Social Insecurity: Inside the 'Trust Fund' Illusion

The recent tax deal approved by Congress and the president cut the payroll taxes that employees will contribute to Social Security for 2011 by about a third, and that $112 billion reduction in receipts has advocates of the program worried that the political meddling in Social Security's finances may threaten its viability.

Unfortunately, the Social Security Administration's (SSA) finances have been meddled with for decades, and a one-year tax holiday is the least of the program's problems. As I reported on DailyFinance this week, Social Security is already deep in the red, with outlays exceeding payroll tax revenues by $76 billion in 2010 -- a deficit that wasn't expected to occur until 2018.

Though the program's trustees continue to reassure the public that Social Security's funding is secure through 2037, rising outlays and slumping revenues -- not even counting the "tax holiday" cut -- call that rosy outlook into question. And the trustees' short-term projections have been so far off the mark that the validity of their longer-term estimates must also be in doubt. Their estimate of total revenues was too high by $50 billion in 2010, and their estimate for 2011 income is $855 billion -- fully $114 billion more than the system's 2010 income.

It would require a stupendous increase in employment to hit that mark, and precious little evidence suggests such a powerful hiring boom is in the works. Instead, there's plenty of evidence that the current recovery is a jobless one: 9 million jobs -- 8% of all private-sector jobs -- have vanished since 2008, and another 8% more have slipped from full-time to part-time or temporary. America's millions of self-employed, freelance and contract workers have seen their incomes decline by 5%.

But if payroll taxes don't rebound strongly in 2011 and beyond, the long-term viability of Social Security will be in doubt, because with the baby boomers beginning to retire en masse, the number of people receiving benefits is climbing rapidly.

About One-Fifth of the Federal Budget

To understand the basics of Social Security's cloudy future, we need a quick refresher on the system.

Social Security has over 53 million beneficiaries -- 17% of the U.S. population of 312 million, or about 1 in 6 Americans. As a comparison, that's substantially more than the entire population of Spain (46.5 million). Its outlays in fiscal year 2010 totaled $707 billion, about one-fifth of the $3.45 trillion federal budget. And its payouts will inexorably rise in coming decades, thanks to the 76 million-strong baby boom generation. The first boomers qualified for Social Security in 2008, and over 3 million more enter the system every year.

Social Security is a "pay as you go" retirement system, intended to run with a surplus designed to fund future shortfalls. Payroll taxes paid by current workers and employers fund today's retiree benefits, and the difference between tax receipts and outlays -- a surplus, until recently -- is transferred to the U.S. Treasury.

In exchange for this excess cash, the Treasury issued the Social Security Trust Fund special nonmarketable securities. The Trust Fund now holds about $2.6 trillion in these securities. (Technically, there are two trust funds, one for the main Social Security program and one for Disability Insurance, but the SSA usually combines the two.)

If You Can't Sell a Bond, Is It Worthless?

Though the SSA doesn't state it directly, what this means is that the Treasury took $2.6 trillion in Social Security cash surpluses and transferred it to the federal government to spend on other government programs. (For context, the total net wealth of U.S. households is $54.9 trillion, according to Federal Reserve data.)

The fact that the Treasury bonds the Trust Fund received in return for that $2.6 trillion are nonmarketable -- that is, they aren't bonds that can be sold on the global bond market -- has led some observers to characterize them as worthless.

The Social Security Administration defends the worthiness of its special bonds in its FAQ page:
"The [surplus] money flowing into the trust funds is invested in U.S. Government securities. Because the government spends this borrowed cash, some people see the current increase in the trust fund assets as an accumulation of securities that the government will be unable to make good on in the future. Without legislation to restore long-range solvency of the trust funds, redemption of long-term securities prior to maturity would be necessary.

Far from being 'worthless IOUs,' the investments held by the trust funds are backed by the full faith and credit of the U.S. Government. The government has always repaid Social Security, with interest. The special-issue securities are, therefore, just as safe as U.S. Savings Bonds or other financial instruments of the Federal government."

