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Social Security 101
A Concise History of Social Security | Understanding Social Security | Is Social Security Safe?
A Concise History of Social Security
Creation
Social Security was created in 1935 at a time when very few workers were covered by pensions. The pensions that existed were not guaranteed and many who were”covered” never got what they earned. The original act had two components, a retirement benefit that covered only workers that was not supposed to pay benefits before 1942 and a welfare program called Old Age Assistance. The funding level for the retirement benefit was low, one percent of wages from the employer and one percent from the employee.
From the beginning Social Security was intended as a base support for retirement to be supplemented by private pensions and savings for those able to invest in a higher retirement lifestyle.
Reform
Social Security has been reformed many times but the basic concept of social insurance has never been changed. Social Security insures against poverty for the living and a key element to its financial success is that some workers pay the tax but do not live to collect any, or only a partial amount, of their entitlement. (The privatization proposals would take money out of the common funding pool for the benefit of the heirs of investors.)
Another key part of the social insurance concept is that benefits are paid according to a progressive funding formula aimed first of all at overcoming poverty. The benefit formula also recognizes that those who paid higher level of taxes should get a higher benefit upon retirement, and, with the boost from those who pay taxes but die early, Social Security retirees have gotten their money’s worth in comparison to the returns from private pensions.
Social Security was amended in 1939 to provide limited support for the survivors of deceased workers and support for spouses of deceased workers or retirees when the spouse reached retirement age. Additionally, the 1939 Act provided for keeping the income from the Social Security payroll tax in a separate fund.
A major reform occurred in 1950 when the Old Age Assistance program was phased out and the Social Security retirement benefit were increased by 77 percent, bringing all recipients into the retirement program. The payroll tax was raised to 6.5 percent to cover the change. These changes were strongly supported by employers who considered Social Security cheaper than private pensions.
From 1950 to 1972 numerous improvements were made and many more groups of workers, such as clergy, were brought into the Social Security program, reaching near universality by 1965. In 1969 benefits were raised by 15 percent and in 1972 by an additional 20 percent with the addition of automatic increases to offset inflation. In 1956 the disability program was added. Early retirement at a reduced benefit rate was allowed for women in 1956 and men in 1961.
In 1983 several significant changes were made to strengthen the financial base of Social Security. President Reagan initially proposed sharp cuts in retirement and disability payments. Instead, a bipartisan compromise decided to reduce the benefits of Social Security recipients with an earnings penalty for wages above a certain level, to delay a cost-of-living increase for 6 months, to reduce the income of those who retired early, to raise the age of full retirement to 67, which has just recently begun to phase in, and to slightly raise the payroll tax. These changes, with an improved economy, have dramatically changed the funding base for Social Security. Instead of a pay-as-you-go reality, tax-payers have begun to significantly forward-fund their own retirement by greatly increasing the Social Security Trust Funds to about $1.6 trillion dollars with a projection that the Funds will increase to over $6 trillion dollars in the 2020s.
In the 1990s the wage penalty was ended.
The Current Picture
According to the 2004 report of the Social Security trustees, “At the end of 2003 47 million people were receiving benefits: 33 million retired workers and their dependents, 7 million survivors of deceased workers, and 8 million disabled workers and their dependents.” (Numbers rounded by SSA) The average retirement benefit is $10,000 a year. Despite a weakened economy and a failure to recover to the 2000 level of employment, the Social Security trust funds still increased by $152 billion in 2003.
Social Security has largely achieved its primary goal. The rate of poverty among the elderly has been reduced from 35 percent in the 1950s to 10 percent today.
Understanding Social Security
Description
Social Security is a social insurance program designed first of all to reduce poverty among the elderly and then expanded to include support for the dependents of retirees, for the spouses and children of deceased workers, and for those who qualify as disabled. Begun in 1935, it has been repeatedly expanded, has repeatedly increased the benefits for those served, and has repeatedly raised the payroll tax by which the program is funded.
