What is Social Security?
Why Do We Need It?

Paul Chadwick

Some people see Social Security as an investment that you make in your own retirement or in case of disability. Others see it as government spending. Actually, Social Security is neither. It is a transfer payment administered by the government. Your payroll taxes do not pay for your own retirement or disability. They pay for the retirement and disability of previous generations, once or twice removed. The rationale for having a system like this has a lot to do with industrial society and social change.

In primitive societies and pre-industrial agriculture-, service-, and craft-based economies, families tended to stay together and there was a compact between generations that made life sustainable for members of all ages – young, old, and middle. Educational demands were less than now, and children typically began working early. Almost nobody needed a college education, or even secondary school. In 1940 only about 6% of Americans had ever attended college. Now, college education and even graduate school are increasingly regarded as essential to any occupation that will support an average middle-class existence. So the parental generation's financial responsibility for raising children to a productive state was less. At the same time, farms and businesses tended to stay in the family, and elderly parents who could no longer work or be as fully productive as their children, if lucky, were supported by the next generation.

With the advent of the industrial world, this system fell apart. Businesses grew in size and capital. Family ties became less important, and less sustainable. Society became highly mobile, with children and parents often moving frequently and becoming separated by large distances. Educating children took more years of parental support, and when parents assumed a major financial role for that, paying for college for example, it tended to decrease their ability to put aside savings for retirement. Some did, of course, if they were fortunate enough to have ample income; others struggled. Some did not fully support the education of their children, so the next generation became burdened with its own commitments, college loans for example, that limited ability to support aging parents. And, in general, the cohesion of family units became less, so that those of productive age often did not feel as close to their parents and grandparents as once was the case, and not so inclined to help support them. And, people began having less children.

The invention of Social Security was a response to these developments in the post-industrial world. It created a mechanism whereby government became the economic mediator between generations, specifically, taking a portion of the productivity of the current working generation in order to provide a minimum level of support for those in prior working generations who could no longer support themselves or depend on their own children for sustenance. One of the principles of government in a laissez-faire economy is that it has a proper role as a provider of goods and services that people need but can not effectively provide for themselves without cooperative effort. In the case of the missing family ties, through Social Security, government became the "family of last resort." The payroll tax is not an investment for your retirement. It is you helping to support your parents (in the form of the generalized previous generations) in return for the work they did and the support they provided to you (i.e., your generation) when you were young. And for the elderly, it is a consideration for the work they did when they were younger to support the next generation, and only available if they were significant economic contributors, i.e., worked productively and paid their taxes.

If we look at what Social Security is, i.e., a generational transfer system, rather than confusing it with what it is not, i.e., savings or investment accounts, only then can we begin to make rational decisions about its future and how to support it in the long run.

Social Security Finance

Government accounting with regard to Social Security in recent years, particularly by those appointed during the George W. Bush administration, appears to consist of bemoaning projected shortfalls in the very distant future – somewhere between 75 years from now and infinity – with lots of dire numbers, charts and graphs in the budgets and financial reports regarding that time frame, based on current payroll tax rates and projections. Meanwhile, with benefit of this distraction, they collect excess payroll taxes in the present and divert them to reduce the reported deficit resulting from profligate fiscal practices with nary a mention. Like looking for a needle in a haystack: Dig through President Bush's last budget in the linked documents (206 pages), and you will find the off-budget surplus of the trust funds reported only once, and not by that name.

What is the Reality?

The Social Security Trust Fund is currently in surplus. At the end of the 2008 fiscal year the surplus was about $2.4 trillion. Unfortunately, this surplus is not real – a surplus on paper only. The balance in the OASDI trust funds that has accumulated since 1990 because of excess collection of payroll taxes has all been spent by the federal government on operations in return for treasury notes that can only be repaid when needed by – guess who – the American taxpayers, i.e., the same taxpayers who paid the payroll taxes to begin with. So, in essence, the excess portion of the payroll tax that has been collected for the past 19 years actually represents a regressive income tax, charged only for those making under, what is it now, about $100,000 per year?

There is mass confusion regarding what is a Trust Fund. A private trust fund is an asset representing funds invested or loaned to others that can be reclaimed, usually with interest, as needed. Therefore, it is a good thing. A federal government Trust Fund is an accounting gimmick by which a balance is recorded on paper, but required to be loaned to the US Treasury which is required to spend the money and place special IOUs – Treasury obligations that can not be sold to the public – in its place. In the short run, if a small surplus were to arise in one year then be paid back in the next, this is not a problem. It just allows the US Treasury to balance the accounts. But, in the long run, this is not a good thing; in fact, it is a meaningless asset. It is as if you deposited money in a savings account, then borrowed all the money you deposited, spent it, and replaced it with IOUs, then let yourself believe you still had that money available for future necessities. There is no money there; just IOUs to yourself.

In reality, the Social Security and other government trust funds serve as balancing accounts to assure that funds generated by earmarked taxes are sufficient to cover the expenditures for which they are collected each year. For the government to allow any of these Trust Funds to accumulate a balance on the assumption that it is an asset similar to a balance in a private trust fund is a deception that plays on the gullibility and lack of financial sophistication of the American public. The fact that it has been allowed to go on for so long is shameful, and a testimony to the failure of our politicians to deal with financial realities when it appears possible to finance federal operations with "found money" instead of dealing with real issues of tax reform, fiscal responsibility, and fairness.

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The Obama administration should act to eliminate this deception now. By reducing the payroll tax rate to that necessary to support current Social Security outlays or a bit less – so that IOUs in the Trust Funds start to be redeemed out of general revenues – we could provide a tax break for both workers and businesses that would stimulate consumption and employment immediately and improve the future of our economy which will allow it to support Social Security programs in the long run on a current, pay-as-you-go basis.