Isn't Social Security set up as a Pension Fund as opposed to a Direct Transfers Scheme?

Question

In the United States, the benefits you receive from Social Security when you retire, is more or less proportional to the amount contributed to it throughout your working life in the form of Payroll and Self-Employment Taxes.

If this is the case, that means that there should have never been a generation who received benefits and who did not make proportional contributions into the system first, which also means, that Generation A's benefits should be paid by Generation A's contributions, not the younger Generation B's contributions. Doesn't that make the U.S' Social Security System a Pension Fund System, and not a Direct Transfers System?

If so, why in any debate about the future solvency of the system, the argument that there will be too many retirees as a proportion of workers is always brought up? Shouldn't the ratio of retirees to workers be completely irrelevant?

Answer 1

That's not actually how Social Security works. Its proponents would like you to think of it like a retirement account or 401k, but it is simply a government welfare program.

Social Security is funded by an income tax

The current tax rate for social security is 6.2% for the employer and 6.2% for the employee, or 12.4% total.

Only the social security tax has a wage base limit. The wage base limit is the maximum wage that's subject to the tax for that year. For earnings in 2019, this base is $132,900.

You can pay taxes on Social Security income if your overall income is high as well.

The problem is there's a fiction called the Social Security Trust Fund

The Social Security Trust Funds are the Old-Age and Survivors Insurance (OASI) and the Disability Insurance (DI) Trust Funds. These funds are accounts managed by the Department of the Treasury. They serve two purposes: (1) they provide an accounting mechanism for tracking all income to and disbursements from the trust funds, and (2) they hold the accumulated assets. These accumulated assets provide automatic spending authority to pay benefits. The Social Security Act limits trust fund expenditures to benefits and administrative costs.

For a long time, SS took in way more than it paid out in benefits. That's where the trust fund came from. There's about $3 trillion in this fund

A 2018 annual surplus of $3.1 billion increased the asset reserves of the combined OASDI trust funds, bringing the total reserves to $2.89 trillion at the end of the year.

So SS is fine right? I mean, they say so later on in that page

The Trustees now project that OASDI annual cost will exceed total income beginning in 2020—two years later than projected in last year's report—and continuing throughout the projection period. After the projected trust fund reserve depletion in 2035, continuing income would be sufficient to pay 80 percent of program cost, declining to 75 percent for 2093.

So where is all this money? They tell us it's well invested

The Social Security trust funds hold money not needed in the current year to pay benefits and administrative costs and, by law, invest it in special Treasury bonds that are guaranteed by the U.S. Government. A market rate of interest is paid to the trust funds on the bonds they hold, and when those bonds reach maturity or are needed to pay benefits, the Treasury redeems them.

Oh, Treasury bills. What is a Treasury Bill?

When an investor purchases a T-Bill, the U.S. government is effectively writing an IOU to the investor. T-bills are considered a safe and conservative investment since the U.S. government backs them.

Er, wait. An IOU? Wikipedia should help clear this up

United States Treasury securities are government debt instruments issued by the United States Department of the Treasury to finance government spending as an alternative to taxation.

So the US Government

• Taxes citizens to fund Social Security
• Takes in surplus
• Uses that surplus to buy Treasury Bills
• Uses the Treasury Bill revenue to pay down US debt
• Repays those Treasury Bills using general appropriations

Surely that can't be right. Or maybe it is...

“In a government shutdown, Social Security checks still go out on time,” Obama said. “In an economic shutdown, if we don’t raise the debt ceiling, they don’t go out on time.”

In other words, the government couldn't borrow the money it needed to repay those Treasury Bills. This is the reason the contributor(worker) to retiree ratio is so critical: as time goes on, more people will be pulling from the system than pay into it. As such, all that money will have to be repaid somehow (likely by financing more debt, raising taxes or both).

Answer 2

Social Security isn't a pension program, it's a tax program.

From Helvering v. Davis:

The proceeds of both taxes [from the employer and employee] are to be paid into the Treasury like internal revenue taxes generally, and are not earmarked in any way.

From SSA itself

In this 1960 Supreme Court decision Nestor's denial of benefits was upheld even though he had contributed to the program for 19 years and was already receiving benefits. Under a 1954 law, Social Security benefits were denied to persons deported for, among other things, having been a member of the Communist party. Accordingly, Mr. Nestor's benefits were terminated. He appealed the termination arguing, among other claims, that promised Social Security benefits were a contract and that Congress could not renege on that contract. In its ruling, the Court rejected this argument and established the principle that entitlement to Social Security benefits is not contractual right.

