Volume 1: Social Security

Three Trillion Dollars in a Filing Cabinet

“You really should read the OASDI Trustees Report,” - Anonymous

Like so many pieces of advice I’ve given to my friends, I would guess this one has literally never been followed. But why haven’t you read the report? If you work for 40 years and earn $100,000 per year, by the time you retire you will have invested $496,000 into Social Security, based on current tax policy. Do you have other large investments that you know nothing about?

Despite being a constant in political discussions, and representing annual payments of $888 billion – 24% of the federal government’s budget – most people have no idea what Social Security is, how it works or what its future looks like.

  • What is Social Security?

  • How does Social Security work? What is the “Trust Fund”?

  • What is the prognosis for the system? Is there a “crisis”?

  • What about the various changes that have been proposed?


What is Social Security?

“Social Security” is the common name for the Old-Age, Survivors, and Disability Insurance (“OASDI”) Program. Created by the 1935 Social Security Act as part of the New Deal, the intention was to combat rampant poverty among seniors, which at the peak of the Great Depression was approaching 50%(1). The Social Security Administration (SSA) was created to manage the program. An initial check for $22.54, written to Ida May Fuller in 1940(2), has evolved into the largest Federal Government expenditure and a major factor in the US economy. As of 2015, 60 million Americans were receiving benefits from Social Security(3).

In the eighty years of its existence, Social Security has been modified many times by Congress. Some of the major events in the program’s history are(4):

  • 1939: Spouses and minor children added as beneficiaries

  • 1954: Disability program added

  • 1960: Supreme Court clarifies several topics related to Social Security

  • 1965: Medicare created

  • 1977-1983: Significant changes to funding and benefit calculation to ensure stability

  • 1997: Temporary Assistance for Needy Families and State Children’s Health Insurance Program added to SSA

According to the Center on Budget and Policy Priorities, in 2015, Social Security income raised 22 million Americans out of poverty(5).

How does Social Security work? What is the “Trust Fund”?

Social Security is deceptively simple. If you look at your paycheck stub, you will see a field “FICA SS Tax” or something similar. This is equal to 6.2% of your earnings, up to a cap of $118,500 per year. If you have ever managed a payroll, you’ll know that companies pay the same amount based on their employees’ earnings(6). This money goes to the SSA, who sends out monthly checks to beneficiaries(7). The amounts of the withholding taxes and benefits are set by Congress(8). Any extra cash generated goes to the “Trust Fund”(9).

Social Security is a “pay-as-you-go” system, fundamentally different from how a pension funds operate. In a pension fund, contributions are made by or on behalf of current workers, invested until they retire, and then paid out to the same workers. In Social Security, the contributions made today are used primarily to fund today’s retirees. At some point around 1980, some nerds(10) looked at the numbers and saw there was a problem – the system was doing well today, but down the road the demographics didn’t look good. So they made a bunch of changes (increase taxes, reduce benefits, increase retirement age) to ensure the system would remain solvent. The Trust Fund started to grow.

Fast forward to today – the Trust Fund is going strong with $2,800,000,000,000(11) or so in the bank. But of course, the way in which this huge sum is managed is not straightforward, because freedom or something. The Trust Fund used to hold regular old US Government securities, but the Social Security Administration couldn’t handle the mark-to-market. So they created a new class of securities (“special issues”) which can be redeemed by the Trust Fund for face value at any point(12). The certificates for these securities are – literally – in a 3-ring binder in a filing cabinet in Parkersburg, West Virginia.

After touring the building where the filing cabinet sits(13), President Bush made a controversial statement about the nature of the Trust Fund(14):

"There is no "trust fund," just IOUs that I saw firsthand, that future generations will pay -- will pay for either in higher taxes, or reduced benefits, or cuts to other critical government programs.

The office here in Parkersburg stores those IOUs. They're stacked in a filing cabinet. Imagine -- the retirement security for future generations is sitting in a filing cabinet. It's time to strengthen and modernize Social Security for future generations with growing assets that you can control, that you call your own -- assets that the government cannot take away."

I disagree with this description. While they are not marketable, the “special issues” are backed by the “full faith and credit” of the US Government in the same way “normal” Treasuries. Failure to pay them would be a default on federal obligations. And the $2.8 trillion isn’t money that future generations will pay – it’s money that past generations have invested in US government debt. It did not change the amount we have borrowed; if the Trust Fund wasn’t holding it, somebody else would be. I would mostly agree that the government could take them away – but what type of investment can’t the government take away, if it wanted to? I agree completely that we could probably find a better plan than storing $2.8 trillion(15) in a filing cabinet in a small city in West Virginia.

But let’s focus on what he said would happen if the Trust Fund were depleted. Fortunately, we know the answer, because it is in the law. Social Security has a dedicated funding source, so a deficit would be bridged by reducing benefits(16). This would indeed be bad for people who were expecting to receive full benefits.

What is the prognosis for the system? Is there a “crisis”?

The phrase “Social Security Crisis” has been thrown around so much that it’s lost all meaning(17).

Let’s look at wh