Sunday, February 13, 2005

Social Security, Part II: 2018 or 2042?

This is the second post in my series on Social Security. Click here for Part I of the series.

The topic today is whether we should consider Social Security to be in financial trouble in 2018, when payroll taxes will fail to cover promised benefits, or 2042, when the trust fund will be exhausted.

The natural reaction is, "Social Security's trust fund will last until 2042! Why, we don't need to worry about it now." If the trust fund were composed of real assets, then this view would be completely correct.

The problem with the trust fund is that it's not composed of real assets, but instead of treasury bonds. This means that when Social Security draws upon the trust fund, it will really be drawing upon other government income. That means that spending will have to be cut or taxes raised because the bonds in the trust fund must be repaid. This means Social Security is in financial trouble.

By the definition above, we have 13 years before Social Security is in financial trouble. Yes, it will be 37 years until Social Security will require direct transfers from the general fund, though it will have been drawing on the general fund via bond repayments for over two decades at that point.

The question really comes down to theory vs. practice. In theory, Social Security is in assets up to its eyeballs thanks to the trust fund. In practice, these assets are nothing but a promise to pay the Social Security Administration out of the general fund, meaning they are worthless if we view the federal government as a whole. The federal government will only take in X amount of dollars in 2018. That money can only buy so much. If we decide to pay out all the benefits promised in that year, spending will have to be cut somewhere else or else taxes will have to be raised. This would happen with or without the trust fund.

In theory, 2042 is when social security will be a problem. In practice, 2018 is when Social Security will be a problem. Wise people know practice beats theory every time.

Continue on to: Social Security, Part III: Congress or Wall Street...
Previously: Social Security, Part I