Emphasis added.

In other words, just because you put money in doesn't mean you're entitled to taking money out.

Future solvency of the program is in question by some because money that's been paid into it has already been spent, so if a glut of people begin to withdraw all at once (say, the Baby Boomers) there will be a relatively larger portion of people withdrawing than contributing when compared to past generations.

Answer 3

In addition to the other great answers here, I would like to point out that this statement:

that means that there should have never been a generation who received benefits and who did not make proportional contributions into the system first, which also means, that Generation A's benefits should be paid by Generation A's contributions, not the younger Generation B's contributions

Is irrelevant to the conversation.

The reason why is that people cannot eat literal money, they cannot build houses out of literal money, and they cannot fill their tank with literal money. They have to eat bread that is grown by the hands of non-retired folks. They have to build houses with timber cut and hauled by non-retired folks. They have to fill their tank with gas from refineries kept running by non-retired folks. The amount of money that retired folks have in a pile will not increase the total production of non-retired people. If we, as a society, decide to give the retired bread, housing and gas, then whether that bread, housing and gas is gotten via a middle-step of a pile of money, or if it is just taxed to the current generation, the amount of resources given to the retired is the same, and the amount of resources left for the non-retired is the same.

I say "mostly" irrelevant, because this assumes a closed system, and interest from loans to foreign countries, etc come into play.

In other words, the "two" systems: "Generation A's benefits should be paid by Generation A's contributions, not the younger Generation B's contributions" are in reality the exact same system. Since the government literally prints the money, then whether or not they have a pile on hand that represents current retirees' payments is totally moot. They could create the pile on demand, or burn it, and the amount of money "available" to them is identical. Printing the money is essentially a tax on the non-retired. Or they could tax the non-retireds' income (this is the current scheme). Or they could tax the non-retired in some other way. Either way, the retired can't generate their bread, housing and gas because they're retired. The non-retired are the ones paying the bill no matter what system you instate.

In this light, your question: "Shouldn't the ratio of retirees to workers be completely irrelevant?" is a "no" in all possible retirement systems, and is not a function of whether or not there exists a pile of money to draw on for retiree's payouts. The non-retired must foot the bill in terms of bread, housing and gas.

As an extreme example to get your imagination juices flowing, imagine a world where everyone is retired except for one person: you. No matter how much money the retired have saved up and are willing to give you, you can't possibly generate the bread, housing and gas for them all, much less have any left over for yourself. Their money has nothing to do with the problem. You are physically limited as to how much you can produce. This applies if there are two non-retired people vs a world of retirees. It also applies if the ratio of retirees to non-retirees is too high. If the number of people actually generating the bread is too low compared to the number of people eating the bread, then there will not be enough bread.

Answer 4

I'm not sure why the big surprise here. As the quasi-official historians of the US scheme would tell you, they copied Bismarck, just some 40 something years later (and more or less for the same reasons):

Thus, the United States embarked in 1935 on the road to providing its working population with old-age pensions, following in many respects the social insurance models adopted by Germany in 1889, Belgium in 1900, the Netherlands in 1901, Austria in 1906, France in 1910, Italy and Spain in 1919, and Hungary in 1928 (Social Security Administration 2008).

[...] At their inception, most European old-age insurance programs covered only blue-collar workers, reflecting their governments' desire for more stability in the labor markets and to fend off the political threat of national socialism and communism.

Even the noncontributory, means-tested flat-rate pension adopted by the United Kingdom in 1908 seems not to have elicited much enthusiasm on this side of the Atlantic, although the United Kingdom was the leading industrial power of its time and its historic ties with the United States would have meant that American experts closely followed British social security developments. There was a similar lack of enthusiasm regarding the Canadian initiative, which put in place a universal federal old-age assistance program in 1927, and left the United States as the only major industrialized country which had not implemented a public old-age income security program before the Great Depression.

[...] It is not surprising that the U.S. reformers felt generally more comfortable with the Bismarckian or German model of social security protection (mandatory social insurance financed from payroll taxes) than with the UK or Nordic approach of universal benefits (often flat-rate benefits subject to a means or earnings test). The consensus from President Roosevelt down to the original members of the Committee on Economic Security was that Social Security should not be compared to the "dole." In arguing for Social Security, Roosevelt clearly made the distinction between social insurance and social assistance, drawing on the American tradition of individual responsibility and self-reliance as being more consistent with the social insurance approach.

