Under the present system, workers' earnings are subject to a payroll tax of 6.2% of their earnings (up to $84,900 in 2002) which is matched by their employers under the Federal Insurance Contribution Act (FICA) for total contribution of 12.4%. (An additional tax is paid for Hospital Insurance.) These payroll taxes are collected by the IRS and deposited in what is commonly called the Social Security Trust Fund, OASDI (a combination of the Old-Age and Survivors' Insurance (OASI) and Disability (DI) funds.) Of the 12.4%, 10.6% is deposited in the OASI account and 1.8% in the DI account. The Trust Fund is effectively a portfolio of Government Securities which earns interest at around 5% or 6% per year. In the year 2001, the Trust Fund collected $516.4 billion in payroll taxes, $72.9 billion in interest and $12.7 billion in income taxes on Social Security benefits, for a total of $602 billion. Expenditures were $438.9 billion, mostly in benefits ($431.9 billion). The Trust Fund increased in value by $163.1 billion.
Covered workers who have worked the number of years required to become eligible are paid a pension upon reaching the required age. Initial benefits for retirees are determined by a wage index (prescribed by law) which favors workers with low career earnings. The index is adjusted each year to reflect changes in economy-wide wages and, once retired, benefits are adjusted annually to reflect changes in the Consumer Price Index (CPI). It is a defined benefits retirement system as opposed to a defined contribution system. Today's retiree benefits are paid out of the FICA contributions of today's workers. It is a pay-as-you-go system as opposed to an investment system. When FICA contributions exceed the benefits paid in any year, the balance in the trust fund is increased. When benefits exceed FICA contributions, the balance is decreased. In addition to favoring workers with low career earnings, the system also favors married couples with only one wage earner. Spouses of retired workers also receive a pension, and survivors of covered workers or retirees are eligible for benefits upon the covered person's death.
When the Social Security system was established in 1935, the payroll tax was 1% of earnings up to $3,000, making the maximum employee contribution $30 per year. The maximum contribution did not reach $100 until 1959. The obvious purpose of the system at that time was to provide income to a relatively small number of impoverished older Americans and their survivors in a time of high unemployment and depression, as the name Old Age and Survivors Insurance implies. It has grown to the point where the maximum employee contribution is over $5,000, and benefits are paid to about forty million older Americans. More than 60% of these retirees rely on Social Security for more than half their income. It has grown from an insurance program for a few, to the primary source of income for a large number of American retirees. FICA contributions to OASDI constitute the greatest source of federal tax revenue after the income tax, $602 billion in 2001. As those who would privatize the system point out, it is a large drain on the economy and greater than it need be to fund the benefits provided.
Projections of the expected performance of the Social Security system over the next thirty eight years as reported in the 2002 Annual report of the Social Security and Medicare Board of Trustees (Table 14) are shown in Figure 1. Projections are based on Intermediate Cost Assumptions and are given in current dollars. The annual income to the Trust Fund (excluding interest) is expected to exceed the cost of benefits until 2016. After that, benefits will have to be paid out of the trust fund, effectively cashing in the bonds. The trust fund is expected to be depleted by 2040. After that, the Social System, in its present form, would not be able to support itself and general revenues would have to be used to pay benefits. This situation is attributed primarily to the fact that the ratio of number of workers paying payroll taxes to the number of retirees is decreasing. It is also affected by the rates of increase in the wage index and the CPI. The wage index is expected to increase at the rate of 4.25% per year and the CPI at a rate of 3.0% per year after 2005. The magnitude of the problem is shown clearly by Figure 1. The system simply cannot survive without major reforms.