This debt to Social Security is called "intragovernmental holdings," and it is included in the total national debt, along with other special Treasury securities held by other agencies.

The "Trust Fund" Is Not a "Lockbox"

What the Social Security website fails to explain is where the Treasury gets the money to redeem those bonds. The answer: It borrows the money on the global bond market by selling freshly issued real Treasury bonds.

In other words, Social Security's nonmarketable bonds are merely markers for actual Treasury bonds, which must be sold, and for which interest must be paid. Thus, Social Security is entirely dependent on the Treasury's sale of new bonds for its future solvency. If interest rates spike or global buyers become wary of buying trillions of dollars in U.S. T-bills, costs for that borrowing will skyrocket, crowding out all other federal spending.

As a result, U.S. taxpayers are now paying twice for their Social Security benefits: Once through payroll taxes, and again when the Treasury uses their taxes to pay interest on the bonds it sold to fund Social Security.

This is not some far-in-the-future issue: The Treasury reported in October that it had to sell new bonds to fund Social Security shortfalls in 15 of the previous 25 months.

A Budgetary Illusion

Another way of understanding the hollowness of Social Security's nonmarketable securities is to ask: What difference would it make if we erased the Trust Fund from the ledger?

The answer: none whatsoever. In the "Trust Fund" we now have, when Social Security's outlays exceed its payroll-tax income, then the Treasury sells freshly minted bonds and transfers the cash to Social Security. If we eliminated the so-called Trust Fund, the exact same thing would occur: When Social Security's outlays exceed its payroll-tax income, the Treasury would sell bonds and transfer the cash to Social Security.

This thought experiment reveals that the Trust Fund is illusory, but the reality is that the U.S. Treasury will have to borrow $2.6 trillion on the global bond market to redeem Social Security's nonmarketable securities. That means the Social Security system is totally dependent on the Treasury's ability to sell trillions of dollars of bonds at interest rates that won't cripple the federal government.

The Treasury borrowed $1.3 trillion in 2010 just to fund the federal deficit. As baby boomers retire and payroll taxes remain stagnant, the Treasury will have to borrow substantially more to fund shortfalls in Social Security. If the global bond market hesitates to buy more Treasury debt at low interest rates, then all federal programs will feel the impact -- including Social Security.

Increase your money and finance knowledge from home

Banking Services 101

Understand your bank's services, and how to get the most from them

View Course »

How to Avoid Financial Scams

Avoid getting duped by financial scams.

View Course »

Add a Comment

*0 / 3000 Character Maximum


Filter by:

I think we are fast approaching, if not already there, the same scenario that existed in Germany after World War I. During the era of the Weimar Republic, you had to load a wheelbarrow with Reichsmarks when you went to the butcher shop to buy a couple of knockwursts.

September 18 2011 at 11:20 PM Report abuse rate up rate down Reply

billions are spent every year defending every border but our own. right california is billions in the hole and is bankrupt. their state is so full of illegals in their prisons they cant afford it any longer. billions are spent on this and the figure is rising every year. their cities are full of illegal gangs. welfare receipients around here ride around in escalades with chrome rims with their 9 kids inside. Our government is the sickest it has ever been. we older retired people that worked all our lives are the ones penalized. examine every welfare check and see what it is spent on and the billions that is wasted on luxury vehicles and chrome rims. put all politicians on the same system we are on and do it now.

January 21 2011 at 3:40 PM Report abuse +2 rate up rate down Reply
1 reply to rricejr106's comment

As SS was originally funded ,if not for taking money from it , there was some concern that it would eventually have all the liquid funds available to the government,so the solution has been to take money from it so that did not happen. Time to put it back.

