for spending that trust fund down. In other words, the Social Security program believes it will continue to earn interest even while its program generates losses. Not only do they not recognize that there is no money in its trusts fund (in my analogy, I would discover that the bank had spent all my money and is bankrupt), they believe that they can also now live on the accrued interest from past profits from an entity (the federal government) that has no ability to pay program losses or “accrued interest” without going deeper into debt.
Incredibly, the Adminstration says it still earns tens of billions of dollars a year, based on “accrued” interest on past profits, even as generates losses and spends down its mythical trust funds. Even with the aid of imaginary bond interest added to its revenues, the Administration now expects Social Security to burn through its entire $2.8 trillion in “reserves”/“assets”/“bonds” (whatever they want to call it), in just 16 years. According to the Social Security Administration, its cash losses are already close to $100 billion a year and will grow to hundreds of billions of dollars a year within a decade.
And where is the money coming from to cover those losses? Not Social Security Trust funds of course, because there is no money in there. No, losses from the Social Security program are now coming from the same place that all government programs and agencies get money from to cover its deficits: the U.S. Treasury. Thus, despite any imaginary interest the Social Security Administration thinks they are earning and that have been keeping it profitable, in the real world, Social Security is losing money and asking the Treasury to pay for its losses, to be financed by more government borrowing, money printing or higher taxes.
Next time, I finish this up with a discussion of how the growth of Social Security and Medicare are crowding out the rest of the government, and have become such an enormous part of the American economy, that pulling back these programs, mathematically necessary in the long-run, will cause much shorter-term pain for the U.S. economy, and especially those dependent on these programs.