1) Social Security payroll taxes are collected from current workers to pay benefits for current retirees (the “pay-as-you-go” system).
2) At present, SS takes in from taxes more than it pays out in benefits; this has been going on for a while now and will go on for a while longer, so the surplus contributions are stored in the designated Social Security trust fund.
3) That trust fund, though sizeable, is small compared to the total federal debt, so there’s some question about whether the money in it is “really there”. Other such assets, like US government bonds owned by foreign governments, are considered to be “really there”—i.e., we consider them valid IOU’s from the USA and are committed to paying them—so it seems reasonable to conclude that the SS trust fund is valid too. However, the IOU’s in the SS trust fund do have to be paid back from other government revenues eventually.
4) “Eventually” begins when SS starts having to pay out in benefits more than it takes in from payroll taxes, which will be sometime within the next couple decades. (This is due to the fact that the big generation of baby boomers will stop being workers and start being retirees; the baby-boom generation is moving through the American demographic “like a pig through a python”, in one economist’s words. As more workers become retirees, the ratio of tax revenues to benefit payments decreases.)
5) Even if the SS trust fund IOU’s are paid back in full from other government revenues, that won’t get us all the way over the baby-boom hump. At some point—currently predicted to occur somewhere in the 2040’s—the trust fund will be exhausted and SS will still be paying out in benefits more than it takes in from payroll taxes.
6) Therefore, to make ends meet for the Social Security system, something will have to give. Either:
a) SS benefits will have to be cut to match the available income from payroll taxes;
b) SS payroll taxes will have to be raised to match the required outlays on benefits;
c) other government revenues will have to be used to make up the shortfall; or
d) some combination of the above. (“Cutting benefits” includes targeted measures like means-testing benefits, while “raising payroll taxes” includes targeted measures like lifting the payroll tax cap. There’s a whole menu of possible options.)
7) The proposed Bush plan advocates making ends meet solely by means of option (6a): cutting benefits. This would be achieved by changing the economic formula by which the benefits are calculated: in econo-speak, switching from “wage-indexing” benefits to “price-indexing” them. In other words, the amount of benefits would rise along with inflation rather than with wages, which would mean much slower increase in benefits.
8) The Bush plan would actually result in cutting benefits much more than is required to make ends meet for SS. Over subsequent decades, the amount of benefits would get smaller and smaller compared to what they would be under the current system.
9) The Bush plan also proposes allowing workers to divert some payroll tax into “private accounts” or “personal accounts”—sort of like multiple, individual Social Security trust funds. This would make the SS system no longer completely “pay-as-you-go”; instead, it would be part “pay-as-you-go” and part “save-for-yourself”.
10) These individual accounts in the Bush plan are actually designed to be revenue-neutral for SS in the long run. That is, they will not save any money or reduce any expenses for SS. It’s the benefit-cutting that accomplishes that.
11) Under the Bush plan, the idea is that the personal accounts would help retirees offset the effect of the benefit cuts by generating returns greater than 3%. Anything you put into your personal account, plus 3% interest, goes to the government when you retire, in the form of additional cuts in your benefits. (That’s how they keep the plan revenue-neutral. No matter how much interest you actually got on your personal account investment—even if you ended up losing part of your investment—the government still has to cut your benefits by the same amount of total-contribution-plus-3%, in order to keep Social Security from losing money.)
12) Anything left over in your personal account, if there is anything left over, you would get to keep. Most people would probably have something left over, although as […] noted above, it’s unlikely that these leftovers would make up for the original reduction in benefits from the switch to price-indexing.
13) Although the private accounts are supposed to be revenue-neutral in the long run, they would cost a fair bit of money (“transition costs”) in the near term. That’s because if you’re letting today’s workers divert some of their payroll taxes into save-for-yourself accounts, you have to find some other money to meet the current pay-as-you-go obligations to today’s retirees. The Bush plan would simply borrow that amount—i.e., add it to the national debt. The transition costs are estimated to be anywhere from about $600 billion to $2 trillion over the next ten years alone, and more after that.
14) Finally, under the proposed Bush plan, none of these proposed changes would affect anybody born before 1950. Everybody scheduled to retire in 2017 or before would get the currently-scheduled SS benefits: no “price-indexed” benefit cuts, no personal accounts, no change whatsoever.
