The Politics and Practicalities of the Social Security Trust Fund

Everyone’s favorite bad horror movie summer sequel returned last week, with the Social Security Trustees’ report revealing the Social Security “trust fund” is on pace to run out in Q4 2032—a quarter earlier than last year’s projection. With the alleged depletion day now just over six years away, there is renewed handwringing about slashed benefits and upended retirement plans. Please do yourself a favor and take a deep breath and relax. This is a political kerfuffle that means precious little for anyone’s actual state retirement benefits.

Social Security trust fund has always been a bit of a misnomer, as a timely Wall Street Journal op-ed reminded us all last Thursday. Social Security is, always has been and probably shall remain a pay-as-you-go system. Meaning, it pays benefits with incoming payroll tax revenue. The “trust fund” is the accumulated surplus from the years when payroll taxes exceeded benefits. When revenues slipped below benefits, the Social Security Administration funded the shortfall with money from that accumulated surplus.

While this is called a trust fund, it doesn’t operate as a trust or pension fund would in the private sector (or even in the public sector abroad). Uncle Sam didn’t invest his surplus in a mix of assets in hopes of achieving a long-term return to help fund future liabilities. As the Journal explained: “Congress directed that Social Security ‘invest’ only in special-issue U.S. Treasury bonds. The trust funds therefore represent borrowing by one hand of government from another. This transferred the cash to Congress to spend in the flush years, while putting the Treasury on the hook to redeem the bonds out of general revenue or borrowing once Social Security payouts began to exceed payroll-tax revenue.”^[i] You may remember all the careless chatter in the 1990s and 2000s about Congress supposedly raiding Social Security to fund pet projects or treating it as a slush fund—this arrangement is why. It is also why that accusation has died down since 2010, when benefits first exceeded revenue and forced the Treasury to begin redeeming those bonds to pay retirees as scheduled.

When you cast the trust fund in this correct light, things look more benign. It isn’t that Social Security was seeded with a big pile of money that is now running out as America squandered her inheritance. The issue here is that while benefits rose with inflation, population growth and longer lifespans, the payroll tax stayed at 12.4% for most of the past 36 years (6.2% for employees, 6.2% for employers). It has also applied only to a share of higher earners’ paychecks, with the ceiling indexed for inflation. We aren’t advocating the government change this stuff—we aren’t in the advocation business. We are simply pointing out the issue here is structural and mathematic.

Once the “trust funds” are gone, under current tax policy and the trustees’ projections (always suspect given the inputs and use of straight-line math, as any long-range forecast is), incoming tax revenue would fund about 78% of benefits. This leads some to warn of immediate 20% benefit cuts.

We doubt it. Cutting retirees’ existing benefits near guarantees all sitting politicians get voted out. The backlash would be huuuuuuuuuuuuuuuuuge. Politicians’ sole purpose in life seems to be staying in office as long as possible, so they will not voluntarily write their own ticket home. Instead, as they did the last time Social Security faced a depleted trust fund, in 1983, they will most likely find ways to extend funding without affecting current beneficiaries. Then, the flagship measures were payroll tax hikes and retirement age increases, along with a bunch of tweaks to benefits calculations affecting future retirees.^[ii]

It will be similarly easy for Congress to patch Social Security funding this time, whenever politicians finally decide to stop using this problem as a wedge issue for fundraising, campaigning and grandstanding. They could take advantage of all the advances in “longevity” and inch the retirement age higher again, recognizing people are capable of performing service and knowledge-based work in their 70s (and have much value to add via hard-earned wisdom). They could also tweak the benefits formula again.

Or they could amend payroll taxes, perhaps in one of the 35 ways the Social Security Administration’s Chief Actuary helpfully lists on its tax proposals page. We don’t love tax hikes, but it actually wouldn’t take much pain to bring revenues back in line with benefits. Raising the payroll tax to 16.4% would get us there easily, according to the actuaries’ math.^[iii] So would a more modest hike paired with elimination of the ceiling. Or Congress could kick the can by raising the payroll tax by 0.1 percentage point each year, buying time for a larger change later.

This is all simple administrative stuff, no Social Security moonshot investments in SpaceX required.^[iv] Just boring tax tweaks and some math. The US economy and markets did a-ok the last time Congress raised payroll taxes, and we doubt another hike would matter much. Tax hikes rarely do—markets price them and move on. Just don’t expect politicians from either party to tell you this boring truth or confess six years before they have to that your benefits will be fine.