January 21 2011 at 12:52 PM Report abuse rate up rate down Reply

Most American's are spend today and worry about tomorrow, tomorrow. Well here it is tomorrow! Why aren't more people saving more for retirement through 401k's, IRA, or other savings methods. Oh, I can't afford it, you have a new car, flat screen tv's, RV's, Boats, and so on. We failed our children by not teaching them the realities of life, instead me tried to make their life easier than ours had been. In the process we ruined several generations. When I was a child and wanted to go the movies, I broke out the "push mower" and went down the street to find mowing jobs. No one has ever come to my door in the 40 years!

January 21 2011 at 12:32 PM Report abuse +1 rate up rate down Reply
1 reply to gpfs's comment

Good news, I'm getting mine, bad news your paying for it. More bad news, who's going to pay for yours? SS is a typical federal program, they are never repeat never properly funded! But they do buy votes!

January 21 2011 at 12:24 PM Report abuse +1 rate up rate down Reply
1 reply to gpfs's comment

Congress has known about this problem since the 80's and kicked the can down the road. SS must be changed, but name a politian that want's to take that case on! When Johnson unlocked the SS funds box, it went down hill very quickly, but covered up government spending vs revenue shortfalls. What to do, means testing is one idea that is batted around, Clearly Warren Buffett does not need SS, but he is entitled to it, therefore I have no problem with him collecting it. Taking the cap off earnings which are taxed is another idea. The problem there is that raises the entitilements to those and sooner or later SS will be obligated to pay them more too. Maybe a combination of the two, or raise taxes, or cut benefits, maybe a combination of all of them. In the orignal SS law it was designed as a "partial" replacement of earnings. It was not meant to retire on. There was even discussion that the money should be put in bank accounts, that lost out quickly due to the 1929 crash and bank failures. Now we have the 2010 government failure! Congress violated our trust!

January 21 2011 at 12:13 PM Report abuse +1 rate up rate down Reply

The social security program needs to be changed. How about we revise benefit payments and reduce payment amounts to those with income and assets outside of the program. Certainly a person with several million dollars of assets has less need to collect social security than a person with zero assets. Also, the payments should be revised to reflect life expectancy, which is greater than it was when the program was initially implemented. Finally, how about we call for Americans to delay collecting social security benefits if they can afford to do so. Of course, we might not be having this discussion at all if our government was paying attention to trade, jobs, and spending...

January 21 2011 at 11:03 AM Report abuse +1 rate up rate down Reply

I wish schools would teach basic finance courses that clearly show how saving over time and compounding interest/reinvesting dividends has a way of adding up. We need to teach our young with practical advice and show they can be financially independent. I've seen too many course where they hypothosize you are the CEO of a major company and what would you do in this or that situation....Those course are still necessary if you are going for a business degree....but lets have some good old common sense, down to earth classes.

January 21 2011 at 11:00 AM Report abuse +2 rate up rate down Reply

This guy is nothing more than a pannic pedler who is a few cards short of a full deck. Some Commie must be paying him to write such propaganda or he must be a Republican who is determined to suck the wealth out of our government and it's people for his own personal gain. The Republicans sucked the treasure dry and now they want to steel the money that we all paid into the SSA for our future retirement.

January 21 2011 at 10:56 AM Report abuse -1 rate up rate down Reply
1 reply to josephbvrlyhlls's comment

You paid zero into Socialist Insecurity for your future retirement, Rather, you paid into Socialist Insecurity for someone else's current retirement. Aint ponzi scheme's grand?

January 21 2011 at 11:27 AM Report abuse rate up rate down Reply

Here's how much additional debt the Federal Government incurred in the first three quarters of 2010: First Quarter - $400 billion; Second Quarter - $501 billion; Third Quarter - $349 billion. In fiscal 2010 the Federal Government increased its debt by $1,744 billion ($1.74 trillion) and claimed a budget deficit of $1.3 trillion. Where did the other $440 billion come from? It came from "emergency spending", mostly for the military. "emergency spending" doesn't count because it's not in the budget.

January 21 2011 at 10:29 AM Report abuse +1 rate up rate down Reply