When Social Security was originally conceived, the system was not a generational wealth transfer or ponzi scheme. Social Security was designed to be funded by workers not financed by their children.

Since that time, the system's finances have deteriorated to the point where the financing gap is nearly the size of our entire GDP. So what the hell happened? How to destroy the future in four easy steps.

1. Cut Costs On Voters

The original law included automatic tax increases which would have increased the cost of Social Security to 6% of wages from its 2% base. Congress waived every increase, one of which required a Congressional override of FDR's Veto. Funding for Social Security did not reach the originally envisioned 6% until 1960. Self-employed workers would not pay 6% until the 1970s.

These tax-cuts transformed Social Security from a system paid by workers to a system financed by children.

2. Make Promises From The Pockets Of Non-Voters

Congress raised benefits every election year in the 1950s. Social Security Act Amendments of 1950, 1952, 1954, 1956, 1958 all increased benefits. These increased the value of existing benefits, created new benefits, or expanded coverage to more Americans. The 1950 Amendment raised benefits by 77%, 1952 (12.5%), 1954 (13%), 1956(added disability), 1958 (7%). (source)

A couple retiring in 1960 expected to collect $8 of benefits for every $1 of contribution. Basically Congress was selling dollars of benefits to voters for little more than a dime. The difference was largely passed on to future generations who had no vote in 1950.

3. Allow The Federal Reserve To Lower Interest Rates At A Cost Of $1.2 trillion of projected interest income (in 2012 alone)

In 2011, projected interest income over the life of the Trust Fund was (3.6 trillion)

In 2012, projected interest income over the life of the Trust Fund was (2.4 trillion)

Thanks Ben Bernanke.

4. Ignore The Problem

Social Security almost reached insolvency in 1983. At that time, Social Security had more than 40 years of promises embedded in a system that did not have a penny to pay them. The solution to these problems in 1983? Repeat step 1. Repeat step 2. Prepare for step 3. The solution to these problems in 2013? Repeat step 1. Repeat step 2.

DC and its think tanks are selling the idea that Immigration Reform will help fix Social Security.  For example, "Improving Lives, Strengthening Finances: The Benefits of Immigration Reform to Social Security".  Without making any statement on the merits of Immigration Reform, there seems to be little actual research that supports the idea that Immigration Reform will improve the outlook of Social Security. 

There are not any reforms on the table for the Social Security Administration to score.  But I make the statement based on information that the SSA has already provided.

First, undocumented workers provide a stable source of unattached revenue.  When Americans pay payroll taxes, the revenue creates future costs in the form of promised benefits.  Undocumented workers cannot collect Social Security benefits.  Millions of undocumented workers pay payroll taxes by either using someone else’s Social Security card or by using a false name and Social Security number.  The Social Security Administration estimated that this revenue exceeded 10 billion dollars in 2010.  Losing free revenue cannot help Social Security.

Second, the demographic mix of workers affects Social Security.  If the immigration reform brings in a higher percentage of single workers, or high-paid workers, or workers that work longer than 35 years then immigration reform may help improve the picture of Social Security.  None of the media reports suggest that the system will enjoy more profitable demographics.  And to be clear, improve the picture of Social Security and fix Social Security are trillions of dollars apart. 

Third, immigrants tend to be a very poor demographic to add to the mix of Social Security because they do not have parents that depend upon the system.  Social Security is an electorial priority.  Voters elect Congress which sets the payroll taxes, which dictates the level of benefits.  We are adding an audience that has no value to parental support.  This change will overtime work its way into our representative government.  Unless the individual prospects of Social Security are dramatically improved for workers - we should expect immigration reform to negatively affect support for the system.

What supporters of Immigration Reform are saying is that Social Security will enjoy a boost in the number of workers.  More workers equals more revenue - but they ignore the cost of taking that revenue.  It may help Social Security in the short-term, but longer term it will make the system even more unworkable.  This is not a good trade-off for the system or the people who will depend upon the system in the future.

