Social Security is a government system that provides benefits to those who are retired, unemployed or disabled. Everyone in the United States, with a few exceptions, has an individual Social Security number. It sounds great, but can we really afford it?
Depending on the year you’re born in, your retirement benefits can start as early as age 62 and as late as age 67. The amount you receive depends on the wages you earn in your lifetime.
Social Security is one of the largest government programs in the world, paying out hundreds of billions of dollars each year.
How it Began
Social Security started in 1935, but before that there were programs that we may recognize as a social security program. Following the Civil War, there were hundreds of thousands of widows and orphans – a sad eventuality of any conflict. There were as many or more disabled veterans. Because there were so many people now who were either disabled or survivors of the once-primary breadwinners the country had to implement a generous military pension program. The First National Pension program for soldiers was passed in 1776 but it was the Civil War that spurred the creation of a full-fledged pension system.
These military pensions were an important form of economic security. In 1893 the government spent $165 million on “social security” – 37% of the entire budget and the single largest expenditure ever made by the federal government. That trend would continue.
The Social Security program, conceived by President Roosevelt and adopted in 1935 hoped to address the problem of economic security for the elderly, in the tumultuous time period following the Great Depression and stock market crash that wiped out nearly $26 billion of American wealth.
The first payments were scheduled to begin 1942. Ernest Ackerman, who retired a day after the program started, was one of the first recipients of a Social Security check: a lump sum payment of 17 cents.
What is PAYGO?
Social Security in the United States is a Pay-As-You-Go (PAYGO) system and is funded through the Federal Insurance Contributions Act tax (FICA). The FICA tax is a payroll tax, meaning it is deducted from your pay check and then deposited into a Social Security Trust Fund.
Pay-As-You-Go means that what you pay into the Trust Fund is not invested on your behalf. What actually happens is that what you pay into Social Security now is used to pay retirees today. The current working generation is paying the benefits of the previous one. In a pure PAYGO system all of today’s contributions are paid out in the same time period.
Imagine a society of 100 million, which includes 30 million retirees. Tax the salaries of existing workers and give it directly to the retirees – right now. That is a Pay-as-you-go system.
That sits in contrast with a fully-funded social security system where a citizen’s savings contribute to their own retirement.
The U.S. does not have a pure PAYGO system. Instead the contributions accumulate because not all the money that is collected by the currently employed is paid out.
As you can imagine there are a few problems with that system.
What’s Wrong with the System?
The PAYGO system puts a huge strain on generations that aren’t as large as the cohort that came before them. According to the Cato Institute, only 2 workers will support a beneficiary of Social Security in 2025. For comparison there were 16 workers for every beneficiary in 1950.
Think of the Baby boomers: the people born between the years 1946 and 1964. Someone born in 1950 would be turning 65 this year and therefore be eligible to receive benefits. Except now consider that a whole generation, nearly 71 million, is retiring and the current, smaller generation Y (about 41 million) has to pay for their retirement.
There is an incredible strain when 41 million people have to pay for the retirement of 71 million people. Generation Y will end up paying more than their fair share, because what happens when it’s time for them to retire? That will be taken care of by the Millennial generation (about 70 million). 70 million people paying for the old age benefits of 41 million seems a lot easier to handle than the other way around.
There will always be imbalance and strain with this system.
Ida May Fuller was one of the first to receive retirement checks under the Social Security System. She retired in 1939 at the age of 65, having worked under the Social Insurance program for three years.
The taxes she paid into that program: $24.75.
Ida May lived to be 100 years old, dying in 1975. The total amount of benefits she collected in her lifetime: $22,888.92.
How to Fix it
Social Security has grown to become an insanely huge government program and faces real threats of insolvency.
In 1950 the program paid out $961 million in benefits to about 3.5 million beneficiaries. In 2008 the program paid out $615 billion to nearly 51 million retirees. In 2010 the Social Security program paid out more in benefits than it took in through taxes. The Office of Retirement and Disability Policy projects that program costs will rise high enough by 2035 that taxes will be enough to pay for only 75$ of scheduled benefits.
The two Social Security Trust funds – the Old-Age and Survivors Insurance (OASI) benefits and Disability Insurance (DI) benefits – do not have the ability to borrow in order to pay benefits. They have to pay out using the assets in the fund.
The program is a hot-topic issue and presidential candidates often address it – calling it the ‘third rail” of American politics. Governor Rick Perry has gone as far as labeling Social Security a “Ponzi scheme”, but there are more labels than solutions being thrown around. Current solutions include raising the retirement age, so less benefits are paid out as a whole; increasing the payroll tax, so more money can be collected; and privatizing the system.
The first is a stopgap approach, which will likely just buy time. The second, increasing the payroll tax, is likely to be hugely unpopular. The third, privatization, could work, as an entity that invests the money collected from taxes would be held to returning a fair rate of return. The problem is that at that point we might as well just tell everyone to take care of investing their money themselves. While the shift to privatization might hurt current retirees, it is probably the best option.
Whatever happens, America’s social insurance program needs overhaul.