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.