Social Security 101: What’s next?

In my last post, I went over the basics of Social Security: how the system works, how benefits are determined, and what the Trust Fund does. Now, to get an idea of where the system is headed, and why we should be paying attention to it, we need to look at its finances and projections over the next few decades.

Social Security has three main sources of income: payroll taxes, benefits taxation, and interest income. Payroll taxes, which amounted to $564.2 billion in 2011, are the 6.2% of wage withheld from workers’ paychecks. Since 1983, retirees’ benefits are also taxed before they receive their checks. Benefits are treated just like ordinary income, and are taxed as such, depending on which income bracket the retiree is in. Receipts from benefits taxation amounted to $23.8 billion in 2011. The last primary source of income for the program is interest, which is earned from the investment of surplus funds in government-issues securities. As I mentioned in the last post, Social Security is required by law to loan any surplus revenue to the federal government. This means that the Trust Fund is made up of government bonds that will be redeemed as the Trust Fund gets drawn down. As long as the Trust Fund holds these bonds, it is also earning interest off of them. This interest comes directly out of the General Fund of the Treasury to finance each year’s benefits. Interest income in 2011 totaled $114.4 billion, accounting for about 3% of the federal budget. As you can see, the majority of the program’s receipts come from payroll tax contributions, which make up 70% of its income.

One quick note I want to make about payroll tax contributions in 2011: for the first time ever, in December 2010, in an effort to help the ailing economy, Congress passed a temporary payroll tax cut, reducing the payroll tax rate to 4.2% of wages for one year. The tax cut was then extended in December 2011 for another two months. In February 2012 the tax cut was again extended to the end of 2012 as part of the Middle Class Tax Relief and Job Creation Act of 2012. There was much ado about how this would affect the finances of Social Security. The answer: it didn’t.

As part of the tax cut, the General Fund would reimburse Social Security each year by the amount of forgone payroll tax contributions. In 2010, Social Security lost $2.4 billion because of the cut and was repaid this amount by the federal government. In 2011, the tax cut reduced payroll tax receipts by $102.7 billion, which was also reimbursed. As a result, Social Security income was $805.1 billion in 2011. This obviously does not affect Social Security’s financial position, but for those deficit hawks out there, it is yet another expenditure (that’s right: tax cuts cost money) piled on to the already staggering federal deficit. The cost of the tax cut was nearly as much as the federal government’s interest payments on the Trust Fund.

Social Security has three main expenditures: benefits, Railroad Retirement Benefits (RRB), and administrative costs. Benefits totaled $725.1 billion in 2011. The Railroad Retirement program covers all rail employees. [They pay higher payroll taxes and in return receive higher benefits. They pay the typical 6.2% for Social Security and (well, 4.2% considering the payroll tax cut) and 1.45% for Medicare. On top of this, they pay 3.9% on earnings up to $79,200 and the employers pay 12.1%.] Benefits for the Railroad Retirement program totaled $4.6 billion. Administrative expenses totaled $6.4 billion in 2011, or about 0.9% of total Social Security disbursements.

To sum up:

Total 2011 receipts:

Net payroll tax contributions……………………………………$564.231 billion
Benefits taxation………………………………………..……………..$23.792 billion
Interest income………………………………………..……………..$114.354 billion
Total receipts………………………………………………$805.057 billion

Total 2011 disbursements:

Benefit payments…………………………………………………..$725.103 billion
Railroad Retirement benefits……………………..………………$4.574 billion
Administrative expenses…………………………………….……..$6.405 billion
Total disbursements………………………………….$736.083 billion

As you can see, Social Security did pay out more in benefits than it took in through net payroll tax contributions, but when you consider interest income and benefits taxation, total receipts still exceed total disbursements. However, based on intermediate 2011 actuarial projections, we should expect to see the total disbursements figure surpass total receipts in 2021. The chart below details projected finances over the next 10 years.

from the 2012 Trustees Report

If you look at the column under “Assets” named “Net increase during year,” surpluses actually increase from 2013 to 2017, and then fall dramatically starting in 2018. This column calculates the overall surplus of the program, which in turn is how much additional money is put into the Trust Fund (and subsequently loaned to the federal government to earn interest). This is due to growth from the recovered economy, which will help Social Security’s outlook for a few years. From 2021 on, the program is expected to run increasing deficits unless legislation is enacted to address this.

