A Social Security Reserve Fund? Don’t Bet Your Retirement on It

Friday, October 30, 1998
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Congress has before it more than two dozen proposals for reforming Social Security. Many proposals follow the same approach: calling for the creation of a large reserve fund within the federal budget. Such a fund is necessary, proponents argue, to keep Social Security solvent when the baby boom generation retires. The implicit assumption behind Social Security, of course, is that individual citizens won’t save the necessary funds for retirement. But can elected officials be expected to exercise the discipline required to build and maintain a Social Security reserve? Or will their efforts yield to inevitable pressures to expand benefits?

Social Security’s sixty-year legislative history offers a clear assessment of this approach: It doesn’t work.

The original Social Security Act of 1935 contained a financing plan to build a substantial reserve. President Franklin Roosevelt knew that the program’s future costs would rise, and he sought to defray some of this burden. Creating a large reserve during the program’s early years seemed a sensible approach. But in congressional debates over the plan, many members raised warnings about the dangers of a reserve. “Does anybody believe that such a large sum of money accumulated for any purpose could be preserved intact?” asked Senator Daniel Hastings (R.-Del.). “Does anybody doubt that it would be subjected to all kinds of demands?”

Indeed, within four years, the large-reserve policy collapsed under an avalanche of criticism and increasing pressure for expanding benefits. Some argued that surplus payroll tax revenue was being used to expand the federal government’s activities. Arthur Linton, a key adviser to the Roosevelt administration, insightfully noted that “[the] politician had but scant appreciation . . . of the necessity of forgoing the expenditure of current revenue in favor of investing it to benefit voters of the more or less distant future.”

Others argued that even if Congress did have the discipline not to spend the reserve, it was nonetheless wrong to rely on regressive taxes to build it. Abraham Epstein, another administration adviser and the author of two influential books on Social Security, noted that “even if it were . . . possible to reduce the National Debt, no more antisocial means of accomplishing this could be imagined than through a tax on work directly or indirectly—a tax hard to bear and repressive of employment.” Critics also noted that Germany and Britain, two pioneers in the establishment of social security programs, had abandoned attempts to maintain significant reserves.

Meanwhile, the growing reserve attracted advocates who lobbied for expanding eligibility and benefits. By 1939 the reserve that had seemed such a good idea four years earlier had become a political liability. Congress responded by enacting legislation to dissipate the reserve. The new law raised benefits, delivered them a year earlier than the original law had planned, and added survivors and dependents of eligible workers to the rolls.

Throughout the history of Social Security, whenever there has been a large reserve, Congress has invariably spent it.

The 1940s wartime economy generated a series of apparent Social Security surpluses. By 1950 the trust fund balance had grown to a level large enough to finance benefits fully for the next decade. But this balance existed only on paper. The war’s cost had also driven up the national debt, which had registered a fivefold increase during the 1940s. One reason was that the federal government had used surplus payroll taxes to finance the war effort, so as to limit increases in other taxes. Because of this, the trust fund was given credit for debt reduction that had never occurred.

Nevertheless, the large apparent reserve generated spending pressures that manifested themselves every two years. Social Security presented members of Congress with a new means of publicly financing their reelection campaigns. In each election year from 1950 through 1960, Congress raised benefits or expanded eligibility. Each time, except one, the liberalization was scheduled to take effect within a month of the general election. The benefit increases were large; the Social Security Amendments of 1950–1954 more than doubled the typical recipient’s benefits.

During the 1960s, the U.S. economy entered a decade-long period of strong economic growth, which fueled large increases in payroll tax revenue. Forecasts of the trust fund’s near-term growth during 1965–1973 were consistently the largest in the program’s history. Instead of holding the surplus, Congress expanded benefits. In just these nine years, Congress enacted seven across-the-board increases that raised benefits by 83 percent, a third more than inflation. This period of extravagance ended with a 20 percent across-the-board benefit increase that first appeared in Social Security checks five weeks before the 1972 election.

Some observers believe that the coming retirement of the baby boom generation has made elected officials more financially responsible. Don’t bet on it. Social Security’s demographic problem is nothing new. Knowledge of large projected increases in the size of the beneficiary population has never deterred elected officials from spending surplus Social Security funds. In the 1930s, the projected thirty-year growth in the elderly population, relative to the total population, was even larger than it is today. Yet political pressures spurred the federal government to spend the reserve by adding new categories of beneficiaries and increasing the level of benefits. In early 1950, Social Security actuaries estimated that the number of beneficiaries per worker would rise by 170 percent in the ensuing thirty years, compared with today’s thirty-year estimate of only 70 percent. Yet in 1950 alone, the federal government granted a 77 percent increase in benefits for current and future retirees.

Observers often point to the absence of legislation expanding benefits during the late 1970s and 1980s as evidence that elected officials won’t spend the surplus. But the more likely reason benefits didn’t expand during those years is that the trust fund balances were persistently low. In fact, recent behavior suggests that today’s elected officials are no more capable of restraint than their predecessors. In 1992, a prior decade of strong economic growth had raised the trust fund balance to an amount that could finance one year’s worth of benefits. Two years later, Congress voted to lower the Social Security payroll tax and raise the disability insurance payroll tax by equal amounts. This had the practical effect of diverting Social Security revenue that had been earmarked for future recipients to current recipients of disability benefits. The diversion, which continues today, has already drained $50 billion from the Social Security trust fund.

The lesson of Social Security’s history should be clear: Unless elected officials suddenly stop behaving the way they have for the past sixty years, any attempt to ensure Social Security’s solvency by building a large trust fund reserve will likely fail. As former congressman Andrew Jacobs (D.-Ind.) put it: “It’ll be like walking through a bad neighborhood with a diamond ring.” The pursuit of such a reserve will ultimately lead to program expansions, either in Social Security or elsewhere. It will raise the burden of government borne by both current and future generations of taxpayers.