Old Age, Survivors and Disability Insurance — better known as Social Security — is the largest and most popular government program aimed at reducing poverty.

At about $1.047 trillion for Fiscal Year 2019, it makes up 23% of all federal outlays and would equal 5.26% of the total value of goods and services produced in the nation in a year. Yet because it is a transfer payment to individuals, its outlays are not part of Gross Domestic Product in the way that federal spending on highways, the National Weather Service or the U.S. Navy are.

The program has reduced poverty and increased economic efficiency. But despite its size and popularity, it is very poorly understood by the American people and even by many members of Congress.

Social Security’s formula provides higher benefits relative to taxes paid for low-income people and tapers to lower benefits relative to taxes paid for higher-income people. Thus, there is no single “return” to taxes paid and there is income redistribution from higher-income to low-income people. The idea that we are just getting back in retirement what we paid during our working years is a myth that many have come to believe. But it’s not true.

However, the tax structure itself, both in rate and in the level of income subject to tax, has changed repeatedly and irregularly within the lifetime of people now in the system.

Consider someone now 96 years old, born in 1923 and working from age 18 in 1941 to age 65 in 1988. A second person, now 66, was born in 1953 and worked from age 18 in 1971 until retirement this year. A third person, right in the middle at age 81 was born in 1938 and worked from age 18 in 1956 until retirement at age 65 in 2003.

The first 20 years the oldest person worked had an average FICA rate of 1.56% with an equal sum from her employer. The average limit subject to tax was $3,600. The most that could have been paid to the Treasury per year, employee and employer combined was $60 in 1941 growing to $264 in 1961.

The first 20 years the youngest person worked had an average FICA rate of 4.77% with an equal sum from her employer. The average limit subject to tax was $29,138. The highest amount possibly paid in per year was $5,981.

For the first two decades of the middle worker, the average FICA rate was 3.33%, average maximum subject to tax $7,286 and maximum annual tax ever payable of $1,339.

One can see that even if all three current beneficiaries had the same earnings, adjusted by either a consumer price or the average earnings index used by Social Security, they would have faced very different levels of taxation because they were born in different years. The low FICA rates and low covered earnings caps faced by pre-baby boomers meant that total amounts paid in were very small compared to eventual benefits received. If one looks at the last decades of these same people’s lives instead of the first, the differences are less stark, but remain substantial.

Rates essentially have been the same since 1984, while covered earnings have ratcheted up with the earnings index. So people age 52 and younger have faced pretty much the same tax parameters over their whole post-secondary lives. But those who are older, including me, born in 1950, had lower levels of tax over part of our work life. And the very old paid in very little.

The upshot is that over the whole life of Social Security, the majority of recipients got substantially more than they paid in. This was especially true for those retiring in the mid-1970s who had faced very low tax rates, but benefited from the higher benefits formulas.

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It is a tragedy of U.S. public policy that no overall strategy or philosophy for long-term funding of Social Security was written into the 1935 act. But the clear intent was that each age cohort should roughly pay for its own benefits.

It was an insurance plan and there would be differences in returns to different individuals. All the taxes paid by a someone who died at age 60 would go to others. Someone who lived to 95 would get paid much by others. But, overall, any birth group of people would pay taxes to generate an equivalent actuarial amount of lifetime benefits.

This general understanding was not written into the law.

Conservative critics charge that the old-age component of Social Security is a Ponzi scheme based on many new entrants paying in so that a smaller number of people going out can get unsustainably high benefits. This is incorrect as to the intent of the framers, but has an element of truth in terms of effects. The “trust funds,” earmarked accounts in the U.S. Treasury, into which FICA nominally flowed, acted as simple checking accounts for decades. The system was on a pay-as-you-go basis. Current taxes went out to current beneficiaries.

Giving increases in the 1950s into the 1970s was fine as long as there was cash in the account. Only a handful of economists, actuaries and members of Congress worried then about the longer term. The rush of baby boomers entering the work force and paying FICA from the mid-1960s to the mid-1980s made cash flow easier. But there was enough concern that President Ronald Reagan appointed a high-level commission, headed by Alan Greenspan, to recommend measures to put funding on a sound basis over the long term. 

The commission made a good faith effort that depended on responsible action by Congress over decades. It also assumed that any increases in national income would be divided between economic classes. Neither assumption proved true, so it failed.

As a result, while working people now pay higher FICA, the system still depends on transfers of money from younger people. The inequities in the system could be lessened if we addressed the problem. Amid population-trend changes, tax-rate changes, employment-trend changes and a burgeoning retirement class, it gets progressively harder. So generational unfairness accumulates.

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St. Paul economist and writer Edward Lotterman can be reached at bismarck@edlotterman.com.