For most people it's TMI--- Too Much Information. In recent weeks, one reader confidently informed me that Social Security has no unfunded liabilities "because it is a pay-as-you-go program." Another reader wrote that future benefits wouldn't be threatened if Congress hadn't spent the money in the Social Security Trust Fund. And still another wrote that our children had nothing to worry about because our economy was large and growing.

Those are nice thoughts. And they are somewhat true. But we still have the largest problem in American economic history coming our way. Most of it will happen over the next 25 years.

Everyone needs a basic education on this subject. Once we have our education we can tutor our Representatives and Senators. Sadly, most of them remain willfully clueless. Here's a basic primer on Social Security.

Pay As You Go or Funded Trust?   When Social Security was created in 1935 it was designed as a pay-as-you-go program. The employment tax would transfer money from people who were working to people who were retired. It was a good idea because most Americans had seen their savings wiped out during the Great Depression. Social Security would put purchasing power in the hands of people who didn't have any. The money would stimulate the economy. It would also stave off the (then) rising tide of Socialism and Communism.

Basically, Social Security was a welfare program for elderly Americans. It was never discussed as a welfare program. All the language used to describe it---such as "your account" and "trust fund" was done to create greater public acceptance.

An account called the "Trust Fund" has existed since 1937. It is a buffer account. It was designed to handle the year-to-year ups and downs of employment tax collections. While money in the fund has earned interest since 1940, interest earnings have never been a significant part of the money paid out by Social Security.

Starting in 1975, benefit expenditures exceeded employment tax revenue. The trust fund, which had enough money in 1974 to pay about 8 months of benefits, started to shrink. By 1983 it hit rock bottom. It ended the year with only $19.7 billion in assets--- enough to pay about two months of benefits.

Since then, following recommendations from a committee chaired by economist Alan Greenspan, employment taxes have been increased, retirement ages were advanced, and benefits have been subject to taxation.

The idea was to build the Trust Fund account.   It would do far more than buffer minor economic ups and downs. It would "smooth out" the retirement of an entire generation, the baby boomers. It would do this by building a large balance that could be drawn down over a period of decades, not months.

By the end of 2003 the Trust Fund had accumulated Treasury obligations of $1,355.3 billion. That's three years of benefit payments. The fund increased $137.8 billion from the previous year. An impressive $75.2 billion in interest was credited to the fund. And the IRS collected $12.5 billion in taxes on benefits. (The entire year-by-year history is provided in Table VI.A.2. in the current Trustees report. See URLs below.)

As boomers start to retire and benefit payments exceed employment tax collections, the trust fund is expected to peak at 5 years of benefits in 2015.   Five years of benefits, however, isn't a funded trust. It's just a large buffer account.

The trustees expect the trust will be exhausted in 2042. That's when, according to Social Security Commissioner Jo-Anne Barnhart, benefits would have to be cut by 27 percent.

Bottom line: Social Security is a pay-as-you-go program. Future tax payments won't cover promised future benefits.

There Would Be No Problem If Congress Hadn't Spent The Money.   For better or worse, money for Social Security isn't like the money in Scrooge McDucks' vault. Employment tax dollars come into the U.S. Treasury. The Social Security Trust fund is credited with Treasury obligations for revenue not spent. It is also credited with interest on the accumulated Treasury obligations. Social Security has Trust fund assets and the U.S. Treasury has a liability that is exactly equal. They zero each other out.

Unfortunately, total government spending has exceeded government revenue collection in virtually all of the last half century. Our employment tax dollars were spent. What Social Security got was an IOU from the U.S. Treasury.   The higher employment taxes paid by everyone who has been working since 1983 became a mega-billion dollar slush fund for politicians of both parties. The Social Security surplus meant Washington could spend more. They didn't have to raise income taxes because every worker was paying more employment taxes.

