Shmoop Politics Guide: Social Security Privatization Debate

The Question: Does America need to reform Social Security?

At Issue:

What’s wrong with Social Security?

Everything!

Or maybe nothing.

This is one of those issues where the two opposing sides see things so differently that they have almost nothing in common.

Take one:  The basic math of Social Security is horribly broken.  People are living longer, which means that more and more retirees have to be supported, over time, by fewer and fewer workers.  The entire program is thus a ticking time bomb, which will eventually bankrupt the government.  Young people paying into the system today will almost certainly never get the same kind of benefits retirees receive today.  The only way to save Social Security is either to privatize it – essentially scrapping the existing system – or sharply increasing taxes or cutting benefits.  The greatest risk to Social Security is inaction; if we fail to act now to reform the system, if will surely collapse in the near future.

Take two:  The basic math of Social Security is just fine.  In fact, Social Security runs at a huge surplus, and if the American economy continues to grow in the future at anything close to the same rate as it has grown over the past 80 years, Social Security will continue to run at a surplus forever.  And even if overall economic growth slows in the future, Social Security’s problems won’t be too hard to fix with only minor tax increases or benefit adjustments.   The greatest risk to Social Security comes from people losing faith in the system, which could allow unnecessary radical changes to destroy the most successful government program in U.S. history.

So there you have it:  either Social Security faces huge, devastating problems… or no problem at all.  We either desperately need to do something right now to reform a failing system… or we desperately need to block anyone who wants to pass radical reforms that could break a successful system.

Well, that’s about as clear as mud!

Why You Care:

If you’re a teenager, you might not care too much about Social Security… yet.  But you will.  Retirement probably seems a long way off – and it is! – but you probably would prefer not to have to work until the day you die.

And even if that’s barely on your radar, you should care about Social Security because you’re paying for it!  Now, today, every single time you get a paycheck and notice that somebody named FICA took a pretty big cut right off the top.  Even if you don’t make enough to pay much (or any) income tax, you still have to pay your share of Social Security.  So… what are you going to get for your money?  Will Social Security still be there in 40 or 50 years when it’s time for you to cash in?  Or is the whole system about to go broke, leaving you holding the bag?

Dive Deeper in Shmoop US History, Biography, and Economics

Context:

Social Security has been around since the 1930s, when President Franklin D. Roosevelt made it the centerpiece of his New Deal response to the Great Depression.  The basic idea is pretty simple: all workers contribute to a government program, which then guarantees all workers a modest government-funded pension when they retire.

Social Security basically invented the concept of “retirement”; before the program existed, most Americans workers had to stay on the job until the day they died.  And the program has always been quite popular with the public, even as the country as a whole has shifted to a more conservative, anti-government politics over the past few decades.  Political scientists call Social Security “the third rail of American politics,” meaning that politicians who try to touch it tend to end up getting fried.  To take one recent example, George W. Bush led an effort to privatize Social Security shortly after winning a second term in 2004 and saw his public approval ratings plummet to depths from which he never recovered.

Apparently not learning from this history, though, and worried about long-term budget deficits, President Obama recently announced the formation of a bipartisan commission to study Social Security reform.  The commission hasn’t even started its work yet, but this has mobilized defenders of the program as it is to resume defending it, while energizing proponents of change to push harder for change.  The future of this 70-plus year-old-program may be determined over the next several months.

So what’s the deal with Social Security?

Before you can weigh the pros and cons of reform, you need to understand how Social Security works (and how it might be broken).

Social Security raises its revenues through a payroll tax.  Everyone who works – well, almost everyone; there are a couple oddball exceptions you don’t really need to know about – pays 7.3% of their earnings into the system.  (And their employers pay an equal amount; economists argue that this cost gets passed onto workers through lower salaries, effectively making the Social Security tax rate 14.6%.)  Unlike income taxes, the payroll tax has no deductions or loopholes.  Also unlike income taxes, which are paid at higher rates by rich people than by poor people, the Social Security tax rate is the same for everyone… up to a point.  There is actually an annual cap – if you make more than $106,000 a year, you don’t have to pay any Social Security tax at all on earnings above that amount.  This means that a person who makes $10,000 a year pays payroll tax at the exact same rate as someone who makes $100,000 a year, and both of them pay at a much higher rate than someone who makes $10 million (since only the first $106,000 of his earnings get docked for Social Security taxes).  The average (median) American family actually pays more in payroll tax than in income tax.