If you insure your house and it burns down you can get paid more than what you've contributed to that date. In order for the overall program (or insurance company) not to end up broke, some people will collect less than what they've paid in.

This is also admitted in that quasi-official history, albeit with a bit of sugar coating:

Although Congress has commissioned numerous studies, and public interest groups have invested enormous amounts of energy into finding a solution, the twin goals of the Social Security program—social adequacy and individual equity—remain in occasional opposition.

Likewise

By the time America adopted its first national social insurance plan in 1935, there were already more than 20 nations around the world with operating social insurance systems (Liu 2001). The first Social Security retirement system was put in place in Germany in 1889. [...]

Because social insurance began in Europe decades before it crossed the Atlantic to our shores, there was time for the development of American expertise on the subject. Among the notable academic experts were Henry Seager, professor at Columbia University, who authored the first American book on social insurance, and Barbara Armstrong, professor at the University of California at Los Angeles (Seager 1910; Armstrong 1932). Two social insurance advocates stand out: Isaac Rubinow and Abraham Epstein (Rubinow 1913 and 1934; A. Epstein 1936; P. Epstein 2006). In addition to these advocates for a European style social insurance system, there were related developments at the state level in America before 1935. [...]

This extreme economic climate of the 1930s saw a proliferation of "pension movements," most of which were dubious and almost certainly unworkable. The most well known of these radical pension movements was the Townsend Plan. It promised every American aged 60 or older a retirement benefit of $200 per month—at a time when the average income of working Americans was about $100 a month (Amenta 2006). Huey Long, senator from Louisiana, offered his Share the Wealth plan; Father Charles Coughlin, the radio priest, advanced his Union for Social Justice; and the novelist Upton Sinclair promoted the End Poverty in California plan. Millions of desperate seniors joined efforts to make these schemes national policy. As the clamor for old-age pensions rose, President Roosevelt decided that the government needed to come forward with some realistic and workable form of old-age pension.

BTW, if you wonder why the first bit mentioned national socialism (which wasn't yet a thing as such in Bismarck's time), it's probably in part because of Coughlin was a thing during the FDR years (although Coughlin's positions were more like clerical fascism, but with a strong economic populism component, which he melded with some anti-semitism, often couched as anti-[international-]bankerism etc.)

Roosevelt himself seems to have seen the Townsend Plan as a more concrete political threat though, at least in that narrow regard (Wikipedia):

By January 1935 there were 3000 clubs nationwide with 500,000 members. They circulated petitions to Congress with 20 million names. [...]

Frances Perkins, President Roosevelt's Secretary of Labor, in her memoir, The Roosevelt I Knew (p. 294) says that Roosevelt told her, "We have to have it [Social Security]. Congress can't stand the pressure of the Townsend Plan unless we have a real old-age insurance system."

So, yeah, the Social Security as adopted back then was a somewhat moderate solution compared to some alternatives that were being aired.

And if someone is curious how Rubinow argued this old-age issue, here's an excerpt from his 1904 article:

Permanent disability, moreover, may happen from other causes than accidental injury, as from invalidity due to sickness, or from old age.

As saving, on the one hand, and charity, on the other, are the ordinary methods of meeting the failing power of production in old age, so old-age insurance may be made to approach either saving or public help. Where old-age insurance is made to depend upon the individual contributions of the workingmen, it is, after all, only a modified form of saving. If society is made a partial or chief or sole contributor, old-age insurance is nothing but a guaranteed form of old-age pension. From a sociological point of view, the workingman who has spent his life in socially useful and necessary toil is entitled to support during his old age-entitled to it not as a matter of public safety, the basis of most of the charitable work done today, but as a matter of justice and right. Here is the difference between the English poor-law and a system of old-age pensions or insurance. If, however, a small individual payment from the insured be required, it may have the value of giving the insured the illusion that in getting the pension he is not exactly a public charge. But this psychological value is only temporary and conditioned by the laborer's lack of education. A soldier is not ashamed of his pension. Why should a workingman be? Are we ready to admit that a life full of toil is of less social value than a life full of play and parade, with a few occasional battles thrown in?