December 16, 2004 - The Social Security System is financed by a flat tax on the first $87,900 of earned income (salary, wages, or self-employment income) received by the taxpayer. Every cent of earned income above $87,900 is free of the tax as is unearned income from the first penny. The more money you earn the less you pay as a percentage of your total income. If your income is entirely from interest, dividends, rentals or other investments you pay no Social Security tax at all.

Theoretically Social Security Taxes are paid into the Social Security Trust Fund out of which the benefits flowing to retired workers are paid. Theoretically the system is self-sustaining, the annuities paid to retirees being financed by the contributions that they and their employers paid into the trust fund together with the interest generated when the fund is invested in government securities and not from general revenue funds. Of course the interest paid into the trust fund came from general revenue and the surplus in the social security trust fund is an accounting fiction. The tax revenue received in excess of the benefits being paid out finances government operations when it is “loaned” to the Treasury.

Until the Johnson Administration the Social Security Trust Fund, like the trust funds supposedly holding the revenue from other earmarked taxes, was accounted for separately. The general operating budget reflected only the receipt of general taxes and the expenditures for general government purposes. When the operating deficit rose to a politically dangerous level, driven by spending for the Vietnam War and the Johnson war on poverty, the trust funds were merged into a unified budget, which disguised the amount by which general spending exceeded general revenues. That maneuver did not change the fiscal results of government operations; it merely hid the amount by which we were running up debt by applying another creative accounting fiction in which we continue to indulge. It shrinks the apparent operating deficit to politically manageable proportions.

When the politicians point to 2018 as the year that the Social Security System breaks down what they really mean is that in that year the current Social Security Tax revenue will equal the current benefits paid and the current Social Security Surplus will no longer be available to conceal the real magnitude of the operating deficit from the public. In that year the accumulated surplus supposedly sequestered in the Social Security Trust Fund must be spent, not on general government operations, but on the benefits due to the wage-earners who have paid into the system for a lifetime. Even in 2042, the date on which the trust fund will be depleted, the current receipts from the Social Security Tax will cover 81% of the benefit cost without increasing the rate or raising the limit. The so-called Social Security crisis is a political one – not a fiscal one.

What will the President’s proposal to convert a part of the social security system into a mandatory 401(k) program for younger workers accomplish? It will immediately open the vault to the Wall Street money managers. It will diminish the current receipts going into the Social Security Trust fund and advance the date on which the depletion of the fund commences. By how much we cannot know.

The President has not presented his privatization scheme as anything more than a series of slogans. He has not explained who would administer the privatized accounts; how investment decisions would be made by the individual account holder or how the increased administrative cost would be borne. He has not explained by how much the annuities to holders of the new private accounts would be reduced by diminishing their contributions to the Social Security Trust Fund. Most basically he has not explained how his privatization scheme would enhance the system rather than destroy it.