‘Entitlements’ misunderstood

We are now hurtling toward the so-called fiscal cliff, a package of automatic tax increases and spending cuts for 2013 designed to stampede Congress and the president into a “grand bargain” on deficit reduction, to include new revenues (translation: taxes) and entitlement reforms (translation: cuts to Medicare and Social Security).

Social Security constitutes roughly 20 percent of the federal budget. Deficit hawks insist that the U.S. cannot afford benefits at the current level. They are wrong. Most middle-class Americans, now and in the future, will depend on Social Security for a dignified retirement.

We should take Social Security off the table in this debate.

For a familiar program, Social Security is surprisingly misunderstood. Those who think the program primarily benefits the poor should know that it is actually a public pension plan for the middle class, tied to work. Workers (and employers) contribute a substantial percentage of wages and salaries – 12.4 percent (except during the current payroll tax “holiday”) – throughout their working lives to cover benefits in their retirement years. Even the poorest workers pay this tax, no matter how little they earn. Those who don’t work (or are not dependents of a worker) can’t collect.

The word “entitlement” is often thrown around like a slur these days, but the fact is, retirees are indeed entitled to their benefits.

Although Social Security does not mainly help poor people, it is also the case that no one is getting rich from it. The benefits are modest; the median annual amount in 2010 was $15,701. The median income for retirees over 65 was $25,767, lower than for those still working. (There was a time when benefits significantly exceeded contributions, but that is no longer true.)

Social Security payments are particularly valuable, though, because they are backed by the full faith and credit of the U.S. government.

This brings us to the most misunderstood feature of Social Security, the Trust Fund. Social Security is often described as a pay-as-you-go system, with taxes from current workers going to pay benefits of today’s retirees. Conservatives conclude that since the ratio of workers to beneficiaries will decline as we boomers retire, benefit payments must be reduced.

That argument fails to take account of the Trust Fund. To deal with the projected retirement of the huge baby boomer generation, in 1983 Congress raised the payroll tax and gradually extended the retirement age for boomers from 65 to 67.

The extra revenue was not needed for 1980s retirees; it was set aside to fund the boomers’ retirement – in the Trust Fund. Perhaps critics think the surplus should have been stashed in a vault at Fort Knox. Instead, of course, the money was saved as all money is saved in a modern economy: the trustees invested it in safe financial assets, U.S. Treasuries, to generate interest until the principal was needed.

Conservatives claim that the Trust Fund is a fiction – that the Social Security surplus was spent, not lent. That is wrong. The government borrows from the Trust Fund just as it borrows from China. If these bonds are not redeemed or rolled over when they come due, the U.S. will default. Any other result would be a betrayal of President Ronald Reagan, Congress, and millions of boomers who paid trillions of dollars in extra taxes over four decades to secure a dignified retirement.

Despite widespread skepticism among the young about the future of Social Security, the program is more important now than ever.

Years ago, retirement security was said to rest on a three-legged stool: Social Security, private pensions and personal savings. However, since the 1980s, most employers have switched from defined benefit plans, in which employers guaranteed qualified retirees a monthly payment for life, to much cheaper 401(k) or defined contribution plans, which allow employees to set aside some earnings in a tax-sheltered retirement account. The employer may match part of the employee’s contribution – or not. So today, savings and pension have become, for most, a single leg of a far more rickety two-legged stool.

Now, workers must save extra to cushion themselves against longevity risk – outliving their money – as well as financial risk from a potential stock market downturn when they retire.

Yet, with median income stagnant over the past 30 years despite the rising cost of housing, education and health care, it is difficult for many to save such large sums. That is why Social Security, which guarantees stable payments for life, is so valuable and must be protected.

The Trust Fund is expected to run out in 2035, and Congress should make provision for the out years, as it did in 1983 for the boomers.

But Social Security did not cause the federal deficit and should not be part of any “grand bargain” to fix it.