Social Security Funds and the Payroll Tax Cuts

by Veronique de Rugy

Allan Sloan, editor-at-large of Fortune magazine, had a good piece in the Washington Post on Monday about how the cut in payroll taxes exposed the Social Security trust funds for what they are: accounts with IOUs, some of them even made of thin air.

There is currently some $2.5 trillion in IOUs in the Social Security trust funds. Since the 1980s, all the extra payroll taxes collected supposedly for future benefits were by law used to buy U.S. Treasuries, hence the IOUs. The problem, of course, is that when the trust funds run out of cash flow in 2015, the Social Security Administration will want its money pack to pay for benefits, but Treasury doesn’t have this money anymore. Treasury will have to borrow money or tax us to pay back the program. Now, Sloan explains what the implications will be for the trust funds after the payroll-tax cut, which in theory should create a shortfall in tax collection. His answer: on paper, nothing.

Let me show you how this works. Next year, as you probably know, workers subject to Social Security taxes will pay only 4.2 percent of their “covered wages” -wages up to $106,800 – rather than the normal 6.2 percent. This will reduce Social Security’s cash proceeds by $112 billion, according to Congress’ Joint Committee on Taxation.

What impact will this cash shortfall have on the Social Security trust fund? None. Zero. Zip.

How can a $112 billion cut in Social Security revenues not affect the trust fund? Because Treasury will give the trust fund the same amount of bonds it would have gotten had the two-percentage-point tax holiday didn’t exist.

In other words, Treasury isn’t selling bonds to Social Security, it is creating them out of thin air and putting them into the trust fund. The missing cash? Uncle Sam will just borrow $112 billion from somewhere.

As Sloan explains well in this piece, the payroll-tax cut and the way it is handled by Treasury exposes the total mirage that is the trust funds. I have raised the issue many times, for instance here.