The point here isn't the immigration reform is wrong, but the people who tell you that Immigration Reform will fix Social Security are wrong.

In the 2013 Annual Report to Congress, the Trustees announced:

• The combined trust fund reserves are still growing and will continue to do so through 2020. Beginning with 2021, the cost of the program is projected to exceed income.
   
• The projected point at which the combined trust fund reserves will become depleted, if Congress does not act before then, comes in 2033 – the same as projected last year. At that time, there will be sufficient income coming in to pay 77 percent of scheduled benefits.
   
• The projected actuarial deficit over the 75-year long-range period is 2.72 percent of taxable payroll -- 0.05 percentage point larger than in last year’s report..
   
• Program costs are projected to exceed non-interest income throughout the remainder of the 75-year period.

Pew Research has produced a report on the preparedness of generations for retirement. 

"When the Great Recession hit in 2007, the oldest baby boomers faced the real possibility of downward mobility just as they were entering their golden years.The downturn also heightened concerns about retirement planning—or lack of planning—by younger generations. Many younger Americans were already behind in saving for retirement, and suddenly millions of them were out of work or owned homes worth far less than they had been just a few years earlier"  (read more)

The research includes expected revenue from Social Security.  It reports the expected benefit levels to continue forever.  This will significantly overstate the preparedness of early Boomers.  According to the report, various studies have shown that pensions (such as Social Security) contribute as much as 50 percent to the household wealth projections. (See the full study)

The debate about Social Security reform isn’t serious.  It is noise filled with statistics that paint a picture of convenience.  This piece comes from testimony in a hearing about Social Security reform before the Ways And Means Sub-Committee.

Despite Social Security’s great success, its growth in lifetime benefits over time has been decreasingly targeted at its major goals. Even while programs for children and working families are being cut, combined lifetime benefits for couples turning 65 rise by an average of about $20,000 every year, so that couples in their mid-40s today are scheduled to get about $1.4 million in lifetime benefits, of which $700,000 is in Social Security.

What Are The Major Goals Of Social Security?

Social Security is suppose to be old-age insurance, and has virtually nothing to do with other programs for the children and working families.  What is really meant here is that the system does not serve the major goals of the person testifying.

What About The Growth Of Benefits?

In all honesty, this couple does not expect to collect $700,000 or anything close to it.

1. When he says ‘scheduled’ he ignores the fact that this couple expects to retire after the Trust Fund is exhausted which means that they will be subjected to benefit cuts. 
2. These people would likely trigger means-testing that would claw back benefits at more than 10% per year  
3. These people may die before collecting a penny

But the number sounds impressive.  Well, until you consider how much this couple has contributed.  In all honesty, the couple depicted probably deserves more than $700,000.  Someone born in 1970, making 2/3rds of median income (roughly 34K in 2010) will lose about $600,000 in savings to Social Security.  In case of this couple, two people were contributing, and both made more than median income.

If fixing Social Security were easy, it would already be done.  Politicians are paid to hide problems, not solutions from the electorate. 

Nonetheless, the mainstream media continues to say that Social Security is an easy fix.  Typically the line runs something like “Social Security has become the focal point of entitlement debate because it's so easy to find different ways to address its funding problems.”  Basically, the hardest part of fixing Social Security is choosing from so many different options. 

A lot of the ease comes from changing the meaning of words.  The first word to lose its meaning is the word ‘fixed’.  Normally, the word ‘fixed’ means that there is no problem. In the Social Security debate, the word fixed means solvent, or the cost to make our problem a problem for our children.  Solvent and fixed are about 12 trillion dollars apart.  So, saying that fixing Social Security is easy, essentially is comparable to saying it is easy to run a 4 minute mile without telling anyone that the mile is actually only a 100 yards long.

