Social Security Trust Fund Is an "Illusion," Warns Former CBO Director June O'Neill

April 15, 2002

In a Social Security Privatization study issued by the Cato Institute, "The Trust Fund, The Surplus and The Real Social Security Problem," former Congressional Budget Office Director June O'Neill warns Congress to stop playing games over the "accounting gimmicks" Social Security Trust Fund and start the serious project of Social Security reform. "The language of the Social Security Trust Fund gives the illusion that it is an investment fund with tradable economic assets that can be held until needed to pay the benefits of future retirees," the report states.

According to O'Neill, discussions of Social Security "lock boxes" and "raiding the surplus" sidestep the true demographic crisis ahead as surpluses generated in Social Security's trust fund add little cash flow value to Social Security, having traditionally been applied to non-Social Security budget deficits to boost the unified federal budget. "It is a fund in name only," O'Neill reports. "It holds no real assets. Consequently, it does not generate funds to pay future benefits. These so-called trust fund 'assets' simply reflect the accumulated sum of funds transferred from Social Security over the years to finance other government operations." The trust fund generates promises to pay beneficiaries rather than money to finance shortfalls.

Rather than accumulating pre-funding future benefits, the pay-as-you-go plan has allowed politicians over the last 40 years to deny real assets to future beneficiaries, and has instead transformed the trust fund into promissory notes to future generations. Since the early 1960's, the non-Social Security part of the budget has run a deficit every year except 1999 and 2000. Social Security Trust Fund surpluses – Social Security tax collections minus payments to beneficiaries – have automatically been transferred to cover the gap. In fact, trust fund surpluses have actually encouraged non-Social Security spending. "History has shown that Social Security surpluses, if anything, have led to more spending, not saving," O'Neill concludes.

In the face of the demographic crisis predicted to begin when the baby boom generation begins to retire at the end of this decade (when the worker-to-beneficiary ratio begins its decline from 3.3 today to 2 by 2030), pay-as-you-go advocates face tough and possibly risky choices. By roughly 2016, Social Security actuaries predict that Social Security payments will begin to exceed Social Security taxes. "Even though the trust fund is projected to hold about $5 trillion in reserves, those reserves hold no assets that can be simply cashed to pay the bills," O'Neill reports. "The existence of the trust fund in no way eases the real cash flow problem." Instead, new money will need to be generated to satisfy Social Security's promises.

"Pay-as-you-go is not risk free," O'Neill says. Proposals to reform the pay-as-you-go system that will remain subject to the whim of public policy, changes in immigration patterns and the participation of older workers in the work force include:

A tax hike that could double payroll taxes for Social Security and Medicare by mid-century:

• Raising the tax ceiling;
• Reducing other government expenditures;
• Borrowing from the public;
• Reducing benefits by either postponing a cost of living increase or modifying the benefits formula;
• Increasing the retirement age.

A proposal to use unified budget surpluses – surpluses that remain after Social Security surpluses have been applied to the federal budget – to retire the publicly held debt and reduce interest rates to spur economic growth holds its own element of risk. Even if extra revenues are generated as a result, there is no guarantee these savings will revert back to the Social Security system.

In addition, the Social Security system has also failed to eliminate poverty for those over 65. "Social Security provides no or very low benefits to those who neither earned enough themselves to qualify for benefits, nor were married to someone who so qualified," O'Neill reports. It would have required only 20% of Social Security expenditures in 1999 to eliminate elderly poverty altogether. "That is why the poverty rate of the elderly is 10% today, not zero," she reports.

The Social Security program has also had a negative impact on private savings and labor force participation, as workers have come to expect Social Security benefits to substitute for private savings.

O'Neill proposes substituting a system of individual accounts in which individuals pre-fund their own retirement to increase national saving and contribute to economic growth. Individual accounts would prevent surpluses from being diverted to other uses and assure that earnings from the investment are dedicated to future Social Security liabilities. "The only way to reliably pre-fund retirement benefits is through a system of individual accounts that are privately held and owned by the worker," she concludes.

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