If you visit the government website that keeps daily track of all government debt, you'll learn that total government debt has increased in every single year. This includes the years Democrats and Republicans celebrated as years of "surplus." (URL below)

You can see how this works by examining a broad summary of government finances published monthly in "Economic Indicators" by the Council of Economic Advisors. (URL below)

In the figures below, the "Off Budget" is primarily a record of surpluses for Social Security and related trust funds. The "On Budget" is regular government operations. And the "Unified Budget" is the combination of both.

The Off Budget has had large and growing surpluses. The On Budget has enjoyed small surpluses in three years: 1999, 2000, and 2001. The Unified Budget, bolstered by Off Budget Surpluses, shows surpluses in four years: 1998, 1999, 2000, and 2001.

  
Q. Which Budget Will We Use? A. The One That Looks Best
Note that gross government debt rose consistently through the period, regardless of reported surpluses in the Unified Budget.
Year Unified Budget On Budget Off Budget Gross Debt Held by Public
1996 ($107.5) ($174.1) $   66.6 $5,181.5 $3,734.1
1997 ($   22.5) ($103.3) $   81.4 $5,369.2 $3,772.3
1998   $   69.2 ($   30.0) $   99.2 $5,478.2 $3,721.1
1999   $125.6   $       1.9 $123.7 $5,605.5 $3,632.4
2000   $236.4   $   86.6 $149.8 $5,628.7 $3,409.8
2001   $127.4   $   33.4 $160.7 $5,769.9 $3,319.6
2002 ($157.8) ($317.5) $159.7 $6,198.4 $3,540.4
2003 ($375.3) ($536.1) $160.8 $6,760.0 $3,913.5
2004e ($520.7) ($674.8) $154.0 $7,486.4 $4,420.8
Source: Economic Indicators, March 2004
  

But our "Gross Debt" has increased in every single year!

The problem coming our way is very simple. With government debt growing by $500 billion a year, will Social Security be able to redeem its hoard of Treasury IOUs when benefit payments again exceed payroll tax collections?

Not to Worry, Economic Growth Will Be More Generous Than the Tooth Fairy.   Hey, Burns, this is a $10 trillion economy, the biggest in the world! All that debt and all those promised benefits may look large today but our future economy will be big enough to handle it.

That's the happy pill preferred by both political parties.

Unfortunately, it's a placebo. The cash surpluses in the combined Social Security and Medicare programs are disappearing as this is written. Instead of adding cash to general revenues, these programs are expected to draw on general revenues (Federal Income taxes and such) for the first time in years.

A recent paper for the National Center for Policy Analysis, co-authored by former Social Security Trustee Thomas R. Saving, estimates that elderly funding will consume 3.6 percent of federal income taxes this year, twice that in 5 years, and twice that again in 10 years. By 2019 a quarter of all federal income tax dollars will go to elder benefits. By 2030 elder benefits will take half of all income taxes. This is in addition to the dedicated employment tax. Elder benefits will be crowding out all other government spending.

All that assumes healthy economic growth.

These are not figures from the Cassandra Institute--- far out predictions of disaster. Similar estimates, measured in percent of GDP or percent of payroll, are available from major centrist institutions:   the Social Security Trustees and the Congressional Budget Office.

The issue isn't whether a fiscal crisis is coming. It is. The question is when? Fortunately, 2019 or 2042 are a long way off.

Right?

Wrong. The real crunch will hit earlier.

Next Sunday: To learn when, follow the cash.

  On the web:

Social Security Trustees Report for 2004

History of the Trust Fund

Projections for the Trust Fund as Percent of Benefits

Government Debt to the Penny

Economic Indicators, Government Finances and Gross Debt

NCPA Paper: The 2004 Medicare and Social Security Trustee Reports   (download publication #266)

Related columns on this topic: Generational Storm Reader

Background books on this topic at Amazon.com:

The Coming Generational Storm, Kotlikoff and Burns

The Empty Cradle, Phillip Longman

Gray Dawn, Peter G. Peterson