Social Security: A Brief History

When Social Security was created in 1935, the average life expectancy was under the retirement age of 65. This fact ensured that comparatively few people would receive Social Security benefits and so the payroll taxes to support them were low (two percent on an annual income of $3,000, or $60 per year).

Ida Fuller was the first person to receive Social Security benefits. She retired in 1940 after paying only $44 into the system, and by the time of her death in 1975 at age 100, she had received $21,000 in benefits. Her case shows the inherent unfairness of the pay-as-you-go nature of Social Security: A savings of $44 cannot possibly pay $21,000 in benefits over 35 years, so her benefits were actually paid by taxes collected from younger workers.

Ostensibly, a trust fund collects Social Security payroll taxes from employees and employers. In reality, however, the fund is used to pay benefits to current retirees. The money is not saved or invested for the retirement benefits of each contributor. The trust fund is simply an accounting fiction, not the equivalent of a private account owned by an individual which can be invested for the future. A big first step in building support for change is broad public understanding of the pay-as-you-go design of Social Security versus accounts owned by each person.

Since the 1940s, significant shifts in birth rates and life expectancies have occurred. At the outset of Social Security, there were 16 workers paying into the system for every retiree drawing benefits. Today, the ratio is three workers for every retiree and by 2030 the ratio will fall to two workers per Social Security beneficiary, according to government estimates. At the same time, retirees are living longer than ever (average life expectancy now exceeds 75): This fact is a key reason why greater retirement resources are needed for current and future retirees.

Over the past 60 years, Congress has raised Social Security payroll taxes repeatedly in an effort to keep the benefits flowing. The current tax rate of 6.2 percent for both the employer and employee is applied to wages up to $68,400 and marks an amazing 950 percent increase from the initial $60 per year paid to Social Security by employers and employees.

Of that 6.2 percent, 0.94 percent goes toward survivor benefits in the case of death and disability benefits for people unable to work. The remaining 5.26 percent is applied primarily toward retirement benefits for current retirees. An additional uncapped 1.45-percent payroll tax is also levied for Medicare, but this report’s focus is on Social Security retirement benefits only.

Today, the Social Security trust fund is theoretically in surplus and will continue to be until about 2015—"theoretically" because all excess money above what is needed to pay benefits to current retirees is immediately borrowed for other government spending.

The real crisis will begin after 2015, when Social Security benefit payments will exceed the amount of money workers pay into the system and large numbers of baby boomers begin to retire. Changes must be made now to keep the current system from going bankrupt and leaving today’s workers and tomorrow’s retirees both out in the cold.

The problem of Social Security’s looming bankruptcy is serious. A number of proposals for "saving" Social Security have been made, many of which argue that taxes must be raised sharply on younger workers or else benefits cut to retirees. But fortunately there is a positive alternative to higher taxes and decreased benefits: opting out.