Very long story short: some people think this system is fair, and some don’t.  There are reasonable arguments in favor of the cap, and reasonable arguments in favor of getting rid of it.

Anyways… what happens to all of this money raised by these payroll taxes?  It funds retirement pensions (and disability pensions, too) for people who used to contribute to Social Security but are no longer in the workforce.  Anyone who lives long enough to start collecting benefits (traditionally age 65, now rising to 67) gets a pension check from the government every month until they die.

It’s important to understand that Social Security is not like a savings account; the money you send with each paycheck in is not being set aside for you to use later.  Instead, it’s being used now to pay for retired workers’ pensions today.  When you retire several decades from now, the workers of the future will be paying for you.  (Presuming the system hasn’t radically changed, of course…)  The monthly amount of your benefits will change a bit, depending on how much money you contributed over the course of your working life.  But whether or not Social Security is a “good deal” for you will depend almost entirely on how long you live.  If you contribute payroll taxes for your entire working life and then kick the bucket on your 65th birthday, you get hosed.  On the other hand, if you live to the ripe old age of 107, you’ll get out way more from Social Security than you ever put in.

But will the system even still be there by the time you retire?  Social Security faces financial challenges that have led many to believe it is unsustainable.  Why?  Because more people are living longer, which means that the ratio of workers to retirees is getting lower.  Think about how the system is funded, again: Social Security works as a giant transfer of wealth from younger working people to older retired people.  This works great… as long as the workforce keeps growing (and the workers’ salaries keep growing, too), fast enough to offset the increase in the number of retired people.  But if payrolls don’t grow fast enough to keep up with retirees, the system starts losing money.

Needless to say, most people today live longer than they did in the 1930s.  And American families are having fewer children, which means that the workforce isn’t growing as fast as it used to (except by immigration, which has slowed dramatically over the past few years).  And wages and salaries haven’t been increasing as fast as they used to, either.  All of this means that Social Security’s future is in question.

Today, the program continues to operate most years at a fairly substantial surplus, meaning it takes in more than it pays out.  (2009 was an exception, due to the terrible recession cutting into payrolls… but hopefully that was a short-term aberration.)  Those annual surpluses pile up in the Social Security Trust Fund, which currently holds more than $2 trillion.  If and when the annual surplus turns into an annual deficit, the Trust Fund will begin to draw down.  And if payments then continue to outpace revenues over the long-ish term, the Trust Fund will eventually go broke.

When will that happen, if it happens at all?  Unless you’re a palm reader, predicting the future is hard to do.  Every year the Social Security Trustees – the folks who run the program – issue a report giving their best guess of the program’s future outlook.  Each time, they offer three scenarios – one optimistic (they call it “low-cost”), one pessimistic (“high-cost”), and one in the middle (“intermediate”).  In 2010 the intermediate projection, which usually gets the most attention in news headlines, predicted that the program would continue to operate in surplus through 2024, begin drawing down the Trust Fund in 2025, and exhaust the Trust Fund’s savings in 2037.  Under the pessimistic forecast, those bad things start happening even sooner; under the optimistic forecast, Social Security actually keeps operating in surplus forever.

Historically speaking, the optimistic forecast has actually performed closest to reality.  But there’s no guarantee that it will continue to do so in the future.

So… is the substantial (but not certain) risk that the Social Security Trust Fund is going to go broke sometime in the 2030s enough of a danger that we should overhaul the program today?

Key Arguments:

The debate over Social Security tends to fall into two camps: those who want to change the program in fundamental ways (usually by privatizing it) and those who want to keep it the same or make only minor changes to tinker with the existing system.  Here are some of both sides’ key points:

Arguments for Overhauling Social Security:

  • Unsustainable Financial Structure: The ratio of workers to retirees has already shrunk substantially since the program began, and will continue to shrink in the future.  Fewer workers paying for more retirees just doesn’t add up.
  • Longer Lifespans: Retirees are living longer than they used to, which means they’re drawing more Social Security benefits.  This, too, is financially unsustainable.  The retirement age must be raised or
  • Advantages of Privatization: Transforming Social Security into a system of private accounts would allow savvy individuals to make good investments, which would potentially earn them more money than current government benefits.  Private accounts would also reward individual initiative and reduce dependency on government.
  • Urgency: It’s not fair for young workers to have to pay into the system, if it’s not going to be there to support them when they retire.  The sooner we get this sorted out, the better.  Waiting until the existing system goes broke will only make things worse.