The debate about fixing Social Security isn’t about fixing the system.  It is about paying for it.  The discussion is entirely about increasing revenue or decreasing expense.  The best example of this false dichotomy is the discussion of the COLA change to Chain-CPI.  Social Security is intended to be old-age insurance.  Yet, we are looking at a ‘fix’ which progressively reduces benefits as one gets older.  In all honesty, this is no different than fixing a broken refrigerator by calling it a doorstop.

If we are going to increase revenue, we have to understand that there are three kinds of revenue in Social Security.  The Social Security Trust Fund is funded money.  Contributions are revenue financed with the promise of future benefits.  Finally there are taxes, or the part of the part of payroll taxes on which there is no economic return.  In terms of a house, the word ‘funded’ means that you own the house.  Financed revenue is the loan from the bank.  Tax revenue means that the bank bought the house for you out of the goodness of its heart.

None of these revenue sources provides a stable solution.  Today, the Trust Fund provides about a nickel or a dime per dollar of benefits, but that contribution will go away as the Trust Fund is depleted.  Increasing the level of contributions - say immigration reform - only creates the promise of larger benefits in the future.  This enables us to postpone our problem, but creates an even larger problem for our children. 

The only other type of money in the system is taxes which is a dangerous game for old-age insurance because taxes are a political priority.  FDR rejected this model.  In 1941, he said that the contributions were vital as a means to ensure workers ‘a legal, moral, and political’ right to benefits.  He understood that taxes are dependent upon shifting political priorities.  FDR saw that contributions were the only way to make sure that ‘no damn politician could ever scrap' his program.[1] 

The other problem with increasing tax revenue for Social Security is that it makes it more difficult to raising taxes to control the debt.  We aren't raising taxes as much as we are shifting the taxbase away from debt control to Social Security.  This strategy preserves the debt load for the future generations on whom Social Security depends.

Decreasing benefits is possible, but it is difficult to sell.  The reality of decreasing benefits is that politicians would have to explain to voters that they never made a contribution on which they can expect to collect benefits.  They actually paid a tax on which they collect nothing.  This alternative is very difficult because these same politicians are the ones who have said for years that there is no problem in Social Security.

Every easy solution has a loser, and trying to convince that person that losing is winning is never easy.  So how does the media get back to easy.  We cut the benefits of future generations, and raise taxes on future generations.  It is easy to say that future generations will pay taxes that we will not.  It is easy to say future generations will accept benefit cuts that we will not.  In that context, it is very easy to say that Social Security is easy to fix. 

1 :  The exact quote is : "(Contributions) are politics all the way through. We put those pay roll contributions there so as to give the contributors a legal, moral, and political right to collect their pensions and their unemployment benefits. With those taxes in there, no damn politician can ever scrap my social security program. Those taxes aren’t a matter of economics, they’re straight politics.” (source)

Social Security consists of two programs.  One is old-age and survivors insurance (OAS) and the other is the disability insurance (DI).  While these programs are legally distinct and separate, Social Security OAS is not completely independent of the DI system because both systems draw on the same tax base for support.  They inherently compete against each other for resources. 

The DI system according to the Trustees 2012 is projected to reach insolvency in 2016.  At that time, Congress will have one of three choices.  It will be able to pull payroll taxes away from OAS to fund the shortfall.  It can pull general taxes away from debt control.  Or, it will have to redefine the benefit levels of the DI program.  It is unreasonable to believe that OAS will not be part of this discussion.

If we perserve the 15.3% payroll tax, it is possible to shift the percentages such that DI gets a larger portion of the revenue directly taking money from the OAS program.  This is the assumption built into the Trustee's projection that the combined trust-funds will be exhausted in 2033.  The Trustee's projections use the OAS trust-fund to cover-up the shortfalls in DI.  If we consider the OAS without support for the DI, the Trustees project that full benefits would last until 2035.

It is possible to increase the payroll tax rate from 15.3%, but that tax revenue that cannot be raised for the OAS system. Increasing payroll tax rates for DI, means that it will be harder to raise them for OAS or medicare.  It is possible that we could provide a subsidy from the general tax payer, like the EITC, which is an offset for the high cost of payroll taxes.  Such a change would come at the expense of not controlling the debt.  It is possible to lift the cap making more of the wages subject to taxes, but against this revenue could have been raised as an income tax to control the debt. 

