Every month, 63 million people receive a Social Security benefit, 44 million of whom are retired workers. These retirees tend to lean pretty significantly on this monthly stipend, with 62% counting on their benefit check to account for at least half of their income. Despite this heavier-than-recommended reliance, the program is still responsible for lifting more than 15 million of these retirees out of poverty.
Big problems await America's most important social program
Of course, Social Security is also facing what's arguably its toughest challenge since inception. A handful of ongoing demographic changes, such as the retirement of boomers, increased longevity, lower birth rates, and growing income inequality, is weighing on the program. Beginning perhaps as early as this year, Social Security may expend more than it collects for the first time since 1982. Over time, the net cash outflow caused by these changes is expected to accelerate, with the end result being the complete exhaustion of Social Security's $2.89 trillion in asset reserves by 2034.
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What does this mean, exactly? On one hand, it signals that Social Security's existing payout schedule isn't sustainable and that cuts may be needed to sustain payouts over the long run. The Social Security Board of Trustees has forecast the need for an across-the-board cut to benefits of up to 21% by 2034 in order to mitigate an expected $13.2 trillion cash shortfall on the current payout schedule between 2034 and 2092.
On the other hand, there's pretty much zero concern about Social Security's solvency. The 12.4% payroll tax on earned income and the taxation of benefits will provide plenty of recurring income that can be distributed to eligible beneficiaries. In essence, Social Security is in no danger of bankruptcy, but maintaining its current payout schedule is very much in question without an infusion of additional revenue and/or expenditure cuts.
Did Congress put its hand in Social Security's cookie jar?
With Social Security's problems well known, one of the most commonly requested "fixes" from the public is the idea of the "federal government paying back what it's borrowed from Social Security, with interest."
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The thesis here is that the federal government has unlawfully taken and squandered Social Security's asset reserves on wars and other unnecessary projects. Rather than the program holding its excess cash, it instead is invested in $2.89 trillion worth of special-issue government bonds that the public affably refers to as "IOUs." Folks who believe this thesis suggest that if the federal government were to simply repay what it's borrowed, with interest, the program would be doing just fine and no cuts would be necessary.
While this idea is incredibly common, and quite a few people actually believe it, it's riddled with inaccuracies. The fact of the matter is that Congress hasn't taken a dime from the Social Security program, and every cent that's been borrowed is accurately accounted for. Further, if the federal government were to simply repay what it's borrowed, Social Security would be in much worse shape in the years that lie ahead.
Allow me to explain in easy-to-understand terms.
Changing asset type doesn't mean changing asset value
Imagine you have $1,000 in cash sitting in your bank account, and let's assume, for the sake of simplicity, that you don't need this $1,000 for any near-term bills or emergency spending. You could choose two paths for this cash. First, you could let it sit in your account, although it'll slowly lose value over time to inflation, which is the rising price of goods and services. Or, second, you could put this money to work and allow it to grow over time.
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Let's say you chose the latter and decided to purchase a certificate of deposit (CD) at your current bank or credit union. Rather than the money simply sitting in your account and collecting dust while losing value to inflation, your money will instead be earning interest income over time. What's more, the $1,000 in principal that you gave to your bank is still very much there. In other words, it hasn't lost or gained value. You've simply changed the state of the asset from cash to a CD.
Why the long-winded example? Because the Social Security Administration (SSA) has done the exact same thing with its net cash surpluses. The SSA is required by law -- i.e., it's not just investing in bonds on a whim -- to purchase special-issue bonds and certificates of indebtedness with the program's excess cash. Instead of having $2.89 trillion in cash sitting around and collecting dust while losing value to inflation, this cash is earning an average rate of 2.848%, as of the end of February 2019. Again, no value from Social Security's asset reserves has disappeared. The only thing that's changed is the state of the asset from cash to bonds.
If Congress repaid what it's borrowed, Social Security would be in much worse shape
There are two very important things to note here. First, the Social Security program is already collecting interest from the federal government. I often hear folks complain on social media about the federal government borrowing from Social Security without paying interest, which simply isn't true. In 2017, the program collected $85.1 billion in interest income, and it expects to earn an estimated $804 billion from interest income between 2018 and 2027.
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Second, note that changing the state of an asset doesn't mean changing the value of that asset. Regardless of whether the SSA were holding cash or bonds, the program's asset reserves are $2.89 trillion right now. Therefore, even if the federal government were to pay back $2.89 trillion in bonds, the total asset value of the program's reserves would be...still $2.89 trillion. Thus, the argument that suggests the federal government repay what it's borrowed would not create any new value. It would simply change the state of the reserves from bonds to cash and, in the process, take away the valuable interest income that contributed $85.1 billion in 2017.
Long story short, the idea of the federal government absconding with Social Security's excess cash and not paying interest on this cash is a long-running myth that seriously needs to go away. The truth is that if the federal government did repay what it's borrowed, Social Security's cash crunch would get a whole lot worse, and benefit cuts might be steeper and happen sooner than expected.