Social Security has largely reached its initial goal of reducing poverty among the elderly. The elderly poverty rate has dropped from 35 percent in the 1950s to about 10 percent today. Currently about 47 million people receive some benefit from Social Security. 40 million retirees and their dependents receive an average payment of $10,000 a year. Social Security provides more than half of the income for about two-thirds of elderly households.
How It Works
Social Security is paid for by a 12.4 percent tax on wages up to a maximum of $87,900 in 2004. The maximum increases annually in response to inflation. Payment of the retirement benefit is according to a formula that gives some advantage to those with lowest incomes but is also weighted to pay higher benefits to those who paid in higher payroll taxes. While the current political focus is on issues of retirement, it should be remembered that the benefits paid to the disabled, to the survivors of deceased workers, and to the spouses of retired workers are a critical part of the anti-poverty effort of the United States.
The basic operation of Social Security is extremely cost-effective because the income is gathered inexpensively through the annual income tax structure, the investment process is very inexpensive because the trust funds are fully invested in the equivalent of treasury bonds, and the payout system is inexpensive because all beneficiaries are paid according to nationwide formulas. The main operational challenges are running the Social Security centers that register participants and dealing with issues in record keeping.
How The Money Is Handled
The tax revenue comes into the U.S. Treasury and is distributed to the two Social Security Trust Funds: the Old Age and Survivors Insurance Trust Fund and the Disability Insurance Trust Fund, jointly called the OASDI Trust Funds. $533.5 billion dollars was collected in tax revenue in 2003. The trust funds also increased by $84.9 billion from interest payments by the U.S. Treasury for the Social Security investment in the equivalent of Treasury Bonds, and by $13.4 billion from the income tax paid on Social Security benefits. Total income was $631.9 while benefits cost $474.5 billion, and the administrative expense was $4.6 billion. The net income of $152.8 billion was invested in additional equivalents of U.S. Treasury bonds. At the end of 2004 the OASDI Trust Funds were worth more than $1.6 trillion dollars.
If the time comes, as expected, when benefits and administration cost more tax revenues, then the trust funds will be reduced to pay the difference. Since the trust funds are expected to grow to a sufficient amount, over $6 trillion in the 2020s, to pay for the influx of “Baby Boomers” born in the late 1940s and 1950s into the retirement program, the long range question is about the relationship of the longevity of retirees to the level of the U.S. economy that generates the payroll income upon which the Social Security system is based. There are many factors that affect the economy. One rule of thumb is that if the economy stays as strong as it has been for the last decade, including the downturn since 2000, there would be no long term problem. If the economy turned bad, and stayed bad, then there would eventually be problems.
From 1935 to 1983 the trust funds stayed close to zero. Income was only a little higher than benefits and administrative costs. Since the changes made in 1983 the trust funds have sharply increased so that current generations are partially forward funding their own retirement. Social Security financing is stronger than it has ever been and so it is quite surprising that the scary rhetoric by opponents of Social Security has gathered significant political strength.
Those promoting the idea that Social Security is in economic crisis overlook the unpredicted improvement in the OASDI trust funds since 1983 and focus on the prediction of the Social Security Trustees that the funds will run out of money in the 2040s with reduced payments to today’s younger workers.
First of all, it should be noted that the prediction of the Trustees are made on assumptions about the birth rate and the general economy that are worse than the experience of the last dozen years, and in the case of the economy, worse than the average U.S. economy since 1960.
Furthermore, those promoting fear assume that the federal government would not do anything to correct problems that would show up decades before they became serious. This assumes that future governments would be far more hard-hearted than all the governments from 1935 to the present that have improved, expanded, and strengthened the core Social Security programs.
Privatization?