In all likelihood, the issue of DI's financial imbalances will trigger a national discussion about taxes and how to deploy new tax revenue.  If we raise taxes, the voters will set the priority for that revenue.  The priority might be DI.  It might be OAS.  It might be lowering the debt.  It might be something else.

Here is NPR aritcle on the problems in DI, and it is a reminder that Social Security does not operate in a vacuum.

We cover a number of Chuck Saletta's pieces on Social Security.  This piece is worth reading because it is well written and well thought.

"Over the last several years, the news about Social Security's long-term health has gotten progressively worse. With nearly every passing year, the Social Security Administration's annual Trustees' Report has pulled forward the date when the Social Security Trust Funds are expected to run out of cash."

The article spells out the problem and the consequences.  It tells you about the problem, and what is being done about the problems.

Last week, the authors of the Simpson-Bowles plan released an updated version of their plan.  The part pertaining to Social Security can be found in Appendix A on page 41.  The key phrase is : Unfortunately since the Fiscal Commission proposal was released, the 75 year shortfall actuarial shortfall has increased significantly" 

In football, we throw to where the receiver will be.  In DC, we throw to where the problem looks smallest and most remote.  This is why we measure Social Security by the 75 year solvency. 

The 75 year window is a bad measure of Social Security's security because it makes the problem appear smaller and far away.  How? The figure does not include the financing costs of the system.  It shows the payroll taxes we collect today as revenue, but does not include the cost of benefits associated with taking that revenue.  

Solving the problem for 2010 through 2085 is completely different from 2013 through 2088 because you are bring on the cost of future benefits. In five years, fixing Social Security will be defined by 2018 through 2093 and once again we will have a problem.  Soon enough we will be right back where we were in 2010. 

This is why Social Security has been 'solvent' three times in my life.

The New York Times Room for Debate section covers an open discussion about increasing the amount of wages subject to payroll taxes, also called the wage base. 

The best material comes from Andrew Biggs, who offers a summary of the reasons not to raise the wage base.

1. Roosevelt wouldn’t want it, since the cap helps distinguish Social Security from a “welfare” program. Under his administration’s original plans, high earners wouldn’t even have participated in Social Security, much less paid multiples more in taxes than they’ll collect in benefits. Come on, lefties, let’s honor FDR’s legacy.
2. The cap isn’t unusually low: today, 85% of wages are hit by Social Security taxes. The average since 1935? Eighty-four percent.
3. While coverage has fallen from 90% since the mid-1980s, research points to health care as a major culprit. When employers’ health outlays rise they reduce wages for employees, with middle class workers hit the most. The solution isn’t to tax the rich more, it’s to address health care costs.
4. Other countries have lower caps: in Canada payroll taxes are capped at the average wage, in the UK at 1.15 times, and in Japan at 1.5 times the average. Social Security’s tax ceiling is 2.9 times the average wage in US.
5. It’s a fat tax increase. Today’s top federal tax rate on earned income is about 45%. Adding state income taxes boosts it to around 50%. Eliminating the tax max effectively raises the top tax rate by around 12 percentage points. If I wanted that I’d move to Scandinavia. Except their taxes are lower…
6. And that’s before we’ve done anything to fix Medicare and Medicaid. Think the Left won’t ask for higher taxes there, too?
7. And we wouldn’t even collect all that money. Economists Emmanuel Saez and Jeffrey Liebman — no conservatives — concluded that, due to income shifting and behavioral responses, we’d collect less than 60% of what static projections claim.
8. Using more aggressive but still reasonable assumptions regarding economic behavior, such as from Harvard’s Marty Feldstein, net revenue gains would essentially be zero.
9. And to the degree we did raise extra money, Congress would spend it — it’s not going to be there to pay the bills in the future.