It’s also important to look at the column under “Assets” named “Amount at the end of year.” This column measures the amount of total accumulated surpluses in the Trust Fund at the end of each year. Every year there is a surplus, the total assets increase by that amount. This also means that, starting in 2021, deficits require money to be drawn out of the Trust Fund. The increasing deficits from 2021 onward are projected to exhaust the Trust Fund by 2033. At that point, benefits will instantly be cut to 74% of promised benefits under current law.

This all should cause us to wonder, exactly when is there a real and dire problem? Was it in 2008 when the first baby boomers retired? Was it in 2009 when benefits payments first exceeded net payroll tax contributions? Is it 2021 when we first run an overall program deficit? Or is it 2033, when the Trust Fund is expected to be depleted and benefits will be cut? There is no right answer, but we can all agree that there is a clear problem that will grow more formidable with time. And the longer we wait to address it, the more costly it will be for the entire population.

– Anthony

Social Security 101: The Basics

As I’ve mentioned before, my pet issue is Social Security. Why? I don’t know. It probably seems pretty boring, but it’s relevant to nearly all American citizens, and it’s something that will be a major issue in about 10 or 15 years. Indeed, it’s very important that people, especially my generation, take the time to learn how the program works and what the future looks like for the program. Especially when it comes time to make some important decisions about Social Security, we need to be able to separate fact from fiction, and critique the statements that will undoubtedly be made by Democrats and Republicans about the program. In this post, I will run through some of the basics of Social Security that may serve as a foundation for future posts.

1. Social Security is independent of the general fund of the Treasury. That is, it has its own source of income (payroll taxes) which finances its outlays (benefits). Currently, the payroll tax rate is 12.4% (6.2% paid by employees, and 6.2% paid by employers).
2. It is a pay-as-you-go system. So the payroll taxes withheld from your paycheck today finance the benefits of current retirees. Often, people talk about the worker-to-beneficiary ratio, which measures how many workers are currently paying into the system compared with the number of retirees currently receiving benefits. That ratio was about 2.9 in 2011 and will decline to about 2.0 in 2035 when the baby-boom generation will have largely retired, and with further gradual increases in longevity.
3. Benefits are determined based on one’s highest 35 years of (taxable) earnings (see #4). These earnings are indexed for inflation (bring previous years’ earnings to current-year dollars) and then averaged to get one’s Average Indexed Monthly Earnings (AIME). One’s Primary Insurance Amount (PIA) is calculated from the AIME. The PIA formula is progressive, in that it redistributes some contributions from high-earning workers to lower-earning beneficiaries. More on this in a later post.
4. Payroll taxes are levied on earnings up to a certain amount. Currently, that amount is $110,100 and is indexed with average wages (rises proportionally with average wages each year). In this way, the program is also regressive. For example, an individual making $120,000 per year will pay the same amount in taxes and receive the same benefits as an individual making $2,000,000 per year. And both will pay less than someone making $45,000 per year as a percentage of total income. The individual making $120,000 per year will pay 6.2% of the first $110,100 of his earnings, which amounts to $6,826.20, or about 5.7% of his total income. The individual making $2,000,000 will pay the same in payroll taxes, which makes up 0.3% of his total income. However, the individual making $45,000 per year still pays 6.2% of his total income because his earnings are not above the taxable maximum ($110,100). As you can see, the program has both progressive and regressive components.
5. When Social Security brings in more money in payroll taxes than it pays out in benefits, that money is put in the Federal Old-Age and Survivors’ Insurance Trust Fund, or just “the Trust Fund.” Since 1983, the program has run surpluses and these surpluses have been put in the Trust Fund. In a future post, I will go into more detail about the Trust Fund, but it will suffice to say here that by law, each year’s surpluses are required to be loaned to the federal government. Essentially, the Trust Fund consists of accumulated surpluses invested in Treasury securities (bonds), and earning interest on these bonds. The year 2011 was the first year in which Social Security paid out more in benefits than it brought in through payroll taxes. However, the program also earns interest income from these surpluses, as well as taxes paid on benefits. So the program did not run an overall budget deficit. When it does, it will start redeeming some of the bonds held in the Trust Fund, and tap into those surpluses that have accumulated from 1983 to 2011. It is currently projected that the Trust Fund will be exhausted by the year 2033.

There are many more details associated with Social Security, but these are the nuts and bolts. Be on the lookout for the next post, in which I’ll tell you exactly what the future looks like for Social Security – and for you and me.

– Anthony