The several privatization plans promoted as “saving” Social Security are all wolves in sheep’s clothing. They would take money out of the general Social Security accounts and trust funds and turn them into private investment accounts that individuals would own. This approach undercuts the fundamental social insurance concept of Social Security, that makes the benefit formulas come out so nicely because the money goes to those who live long enough to get it and not to the heirs of those who died at a younger age. Social Security is an anti-poverty program for all U.S. elderly and a floor of income for those fortunate enough to have pensions and/or savings. Because of the social insurance design, even with the weighting of benefit formulas to those with lowest incomes, surviving elderly get their money’s worth in benefits for their tax payments into Social Security compared to average pension investments.
The financial problems facing the elderly come from breakdowns in the private sector from pension troubles and a lack of adequate savings, not from any problem with Social Security. Things could be done to strengthen pensions and savings but that can be done in addition to, not by attacking, Social Security.
Is Social Security Safe?
The Short Answer
Social Security is as safe as the economy of the United States. Social Security helps the economy in hard times because the benefits paid by Social Security continue in hard times and serve as a stimulus to the economy to counteract downward pressures. The main thing to remember is that a decline in tax revenues because of a bad economy would be a problem that touches all society, not just Social Security.
A More Complete Answer
A lot of damaging and misleading things have been said by opponents of Social Security in hopes of scaring the people of the United States into radically changing the most successful anti-poverty program in the history of the United States. Before getting to the substantive debate, some widely promoted negative mythology has to be cleared up. This negative mythology has been so successfully promoted that many politically progressive people believe it and some news sources that should know better report the negative mythology as if it were fact.
In an attempt to undercut confidence in Social Security, then (2001) Treasury Secretary Paul O’Neill said, “The Social Security Trust Fund does not consist of real economic assets.” No doubt Mr. O’Neill has some definition of “real” that he thinks makes it acceptable to say such things, but the clear intent is to make people uncomfortable about the security of Social Security.
The Social Security trust funds are totally invested in the equivalent of U.S. Treasury bonds. When Mr. O’Neill was selling treasury bonds to individuals, to corporations, to local and state governments, and to foreign nations he got very low interest rates because all the buyers believed that U.S. Treasury Bonds are among the safest of all possible investments.
The substantial question is the one repeatedly posed by the Social Security Trustees in their annual reports. By law they are required to predict the future solvency of the Social Security Trust Funds. Until 1983 those funds were close to zero and just about all of the income from payroll taxes was used to pay benefits to then current Social Security retirees and their dependents, to the survivors of deceased workers, and to those eligible for disability payments. In 1983 changes were made that have led to a sharp increase in the trust funds to a current level of about $1.6 trillion dollars. The prediction is that they will rise above $6 trillion in the 2020s. In the short and medium run, Social Security has never before had it so good.
But what about the long run? The trustees predict that the trust surpluses will all be gone in the 2040s. (The Congressional Budget Office recently set a date in the 2050s.)
The first thing to remember is that it is very hard to make long term predictions. The predictions of 1983 were not for any thing like a $1.6 trillion surplus in 2004. In the late 1990's the economy sharply out performed even optimistic predictions, employment was higher than many economists thought was possible, and the trust funds racked up big gains. Even in the weak economic and employment year of 2003 the trust funds increased by $152 billion dollars.
The trustees predict that the economy is going to be worse than the average economy between 1960 and 2000 and significantly worse than the economy for the last ten years. They also make gloomy demographic projections. Despite the fact that the total fertility rate (number of babies per woman) has been over 2.0 since 1990, they predict 1.95 and then argue that there wont be enough workers to keep the economy going. Similarly, despite recently high rates of immigration they predict low immigration. In short, if the population and the economy continue like they have for the last ten years there would be no long-range Social Security funding problem. Since both political parties and most citizens want a strong economy, why pick assumptions that lead to prediction of a bad economy? Social Security looks reasonably safe for a long time unless we give in to fear, unless we allow opponents of the core concepts of Social Security to have their way.
Written by: Pat Conover (January 2005)
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Last Updated January 1, 2005
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