Social Security Basics: Don’t Steal From Granny

OASDI is better knows as Social Security.

OASDI is better knows as Social Security.Social security is the state-run old age insurance plan in the United States. Officially know as Old Age, Survivors, and Disability Insurance (OASDI), it is the largest domestic spending program. Unfortunately, Social Security is one of the most misunderstood government spending programs. Many of these misconceptions lead to ill-advised schemes to fix a program in ways that it is not broken to the degree that is often claimed, if it is broken at all. This article offers a brief description of how the program works in order to help a policy analyst determine what proposals might work, and those that cannot.

First of all, Social Security is an old-age insurance program that covers almost all workers in the US. What exactly is the insurance aspect of Social Security? It is simply insurance against living longer than you planned to live. If a person expects to live to age 80 (and saves accordingly) but ends up living to age 85, Social Security provides an income benefit that helps cover this difference. Just like any other insurance policy, you pay a relatively smaller premium over a long period of in order to receive a relatively larger benefit over a short period of time.

Besides OASDI, the Social Security Administration also administers Supplemental Security Income (SSI). This program provides elderly and disabled workers with a minimum level of income by providing cash transfers allowing a minimum level of income. SSI, unlike OASDI, is not old age insurance. Instead, it is a form of welfare for the elderly or disabled. This note will focus on the insurance part of Social Security, OASDI.

When it was established in 1935, Social Security was funded in a manner known as “fully funded”. In a fully funded system, a worker works and is paid. Some portion of those wages are taken from the worker and put into the social security fund. As workers contribute, the fund accumulates and earns interest. When the worker retires, the principal and interest is used to pay for retirement. The fully funded model for Social Security was scrapped in 1939 in favor of a “pay-as-you-go” (PAYGO) system.

In a PAYGO system, today’s workers fund tomorrow’s retirees. In other words, for every dollar a worker earns, a portion (currently 12.4% split evenly between employer and employee) is taken out and used to pay for the current Social Security obligations. In other words, when you pay Social Security taxes, you are not saving for your retirement, you are simply paying the checks that go to your parents and grandparents (and mine too). If workers earn more than the current level of the obligation, then the money is put into a fund, known as the Social Security trust fund. This trust fund was established in 1983 in anticipation of the glut of retirement that would occur as the baby boom retires. If, on the other hand, the current obligations exceed the income from taxes, Social Security must borrow to cover the difference. As we speak, the Social Security trust fund has built up substantial resources. Currently, however, some projections show that the trust fund is not big enough to support all future retirees at the current level of obligations.

Since the PAYGO system uses today’s taxes to pay today’s obligations, we can only divert taxes to the trust fund if income exceeds obligations. The implication here is that if we move to individual savings for retirement, as has been proposed, we must either divert money away from current obligations, divert money away from future obligations (by contributing less to the Social Security trust fund), or divert money from other spending (by government borrowing). So, while putting some of my money in the stock market sounds appealing, we must realize that there is a cost–my Social Security taxes are not mine, they are somebody else’s nest egg.

There are lots of proposals out there on how to fix social security. When analyzing these solutions, we must remember a few things. First, the system is not broken, and it is not just about to run out of money. The trust fund is not bankrupt, and it has been accumulating money for almost 20 years. Even we have not saved enough in the trust fund to cover all retirees in the baby boom, minor tweaks rather than major changes are required. Finally, as many proposals seem to forget, the system is not fully funded, it is a PAYGO system with accumulated savings. Any changes to what goes into Social Security, will necessarily change what comes out to current retirees.