Social Security crisis? Not if wealthy pay their way

Is Social Security headed for a crisis sooner than thought? Although President Bush says so, not everyone agrees. The system's trustees estimate the Social Security trust fund is in good shape for another four decades. The nonpartisan Congressional Budget Office figures five decades. Many independent economists think Social Security is healthy for more like six or seven decades.

But there's a vocal contingent that thinks Social Security has much more urgent problems. For years, Social Security has been amassing surpluses that the system's trustees use to accumulate Treasury bonds in its trust fund.

But as the baby boomers begin to retire, they're going to have to start selling those bonds back to the federal government in order to raise money to pay benefits. This could happen as soon as 2018, little more than a decade away.

To some people, this looks like a shell game, one branch of the government merely redeeming IOUs from another branch. Sen. Wayne Allard (R) of Colorado, for example, told constituents recently, "The money is spent. I don't believe, in my own opinion, we'll be able to raise the funds to pay it back."

This statement betrays a fundamental misunderstanding of how Social Security works. Unlike ordinary government functions, Social Security is funded by its own tax, the payroll tax. In 1983, at a time when Social Security was genuinely facing a crisis - it was mere months away from failing at the time - a commission appointed by President Reagan and headed by Alan Greenspan proposed a series of fixes. Among other things, the Greenspan commission recommended increasing payroll taxes.

But there was a twist: Knowing that the baby boomers would begin retiring around 2010, Mr. Greenspan recommended raising payroll taxes by much more than was needed to pay benefits at the time. The surplus would be used to buy Treasury bonds, which could be redeemed when the boomers retired and payroll taxes were no longer sufficient to fully fund retirement benefits.

This is where the second twist comes in. Because the surplus payroll taxes were handed over to the federal government (in return for Treasury bonds), this meant ordinary income taxes could be kept low. After all, the federal government has a fixed need for money, and if it gets excess money from payroll taxes it can afford to keep income taxes lower than they'd otherwise be.

But the payroll tax is a flat tax, paid disproportionately by low and middle income workers. The income tax is a progressive tax and is paid disproportionately by high earners.

So this was the implicit bargain in the reforms recommended by Greenspan and signed into law by Reagan: From 1983 to 2018, low- and middle-income earners would pay excess payroll taxes. This allowed income taxes to be kept low, and primarily benefited high earners.

Then, beginning in 2018, instead of raising payroll taxes to pay for baby-boomer retirement benefits, Social Security would begin selling its bonds back to the government.

To pay for those bonds, income taxes would be raised - high earners would begin paying higher income taxes.

In other words, the fact that income taxes will eventually need to be increased in order to cover Social Security benefits was part of the Greenspan/Reagan plan from the start.

That's the real meaning of the trust fund: It's an implicit promise that high earners will keep their part of the bargain and begin paying their share of Social Security's costs when the baby boomers retire.

So to suggest, as Senator Allard and others sometimes do, that the trust fund is just a bunch of meaningless IOUs that will never be paid back is more than just a breach of faith between generations. It's a breach of faith among taxpayers.

For more than two decades, low- and middle-income Americans have kept their part of the bargain, paying more in payroll taxes than Social Security needs and helping to keep income taxes low. In return, beginning in 2018, high earners are expected to start paying a bit more in income taxes in order to help keep payroll taxes low.

That's the bargain that was struck in 1983. It's one we should keep.

• Kevin Drum is a writer for the Washington Monthly.