Social Security is a social insurance program. The United States Social Security program provides benefits for retirement, disability, and death. There has been a great deal of public discussion recently, largely spawned from President Bush’s 2005 State of the Union address, when he said that “on its current path, [Social Security] is headed toward bankruptcy… by 2042 the entire system would be exhausted and bankrupt” (C-SPAN, 2005). This essay examines that statement from an economic perspective and analyzes some of the highly publicized proposed solutions. While historical aspects of the program will be mentioned peripherally, “Social Security” within this context refers to only the defined-benefit pension plan, with a specific focus on the retirement benefits.

How Social Security Works

The Social Security Act was signed into law under President Franklin D. Roosevelt in 1935. As originally drafted, the program was far less ambitious than it has become. It outlined a wealth transfer system whereby current workers were taxed at a rate of 2%, paid equally by the worker and the employer. While both the defined benefits and the tax rate have changed, the fundamental act of transferring wealth via payroll tax from current workers to retirees remains in effect presently (Wikipedia, 2006).

In the years since the act was first signed into law, the program has expanded to include medical insurance to the elderly through Medicare, disability insurance, and the expansion of participation to include nearly all workers. Whereas half of workers in 1935 were exempt from the program, it is now nearly impossible to avoid participation. The defined-benefits pension portion of the program is funded today by a 12.4% tax split evenly between employers and employees. Medicare is funded and accounted for separately with a 2.9% tax, also split between workers and employers (Social Security Online, 2005). These taxes are imposed only on the Social Security wage base, or “Contribution and Benefit Base”. The wage base was $90,000 in 2005, having risen dramatically since the 1983 Amendments to Social Security (Social Security Online, 2005), signed into law by President Reagan based on recommendations from a commission chaired by Alan Greenspan. This amendment allowed for adjustments to both the wage base and benefits payments based on the National Average Wage Index, an index compiled by the Social Security Administration, rather than direct congressional direction through a statute.

Social Security has run a surplus since its inception. Since 1983, the program has run a dramatic surplus. However, due to unified budgeting, the practice of including social security surpluses (or shortfalls, were there any) in the government’s general accounting, these receipts have served to offset annual budget deficits. As of 2005, the Social Security program has amassed a surplus of $1.86 trillion (Social Security Online, 2006). However, this “result[s] in the issuance of Treasury bonds to the [Medicare and Social Security] trust funds in years of annual cash flow surpluses” (Social Security Online, 2005). This means that government “buys” bonds from itself. Furthermore, “since neither the interest paid on the Treasury bonds held… nor their redemption, provides any net new income to the Treasury, the full amount of the required Treasury payments to these trust funds must be financed by some combination of www.senseofsecurity.nl taxation, increased Federal borrowing and debt, or a reduction in other government expenditures” (Social Security Online, 2005). These bonds are also excluded from the accounting of the National Debt. Ultimately, this means that the Social Security Trust Fund is merely an accounting ruse and that these paper surpluses have long since been spent through mismanagement of funds. Despite political rhetoric to the contrary, the current Social Security system is entirely a “pay as you go” program. Funding to retirees, beneficiaries drawing income from the system, is provided directly from current worker contributions.