Arguments Against Overhauling Social Security:

  • Better Financial Outlook Than Most People Think: Social Security’s finances are in better shape than many want you to believe.  There is a decent change that the program will keep operating in surplus forever.  And even if it doesn’t, future shortfalls could be covered with small tweaks to Social Security taxes or benefits. No radical revamp of the program is needed.
  • Longer Lifespans Don’t Equal Longer Retirements: It’s true that the average American lives longer today than he did in the 1930s.  But most of those gains came from reductions in childhood mortality – a lot fewer 3 year-olds today die of polio, whooping cough, and so on.  The average man who made it to age 65 back in 1940 lived to age 77, meaning he drew 12 years’ worth of Social Security.  Today, he lives to age 80.  Those extra three years of Social Security checks shouldn’t cripple the system.
  • Risk: The whole point of Social Security is “security.”  Switching to private accounts would expose individuals to huge risk; what happens if the stock market happens to take a dive right when you need to retire.  And what happens if your private account runs out when you hit age 88, but you live to 103?
  • No Urgency: We literally have decades to solve this problem, if there even really is one.  If the Trust Fund really does start being drained 15 years from now, we can come up with a fix then.  The risk of ill-advised change today is much greater than the risk of waiting.

4 thoughts on “Shmoop Politics Guide: Social Security Privatization Debate

  1. Good article, but it is missing the most important argument against Social Security, that the Social Security Trust Fund surplus doesn’t actually exist. It is just not-so-clever sleight of hand accounting trick because the US Gov’t already spent all the money and replaced it with IOU’s to itself (which officially is not counted as part of the national debt). When the SSA needs to make a payment to an old investor, they use the incoming cash from the new investor. This is by definition a Ponzi scheme.

    The esteemed Thomas Sowell of Stanford’s Hoover Institution elaborates nicely:

    http://www.capitalismmagazine.com/markets/enron/1505-Social-Security-The-Enron-That-Politicians-Have-the-Closet.html

    http://www.freerepublic.com/focus/f-news/1960139/posts

  2. ~ The commenter “Chris Finne” has a good point. . . . Actually, if you listen to some politicians comments about SS – they say that there is nothing in the Trust Fund but IOU’s……. and I believe that is the concern – – NO MORE RESERVES. And, maybe even a minus (if that’s possible)…..Mr. Finne is right to say it is now nothing more than a Ponzi scheme –

    So, our own govrnment has stiffed the people – how’s that for a government that is supposed to have our interests at heart and not put their greed and opportunistic natures ahead of that. . . .

    Social Security was doing so well – the politicians couldn’t stand the money just sitting in those reserves doing nothing……. It was burning a hole in their greedy pockets. The devil made them do it and every other clechett you can think of to explain their behaviors. . . . . .

    Yet their is a govenment website that does not reflect this supposed truth, in fact it claims SS is funded for at least another 30 or so years….. Go figure.

  3. My Long Lasting Fix Idea is to put SS into a LOCK-BOX as some politicians have suggested, never to be stolen again by our own govenment.

    To catch up on reserves – – some of it should be invested – in safe investments. Florida’s Pension Fund has been a success story – just find out how they have done it……and go from their. No need to increase the age limits which are already too high in my opinion. If the government is allowed to raise the retirement age – people won’t live long enough to collect, and although that was the purpose when SS was first founded – – according to historians – – that is’n’t the right thing to do to the people. With the advent of the information highway we ‘the people’ have found out that Europe and other countries have been retiring at much younger ages than Americans, and until this downturn were doing just fine. . . . . It’s sad to say – but American’s have been lied to – – all these years we have been told that we have had it so much better than the rest of the World and that just isn’t true. . . . . Yes, we have had it better than the third-world countries but not better than countries comparable to America. They even get more vacation time than Americans, and other goodies we don’t get……if you know and talk to some Europeans you will find the truth…..

  4. I am soooo tired of mainly old retired people who call local and nationwide talk shows and write letters to the Editor complaining that Obama and his “crew” are a bunch of Socialists spending us into oblivion. Yet at the very same time they bitch they’re willing to fight ANYBODY who dares to touch their SOCIALISM Security check! That, even though they claim to be “conservative”, but like true SOCIALISTS are always taking MORE than any of the freeloaders ever put in! That my dear retired stone throwers is what SOCIALISM is all about…YOU taking MORE from ME (the people and govt) than YOU EVER put in!

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